A banker asked us: In a Canadian secured loan transaction involving foreign assets, what law should govern the guarantee and security agreement?

30 October 2019

Background: The "governing law" clause, also known as "choice of law," allows parties to select the jurisdiction (e.g., Ontario law) whose laws will govern their contract when legal issues arise.

Q: If Canadian1 law governed the underlying loan agreement but the assets of a foreign guarantor are located in a foreign jurisdiction, I would expect the security agreement from the foreign guarantor to be governed by the law of the jurisdiction in which the assets are located. Does it follow that the foreign law would also govern the related guarantee?

A: The choice of governing law for a guarantee and security agreement in a Canadian secured loan transaction involving foreign guarantors and foreign-based assets depends on a variety of considerations, including the amount of the loan, the foreign jurisdiction involved, and the value of the collateral. The table below provides an overview of the relative strengths associated with having a guarantee and/or security agreement governed by foreign versus Canadian law.

Governing law of guarantee and/or security agreement Applicable context
Foreign

Preferred when:

  • taking security in foreign-based assets.
  • unclear whether foreign jurisdiction will enforce Canadian judgments.
  • value of foreign collateral is high relative to costs associated with the taking and enforcing security interest over foreign collateral.
Canada

Effective option when:

  • foreign jurisdiction has an established practice of enforcing foreign judgments.
  • value of foreign collateral is low relative to costs associated with the taking and enforcing security interest over foreign collateral.

Choice of law generally: The home court advantage

Depending on the foreign jurisdiction and the nature of the collateral, 2 the contracting parties may be able to negotiate and decide on the governing law of the loan documents. It is a well-established principle at common law that the courts will uphold the governing law clause of a contract, even when the contracting parties have no connection to the jurisdiction chosen, if the choice of law is:

  • bona fide,
  • legal, and
  • not against public policy.3

In a cross-border loan transaction, it is often more cost-efficient for a lender to choose the same governing law for the underlying loan agreement, the guarantee, and the security agreement. Choosing the same jurisdiction to govern the guarantee and the underlying loan agreement typically allows for predictability and familiarity if the lender needs to bring an action against the credit parties in a consolidated debt action.

Choice of law: Taking security over foreign-based assets

At common law, the choice of law in a Canadian-governed guarantee and/or security agreement will typically be applied in a foreign court. However, for the purposes of enforcing security located outside of Canada it may be in the lender's best interest to have foreign law govern the guarantee and/or security agreement. To enforce a guarantee and/or security agreement governed by Canadian law in a foreign jurisdiction, the court of the foreign jurisdiction must correctly interpret and impose Canadian laws within a foreign proceeding. The process for doing that introduces the potential for delays, unpredictable interpretations of law, additional costs, and at worst, the possibility for the guarantee and/or security agreement to be held invalid or otherwise unenforceable.

In the context of cross-border loan transactions involving US-based collateral, US courts have generally enforced guarantees and security agreements governed by Canadian law,4 absent fraud or public policy concerns. However, given the potential risks, jurisdiction-specific guarantees and/or security agreements are usually obtained if the likelihood of enforcement and value of the collateral outweigh the cost associated with engaging foreign counsel to assist with preparing foreign law documents and rendering of a legal opinion regarding their enforceability.

In cases where both the value of the security and lender's reliance on the security are high, lenders may choose to obtain a guarantee and security agreement governed under each of the foreign jurisdictions applicable to the guarantor to maximize their options for enforcing on their security interests.

[1] Governing law clauses are usually drafted to include the choice of law of a particular Canadian province or territory, with language suggesting that federal laws also apply. For the purposes of this article, the term "Canadian law" is used to include provincial and federal laws, as applicable.

[2] Foreign counsel should be engaged to consider the enforceability of "governing law" provisions on a case-by-case basis; for example, security documents involving foreign real estate assets often require jurisdiction-specific governing law provisions.

[3] Vita Food Products Inc v Unus Shipping Co. Ltd., [1939] UKPC 7, [1939] 1 All E.R. 513 (P.C.).

[4] See for example: Barlow Lane Holdings Ltd. v. Applied Carbon Tech. (Am.), Inc., 2004 U.S. Dist. LEXIS 16194 (W.D.N.Y. Aug. 11, 2004)


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