Creditors' Remedies against Debtors (10:III)

Prior to taking action against a debtor, the creditor must provide a reasonable time for payment on a demand loan or term loan. That time begins to run from the date of the demand for payment and not the date of the loan. What constitutes a reasonable demand period depends upon the facts of each case: see Redhawk Drilling Ltd. v TD Bank (1986), 49 Alta LR (2d) 38; Whonnock Industries v National Bank of Canada (1987), 16 BCLR (2d) 320, 42 DLR (4th) 163; Lister v Dunlop (Ronald Elwyn Lister Ltd vDunlop Canada Ltd), [1982] 1 SCR 726. For a list of factors to be considered see Mister Broadloom Corporation (1968) Ltd v Bank of Montreal (1979), 25 OR (2d) 198 (Ont HCJ). As a result of the recent passage of a revised Limitation Act in British Columbia the period for commencement of proceedings for the collection of a debt in B.C. is 2 years from the “date of discovery” of the claim. The date of discovery is defined as the day on which the claimant knew or ought reasonably to have known all of the following:

• a) That injury, loss or damage had occurred;
• b) That the injury, loss or damage was caused by or contributed to by an act or omission;
• c) That the act or omission was that of the person against whom the claim is or may be made;
• d) That, having regard to the nature of the injury, loss or damage, a court proceeding would be an appropriate means to seek to remedy the injury, loss or damage

If however, the cause of action occurred prior to the coming into force of the revised Limitation Act, the previous limitation periods remain in effect. Therefore, if the debtor’s acknowledgement in writing of the cause of action, or the last payment on the debt occurred prior to June 1, 2013, then the limitation period for the commencement of proceedings for the collection of debt is 6 years from that time.

NOTE: The limitation period does not apply to claims exempted under sections 3 or 7.

A. Secured Creditors

1. Definition

A secured creditor holds a lien, mortgage, or charge against the debtor’s assets or collateral as security for the repayment of the debt.

2. General Introduction to the PPSA

The Personal Property Security Act [PPSA] establishes a system for the registration, priority, and enforcement of secured loan and credit transactions involving personal property in B.C. Secured creditors holding agreements that create or provide for security interests (i.e. chattel mortgages and conditional sales agreements) must register these security agreements in order to “perfect” its interest and establish its priority vis-à-vis third parties.

For agreements that are subject to the PPSA, Part 5 of the PPSA outlines the creditor’s remedies (ss 56 - Rights and remedies, 57 - Collection of payments under intangibles or chattel paper, 58 – Right of seizure or repossession, and 67 - Rights and remedies: consumer goods). For agreements that involve fixtures, crops or accessions, ss 36 – 38 apply. In addition, Part 6 contains some sections (i.e. ss 68(2) - Good faith and commercially reasonable, and 72 - Notice) that are of procedural importance.

NOTE: These are examples of issues that may be encountered by clinicians while dealing with the PPSA. Remember that PPSA issues, particularly those involving priority disputes or matters relating to the transitional provisions, are complex and may have to be referred to a lawyer.

3. What Does the PPSA Govern?

The scope of the PPSA is defined in s 2 as including every transaction that in substance creates a security interest without regard to its form. As well, under s 3, a transaction involving either a transfer of an account or chattel paper, a commercial consignment, or a lease for a term of more than one year that does not secure payment or performance of an obligation (i.e. does not create a security interest) is subject to the PPSA. Section 55 provides that Part 5 does not apply to transactions brought within the PPSA by s 3. It is necessary to look to the terms and the common law.

NOTE: Section 4 lists types of transactions that are exempt from the PPSA. The PPSA does not apply to a “lien, charge or other interest given by a rule of law or an enactment unless the enactment contains an express provision that the PPSA applies”. Generally this excludes real property and natural resources.

a) Perfection

For a creditor’s interest in a good to be practically effective, s 35(1)(b) of the PPSA states that the interest must be “perfected”, whereby the creditor becomes a “secured” party. By virtue of s 19, a security interest must satisfy two conditions to be “perfected”:

• i) the security interest must have “attached” (see below); and
• ii) the secured party must ensure that “all steps required for perfection under this Act have been completed” (see below).

In general, attachment will ensure that the security interest is enforceable against the debtor, while perfection will protect the security interest against competing third party claims.

“Attachment”: Section 12 states that a security interest attaches to the good when:

• i) value is given;
• ii) the debtor has rights in the collateral; and
• iii) except for the purpose of enforcing rights between the parties to the security agreement, the security interest becomes enforceable under s 10 (unless the parties specifically agreed to postpone the time for attachment in which case the security interest will attach at the time specified in the agreement).

4. Methods of Perfection

• i) perfection by possession of collateral applies to all forms of security interests (s 24);

• ii) perfection by registration. Subject to s 19, registration of a financing statement perfects a security interest in collateral. (s 25); and

• iii) temporary perfection (ss 5(3), 7(3), 26, 28(3), 29(4) and 51).

5. Remedies

Where a debtor defaults on a security agreement, s 56 provides that the only rights and remedies the secured party has against the debtor are those provided in the security agreement (as long as they do not derogate those rights given to the debtor by the PPSA), as well as those specifically provided by the PPSA (s 17 and ss 36 – 38).

Important sections of the PPSA for the creditor are ss 58 and 59, which contain rules for seizing and disposing of collateral. These sections provide that, unless the security agreement states otherwise, where the debtor defaults on their payment, the creditor may elect to take possession of the collateral pursuant to the contract, dispose of the collateral and then sue for any amount still owing. Section 67, provides for a more limited set of remedies where the collateral takes the form of consumer goods – known as the “seize or sue” rule. Formerly, under legislation repealed by the PPSA, all creditors could only seize or sue but not both. The principle of “seize or sue” still applies to “consumer goods” (see Section II.A.6: Seizure, below); it no longer applies to commercial goods.

6. Seizure

Where the security interest does not involve fixtures, accessions, crops, or consumer goods, s 58 provides the fundamental rule for realization upon non-possessory security interest in tangible personal property: the secured party has a right to seize (in the case of a secured loan transaction) or to repossess (in the case of a secured credit sales transaction) the collateral. Upon seizing the collateral, s 17 defines the rights and obligations of secured parties in possession of collateral. The section imposes a standard of reasonable care on the secured party in possession of the collateral and the secured party must follow the notice provisions outlined in ss 59(6) – (12) before they are entitled to carry through with disposal.

7. Disposal of Collateral

After seizing collateral, the secured party under s 59(2) may dispose of it either in its present condition or after repairing it (though s 68(2) protects the debtor from incurring unnecessary expenses because all rights, etc., under the PPSA must be discharged “in good faith”). Further, s 59(3) provides that the secured party may dispose of the collateral by a private or public sale (either as a whole or in commercial units or parts) and, if the security agreement so provides, by lease. See also Section II.A.10: Voluntary Foreclosure.

Section 59(2) provides a priority scheme regarding application of the proceeds of sale: first, toward the reasonable expenses of seizing, repairing, etc.; second, toward the satisfaction of the obligations owed to the secured party; and last, if any surplus exists, to the satisfaction of obligations owed to persons holding a subordinate security interest, and then toward the debtor (s 60).

A person who buys an item from a disposal sale takes the good free and clear of the debtor, the secured party, and any subordinate creditors whether or not the secured party complied with the requirements of the section. In the case of a prior secured creditor’s interest, if the goods are “consumer goods” of a value less than $1,000 and the purchaser gave value for the goods, the purchaser takes them free of the prior secured creditor’s interest (see s 59(14)).

8. Notice of Intention to Dispose of Collateral

NOTE: The forms of notices under the PPSA depend on a number of factors, including the nature of the security and the terms of the security agreement. Advice concerning the validity of notices should be referred to a lawyer.

Subject to the circumstances where notice is not required as per s 59(17) (e.g. for perishable collateral, collateral requiring disproportionately high storage costs relative to its value, etc.), the requirements for notice are outlined in ss 59(6) and (10). These sections require that the secured party, or receiver, as the case may be, must provide at least 20 days’ notice of their intention to dispose of the collateral to parties including the debtor and any other creditor.

When a secured party is considering methods of disposal, they must give notice to the following parties (see s 59(6)):

• i) the debtor;
• ii) any other person who is known by the secured party as the owner of the collateral (where that is not the debtor);
• iii) any creditor or person with a security interest in the collateral whose interest is subordinate to the secured party, who registered a financing statement, or whose security interest is perfected by possession at the time of seizure or repossession of the collateral; and
• iv) any other person with an interest in the collateral who has given notice to the secured party of their interest in the collateral before the notice of disposition is given to the debtor.

The secured party is required to include specific information in the notice (see s 59(7)):

• i) a description of the collateral;
• ii) the amount required to satisfy the obligation secured by the security interest;
• iii) the arrears owing (exclusive of the operation of an acceleration clause);
• iv) the expenses associated with seizure and repossession; and
• v) the date, time and place of disposition.

In the case of a receiver attending to the disposition of the collateral, the receiver must give notice to (see s 59(10)):

• i) the debtor;
• ii) any other person known by the secured party to be an owner of the collateral;
• iii) any creditor with a security interest subordinate to that other secured party, who has either registered the financing statement, or who has perfected its security interest by possession at the time of the seizure or repossession of the collateral; and
• iv) any other person with an interest in the collateral who has notified the receiver of that interest in the collateral before the notice of disposition is given to the debtor.

The notice that the receiver must provide need contain only (see s 59(11)):

• i) a description of the collateral;
• ii) a statement that unless the collateral is redeemed it will be disposed of; and
• iii) the particulars relating to the place of disposition or where tenders may be delivered.

9. Surplus or Deficiency

When a secured party is left with a surplus after disposal of the collateral, it must be accounted for and paid to the parties in the order specified in s 60(2). If a dispute regarding entitlement arises, s 60(4) provides for the secured party to pay the secured funds into court, which gives those claiming entitlement the opportunity to make an application under s 70 for payment.

Under s 60(5), the debtor is responsible for any deficiency balance unless the secured party and the debtor have agreed otherwise and made provisionsas such in the security agreement.

NOTE: This section does not apply to consumer goods.

10. Voluntary Foreclosure

After default, a secured party may make a proposal to the debtor and other interested parties to take the collateral to satisfy obligations secured by it (s 61).

The debtor and other interested parties have 15 days to object to the secured party’s proposal. Failure to object is deemed to be an irrevocable election to forfeit all rights and interests in the good and entitles the secured party to retain the good.

If the debtor or other secured party provides notice of objection to the secured party within 15 days after the notice is given, the secured party must dispose of the collateral in accordance with the provisions of s 59. In such circumstances, the secured party may make an application to the court for an order that an objection to the secured party’s proposal is ineffective because:

• i) the objection was made for a purpose other than protecting an interest in the collateral or the proceeds of the disposition of the collateral; or
• ii) the market value of the collateral is less than the total amount owing to the secured party plus the costs of disposition.

11. Restrictions on Realization

a) Subordination of Unperfected Security Interests

Under s 20(a), an unperfected security interest is subordinate to the interest of:

• a person who causes the collateral to be seized under legal process to enforce a judgment (including execution, garnishment or attachment), or who has obtained a charging order or equitable execution affecting or relating to the collateral;
• a representative of a creditor enforcing the rights of a person referred to above; and
• a sheriff acting under the Creditor Assistance Act and any judgment creditor entitled to participate in the distribution of property under the Creditor Assistance Act.

Also, if an interest is unperfected at the date of the bankruptcy or winding-up, then that interest is not effective against a trustee in bankruptcy or a liquidator (Winding-up and Restructuring Act, RSC 1985, c 6).

In addition, ss 20(c), 30(3) and 31 confirm the subordination of the interest of a secured party to a bona fide purchaser for value under various circumstances.

b) Restriction on the Right to Accelerate a Term Debt

The security agreement may contain an “acceleration clause” that provides that the total amount owing becomes due upon default in payments or whenever the secured party has “commercially reasonable grounds” to believe that they may not be repaid or that the collateral is “in jeopardy”. If there is an acceleration clause in the security agreement, it may not be invoked unless this objective test of “commercially reasonable grounds” has been satisfied. A secured creditor has commercially reasonable grounds when they have a reasonable belief that there is a risk of non-payment. This could occur for a variety of reasons including the debtor fleeing the country, being hospitalized or illegal activity taking place on the premises. If the risk is not obvious the creditor must make commercially reasonable efforts to verify their suspicions. Commercially reasonable efforts do not mean best efforts.

c) Limitation of the Right of Seizure for Consumer Goods

For collateral that is a “consumer good”, where the debtor has paid at least two-thirds of the total amount secured, the creditor may not seize the good without first obtaining a court order (see Section II.A.12.a: Secured Party's Remedies).

d) Obligation While in Possession of Collateral

Section 17 of the PPSA imposes a standard of reasonable care on any secured party in possession of the collateral.

e) Rights of a Debtor

The PPSA preserves the debtor’s (but not the secured party’s) rights and remedies under other statutes that are not inconsistent with the PPSA as well as the specific rights and remedies provided in the security agreement, ss 17 and 56(2)(b).

f) Rights of Redemption and Reinstatement

Under s 62, a debtor has redemption rights. Any person entitled to notice of a pending disposition of collateral may “redeem” the collateral by tendering to the secured party fulfilment of the obligations secured by the collateral plus the reasonable expenses incurred by the secured party associated in seizing the collateral or otherwise preparing it for disposition. The aforementioned obligations may simply be the amount in arrears; however, it is more often the case that an acceleration clause applies, and that the obligations will be the total amount of the debt. Where the security agreement contains an acceleration clause, the debtor may apply to court for relief from the consequences of default or for an order staying enforcement of the security agreement’s acceleration provision.

Where the collateral is a “consumer good”, the calculation of the obligation secured and the obligation that must be tendered is varied. The debtor may “reinstate” the security agreement by paying only the monies actually in arrears – negating the operation of any acceleration clause. The debtor may waive this right but any such agreement must be in writing after default. Note that the number of times the debtor may reinstate the security agreement is limited depending on the period of time for repayment set out in the security agreement; however, the frequency of reinstatement may be varied by agreement between the parties.

12. Consumer Goods

a) Secured Party’s Remedies

Section 67(1) lists the options available to a secured party. The secured party may elect to pursue one of the following remedies:

• seize or repossess the goods (s 58);
• enact the voluntary foreclosure remedy (s 61) (discussed above);
• accept the surrender of the goods by the debtor; or
• start an action to recover a judgment against the debtor for the amount of the unpaid debt or unperformed obligations under the security agreement.

This is sometimes called the “seize or sue” rule.

If the debtor has paid at least two-thirds of the total amount of the secured obligation, the secured party may not seize the consumer good used as collateral (s 58(3)). However, the secured party may apply to court for an order that the “two-thirds rule” should not apply and the court will make a decision based on (s 58(4), (5)):

• the value of the collateral;
• the amount of the obligation that has been discharged;
• the reasons for default; and
• the current and future financial circumstances of the parties.

b) Disqualification from “Seize or Sue” and Leases

A secured party with a security interest in “consumer goods” may escape the seize or sue provisions when:

• the debtor has engaged in wilful or reckless acts or neglect that has caused substantial damage or deterioration to the goods; the secured party may seek a court order pursuant to s 67(8) disqualifying the debtor from the rights and remedies ordinarily available under s 67(1)-(5) (s 67(8)); or
• the secured party discovers after seizure that an accession that was collateral has been removed and not replaced by other goods of equivalent value and free from prior security interests, a claim may be advanced against the debtor for the value of the accession (s 67(8)).

NOTE: The “seize or sue” rule does not apply to “true leases” but will apply to “security leases” or “conditional sales agreements”. BC courts have been developing tests to distinguish between true leases and security leases. Disputes often arise over car leases. Clients should consult with a lawyer who is familiar with this area of law when trying to figure out whether their contract is a true lease or a security lease. If the lease is a true lease the creditor has the option to seize and sue; see Daimler Chrysler Services Canada Inc v Cameron, 2007 BCCA 144.

c) Consequences of Electing to Proceed Against Collateral

Under s 67(2), an election to proceed against the collateral results in the extinguishment of the debtor’s obligations under the security agreement or any related agreement (with the exception of land mortgages executed before July 1, 1973), thereby automatically releasing any guarantor or indemnitor of the obligations contained in the security agreement. However, ss 67(3) and 67(4) contain exceptions.

Since proceeding against the collateral precludes the creditor from recovering the deficiency of the debt, the creditor is well advised to collect as much of the debt as possible, from other sources prior to seizing the goods. Remember, however, that if the creditor collects 2/3 or more of the debt they lose the right to seize the goods.

d) Consequences of Electing to Sue

An election to sue results in the following consequences for the creditor:

• Under s 67(6), if the creditor gets a judgment against the debtor and seizes the collateral pursuant to a writ of seizure and sale, the right of recovery is limited to the gross amount realized from the sale of the collateral;
• Under s 67(10), commencement of proceedings against the debtor extinguishes the security interest of the creditor in the goods.

Therefore, the sale proceeds become subject to a bankruptcy stay; and the creditor may have to share the proceeds of the seizure and sale with other creditors as they will no longer have priority based on secured creditor status.

Exceptions include cases of fraud or cases where the stay is unjust. Where there is alleged fraud or the stay is unjust for other reasons, the creditor can apply to the court to have the stay removed against them specifically. Generally the stay is removed so that litigants can continue their litigation.