Credit Suisse Canada v. 1133 Yonge Street Holdings Limited

Credit Suisse Canada v. 1133 Yonge Street Holdings Limited Collection Decisions of the Court of Appeal Date 1998-11-02 Docket numbers C24568 Judges McKinlay, Hilda Margaret; Weiler, Karen Merle Magnuson; Blair, Robert Ashley Subject Civil Decision Content DATE: 19981102 DOCKET: C24568 COURT OF APPEAL FOR ONTARIO McKINLAY AND WEILER JJ.A. AND BLAIR J. (ad hoc) BETWEEN: ) ) CREDIT SUISSE CANADA ) Catherine Francis ) for the appellant Applicant ) (Respondent) ) ) and ) ) David W. Kent 1133 YONGE STREET HOLDINGS LIMITED ) for the respondent and EUROMART MANAGEMENT GROUP LTD. ) ) Respondent ) (Appellant) ) Heard: October 5, 1998 ) BLAIR J. (ad hoc): [1] 1133 Yonge Street Holdings Limited appeals from the judgment of the Honourable Mr. Justice Day dated April 16, 1996.1 Day J. gave judgment declaring that the respondent, Credit Suisse Canada, holds a valid security interest in certain net rental proceeds paid to Holdings by commercial tenants at 1133 Yonge Street in Toronto. Day J. ordered that the proceeds (the "Surplus Funds"), which amount to approximately $550,000 plus interest, be paid to Credit Suisse. [2] Construction of the commercial premises at 1133 Yonge St. had been financed through a $7 million loan facility arranged between Holdings, as Borrower, and Credit Suisse, as Lender. The security interest in question B an Assignment of Leases and Rents granted to Credit Suisse by Holdings on January 2, 1987 (the "Assignment") B was one of several security instruments executed in connection with the loan transaction. The Assignment was duly registered under the Personal Property Security Act, R.S.O. 1980, c. 375 ("PPSA")2. [3] Under the Loan Commitment and the related security documentation, Holdings (the Borrower) was to make monthly payments of $60,000 to Credit Suisse (the Lender) and the Lender was to hold these payments in an interest bearing account and was to pay interest and principal payments out of that account. The Lender had the right to call for an increase in such monthly payments (although it never did). The excess funds in this account were called "the Cash Collateral Account", and were secured by a separate security interest in that account in favour of Credit Suisse. As well as this security, and the Assignment mentioned above, Credit Suisse also held a first collateral mortgage on the Property. [4] Under the Assignment, Holdings assigned to Credit Suisse the full benefit and advantage of all existing and future leases, including all rents. The Assignment was acknowledged to be an effective, present assignment. Paragraph 11 stated: 11. The Mortgagor (Holdings) acknowledges and agrees with the Mortgagee (Credit Suisse) that this assignment is an effective, present assignment, provided and it is expressly understood and agreed, anything herein contained to the contrary notwithstanding, that the Mortgagee shall not exercise any of the rights or powers herein conferred upon it until a default shall occur under the terms and provision of this assignment, the Commitment Letter or under the Mortgage. [5] Default under the Assignment was defined to include not only defaults of varying kinds under the Assignment itself, but also any default under the Property Mortgage or the Commitment Letter. [6] Paragraph 7 of the Assignment is of central importance to this proceeding. The pertinent part provides as follows: 7. Until notified to the contrary in writing, the Mortgagor shall be entitled to, and the lessee under any lease shall pay to the Mortgagor, all rents and other amounts then due under such lease and thereafter accruing. [Emphasis added.] [7] From the inception of the transaction until the end of November, 1994, all requisite payments of principal and interest were made. The parties operated on a pattern whereby all rents were paid into a separate account from which expenses (and monies required to freshen up the Cash Collateral Account) were paid, and the surpluses were then paid out to accounts for the benefit of Holdings or its Owners. [8] The Loan matured on November 30, 1994 without being paid. On December 1, 1994 Credit Suisse made written demand for payment and served notice of its intention to enforce its security, under s. 244(1) of the Bankruptcy and Insolvency Act, R.S.C. 1985, c. B- 3, as amended. The Loan has been in default since that date. [9] As at November 30, 1994, the approximate sum of $550,000 was deposited in accounts which could be traced from such net rental proceeds. The monies are held in trust either for Holdings or for its several Owners (as some payments have been made to shareholders who, in turn have given directions as to the funds). It is these amounts, plus interest, which are at issue on this appeal. A December 1994 Surplus of approximately $100,000 is no longer at issue, since it is conceded that it represented monies paid after default had occurred. [10] On the argument before Day J. much attention was paid to the question whether the concept of crystallization continues to apply to securities granted under the PPSA. Credit Suisse argued, as it does here, that crystallization has no application, and that their security interest B having attached and been perfected under the PPSA legislation B was fully enforceable, and, further, that the security extended not simply to the original collateral (the rents) but also to the proceeds of that collateral (its various traceable forms in other bank accounts). Day J. reviewed the law regarding the crystallization question and concluded, correctly, that the concept of crystallization is irrelevant under the PPSA regime. Appellate jurisprudence has confirmed the correctness of that decision: see, Canadian Imperial Bank of Commerce v. Otto Timm Enterprises Ltd. (1995), 26 O.R. (3d) 724 (C.A.); Royal Bank of Canada v. Sparrow Electric Corp. (1997), 143 D.L.R. (4th) 385 (S.C.C.). [11] Subsection 11(2) of the PPSA stipulates that attachment occurs under the Act when the three elements set out in that subsection have been satisfied "unless the parties have agreed to postpone the time for attachment". Having concluded that Credit Suisse had an attached and perfected security interest in the rents following registration of the Assignment on January 22, 1987, Day J. commented3 that in his view the portion of clause 7 of the Assignment which allows Holdings to deal with the rents until default was not sufficient to establish a contrary intention that attachment would take place at another time. He decided that Credit Suisse's statutory right to the rental proceeds existed "independently of any entitlement Holdings had to deal with the original rents"4. In speaking of an entitlement to deal with rents, it may be that Day J. also had in mind the language of subsection 25(1) of the PPSA, which was relied upon by counsel for Credit Suisse, too, and which states: s. 25(1) Where collateral gives rise to proceeds, the security interest therein, (a) continues as to the collateral, unless the secured party expressly or impliedly authorized the dealing with the collateral (emphasis added); and (b) extends to the proceeds. [12] In my respectful view, Day J. erred in coming to these conclusions. He misapprehended the combined effect of that portion of paragraph 7 of the Assignment cited above, and subsection 9(1) of the PPSA. Subsection 9(1) specifies: 9(1) Except as otherwise provided by this or any other Act, a security agreement is effective according to its terms between the parties to it and against third parties. [Emphasis added.] [13] By these provisions, the PPSA has preserved the principle of freedom of contract as between the parties in securities transactions, subject to any restrictions appearing in the PPSA itself or in other provincial legislation: see Ziegel and Denomme, The Personal Property Security Act; Commentary and Analysis (1994), pp. 104-105; Richard H. McLaren, The 1998 Ontario Personal Property Security Act (Carswell 1997), at p. 61. There is nothing to override the freedom of contract principle in the circumstances of this case. [14] Here, the parties have agreed by their contract that Holdings "shall be entitled to . . . the rents . . . due [under the Leases]", until notified to the contrary in writing, and that Credit Suisse "shall not exercise any of the rights or powers . . . conferred upon it until a default shall occur". The security agreement itself, therefore, not only entitles the Borrower, Holdings, to deal with the security prior to default B the rents are the "security" in question under the Assignment B but it entitles Holdings to the security prior to such event. [15] The word "entitlement" must be given its plain and ordinary meaning, namely, "to give a rightful claim", or "to give a right or legal title". Black's Law Dictionary, (West Publishing Co. 1979), for instance, contains the following definitions, at p. 477: Entitle. In its usual sense, to entitle is to give a right or legal title to. Entitlement. Right to benefits, income or property which may not be abridged without due process. [16] Jowitt, The Dictionary of English Law, (London: Street & Maxwell, 1959) says this with respect to "entitle" (p. 718): In its usual sense, to entitle is to give a right; therefore a person is said to be entitled to property when he has a right to it. [17] Thus, in my view, to be "effective in accordance with its terms" the Assignment is to be interpreted in a fashion which recognizes the right of Holdings B during the currency of the Loan term and provided that the Borrower is not in default B to take for its own use and benefit the net rental proceeds from the Leases. The effect of this is to discharge and release the Lender's security in such proceeds, i.e., with respect to that "collateral" and the "proceeds" of that collateral. The security is discharged, however, only with respect to those amounts which are paid over prior to default. It continues to be attached and enforceable under the PPSA, and "effective according to its terms between the parties". [18] Day J. concluded that because Credit Suisse had an attached and perfected security interest in the rents as at January 22, 1987, that security interest extended to the proceeds of those proceeds, and to successive generations of proceeds, by virtue of subsection 25(1)(b) of the PPSA, and that the Lender was entitled to claim the funds which constitute the Surplus provided the funds were identifiable or traceable as proceeds of the rents. In the end, he was satisfied that the funds could be traced, and he granted judgment accordingly. [19] The real question in these proceedings, however, is whether the Assignment by its terms enables the Lender retrospectively to reach the net rental proceeds paid to Holdings during the loan period but prior to default. For the reasons I have indicated, I do not think it does. While the security interest "attaches", within the meaning of the PPSA, its "effect" is to permit the Borrower to deal with the net rents for its own account until default occurs and it is "notified to the contrary in writing". In short, the security interest of the Lender, insofar as it attaches to the net rental proceeds, is released or discharged with respect to such proceeds once they are paid out to the Borrower in accordance with the terms of the agreement. Consequently, to the extent that the net rentals are discharged upon payment to the Borrower, the issue of whether attachment and perfection of the security causes the security to extend to the proceeds of the collateral B which is what subsection 25(1) is about B is not engaged, and the matter of identifying or tracing the proceeds does not arise. [20] Counsel for the respondent submitted that to interpret the Assignment in this fashion would be tantamount to re-introducing the concepts of the floating charge and crystallization to PPSA matters, contrary to what has recently been clarified in cases such as Royal Bank of Canada v. Sparrow Electric Corp., supra, and Canadian Imperial Bank of Commerce v. Otto Timm Enterprises, supra. I do not agree. It can be equally as misleading and confusing to suggest that a given security structure created by the parties should not be recognized because to do so would re- invoke the concepts of old forms of security. Such an argument B a sort of in terrorem response B runs the risk of precluding the legitimate creativity of parties to tailor their agreements to meet their particular circumstances. There is ample scope within the provisions of the PPSA to permit debtors to deal with collateral in various fashions B including dealing with it on their own account B notwithstanding that the creditor's security interest in the collateral has attached and been perfected. It is not the purpose of the PPSA to render security transactions inflexible or, indeed, to prevent the parties from agreeing to security structures which may well accomplish the same kind of protection that older forms of security B such as floating charges B seek to provide. The purpose of the PPSA is to establish and clarify priorities and notions of attachment and perfection which relate to the registration and operation of security instruments. What academics have suggested, and the courts have confirmed, is that attempts to interpret the PPSA and the regime it establishes in terms of the old forms of security are not helpful, and that those old forms and their concepts do not govern how the PPSA regime should unfold. Professor McLaren captures the tension between these two concepts in the following passage of his text, Secured Transactions in Personal Property in Canada, 2nd ed. (Carswell), at pp. 2-37 and 2-38: There is no historical need or justification for carrying the concept (i.e. the floating charge concept) forward into the Act. The Act has created a flexible single security interest which can meet the needs of the business community as they arise. It should not be burdened with a concept designed to serve the needs of the financial community of the nineteenth century. [Emphasis added.] [21] In each case, it is a matter of examining the terms of the security interest in question to determine what precisely are its terms as between the parties, because subsection 9(1) of the PPSA makes it clear that the security instrument is only effective in accordance with those terms. There is nothing which prevents commercial parties from negotiating terms which may, in practical terms, have similar commercial consequences to those encompassed in older forms of security. Such flexibility is required. [22] Indeed, to interpret the Assignment of Leases and Rents in this case in the fashion sought by the respondent might well lead to commercial instability, in my view. Debtors who are entitled under security instruments to take the collateral and deal with it as their own pending default or notification to the contrary B and who do so B should not be subjected to the risk and uncertainty of the funds representing the collateral or its proceeds being taken from them retrospectively at some time in the future in the event that such a default occurs or notification is given. Relying upon their right to utilize the funds, to take but one example, they might in turn have used those funds B assuming they are not otherwise encumbered B as security for other commercial transactions, or to purchase other identifiable assets. I do not think that such authorized transactions should be placed in jeopardy simply because of the happenstance that the funds or proceeds remain in some identifiable or traceable form and remain within the jurisdiction. The situation becomes even less tenable when, as here, the debtor pays out the funds to shareholders or other third parties but they, in turn, utilize the funds in a fashion in which they remain identifiable or traceable. [23] I do not mean to suggest by these remarks that the nature of a security instrument can be determined by the use which the debtor makes of the collateral. Collateral, or the proceeds of collateral, which the security instrument is "effective" to reach, continue to be caught by the security instrument and cannot be utilised by the debtor in a way that ignores the security interest. Where, as here, however, the debtor is entitled to the collateral itself, subject to certain events occurring, and where the parties conduct themselves over the period of the loan transaction in a fashion which acknowledges the debtor's right to use the funds representing the collateral on its own account, circumstances of great commercial ambivalence would exist if the lender were able at the end of the day to undo what had been done. At the very least, Credit Suisse is estopped from taking such a position in the circumstances of this case: PPSA, s. 72. [24] Accordingly, I would allow the appeal and vary the judgment of the Honourable Mr. Justice Day dated April 17, 1996, in that the Application of Credit Suisse Canada for a declaration that it holds a valid security interest in what is referred to therein as "the accrued surplus" is dismissed. The appellant is entitled to its costs of the appeal. As Credit Suisse remains partially successful on the Application, the declaration in its favour with respect to what is referred to as "the December Surplus" continues to stand. I would not interfere with the disposition as to costs on the Application. Released: November 2, 1998 _______________________________ 1(1996), 28 O.R. (3d) 670 2Now R.S.O. 1990, c. P.10. 3 28 O.R. (3d), at p. 685 4 Ibid., p. 685.