As we summarized in a recent Financial Services & Insolvency Communiqué, Saskatchewan has introduced Bill 151 (the Bill) which amends The Personal Property Security Act, 1993 (Saskatchewan) (the PPSA or the Act). Over the coming weeks our Saskatchewan Financial Services team will bring you a number of posts to inform you about the upcoming changes and how they may impact you.
This post will focus on amendments to the PPSA’s rules for purchase-money security interests (PMSIs). Broadly, the PMSI amendments entail three main changes:
- new rules regarding cross-collateralization in the context of purchase-money financing arrangements involving inventory;
- PMSI status to continue through refinancing, whether a refinancing by the original lender or a new third party lender; and
- how payments to a specific creditor are to be allocated where not already stipulated by the parties, such that obligations secured by a PMSI would be the last loans to which payments would be allocated.
We will discuss each of these amendments in more detail below.
PMSIs and Cross-Collateralization
Bill 151 introduces amendments to address cross-collateralization where a secured party provides purchase money inventory financing involving a series of transactions with the same debtor. This could arise in a floor plan financing of large whole goods inventory, where payments are generally tracked piece by piece, or it may be a supplier of smaller inventory, such as parts or retail inventory, where it’s much more difficult to allocate payments to particular contracts or purchase orders.
One problem the amendments are meant to tackle is the extensive bookkeeping currently required by a secured inventory lender to keep track of which payments relate to which particular pieces of inventory and to track payments that discharge particular purchase money debt. Thus, this amendment is aimed at increasing efficiency and certainty in inventory financing relationships.
Under the amendments, there will be new sections 2(5) and 2(6) in the PPSA. Section 2(5) will provide that a PMSI in inventory will secure all obligations arising from related transactions creating a PMSI and it will extend to other inventory in which the secured party holds or held a security interest pursuant to a related transaction. Section 2(6) then defines related transactions as being where the possibility for both transactions is provided for in both transactions or an agreement between the parties entered into before the first transaction. A floor plan financing agreement should easily meet the test for creating a related transaction, but less formal arrangements could also meet the test, such as where an oral agreement exists that there will be financing pursuant to a series of purchase orders.
This should simplify accounting requirements greatly for inventory lenders, and perhaps even their borrowers, as it will be clear that so long as the related transactions test is met, it will not be necessary to track specific payments to specific inventory.
For other creditors who might be seeking an avenue to claim priority against an inventory lender, the amendments will make that more difficult. In the past there have been examples of non-PMSI creditors challenging the priority of inventory financiers on the basis that certain inventory had been paid for and thus was free of the PMSI priority. If the inventory lender can establish that the inventory was all supplied under related transactions, it will have PMSI status on all the inventory financed or supplied by it, irrespective of what payments it has received. The non-PMSI secured party may have nothing left to argue if the inventory lender has registered properly to attain PMSI status and meets the related transactions test.
Effect of Refinancing on PMSIs
It is common for debtors to consolidate their loans with their existing lender or to refinance through a new lender. Where such consolidation or refinancing involves PMSI security interests, the question arises as to whether the refinancing lender acquires the PMSI security interest in the collateral.
For some other provinces, this may be a new concept but it has been the law in Saskatchewan for nearly 20 years as a result of the court decision in Battlefords Credit Union Limited v. Ilnicki, [1991] 5 WWR 673 (Sask. C.A.) (Ilnicki). Ilnicki held (in the context of debtor protection legislation, as we will discuss below) that a lender who lends money to a debtor for the purpose of enabling that debtor to reduce or eliminate an existing security interest in the debtor‘s personal property has given value for the purpose of enabling the debtor to acquire rights in the property. When the financing pays out a loan secured by a PMSI, the new lender obtains a PMSI in the collateral.
Where the same lender refinances, the continuation of the PMSI status will be automatic. Where a new secured party is lending to pay out the debt owed to a prior PMSI lender, there are two methods where the PMSI status may continue: (a) the first lender may assign its security to the new lender, though that will not be common, or (b) the new rules will deem the assignment of the PMSI status to the refinancing secured party.
Note that where the new lender is relying on the deeming provision, it is crucial for that lender to register its security interest before the original lender discharges its registration. That is normal commercial practice, but still critically important.
Thus, Bill 151 is largely enshrining into the PPSA what has long been the law in Saskatchewan pursuant to Ilnicki. As is often the case where Saskatchewan leads the way in modernizing PPSA rules, we expect that other PPSA provinces will likely follow suit, to provide more certainty for lenders in debt consolidation or refinancing situations involving PMSIs.
Restrictions in Saskatchewan on Ability to Sue Debtors for Deficiency After Realization
We mentioned above that Ilnicki actually arose in the context of debtor protection legislation. Saskatchewan laws limit the ability of certain PMSI lenders to sue for deficiency where the proceeds of sale of the collateral are insufficient to retire the debt. As a result, there are times when it is not necessarily desirable for a lender to have PMSI status in Saskatchewan, at least if the lender has registered first or by serial number and would otherwise have priority.
Lenders familiar with Saskatchewan laws are likely aware of the debtor protection legislation in this Province. Both in the farm context, through section 46(2) of The Saskatchewan Farm Security Act (the SFSA), and the non-farm context, through section 18 of The Limitation of Civil Rights Act (Saskatchewan) (the LCRA), restrictions exist on a vendor’s right to sue the debtor for the purchase price or the deficiency where the vendor holds a PMSI. Those provisions in the SFSA and the LCRA restrict the vendor’s right to recover the unpaid purchase money on an article sold to the vendor’s lien on the article and the vendor’s right to repossess and sell only. Note that corporate debtors may waive the LCRA protections, but individual debtors cannot.
Notwithstanding Ilnicki, the “seize only” restrictions do not apply to all PMSI lenders. It is important to understand that these restrictions apply to vendors and not pure lenders where the lender has provided purchase money financing to a debtor to enable the debtor to purchase the collateral, though they will apply to lessors who have “financed” through what are commonly referred to as security leases. That distinction has been made in the past by Saskatchewan Courts and recently confirmed in Richardson International Limited v. Richardson International Limited, 2017 SKQB 332 (Wyllychuk). In Wyllychuk, the Court confirmed that where the lender is purely a lender and not a “vendor”, the restrictions of section 46(2) of the SFSA do not apply to it even where the lender has PMSI status by virtue of having taken an assignment from a prior lender with PMSI status. In Wyllychuk, Rabobank had provided financing as a lender to the debtor concerning the farm equipment collateral that the debtor purchased from Richardson. Rabobank then assigned the loan and security to Richardson and what the Court was looking at was Richardson’s status by virtue of the assignment of Rabobank’s rights. The Court held that Rabobank was a lender and Richardson had acquired Rabobank’s rights under the assignment as a lender and not a vendor and was, therefore, not limited by the SFSA to sue for deficiency.
While the amendments do not affect Wyllychuk, we have included this discussion to ensure that lenders doing business in Saskatchewan are aware of our debtor-protection rules and how they may apply. Lenders engaged in refinancing will want to structure their agreements so that they are not characterized as vendors, to ensure that their PMSI status will not restrict them from suing the debtor for the obligations or any deficiency on the obligations after enforcing the security. A lender who can be characterized as a vendor (which may include a lessor under a security lease) will be at greater risk of being precluded from pursuing a deficiency.
Allocation of Payments
The third amendment relates to allocation of payments to a PMSI secured party. This applies only where the parties have not agreed in advance to how payments would be applied, or where the debtor has not specified how the payments will be applied. In those situations, the prior agreement or instructions will govern.
Under the amendment, where there is no such prior agreement or instructions by the debtor, payments to a PMSI lender that also has non-PMSI debt, and even unsecured debt, will be applied in the following order:
- to unsecured debt;
- then to secured debt that is not subject to a PMSI; and
- then to PMSI debt.
As discussed in the very informative report to the Canadian Conference on Personal Property Security Law on Proposals for Changes to the Personal Property Security Acts, which we have referred to in other posts on Bill 151, this proposed order of allocation varies from the U.S. approach, which would apply payments first to unsecured debt, second to PMSI debt and third to non-PMSI secured debt. In situations where the lender and debtor do not have a prior agreement for the allocation of payments, these amendments give lenders more certainty that payments received by the debtor will not jeopardize their PMSI status where non-PMSI obligations exist.
Conclusion
The PMSI amendments do not represent the most significant changes introduced by Bill 151, particularly in Saskatchewan where Ilnicki provided for PMSI status to flow through refinancings. Nonetheless, it will be important for secured parties to understand these new rules. In particular, secured parties engaged in refinancing debt of another PMSI lender will need to ensure that they register early to qualify under the deeming provision. The amendments simplifying accounting requirements for inventory financiers should represent a very welcome change for those lenders.
