Royal Bank of Canada v. Sparrow Electric Corp., [1997] 1 S.C.R. 411

Her Majesty The Queen Appellant

v.

Royal Bank of Canada Respondent

Indexed as: Royal Bank of Canada v. Sparrow Electric Corp.

File No.: 24713.

1996: June 19; 1997: February 27.

Present: La Forest, Sopinka, Gonthier, Cory, McLachlin, Iacobucci and Major JJ.

on appeal from the court of appeal for alberta

Crown -- Priority -- Employee source deductions not paid by company in receivership -- Company’s inventory subject to fixed charge and to Bank Act security -- Whether bank had priority to proceeds of sale of inventory over statutory trust in favour of Her Majesty -- Bank Act, S.C. 1991, c. 46, s. 427 -- Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.), ss. 153, 227(4), (5) -- Personal Property Security Act, S.A. 1988, c. P‑4.05, s. 28(1).

Banks and banking operations ‑‑ Security -- Company’s inventory subject to fixed charge and to Bank Act security -- Employee source deductions not paid by company in receivership -- Whether bank had priority to proceeds of sale of inventory over statutory trust in favour of Her Majesty -- Bank Act, S.C. 1991, c. 46, s. 427 -- Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.), ss. 153, 227(4), (5) -- Personal Property Security Act, S.A. 1988, c. P‑4.05, s. 28(1).

The Royal Bank secured a loan made to Sparrow Electric with a general security agreement (GSA) covering Sparrow’s present and after‑acquired property and with Bank Act security (BAS) created by an assignment of inventory under s. 427 of the Bank Act. When Sparrow experienced financial difficulties, a standstill agreement was executed. This agreement allowed Sparrow to continue its business but permitted the bank, on default, to appoint a receiver and enforce its security. A receiver was appointed in November 1992 at which time it was discovered that Sparrow had not been remitting its payroll deductions as required by s. 153 of the Income Tax Act (ITA). It is probable that these defaults had occurred in 1992. In January 1993, the receiver received court permission to sell Sparrow’s assets. An amount from the proceeds of sale equivalent to that owing the federal government was ordered to be held in trust pending resolution as to entitlement. The bank claimed priority based on its GSA and its BAS, which entitled it to inventory proceeds. The federal government’s claim was based on the s. 227 ITA deemed trust provisions, which created a deemed statutory trust in the moneys deducted from wages but not remitted to Her Majesty.

On the first application to determine priority, the deemed trust was held to take priority over the GSA. On a subsequent application by the bank for a determination of whether its BAS took priority over the deemed trust, the Court of Queen’s Bench found that the deemed trust took priority. The Court of Appeal found that the BAS took priority over the deemed trust. At issue here is whether the s. 227(5) ITA deemed trust takes priority over a previously executed GSA and a previously executed BAS with respect to the proceeds of the sale of the inventory.

Held (La Forest, Gonthier and Cory JJ. dissenting): The appeal should be dismissed.

(1) Section 227(4) and (5) of the Income Tax Act

Although the employer, at the point of withholding, becomes the trustee of a fund which is in law the property of its employee, s. 227(4) ITA has the effect of making Her Majesty the beneficiary under that trust. A conceptual difficulty arises when the tax debtor fails to set aside moneys which are to be remitted. The subject of Her Majesty's beneficial interest at that point becomes intermingled with the general assets of the tax debtor and Her Majesty's claim then becomes that of a beneficiary under a non‑existent trust. Subsections (4) and (5) of s. 227 resolve this conceptual dilemma by clearly and unambiguously rendering amounts unremitted as held in trust for Her Majesty. In particular, s. 227(5) is designed to, upon liquidation, assignment, receivership or bankruptcy, seek out and attach Her Majesty's beneficial interest to property of the debtor which is in existence at that time. The trust is not a real trust, as its subject matter cannot be identified from the date of the trust’s creation. However, s. 227(5) has the effect of revitalizing the trust whose subject matter has lost all identity. This identification of the subject matter of the trust therefore occurs ex post facto. Her Majesty has a statutory right to access whatever assets the employer then has, and may realize from those assets the original trust debt. This interpretation is consistent with the scheme of distribution under the Bankruptcy and Insolvency Act.

The s. 227(5) deemed trust operates to Her Majesty’s benefit in a secondary manner. Under it, Her Majesty’s interest can attach retroactively to disputed collateral if the competing security interest has attached after the deductions giving rise to Her Majesty’s claim in fact occurred. Conceptually, the s. 227(5) deemed trust allows that claim to go back in time and attach its outstanding s. 227(4) interest to the collateral before that collateral became subject to a fixed charge. The same result occurs when a statutory lien attaches prior to the mortgaging of disputed collateral. Here, the deductions of tax from the employees' pay cheques occurred after the attachment of the bank's fixed charge to the inventory, so this second aspect of s. 227(5)'s operation did not arise.

The mechanism of s. 227(5) cannot accurately be described as a means of “tracing”; indeed, this subsection is antithetical to tracing in the traditional sense in that it requires no link at all between the subject matter of the trust and the fund or asset into which the subject matter is being traced. Section 227(5) is more accurately described as a “relaxation of the equitable tracing rules”.

Section 227(5) does not permit Her Majesty to attach Her beneficial interest to property which, at the time of liquidation, assignment, receivership or bankruptcy, in law belongs to a party other than the tax debtor. Subsections (4) and (5) of s. 227 are manifestly directed towards the property of the tax debtor, and it would be contrary to well‑established authority to stretch the interpretation of s. 227(5) to permit the expropriation of the property of third parties who are not specifically mentioned in the statute.

Therefore, the proper analysis in determining whether Her Majesty is entitled to priority pursuant to these subsections must utilize principles of property law. The nature of the interests competing with those of Her Majesty must be scrutinized in order to determine whether and to what extent such interests have title in the disputed fund. If it is found that legal title in the collateral is in the bank, and not Sparrow, Her Majesty’s deemed trust could only attach to Sparrow's equity of redemption.

The “statutory trust” approach can be distinguished from other legislative methods, such as an explicit “Crown priority” provision, used to secure an interest to unremitted payroll deductions. The application of such a provision to a priority competition can proceed without regard to the quality of the “security interest” which competes with Her Majesty’s claim. Such a provision simply transfers title in the collateral to Her Majesty regardless of whose interest may compete with it, so long as its requirements are met.

(2) Characterization of the Bank’s Interests

The bank's interest in Sparrow's inventory must be characterized as either a floating charge or a fixed and specific charge. A specific charge is one that, without more, fastens on ascertained and definite property or property capable of being ascertained and defined. A floating charge floats with the property which it is intended to affect until it crystallizes. Crystallization occurs upon the default of the debtor and transforms the interest into a fixed and specific charge over the inventory. The critical significance of the characterizing of an interest as being fixed or floating is that it describes the extent to which a creditor can be said to have a proprietary interest in the collateral. During the period in which a charge over inventory is floating, the creditor possesses no legal title to that collateral and a statutory trust or lien attaching during this time will attach to the debtor's interest and take priority over a subsequently crystallized floating charge. A security interest characterized as a fixed and specific charge, however, will take priority over a subsequent statutory lien or charge because all that the lien can attach to is the debtor's equity of redemption in the collateral.

Common law principles did not alter the effect that legislation may have on the characterization of security interests. Here, the Alberta Personal Property Security Act (PPSA) and the Bank Act are determinative of the characterization of the bank's GSA and BAS, respectively. The PPSA explicitly removes statutory trusts from its operation and accordingly does not govern the priority competition between a statutory trust and a security interest. The Act’s effect, however, fundamentally changes the characterization of security interests. Generally speaking, absent an express intention to the contrary, a security interest in all present and after‑acquired personal property will attach when that agreement is executed by the parties. Once attachment has occurred, the GSA becomes in law a fixed and specific charge over the collateral. For these reasons, the GSA held by the respondent bank must be characterized as a fixed and specific charge with a licence to deal with the inventory that arose because of the bank’s granting Sparrow permission to sell the encumbered inventory. The fixed charge attached on the agreement’s execution.

Similarly, security taken under the Bank Act is in the nature of a fixed and specific charge. The concept of the fixed charge is correlative to the notion of a creditor’s having legal proprietary rights in the collateral. It is misleading to suggest that s. 427 security is in the nature of a floating charge because the bank effectively acquires legal title. Unlike a floating charge which may apply to all property of a specified kind held by the borrower from time to time but does not affix itself specifically upon any particular item of property until it crystallizes upon default by the borrower, s. 427 security is a fixed charge on each item of assigned property held from time to time whether or not the loan is in default. This gives a bank significantly greater rights than it would hold under a floating charge debenture on inventory. For this reason, the security interest of the bank in the form of BAS should be characterized as a fixed and specific charge with a licence to sell the inventory.

The traditional concept of the fixed charge seems to be at odds with the notion of having a proprietary right over collateral such as after‑acquired inventory which is not yet in existence at the time the security agreement is executed. A fixed charge over all present and future inventory represents a proprietary interest over a dynamic collective of present and future assets. The conception of this form of charge must change to meet the modern realities of commercial law and in particular the legislative provisions which have been brought to bear in this appeal. In effect, the fixed and specific charge gives to the secured creditor the title (subject to the debtor's equitable right of redemption) to the present inventory of the debtor, as well as the after‑acquired inventory of the debtor. In this way, the secured creditor becomes the legal owner of inventory as it comes into possession of the debtor.

Where a secured creditor holds a fixed charge over a debtor's inventory, that charge will have the effect of ensuring the creditor has legal title to any and all inventory subject to the charge at any given time, subject to the caveat (not operative here) that no outstanding statutory payroll deductions had in fact been made prior to the attachment of the fixed charge. Here, the inventory which was subject to the liquidation sale belonged in law to the respondent bank: both under its GSA and its BAS the bank held a fixed charge over Sparrow's inventory. Her Majesty’s beneficial interest accordingly could only attach, before its sale, to Sparrow's equity of redemption in the property.

(3) Licence Theory

Per Sopinka, McLachlin, Iacobucci and Major JJ.: The security interests that the respondent has under the Bank Act and the PPSA take priority over the deemed trust that arises in favour of Her Majesty by operation of s. 227(4) ITA. While the former interests are subject to a licence to sell, that licence is not nearly so broad as to encompass the satisfaction of income tax obligations. A licence to sell inventory authorizes at most only the satisfaction of obligations that are immediately incidental to an actual sale of the inventory.

The licence theory holds that a bank’s security interest in a debtor’s inventory, whether fixed and specific, is subject to a licence in the debtor to deal with that inventory in the ordinary course of business. The point is that the bank’s claim to the inventory must as a consequence give way to any debts incurred in the ordinary course of business. In theory, a creditor who has granted a licence to sell inventory has thereby consented to his security interest’s being subject to other obligations that may arise “in the ordinary course of business”. The licence is thus supposed to afford evidence of the respondent’s intention to take less than an entire security interest in the inventory.

The licence affords no such evidence. The potential sale of the inventory does not amount to an actual limitation of the security interest. A great difference exists between saying, on the one hand, that if a debtor sells inventory and applies the proceeds to a debt to a third party, then the third party takes the proceeds free of any security interest and saying, on the other hand, that because a third party could take the proceeds free of any security interest, no security interest exists in the proceeds as against that third party. A licence to sell inventory in the ordinary course of business is a condition of the former kind. The consequent (defeasance of the security interest) follows only if the antecedent (sale of the inventory and application of proceeds to an obligation to a third party) is satisfied. The security interest in the inventory disappears only if the debtor actually sells the inventory and applies the proceeds to a debt to a third party.

In accordance with s. 28(1) PPSA, the result of a sale of inventory is to give the purchaser an unencumbered interest in the inventory and the licensor a continuing security interest in the proceeds of the sale. Only if the debtor subsequently uses the proceeds to satisfy an obligation to a third party will the proceeds be removed from the scope of the licensor’s security interest in them. Accordingly, a security agreement with a licence to sell creates a defeasible interest; but the event of defeasance is the actual sale of the inventory and the actual application of the proceeds against an obligation to a third party.

By itself, s. 28(1) PPSA does not necessarily compel rejection of the broad interpretation of the licence to sell. However, the maxim expressio unius est exclusio alterius is appropriately invoked here to complete the argument. The statute prescribes certain consequences for the security interest that follow a dealing with inventory, and in particular, it prescribes the defeasance of the interest if the debtor actually sells the inventory and applies the proceeds to an obligation to a third party. Significantly, the statute does not contemplate a defeasance on the happening of any other event. The statute occupies the field and crowds out other possible interpretations of the licence.

Because the inventory in question was not sold pursuant to the licence, here the licence can have had no effect on the respondent’s security interest. What the debtor might have done with the licence does not matter. If it were otherwise, the licence to sell inventory would entirely eviscerate the respondent’s GSA.

The argument might be made that the deemed trust works by deeming an actual sale of the inventory to have been made. It this were correct, then it would not matter that the inventory was not actually sold pursuant to the licence. However, the deeming is not a mechanism for undoing an existing security interest, but rather a device for going back in time and seeking out an asset that was not, at the moment the income taxes came due, subject to any competing security interest. The deemed trust provision cannot be effective unless it is first determined that there is some unencumbered asset out of which the trust may be deemed. In this case the inventory was encumbered by the GSA.

The debtor’s covenant in the GSA to pay all taxes was not part of the licence and was merely a covenant to obey the law. It adds nothing to s. 153(1) ITA and does not prescribe the outcome of a priority contest.

A number of policy considerations support this conclusion. Judicial innovation in this field risks legal uncertainty. Inventory financiers would have to provide against the risk that their security interest might be defeated by some rival claim. There is also a real possibility that recognition of a broad licence theory would obliterate the PPSA charge against inventory. If Parliament wishes to do so, it may step in and assign absolute priority to the deemed trust. But in the absence of clear statutory language to that effect, the bank’s GSA must prevail.

Per La Forest, Gonthier and Cory JJ. (dissenting): The critical issue here was the scope of the contractual licence. In particular, if the bank's consent included the right to sell the inventory in order to pay wages, then that consent by necessity included the right to sell inventory to remit payroll deductions. In such a situation, Her Majesty’s interest would be able to attach to the proceeds of the inventory and so take priority over the bank's interest.

The licence theory operates, in the context of the statutory scheme at issue here, as an exception to the general rule that at the time of “liquidation, assignment, receivership or bankruptcy” Her Majesty’s interest cannot attach to property which is at that time the property of a secured creditor. Where a secured creditor has consented to the use of its collateral when deductions are made in order to pay the statutory deductions which are the object of a deemed trust, that creditor has bound itself by the statutory requirements relating to those deductions. Here, therefore, the wage deductions at issue were made at a time when the bank had permitted the sale of inventory in order to pay wages (and thus wage deductions), and the bank’s inventory existent at the time of receivership can accordingly be attached under s. 227(5).

The critical factor in the “licence to sell” argument is the permission which must be found to have been granted with respect to the usage of the proceeds of the disputed collateral. While licences are often expressed in terms of a “right to sell in the ordinary course of business”, this permission is made with respect to the usage of proceeds, which is the proper focus of the inquiry, and not necessarily the circumstances of sale. Here, Sparrow was permitted to sell its inventory in the ordinary course of its business and “use” the proceeds generated therefrom.

The licence to sell inventory in the ordinary course of business in this case necessarily included a licence to sell inventory to pay wages, and remit wage deductions, in the course of Sparrow’s business. Where, as here, the secured party has security over the majority of the assets of the debtor, the security interest over the inventory must permit the debtor to sell the inventory and put it to the general use of its business, including towards the payment of wages. The scope of the licence can be ascertained either from the express terms of the security agreement or from the nature of the agreement and the conduct of the parties. The licence here was to sell inventory in the “ordinary course of [Sparrow's] business . . . and use [the proceeds]” which renders it of such a quality as to include a right to use the proceeds to pay wages. A licence to sell inventory may in certain circumstances be circumscribed so as not to include a right to use the proceeds to pay wages.

The true test of whether the licence to sell inventory includes the right to pay wages is a matter of interpreting the contractual arrangement between the parties. The focus is not so much on the circumstances of the selling of inventory, but rather the permitted usage of the proceeds of inventory. Where the licence has a limited scope, that licence may not include the right to use proceeds to pay wages. However, the expression of a limited use for proceeds of inventory cannot prevail if the arrangement between the parties is such as to allow, in practice, the debtor to use the inventory proceeds in the course of its business. The test should be whether the debtor had the freedom to use these funds in the ordinary course of business as opposed to being under an obligation to remit them to the secured party.

The GSA contained an express licence permitting Sparrow to sell inventory in the course of its business and use the proceeds available; the BAS contained an implied licence to this effect. While it is true that the GSA contained a trust proceeds clause, this clause cannot have the effect of limiting the scope of the licence where the real arrangement between the parties was, as expressly stated, that Sparrow could use the proceeds of inventory in the course of its business. The bank in this case was not a small inventory financier who required Sparrow to remit proceeds of inventory to it immediately. To the contrary, the bank was a large scale lender who permitted Sparrow to use inventory sales to maintain the viability of its enterprise. Under the licence at issue here, the bank permitted Sparrow to sell inventory to pay wages and, necessarily, payroll deduction obligations.

The appellant’s s. 227(5) deemed trust must take priority over the bank’s security interests in the disputed collateral. The trust fund representing the deducted amounts, while without identified subject matter from the date of its inception, is capable of identifying property subject to that trust ex post facto. This result is not precluded with respect to the BAS by virtue of s. 428(1) of the Bank Act. Although s. 428(1) secures the respondent bank’s proprietary right to the disputed collateral, the bank nevertheless consented to the divestment of this interest. Such a waiver of priority renders s. 428(1) of no assistance to the bank.

The licence theory, in addition to providing certainty in disputes between consensual and non‑consensual security interests, achieves fairness in commercial law. In essence, the bank is willing to accept the benefits of Sparrow’s non‑payment of statutory deductions and has permitted the use of its collateral to pay these deductions, but refuses to accept the burden of Sparrow’s unlawful action at the time of its receivership. It should be the policy of the law that the respondent bank be held accountable for Sparrow’s outstanding statutory obligations. The licence theory ensures that in appropriate circumstances this result will obtain.

The licence theory does not go so far as to mean that every subsequent claim should prevail over the GSA because every rival claim might have to be satisfied out of the proceeds of a hypothetical sale of the inventory. The consent to pay wages is a necessary but not sufficient condition. It did not simpliciter lead to the conclusion that Her Majesty’s interest must prevail. What is significant is that the bank consented to payment of wages, including deductions, out of inventory which, at the time of the deductions and upon actual payment of wages, were deemed by statute to be taken out of the estate of the debtor. The unique nature of the statutory provisions applicable to wage deductions, and the bank’s consent thereto, are integral to the success of the s. 227(5) claim in the case at bar. In this way, the licence theory is circumscribed in its ability to defeat prior secured interests.

In addition, the licence theory as applied here is not inimical to the integrity of commercial law. It operates narrowly, in conjunction with unique statutory provisions, so as to actualize legally performed obligations. It does not create uncertainty in commercial transactions.

Cases Cited

By Iacobucci J.

Referred to: R. in Right of B.C. v. F.B.D.B., 1987 CanLII 156 (BC CA), [1988] 1 W.W.R. 1; Alberta (Treasury Branches) v. M.N.R.; Toronto-Dominion Bank v. M.N.R., 1996 CanLII 244 (SCC), [1996] 1 S.C.R. 963.

By Gonthier J. (dissenting)

Royal Bank v. Sparrow Electric Corp., Alberta Court of Queen’s Bench, Edmonton, November 24, 1993, unreported; R. in Right of B.C. v. F.B.D.B., 1987 CanLII 156 (BC CA), [1988] 1 W.W.R. 1; Dauphin Plains Credit Union Ltd. v. Xyloid Industries Ltd., 1980 CanLII 186 (SCC), [1980] 1 S.C.R. 1182; Bank of Montreal v. Hall, 1990 CanLII 157 (SCC), [1990] 1 S.C.R. 121; Board of Industrial Relations v. Avco Financial Services Realty Ltd., 1979 CanLII 230 (SCC), [1979] 2 S.C.R. 699; Royal Bank of Canada v. G.M. Homes Inc. (1984), 1984 CanLII 2540 (SK CA), 52 C.B.R. (N.S.) 244; Roynat Inc. v. Ja‑Sha Trucking & Leasing Ltd., 1992 CanLII 2767 (MB CA), [1992] 2 W.W.R. 641; Ford Motor Co. of Canada Ltd. v. Manning Mercury Sales Ltd. (Trustee of), 1994 CanLII 4852 (SK QB), [1994] 6 W.W.R. 372; National Bank of Canada v. Director of Employment Standards (1986), 5 P.P.S.A.C. 326; Abraham v. Coopers & Lybrand Ltd. (1993), 1993 CanLII 8538 (ON SC), 13 O.R. (3d) 649; Armstrong v. Coopers & Lybrand Ltd. (1986), 1986 CanLII 2621 (ON SC), 53 O.R. (2d) 468, aff'd (1987), 1987 CanLII 4362 (ON CA), 61 O.R. (2d) 129, leave to appeal refused, sub nom. National Bank of Canada v. Armstrong, [1988] 1 S.C.R. xii; Manitoba (Minister of Labour) v. Omega Autobody Ltd. (Receiver of) (1989), 1989 CanLII 178 (MB CA), 59 D.L.R. (4th) 34; Re Deslauriers Construction Products Ltd., 1970 CanLII 402 (ON CA), [1970] 3 O.R. 599; Pembina on the Red Development Corp. Ltd. v. Triman Industries Ltd. (1991), 1991 CanLII 2699 (MB CA), 85 D.L.R. (4th) 29; Alberta (Treasury Branches) v. M.N.R.; Toronto-Dominion Bank v. M.N.R., 1996 CanLII 244 (SCC), [1996] 1 S.C.R. 963; Friesen v. Canada, 1995 CanLII 62 (SCC), [1995] 3 S.C.R. 103; Illingworth v. Houldsworth, [1904] A.C. 355; Re Urman (1983), 1983 CanLII 1854 (ON CA), 44 O.R. (2d) 248; North Sky Trading Inc. (Bankrupt), Re (1994), 1994 CanLII 8986 (AB KB), 158 A.R. 117; Royal Bank of Canada v. Workmen's Compensation Board of Nova Scotia, 1936 CanLII 39 (SCC), [1936] S.C.R. 560; C.I.B.C. v. Klymchuk (1990), 1990 ABCA 141, 74 Alta. L.R. (2d) 232.

Statutes and Regulations Cited

Bank Act, R.S.C. 1927, c. 12, s. 88.

Bank Act, R.S.C., 1985, c. B-1, ss. 2(1), 178, 179(1), 185(2), 186(2).

Bank Act, S.C. 1991, c. 46, ss. 425(1) “goods, wares and merchandise”, 427(1), (2), 428(1), 434(2), 435(2).

Bankruptcy and Insolvency Act, R.S.C., 1985, c. B‑3, s. 67 [am. 1992, c. 27, s. 33].

Canada Pension Plan, R.S.C. 1970, c. C‑5.

Canada Pension Plan, R.S.C., 1985, c. C‑8, s. 23(3), (4).

Canada Pension Plan, S.C. 1964‑65, c. 51, s. 24(3), (4).

Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.), ss. 153(1)(a), (3), 224(1.2) [ad. 1987, c. 46, s. 66; am. 1990 c. 34, s.1], (1.3) [ad. 1987, c. 46, s.66], 227(4), (5).

Personal Property Security Act, S.A. 1988, c. P‑4.05, ss. 4(a), 10(1), 12(1), 13(1), 28(1).

Personal Property Security Act, S.B.C. 1989, c. 36.

Personal Property Security Act, R.S.O. 1990, c. P.10.

Unemployment Insurance Act, 1971, S.C. 1970‑71‑72, c. 48.

Unemployment Insurance Act, R.S.C., 1985, c. U‑1, s. 57(2), (3).

Workmen's Compensation Act, R.S.N.S. 1923, c. 129, s. 79(2).

Authors Cited

Cuming, Ronald C. C. “Commercial Law -- Floating Charges and Fixed Charges of After‑Acquired Property: The Queen in the Right of British Columbia v. Federal Business Development Bank” (1988), 67 Can. Bar Rev. 506.

Cuming, Ronald C. C., and Roderick J. Wood. Alberta Personal Property Security Act Handbook, 2nd ed. Toronto: Carswell, 1993.

Cuming, Ronald C. C., and Roderick J. Wood. British Columbia Personal Property Security Handbook, 2nd ed. Toronto: Carswell, 1993.

Moull, William D. “Security Under Sections 177 and 178 of the Bank Act” (1986), 65 Can. Bar Rev. 242.

Waters, D. W. M. Law of Trusts in Canada, 2nd ed. Toronto: Carswell, 1984.

Wood, Roderick J. “The Floating Charge in Canada” (1989), 27 Alta. L. Rev. 191.

Wood, Roderick J. “Revenue Canada's Deemed Trust Extends Its Tentacles: Royal Bank of Canada v. Sparrow Electric Corp.” (1995), 10 B.F.L.R. 429.

Wood, Roderick J., and Michael I. Wylie. “Non‑Consensual Security Interests in Personal Property” (1992), 30 Alta. L. Rev. 1055.

Ziegel, Jacob S. “Symposium: Recent and Prospective Developments in the Personal Property Security Law Area” (1985), 10 Can. Bus. L.J. 131.

Ziegel, Jacob S., Benjamin Geva and R. C. C. Cuming. Commercial and Consumer Transactions, Rev. 2nd ed. Toronto: Emond Montgomery, 1990.

APPEAL from a judgment of the Alberta Court of Appeal (1995), 1995 ABCA 133, 28 Alta. L.R. (3d) 153, 165 A.R. 132, 89 W.A.C. 132, [1995] 6 W.W.R. 718, 33 C.B.R. (3d) 34, 10 P.P.S.A.C. (2d) 1, allowing an appeal from judgments of Agrios J. (1993), 1993 CanLII 7257 (AB KB), 19 Alta. L.R. (3d) 183, 10 P.P.S.A.C. (2d) 1, at p. 3, [1995] 1 C.T.C. 101, and (1994), 1994 CanLII 8992 (AB KB), 21 Alta. L. R. (3d) 275, 156 A.R. 187, [1994] 9 W.W.R. 338. Appeal dismissed, La Forest, Gonthier and Cory JJ. dissenting.

Edward R. Sojonky, Q.C., and Michael J. Lema, for the appellant.

Ray C. Rutman, for the respondent.

The reasons of La Forest, Gonthier and Cory JJ. were delivered by

1 Gonthier J. (dissenting) -- This case involves a determination of priority between a deemed statutory trust and various security instruments in regard to the proceeds of a liquidation sale of inventory. In particular, the appeal requires a determination of the priority status of Her Majesty's deemed trust under s. 227(4) and (5) of the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.) (hereinafter “ITA”), these provisions becoming operative in this case because of the misappropriation of unremitted payroll deductions lawfully belonging to Her Majesty. In competition to this claim, the Royal Bank of Canada asserts priority under both a general security agreement and an assignment of inventory under s. 427 of the Bank Act, S.C. 1991, c. 46.

I - Facts

2 The debtor, Sparrow Electric Corporation (hereinafter “Sparrow”), carried on business as an electrical contractor in Alberta. The enterprise was of a substantial size, employing 200 to 300 employees in its business operations. To finance these operations, Sparrow borrowed heavily from the respondent Royal Bank of Canada (hereinafter the “bank”). The bank secured Sparrow's borrowing with various forms of security, covering most of the assets utilized in Sparrow's business. Of particular relevance to this appeal, however, the bank held a general security agreement over all of Sparrow's present and after-acquired personal property, as well as an assignment of inventory under s. 178 (now s. 427) of the Bank Act, R.S.C., 1985, c. B-1.

3 In 1992, it became apparent to the bank that Sparrow was having financial difficulties. On two occasions, August 5, 1992 and September 30, 1992, the bank wrote to Sparrow advising its management that Sparrow was in default on its loan obligations. On October 16, 1992, in order to give Sparrow some time to correct its default situation, the bank and Sparrow entered into a “Standstill Agreement”. This agreement permitted Sparrow to continue carrying on business under the proviso that, should Sparrow's position fail to improve, the bank would be entitled to appoint a receiver and enforce its security.

4 Sparrow's financial position did not improve. For this reason, on November 19, 1992, the bank appointed a receiver to take over Sparrow's business, and on December 8, 1992, the bank successfully petitioned Sparrow into bankruptcy. The order appointing the receiver empowered the receiver to, among other things, carry on Sparrow’s business as it deemed necessary. The receiver did in fact carry on Sparrow’s business for some time, employing approximately 200 employees in order to fulfil Sparrow's outstanding contractual obligations. These employees were terminated effective January 15, 1993.

5 In addition to the failure to pay the loan obligations which inevitably led to its bankruptcy and receivership, Sparrow had failed to honour other obligations in its attempt to remain in business. In particular, Sparrow failed to remit payroll deductions as required by s. 153 ITA. While the record does not disclose the exact date of these failures, it appears that the first instance of non-remittance could have occurred no later than August 7, 1992. Having regard to the amount of payroll deductions outstanding as of August 7, and to the average number of Sparrow's employees on the payroll, we can conclude that the actual payroll deductions which give rise to Her Majesty's claim in all likelihood occurred some time in the year 1992. In any event, by the time of its receivership, in addition to substantial amounts outstanding to the bank, Sparrow was indebted to the appellant (“Her Majesty”) in the amount of $625,990.86 for unremitted income tax payroll deductions.

6 On January 12, 1993, the receiver applied to the Alberta Court of Queen's Bench for authorization to sell various Sparrow assets. Part of the pool of assets to be sold included Sparrow’s inventory which is the subject of this appeal. On January 15, 1993, Wilson J. authorized both the sale of the assets and remittance of its proceeds to the bank in partial repayment of its claims, but ordered that an amount equal to Her Majesty’s claim for unremitted payroll deductions be held in trust pending a resolution as to the entitlement to this portion of the proceeds. At some later date, the assets were in fact sold, and the amount of $625,990.86 set aside. It has been held in judicial proceedings that the amount held is constituted entirely of proceeds from inventory (Royal Bank v. Sparrow Electric Corp., Alberta Court of Queen’s Bench, Edmonton, November 24, 1993, unreported). That ruling is not at issue in this appeal.

7 At present, the fund being held and constituting the proceeds of inventory is sufficient to satisfy either Her Majesty's claim, or part of the outstanding claims owing to the bank. The determination of priority in this appeal will therefore be determinative as to which party is entitled to the entirety of the disputed fund.

II - The Competing Interests

8 For convenience, I will at the outset outline the claims of the bank and of Her Majesty which are advanced as being entitled to the proceeds of the inventory.

(A) The Bank

9 The respondent bank advances two distinct security instruments in order to establish its claim to the disputed fund. First, the bank argues that its general security agreement (“GSA”), executed on February 25, 1992, and perfected pursuant to the Alberta Personal Property Security Act, S.A. 1988, c. P‑4.05 (“PPSA”), is entitled to priority. By this agreement, Sparrow assigned to the bank a security interest in all of its present and after-acquired personal property, including “all inventory of whatever kind and wherever situate” (para. 1(a)(i)). In addition, para. 7 of that agreement provided that proceeds of the collateral received by Sparrow would be received and held in trust for the bank. Of significance to this appeal, however, para. 4 of the GSA contained two express covenants, providing:

So long as this Security Agreement remains in effect Debtor covenants and agrees:

(a) to defend the Collateral against the claims and demands of all other parties claiming the same or an interest therein; to keep the Collateral free from all Encumbrances ...; provided always that, until default, Debtor may, in the ordinary course of Debtor's business, sell or lease inventory and, subject to Clause 7 hereof, use Money available to Debtor,

(e) to pay all taxes, rates, levies, assessments and other charges of every nature which may be lawfully levied, assessed or imposed against or in respect of Debtor or Collateral as and when the same become due and payable; [Emphasis added.]

Additionally, under the credit facilities agreement between Sparrow and the bank, dated January 22, 1992, Sparrow covenanted as follows:

(3) it will promptly pay when due all business, income and other taxes properly levied on its operations and property and remit all statutory employee deductions when due; [Emphasis added.]

10 The bank's second claim is that its Bank Act security (“BAS”) entitles it to priority to the inventory proceeds. That security instrument was executed on two occasions, January 29, 1990 and December 12, 1990. Under the General Assignment, Sparrow assigned to the bank, inter alia, “all goods inventory, [and] stock-in-trade” as continuing security for the payment of loans to the bank. In addition, as part of the Agreement as to Loans and Advances, Sparrow granted security in both its inventory and its proceeds. At the time these instruments were executed, s. 178 of the Bank Act, R.S.C., 1985, c. B-1, was in effect. However, on June 1, 1992, that Act was replaced with the Bank Act, S.C. 1991, c. 46. The relevant portions of these two acts are identical. However, as the facts giving rise to this case occurred while the latter Act was in force, I will refer to the provisions of this new Act for the purposes of this appeal. As such, the bank's claim for security under its BAS is grounded in s. 427 (formerly s. 178) of the Bank Act, which provides:

427. (1) A bank may lend money and make advances

(a) to any wholesale or retail purchaser or shipper of, or dealer in, products of agriculture, products of aquaculture, products of the forest, products of the quarry and mine, products of the sea, lakes and rivers or goods, wares and merchandise, manufactured or otherwise, on the security of such products or goods, wares and merchandise and of goods, wares and merchandise used in or procured for the packing of such products or goods, wares and merchandise,

(2) Delivery of a document giving security on property to a bank under the authority of this section vests in the bank in respect of the property therein described

(a) of which the person giving security is the owner at the time of the delivery of the document, or

(b) of which that person becomes the owner at any time thereafter before the release of the security by the bank, whether or not the property is in existence at the time of the delivery,

the following rights and powers, namely,

(c) if the property is property on which security is given under paragraph (1)(a), (b), (g), (h), (i), (j) or (o), under paragraph (1)(c) or (m) consisting of aquacultural implements, under paragraph (1)(d) or (n) consisting of agricultural implements or under paragraph (1)(p) consisting of forestry implements, the same rights and powers as if the bank had acquired a warehouse receipt or bill of lading in which that property was described, ...

and all such property in respect of which such rights and powers are vested in the bank under this section is for the purposes of this Act property covered by the security. [Emphasis added.]

Section 425(1) (formerly contained within s. 2(1)) provides that:

425. (1) ...

“goods, wares and merchandise” includes products of agriculture, products of aquaculture, products of the forest, products of the quarry and mine, products of the sea, lakes and rivers, and all other articles of commerce; [Emphasis added.]

And s. 435(2) (formerly s. 186(2)) provides:

435. ...

(2) Any warehouse receipt or bill of lading acquired by a bank under subsection (1) vests in the bank, from the date of the acquisition thereof,

(a) all the right and title to the warehouse receipt or bill of lading and to the goods, wares and merchandise covered thereby of the previous holder or owner thereof; and

(b) all the right and title to the goods, wares and merchandise mentioned therein of the person from whom the goods, wares and merchandise were received or acquired by the bank, if the warehouse receipt or bill of lading is made directly in favour of the bank, instead of to the previous holder or owner of the goods, wares and merchandise.

11 In addition, the respondent directed this Court's attention to s. 428(1) (formerly s. 179(1)), which it was submitted affected the priority position of the bank's BAS:

428. (1) All the rights and powers of a bank in respect of the property mentioned in or covered by a warehouse receipt or bill of lading acquired and held by the bank, and the rights and powers of the bank in respect of the property covered by a security given to the bank under section 427 that are the same as if the bank had acquired a warehouse receipt or bill of lading in which that property was described, have, subject to subsection 427(4) and subsections (3) to (6) of this section, priority over all rights subsequently acquired in, on or in respect of that property, and also over the claim of any unpaid vendor. [Emphasis added.]

Finally, s. 434(2) (formerly s. 185(2)) provides:

434. ...

(2) Nothing in any charter, Act or law shall be construed as ever having been intended to prevent or as preventing a bank from acquiring and holding an absolute title to and in any mortgaged or hypothecated real property, whatever the value thereof, or from exercising or acting on any power of sale contained in any mortgage given to or held by the bank, authorizing or enabling it to sell or convey any property so mortgaged. [Emphasis added.]

12 While no provision in the BAS explicitly permitted Sparrow to sell its inventory, the respondent bank has conceded that such a licence existed, as a practical matter, as between the parties. In any event, I would have thought that once a licence to sell inventory had been granted under the GSA, it would be impossible to grant a more restricted licence to deal with the same collateral under the provisions of the BAS.

(B) Her Majesty's Interest

13 Her Majesty’s claim arises under the s. 227 deemed trust provisions of the ITA. Section 153(1)(a) of that Act requires employers to withhold from the pay cheques of its employees and remit to the Receiver General amounts on account of the payee's tax for the year:

153. (1) Every person paying at any time in a taxation year

(a) salary or wages or other remuneration,

shall deduct or withhold therefrom such amount as may be determined in accordance with prescribed rules and shall, at such time as may be prescribed, remit that amount to the Receiver General on account of the payee's tax for the year.... [Emphasis added.]

Such amounts are deemed to be held in trust for Her Majesty by virtue of s. 227(4) and (5) ITA, which provide:

227. ...

(4) Every person who deducts or withholds any amount under this Act shall be deemed to hold the amount so deducted or withheld in trust for Her Majesty.

(5) Notwithstanding any provision of the Bankruptcy Act, in the event of any liquidation, assignment, receivership or bankruptcy of or by a person, an amount equal to any amount

(a) deemed by subsection (4) to be held in trust for Her Majesty, ...

shall be deemed to be separate from and form no part of the estate in liquidation, assignment, receivership or bankruptcy, whether or not that amount has in fact been kept separate and apart from the person's own moneys or from the assets of the estate.

As of June 15, 1994, these provisions have been repealed and replaced by a revised s. 227(4): S.C. 1994, c. 21, s. 104(1). However, as this amendment was not effective at the time the facts of this appeal arose, I decline to comment on the application of the new s. 227(4) to this case.

III - Judgments of the Courts Below

Alberta Court of Queen's Bench (1993), 1993 CanLII 7257 (AB KB), 19 Alta. L.R. (3d) 183

14 The first application brought to determine the priority over the inventory proceeds involved the competing claims under the GSA advanced by the bank, and Her Majesty's deemed trust. Agrios J. held that the deemed trust took priority over the GSA. In characterizing the statutory trust, Agrios J. concluded at p. 189 that the trust attaches to “whatever assets are left” upon bankruptcy. With regard to the GSA security interest, Agrios J. was of the view that it took the form of a fixed charge on the inventory with a licence to sell in the ordinary course of business. However, this latter characterization was not necessary to reach his decision, as the learned chambers judge ultimately reasoned, at p. 188, “[w]hether 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”. Relying on the decision of McLachlin J.A. (as she then was) in R. in Right of B.C. v. F.B.D.B., 1987 CanLII 156 (BC CA), [1988] 1 W.W.R. 1 (B.C.C.A.) (hereinafter “FBDB”), Agrios J. found that a normal incident of selling inventory was the payment of statutory liens. The sale of the inventory therefore permitted the statutory trust to attach.

Alberta Court of Queen's Bench (1994), 1994 CanLII 8992 (AB KB), 21 Alta. L.R. (3d) 275

15 The bank subsequently applied for a determination of whether their BAS over Sparrow's inventory took priority over Her Majesty's deemed trust. For substantially similar reasons, Agrios J. held that the deemed trust once again took priority. Whether the BAS could be characterized as a fixed charge with a licence to sell, or a floating charge, the sale of the inventory subjected the bank's interest in it to the “normal incidents of business” (at p. 283). And, in Agrios J.'s view, one of these incidents was the paying of wages and withholdings. As these proceeds were impressed with the deemed trust, whatever interest the bank had could not attach to them, as they were no longer the property of Sparrow.

Alberta Court of Appeal (1995), 1995 ABCA 133, 28 Alta. L.R. (3d) 153

16 Both the decisions of Agrios J. were appealed to the Alberta Court of Appeal. As such, the priority of both the GSA and the BAS were at issue before that court. However, the Court of Appeal, unanimously deciding to dispose of the appeal solely on the grounds that the BAS took priority over the statutory trust, neither heard oral argument nor ruled with regard to the priority of the GSA.

17 The Court of Appeal began with the premise that BAS was a fixed and specific charge transferring legal title to the bank and not a floating charge over inventory. For this proposition, the court relied upon two judgments of this Court, Dauphin Plains Credit Union Ltd. v. Xyloid Industries Ltd., 1980 CanLII 186 (SCC), [1980] 1 S.C.R. 1182, and Bank of Montreal v. Hall, 1990 CanLII 157 (SCC), [1990] 1 S.C.R. 121, both decisions which the court considered binding upon it. As the claim of Her Majesty arose subsequent to the execution of the BAS, in the court's opinion, the deemed trust could have nothing to attach to. In addition, the court rejected the argument that the inventory was subject to a licence to sell which would provide Her Majesty with an opportunity to attach its interest. The Court of Appeal found FBDB, supra, relied upon by Agrios J. to be distinguishable on the basis that the intimacy in that case between the sale of inventory and the statutory trust was not present in the case before it. In contrast, in the present case, the court found no conceptual or evidentiary link between the sale of inventory and the withholding of payroll deductions. In any event, the court found that any licence to sell inventory only lasted until default, and as the sale in this case occurred well after any default by Sparrow, the licence must therefore have been extinguished at the relevant time. For these reasons, the Court of Appeal found that the BAS took priority over Her Majesty's deemed trust.

IV - Issues

18 There are two issues to be resolved in this appeal: (1) whether, on the facts of this case, Her Majesty's s. 227(5) ITA deemed trust takes priority over a previously executed GSA with respect to the proceeds of the sale of inventory; and (2) whether, on the facts of this case, Her Majesty's s. 227(5) ITA deemed trust takes priority over a previously executed BAS with respect to the proceeds of the sale of inventory?

V - Analysis

(A) Introduction

19 The law reports are replete with cases involving competing claims between statutory liens and deemed trusts, such as the one found in s. 227 ITA, and other previously executed consensual security interests: Dauphin Plains Credit Union Ltd. v. Xyloid Industries Ltd., supra; Board of Industrial Relations v. Avco Financial Services Realty Ltd., 1979 CanLII 230 (SCC), [1979] 2 S.C.R. 699; Royal Bank of Canada v. G. M. Homes Inc. (1984), 1984 CanLII 2540 (SK CA), 52 C.B.R. (N.S.) 244 (Sask. C.A.); Roynat Inc. v. Ja-Sha Trucking & Leasing Ltd., 1992 CanLII 2767 (MB CA), [1992] 2 W.W.R. 641 (Man. C.A.); FBDB, supra; Ford Motor Co. of Canada Ltd. v. Manning Mercury Sales Ltd. (Trustee of), 1994 CanLII 4852 (SK QB), [1994] 6 W.W.R. 372 (Sask. Q.B.); National Bank of Canada v. Director of Employment Standards (1986), 5 P.P.S.A.C. 326 (Ont. Div. Ct.); Abraham v. Coopers & Lybrand Ltd. (1993), 1993 CanLII 8538 (ON SC), 13 O.R. (3d) 649 (Gen. Div.) (under appeal); Armstrong v. Coopers & Lybrand Ltd. (1986), 1986 CanLII 2621 (ON SC), 53 O.R. (2d) 468 (H.C.), aff'd (1987), 1987 CanLII 4362 (ON CA), 61 O.R. (2d) 129 (C.A.), leave refused, sub nom. National Bank of Canada v. Armstrong, [1988] 1 S.C.R. xii. The ubiquitousness of this legal dilemma in our courts speaks no doubt, at least in part, to the prevalence of the unfortunate factual situation which such statutory trusts and liens were meant to counter. Namely, such deemed trusts or liens are devices which legislators often employ in order to recover moneys which ought to have lawfully been paid to them but have been unlawfully misappropriated by a debtor who subsequently encounters financial difficulty and is forced into winding up its business, e.g., Canada Pension Plan, R.S.C., 1985, c. C‑8, s. 23(3) and (4); Unemployment Insurance Act, R.S.C., 1985, c. U‑1, s. 57(2) and (3); and the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.), s. 227(4) and (5). Indeed, it is perhaps more accurate to speculate that this sort of misappropriation of public funds is often a manifestation of an already-existing financial difficulty in a debtor's business, as a debtor foregoes statutory payments as required of it in order to increase artificially its supply of working capital.

20 At the same time that legislators have sought to protect the fiscal integrity of public institutions through the devices of statutory trusts and liens, however, they have also endeavoured to protect the security interests of those private institutions who are involved in providing credit to Canadian businesses. For example, the Bank Act has historically provided for the protection of the collateral of banking institutions. The current provision of the Bank Act granting a security interest in a debtor's inventory, s. 427, can be traced back over one hundred years to the enactment of its predecessor section, s. 74, in 1890 (S.C. 1890, c. 31). The historical and societal importance of this form of security was observed by this Court in Hall, supra, where, at p. 139, La Forest J. commented that “[i]n a word, the creation of the Bank Act security interest has been a key factor in the evolution of banking in this country”. Later, at p. 140, La Forest J. concluded:

The above considerations establish, to my satisfaction, that the s. 178 security interest, which originated as a policy response to structural deficiencies in the lending regimes of the nascent Canadian economy, has, since its inception, played a primordial role in facilitating access to capital by several groups that play a key role in the national economy. [Emphasis added.]

21 More recently, provincial legislatures have moved to protect secured creditors generally through the enactment of personal property security legislation: e.g. Personal Property Security Act, R.S.O. 1990, c. P.10; Personal Property Security Act, S.B.C. 1989, c. 36; and the PPSA. These statutory regimes have been implemented to increase certainty and predictability in secured transactions through the creation of a coherent system of priorities: Ronald C. C. Cuming and Roderick J. Wood, British Columbia Personal Property Security Act Handbook (2nd ed. 1993), at pp. 4‑5; G.M. Homes Inc., supra, at p. 252. The benefits of such certainty in commercial transactions, on basic economic principles, are intended to accrue to the health of the economy in general.

22 It can be seen from the foregoing, therefore, that the priority competition between statutory trusts and consensual security interests represents, in a broad sense, a clash between conflicting legislative objectives. To this extent, then, a resolution of the priority competition in the present case requires a sensitivity to the differing legislative objectives here at play. In particular, however, to the extent that the aim of personal property security regimes is to effect certainty in commercial transactions, the interpretation by the courts of such legislation and the development of the jurisprudence generally in this area must, to every extent possible, seek to achieve predictable results.

23 It has been unfortunate that the development of the case law, to this point, has not inspired the degree of certainty which is so manifestly desirable in this area of commercial law. Indeed, the jurisprudence has been referred to as a “troubled area of the law” (Manitoba (Minister of Labour) v. Omega Autobody Ltd. (Receiver of) (1989), 1989 CanLII 178 (MB CA), 59 D.L.R. (4th) 34 (Man. C.A.), at p. 36), and has been the subject of, at times, scathing academic criticism (Roderick J. Wood, “Revenue Canada's Deemed Trust Extends Its Tentacles: Royal Bank of Canada v. Sparrow Electric Corp.” (1995), 10 B.F.L.R. 429, and Roderick J. Wood and Michael I. Wylie, “Non-Consensual Security Interests in Personal Property” (1992), 30 Alta. L. Rev. 1055). The general view, I believe, has been summarized by Professor Wood in his most helpful case commentary, “Revenue Canada's Deemed Trust Extends Its Tentacles: Royal Bank of Canada v. Sparrow Electric Corp.”, supra, at p. 430: “[i]t is somewhat of an embarrassment that after more than two decades we still cannot confidently predict the outcome of a priority dispute between a deemed trust and a security interest”. The above judicial and academic commentary, I believe, invites this Court to proceed steadfastly towards the pronouncement of clear principles to be applied in determining the priority between statutory trusts and consensual security interests.

24 With these general observations in mind, I will now proceed to analyze the specific aspects of the competing claims advanced by the parties in the present case.

(B) The Nature of Section 227(4) and (5) Statutory Trusts

25 Section 153(1)(a) ITA places an affirmative duty upon employers to deduct and withhold amounts from their employees' pay cheques, and remit those withholdings to the Receiver General on account of the employees' tax payable. By virtue of s. 153(3) ITA, these withholdings are deemed to become the property of the employee:

153. ...

(3) When an amount has been deducted or withheld under subsection (1), it shall, for all the purposes of this Act, be deemed to have been received at that time by the person to whom the remuneration, benefit, payment, fees, commissions or other amounts were paid.

In a perfect world, these deductions would be made, a cash fund would be set aside by the employer, and the withheld amounts would be promptly remitted to the Receiver General when due. The deducted amounts, lawfully the property of the employee, would in this way be transferred to Her Majesty to be set against his overall tax payable.

26 As a practical reality, however, these deductions are often not remitted as required under the ITA. Instead, the withholdings are commonly made solely as a book entry, and therefore the deduction of taxes from wages becomes merely a notional transaction; no cash is actually set aside for remittance and, often, the deductions are not transferred to the Receiver General: see, e.g., Re Deslauriers Construction Products Ltd., 1970 CanLII 402 (ON CA), [1970] 3 O.R. 599 (C.A.), at p. 601. It is at this point which a business becomes indebted to Her Majesty for the amount of moneys only fictionally deducted. I hasten to add, however, that while it can be said Her Majesty at this point becomes de facto, if not de jure, a creditor of the non-remitting employer, the arrangement is dissimilar to an ordinary debtor-creditor situation in two fundamental respects. First, in contrast to usual negotiated credit arrangements, this transaction is of manifestly a non-consensual nature. Second, by virtue of s. 153(3), the debtor can in law be considered to be utilizing an asset which is the property of its employees. In this sense, it is not inaccurate to characterize the non-remittance of payroll deductions as a “misappropriation” of the property of another. Indeed, the authorities, correctly in my view, commonly refer to the conduct of the tax debtor in this manner: Roynat, supra, at p. 646, per Twaddle J.A.; and Pembina on the Red Development Corp. Ltd. v. Triman Industries Ltd. (1991), 1991 CanLII 2699 (MB CA), 85 D.L.R. (4th) 29 (Man. C.A.), at p. 48, per Lyon J.A. dissenting.

27 The economic reality of this sort of misappropriation of statutory deductions is artificially to increase the working capital of the tax debtor. By foregoing a cash payment to Her Majesty in the amount of the payroll deductions, the tax debtor is able to utilize the freed resources elsewhere in its business. The effect of non-remittance was summarized by Lyon J.A. in his dissenting reasons in Pembina on the Red Development, supra, at p. 48:

... either the tax debtor used the misappropriated deductions for its own purposes or the pool of moneys available for distribution to the tax debtor's creditors ... has been increased by the amount which the tax debtor failed to remit to the Receiver-General.

28 It is against the backdrop of this unfortunate factual scenario that the provisions of s. 227(4) and (5) can be seen to have been enacted. While it can be said that at the point of withholding the employer becomes the trustee of a fund which is in law the property of its employee, s. 227(4) has the effect of making Her Majesty the beneficiary under that trust. I agree with the observation of the mechanics of s. 227(4) made by Twaddle J.A. in Roynat, supra, at p. 646, where he states:

Although [s. 227(4)] calls the trust created by it a deemed one, the trust is in truth a real one. The employer is required to deduct from his employees' wages the amounts due by the employees under the statute. This money does not belong to the employer anymore. It belongs to the employees. The employer holds it in a statutory trust to satisfy their obligations.

The conceptual difficulty arises, of course, when the tax debtor fails to set aside moneys which are to be remitted. At this point, the subject of Her Majesty's beneficial interest becomes intermingled with the general assets of the tax debtor. As Twaddle J.A. rightly observed in Roynat, supra, at p. 646, “Her Majesty's claim ... then be[comes] that of a beneficiary under a non-existent trust”. In short, the misappropriation of statutory deductions conceptually problematizes the legal vehicle -- the concept of the trust -- which Parliament has invoked in order to regain the moneys lawfully owed to Her Majesty.

29 This conceptual dilemma is resolved by s. 227(5). That provision states that:

227. ...

(5) Notwithstanding any provision of the Bankruptcy Act, in the event of any liquidation, assignment, receivership or bankruptcy of or by a person, an amount equal to any amount

(a) deemed by subsection (4) to be held in trust for Her Majesty, ...

shall be deemed to be separate from and form no part of the estate in liquidation, assignment, receivership or bankruptcy, whether or not that amount has in fact been kept separate and apart from the person's own moneys or from the assets of the estate.

The effect of s. 227(5) naturally falls to be determined through a proper interpretation of the language contained in that subsection.

30 This Court recently had occasion to review the principles of law to be applied to the interpretation of tax legislation. In Alberta (Treasury Branches) v. M.N.R.; Toronto-Dominion Bank v. M.N.R., 1996 CanLII 244 (SCC), [1996] 1 S.C.R. 963, at pp. 975-76, Cory J. quoted this Court's decision in Friesen v. Canada, 1995 CanLII 62 (SCC), [1995] 3 S.C.R. 103, at pp. 112-14, where the relevant principles were summarized as follows:

In interpreting sections of the Income Tax Act, the correct approach, as set out by Estey J. in Stubart Investments Ltd. v. The Queen, 1984 CanLII 20 (SCC), [1984] 1 S.C.R. 536, is to apply the plain meaning rule. Estey J. at p. 578 relied on the following passage from E. A. Driedger, Construction of Statutes (2nd ed. 1983), at p. 87:

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

The principle that the plain meaning of the relevant sections of the Income Tax Act is to prevail unless the transaction is a sham has recently been affirmed by this Court in Canada v. Antosko, 1994 CanLII 88 (SCC), [1994] 2 S.C.R. 312. Iacobucci J., writing for the Court, held at pp. 326-27 that:

While it is true that the courts must view discrete sections of the Income Tax Act in light of the other provisions of the Act and of the purpose of the legislation, and that they must analyze a given transaction in the context of economic and commercial reality, such techniques cannot alter the result where the words of the statute are clear and plain and where the legal and practical effect of the transaction is undisputed: Mattabi Mines Ltd. v. Ontario (Minister of Revenue), 1988 CanLII 58 (SCC), [1988] 2 S.C.R. 175, at p. 194; see also Symes v. Canada, 1993 CanLII 55 (SCC), [1993] 4 S.C.R. 695.

I accept the following comments on the Antosko case in P. W. Hogg and J. E. Magee, Principles of Canadian Income Tax Law (1995), Section 22.3© “Strict and purposive interpretation”, at pp. 453-54:

It would introduce intolerable uncertainty into the Income Tax Act if clear language in a detailed provision of the Act were to be qualified by unexpressed exceptions derived from a court's view of the object and purpose of the provision.... (The Antosko case) is simply a recognition that “object and purpose” can play only a limited role in the interpretation of a statute that is as precise and detailed as the Income Tax Act. When a provision is couched in specific language that admits of no doubt or ambiguity in its application to the facts, then the provision must be applied regardless of its object and purpose. Only when the statutory language admits of some doubt or ambiguity in its application to the facts is it useful to resort to the object and purpose of the provision.

At pp. 976-77 of Alberta (Treasury Branches), supra, Cory J. concluded:

Thus, when there is neither any doubt as to the meaning of the legislation nor any ambiguity in its application to the facts then the statutory provision must be applied regardless of its object or purpose. I recognize that agile legal minds could probably find an ambiguity in as simple a request as “close the door please” and most certainly in even the shortest and clearest of the ten commandments. However, the very history of this case with the clear differences of opinion expressed as between the trial judges and the Court of Appeal of Alberta indicates that for able and experienced legal minds, neither the meaning of the legislation nor its application to the facts is clear. It would therefore seem to be appropriate to consider the object and purpose of the legislation. Even if the ambiguity were not apparent, it is significant that in order to determine the clear and plain meaning of the statute it is always appropriate to consider the “scheme of the Act, the object of the Act, and the intention of Parliament”.

31 In the present case, I find the language in s. 227(5) to be clear and unambiguous, especially when viewed as a provision directly following s. 227(4), which renders amounts unremitted as held in trust for Her Majesty. In my view, this section is designed to, upon liquidation, assignment, receivership or bankruptcy, seek out and attach Her Majesty's beneficial interest to property of the debtor which at that time is in existence. The trust is not in truth a real one, as the subject matter of the trust cannot be identified from the date of creation of the trust: D. W. M. Waters, Law of Trusts in Canada (2nd ed. 1984), at p. 117. However, s. 227(5) has the effect of revitalizing the trust whose subject matter has lost all identity. This identification of the subject matter of the trust therefore occurs ex post facto. In this respect, I agree with the conclusion of Twaddle J.A. in Roynat, supra, where he states the effect of s. 227(5) as follows, at p. 647: “Her Majesty has a statutory right of access to whatever assets the employer then has, out of which to realize the original trust debt due to Her”.

32 I add that this approach was taken to a provision substantially similar to s. 227(5) by Gale C.J. in Re Deslauriers Construction Products Ltd., 1970 CanLII 402 (ON CA), [1970] 3 O.R. 599 (C.A.), at p. 601, whose reasoning was affirmed by this Court in Dauphin Plains, supra. The Deslauriers case, supra, involved a priority competition between a trustee-in-bankruptcy and a statutory deemed trust provision created under the Canada Pension Plan, S.C. 1964-65, c. 51. Section 24(3) and (4) of that Act stated:

24. ...

(3) Where an employer has deducted an amount from the remuneration of an employee as or on account of any contribution required to be made by the employee but has not remitted such amount to the Receiver General of Canada, the employer shall keep such amount separate and apart from his own moneys and shall be deemed to hold the amount so deducted in trust for Her Majesty.

(4) In the event of any liquidation, assignment or bankruptcy of an employer, an amount equal to the amount that by subsection (3) is deemed to be held in trust for Her Majesty shall be deemed to be separate from and form no part of the estate in liquidation, assignment or bankruptcy, whether or not that amount has in fact been kept separate and apart from the employer's own moneys or from the assets of the estate.

This Court in Dauphin Plains, supra, at p. 1198, approved of Gale C.J.'s conclusion as to the interpretation of s. 24(4) (at p. 601 of Deslauriers, supra):

It seems to us that s-s. (4), and particularly the concluding six words thereof, were inserted in the Act specifically for the purpose of taking the moneys equivalent to the deductions out of the estate of the bankrupt by the creation of a trust and making those moneys the property of the Minister.

33 This interpretation of s. 227(5) also has the virtue of being consistent with the scheme of distribution under the Bankruptcy and Insolvency Act, R.S.C., 1985, c. B-3. Section 67 of that Act expressly removes claims for unremitted payroll deductions, which are held in trust (inter alia) pursuant to s. 227 ITA, from the bankrupt's estate:

67. (1) The property of a bankrupt divisible among his creditors shall not comprise

(a) property held by the bankrupt in trust for any other person,

(2) Subject to subsection (3), notwithstanding any provision in federal or provincial legislation that has the effect of deeming property to be held in trust for Her Majesty, property of a bankrupt shall not be regarded as held in trust for Her Majesty for the purpose of paragraph (1)(a) unless it would be so regarded in the absence of that statutory provision.

(3) Subsection (2) does not apply in respect of subsections 227(4) and (5) of the Income Tax Act, subsections 23(3) and (4) of the Canada Pension Plan or subsections 57(2) and (3) of the Unemployment Insurance Act....

34 It is to be observed that in addition to attaching Her Majesty's interest to the debtor's property upon the triggering of any of the events mentioned in s. 227(5), the deemed trust operates to the benefit of Her Majesty in a secondary manner. Namely, s. 227(5) permits Her Majesty's interest to attach to collateral which is subject to a fixed charge if the deductions giving rise to Her Majesty's claim arose before that charge attached to that collateral. This proposition flows from the decision of this Court in Dauphin Plains, supra. Dauphin Plains involved a determination as to priority in respect of the proceeds of a liquidation sale of a receiver-manager. In that case, the claims of Her Majesty (inter alia) arose by virtue of the non-remittance of payroll deductions in regard to payments under the Canada Pension Plan, R.S.C. 1970, c. C-5, and the Unemployment Insurance Act, 1971, S.C. 1970-71-72, c. 48. Those Acts provided Her Majesty with claims pursuant to deemed trusts whose language is substantially similar to the version of s. 227(4) and (5) at issue in this appeal. In finding that these claims took precedence over a floating charge which had crystallized after the deductions at issue were actually made, Pigeon J. stated at p. 1199:

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 dates is selected, both are subsequent to the deductions. [Emphasis added.]

Thus, s. 227(5) alternatively permits Her Majesty's interest to attach retroactively to the disputed collateral if the competing security interest has attached after the deductions giving rise to Her Majesty's claim in fact occurred. Conceptually, the s. 227(5) deemed trust allows Her Majesty's claim to go back in time and attach its outstanding s. 227(4) interest to the collateral before that collateral became subject to a fixed charge. The same result occurs when a statutory lien attaches prior to the mortgaging of disputed collateral. In Avco, supra, this Court per Martland J. commented upon just such a scenario, at p. 706:

From that date, the lien attaches to the employer's property and, as provided in subs. (1), it will take priority over any other claim, including an assignment or mortgage. In other words, after the lien attaches, its priority is unaffected by a disposition of his property made by the employer. Where a mortgage has been made prior to the lien attaching, it is not affected. The lien will only attach to the employer's equity in that property. [Emphasis added.]

See also G.M. Homes Inc., supra, at p. 250.

35 In this appeal, however, the deductions of tax from the employees' pay cheques occurred after the attachment of the bank's fixed charge to the inventory. As such, this second aspect of s. 227(5)'s operation is not at issue in this case.

36 I find support for the interpretation of s. 227(5) that I have taken in as much as it is consistent with the overall purpose of s. 227(4) and (5). In Pembina on the Red Development, supra, Lyon J.A. (dissenting) had occasion to comment upon the purpose of the predecessor section to the current s. 224(1.2) ITA, namely s. 224(1.2) and (1.3) of the Income Tax Act, S.C. 1970-71-72, c. 63, which were added by S.C. 1987, c. 46, s. 66. I find that Lyon J.A.'s comments in this respect to be fully applicable to the articulation of the purpose of s. 227(5). At p. 51, Lyon J.A. stated:

One must always remember that the withholding tax or source deduction to which s. 224 applies is at the heart of the collection procedures for personal income taxation in Canada. Indeed, if one makes a calculation from the statistics reported in “Taxation Statistics, 1987”, a publication of Revenue Canada Taxation, Catalogue No. RV-1987, one finds that 87% of all personal income taxes paid in Canada are collected by source deductions. It can thus be seen that Parliament in passing s. 224(1.2) made it as all-encompassing as it is in order to ensure its continued viability. No other system is so crucial to the overall collection procedure adopted by the Crown. Parliament clearly meant to protect this system. Using the employer as a tax collector requires such extra protection in cases such as the one at bar where the employer converts the withheld tax money to its own purposes. Understandably, that conversion cannot be countenanced if the integrity of that system is to be preserved. Parliament, therefore, acting within its constitutional authority, has taken this extraordinary remedy to protect a major collection source.

Similarly, Parliament has clearly sought to protect the collection of unremitted payroll deductions through the device of the statutory deemed trust. Accordingly, s. 227(5) must be interpreted in light of this purpose. To summarize, it operates in a twofold manner: upon the triggering of an event specified in s. 227(5), Her Majesty's beneficial interest (i) attaches to the tax debtor's property then in existence; or (ii) attaches to collateral subject either to a fixed charge, or a crystallized floating charge, if the actual deductions giving rise to Her Majesty's claim occurred before the fixed charge attached, or the floating charge crystallized, respectively.

37 One further point with respect to terminology is necessary before leaving the present discussion. The method of attachment of Her Majesty's beneficial interest pursuant to s. 227(5) has been referred to at times as a “mechanism for tracing”: Roynat, supra, at p. 647. This was indeed how it was presented by counsel for Her Majesty in his submissions before this Court. During the hearing of this case, it was questioned whether this was not an awkward usage of the word “tracing”. After considering the matter, it is my view that it is not accurate to describe the mechanism of s. 227(5) as a means of “tracing”; indeed, it would seem that this subsection is antithetical to tracing in the traditional sense, to the extent that it requires no link at all between the subject matter of the trust and the fund or asset which the subject matter is being traced into: D. W. M. Waters, Law of Trusts in Canada, supra, at pp. 1037-53. For this reason, I find Professor Wood's description of the operation of s. 227(5), namely, a “relaxation of the equitable tracing rules”, to be most accurate: Roderick J. Wood, “The Floating Charge in Canada” (1989), 27 Alta. L. Rev. 191, at p. 221; see also Omega, supra, at p. 43; and Re Deslauriers Construction Products Ltd., supra, at p. 603.

38 In conclusion, s. 227(5) is a provision designed to minimize the adverse effect upon Her Majesty from the misappropriation of trust funds held by tax debtors on account of their employees' tax payable. The provision contemplates an intermingling of Her Majesty's property with that of a tax debtor's, such that the subject matter of the trust cannot be (or indeed never was) identifiable. To address this conceptual problem, s. 227(5) allows Her Majesty to attach its interest to any property which lawfully belongs to the debtor at the time of liquidation, assignment, receivership or bankruptcy; this property is then deemed to exist “separate” and apart from the tax debtor's estate. The ITA thus permits Her Majesty to transfer title in the property from the tax debtor to Herself in order to satisfy the tax debtor's outstanding unremitted payroll obligations.

39 I would hasten to add to this, however, that this provision does not permit Her Majesty to attach Her beneficial interest to property which, at the time of liquidation, assignment, receivership or bankruptcy, in law belongs to a party other than the tax debtor. Section 227(4) and (5) are manifestly directed towards the property of the tax debtor, and it would be contrary to well-established authority to stretch the interpretation of s. 227(5) to permit the expropriation of the property of third parties who are not specifically mentioned in the statute. As Martland J. stated in Avco, supra, at p. 706:

The property to which a s. 5A lien attaches is not defined nor identified. In the absence of a specific statutory provision to that effect, in my view it should not be construed in a manner which could deprive third parties of their pre-existing property rights.

Similarly, in Pembina on the Red Development, supra, Scott C.J. stated the presumption against expropriation of property, at p. 38:

In Cross, Statutory Interpretation (London: Butterworths, 1987), the author writes at p. 180:

There is a general presumption that Parliament does not intend to take away private property rights unless the contrary is clearly indicated. Lord Atkinson stated that there is a canon of interpretation “that an intention to take away the property of a subject without giving to him a legal right to compensation for the loss of it is not to be imputed to the legislature unless that intention is expressed in unequivocal terms.” After all, the protection of property is generally regarded as one of the fundamental values of a liberal society. [Emphasis added.]

Later in that same case, Twaddle J.A., in separate concurring reasons, articulated this same principle as follows, at p. 46, “[i]t is a long-established principle of law that, in the absence of clear language to the contrary, a tax on one person cannot be collected out of property belonging to another”.

40 Thus, while s. 227(5) can be seen as a provision enacted to solve the conceptual dilemma precipitated by an intermingling of unremitted payroll deductions with a tax debtor's general assets, it is a legal vehicle not without its own conceptual limitations. Namely, while the s. 227(5) deemed trust permits Her Majesty to attach Her beneficial interest to property of the tax debtor upon liquidation (assignment, receivership or bankruptcy), it does not permit the expropriation of property which may belong to a third party creditor at the time the subsection becomes engaged.

41 However, as will be discussed in further detail, infra, it is my opinion that the licence theory may, in certain cases, create an exception to this general principle. In particular, where a secured creditor consents to the disposition of his collateral in order to pay wage deductions, that consent, coupled with the statutory trust provisions here at issue, may act to divest that creditor of its proprietary interest in that collateral at the time of liquidation, assignment, receivership or bankruptcy. Indeed, it is my view that this exception is engaged in the present case such that the s. 227(5) claim of Her Majesty must prevail.

(C) The Nature of the Bank's Security Interests

42 I begin from the observation that Parliament, in enacting s. 227(4) and (5), has chosen to secure Her Majesty's claims to unremitted payroll deductions through employing the concept of a deemed trust. Therefore, the proper analysis to follow in determining whether Her Majesty is entitled to priority pursuant to these subsections must utilize principles of property law. For this reason, it becomes relevant and indeed essential to scrutinize the nature of the interests which compete with Her Majesty's trust in order to determine whether and to what extent such interests have title in the disputed fund. As I mentioned previously, Her Majesty's trust can attach to the disputed collateral only to the extent that that collateral is not in law the property of a party other than the tax debtor at the time the deemed trust is engaged. More specifically, subject to the application of the licence theory, if it is found that legal title in the collateral is in the bank, and not Sparrow, Her Majesty's deemed trust could only attach to Sparrow's equity of redemption: see Avco, supra, at p. 706.

43 This “statutory trust” approach can be distinguished from other legislative methods which are used to secure an interest to unremitted payroll deductions, namely, through employing an explicit “Crown priority” provision. An example of such a provision can be found in s. 224(1.2) ITA, a subsection which was recently the subject of consideration of this Court in Alberta (Treasury Branches), supra. That provision reads:

224. ...

(1.2) Notwithstanding any other provision of this Act, the Bankruptcy Act, any other enactment of Canada, any enactment of a province or any law, where the Minister has knowledge or suspects that a particular person is or will become, within 90 days, liable to make a payment

(a) to another person ... who is liable to pay an amount assessed under subsection 227(10.1) or a similar provision, or

(b) to a secured creditor who has a right to receive the payment that, but for a security interest in favour of the secured creditor, would be payable to the tax debtor,

the Minister may, by registered letter or by a letter served personally, require the particular person to pay forthwith, where the moneys are immediately payable, and in any other case, as and when the moneys become payable, the moneys otherwise payable to the tax debtor or the secured creditor in whole or in part to the Receiver General on account of the tax debtor's liability under subsection 227(10.1) or a similar provision, and on receipt of that letter by the particular person, the amount of those moneys that is required by that letter to be paid to the Receiver General shall, notwithstanding any security interest in those moneys, become the property of Her Majesty and shall be paid to the Receiver General in priority to any such security interest. [Emphasis added.]

In contrast to the “deemed trust” approach, the application of this section to a priority competition can proceed without regard to the quality of the “security interest” which competes with Her Majesty's claim. Indeed, s. 224(1.2) simply transfers title in the collateral to Her Majesty regardless of whose interest may compete with it, so long as the requirements of s. 224(1.2) are met: see, e.g., Alberta (Treasury Branches), supra. For a general discussion of these two distinct analytical methods of determining priority between non-consensual security interests (such as statutory trusts) and consensual security interests, see Wood and Wylie, “Non-Consensual Security Interests in Personal Property”, supra, at pp. 1072-83.

44 In the present case, it therefore becomes necessary to characterize the bank's interest in Sparrow's inventory as either a floating, or a fixed and specific charge.

45 The basic distinction between fixed and floating charges was articulated by Lord Macnaghten in Illingworth v. Houldsworth, [1904] A.C. 355 (H.L.), at p. 358:

A specific charge, I think, is one that without more fastens on ascertained and definite property or property capable of being ascertained and defined; a floating charge, on the other hand, is ambulatory and shifting in its nature, hovering over and so to speak floating with the property which it is intended to affect until some event occurs or some act is done which causes it to settle and fasten on the subject of the charge within its reach and grasp.

The “event ... or ... act” to which Lord Macnaghten refers to as causing the floating interest to “settle and fasten” is described in the modern authorities as “crystallization”. Generally speaking, crystallization occurs upon the default of the debtor. Once the floating interest has been said to crystallize, that interest is transformed into a fixed and specific charge over the inventory. See Wood, “The Floating Charge in Canada”, supra, at pp. 204-8.

46 The critical significance of the characterization of an interest as being fixed or floating, of course, is that it describes the extent to which a creditor can be said to have a proprietary interest in the collateral. In particular, during the period in which a charge over inventory is floating, the creditor possesses no legal title to that collateral. For this reason, if a statutory trust or lien attaches during this time, it will attach to the debtor's interest and take priority over a subsequently crystallized floating charge. However, if a security interest can be characterized as a fixed and specific charge, it will take priority over a subsequent statutory lien or charge; in such a case, all that the lien can attach to is the debtor's equity of redemption in the collateral: Avco, supra, at p. 706. This correlative relationship between fixed charges and legal ownership was articulated by this Court in Dauphin Plains, supra, at p. 1199, where Pigeon J. stated:

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. [Emphasis added.]

See also Avco, supra.

47 There has been much debate as to whether it is appropriate to characterize a security interest over inventory which permits the debtor to sell that inventory in the ordinary course of business as a floating charge. The debate centres around the ability to characterize a security interest as fixed, in the presence of a licence given to the debtor to sell the collateral, where such an arrangement involves “no final and irrevocable appropriation of property to the creditor”: FBDB, supra, at p. 33. McLachlin J.A. (as she then was) in FBDB, supra, fully considered the conflicting authorities on this point and concluded at pp. 37-38 and 40:

In short, the answer to the question of whether the courts have recognized a fixed charge subject to a licence to sell in the ordinary course of business is no, with the exception of the line of cases confirming the right of a chattel mortgagor to sell mortgaged stock in the ordinary course of business.

If a charge conferred on the debtor the right to deal with the goods in the ordinary course of business then, regardless of what the parties chose to call it, it was regarded as floating, with the result that third party interests acquired prior to crystallization of the charge had priority over the chargeholder.

Adopting this “either-or” doctrine, McLachlin J.A. chose to characterize the security agreement in FBDB, which permitted the debtor to sell the secured collateral in the ordinary course of the debtor's business, as a floating charge.

48 I note also that this Court very recently referred to the decision of McLachlin J.A. in FBDB, supra, with approval: Alberta (Treasury Branches), supra. While the issue in that case was different from that in FBDB, the comments of Cory J. can, I think, be taken as affirming the “either-or” doctrine as applied in FBDB.

49 The relevance of the “either-or” doctrine to the present case, of course, lies in the fact that Sparrow had been granted by the bank, both expressly and impliedly, a licence to sell the inventory over which the bank held a security interest. It therefore could be argued that such a licence renders the interest of the bank in the nature of a floating charge, an interest which must yield to a statutory trust which attaches prior to the charge's crystallization.

50 I do not find it necessary to comment on FBDB to the extent that that decision suggests that in the present case the interests of the bank should be characterized as a floating charge. It should be noted that the decision of McLachlin J.A. in the FBDB case predated the enactment of personal property security legislation in British Columbia, and so does not speak to the state of the law in a PPSA jurisdiction. Nor did that case deal with any other statutory enactment, such as the Bank Act, which could affect the characterization of the security agreement there at issue. For these reasons, I consider the comments of McLachlin J.A. in FBDB to be directed to the common law position with regard to the characterization of fixed and floating charges. Whatever those common law principles may be, they cannot be taken to alter the effect that legislation may have on the characterization of security interests. As it is my view that the Alberta PPSA and the Bank Act are determinative of the characterization of the bank's GSA and BAS, respectively, I do not need to address the common law view articulated in FBDB.

51 I turn now to consider each of the bank's security interests.

(i) The General Security Agreement (GSA)

52 Counsel for the appellant, Her Majesty, argued in his factum that the bank's GSA is to be considered in the nature of a floating charge. In support of this proposition, counsel advances the decision of the Ontario Court of Appeal in Re Urman (1983), 1983 CanLII 1854 (ON CA), 44 O.R. (2d) 248. In that case, involving a general assignment of book debts perfected under the Ontario Personal Property Security Act, the security interest was characterized as a floating charge.

53 For the reasons which follow, I cannot accept this submission. In my view, the general security agreement in this case, which was subject to the Alberta personal property security legislation, must be characterized as a fixed and specific charge subject to a licence to sell the inventory.

54 It is of course true that the PPSA does not govern the priority competition between a statutory trust and a security interest. Subsection 4(a) explicitly removes statutory trusts such as the one created by s. 227 ITA from the province of the Alberta PPSA:

4 Except as otherwise provided in this Act, this Act does not apply to the following:

(a) a lien, charge or other interest given by an Act or rule of law in force in Alberta;

However, this does not mean that the PPSA does not affect the characterization of a charge executed in a jurisdiction which is subject to such an Act. To the contrary, the effect of personal property security legislation has been said to have “fundamentally changed the characterization of security interests”: Wood and Wylie, “Non-Consensual Security Interests in Personal Property”, supra, at p. 1082. In particular, while pre-PPSA, a security agreement purporting to create a floating charge could be said to remain unattached to the collateral until crystallization, s. 12(1) of the Alberta PPSA manifestly alters this situation. That subsection reads:

12(1) A security interest, including a security interest in the nature of a floating charge, attaches when

(a) value is given,

(b) the debtor has rights in the collateral, and

(c) except for the purpose of enforcing rights between the parties to the security agreement, the security interest becomes enforceable within the meaning of section 10,

unless the parties specifically agree in writing to postpone the time for attachment, in which case the security interest attaches at the time specified in the agreement.

The relevant portion of s. 10 for our purposes states:

10(1) Subject to subsection (2), a security interest is enforceable against a third party only where

(a) the collateral is in the possession of the secured party, or

(b) the debtor has signed a security agreement that contains

(ii) a statement that a security interest is taken in all of the debtor's present and after-acquired personal property ....

Generally speaking, therefore, absent an express intention to the contrary, a security interest in all present and after-acquired personal property will attach when that agreement is executed by the parties. Once attachment has occurred, in my view, the GSA then becomes in law a fixed and specific charge over the collateral.

55 I find support in this conclusion as to the effect of personal property security legislation upon security interests from the fact that the academic literature is unanimous on this point. For example, Professor Jacob S. Ziegel in his article “Symposium: Recent and Prospective Developments in the Personal Property Security Law Area” (1985), 10 Can. Bus. L.J. 131, commented as follows, at p. 152:

It is of the first importance to determine whether a security interest under the PPSA retains any of the common law characteristics of a floating charge and if so which. My own view is that once a security interest has attached under the PPSA it has no “floating” attributes even though the security agreement, expressly or impliedly, gives the debtor considerable powers to dispose of the collateral in the course of his business. In brief, the PPSA only recognizes specific or fixed security interests although admittedly the collateral itself may often change its character because of the express or implied powers of disposition given the debtor. [Emphasis added.]

This opinion is echoed by Professor Wood in his recent article “Revenue Canada's Deemed Trust Extends Its Tentacles: Royal Bank of Canada v. Sparrow Electric Corp.”, supra, at p. 433:

Under pre-PPSA law, a plausible argument could be made that a security interest in the form of a fixed charge combined with a licence to deal is, in effect nothing more than a floating charge. However, this argument [is] untenable in the cases involving PPSA security interests....

Similarly, Professor Ronald C. C. Cuming, in “Commercial Law -- Floating Charges and Fixed Charges of After-Acquired Property: The Queen in the Right of British Columbia v. Federal Business Development Bank” (1988), 67 Can. Bar Rev. 506, at pp. 510-11, opined:

In effect, [PPS] legislation treats all charges, including floating securities, as fixed charges. The legislatures that have enacted Personal Property Security Acts have implicitly declared that, as a matter of public policy, there is nothing objectionable to having a fixed charge on stock-in-trade of a debtor coupled with a licence to deal with the collateral in the ordinary course of business. [Emphasis added.]

At p. 519, the learned author concludes “there can be no such thing as a floating charge under a Personal Property Security Act”.

56 Applying this principle to the case at bar, the GSA held by the respondent bank must certainly be characterized as a fixed and specific charge. It attached at the time the agreement was executed, February 25, 1992. More specifically, however, because of the permission granted by the bank which allowed Sparrow to sell the encumbered inventory, the GSA is in the nature of a fixed charge with a licence to deal with the inventory.

(ii) Bank Act Security (BAS)

57 The appellant has further submitted that the respondent bank's BAS is in the nature of a floating charge over the inventory. Several lower court decisions have been relied upon in support of this proposition: Abraham, supra (under appeal); Armstrong, supra; and North Sky Trading Inc. (Bankrupt), Re (1994), 1994 CanLII 8986 (AB KB), 158 A.R. 117 (Q.B.) (under appeal).

58 The earliest authority to comment upon the nature of BAS is the decision of this Court in Royal Bank of Canada v. Workmen's Compensation Board of Nova Scotia, 1936 CanLII 39 (SCC), [1936] S.C.R. 560. That case involved a priority competition between security under s. 88 of the Bank Act, R.S.C. 1927, c. 12, the predecessor of s. 427, and a lien created by s. 79(2) of The Workmen's Compensation Act, R.S.N.S. 1923, c. 129. In his concurring judgment, Davis J. observed the effect of s. 88 security as follows, at p. 567:

. . . the security [does] not operate to transfer absolutely the ownership in the goods but ... the transaction [is] essentially a mortgage transaction and subject to the general law of mortgages except where the statute has otherwise expressly provided.... Section 88 set up by the Bank Act enables manufacturers, who desire to obtain large loans from their bankers in order to carry on their industrial activities, to give to the bank a special and convenient form of security for the bank's protection in the large banking transactions necessary in the carrying on of industry throughout the country. Until the moneys are repaid, the bank is the legal owner of the goods but sale before default is prohibited and provision is made for the manufacturer regaining title upon repayment. To say that Parliament did not use language to expressly provide that the bank shall have a first lien on the goods is beside the mark. The bank acquires ownership in the goods by the statute. [Emphasis added.]

59 More recently, this Court had occasion to consider the attributes of Bank Act security in Hall, supra. In that case, La Forest J. underlined this Court's previous ruling in Workmen's Compensation Board of Nova Scotia, supra, that BAS gives to the lender legal title in the collateral. At pp. 133-34, La Forest J. stated:

By section 178(2) [now s. 427(2)], a bank may take security in property owned by the borrower at the time of the loan transaction, and any property acquired during the pendency of the security agreement. The rights and powers of the bank with respect to the secured property are set out in s. 178(2)(c). By the terms of s. 178(2)(c), these rights and powers are stated to be “the same rights and powers as if the bank had acquired a warehouse receipt or bill of lading in which such property was described”. These powers are defined, in turn, in s. 186 [now s. 435] of the Act where it is specified that any warehouse receipt or bill acquired by a bank as security for the payment of a debt, vests in the bank all the right and title to goods, wares and merchandise covered by the holder or owner thereof.

The nature of the rights and powers vested in the bank by the delivery of the document giving the security interest has been the object of some debate. Argument has centred on whether the security interest should be likened to a pledge or bailment, or whether it is more in the nature of a chattel mortgage. I find the most precise description of this interest to be that given by Professor Moull in his article “Security Under Sections 177 and 178 of the Bank Act” (1986), 65 Can. Bar Rev. 242, at p. 251. Professor Moull, correctly in my view, stresses that the effect of the interest is to vest title to the property in question in the bank when the security interest is taken out. He states, at p. 251:

The result, then, is that a bank taking security under section 178 effectively acquires legal title to the borrower's interest in the present and after-acquired property assigned to it by the borrower. The bank's interest attaches to the assigned property when the security is given or the property is acquired by the borrower and remains attached until released by the bank, despite changes in the attributes or composition of the assigned property. The borrower retains an equitable right of redemption, of course, but the bank effectively acquires legal title to whatever rights the borrower holds in the assigned property from time to time. [Emphasis added.]

60 It follows from the comments of this Court regarding the ownership rights in inventory conferred by the Bank Act that security taken under that Act must be considered to be in the nature of a fixed and specific charge. As stated above, the concept of the fixed charge is correlative to the notion of a creditor’s having legal proprietary rights in the collateral. I add that this view has been adopted by academic literature in this area: R. J. Wood, “Revenue Canada's Deemed Trust Extends Its Tentacles: Royal Bank of Canada v. Sparrow Electric Corp.”, supra, at p. 433; and William D. Moull, “Security Under Sections 177 and 178 of the Bank Act” (1986), 65 Can. Bar Rev. 242. I find this following passage, at p. 251, from the article written by Professor Moull which was cited with approval by this Court in Hall, supra, particularly persuasive:

Because of its scope and flexibility, some commentators have suggested that section 178 [now 427] security is in the nature of a floating charge. This can be misleading, however. Because the bank effectively acquires legal title, section 178 security is really in the nature of a fixed charge on the present and after-acquired property of the borrower assigned to the bank. One attribute that section 178 security may be said to share with a floating charge is its application to all property of a specified class held by the borrower from time to time. But while a floating charge may apply to all property of a specified kind held by the borrower from time to time, it does not affix itself specifically upon any particular item of property until it crystallizes upon default by the borrower. Conversely, a section 178 security is a fixed charge on each item of assigned property held from time to time whether or not the loan is in default. This gives a bank significantly greater rights than it would hold under a floating charge debenture on inventory.

61 For these reasons, I consider the security interest of the bank in the form of BAS to be in the nature of a fixed and specific charge with a licence to sell the inventory.

(iii) Summary -- Fixed and Specific Charge Over Inventory

62 It would seem appropriate at this point, before leaving the present discussion, to comment briefly upon this novel and perhaps abstract notion of possessing a fixed charge over all of the present and future inventory of a debtor. To begin with, I note that traditional definitions of the fixed charge, as for example the one I previously quoted above from Illingworth, supra, emphasize the ability to “settle and fasten” upon ascertainable and defined property as being an integral attribute to this particular form of charge. This type of attachment to tangible and ascertainable property, of course, is impossible to achieve in the case of an assignment of inventory, where that collateral is changing constantly. In short, the traditional concept of the fixed charge seems to be at odds with the notion of having a proprietary right over collateral such as after-acquired inventory which, by definition, is not yet in existence at the time the security agreement is executed.

63 In my view, however, a fixed charge over all present and future inventory represents a proprietary interest over a dynamic collective of present and future assets. To this extent, as stated above, this form of security interest challenges our traditional conception of a fixed charge; to the same extent, in my opinion, our conception of this form of charge must change to meet the modern realities of commercial law, and in particular the legislative provisions which have been brought to bear in this appeal.

64 In effect, the fixed and specific charge gives to the secured creditor the title (subject, of course, to the debtor's equitable right of redemption) to the present inventory of the debtor, as well as the after-acquired inventory of the debtor. In this way, the secured creditor becomes the legal owner of inventory as it comes into possession of the debtor. I note that the Alberta PPSA contains a specific provision securing a creditor's proprietary right to after-acquired property in this way:

13(1) Except as provided in subsection (2), where a security agreement provides for a security interest in after-acquired property, the security interest attaches in accordance with section 12, without the need for specific appropriation. [Emphasis added.]

Professors Cuming and Wood, in their published annotation of the Alberta PPSA, observe that by virtue of this subsection “the security interest in after-acquired property has equal status with a security interest in collateral in existence at the time the security agreement is executed”: Cuming and Wood, Alberta Personal Property Security Act Handbook (2nd ed. 1993), at p. 121 (emphasis added). Similarly, the BAS has the effect of presently attaching the secured creditor's interest to the after-acquired inventory of the debtor. In Hall, supra, La Forest J. approved of Professor Moull's description of the effect of the relevant provisions of the Bank Act, at p. 134, which is particularly apposite to the present discussion:

The result, then, is that a bank taking security under section 178 [now s. 427] effectively acquires legal title to the borrower's interest in the present and after-acquired property assigned to it by the borrower. The bank's interest attaches to the assigned property when the security is given or the property is acquired by the borrower and remains attached until released by the bank, despite changes in the attributes or composition of the assigned property. The borrower retains an equitable right of redemption, of course, but the bank effectively acquires legal title to whatever rights the borrower holds in the assigned property from time to time. [Emphasis added.]

65 It follows from these observations that where, as here, a secured creditor holds a fixed charge over a debtor's inventory, that charge will have the effect of ensuring the creditor has legal title to any and all inventory subject to the charge at any given point in time. This, of course, is subject to the caveat (not operative in this case) that no outstanding statutory payroll deductions had in fact been made prior to the attachment of the fixed charge. Thus, in the present case, the inventory which was subject to the liquidation sale belonged in law to the respondent bank: both under its GSA and its BAS the bank held a fixed charge over Sparrow's inventory. As such, all that Her Majesty's beneficial interest could attach to, before its sale, was Sparrow's equity of redemption in the property: Avco, supra; C.I.B.C. v. Klymchuk (1990), 1990 ABCA 141, 74 Alta. L.R. (2d) 232 (C.A.), at p. 240.

66 But this of course does not end the matter. While it is true that the bank held legal title in the inventory which is the subject of the dispute in this case, it is also true that at the time the deductions were made the bank had given its permission to Sparrow to sell this inventory in the course of its business. The GSA contained an express licence to this effect; and the BAS impliedly contained such a licence. In this way, the bank had consented, contractually, to the divestment of their interest in the collateral taken in inventory and the usage of the proceeds of that collateral for certain purposes. The critical issue which falls to be decided is, then, what is the scope of this contractual licence? In particular, if this bank's consent included the right to sell the inventory in order to pay wages, then that consent by necessity included the right to sell inventory to remit payroll deductions. In such a situation, for the following reasons, Her Majesty's interest would be able to attach to the proceeds of the inventory, and in this way take priority over the bank's interest.

67 As stated previously, at para. 41, it is my opinion that the licence theory may operate, in the context of the statutory scheme at issue in the present appeal, as an exception to the general rule that at the time of “liquidation, assignment, receivership or bankruptcy” Her Majesty’s interest cannot attach to property which is at that time the property of a secured creditor. More specifically, where it can be said that at the time the deductions were made a secured creditor had consented to the use of its collateral in order to pay the statutory deductions which are the object of a deemed trust, it may also be said that that creditor has bound itself by the statutory requirements relating to those deductions. Here, therefore, if it can be said that at the time the wage deductions at issue were made the bank had permitted the sale of inventory in order to pay wages, and thus wage deductions, it will be possible for s. 227(5) to attach to the bank’s inventory existent at the time of receivership. With regard to this approach to the licence theory, see FBDB, supra, at pp. 40-41, Roynat, supra, at pp. 649-50, and G.M. Homes Inc., supra, at pp. 252-54.

68 In short, where the bank has consented to the reduction in the value of its security in order to pay statutory deductions at the time those deductions are made, they have to the same extent, by virtue of s. 227(5), consented to the reduction in their security at the time of receivership. The critical question which falls to be decided in this case, then, is what was the scope of the bank’s consent to sell inventory at the time the deductions were made?

(D) Whether on the Facts the Licence to Sell Included the Right to Use the Proceeds to Pay Wages?

69 I underline at the outset that the critical factor in the “licence to sell” argument is the permission which must be found to have been granted with respect to the usage of the proceeds of the disputed collateral. Thus, while licences may often be mouthed in terms of a “right to sell in the ordinary course of business”, it must not be forgotten that it is permission with respect to the usage of proceeds, and not necessarily the circumstances of sale, which is the proper focus of the inquiry.

70 When interpreting the contractual provisions which gave Sparrow the right to sell the encumbered inventory, it is necessary to look at the words of the contract, the nature of the transaction which the parties entered into, and all of the surrounding circumstances.

71 The express provisions of the GSA establishes that Sparrow was granted a licence to sell the encumbered inventory. In particular, the licence stated that:

. . . until default, Debtor may, in the ordinary course of Debtor's business, sell or lease inventory and, subject to Clause 7 hereof, use Money available to Debtor. [Emphasis added.]

Therefore, Sparrow was permitted to sell its inventory in the ordinary course of its business and “use” the proceeds generated therefrom. The critical question is what “us[age]” this licence to sell in the “ordinary course of ... business” contemplated. In this connection, I find two of the express covenants in Sparrow's contractual arrangements to be salient. Paragraph 4(e) of the GSA required Sparrow:

(e) to pay all taxes, rates, levies, assessments and other charges of every nature which may be lawfully levied, assessed or imposed against or in respect of Debtor or Collateral as and when the same become due and payable; [Emphasis added.]

In addition, in the Credit Facilities Agreement, Sparrow covenanted to the bank as follows:

(3) it will promptly pay when due all business, income and other taxes properly levied on its operations and property and remit all statutory employee deductions when due; [Emphasis added.]

72 Looking at these express provisions of the contractual arrangements between Sparrow and the bank, I conclude that the payment of payroll deductions would be a usage to which the bank contemplated Sparrow would use the proceeds of inventory sold in the “ordinary course of ... business”. My conclusion in this respect is buttressed when the nature of the dealings between Sparrow and the bank, and all the surrounding circumstances.

73 The bank was Sparrow's primary lender; it held a security interest in most, if not all, of Sparrow's assets. In particular, the bank held various security interests in Sparrow's inventory. It was of course in the bank's best interest that Sparrow function as a viable economic unit. To do so, Sparrow was required to sell its services as an electrical contractor and, necessarily, sell its inventory. From the sales of the inventory, Sparrow could generate revenues to, inter alia, pay its outstanding operating debts. If it failed to do so, Sparrow could be petitioned into bankruptcy, with the result that Sparrow could no longer generate the profits necessary to pay its loan obligations to the bank in the long term. One of Sparrow's ongoing obligations, its costs of doing business, was the paying of wages. In order to stay in business, and operate as a profitable business enterprise, Sparrow would have to pay its employees. This is a necessary requirement of continuing in business. It would be reasonable that the bank expect, taking into consideration all the circumstances of this arrangement, that revenue from the sale of inventory would be used to pay wages.

74 From these observations, I consider the licence to sell inventory in the ordinary course of business in this case necessarily included a licence to sell inventory to pay wages, and remit wage deductions, in the course of its business. Where, as here, the secured party has security over the majority of the assets of the debtor, the security interest over the inventory must permit the debtor to sell the inventory and put it to the general use of its business, including towards the payment of wages. Indeed, the express terms of the licence intimates this, providing Sparrow could, “in the ordinary course of ... business, ... use Money available”. The scope of the licence can thus be ascertained either from the express terms of the security agreement, or from the nature of the agreement and the conduct of the parties. To be clear, however, the scope of the licence in this case flows not merely from a right to sell inventory per se. Instead, it is the licence to sell inventory in the “ordinary course of [Sparrow's] business ... and use [the proceeds]” which renders it of such a quality as to include a right to use the proceeds to pay wages. As Professor Wood has correctly observed in “Revenue Canada’s Deemed Trust Extends Its Tentacles: Royal Bank of Canada v. Sparrow Electric Corp.”, supra, at p. 435, a licence to sell inventory may in certain circumstances be circumscribed so as to not include a right to use the proceeds to pay wages:

The fact that the secured party permits the debtor to sell the inventory does not in itself imply that the secured party permits the debtor to use these proceeds to pay employees. In some cases the secured party will not restrict the debtor's ability to use the proceeds in the ordinary course of business, but this depends entirely on the security arrangement negotiated between the debtor and the secured party. Consider the following scenario:

SP finances the acquisition of inventory by an automobile dealer (D), and is granted a security interest in the inventory. The wholesale security agreement provides that D may sell the inventory in the ordinary course of business and that upon doing so D must immediately remit the wholesale purchase price of the automobile to SP.

In this scenario, SP clearly does not permit the debtor to use the proceeds of inventory to pay its employees. Indeed, it is common for SP to regularly monitor the debtor to ensure that the debtor is not “out of trust” by failing to remit the proceeds of sale.

75 In summary, the true test of whether the licence to sell inventory includes the right to pay wages must therefore be a matter of interpreting the contractual arrangement between the parties. The focus is not so much on the circumstances of the selling of inventory, but rather the permitted usage of the proceeds of inventory. As in Professor Wood's example, where the licence has a limited scope, that licence may not include the right to use proceeds to pay wages. However, the expression of a limited use for proceeds of inventory cannot prevail if the arrangement between the parties is such as to allow, in practice, the debtor to use the inventory proceeds in the course of its business. In this respect, I agree with Professor Wood's comments regarding the appropriate test for determining whether a licence to sell inventory includes permission to pay wages with the proceeds (“Revenue Canada's Deemed Trust Extends Its Tentacles: Royal Bank of Canada v. Sparrow Electric Corp.”, supra, at pp. 435-36):

This is not to say that the analysis should hinge on the existence of a trust proceeds clause or other contractual provision requiring the debtor to remit proceeds. A contractual provision of this type should not govern if the real arrangement between the parties is such that the debtor has the freedom to use the proceeds of inventory in the ordinary course of business.

To make any sense at all, the licence theory must, at the very least, be restricted to cases where the secured party permits the debtor to pay employees either out of its collateral or out of the proceeds of its collateral. This permission cannot be derived merely from the existence of a licence to sell inventory. The test should be whether the debtor had the freedom to use these funds in the ordinary course of business as opposed to being under an obligation to remit them to the secured party. [Emphasis added.]

76 In the case at bar, the GSA contained an express licence permitting Sparrow to sell inventory in the course of its business and use the proceeds available; the BAS contained an implied licence to this effect. While it is true that the GSA contained a trust proceeds clause, I find that this cannot have the effect of limiting the scope of the licence where the real arrangement between the parties was, as expressly stated, that Sparrow could use the proceeds of inventory in the course of its business. The bank in this case was not a small inventory financier who required Sparrow to immediately remit proceeds of inventory to it. To the contrary, the bank was a large scale lender who permitted Sparrow to use inventory sales to maintain the viability of its enterprise. For these reasons, applying Professor Wood's test, I find that under the licence to “sell ... inventory” “in the ordinary course of ... business” and “use [the] [m]oneys available” the bank permitted Sparrow to sell inventory to pay wages and, necessarily, payroll deduction obligations.

77 For all these reasons, through the application of the licence theory, it is my conclusion that the appellant’s s. 227(5) deemed trust must take priority over the bank’s security interests in the disputed collateral. The trust fund representing the deducted amounts, while without identified subject matter from the date of its inception, is capable of identifying property subject to that trust ex post facto. To reiterate, the bank consented to the reduction in its security in inventory in order to pay wage deductions at the time those deductions were made, and s. 227(5) ITA has the effect of carrying forward that consent to the time of receivership. By consenting to the payment of wages out of the proceeds of inventory during the course of Sparrow’s business, the bank ipso facto consented to the statutory scheme under the ITA designed to cover unpaid wage deductions. In short, in the present case the licence to deal with inventory proceeds coupled with the statutory scheme in s. 227(4) and (5) ITA gives priority to Her Majesty’s claims for statutory wage deductions. This result is obtained both in regard to the bank’s GSA, and its BAS.

78 The respondent bank has submitted that this result is necessarily precluded with regard to their BAS by virtue of s. 428(1) of the Bank Act, which provides as follows:

428. (1) All the rights and powers of a bank in respect of the property mentioned in or covered by a warehouse receipt or bill of lading acquired and held by the bank, and the rights and powers of the bank in respect of the property covered by a security given to the bank under section 427 that are the same as if the bank had acquired a warehouse receipt or bill of lading in which that property was described, have, subject to subsection 427(4) and subsections (3) to (6) of this section, priority over all rights subsequently acquired in, on or in respect of that property, and also over the claim of any unpaid vendor. [Emphasis added.]

I cannot agree with this submission. It is true that s. 428(1) secures the respondent bank’s proprietary right to the disputed collateral. However, for the reasons I have expressed, the fact remains that the bank has consented to the divestment of this interest. Such a waiver of priority, in my view, renders s. 428(1) of no assistance to the respondent bank.

79 I add as a final matter that in addition to providing certainty in disputes between consensual and non-consensual security interests, the licence theory has the virtue of achieving fairness in commercial law. Here, the respondent bank had permitted Sparrow to sell its inventory in the course of its business in order to, among other things, pay wages and wage deductions. To this extent, therefore, the bank permitted the reduction in the value of its security interest in Sparrow’s inventory, during the ordinary course of Sparrow’s business. Implicit in the bank’s consent is the assumption that in so doing, Sparrow would generate profits from the conversion of inventory into revenues; this economic process, as I noted above, ensures that interest payments owing to the bank would be paid to them on a sustainable basis. In short, the bank benefitted in a general sense from Sparrow’s carrying on its business operations, an endeavour which required Sparrow to pay wages and wage deductions. More specifically, however, when Sparrow stopped paying its wage deductions, as required, the bank could be said to benefit from the artificial increase in Sparrow’s working capital, allowing an extension of the life of Sparrow’s business.

80 Now, when Sparrow’s business is no longer a viable enterprise, the bank says that it is entitled to the very payments which allowed Sparrow, in part at least, to stay in business longer than was legally economical. In essence, the bank is willing to accept the benefits of Sparrow’s non-payment of statutory deductions, and can be said to have reasonably permitted the use of its collateral to pay these deductions at the time they should have lawfully been paid, but refuses to accept the burden of Sparrow’s unlawful action at the time of its receivership. In my view, it should be the policy of the law that the respondent bank be held accountable for Sparrow’s outstanding statutory obligations. The licence theory, as I have developed it, ensures that in appropriate circumstances this result will obtain. In this way, in my opinion the licence theory is grounded not only in legal principles, but also in sound policy.

81 Since writing the foregoing, I have had the benefit of reading the careful reasons of my colleague, Mr. Justice Iacobucci. With deference however, I do not share his views or his concerns.

82 I note that Iacobucci J., in his reasons, has taken me to have adopted the licence theory in extremely broad terms. Specifically, when summarizing the conceptual basis of my reasoning, he states at para. 91:

Consequently, says the [licence] theory, the bank’s claim to the inventory must give way to any debts incurred in the ordinary course of business. [Emphasis added.]

Similarly, Iacobucci J. writes at para. 97:

The satisfaction of any legitimate debt or obligation, whenever incurred, is arguably “in the ordinary course of business”. Certainly, the payment of creditors is a permissible “use” of the proceeds of a sale of inventory. Following my colleague’s reasoning, this would mean that every subsequent claim should prevail over the respondent’s general security agreement, because every rival claim might have been satisfied out of the proceeds of a hypothetical sale of the inventory. [Emphasis added.]

83 With respect, as he acknowledges, my reasons do not go this far. It is not the consent to payment of wage deductions from the proceeds of inventory simpliciter which drives me to the conclusion that Her Majesty’s interest must prevail. This is a necessary, but not sufficient, condition. In addition, however, what is significant to the outcome of this case is that the bank has consented to payment of wages including deductions, out of inventory which, at the time of the deductions, are by statute deemed to be taken out of the estate of the debtor (see ss. 153(3) and 227(4) ITA). Section 227(5) carries that consent forward to the time of liquidation, assignment, receivership or bankruptcy, to realize Her Majesty’s claim out of the bank’s inventory.

84 Therefore, the unique nature of the statutory provisions applicable to wage deductions, and the bank’s consent thereto, are integral to the success of the s. 227(5) claim in the case at bar. In this way, the licence theory, as I have employed it, is circumscribed.

85 It must be stressed that the issue relates to wages actually paid to employees -- not a simple obligation to pay wages -- a portion of which has been deducted from the amount remitted to the employee and must be remitted to Her Majesty. Pending such remittance, the amount deducted is deemed under s. 227(4) to be held in trust for Her Majesty. By virtue of these ITA provisions, and unlike ordinary debts and obligations, unpaid wage deductions are, in law, performed obligations. The consent by the bank to the payment of wages out of the proceeds of the sale of inventory must be taken to cover the wages paid according to law including that portion which has been deducted from the remittance to the employee, pursuant to the ITA, in order that it be remitted to Her Majesty. While the value of the bank’s security in the inventory may be thereby reduced, this is by virtue of specific statutory requirements under well-defined rules limited in their application to actual payment of wages. These requirements are well known and are encompassed by the bank’s consent to the payment of wages in the ordinary course of business and do not open the door to uncertainty as to the value of security. Any risk to the bank’s security is part of the very risk involved in consenting to the payment of wages. This does not open the door to any uncertainty as to the value of the bank’s security arising from unperformed obligations incurred by the debtor in the ordinary course of business.

86 For these reasons, I cannot agree with the premise underlying Iacobucci J.’s reasons, namely, that the licence theory as I have employed it is inimical to the integrity of commercial law. It does not have the extensive application suggested by my colleague; it does not create uncertainty in commercial transactions. Instead, the licence theory operates narrowly, in conjunction with unique statutory provisions, so as to actualize legally performed obligations when they, in fact, exist.

VI - Conclusion

87 It is possible to summarize my conclusions in this case into the following five propositions:

1. Priorities between statutory trusts and consensual security interests are resolved by determining which interest has an attached interest in the disputed collateral at the time the statutory trust becomes operative.

2. The s. 227(5) ITA deemed trust attaches to any property of the debtor which exists upon liquidation, assignment, bankruptcy or receivership.

3. For example, if deductions are made prior to the attachment of a fixed charge over collateral, the s. 227(5) deemed trust will engage to retroactively attach Her Majesty's beneficial interest to that collateral. The fixed charge over that collateral will thereafter be subject to Her Majesty's pre-existing claims for unremitted payroll deductions.

4. Otherwise, if a security interest is in the nature of a fixed and specific charge, that interest gives the holder legal title to the collateral, such that a subsequent competing statutory trust will not be able to attach its interest. In such a case, all the statutory trust can attach to is the equity of redemption in the collateral.

5. However, as an exception to propositions 2 and 4, where the holder of a fixed security interest permits the debtor to sell the collateral, this may provide an opportunity for the statutory trust to attach. Whether this actually occurs depends entirely on the facts of each case. The test is whether, at the time the deductions occurred, the debtor had the right to sell the collateral and use the proceeds to pay the obligation to which the statutory trust is related.

88 I have found that, on the facts of this case, the licence invoked to sell inventory included the permission to use its proceeds to pay wages or wage deductions. The test in proposition 5 has therefore been made out. Accordingly, I would allow the appeal with costs.

The judgment of Sopinka, McLachlin, Iacobucci and Major JJ. was delivered by

89 Iacobucci J. -- I have read the lucid reasons of my colleague, Justice Gonthier, and although I agree with much of his reasoning, I cannot, with respect, accept the conclusion that he reaches. In particular, I do not accept that the deemed trust that arises in favour of the Crown by operation of s. 227(4) of the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.) (hereinafter “ITA”), takes priority over the security interests that the respondent has under the Bank Act, S.C. 1991, c. 46, and the Personal Property Security Act, S.A. 1988, c. P-4.05 (hereinafter “PPSA”). Even conceding that the latter interests are subject to a licence to sell, the licence is not nearly so broad as to encompass the satisfaction of income tax obligations. As I will discuss below, a licence to sell inventory authorizes at most only the satisfaction of obligations that are immediately incidental to an actual sale of the inventory.

90 Because my only disagreement with my colleague is in his application of the licence-to-sell approach to this case, I do not propose to discuss the facts or background that he has so ably described or to dwell on any other part of his reasons. I need not say anything more about the character of the respondent’s security interests than that they are fixed and specific.

91 My colleague disposes of this appeal on the basis of the so-called “licence theory”. Briefly, the licence theory holds that a bank’s security interest in a debtor’s inventory, though it be fixed and specific, is subject nevertheless to a licence in the debtor to deal with that inventory in the ordinary course of business. Consequently, says the theory, the bank’s claim to the inventory must give way to any debts incurred in the ordinary course of business. The leading articulation of the licence theory appears in McLachlin J.A.’s (as she then was) reasons in R. in Right of B.C. v. F.B.D.B., 1987 CanLII 156 (BC CA), [1988] 1 W.W.R. 1 (B.C.C.A.) (hereinafter “FBDB”), at p. 40.

92 The theoretical basis of the licence theory seems to be that a creditor who has granted a licence to sell inventory has thereby consented to the subjection of his security interest to other obligations that may arise “in the ordinary course of business”. My colleague says this in his reasons, at para. 68:

In short, where the bank has consented to the reduction in the value of its security in order to pay statutory deductions at the time those deductions are made, they have to the same extent, by virtue of s. 227(5) [ITA], consented to the reduction in their security at the time of receivership.

This is sensible, because it is only if the licence is understood as a kind of tacit lessening of the creditor’s security interest that the appellant’s cause is advanced. Certainly the actual operation of the licence is not relevant, because in this case the inventory in question was never actually sold pursuant to the licence. Rather, the receiver sold it by court order. If the licence is to have anything to do with the disposition of this appeal, it must be by virtue of the evidence it affords of the respondent’s intention to take less than an entire security interest in the inventory.

93 In my view, the licence affords no such evidence. My colleague seems to think that the potential sale of the inventory amounts to an actual limitation of the security interest. For my part, I do not see what the one thing has to do with the other. There is a great difference between saying, on the one hand, that if a debtor sells inventory and applies the proceeds to a debt to a third party, then the third party takes the proceeds free of any security interest and saying, on the other hand, that because a third party could take the proceeds free of any security interest, no security interest exists in the proceeds as against that third party. A licence to sell inventory in the ordinary course of business is a condition of the former kind. The consequent (defeasance of the security interest) follows only if the antecedent (sale of the inventory and application of proceeds to an obligation to a third party) is satisfied. In other words, the security interest in the inventory disappears only if the debtor actually sells the inventory and applies the proceeds to a debt to a third party.

94 That this is so is suggested by s. 28(1) PPSA, which provides:

28(1) Subject to this Act, where collateral is dealt with or otherwise gives rise to proceeds, the security interest

(a) continues in the collateral, unless the secured party expressly or impliedly authorized the dealing, and

(b) extends to the proceeds,

but where the secured party enforces a security interest against both the collateral and the proceeds, the amount secured by the security interest in the collateral and the proceeds is limited to the market value of the collateral at the date of the dealing.

In accordance with this provision, the result of a sale of inventory is to give the purchaser an unencumbered interest in the inventory and the licensor a continuing security interest in the proceeds of the sale. It is only if the debtor subsequently uses the proceeds to satisfy an obligation to a third party that the proceeds will be removed from the scope of the licensor’s security interest in them. Accordingly, what a security agreement with a licence to sell creates is a defeasible interest; but the event of defeasance is the actual sale of the inventory and the actual application of the proceeds against an obligation to a third party.

95 I recognize that the operation of s. 28(1) PPSA is not necessarily inconsistent with the broad interpretation of the licence to sell that my colleague advances. However, it seems to me that this is an appropriate case for the invocation of the maxim expressio unius est exclusio alterius. The statute prescribes certain consequences for the security interest that follow a dealing with inventory. In particular, the statute contemplates defeasance of the interest if the debtor actually sells the inventory and applies the proceeds to an obligation to a third party. Significantly, the statute does not contemplate a defeasance on the happening of any other event. In my view, the statute occupies the field and crowds out other possible interpretations of the licence, including the one that Gonthier J. favours.

96 Because in this case there was no actual sale of the inventory in question, let alone any disposition of the proceeds, the licence can have had no effect on the respondent’s security interest. What the debtor might have done with the licence does not matter.

97 If it were otherwise, the licence to sell inventory would entirely eviscercate the respondent’s general security agreement. The satisfaction of any legitimate debt or obligation, whenever incurred, is arguably “in the ordinary course of business”. Certainly the payment of creditors is a permissible “use” of the proceeds of a sale of inventory. Following my colleague’s reasoning, this would mean that every subsequent claim should prevail over the respondent’s general security agreement, because every rival claim might have been satisfied out of the proceeds of a hypothetical sale of the inventory. Moreover, the priority rules of the PPSA, whose general policy is to assign priority to the earliest registered security interest, would be turned on their head. Presuming that every charge against inventory is subject to a licence to sell -- a presumption that accords with the interest of creditors in ensuring the debtor’s continued vitality -- the last security interest would take priority over all earlier ones, because only the last interest would not be subject to some charge arising in the ordinary course of business. In answer to this objection, it might be said that as between two PPSA securities, the rules in the Act should be applied to determine priority. However, such an answer would not be consistent with the licence theory, which supposes that the original security interest in the inventory ends where obligations incurred in the ordinary course of business begin. The subsequent interest would prevail because the earlier interest would disappear before it.

98 It is open to my colleague to distinguish the fact situation in this appeal from the hypothetical priority contests I have mentioned on the ground that the Crown’s interest in the inventory is unlike other charges against inventory in that it depends on the fictional device of deeming. What makes this case different, it might be said, is that the ITA deems to have been done what could have been done. On this understanding, it does not matter that the inventory was not actually sold and the proceeds were not actually remitted to the Receiver General, because s. 227(4) and (5) ITA deem these things to have been done. But in my view, this answer cannot succeed because the inventory was not an unencumbered asset at the moment the taxes came due. It was subject to the respondent’s security interest and therefore was legally the respondent’s and not attachable by the deemed trust. As Gonthier J. himself says (at para. 39):

. . . [s. 227(4)] does not permit Her Majesty to attach Her beneficial interest to property which, at the time of liquidation, assignment, receivership or bankruptcy, in law belongs to a party other than the tax debtor.

99 The deeming is thus not a mechanism for undoing an existing security interest, but rather a device for going back in time and seeking out an asset that was not, at the moment the income taxes came due, subject to any competing security interest. In short, the deemed trust provision cannot be effective unless it is first determined that there is some unencumbered asset out of which the trust may be deemed. The deeming follows the answering of the chattel security question; it does not determine the answer.

100 Indeed, Gonthier J. does seize on the peculiar nature of the deemed trust as a possible ground for distinguishing the Crown’s interest from rival interests. However, his argument differs from the one I have outlined to the extent that it emphasizes the deemed performance of the obligation to the Crown. It appears to be my colleague’s position that the licence to sell represents a reduction in the value of the security interest only with respect to performed obligations but not with respect to unperformed ones. In his view, this represents a sufficient check on the licence theory. I agree that, if the distinction between performed and unperformed obligations were maintainable, then the likelihood of the licence consuming the security interest would be greatly reduced. However, in my view, the distinction cannot be maintained. As Gonthier J. says more than once in his reasons, the licence theory rests on the consent of the parties. But the parties to this case consented to the sale of inventory “in the ordinary course of Debtor’s business”. The language is unqualified. No distinction is drawn between performed and unperformed obligations. The only performance that is contemplated in the licence is the actual sale of the inventory and the application of the proceeds to a debt. And, as I have already argued, the deeming mechanism does not furnish the needed actual sale. Accordingly, I conclude that if the words of the licence are to be given their due as an indicium of the parties’ intent, then there can be no distinction between performed and unperformed obligations.

101 My colleague places great emphasis on the fact that the debtor covenanted, in the general security agreement, “to pay all taxes, rates, levies, assessments and other charges of every nature which may be lawfully levied, assessed or imposed against or in respect of Debtor or Collateral as and when the same become due and payable”. But this covenant is not part of the licence. And in any event, it is merely a covenant to obey the law. It adds nothing to s. 153(1) ITA. Furthermore, it does not prescribe the outcome of a priority contest. What is more, the covenant to pay taxes is only one of several in the agreement. Another covenant provides that the debtor shall “carry on and conduct the business of Debtor in a proper and efficient manner”. Presumably the debtor might incur subsequent debts in the course of carrying on and conducting its business. Gonthier J. advances no principle that might permit the settlement of priority disputes as between the Crown and subsequent lenders. In the event of a dispute, both would have the benefit of the licence to sell inventory and of express covenants, so that some other criterion would have to be found to determine which takes priority. Here, as before, the prospect of a reversal of the ordinary priority rules is immediate and troubling.

102 My colleague also relies on comments made in FBDB. In that case, the British Columbia Court of Appeal said, after having disposed of the appeal on another ground, that a licence to sell inventory carries with it a requirement that the licencee should satisfy obligations incurred in “dealing with the stock in the ordinary course of business”: FBDB, supra, at p. 40. Because the obligation to set aside provincial sales taxes is a “legal incident” of the sale of inventory, a lien for unpaid sales taxes comes within the scope of the licence and so is excepted from any security interest that is subject to it: idem.

103 As I understand the comments in FBDB, a licence to sell inventory permits the satisfaction of obligations out of the proceeds only to the extent of the “legal incidents” of the sale. In itself, this greatly limits the scope of the theory. Because the payment of wages, except perhaps to the sales agent, is not a “legal incident” of the sale of inventory, deduction of income taxes from wages does not come within the scope of the licence. This alone would appear sufficient to distinguish FBDB from the instant appeal.

104 However, I think that on closer examination it turns out that FBDB does not even depend on a licence theory, or at least does not depend on a licence theory of the kind advanced by my colleague. I say this because his reasons posit a charge that arises against the value of the inventory as a result of the operation of the licence. But the sales taxes that were at issue in FBDB were not against the value of the inventory. Rather, they were superadded to the underlying value, which is to say that they were calculated on the basis of the sale price of the inventory. Thus, the sales taxes that attend a sale of inventory represent something over and above the value of the inventory. Because a bank’s charge is against the inventory, it does not extend so far as the sales taxes generated by a sale of inventory. But income taxes are not like sales taxes in that they are not as directly related to sales of inventory as sales taxes are. To the extent that income taxes have anything to do with the proceeds of a sale of inventory, they are payable out of the monies received for the value of the inventory. A bank’s charge against the inventory is therefore adequate to defeat subsequent claims for the payment of income taxes. For this reason, McLachlin J.’s reasoning in FBDB is not contrary to what I am advancing herein.

105 I should also mention that in 1988, when the FBDB case was decided, British Columbia’s Personal Property Security Act, S.B.C. 1989, c. 36, was not in force. As a consequence, the British Columbia Court of Appeal did not have to contend with the legislative considerations that we face in this appeal. In particular, there was at the time no equivalent in British Columbia law to s. 28(1) of Alberta’s PPSA. The Court of Appeal therefore had greater latitude than we have to interpret a licence to sell as a tacit consent to a reduction of the security interest in the inventory. It seems to me that as a result of the enactment of the PPSA, something more than an unadorned licence to sell is needed to justify the conclusion that a creditor intended to abridge considerably its security interest in inventory.

106 And so I conclude that the licence to sell inventory is not an exception to the respondent’s fixed and specific charge against the debtor’s inventory. To hold otherwise would be to eviscerate the respondent’s security interest. This is not to say, however, that Parliament could not legislate otherwise. Parliament has shown that it knows how to assert priority over rival security interests. See Alberta (Treasury Branches) v. M.N.R.; Toronto-Dominion Bank v. M.N.R., 1996 CanLII 244 (SCC), [1996] 1 S.C.R. 963, at p. 975. All that is needed to overtake a fixed and specific charge is clear language to that effect.

107 Though I consider the above legal arguments sufficient to dispose of this appeal, I observe that policy considerations also tell in favour of the conclusion I have reached.

108 In this respect, the first thing to notice is that the security agreement that the debtor and the respondent had in this case is an example of a very common and important financing device. To a considerable extent, commerce in our country depends on the vitality of such agreements. As several leading academics have observed, the amounts at stake run into the billions of dollars each year. And though not every creditor seeks security, the incentives to do so are powerful. See Jacob S. Ziegel, Benjamin Geva and R. C. C. Cuming, Commercial and Consumer Transactions (Rev. 2nd ed. 1990), at pp. 957-60. Accordingly, tinkering with security interests is a dangerous business. The risks of judicial innovation in this neighbourhood of the law are considerable.

109 Chief among these is the risk that attends legal uncertainty. If the legal rule is not clear, then inventory financiers will have to provide against the risk that their security interest might be defeated by some rival claim. The danger is particularly acute where as here, the language is as broad as “in the ordinary course of business”. In this regard, I agree with what Professor Roderick J. Wood said in his article (“Revenue Canada’s Deemed Trust Extends Its Tentacles: Royal Bank of Canada v. Sparrow Electric Corp.” (1995), 10 B.F.L.R. 429, at p. 429) that my colleague cites:

. . . there is little controversy with the proposition that a priority rule should be capable of producing reasonably predictable results. An unclear priority rule imposes a number of social costs. It means that creditors must plan their affairs against less certain outcomes. Uncertain rules generate more litigation than clear rules. Over time an uncertain rule is sometimes transformed into a clear rule through the process of judicial interpretation. However, this is a piecemeal approach which often occurs at a glacial pace.

110 Indeed, the consequences of my colleague’s approach might be more dire than even Professor Wood supposes. For, as I have observed, almost any subsequent financial arrangement might be in the ordinary course of business. Accordingly, the possibility is real that my colleague’s proposed rule would effectively obliterate the PPSA charge against inventory. As insurance against this outcome, the costs of financing would presumably increase. I agree that if Parliament mandated this outcome, the courts must perforce accept it. However, judges should not rush to embrace such a weighty consequence unless the statutory language requiring them to do so is unequivocal.

111 Moreover, and for reasons I have already given, there is every likelihood that a broad interpretation of the licence theory would do violence to the PPSA. The Act clearly contemplates that inventory financing will be an important commercial device. But allowing the mere potential operation of a licence to sell to defeat a security interest in inventory would deprive the interest of all efficacy. It would not be any sort of security against subsequent obligations.

112 Finally, I wish to emphasize that it is open to Parliament to step in and assign absolute priority to the deemed trust. A clear illustration of how this might be done is afforded by s. 224(1.2) ITA, which vests certain moneys in the Crown “notwithstanding any security interest in those moneys” and provides that they “shall be paid to the Receiver General in priority to any such security interest”. All that is needed to effect the desired result is clear language of that kind. In the absence of such clear language, judicial innovation is undesirable, both because the issue is policy charged and because a legislative mandate is apt to be clearer than a rule whose precise bounds will become fixed only as a result of expensive and lengthy litigation.

113 It remains to make a few remarks by way of conclusion. Because I believe that the respondent’s general security agreement gave it a fixed and specific charge against the debtor’s inventory, and because I conclude that the licence to sell that inventory does not derogate from the respondent’s security interest, I conclude that this appeal should be dismissed. I do not need to decide whether the Bank Act security would have priority over the deemed trust as well; though given that the licence to sell inventory under the Bank Act security is only implied, I do not see how the Crown could have a greater claim under the Bank Act than it has under the PPSA.

114 Therefore I would dismiss the appeal with costs.

Appeal dismissed with costs, La Forest, Gonthier and Cory JJ. dissenting.

Solicitor for the appellant: The Attorney General of Canada, Ottawa.

Solicitors for the respondent: Milner, Fenerty, Edmonton.