Royal Bank of Canada v. Sparrow Electric Corporation, [1995] 1 CTC 101

Agrios J (orally):-This is an application by Coopers & Lybrand, receiver/manager of Sparrow Electric Corp. ("Sparrow"), for advice and directions as to the priorities of creditors over the proceeds of the sale of certain assets of Sparrow. The proceeds are approximately $625,000 plus interest, and are being held in trust pending the determination of this issue. I think it is fair to say, that we are, in this case, concerned with the proceeds from the sale of the inventory portion of the assets.

The two claimants are, firstly, Her Majesty, more specifically, Revenue Canada for unpaid employee source deductions and secondly the plaintiff, Royal Bank of Canada. The government’s claims arise under subsections 227(4) and (5) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), which gives Revenue Canada a deemed Statutory trust.

Many of the cases that have been referred to by counsel relate to various governmental claims, such as Canada Pension, UIC and similar deductions. They are somewhat generally referred to as statutory liens. Not all statutory liens are, by any means, the same. Each statute has different wordings and not all have the deemed trust provisions that are found in the Income Tax Act. So though I may make reference to statutory liens, I am aware of and recognize the differences.

The Royal Bank of Canada claim arises from a series of security interests from Sparrow, including a general security agreement under the Personal Property Security Act. It is agreed by both parties that the Royal Bank’s securities had been duly executed and registered prior to the difficulties that arose with Sparrow.

This case turns on the characterization of one of the Royal Bank’s security documents, namely, the general security agreement. The question is, does it take priority over the Crown’s statutory lien?

Both counsel started with the same authority, a 1980 Supreme Court of Canada decision Dauphin Plains Credit Union v. Xyloid Industries Ltd. [1980] 1 S.C.R. 1182, [1980] C.T.C. 247, 80 D.T.C. 6123. Both counsel quoted the same paragraph:

It should first be observed that, for reasons similar to those on which the decision in the Avco case, supra, was based, the claim for pension plan and unemployment insurance deductions cannot affect the proceeds of realization of property subject to a fixed and specific charge. From the moment such charge was created, the assets subject thereto, were no longer the property of the debtor except subject to that charge. The claim for the deductions arose subsequently and thus cannot affect this charge in the absence of a statute specifically so providing. However, the floating charge did not crystallize prior to the issue of the writ and the appointment of the Receiver. In the present case, it makes no difference which of the two days is selected, both are subsequent to the deductions.

Accordingly, at first blush, if the security instrument, in this case, the general security agreement, can be characterized as being a fixed and specific charge, the Royal Bank succeeds. If it is a floating charge not crystallized, the Crown wins. As it develops, such as simple determination is not possible in this case.

The problem has been complicated since 1980, both by the advent of PPSA legislation and numerous decisions both pre and post-PPSA. Some of the cases deal with floating charges, others on differing statutory liens with differing provisions. Still others relate to contests between different classes of non-governmental creditors. It is possible, in one way or other, to distinguish every authority.

To understand the depth of the problem, one has to review a British Columbia Court of Appeal decision in R. v. FBDB, (1988) 1 W.W.R. 1. I deal with the majority decision of Madam Justice McLachlin (then of the B.C. Court of Appeal). One then also has to look at an excellent case commentary in (1988) 67 Can. Bar. Rev. 506 by one of Canada’s leading authorities on the PPSA, Professor Ronald C. Cumming of the University of Saskatchewan. What I have to say is too brief and too simple a comment on an excellent piece of work. Professor Cumming is critical of this decision, because in his opinion, it fails to recognize the existence of two different but related equitable securities, firstly, a floating charge debenture, and secondly, a fixed charge security on stock in trade, subject to a license to sell, in the ordinary course of business.

The Alberta Court of Appeal has recognized the two different security interests in a case relied on by, Mr. Rutman, Toronto Dominion Bank v. Hayworth Equipment Sales Ltd., (1987) 35 D.L.R. (4th) 413, 65 C.B.R. 1 (N.S.). The Court in that case noted, that while it may be difficult to distinguish between a floating charge debenture, and the after acquired property clause contained in a chattel mortgage, judicial comment on this point clearly delineates between the two, notwithstanding, the similarity in operation. The fundamental distinction in the debenture and the mortgage, is that the security taken by the former is floating, and the security by the latter is fixed. The distinction has certainly been recognized in two decisions in our jurisdiction even before PPSA. At pages 417-18 (C.B.R. 7) of Hayworth, supra, the Court notes:

Recent appellate authority confirming that a fixed charge granted in the ordinary course of business will take priority over a floating charge is that of Savin Canada Inc. v. Protech Office Electronics Ltd. Equipment (1984), 8 D.L.R. (4th) 225, where Anderson, J.A. said at page 229:

It should also be observed that for more than a century, the commercial realty has been that fixed charges granted in the ordinary course of business have been held to take priority over floating charges.

The facts establish the acquisition of the after-acquired trade-in substitute for the Bellydump truck occurred before the debenture crystallized. Its status will, therefore, determine the entitlement to the sale proceeds.

The Court gains further support from a decision of Justice Forsyth of our Court, Canadian Imperial Bank of Commerce v. Westward.

Suffice it to say that I am satisfied in this case, that the general security agreement may appropriately be described not as a floating charge but as a fixed charge on inventory subject to a licence to sell in the ordinary course of business.

I take it that Mr. Lerna accepts this characterization, am I correct, Mr. Lerna?

Mr. LEMA: Yes.

THE COURT: Thank you.

Initially, I tried to "pigeon hole" all security interests as either fixed and specific or floating charges. Mr. Lerna resisted my characterization, and having read the authorities, he was right to do so. There are now a range of security devices, ranging from fixed charges on real property to fixed charges on inventory with right to sell in the ordinary course of business and floating charges.

The general security agreement in this case, has this provision, and I quote from a portion of paragraph 4:

Debtor may, in the ordinary course of debtor’s business, sell or lease inventory....

And as noted by Mr. Rutman there is a specific provision under 14(0):

The security interest created hereby, is intended to attach when the security agreement is signed by the debtor and delivered to the Royal Bank of Canada.

In Professor Cumming’s analysis he states at page 509:

McLachlin J.A. succinctly summarized the principal question before the Court:

These submissions raised the question of whether the law recognizes a fixed charge subject to a licence to deal with goods charged in the ordinary course of business, if the answer to that question is affirmative, the further question arises of whether such charge gives the charge holder priority over the Crown’s lien on the facts of this case.

It continues:

She reasoned that a licence to sell in the ordinary course of business contained in a fixed charge, must be taken as encompassing the ordinary incidents of business including statutory liens arising as a result of sales tax.

Now, Mr. Cumming does in his analysis, say:

The focus of this comment ts not on the relative priorities of fixed security interests and statutory liens.

This is not really what he was concerned with. he was concerned that the law should recognized the existence of a fixed security interest coupled with a licence given to the debtor to deal with the collateral in the ordinary course of business. In fact, I think he goes on somewhere to say, Ms. Topolniski, am I correct?

A floating charge has no real purpose or existence under the PPSA legislation.

MS. TOPOLNISKI: I believe so, Sir.

THE COURT: All right. So I have accepted Mr. Lerna’s suggestion, this is not really a commentary on governmental liens as opposed to fixed security interests. He is interested in the differentiation of the two. The fixed lien with the licence to deal as opposed to the floating charge.

In any event, my reading of Madam Justice McLachlin’s decision, is that in truth, she addressed both issues, both the matter of floating charges and fixed charges. At page 40 of the decision:

Alternatively if the charge is regarded as fixed, notwithstanding the licence to sell in the ordinary course of business, the result would be the same. This proposition appears not to have been considered by counsel and was not canvassed in their submissions which proceeded on the basis of the issue of priority turned on whether the charge was fixed or floating. Nevertheless, I think it appropriate to express my views on this alternative analysis.

It is the alternative analysis that I think is significant, because it is not fair to say she has dealt only with the rights that flow from a floating charge. She also deals with the second type of interest:

Assuming the charges were regarded as fixed subject to a licence to deal in the ordinary course of business, I am of the opinion that the licence or permission to deal must be taken to encompass all the usual legal incidents of dealing with the stock in the ordinary course of business.

The transfer of title is not the only incident of sale to which the FBDB was subject. Another incident of selling goods in the ordinary course of business, is the lien which arises in support of the vendor’s duty to collect and pay sales tax to the Crown. When FBDB gave Arcrite the power to sell the mortgaged goods in the ordinary course of business, FBDB must be taken to have tacitly accepted that it would cede its priority not only to bona fide purchasers for value, but to other persons who might acquire rights incidental to such sales. The Crown is such a person.

And then concluding the portion of her judgment:

In conclusion, I would answer the question of whether FBDB’s charge on Arcrite’s stock-in-trade gives FBDB the priority over the Crown in the negative. Whether the charge is regarded as a floating or fixed, it does not entitle FBDB to priority over the Crown’s lien. If the charge is floating as I think it is, no priority arises. On the other hand if it were to be regarded as fixed, the licence to sell in the ordinary course of business must be taken as encompassing the ordinary incidents of business including statutory liens arising as a result of sales tax, with the result that FBDB charge is subject not only to the title of the purchasers but to the lien for tax arising from sales.

I very much recognize that this is a matter of sales tax as opposed to income tax, but the principle is the same.

In essence, I have adopted Mr. Lerna’s reasoning. Whether the charge is floating or fixed, if there is an ability to deal with an asset such as inventory, the asset becomes exposed to the normal market incidents of carrying on business. The asset cannot be insulated from these incidents such as sales to third parties without notice, and in the appropriate cases, statutory liens.

I am in no fashion commenting on the contest that exist between different creditors, that is not what this case is about.

Had time permitted, I hoped to go through the rest of the Crown’s authorities and indicate by analogy, why they in my view, support Mr. Lerna’s position, while recognizing Mr. Rutman’s very careful analysis and efforts to distinguish these cases. If the plaintiff wishes to appeal, I reserve the right to provide supplementary reasons and complete the analysis. I await word from Mr. Rutman in this regard.

And in a very cursory fashion, on the secondary arguments, I accept Mr. Lerna’s submissions on a series of these matters. The concept of a deemed trust surmounts the argument of attracting only the receivables. The deemed trust applies not to the proceeds of the inventory, but to the assets themselves. I agree with Mr. Lerna, the trust goes after whatever assets are left.

The decision of Madam Justice Proudfoot of the British Columbia Court of Appeal cited by Mr. Rutman, in no way assists the Royal Bank. This is a contest between creditors and it does not really apply to this case.

I accept the submission by Mr. Lerna, that the portion of Justice Pigeon in the Dauphin case on the two-stage process deemed trust, is appropriate. The interpretive approach of Mr. Rutman is not accepted, as well, I note the language of Justice Stratton in the Lloyd’s Bank case, is in fact directed to enhanced garnishment and not to deemed trusts.

So subject to the caveat that if you need more, I will provide more. In the rather limited time that I had, this is the best I could do with the material and to repeat, it does not do justice to the arguments that were presented before me.

Now, is there anything further we go through this afternoon? Costs?

MR. LEMA: Sorry, I don’t have any submissions prepared at this point on costs.

THE COURT: Let us just leave that for a later date if the parties wish to make representations on costs, I will be pleased to consider them.

Anything else for this afternoon?

MR. RUTMAN: No, My Lord.

Order accordingly.