SCC Cleans Up Mess Caused by Archaic Legislation in Bank of Montreal v Innovation Credit Union

The pressing need to modernize the federal Bank Act, SC 1991, c 46 [Bank Act] was recently highlighted in the Supreme Court of Canada’s (“SCC”) decision in Bank of Montreal v Innovation Credit Union, [2010] 3 SCR 3. In this case, the SCC was forced to engage in legal acrobatics in order to remedy a legislative gap between the Saskatchewan The Personal Property Security Act, 1993, SS 1993, c P-6.2 [PPSA] and the Bank Act. The gap in question arose out of the Bank Act’s silence regarding priority disputes between a prior unregistered security interest taken under the PPSA and a subsequent registered security interest under the Bank Act, both of which have been granted in the same collateral. The Bank Act’s silence on this issue and the restriction on provinces enacting provisions that would affect the priority of a validly created federal security interest meant that the SCC had to fashion a remedy within the framework of the Bank Act that was consistent with constitutional principles.

Bank Engages in Tug-of-War with Credit Union

Unlike the applicable legislative framework, the facts of this case are quite straightforward. In October 1991, a debtor granted a security interest in his present and after-acquired personal property to Innovation Credit Union (“ICU”) pursuant to the PPSA, in exchange for a loan. The debtor subsequently obtained a loan from the Bank of Montreal (“BMO”), which was secured by granting a security interest in favour of BMO pursuant to the Bank Act. Since ICU had not registered its security interest until after BMO had obtained its security interest and the debtor did not inform BMO of the prior security interest, BMO was unaware of the extent of its financial risk. When the debtor defaulted on his bank loan, BMO seized some of the property subject to the Bank Act security. In turn, ICU brought an application pursuant to s. 66 of the PPSA seeking a declaration that it had priority over BMO.

At first blush, one familiar with the PPSA would speculate that BMO would win out over ICU because the latter did not perfect its security interest. As will be discussed later, the applications judge, Zarzeczny J., made the error of adopting that approach. According to Zarzeczny J., the priority rule specified in s. 428 of the Bank Act gave BMO priority over subsequently acquired priority rights.  The rule is that a Bank Act security interest has “priority over all rights subsequently acquired in, on or in respect of that property, and also over the claim of any unpaid vendor.” This approach was rejected by the Saskatchewan Court of Appeal and the SCC.

Legal Acrobatics: Using Provincial Property Law to Interpret Federal Law

Charron J., writing for the unanimous SCC, agreed with the Court of Appeal that the proper approach involved focusing on ss. 427(2) and 435(2) of the Bank Act. The relevant provisions are listed below:

s. 427(2)(c) Delivery of a document giving security on property to a bank under the authority of this section vests in the bank in respect of the property therein described…the following rights and powers, namely…the same rights and powers as if the bank had acquired a warehouse receipt or bill of lading in which that property was described.

s.435(2) Any warehouse receipt or bill of lading acquired by a bank under subsection (1) vests in the bank, from the date of the acquisition thereof, (a) all the right and title to the warehouse receipt or bill of lading and to the goods, wares and merchandise covered thereby of the previous holder or owner thereof; and (b) all the right and title to the goods, wares and merchandise mentioned therein of the person from whom the goods, wares and merchandise were received or acquired by the bank, if the warehouse receipt or bill of lading is made directly in favour of the bank, instead of to the previous holder or owner of the goods, wares and merchandise.

The combined effect of these two provisions is that the “bank can acquire no greater interest in the collateral than the debtor himself has at the relevant time.” To determine the interest that BMO acquired from the debtor, the SCC turned to provincial property law.

Since s. 428 of the Bank Act provides that a security interest granted under it has “priority over all rights subsequently acquired in, on or in respect of that property, and also over the claim of any unpaid vendor” [emphasis added], the SCC stated that the Bank Act is a “property-based” security regime. This regime is to be distinguished from that of the PPSA, which is a “priority-based approach.” Unlike a property-based approach, the regime under the PPSA “does not rely upon either the common law notion of title or the equitable concepts of beneficial interest or equity of redemption to resolve priority disputes.”

To determine what interest the debtor conveyed to BMO, the SCC resorted to provincial property law. This approach is consistent with constitutional principles because the provinces have jurisdiction to legislate on property and civil rights in the provinces. The rule established in Bank of Montreal v Hall, [1990] 1 SCR 121 that “Bank Act security provisions are valid federal legislation which cannot be subject to the operation of provincially enacted priority provisions…” was not contravened because the PPSA’s priority rules were not invoked to resolve this dispute. Instead, it was the Bank Act’s provisions which governed, notwithstanding its silence on the issue of a priority dispute between a prior unregistered security interest taken under the PPSA and a subsequent registered security interest under the Bank Act.

Application of provincial property law yielded the holding that the ICU security interest had priority. The relevant property law applied was the maxim of nemo dat quod non habet – no one can give what he does not have. A useful example was provided by the SCC:

Simply put, under this rule where A conveys legal title to property first to B and subsequent to C, legal title vests in B. Since A no longer has legal title to give to C, A cannot transfer title to C. Thus as between two competing legal interests in property, the nemo dat rule gives priority to the first party to take a legal interest in the property.

Under the circumstances, “A” would be the debtor, “B” would be ICU, and “C” would be BMO. When the debtor granted a security interest to BMO, ICU already had a proprietary interest in the collateral.

The Unsatisfactory Status Quo

The SCC acknowledged that its reasoning in this case may be unsatisfactory, particularly in regards to the fact that BMO did not know about the extent of its financial risk because ICU had not registered its interest. However, the SCC was unwilling to accept a first-to-register rule because of the difficulties that such a rule would create and the intrusion into the federal legislature’s powers. At paragraphs 53 and 61, Charron J. stated that it is exclusively within Parliament’s realm of powers to enact such a rule. Whether Parliament will and/or should exercise that power and remedy the mess that this archaic legislation has created is a matter that will have to be discussed in the future.