Keeping up with the Americans: Ontario’s electronic chattel paper legislation is now in force

19 May 2020

Almost two decades after the United States' enactment of similar legislation, amendments to the Ontario Personal Property Security Act ("PPSA" or the "Act") came into force on May 15, 2020, much to the anticipation of lenders, financiers, and lessors alike looking to digitize their commercial offerings with respect to chattel  paper. These amendments will, among other things, allow for the perfection of security interests by control of electronic chattel paper (a new class of personal property) and set out related priority rules.



The pre-amendment PPSA regime only allowed for perfection of chattel paper (with no distinction made between an electronic or hardcopy format) by "registration" or "possession." Though the latter is often preferred by chattel paper financiers given that it can, if certain requirements are met, confer a preferential priority. The increasing digitization of commercial transactions in recent years has raised questions pertaining to the ability of a secured party to perfect its interest by "possession" in chattel paper that exists only in electronic format, particularly in such cases where there may be competition between multiple parties claiming rights in the chattel paper.

For example, in an automotive financing transaction, the seller (typically a dealer) will provide financing for the sale or lease of a vehicle and then sell the chattel paper (i.e., the purchase contract) to a purchaser or assign its security interest in the resulting chattel paper to the seller's own lender. Under the pre-amendment PPSA regime, the chattel paper purchaser or lender perfects its ownership or security interest by taking physical possession of the chattel paper. With no direction at law on how to take "possession" of an electronic chattel paper (which unlike a hard copy chattel paper, may not be unique and can be duplicated), the priority of a secured party relying on electronic chattel paper historically remained unclear and subject to being challenged by third parties.

By contemplating the use of, and the priority rules pertaining to, electronic chattel paper, these amendments facilitate the ability of lessors and financiers to originate, finance and securitize electronic chattel paper including conditional sales contracts and leases. As per the above example, this new option will be of particular interest to automobile and equipment financiers and lessors who interact with large volumes of chattel paper as a result of their interaction with large dealer networks.

The amendments

The PPSA amendments include the following:

  1. a new provision about what constitutes control of electronic chattel paper, and a new provision regarding how to obtain perfection of electronic chattel paper by control;
  2. amendments to existing provisions regarding conflict of laws and the timing of attachment; and
  3. an amendment to section 28 of the Act, which sets out priority rules for purchasers of chattel paper that now take into account both types of chattel paper.

What is "chattel paper"?

Under the amended PPSA, "chattel paper" is defined "as one or more than one record that evidences both a monetary obligation and a security interest in or a lease of specific goods." The only distinction from the old definition being the use of the term "record" at the outset of the definition rather than "writing".

In addition, two types of chattel paper are now recognized under the Act:

  • "electronic chattel paper" means chattel paper created, recorded, transmitted or stored in digital form or other intangible form by electronic, magnetic or optical means; and
  • "tangible chattel paper" means chattel paper evidenced by a record or records consisting of information inscribed on a tangible medium.

1. Perfection of electronic chattel paper by "control"

The amended PPSA provides that electronic chattel paper can be perfected by "control" (a method intended to be equivalent to perfection by possession). To establish perfection of electronic chattel paper by control, the following six criteria, as set out in subsection 1(3) of the Act, must be met: (emphasis added):

(3) For the purposes of this Act, a secured party has control of electronic chattel paper if the record comprising the chattel paper is created, stored and transferred in a manner so that,

  1. a single authoritative record of the electronic chattel paper exists that is unique, identifiable and, except as otherwise provided in clauses (d), (e), and (f), unalterable;
  2. the authoritative record identifies the secured party as the transferee of the record;
  3. the authoritative record is communicated to and securely maintained by the secured party or the party's designated custodian;
  4. copies of or amendments to the authoritative record that add or change an identified transferee of the authoritative record can be made only with the consent of the secured party;
  5. each copy of the authoritative record and any copy of a copy is readily identifiable as a copy that is not the authoritative record; and
  6. any amendment of the authoritative record is readily identifiable as to whether it is authorized or unauthorized.

While the legislation is silent with respect to the manner in, or the process by, which the above noted criteria is to be achieved, it should be noted that these amendments to the PPSA are largely based on the electronic chattel paper provisions found in the United States Uniform Commercial Code (UCC). As a result, Ontario is well positioned to adopt, or at least consider, the platforms and management processes currently utilized in the United States to meet a similar criteria.   

2. Conflict of laws and timing of attachment

To align the pre-amendment PPSA's conflict of laws provisions with the two types of chattel paper now recognized, the provisions of the amended Act state that "the validity, the perfection, the effect of perfection or non-perfection, and the priority" of a security interest are each governed by the law of the jurisdiction where, at the time the security interest attaches, the:

  • Debtor is located, in the case of a:
    • non-possessory security interest in tangible chattel paper, and
    • security interest in electronic chattel paper.
  • Collateral is situated, in the case of a possessory security interest in tangible chattel paper.

3. Priority rules for purchasers of chattel paper

Prior to being amended, Section 28(3) of the PPSA provided a preferential priority to a purchaser of chattel paper who took possession of the chattel paper under specified circumstances. This section has been repealed and replaced to take into account both types of chattel paper. Specifically, the new Section 28(3) provides a purchaser of chattel paper with priority over any security interest in it if the purchaser, in the ordinary course of the purchaser's business and for new value,

(i) takes possession of the chattel paper if it is tangible chattel paper, or,

(ii) obtains control of the chattel paper if it is electronic chattel paper.

In each case provided the chattel paper does not indicate that it has been assigned to an identified assignee other than the purchaser.

Further, to address the potential for a chattel paper existing simultaneously in both electronic and hardcopy formats, the revised Act introduces a new priority rule. Section 28(3.1) states that the interest of the purchaser of the tangible chattel paper has priority over the interest of the purchaser of the electronic chattel paper if:

  • the rights arising out of tangible chattel paper are transferred to a purchaser as electronic chattel paper for new value and in the ordinary course of the purchaser's business, and
  • the tangible chattel paper is transferred to another purchaser who takes possession of it for new value and in the ordinary course of that purchaser's business, and
  • the tangible chattel paper does not indicate that it has been assigned to an identified assignee other than the purchaser of the tangible chattel paper.

Conclusion

These amendments are intended to modernize laws relating to secured lending and other commercial activity. The desire is to both simplify and clarify certain rules of attachment and priority as businesses become increasingly digital. The option to conduct business online, while subject to a process that will allow for perfection by control, could represent significant cost savings for financiers who have traditionally had to generate, process and store a large volume of tangible chattel paper.


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