Fairbanx Corp. v. Royal Bank of Canada, 2010 ONCA 385

DATE: 2010-05-28

DOCKET: C51186

COURT OF APPEAL FOR ONTARIO

Before: Doherty, Feldman and Cronk JJ.A.

IN THE MATTER OF the bankruptcy of Friction Tecnology Consultants Inc. in the City of Toronto, in the Province of Ontario.

BETWEEN

Fairbanx Corp.

Applicant (Appellant)

and

Royal Bank of Canada, Perry Krieger & Associates Inc., Marketing Impact Limited and The Evercare Company Canada Inc.

Respondents (Respondents)

Counsel: Simon Morris, for the appellant James C. Davies and R. Del Vecchio, for the respondent Royal Bank of Canada

Heard: April 7, 2010

On appeal from the order of Justice Julie A. Thorburn of the Superior Court of Justice, dated July 6, 2009, with reasons reported at 2009 CanLII 55376 (ON S.C.).

Feldman J.A.:

[1] The appellant is in the business of factoring accounts receivable. It attempted to register its assignment of accounts agreement with the debtor under the Personal Property Security Act, R.S.O. 1990, c. P.10 (the “PPSA”), but spelled the debtor’s name incorrectly. The respondent bank later lent money to the same debtor, registering its general security agreement against the debtor’s correct name. The debtor went bankrupt and a priority dispute arose. The appellant appeals from the order of the application judge, which held that the appellant’s security interest was unperfected and that the bank’s perfected security took priority over the appellant’s unperfected interest in the accounts.

[2] For the reasons that follow, I would dismiss the appeal.

Facts

[3] In 2005, Fairbanx Corp. entered into an agreement entitled “Purchase of Accounts Receivable Agreement” with Friction Tecnology Consultants Inc. (the “debtor”), a supplier of plastic injection moulding. The correct spelling of the debtor’s name is “Friction Tecnology Consultants Inc.”, spelling “tec[h]nology” without the “h”. However, the debtor carried on its business using an incorrect spelling of its name: “Friction Technology Consultants Inc.” (Emphasis added). It used this incorrect spelling to enter the agreement with Fairbanx and spelled its name that way on its letterhead and invoices.

[4] Fairbanx registered a financing statement under the PPSA against the debtor, spelling its name incorrectly with the “h”. On an ongoing basis, Fairbanx purchased specific accounts receivable from the debtor, paid a discounted amount for each account, received an assignment of the account, gave notice of the assignment to the party that owed the account, and proceeded to collect or attempt to collect and retain the monies owed on each such account.

[5] In late 2007, the debtor approached the bank for a loan. At that time, the bank conducted a PPSA search under the incorrect spelling of the debtor’s name and found Fairbanx’s registration. In January 2008, the bank agreed to proceed with the loan to the debtor and instructed its secured transactions personnel operating through its head office to conduct the appropriate searches in order to allow the bank to obtain a first charge against the debtor under the PPSA. The bank searched under the correctly spelled name of the debtor. The search disclosed three creditors but not Fairbanx. Before advancing any funds, the bank obtained postponement agreements from the three registered creditors and, on January 22, 2008, it advanced a revolving demand facility to the debtor. The bank registered its financing statement as a first charge under the PPSA, using the proper spelling of the debtor’s name without the “h”.

[6] Because the bank had prior knowledge of the debtor’s relationship with Fairbanx, as a condition of its loan, the bank required the debtor to cease factoring its accounts receivable with Fairbanx. There is no evidence on the record that the factoring actually ceased. In fact, the two accounts in issue in this application were factored after the date of the bank’s agreement and before the debtor’s bankruptcy on March 31, 2009.

Issues

[7] Fairbanx raises two issues on the appeal, both of which were argued before the application judge:

(1) Is the factoring agreement an absolute assignment of accounts that is not subject to the PPSA?

(2) Is Fairbanx’s registration under the incorrectly spelled name of the debtor nevertheless valid under s. 46(4) of the PPSA, thereby standing in priority to the bank’s security?

Analysis

Issue 1: Is the factoring agreement an absolute assignment of accounts that is not subject to the PPSA?

[8] Fairbanx argues that a factoring assignment of an account is effectively a sale of that account because when an account is factored, it is assigned absolutely to the transferee with no reversionary right in the transferor. Fairbanx relies on s. 53(1) of the Conveyancing and Law of Property Act, R.S.O. 1990, c. C.34 (the “CLPA”) for the proposition that an absolute assignment is subject only to equitable rights. Section 53(1) provides:

53(1) Any absolute assignment made on or after the 31st day of December, 1897, by writing under the hand of the assignor, not purporting to be by way of charge only, of any debt or other legal chose in action of which express notice in writing has been given to the debtor, trustee or other person from whom the assignor would have been entitled to receive or claim such debt or chose in action is effectual in law, subject to all equities that would have been entitled to priority over the right of the assignee if this section had not been enacted, to pass and transfer the legal right to such debt or chose in action from the date of such notice, and all legal and other remedies for the same, and the power to give a good discharge for the same without the concurrence of the assignor.

[9] Fairbanx acknowledges, however, that ss. 2(a)(ii) and (b) of the PPSA provide that the PPSA applies to every transaction that in substance creates a security interest, including an assignment that secures the performance of an obligation (s. 2(a)(ii)) and also a transfer of an account or chattel paper even where it does not secure performance of an obligation (s. 2(b)).

[10] Those sections read:

2. Subject to subsection 4(1), this Act applies to,

(a) every transaction without regard to its form and without regard to the person who has title to the collateral that in substance creates a security interest including, without limiting the foregoing,

(ii) an assignment, lease or consignment that secures payment or performance of an obligation;

(b) a transfer of an account or chattel paper even though the transfer may not secure payment or performance of an obligation; and....

[11] The concept of the PPSA applying to a transfer of accounts where the transfer does not secure the performance of an obligation, i.e. an absolute transfer, is difficult to reconcile conceptually with the purpose of the Act, which is to provide a priority system for lenders who take security over the borrower’s assets. However, application of the Act to a transfer of accounts is in fact necessary for the effective operation of the PPSA to ensure that one system of priorities based on notice through registration and searches, applies to all transactions that affect entitlement to a borrower’s assets. The effect is that anyone who intends to lend money and to take security on the assets of a debtor, including on its accounts receivable, will be able to ascertain, by searching under the PPSA, whether and to what extent those assets have already been encumbered in any way.

[12] In Ronald C.C. Cuming, Catherine Walsh, Roderick J. Wood, Personal Property Security Law (Toronto: Irwin Law, 2005), the authors explain the policy rationale for extending the registration requirement to the assignment of accounts, at p. 90:

Endemic to each type of transaction is the potential for third-party deception and the consequent commercial disruptions that this entails.... In the case of a transfer of an account, the transferor retains apparent control of the account even though she no longer owns or has any interest in it. By bringing these transactions within the scope of the registration and priority rules of the PPSA, third parties are placed in the position of being able to discover the existence of these interests before dealing with a[n]... assignor.

[13] To the extent that there may be a conflict between the application of the CLPA and the PPSA respecting an assignment of accounts under a factoring arrangement, that conflict is resolved by s. 73 of the PPSA, which provides that in the case of any conflict between the PPSA and any other Act except the Consumer Protection Act, 2002, the applicable provision of the PPSA prevails. The PPSA therefore applies to the assignment of accounts.

[14] In this case, Fairbanx tried to register its assignment under the PPSA. Had it done so effectively, it would have had priority over the bank’s subsequently acquired interest in the debtor’s accounts. However, because Fairbanx’s registration was ineffective by virtue of the incorrect spelling of the debtor’s name, the bank’s properly perfected security interest ranked ahead of Fairbanx’s interest in the accounts. This remains the case even though value was paid and all steps were taken to achieve an absolute assignment of the two accounts that are in issue in this application. The assignment did not remove those accounts from the security interest of the bank, which applied in this case, on the date of the debtor’s bankruptcy.

Issue 2: Is Fairbanx’s registration under the incorrectly spelled name of the debtor nevertheless valid under s. 46(4) of the PPSA, thereby standing in priority to the bank’s security?

[15] In the alternative, Fairbanx argues that its registration against the misspelled name of the debtor is effective by virtue of s. 46(4) of the PPSA. That section provides:

46(4) A financing statement or financing change statement is not invalidated nor is its effect impaired by reason only of an error or omission therein or in its execution or registration unless a reasonable person is likely to be misled materially by the error or omission.

[16] Fairbanx argues that because the debtor effectively carried on business under the incorrectly spelled “Friction Technology Consultants Inc.”, a reasonable person would search under that name and therefore would not be materially misled by Fairbanx’s error in registering under that name. The evidence of that proposition is in this record: the respondent bank did in fact search under that name and found Fairbanx’s registration. Therefore, the bank, unarguably a reasonable person, was not materially misled.

[17] The leading case on the effect of s. 46(4) of the PPSA is this court’s decision in Re Lambert (1994), 1994 CanLII 10576 (ON CA), 20 O.R. (3d) 108, leave to appeal to S.C.C. refused, [1994] S.C.C.A. No. 555. There the court reviewed both the legislative history of the section and the history of the case law that applied it. Importantly, that history clarified that a creditor’s subjective knowledge of the existence of a financing statement or its registration is irrelevant. The test is an objective one – whether a reasonable person would be materially misled by an error.

[18] Another important feature of s. 46(4) is that a registered financing statement with an error is prima facie effective. It only loses its effect if a reasonable person would be materially misled by the error. Therefore, the meaning and effect of that qualifier must be analyzed in the context of the purpose of the registration system and the importance of maintaining the integrity of that system.

[19] In his text, Secured Transactions in Personal Property in Canada, 2d. ed., looseleaf (Scarborough: Carswell, 1989), Professor Richard H. McLaren describes the purpose of the PPSA registration system in the following way, at para. 30.01:

The personal property security registration system provides the vehicle to permit registration of a security interest and a non-possessory repair or storage lien. It also provides information about the transaction and a means whereby a person who is intending to purchase personal property or to lend money on the security of personal property can determine whether the owner has granted a security interest in the property as security for a debt. This informational function is accomplished by providing a mechanism by which a search of registrations under the Act may be made.

The purpose of the registration system is to provide enough information to enable a person searching the system to know who to contact to obtain information regarding a secured transaction. It is for this reason that the registration system is referred to as a notice-filing system.

[20] Consequently, when a person searches under the debtor’s name and finds registrations of financing statements and financing change statements, those registrations contain information about the secured transaction, about the debtor, about the security and about the lender. Some of that information may contain an error. For example, a financing statement may contain an outdated address of the debtor. A new creditor who knows the current address of the debtor could be materially misled about whether the registration is against the same debtor. Under s. 46(4), a court would have to determine whether a reasonable person would be so misled. Arguably, the person who conducts the search could make further inquiries using the information available from the search in order to try to ascertain whether the debtor at the new address is the same person or entity as at the previous address. On the other hand, there might be reasons in a particular case why that would not be possible, or if possible, might not be reliable. It would ultimately be for the court to decide, based on the objective criteria, whether a reasonable person would be materially misled about the identity of the debtor in that case.

[21] However, where the error in the registered financing statement is in the debtor’s name, no registration will be disclosed by a search of the correct name[^1]. Therefore, the error in the debtor’s name will not come to the attention of the person searching. In those circumstances, s. 46(4) cannot properly apply because the issue of whether the error would materially mislead a reasonable person never arises where the person searching does not find the registration that contains the error.

[22] But even where the reasonable person who searches finds the registration against the incorrectly spelled name of the debtor, either by specifically searching that name as occurred in this case, or because the certificate discloses the registration under s. 43(3), that person may not be able to know whether the misspelled name is an error or the proper spelling of the name of another similarly named person or corporation.

[23] In either case, the curative provision does not apply to validate the error. The reason is that s. 46(4) maintains the effect of a financing statement registered with an error as a perfected security interest of the registering creditor against the secured assets of the named debtor. If the name of the debtor is incorrect on the registered financing statement, then the registration will not perfect the creditor’s security interest in the assets of the correctly named debtor. Of course, the creditor still has an unperfected security interest which ranks behind all properly perfected security interests in the same collateral.

Conclusion

[24] In the result, I would dismiss the appeal with costs to the respondent bank fixed at $7,000, inclusive of disbursements and G.S.T.

Signed: “K. Feldman J.A.”

“I agree Doherty J.A.”

“I agree E. A. Cronke J.A.”

RELEASED: “DD” May 28, 2010

[^1]: Subject to s. 43(3), which allows the Registrar to include in the search certificate a search of similar names.