Supreme Court of Canada
Royal Bank of Canada v. First Pioneer Investments, [1984] 2 S.C.R. 125
The Royal Bank of Canada (Plaintiff) Appellant;
and
First Pioneer Investments Limited, Murray Edgar Hogarth and Brian Spence (Defendants) Respondents.
1983: November 9, 10; 1984: September 17.
Present: Estey, McIntyre, Chouinard, Lamer and Wilson JJ.
ON APPEAL FROM THE COURT OF APPEAL FOR ONTARIO.
Creditor and debtor—Securities—Registration—Debentures—Holder of unregistered debenture realizing assets securing the debt—Whether or not other creditors entitled to share proceeds—The Corporation Securities Registration Act, R.S.O. 1970, c. 88, s. 2(1).
The Royal Bank loaned Rent-A-Bug Limited, a car rental franchisor, $40,000 secured by the personal guarantee of the three principals of the parent company. To overcome a persistent overdraft situation with the Bank and chronic shortage of working capital, Rent‑A‑Bug’s principals approached the Pioneer Group of companies one of which was a successful franchisee. First Pioneer purchased a $60,000 interest in a debenture held by Rent-A-Bug’s parent company on Rent-A-Bug’s assets. The debenture, despite instructions to the contrary, was never registered. When it became apparent that Rent-A-Bug was nearing financial failure, the Bank cancelled its overdraft privileges and, contrary to its agreement with Rent-A-Bug, applied the proceeds of the sale of Rent-A-Bug’s U.S. business to reduce the overdraft. The debenture, having gone into default, First Pioneer proceeded to exercise its power of sale. Although the Bank had actual notice of the debenture and knew of First Pioneer’s intentions, it raised no objections and called upon the personal guarantor.
The Bank sues on its own behalf and on behalf of all other unsecured creditors of Rent‑A-Bug for an accounting, for a share of the proceeds of sale and for damages. Both lower courts found no taint of fraud in the actions taken by First Pioneer and dismissed the action. The issue is whether the holder of an unregistered debenture can as a secured creditor realize on his
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security before unsecured creditors have a chance to intervene to avoid the transaction.
Held: The appeal should be allowed.
Registration required under s. 2(1) of The Corporation Securities Registration Act is to enable the parties dealing with the debtor to determine conclusively what security interests in the debtor’s assets are in existence before advancing credit. The prevention of fraudulent preferences for a particular creditor is only a narrow consequence of this registration scheme. The crucial relationship at which the Act is aimed, therefore, is that between the holder of the unregistered instrument and the other unsecured creditors, rather than the relationship between the holder of the unregistered instrument and the debtor. Although the effect of the non-registration is to render void the debenture holder’s preference vis-à-vis the unsecured creditors, the statutory requirement is not geared toward rendering the debt itself void. The unregistered debenture continues to be valid in so far as it embodies an enforceable contract.
Stein v. The Ship “Kathy K”, 1975 CanLII 146 (SCC), [1976] 2 S.C.R. 802; Beaudoin-Daigneault v. Richard, 1984 CanLII 15 (SCC), [1984] 1 S.C.R. 2, applied; Re Shelly Films Ltd., 1963 CanLII 145 (ON CA), [1963] 1 O.R. 431, overruled; Clarkson v. McMaster & Co. (1895), 1895 CanLII 34 (SCC), 25 S.C.R. 96; Re Perrier-Roy-Therrien Ltd., 1970 CanLII 530 (ON SC), [1970] 3 O.R. 765; Meharg v. Lumbers (1896), 23 O.A.R. 51; Re Crichton Enterprises Ltd. (1979), 1979 CanLII 2548 (NS SC), 31 C.B.R. (N.S.) 43; Baker v. Leeson (1882), 1 O.R. 114; Althen Drilling Co. v. Machinery Depot Ltd. (1960), 1960 CanLII 267 (AB SCAD), 23 D.L.R. (2d) 148, referred to.
APPEAL from a judgment of the Ontario Court of Appeal (1981), 1980 CanLII 203 (SCC), 121 D.L.R. (3d) 510, 32 O.R. (2d) 121, 39 C.B.R. (N.S.) 147, dismissing an appeal from a judgment of Parker A.C.J.H.C. Appeal allowed.
Eric R. Murray, Q.C., and Paul S. Rouleau, for the appellant.
A.M. Rock and M.S.F. Watson, for the respondents.
The judgment of the Court was delivered by
WILSON J.—This action was brought by the appellant Bank on behalf of all the creditors of a bankrupt company called Rent-A-Bug Limited
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(“Rent-A-Bug”). Because the appellant has made allegations of fraud and improper dealing against the respondents it is necessary to review the facts giving rise to the action in some detail.
1. The facts
Rent-A-Bug was a car rental franchisor which, after an initial period of rapid expansion in 1973 and early 1974, through a series of circumstances beyond its control fell upon hard times. The concept of the franchise was that franchise holders would operate car rental agencies which dealt exclusively in Volkswagen “Beetles”. At one point franchises were in existence from British Columbia to Quebec and in parts of the United States and England. Rent-A-Bug provided its franchise holders with the following services:
(1) the right to use the Rent-A-Bug name and have the advantage of the company’s advertising and other promotional material;
(2) group discounts on purchases of “Beetles” from Volkswagen;
(3) group discounts on insurance;
(4) a system-wide car reservation plan; and (in some cases)
(5) accounting services.
In return the franchise holders paid Rent-A-Bug a royalty of 10 per cent of their sales.
The principals of Rent-A-Bug were initially R. Wisener, J.R. Sorrenti and H. Sorrenti who held Rent-A-Bug through a parent company, Duffcote Holdings. Rent-A-Bug’s banker was the appellant, the Royal Bank. The Royal Bank had loaned Rent-A-Bug $40,000 secured by the personal guarantee of Wisener and the Sorrentis. Rent-A-Bug also ran a large overdraft with the Royal Bank in its operating account. Rent-A-Bug’s overdraft fluctuated from time to time and at one point in March 1974 it reached as high as $36,452.93. Under more ordinary circumstances it seems to have been in the $10,000 to $20,000 range.
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The respondent, First Pioneer Investments Limited (“First Pioneer”) is part of the “Pioneer” group of companies controlled by the respondent Hogarth. It would appear that all of the shares in the relevant Pioneer Companies were held by Hogarth or members of his immediate family. The respondent Spence was an employee of First Pioneer and was responsible on a day-to-day basis for the company’s involvement with Rent-A-Bug.
In late 1973 and early 1974 because of its rapid expansion Rent-A-Bug was chronically short of working capital. Pioneer Petroleum, one of the Pioneer group of companies, operated gas stations along the Niagara Peninsula and in conjunction with these operations ran a successful Rent-A-Bug franchise. The principals of Rent-A-Bug approached the Pioneer companies in search of working capital. At first this involved the prepayment of royalties but in December of 1973 First Pioneer purchased a $60,000 interest in a $110,000 debenture held by Duffcote Holdings, Rent-A-Bug’s parent company, on Rent-A-Bug’s assets.
In 1974 First Pioneer made a series of loans to Rent-A-Bug in order to inject working capital. It received as security a debenture for $55,000 from Rent-A-Bug, the debenture being dated March 15, 1974. Rent-A-Bug’s lawyers were instructed to register the debenture but they failed to do so. This debenture is the subject of the present action.
At the same time Hogarth and Spence became officers and directors of Rent-A-Bug. From that time forward Spence assumed major responsibility for overseeing Rent-A-Bug’s day‑to‑day operations. While things went well for Rent-A-Bug in the summer of 1974, the bottom fell out of the business in the fall and winter of 1974 and early 1975. There were several reasons for this decline. In the fall of 1974 Volkswagen discontinued the manufacture of Beetles. The Volkswagen “Rabbit” was in short supply and did not represent a viable alternative. Furthermore it was discovered that the company had no trade mark on the Rent‑A-Bug name and Volkswagen dealers across the country were opening up car rental agencies and trading on Rent-A-Bug’s goodwill. Finally, the
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advent of provincial car insurance in British Columbia made the national group insurance services offered by Rent-A-Bug useless to its franchise holders in that province.
The net result of these developments was that Rent-A-Bug had no services of value to offer its franchise holders and the latter either dropped out or refused or were unable to make their royalty payments. In the course of this decline Rent-A-Bug was still running up bills and the company took a number of initiatives to cut down on its costs and to generate new capital. The most important of these was the sale in October 1974 of Rent-A-Bug’s United States business for $45,000. Rent-A-Bug had an agreement with the Bank that these funds would be earmarked as operating funds and would not be used by the Bank to pay down the company’s overdraft. In fact, however, the Bank subsequently cancelled Rent-A-Bug’s overdraft privileges and applied part of the money to the payment of the existing overdraft. With franchise holders unwilling to pay royalties and the Bank unwilling to extend further credit, it was probably apparent to all concerned by early 1975 that the company’s chances of survival were slim, if not non-existent.
On February 19, 1975 First Pioneer acted on its debenture which was in default and appointed Spence as receiver. In short order Spence came to the conclusion that the company was not viable and proceeded to value its assets. He valued the office furniture at $2,730 and the remaining franchises at $10,000. He sold those assets to Pioneer Computing, another member of the Pioneer group, for $12,730. The proceeds of the sale were returned to First Pioneer in partial satisfaction of its debenture.
Pioneer Computing subsequently changed its name to Pioneer Rent-A-Car and continued to operate the original Rent-A-Bug franchise system. Pioneer Rent-A-Car advised the holders of the Rent-A-Bug franchises that it would continue the accounting and other services which Rent-A-Bug
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had provided but at a reduced royalty of 5 per cent. Within six months Pioneer Rent-A-Car was out of business.
No evidence was presented to contradict Spence’s assertion that he had valued Rent-A-Bug’s office furniture fairly. Both Spence and Hogarth testified that in order to protect himself as receiver Spence had over-valued the Rent-A-Bug franchise. Hogarth’s testimony forces one to the conclusion that the only reason Pioneer Computing paid $10,000 for the franchises was that it knew that First Pioneer would get the money back on its debenture. In fact, it is probably fair to say that the franchises were worthless.
The Bank had actual notice of First Pioneer’s debenture and its intentions throughout the relevant time period. No objection was made to Spence’s appointment as receiver. Instead the Bank called upon Wisener as guarantor of its $40,000 loan. The present action is in fact being financed by Wisener. The Bank is merely lending its name to the proceedings.
2. At trial
The case was tried before Parker A.C.J.H.C. who on November 7, 1974 found in favour of the respondents. In essence he found that while the circumstances of Spence’s actions as receiver were such as to raise a presumption of fraud, the respondents had effectively rebutted that presumption. In particular, he found that Spence had been appointed as receiver in a bona fide attempt to make the Pioneer rental business viable and that this was done with the knowledge of the Bank. He further held that Spence’s sale of Rent-A-Bug’s assets to Pioneer Computing was a final attempt to recoup a small portion of First Pioneer’s investment and that this did not constitute fraud. The respondents’ reasoning for why Spence was appointed receiver instead of an outsider and why he did not seek an independent appraisal of Rent-A-Bug’s assets was, in effect, that First Pioneer
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had already lost a lot of money on Rent-A-Bug and the company did not want to make further expenditures in appraising assets which it considered to be worthless. Finally, the trial judge held that Spence’s appointment as receiver was valid as between Rent-A-Bug and First Pioneer and that Spence had not breached his duties as receiver.
3. On appeal
The Ontario Court of Appeal, in a short judgment by MacKinnon A.C.J.O., Jessup and Morden JJ.A. concurring, affirmed the judgment below. The Court pointed out that the trial judge’s finding that the sale was for valuable consideration precluded the appellant from obtaining the relief it sought and made it unnecessary to consider the Fraudulent Conveyances Act, R.S.O. 1980, c. 176, and the Assignments and Preferences Act, R.S.O. 1980, c. 33. In addition, the Court relied on its own earlier judgment in Re Shelly Films Ltd., 1963 CanLII 145 (ON CA), [1963] 1 O.R. 431, for the proposition that First Pioneer’s failure to register the debenture did not entitle the appellant and other unsecured creditors to share in the proceeds of the receiver’s sale.
In accepting the trial judge’s finding of fact of a proper sale the Court of Appeal correctly asserted that while it was open to the appellant to adduce evidence to challenge the value placed on Rent-A-Bug’s assets by the receiver no such evidence had been put forward. This Court has made it clear that in the absence of palpable and overriding error on the trial judge’s part which affected his assessment of the facts the findings at trial must be accepted: Stein v. The Ship “Kathy K”, 1975 CanLII 146 (SCC), [1976] 2 S.C.R. 802. Mr. Justice Lamer has recently stated in Beaudoin-Daigneault v. Richard, 1984 CanLII 15 (SCC), [1984] 1 S.C.R. 2, at p. 11, that this Court in reviewing the findings of fact of a trial judge will only interfere with such findings if it can “with certainty identify a determinative error”.
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4. The issue
Accepting then the findings of the learned trial judge that there was no fraud or improper dealing on the part of the respondents, the only issue of substance on this appeal is whether Shelly Films (supra) was correctly decided. The issue might be framed more fully as whether the scheme of The Corporation Securities Registration Act, R.S.O. 1970, c. 88, would be defeated by allowing the holder of an unregistered debenture to enjoy the position of a secured creditor by realizing on his security before unsecured creditors had a chance to intervene to avoid the transaction.
Section 2(1) of the Act reads in part:
2.—(1) Every mortgage and every charge, whether specific or floating, of chattels in Ontario created by a corporation, and every assignment of book debts, whether by way of specific or floating charge, made by a corporation engaged in a trade or business in Ontario and contained,
(b) in any bonds, debentures or debenture stock of the corporation as well as in the trust deed or other instrument securing the same, or in a trust deed or other instrument securing the bonds, debentures or debenture stock of any other corporation; or
is void as against creditors of the mortgagor or assignor, and as against subsequent purchasers or mortgagees from or under the mortgagor or assignor, in good faith, for valuable consideration and without notice, unless it is duly registered, and unless, if contained in a trust deed or other instrument to secure bonds, debentures or debenture stock, it complies with subsection 2.
The question of interpretation posed by the phrase “void as against creditors” has been a vexatious one for more than a century with the Courts fluctuating in their assessment of whether the words serve to render the unregistered debenture void ab initio or merely voidable at the timely insistence of other unsecured creditors. The Ontario Court of Appeal in the present case affirmed its own earlier decision in Shelly Films. In that case the court held that the unregistered
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chattel mortgage was voidable only so that the unsecured creditors could not claim against the mortgaged property after the chattel mortgagee had taken possession and sold the assets. The chattel mortgage at that point was spent and no longer subject to being avoided. The appellant, on the other hand, points out that the effect of the rule in Shelly Films is to allow a mortgage or debenture that is declared by statute to be void as against creditors if not registered to be made valid by the debenture holder going quickly into possession and selling the assets under his unregistered instrument before other unsecured creditors have a chance to voice a complaint. Indeed, the appellant argues that the reasoning in Shelly Films is something of an aberration since other courts, including this Court in Clarkson v. McMaster & Co. (1895), 1895 CanLII 34 (SCC), 25 S.C.R. 96, have held that the holder of an unregistered debenture or mortgage cannot enjoy the position of a secured creditor by subsequently realizing on the security.
The two distinct lines of thought on the proper interpretation of the term “void” in s. 2(1) of The Corporation Securities Registration Act may be said to reflect different views of the purpose underlying the Act’s registration scheme. On one hand, the Ontario courts have tended to conclude that “a mortgage of chattels cannot be declared void after the mortgagee who has gone into possession has disposed of the assets”: Re Perrier-Roy-Therrien Ltd., 1970 CanLII 530 (ON SC), [1970] 3 O.R. 765 (Ont. H.C.), at p. 770. It is evident that this line of cases has as its analytic focus the relationship between the unregistered debenture holder and the debtor so that, in the absence of evidence of fraud on the debenture holder’s part, the security interest for which he bargained should not be undermined on the technicality of failure to conform to the registration requirements. As Burton J.A. indicated in Meharg v. Lumbers (1896), 23 O.A.R. 51 (Ont C.A.), there appears to be no reason why the debenture should be void as between the debenture holder and the debtor if the only persons interested in
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having the debenture set aside (i.e. the unsecured creditors of the same debtor) have not done so. The tendency to reason in this way is even stronger in cases such as Shelly Films where the assets have not only been realized by the debenture holder but have been transferred to a bona fide purchaser for value without notice. When viewed in this light the statutory registration scheme is seen to exist in order to prevent the fraudulent seizure and sale of assets by unsecured creditors. In the absence of such fraud no purpose is served by declaring void a legitimately bargained, albeit unregistered, security interest.
On the other hand, the Nova Scotia Supreme Court, in its interpretation of an almost identical provision in that province’s Corporation Securities Registration Act, R.S.N.S. 1967, c. 60, s. 2, took as its analytic starting point the proposition that “Surely the purpose of the Act is to give notice to creditors of documents secured against property of the debtor”: Re Crichton Enterprises Ltd. (1979), 1979 CanLII 2548 (NS SC), 31 C.B.R. (N.S.) 43, at p. 52. From this point of view the prevention of fraud may represent an implicit benefit conferred by the registration scheme but it is not the goal toward which the registration requirement is primarily aimed. Rather, in the words of Chancellor Boyd in Baker v. Leeson (1882), 1 O.R. 114, (one of the few Ontario cases to find unregistered security instruments void rather than voidable) at p. 117:
The object of the act is plainly, by means of registration, to inform everybody that goods apparently in the possession and ownership of A. are not in truth his, but are held by him subject to the claim of B. under a chattel mortgage or a bill of sale. The object of the Act is to enforce a visible and actual transfer of possession upon every change of ownership, or to compel the recording of the instruments which manifest the change of property. The intent is, that persons who are about to become the creditors of others by parting with money or money’s worth, may, by searches in the public office, obtain information for their guidance; and that the ostensible owners of chattels may not gain fictitious credit on the faith of property which is either encumbered or belongs
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to other people.
In perhaps the best illustration of the view that the primary purpose of such legislation is public notice it was held in Althen Drilling Co. v. Machinery Depot Ltd. (1960), 1960 CanLII 267 (AB SCAD), 23 D.L.R. (2d) 148 (Alta. C.A.), that an unregistered bill of sale could be cured only by an open and continuous change of possession which was reasonably sufficient to serve as a national substitute for registration. Such public exposure was seen to provide the requisite notice of the interest of the holder of the bill to all creditors of the grantor whose rights did not arise until after the change of possession took place. Thus, where the Court broadens its perspective from the narrow search for fraud as between the holder of the unregistered instrument and the debtor who has granted it to a perception of registration as serving the wider purpose of enabling parties dealing with the debtor to determine conclusively what security interests in the debtor’s assets are in existence before advancing credit, the significant relationship becomes the one between the holder of the unregistered instrument and the other unsecured creditors.
Once it is recognized that the prevention of fraudulent preferences for a particular creditor is only a narrow consequence of a registration scheme which serves a broader commercial purpose, the problematic consequences of a more literal construction of the statutory language than the one adopted in Shelly Films disappear. The unregistered debenture can then be rendered void (rather than voidable) as against other creditors without undermining the existence of a valid contractual debt owed to the debenture holder. Since the crucial relationship at which the Act is aimed is that between the debenture holder and other unsecured creditors, the effect of non-registration is to render void the debenture holder’s preference vis-à-vis such other creditors. Nothing in the statutory registration requirement, however, is geared toward rendering void the debt itself.
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5. Conclusions
In the result, it would appear that Shelly Films should be overruled and the unregistered debenture held to be valid in so far as it embodies an enforceable contract between First Pioneer and Rent-A-Bug. As against other creditors of Rent-A-Bug, however, the same logic dictates that it be declared void ab initio pursuant to s. 2 of The Corporation Securities Registration Act. As such, the unregistered debenture creates no security interest or preference and the position of the respondent First Pioneer is thereby reduced to that of an unsecured creditor. All of the creditors of Rent-A-Bug, including both the appellant and the respondent First Pioneer, are accordingly entitled to an accounting of the proceeds of sale of Rent-A-Bug’s assets.
Although the appellant sued in a representative capacity on behalf of itself and all other creditors of Rent-A-Bug, this Court is not in a position to adjudicate on such claims and determine the proper disposition of the subject proceeds. A reference to the Master of the Supreme Court of Ontario would appear to be appropriate for this purpose.
I would allow the appeal to the extent of ordering an accounting of the proceeds of sale of Rent-A-Bug’s assets and directing a reference to the Master to determine their proper distribution. I would grant the appellant its costs both here and in the Courts below.
Appeal allowed with costs.
Solicitors for the appellant: Cassels, Brock, Toronto.
Solicitors for the respondents: Fasken & Calvin, Toronto.