Berryland Canning Co. Ltd. et al. v. Toronto-Dominion Bank, [1972] SCR 259

Supreme Court of Canada

Berryland Canning Co. Ltd. et al. v. Toronto-Dominion Bank, [1972] S.C.R. 259

Date: 1971-05-31

Berryland Canning Company Limited et al. Appellants;

and

The Toronto-Dominion Bank Respondent;

and

R. Victor Barnett (Trustee)

and

Gourmet Sales Inc. (Debtor).

1971: February 5; 1971: May 31.

Present: Abbott, Martland, Judson, Ritchie and Pigeon JJ.

ON APPEAL FROM THE COURT OF QUEEN’S BENCH, APPEAL SIDE, PROVINCE OF QUEBEC

Banks and banking—Security—Assignment of inventory to secure advances—Loan to subsidiary company used to reduce indebtedness of parent company—Validity of security given by subsidiary—Appeal by unsecured creditors—Bank Act, 1966-67 (Can.), c. 87, ss. 88, 90—Bankruptcy Act, R.S.C. 1952, c. 14, s. 16.

The respondent bank made substantial advances to Bedford Foods Ltd., which were secured by an assignment of inventory in accordance with s. 88 of the Bank Act, 1966-67 (Can.), c. 87. In February 1965, the company was indebted to the bank in the amount of $900,000. In the fall of 1964, the bank realized that a portion of the inventory on which it had relied belonged to a wholly-owned subsidiary, Gourmet Sales Inc. It was ascertained that the subsidiary’s inventory was approximately $350,000 and the parent’s $750,000. Gourmet then executed documents in accordance with s. 88 and, on February 28, 1965, gave to the bank a note for $300,000 payable on demand. This was treated as a loan, credited to Gourmet’s account and withdrawn the following day by means of a certified cheque to the parent company for $300,000. This cheque was credited to the parent’s current account, then a debit of an equal amount was entered, and the indebtedness of the parent was reduced to $600,000. In August 1965, when Gourmet became bankrupt, the bank took possession of its inventory and disposed of it. The trustee in bankruptcy claimed the value of the goods on the basis that the security was invalid by virtue of s. 90 of the Bank Act. It was alleged that the security was not really taken for a new advance but for a part of an advance previously

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made to the parent company. Both the trial judge and the Court of Appeal concluded that there was no infringement of s. 90 of the Bank Act and that the s. 88 security was valid. The appellants are unsecured creditors who appealed to this Court in accordance with s. 16 of the Bankruptcy Act, R.S.C. 1952, c. 14, in view of the failure of the trustee to appeal.

Held (Pigeon J. dissenting): The appeal should be dismissed.

Per Abbott, Martland, Judson and Ritchie JJ.: The bank had obtained valid security from Gourmet in accordance with the provisions of s. 88 of the Bank Act. This was a perfectly straightforward and proper transaction without any intent to defraud or do anything other than regularize the security arrangements. Gourmet paid Bedford for the inventory which, according to the bank’s records, it held and owned. To do so, it borrowed $300,000 from the bank and gave s. 88 security.

Per Pigeon J., dissenting: The requirements of the statute have not been met. Under s. 90 of the Act, a fresh advance is an essential requirement for the validity of a s. 88 security. This is not met by getting a new note for an old debt as was done in this case. This requirement is a matter of substance, not a mere formality. Gourmet was already liable to the bank under its guarantee of Bedford’s debts.

APPEAL from a judgment of the Court of Queen’s Bench, Appeal Side, province of Quebec, affirming a judgment of the Superior Court which had dismissed a motion attacking the validity of a security given under s. 88 of the Bank Act. Appeal dismissed, Pigeon J. dissenting.

Robert Litvack, for the appellants.

John H. Gomery, for the respondent.

The judgment of Abbott, Martland, Judson and Ritchie JJ. was delivered by

JUDSON J.—This is an appeal from a judgment of the Court of Appeal of Quebec which dismissed the appeal of R. Victor Barnett, in his capacity as

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Trustee to the bankrupt estate of Gourmet Sales Inc. The present appellants are unsecured creditors of Gourmet who appeal in accordance with s. 16 of the Bankruptcy Act, in view of the failure of the Trustee himself to appeal from that judgment. The issue is whether the respondent, The Toronto-Dominion Bank, had obtained valid security from Gourmet in accordance with the provisions of s. 88 of the Bank Act. The petition attacking the validity of this security was dismissed both at trial and on appeal.

The debtor company, Gourmet, was a wholly owned subsidiary of Bedford Foods Limited, which manufactured and canned edible goods. Gourmet was used as the vehicle by which these products were marketed. The two companies were run by the same personnel, had common inventories, storage facilities and offices, and used an integrated bookkeeping system.

Both firms maintained accounts at the same branch of the bank. In February 1965, Bedford was indebted to the bank in the amount of $900,000, which had been secured by an assignment pursuant to s. 88, dated January 16, 1964. Gourmet was not indebted to the bank but did owe Bedford $305,000 and was jointly and severally bound for Bedford’s indebtedness to the bank. Bedford had also given the bank a general assignment of its accounts receivable.

In the fall of 1964, the bank realized that not all of the inventory encumbered by its security was owned by Bedford, and requested a breakdown as between Bedford and Gourmet. The bank’s policy was to require 125 per cent of inventory in support of advances. As the total inventory was valued between $1,100,000 and $1,200,000, the maximum indebtedness allowed Bedford was $900,000.

In February 1965, a breakdown revealed that Bedford owned approximately $750,000 of the inventory while Gourmet owned $350,000, the latter being unencumbered. To remedy this situation, on February 15, 1965, Gourmet executed documents in accordance with s. 88 of the Bank Act.

On February 28, 1965, Gourmet gave the bank a note for $300,000 payable on demand with interest at six per cent per annum. On March 1,

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1965, Gourmet issued its cheque to Bedford for $300,000, which the bank certified. This was first credited to Bedford’s current account, then a debit was entered, and the indebtedness in the loan account was reduced from $900,000 to $600,000. The bank lent $300,00 to Gourmet by crediting its account with that sum to cover the cheque to Bedford.

The loan of $300,000 to Gourmet was part of a revolving line of credit with an upper limit of $500,000. It was the first of a long series of advances, totalling $765,000, which were made by the bank to Gourmet after March 1, 1965 and up to the date of bankruptcy.

Early in August, 1965, on the petition of the bank, receiving orders were made against both Bedford and Gourmet. The bank sold Gourmet’s inventory and realized $246,632.93.

The trustee contested the validity of the bank’s security on the ground that there was no loan of $300,000 to Gourmet but only what amounted to a bookkeeping entry designed to shift part of the pre-existing debt of Bedford to Gourmet—in other words, that the transaction infringed s. 90(1) of The Bank Act, which reads:

90. (1) The bank shall not acquire or hold any warehouse receipt or bill of lading, or any security under section 88, to secure the payment of any debt, liability, loan or advance unless such debt, liability, loan or advance is contracted or made

(a) at the time of the acquisition thereof by the bank, or

(b) upon the written promise or agreement that a warehouse receipt or bill of lading or security under section 88 would be given to the bank, in which case the debt, liability, loan or advance may be contracted or made before or at the time of or after such acquisition,

and such debt, liability, loan or advance may be renewed, or the time for the payment thereof extended, without affecting any security so acquired or held.

On these facts, both the trial judge and a unanimous Court of Appeal concluded that there

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was no infringement of s. 90 of the Bank Act and that the s. 88 security was valid. The conclusion of the Court of Appeal is conveniently summarized in the following extract from the reasons of Hyde J.:

I fully share this view. The transactions effected are perfectly clear from the records of the Bank and of the Companies concerned. The Bank could have required that Bedford reduce its loan to $600,000 by other arrangements and then have proceeded to make a new loan to Gourmet under Sec. 88. There is nothing in the record to suggest that the financial position of the Companies was precarious at this time and, in fact, Edward Tinmouth, one of the auditors of the two Companies, testified (Case, page 176) that Gourmet was operating normally at the end of 1964 and from his examination of its records, Gourmet, which had guaranteed the obligations of Bedford, could meet its obligations as they became due. For reasons which I do not appreciate he was prevented from testifying as regards the consolidated statement of the two Companies. There is nothing that I can see in the record which indicates that the revision of the loan arrangements was due in any sense to anything other than the realization that Bedford did not have title to all the inventory which had supposedly been given as security to the Bank.

I agree with the Trial Judge that this was a perfectly straightforward and proper transaction without any intent to defraud or do anything other than regularize the security arrangements.

To put it another way, when the facts became known, Gourmet paid Bedford for the inventory which, according to the bank’s records, it held and owned. To do so, it borrowed $300,000 from the bank and gave s. 88 security.

Two subsidiary matters were discussed both at trial and on appeal. The first was whether there had been a transfer of assets from Gourmet to Bedford after the giving of security. On this question the Courts considered, among other matters, unsigned minutes of the Board of Directors, those of Bedford being dated April 7, 1965, and those of Gourmet, April 30, 1965. The trial judge thought that there had been a transfer. The Court of Appeal did not accept this conclusion and held that there had been no such transfer but it sus-

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tained the validity of the s. 88 security given by Gourmet. On this point, I agree with the Court of Appeal.

The Trustee in Bankruptcy, at the trial and on appeal, and also the present appellant in this Court sought to show that the bank had failed to get an adequate price on the disposition of the inventory. Again, I agree with both Courts that this allegation is without merit.

I would dismiss the appeal with costs.

PIGEON J. (dissenting)—The respondent bank made substantial advances to Bedford Foods Limited, a manufacturer. These advances were secured by assignment of inventory in accordance with s. 88 of the Bank Act. In the fall of 1964, the Bank realized that a sizeable portion of the inventory on which it had relied in making advances to Bedford was not the property of its debtor but belonged to a wholly owned subsidiary, Gourmet Sales Inc. In February 1965, it was ascertained that the subsidiary’s inventory was approximately $350,000, the parent’s, $750,000.

Gourmet then executed documents in accordance with s. 88 and, on February 28, 1965, gave to the Bank a note for $300,000 payable on demand. This was treated as a loan and debited to a loan account, the proceeds being credited to Gourmet’s current account and withdrawn therefrom the following day, March 1, 1965, by means of a cheque issued by Gourmet to its parent company for $300,000. This cheque was certified by the Bank and credited to the parent company’s current account. But, immediately, a debit of an equal amount was entered in that account for $300,000 of the parent company’s loan account of $900,000 cutting it down to $600,000. Here is how the bank manager described the operation in the witness box:

We are a Bank. We loan money against Security. The Security happens to be Inventory, which we believed was in the name of Bedford Foods. We went along over a period of time on this basis; when it was learned in fact some Inventory was held by

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the Subsidiary Company, Gourmet, it was only a routine matter to take the Section eighty-eight (88) from Gourmet. The results of the Loan Entry were merely formalities.

He also said that he did not believe he would have certified the $300,000 cheque for any other purpose than to pay down the Bedford loan.

Gourmet’s $300,000 loan account remained unchanged until early in August 1965 when Gourmet became bankrupt. The balance in the current account then amounting to $3,299.56 was credited to the loan account bringing it down to $296,700.44. The Bank took possession of the inventory, disposed of it, and realized $246,632.93.

The Trustee in bankruptcy instituted proceedings claiming against the Bank the value of the goods on the basis that the security was invalid by virtue of s. 90 of the Bank Act. It was alleged that the security was not really taken for a new advance but for a part of an advance previously made to the parent company. In fact, Gourmet was already liable to the Bank for that advance by reason of having executed a guarantee whereby it was holding itself jointly and severally liable for Bedford’s debts to the Bank, and Bedford remained liable for the whole debt on account of having given a similar guarantee for Gourmet’s debts.

The Bank defended the petition urging not only that the security was valid by virtue of the $300,000 loan but also by reason of what it claimed to be subsequent advances in the amount of $765,938.75. Exhibit R-11 filed by the Bank manager shows that this amount therein described as the Turnover, is nothing but the total of the sums debited to Gourmet’s current account. I fail to see how such payments can be considered as advances. They were more than fully covered by deposits because, in the end, there was a surplus in the current account. I also fail to see how any part of those sums could be considered as a debt due to the Bank when it took steps to realize its security, or at any other time. In my view, the provisions of the Civil Code respecting the impu-

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tation of payments, art. 1158 to 1161, coupled with those of art. 1227 and 1228 are conclusive against this contention.

The Bank also contended, on the basis of unsigned minutes of meetings, that Gourmet had sold its inventory to the parent company as of January 1, 1965. This contention found favour with the trial judge. But the Court of Appeal held, rightly in my view, that the evidence in that respect failed to establish such sale, pointing out that the current account with the Bank did show that Gourmet continued to carry on its business right to the time of the receiving order.

The Court of Appeal held, however, that the security was valid on the basis that “the Bank could have required that Bedford reduce its loan to $600,000 by other arrangements and then have proceeded to make a new loan to Gourmet under sec. 88”. It was also said that “this was a perfectly straightforward and proper transaction without any intent to defraud or do anything other than regularize the security arrangements”.

With respect, I cannot agree with this reasoning. The question was not whether there was a possibility of obtaining a valid security under the circumstances, nor whether a fraud was committed. In my view, the only question was whether the requirements of the statute had been met. The right to obtain security under s. 88 of the Bank Act is in itself exceptional. It is a derogation from the general rules of law (art. 1970, C.C.). Furthermore, s. 90 is in terms a prohibitive enactment that imports nullity when contravened. This is not, therefore, a matter of honest intention but of strict law.

In The Minister of National Revenue v. Cox[1], the unanimous opinion of this Court was expressed that: “The simultaneous exchange of cheques where neither would be honoured due to

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insufficient funds were it not for the offsetting entry of the other cheque, can only be viewed as a single transaction”.

A similar view of a pre-arranged operation, including not only an exchange of cheques but also a temporary advance by a bank, was taken by this Court in Smythe v. The Minister of National Revenue[2]. It should be noted that in that case, this Court expressly stated that it was not relying on s. 137(2) of the Income Tax Act that provides in some cases for taxation “notwithstanding the form or legal effect of the transactions”. The decision, therefore, implies that the conclusion was reached on the basis of what was in law the true nature of the transaction.

In Monarch Securities Ltd. v. Gold[3], it was held that a court is not prevented by the form of the documents from ascertaining the true nature of a transaction.

Similarly, in Maas v. Pepper[4], a sale of furniture followed by a hire-purchase agreement was found to be really a loan and, therefore, invalid for want of registration. In that case as in the present, consideration was not lacking, but in the light of the true nature of the transaction, legal requirements were not met for the validity of the security.

Under s. 90, a fresh advance is an essential requirement for the validity of a s. 88 security. This is not met by getting a new note for an old debt as was done in this case. This requirement is a matter of substance, not a mere formality.

For the above reasons, I would allow the appeal with costs in this Court to the appellants, reverse the judgments of the Court of Appeal and of the Superior Court, and maintain the Trustee’s petition with costs in both courts below, declare invalid the security given to the Bank, and condemn the latter to pay to the Trustee the sum realized therefrom namely $246,632.93 together with in-

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terest at 5 per cent from August 9, 1965 for the benefit of the appellants herein to the extent of their respective claims and costs incurred in these proceedings beyond the amount taxed against the respondent and the balance, if any, to form part of the assets of the bankrupt debtor.

Appeal dismissed with costs, PIGEON J. dissenting.

Solicitors for the appellants: Chait, Salomon, Gelber, Ciaccia, Reis & Bronstein, Montreal.

Solicitors for the respondent: Martineau, Walker, Allison, Beaulieu, Phelan & MacKell, Montreal.