Business Law, Taxation law

The New Pledge of Cash: Of Help for Escrow Funds? Of Help to Landlords?

Jun 16th, 2016

By Daniel Frajman

Amendments to the Civil Code of Quebec (“CCQ”) that came fully into force in 2016, and which are modelled after older rules relating to security over brokerage and other securities accounts, create control agreements (an “accord de maîtrise” in French) over monetary claims (“créances pécuniaires” in French) (being essentially any claims requiring the debtor to return or reimburse an amount of money), and will be of assistance to banks (and others that issue cash-like accounts, like caisse populaires, credit unions, trust companies, brokers, etc.) taking security over accounts (referred to as “financial accounts” in the law, or a “compte financier” in French) they issue, but also very importantly these new rules should be of assistance in contractual scenarios of benefit to business persons generally, including in relation to escrow accounts. The security is deemed to be a pledge (a hypothec with delivery), and therefore need not be registered, and it ranks ahead of pre-existing registered hypothecary security over the account. Control over such bank and other financial accounts (which essentially perfects the establishment of the security) may even be aided by one of the new rules that puts aside the need for a control agreement and instead provides for the security to be perfected in a situation where the creditor is made the actual account holder (i.e., the bank account or similar account is put in the name of the creditor).

Further amendments to the CCQ made at the same time could be of assistance, for example, to landlords seeking security from tenants (and may also assist in other situations, including again, escrow accounts, and security in favour of banks and other account issuers). These further amendments also provide for a deemed unregistered pledge ranking ahead of pre-existing registered hypothecs, and are technically termed as providing security to a creditor [say, a landlord] over “a monetary claim that the grantor of the hypothec [say, a tenant] has against the creditor”. This may for example assist a landlord in enforcing a security deposit as follows: the landlord has an obligation to return to the tenant the security deposit at the end of the lease (the tenant’s monetary claim); the tenant has an obligation owed to the landlord, to pay rent; to secure the rental obligation owed to the landlord, the landlord takes security over the tenant’s monetary claim to the security deposit. A clause in the lease to this effect should be enough to set this up. The clause would not have to be registered. As a caveat though, note that the 1998 Quebec Court of Appeal case referred to in the next paragraph could negatively affect this landlord security.

In the past, landlords have had trouble enforcing security over tenant’s property. Some cases up to now have returned security deposits to a bankrupt tenant’s trustee in bankruptcy (on the grounds that the landlord has not taken a hypothec and is therefore an unsecured creditor), and in addition there is case law (Restaurant Ocean Drive, 1998, Quebec Court of Appeal) indicating that contractual hypothecs taken by a landlord from a tenant are invalid on the tenant’s bankruptcy, on the questionable grounds that a landlord should have only a lower “preferred” claim (referred to at section 136 of the Bankruptcy and Insolvency Act) on a tenant’s bankruptcy. As a result, many landlords secure unpaid rent through bank guarantees (sometimes cumbersome to set up) received from tenants, which the Quebec courts have essentially upheld on the tenant’s bankruptcy. Given the case of Restaurant Ocean Drive, time will tell, for situations where the tenant goes bankrupt, whether the Courts will uphold landlord security over security deposits based on the apparently easier to use new amendments to the CCQ described in the previous paragraph.

The new conflict of law rules in the CCQ that accompany these new security rules, essentially apply Quebec law (and therefore the abovementioned new security rules) if the contracts state that Quebec law applies. Therefore, when parties from the Canadian provinces other than Quebec (where rules such as these Quebec rules on security over monetary claims have not yet been introduced) or parties from the U.S. (article 9 of the U.S. UCC is not as expansive as these new Quebec rules) are involved, in order to try to avoid the possibility that the Quebec rules will not be applied if the matter ends up before a non-Quebec court, it may be useful to oblige a non-Quebec debtor providing security to use a Quebec corporation [simple to incorporate, with no residence restrictions on shareholders or directors and with a Quebec head office which can be at a Quebec agent’s address] as a special purpose vehicle (SPV) (especially if an SPV would be used anyway) for the granting of the security.

These new provisions of Quebec law should be of help to creditors (including escrow agents, beneficiaries of escrow agreements, landlords possibly, banks and other account issuers, and others) wishing to secure their claims by taking security over cash or bank accounts and similar financial accounts that hold cash and possibly also cash-like assets such as GICs, and can apply to many different commercial situations, even possibly when some of the parties are outside of Quebec.

Therefore, if you are either in Quebec, or can get Quebec law to apply to part of the security arrangements, then “cash can be king”, so to speak, when taking collateral security.

Please feel free to contact me to establish whether these rules can help you.

[Sections of the law consulted for this article: article 2713.1, 2713.2, 2713.3, 2713.4, 2713.5, 2713.6, 2713.7, 2713.8, 2713.9 and 3106.1 of the Civil Code of Quebec (CCQ)]

Daniel Frajman, a shareholder with Spiegel Sohmer, a Montreal law firm, is involved in interprovincial and cross-border matters. He is president of the Montreal branch of the Society of Trust and Estate Practitioners (STEP) and is on the national Board of Directors of STEP.