Court File and Parties

Court File No.: CV-16-11465-00CL Date: 2017-01-18 Superior Court of Justice – Ontario Commercial List

Re: Kari Holdings Inc., Plaintiff And: HSBC Bank Canada, Defendant

Before: Conway J.

Counsel: Edward J. Babin and Morgan Westgate, for the Plaintiff Mark Evans and Chloe Snider, for the Defendant

Heard: November 8, 2016 and January 13, 2017

Reasons for Decision

[1] Kari Holdings Inc. (“Kari”) is a secured creditor of C.I.F. Furniture Limited (“CIF”). CIF was declared bankrupt, placed in receivership and its assets sold in July 2009.

[2] In April 2006, CIF opened two commercial chequing accounts at HSBC Bank Canada (“HSBC” or the “Bank”). The accounts had no automatic overdraft protection. Kari alleges that on 27 occasions between July 2007 and March 2009, the Bank exercised its discretion to grant overdraft protection to CIF and repaid itself with collateral that was subject to Kari’s prior security interest. Kari further alleges that the Bank provided CIF with a corporate credit card and repaid itself for the charges out of Kari’s collateral.

[3] Kari brings a summary judgment motion for a declaration that it had priority over the Bank with respect to the funds in the CIF bank accounts and that any payments made by CIF to the Bank to cover the overdrafts and credit card debt were subject to Kari’s prior security interest. Kari seeks an order that the Bank pay Kari $467,455 for the alleged overdrafts and $57,260 for the credit card debt, together with interest. The Bank brings a cross-motion for summary judgment dismissing Kari’s action against the Bank.

[4] For the reasons that follow, I dismiss Kari’s motion and grant the Bank’s cross-motion. The action is dismissed.

Overview

[5] CIF was a family business founded by Hans and Elizabeth Kamin in 1969. In 2004, the Kamins, through their holding company Kari, sold the business to 1639662 Ontario Inc., which subsequently amalgamated with and continued as CIF.

[6] Kari agreed to finance a portion of the purchase price through a vendor take back note dated December 1, 2004 (the “Vendor Note”). The principal amount of the Vendor Note was $1 million, with interest only payable at the rate of 8% (10% on default) until maturity (December 3, 2009). Kari had the right to accelerate the payment of principal on default.

[7] The Vendor Note was secured by a general security agreement (“GSA”). The GSA granted Kari a broad security interest in CIF’s personal property and assets (the “Collateral”). Kari perfected its security interest by registration of a financing statement under the Personal Property Security Act, R.S.O. 1990, c. P. 10 (the “PPSA”). Pursuant to an inter-creditor agreement, Kari’s security interest was subordinate only to the security granted by CIF to its bank, The Bank of Nova Scotia, and to a $4.35 million senior subordinated debenture in favour of Vengrowth, CIF’s controlling shareholder. [1]

[8] Pursuant to s. 5 of the GSA, CIF was entitled, until default, to use the Collateral in the ordinary course of its business in any manner not inconsistent with the provisions of the GSA.

[9] CIF made regular interest payments to Kari from December 2004 to October 31, 2005. In March 2007, CIF made a lump sum payment for the interest from November 2005 to February 2007. CIF further paid interest from March 2007 to March 2009. While Kari received no payments of principal from CIF, Kari received a $1 million payment from Covington Funds (which purchased Vengrowth) in 2009. Notwithstanding such payments, Kari calculates that the balance of principal and interest owing to it under the Vendor Note is approximately $840,000. [2]

HSBC Proposed Financing of CIF

[10] In the spring of 2006, CIF approached HSBC to replace CIF’s existing credit facility at The Bank of Nova Scotia. HSBC delivered three financing proposals to CIF in April, May and June of 2006. The proposed credit facility included advances for overdrafts and a company credit card for CIF employees.

[11] As a condition of providing the credit facility, the Bank required that Kari subordinate its security to the Bank. Kari refused. CIF initiated arbitration proceedings in June 2006 to require Kari to subordinate its security to HSBC. In October 2006, the arbitrator ruled that Kari was not required to do so.

[12] According to Mr. Robbins (the Bank account manager for CIF at the time), after continuing to monitor the CIF situation, the Bank decided in early 2007 not to proceed with the proposed CIF credit facility. [3]

CIF Chequing Accounts and MasterCard at HSBC

[13] In April 2006, CIF opened two commercial chequing accounts at the Bank’s Mississauga branch. The two accounts were related and had the same base account number – one was a sub-account denominated in Canadian dollars and the other was denominated in U.S. dollars (collectively, the “Accounts”). According to Mr. Robbins, this structure reflected the fact that CIF’s operations involved customers and suppliers in both countries.

[14] The Accounts were opened pursuant to a single HSBC account agreement (the “Account Agreement”). The Account Agreement provided that:

• the Accounts were to be used only for commercial business purposes (s. 2);
• the Bank was entitled to consolidate and set-off amounts owing as between the two Accounts (s. 8);
• overdrafts on the Accounts were prohibited without HSBC’s written agreement (s. 10).

[15] Mr. Robbins’ evidence is that the Accounts remained dormant until late 2006, when CIF began using them in the ordinary course of operating its business. When Mr. Robbins relocated to Alberta in February 2007, Ms. Symes took over as the CIF account manager. Her evidence is that thousands of transactions went through the Accounts and she had no reason to believe that the statements reflect anything other than CIF using the Accounts in the day-to-day operation of its business.

[16] Mr. Robbins also assisted in the opening of a MasterCard account at HSBC in the name of one of CIF’s employees, with a credit limit of $10,000. The card was issued in February 2007 and was cancelled in September 2008.

Overdrafts in the Accounts

[17] As noted, the Account Agreement prohibited overdrafts on the Accounts without the Bank’s prior written consent. Section 10 of the Account Agreement states:

Overdrafts are not permitted on any Account without specific written agreement from HSBC. If HSBC occasionally honours an Instrument drawn on an Account or accepts Instructions to debit an Account when there are insufficient funds on deposit, thus creating or increasing an overdraft on such Account, the amount of any overdraft created is deemed payable immediately without demand, with interest accruing at HSBC prevailing rates for overdrafts.

[18] Kari relies on the evidence of its corporate lawyer Wayne Gray, who reviewed the HSBC bank documents and account statements for CIF. Mr. Gray notes that if a cheque or other debit put an Account into a negative balance on any particular day, the Account was designated as “DR” at the end of that day. The Account was then charged an “Advance Posting Fee” ($5 per transaction) for that day, as well as interest on the amount of the negative balance. These charges applied whether the Account was in a negative balance for one day or longer and applied whether or not HSBC decided to honour or return the cheque in question.

[19] Mr. Gray notes that over the relevant period, HSBC never refused to honour a cheque that put an Account into a negative balance position. He therefore asserts that the Bank was, in effect, providing overdraft privileges to CIF pursuant to its discretionary powers under s. 10 of the Account Agreement. Mr. Gray notes that on 27 occasions, monies were deposited into the Account or transferred from the other Account to cover the overdraft. His position is that this was Collateral that was subject to Kari’s prior ranking security interest and that the Bank, as an unsecured lender to CIF, was not entitled to be repaid for these overdrafts out of the Collateral in priority to Kari.

[20] Ms. Symes gave evidence about the Bank’s standard practices with respect to overdrafts. Her evidence is that if a cheque is posted to an account and could potentially put the account into overdraft, that fact is identified and reported overnight through HSBC’s exception handling system. The account manager is responsible for reviewing the “advance posting report” (“APR”) the next morning. Since the APR is delivered overnight, the decision as to whether to honour or return a cheque can only be made the day after the cheque is posted to the account. The account is therefore charged the Advance Posting Fee and an unauthorized overdraft interest fee, which is a penalty or fee for breaching the account agreement. Those charges apply regardless of HSBC’s subsequent decision to honour or return the cheque.

[21] Ms. Symes’ evidence is that upon receiving the APR, she had one business day to decide whether or not to return the cheque that gave rise to the potential overdraft. Under s. 5 of Rule A4 of the Canadian Payments Association (the “CPA Rules”), HSBC has the right to return the cheque to the presenting institution within that one business day period (the “Recourse Period”), although financial institutions often give two business days.

[22] Ms. Symes and Mr. Robbins both explained that the CPA Rules provide a period of time within which the Bank can determine whether or not to honour the cheque in question. They resisted the suggestion that the Bank advanced credit to CIF as soon as the cheque was posted to the Account. According to Mr. Robbins, the question to be answered by the account manager on reviewing the APR is “Do we allow it to clear? Do we honour it or not?” Ms. Symes disagreed with the suggestion that CIF owed the Bank money as soon as the cheque was posted. She stated “No. No. We haven’t advanced anything. A cheque has been posted, a cheque has been presented, and we have to make the decision whether that...”

[23] Ms. Symes says that it was her standard practice, on receiving the APR, to call the client to request that the client cover the potential debit before the end of that business day, failing which HSBC would likely be forced to return the cheque in question. In all but seven instances, CIF deposited funds into the Account in question within the Recourse Period. Therefore, by the time the Bank was required to decide whether to honour or return the cheque, there were sufficient funds in that Account to cover the cheque. Further, in all but one of those seven instances, there were sufficient funds in the other Account such that CIF Account was in an overall credit position. On one occasion, the overall Account was in a negative balance, in the amount of $4,025. CIF covered that balance within a few days.

[24] Kari did not tender any evidence to contradict the Bank’s evidence about the workings of its internal processing systems. It relied solely on Mr. Gray’s interpretation of the CIF bank account documentation.

Positions of the Parties

[25] Kari’s position is that even though the Account Agreement did not permit overdrafts for the Accounts, the Bank was providing unofficial overdraft protection to CIF on a discretionary basis. Kari submits that once a cheque was posted to an Account that resulted in a “DR” notation and triggered the Advance Posting Fee and interest charge, the Bank had provided credit to CIF by way of overdraft. The fact that the Bank was able to reverse the debit the next day was immaterial.

[26] Kari argues that the CPA Rules are a “red herring” and only govern the relationship between the Bank and other presenting institutions – they do not alter the fact that once the Account was noted as being in a “DR” position, the Bank had provided overdraft privileges to CIF. Kari argues that when CIF injected funds into the Account the next day to cover the overdraft (or funds were transferred from the other Account), CIF was using Collateral (over which Kari had priority) to repay the Bank for these overdrafts. Kari further argues that that it had priority over any funds used by CIF to repay the MasterCard to the Bank.

[27] The Bank’s position is that there were no overdrafts created or authorized in the Accounts, except on one occasion. It argues that even if there were any overdrafts created, and CIF repaid those overdrafts to the Bank out of the Collateral, CIF was doing so in the ordinary course of its business, which was permitted under the GSA. The Bank asserts, in the alternative, that it is protected by s. 28(4) of the PPSA, by s. 29 of the PPSA and Section 165(3) of the Bills of Exchange Act, R.S.C. 1985, c. B-4, and by the provisions of the Limitations Act, 2002, S.O. 2002, c. 24, Sch. B.

Summary Judgment

[28] Rule 20.04(2) of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194 states that the court shall grant summary judgment if it is satisfied that there is no genuine issue requiring a trial with respect to a claim or defence. There will be no genuine issue requiring a trial if the summary judgment process: “(1) allows the judge to make the necessary findings of fact, (2) allows the judge to apply the law to the facts, and (3) is a proportionate, more expeditious and less expensive means to achieve a just result.” [4]

[29] As set out below, I am satisfied that there is no genuine issue requiring a trial and that both Kari’s motion and HSBC’s cross-motion can be decided on a summary judgment basis. I am able to reach a fair and just determination of the issues in this case based on the evidence provided on these motions and my analysis of the factual and legal conclusions that flow from that evidence.

Issue #1 – Did HSBC Provide Credit to CIF by way of Overdraft?

[30] The central premise of Kari’s case is that the Bank provided credit to CIF by way of overdraft and that CIF repaid these overdrafts to the Bank out of the Collateral that was subject to Kari’s prior perfected security interest. The preliminary issue, therefore, is whether the Bank provided credit to CIF by way of overdraft.

[31] When a customer opens an account with a bank, the nature of the relationship is one of debtor and creditor. When the account becomes overdrawn, this constitutes the extension of credit by the bank. As explained by H.G. Beale in Chitty on Contracts (my emphasis added):

When the account is in credit, the customer is the creditor and the banker the debtor. Consequently, funds deposited by the customer become the bank’s money; the customer acquires a debt or chose in action claimable from the bank. The position is reversed when the account is overdrawn…

Overdrafts: Where there are insufficient funds available to cover the full amount of the customer’s cheque, the bank may refuse to honour it. In such circumstances the cheque stands as an offer by the customer to the bank to extend credit to him on the bank’s usual terms as to interest and others charges, unless other terms have been agreed between them. The bank may either reject the offer or accept it by paying the cheque and, in doing so, allow the customer to overdraw … [5]

[32] The legal character of an overdraft is a loan granted to a customer by the bank. As Professor M.H. Ogilvie explains in Bank and Customer Law in Canada (my emphasis added):

Where a bank has permitted overdrafts in the absence of a contract, the course of dealing is established when the customer draws a cheque without sufficient funds in the account and the bank honours that cheque and thereby creates a debit in the account. This is characterized either as a request for an overdraft which has been granted or an offer by the customer to the bank to extend credit to the customer on the bank’s usual terms…Since an overdraft is a loan, it is to be expected that interest may be charged on that loan… [6]

[33] In this case, based on the record before me, Kari has not established on a balance of probabilities that the Bank was extending credit to CIF by way of overdraft. [7]

[34] According to the texts quoted above, an overdraft is created when the Bank makes a decision to cover a cheque that puts the account into a negative balance. This is consistent with s. 10 of the Account Agreement – “Overdrafts are not permitted on any Account without specific written agreement from HSBC. If HSBC occasionally honours an Instrument drawn on an Account or accepts Instructions to debit an Account when there are insufficient funds on deposit, thus creating or increasing an overdraft…”

[35] Here, the Bank’s evidence is that under its system, that decision could not be made until the next day when the account manager reviewed the APR. According to Kari’s argument, an overdraft would be created the moment the cheque was posted to the account, even before the account manager had the opportunity to review the APR and make a decision. That does not accord with the Bank’s system, which requires the account manager to decide whether to honour the cheque or return it to the presenting institution.

[36] Further, until such time as the Bank made a decision to honour or return the cheque, it was not providing any credit to CIF or assuming any risk on its client’s behalf. While the Bank’s internal system marked the Account as being in a debit position (thereby triggering the APR and the account manager’s review), Ms. Symes’ and Mr. Robbins’ uncontradicted evidence is that the Bank did not advance any of its funds to CIF to cover the cheque. [8] By the time the Bank made the decision to honour the cheque, CIF had covered it with its own funds. This was not a case where CIF repaid the Bank for covering the cheque on its behalf.

[37] Kari argues that on receiving the APR, the account manager could have immediately dishonoured the cheque and returned it to the presenting institution, without giving CIF an opportunity to cover the cheque. In my view, the Bank’s accommodation of its client in that way does not assist Kari in establishing that the Bank actually assumed a credit risk on behalf of its client.

[38] Kari relies on the fact that interest was charged (together with the Advance Posting Fee) as soon as a cheque was posted that put the Account into a negative balance. Kari argues that this is evidence that the Bank was permitting overdrafts on the Account, as it is consistent with s. 10 of the Account Agreement (which entitles the Bank to charge interest for overdrafts).

[39] I reject this submission. First, according to Ms. Symes’ uncontradicted evidence, this interest charge was a penalty for the client breaching its account agreement. It was imposed each time a cheque was posted that put the account into a negative balance position, which triggered the APR review process. Second, the fact that the Bank was entitled to charge interest for permitted overdrafts does not establish that the Bank was providing overdrafts. The use of the word “interest”, without more (and in light of my analysis above), is not sufficient to establish that the Bank was providing overdraft facilities to CIF. Third, I note that s. 7 of the Account Agreement entitles the Bank to impose a wide variety of charges on the client, including charges for any Instruments (such as cheques) that may be drawn on the account.

[40] Finally, Kari argues that the Bank, in determining whether to honour or return a cheque that put one Account into a negative balance, was not entitled to take into consideration the funds in the other Account. I disagree. The two Accounts were for the same business operations, were linked with one another and shared the same base Account number. They were covered by one Account Agreement that specifically entitled the Bank to consolidate and set-off amounts owing as between the two Accounts. I see no reason why the Bank could not look to amounts in both Accounts to determine whether CIF was in an overall net credit position, before deciding whether or not to honour a cheque drawn on an Account. [9]

Issue #2 – Was Repayment out of Collateral in the Ordinary Course of CIF’s Business?

[41] If I am wrong in my conclusion that the Bank did not provide credit to CIF by way of overdraft, I have considered whether the use of monies in the Accounts to repay the Bank was in the ordinary course of CIF’s business.

[42] Section 5 of the GSA provides that CIF may, “until default, possess, operate, collect, use and enjoy and deal with Collateral in the ordinary course of [CIF’s] business in any manner not inconsistent with the provision hereof…” Section 4(a) of the GSA further states that “until default, [CIF] may, in the ordinary course of [CIF’s] business, sell or lease Inventory, Equipment and…use Money available to [CIF]”.

[43] The Bank’s uncontradicted evidence is that the Accounts were regular commercial accounts being operated by CIF in the ordinary course of its business. Thousands of cheques came in and out of the Accounts during the relevant period, i.e. July 2007 to March 2009. Over that period of time, CIF deposited funds (or transferred them from the other Account) to eliminate a negative balance in the Account on approximately 27 occasions.

[44] There is no evidence that Kari had taken steps to restrict CIF from operating its business in the ordinary course during that time. Indeed, once CIF made the lump sum payment to Kari in March 2007, Kari’s counsel sent an email dated April 4, 2007 to CIF’s counsel stating that this covered “all interest arrears and costs awarded” and that he had received post-dated cheques covering future payments from April 30, 2007 to November 30, 2008, “all of which is satisfactory”. Further, Kari’s evidence is that (i) Kari was not aware of any notices sent to CIF with respect to other acts of default (apart from notices of default in November and December 2005 with respect to interest payments); (ii) from March 2007 to March 2009, Kari made no demands of CIF that the loan be paid immediately; (iii) no notifications were sent by Kari to any of CIF’s account debtors; and (iv) no notice of any kind was sent to HSBC.

[45] Given the fact that CIF was operating its business in the ordinary course during that period of time, the fact that thousands of transactions were flowing through the Accounts, and the fact that negative balances in the Accounts occurred from time to time, I am satisfied that CIF’s deposit or transfer of funds into the Accounts to cover or eliminate these negative balances fell within the scope of the ordinary course provisions of Sections 4(a) and 5 of the GSA.

[46] Likewise, I find that the repayment of the CIF MasterCard balance between February 2007 and September 2008 was carried out in the ordinary course of CIF’s business, as permitted by Sections 4(a) and 5 of the GSA.

Decision

[47] The basis for Kari’s action is that CIF was repaying the Bank for credit facilities with Collateral that was subject to Kari’s perfected security interest. My findings that the Bank did not provide credit by way of overdraft and that, in any event, CIF was dealing with the Collateral in the ordinary course of its business, are sufficient to defeat Kari’s claim against the Bank. There is no need for me to consider the Bank’s alternative defences. Kari has conceded that if I found against it on its central premise, there was no basis for any of its other causes of action against the Bank (wrongful conversion, intentional interference with economic relations, inducing breach of contract, or knowing assistance of breach of trust or fiduciary duty).

[48] Kari’s action against the Bank is therefore dismissed.

[49] If the parties are unable to agree on costs of this proceeding, written submissions not exceeding 3 pages (double spaced) may be made to me, by the Bank within 15 days and by Kari within 10 days thereafter.

Conway J. Date: January 18, 2017

Footnotes

[1] “Vengrowth” consists of Vengrowth II Investment Fund and Vengrowth Traditional Industries Fund Inc.

[2] The Bank disputes that Kari has suffered any damages under the Vendor Note. Counsel agreed to defer the issue of damages until the court ruled on whether the Bank had any liability to Kari.

[3] Internal Bank documents from October and December 2006 indicate that HSBC was continuing to consider the proposed CIF credit facility and that at one point there was a suggestion that Vengrowth would buy out the Vendor Note. Mr. Robbins’ evidence is that the Bank decided not to grant the credit facility shortly before he left the Mississauga branch in February 2007. The Bank documented this decision internally in August 2007.

[4] Hyrniak v. Mauldin, 2014 SCC 7, at para. 49.

[5] H.G. Beale, Chitty on Contracts, 31st ed (London, UK: Sweet & Maxwell, 2012) at 409.

[6] M.H. Ogilvie, Bank and Customer Law in Canada, 2nd ed (Toronto: Irwin Law Inc., 2013) at 242.

[7] On the one occasion that there was a $4025 shortfall in the Accounts when the cheque was honoured, CIF covered the shortfall within a few days. In any event, as described below, I consider this payment was made in the ordinary course of CIF’s business.

[8] As Ms. Symes explained on cross-examination, if HSBC does not return the cheque within the Recourse Period, that is when the presenting bank is entitled to get the funds from HSBC to cover the cheque.

[9] Kari argues in its factum that this set-off cannot be used to trump a perfected prior security interest under the PPSA, citing s. 40(1.1) of the PPSA. That section has no application to the facts of this case.