SECURITY INTERESTS IN SERIAL NUMBERED GOODS - MORE PROBLEMS

Posted: June 26, 2018 | Last Updated: July 10, 2018
Written by: Edward D. Brown

Edward D. (Ned) Brown
Pitblado LLP
Winnipeg, Manitoba
June, 2018

You provide credit to someone (the "Debtor") and take a security interest in an item of equipment which the Debtor acquires utilizing the benefit of your credit.  You properly perfect your security interest by registering it against the Debtor's name and against the item's serial number in the Manitoba Personal Property Registry (the "MPPR") as per the requirements of the Manitoba Personal Property Security Act (the "MPPSA").  Subsequently, the Debtor sells the equipment to "X".  The purchase price owed by "X" to the Debtor is fully paid by "X" transferring ownership of a different piece of equipment which "X" has theretofore owned, and which also happens to be an item of serial numbered goods under the MPPSA.  The Debtor then goes and borrows funds from "A" and grants "A" a security interest in the new item of equipment.  "A" properly perfects its security interest by registering against the Debtor's name and against the serial number of the new item of equipment.  The Debtor then reneges in its debt obligations owed to both you and to "A" and the (new) item of equipment held by the Debtor is liquidated in security realization proceedings.  Who is entitled to the funds received in such security interest realization proceeds, you or "A"?

It is this writer's opinion that "A" would have first entitlement to the realization proceeds.  The MPPSA, as a general rule, provides that the secured party who perfects first (in this case by way of registration in the MPPR) wins the priority battle.  Additionally, the MPPSA provides that when perfecting a security interest in serial numbered goods, a secured party must correctly register against the goods' serial number(s) (as well as against the debtor's name). Failure to do so, when the goods are equipment or consumer goods, will cause the security interest to become unperfected. If someone subsequently properly perfects against the serial numbered goods, the later perfecting secured party will take priority.

Given that, in the above example, the original secured party would probably have no knowledge of the exchange of one item of serial numbered goods for a different item of serial numbered goods, how can the original secured party protect itself?  Unfortunately, the answer appears to be simply that "it can't"!  This situation is analogous to one in which a first secured party takes a general security agreement from a debtor with the intent that all future acquired personal property will be subject to the security agreement's charge, with priority starting from when the secured party perfects its interest.  Then subsequently, the debtor - without advising the original secured party - acquires one or more serial numbered goods, with another secured party acquiring - and properly registering against - the subsequently acquired serial numbered goods.  The "later in time" secured party will hold priority over the original GSA holding secured party with respect to the serial numbered goods.  This seems unfair.

The writer has concluded that the unfairness of the original secured party's position will remain so for the foreseeable future because the Legislature has decided that on a "public policy" basis, it is reasonable to place the risk of loss on the original secured party who - at least in theory - is better able to monitor what its debtor does from time to time with the secured collateral.  This means that for a potential creditor who anticipates taking a security interest in original collateral which is serial numbered goods, such potential creditor should base its credit decision on such considerations as:

(1)        whether or not the increased risk of losing priority calls for the charging of a higher interest rate on the credit extended; and

(2)        whether or not the potential creditor will be in a position to properly monitor the debtor's use of and dealings with the original collateral, even on a modest basis.

  In the above example, the problem arises because the proceeds comprise another serial numbered good (or goods), and typically, the original secured party is not able to discover the debtor's disposition of the original collateral (or the debtor's acquisition of replacement serial numbered goods) until after the debtor has granted a new security interest to another creditor in the newly acquired serial numbered goods, or has gone bankrupt, thus depriving the original secured party of the opportunity to reperfect its security interest against the newly acquired serial numbered goods in a timely manner.  The writer suggests that this conclusion is supported by the wording of Section 28(2) of the legislation which provides, in effect, that where the security interest in the original collateral has been perfected by registration, and is so at the time that proceeds are created, while the security interest in the proceeds (replacement serial numbered goods in the above example) remains continuously perfected, such continuous perfection exists for only "so long as the registration remains effective" (the underlining here is added for emphasis purposes).  Arguably, the original registration becomes ineffective immediately upon the debtor's acquisition of the replacement serial numbered goods and the original secured party, not knowing of the transaction, fails to amend its registration to cover the newly acquired collateral.

The MPPSA provides some "relief" for a secured creditor whose debtor disposes of the original collateral.  Insofar as the original secured party's right to proceed against the original collateral (now in the hands of a new owner) is concerned, Section 51(2) of the MPPSA appears to entitle the original secured party to hold its original security in place against the original collateral in the hands of the new owner.  However, this protection only exists if the original secured party:

  1. has not consented to the transfer and
  2. has not learned of the transfer. 

Where the secured party has learned of the transfer (not having consented to it previously), the original secured party can maintain its perfection only if it registers an amendment to its financing statement in the MPPR within fifteen days of learning of the transfer.  In the typical situation described above, it is unlikely that the original secured party would have discovered the transfer any time soon after the transfer occurs.  By that time, the original collateral may be on the other side of the continent and/or have fallen considerably in value.  Again, the risks faced by a potential creditor may lead to more onerous credit terms (in particular, higher interest charges) being imposed on the debtor, and in some cases, it might induce a potential creditor to completely pass on extending credit at all.

A further difficulty — essentially an "interpretation problem" — relates to the meaning of section 28(2) of the MPPSA.  Section 28(2) provides that "…where the security interest was perfected by registration when the proceeds arose, the security interest in the proceeds remains continuously perfected so long as the registration remains effective …".  Do the underlined words mean effective against the original collateral or against the proceeds?  If the proceeds are consumer goods which happen to be serial numbered goods, then by Section 43(8), the secured creditor's failure to properly register against the serial number of the proceeds will invalidate that secured creditor's interest.  If the wording means "effective against the original collateral" it's difficult to understand why the continuing existence in the MPPR of the secured creditor's registration against the original collateral in any way assists anyone in determining that the secured creditor's security interest has now attached itself to the proceeds.  What this may mean is that the secured creditor's security interest against the proceeds is initially effective only if the secured creditor's registration against the original collateral is properly perfected at the time that the proceeds arise (in the hands of the debtor), but then are subject to loss of priority where the secured creditor fails to properly register against the proceeds within 15 days from consenting to the disposition (which gave rise to the proceeds) or learns of the disposition.

In the end, while there are clearly still issues to be resolved by the courts in this scenario, in the view of the writer, the weight of interpretation rules would seem to suggest that the party who registers against both the name and serial number of the new collateral will be successful as against the party that is claiming the new collateral as proceeds of an earlier perfected security interest.

The writer wishes to thank Professor Darcy MacPherson of Robson Hall in Winnipeg (The Manitoba Law School) for his invaluable assistance in reviewing and preparing this paper.