Secured Lenders’ Priorities and Unknown Transferred Assets: The Lisec America Case

February 23rd, 2016 by Alexandra Tratnik

By Alexandra Tratnik Ivan Merrow

Innocent creditors face indeterminate risk even when taking security in collateral in accordance with the Personal Property Security Act, RSO 1990, c P.10 (“PPSA”). One such risk arises in a situation where a debtor transfers the secured assets without the secured creditor’s knowledge or approval. That was the subject of the Ontario Court of Appeal decision in Lisec America Inc. v. Barber Suffolk Ltd., 2012 ONCA 37 .
Facts

This case involves a dispute between two secured creditors, Lisec America Inc. (“Lisec”) and Roynat Capital Inc. (“Roynat”), over which creditor held a prior perfected and first ranking security interest in a $1.4 million dollar waterjet cutting machine (the “Waterjet”).

Lisec sold the Waterjet to Barber Suffolk Ltd. (“Suffolk”) in exchange for a purchase money security interest (“PMSI”) in favour of Lisec.  Lisec simultaneously sold two additional pieces of equipment to Barber Glass Industries Inc. (“Glass”), a company related to Suffolk.  On the same day, unknown to Lisec at the time, Suffolk transferred its interest in the Waterjet to Glass.

Prior to the delivery of the Waterjet, Lisec perfected its security interest in the Waterjet by registering a financing statement against Suffolk and perfected its security interest in the additional two pieces of equipment by registering financing statements against Glass.

At the time of the delivery of the equipment, Glass was in need of additional financing and arranged same through Roynat.  Lisec agreed to discharge its PPSA registration against Glass on the understanding that Lisec would receive payment for the two pieces of equipment from the proceeds of the Roynat financing.  the In reliance upon that discharge, Roynat then advanced funds to Glass and registered a financing statement against Glass to perfect its security interest in Glass’s assetsincluding the Waterjet.

Approximately two years later, Glass went into receivership. At that time, Lisec discovered that Suffolk had sold the Waterjet to Glass. Accordingly, Lisec claimed a PMSI in the Waterjet and subsequently registered a financing statement showing Glass as the new debtor, within the 30 day time limit set out in s. 48(2) of the PPSA.

As the receiver was looking to sell the waterjet as part of the sale of Glass’s assets, Lisec applied to the Superior Court of Justice for a determination of its right and entitlement in the waterjet.  The application judge dismissed Lisec’s application and Lisec appealed the decision to the Ontario Court of Appeal.

Issues

The Court of Appeal bisected the case into two main issues:

  • Did the unknown transfer of the Waterjet affect Lisec’s registration against Suffolk?
  • What effect did Lisec’s discharge of the Glass registration have on Lisec’s PMSI in the Waterjet?

Result

(1) No, the unknown transfer did not affect Lisec’s registration against Suffolk.

The Court of Appeal agreed with the application judgment in finding that the unknown transfer of the Waterjet did not “unperfect” Lisec’s PMSI in the Waterjet as Lisec complied with PPSA s. 48(2), which required Lisec to register a financing change statement against Glass within 30 days upon learning of such transfer.

(2) Lisec’s discharge of the Glass registration had no effect on Lisec’s PMSI in the Waterjet.

The Court of Appeal parted ways with the application judge on this issue for two reasons:

  1. At no time did Glass grant Lisec a security interest in the waterjet via a general security agreement or other instrument that would have provided security over the Waterjet. Rather, Glass executed equipment purchase agreements granting security interests to Lisec only for the two other pieces of equipment.  As such, neither Lisec’s PPSA registration against Glass nor its discharge could have an impact on ss. 39[1] and 48(2) in maintaining the priority of Lisec’s PMSI in the waterjet.  The Glass PPSA registration was entirely unrelated to Lisec’s PMSI in the waterjet.
  1. The Court found that, in any event, the Lisec PPSA registration and subsequent discharge against Glass were irrelevant and were red herrings in the lower court’s analysis. Lisec’s PPSA registration against Suffolk is a stand-alone registration and was not dependent upon nor was it replaced by Lisec’s PPSA registration against Glass.  Even if the Lisec’s PPSA registration against Glass did cover Lisec’s security interest in the Waterjet (which it did not), the discharge of the Glass registration did not take with it the discharge of the Suffolk registration.  Simply put, as Lisec registered against the Waterjet first, and that registration remained in place and perfected at all material times, Lisec’s registration prevails over Roynat’s registration.

Conclusion

This case demonstrates the vulnerability of creditors in Roynat’s position.  Roynat, an innocent party in this case, had no real way of protecting itself from Lisec’s priority claim in these circumstances.  Roynat advanced funds and perfected its security interest in Glass’s collateral without knowing that Lisec claimed a security interest in that same collateral.  Indeed, Roynat had every reason to believe that Lisec did not hold security in the Waterjet, since Lisec discharged its PPSA registration against Glass at Roynat’s request.  There is little to nothing the Roynat could have done to avoid this result.

If you have questions regarding the Lisec America decision or any other questions regarding transfers of secured collateral or priorities among secured creditors in general, please contact the Commercial Recovery and Bankruptcy Insolvency teams at Devry Smith Frank LLP 1-416-449-1400.

[1] S. 39 of the PPSA provides that the rights of a debtor in collateral may be transferred voluntarily or involuntarily, but no transfer prejudices the rights of the secured party under the security agreement or otherwise.


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