Banking & Financial Services Law

Superior Court of Québec Refuses to Apply Indalex

Martin Desrosiers — Thu, 10 May 2012 11:01:52 -0500

In April 2011, the Ontario Court of Appeal rendered a unanimous judgment in Re Indalex Limited which ordered that the amount the debtor was required to contribute towards its pension plan wind up deficiency be paid in higher priority to repayments to its interim (DIP) lender. This judgment was a departure from prior law and a surprise to the legal community. Leave to appeal has since been granted by the Supreme Court of Canada.

In November 2011, groups of White Birch Paper employees and retirees filed motions seeking the application of the legal findings of Indalex to White Birch. Recently, Justice Mongeon categorically held that the main legal principles arising out of Indalex cannot be applied in Québec and dismissed the motions. This judgment could still be appealed by the employees. In any event, stakeholders in the restructuring community will be closely watching the Supreme Court’s decision in Indalex and any hints as to its consequences in Québec.

Click here to read a full Osler Update regarding this decision of Justice Mongeon, authored by Martin Desrosiers, Sandra Abitan and Julien Morissette.

Inapplicability of the Personal Property Security Act (Ontario) to Insurance

Scott Horner — Mon, 30 Apr 2012 11:49:12 -0500

We recently represented a US bank in Ontario on a secured refinancing for a Canadian borrower. The Canadian borrower owns a number of Canadian and US subsidiaries (the Canadian borrower and its subsidiaries, the “Loan Parties”) which delivered secured guarantees. US counsel for the bank agreed to a request of US counsel for the Loan Parties that the US security agreement contain only a grant of a security interest (in contrast to also including an assignment, charge etc. by way of security like the US security agreement did on the original financing). The bank’s US counsel stated that they accepted this request on the basis that the Uniform Commercial Code applied to insurance proceeds.

The Loan Parties’ US counsel requested that the Canadian security agreement be conformed to the US security agreement on point. We advised our client to not accept this request on the basis that the Personal Property Security Act (Ontario) ("PPSA") does not apply to a claim in or under, or the proceeds of, the Loan Parties’ property insurance (which is unlike some other Canadian jurisdictions where the PPSAs are stated to apply to insurance proceeds) and, accordingly, the Canadian security agreement should contain an assignment by way of security. Canadian counsel for the Loan Parties agreed with us and, accordingly, the Canadian security agreement was not conformed to the US security agreement on point.

The covenant in the 2012 credit agreement on naming the collateral agent as loss payee under the Loan Parties’ property insurance also was amended, from the unconditional covenant contained in the original credit agreement, to require the Loan Parties to use commercially reasonable efforts to so name the collateral agent. This accommodation of the Loan Parties was made on account of their expressed administrative burden in amending approximately 100 insurance policies (the collateral agent not being the same person under the refinancing as in the original financing). We advised our client that in order to be perfected on property insurance, the insurers should at least be notified of our client’s interest in the Loan Parties’ insurance and requested to acknowledge that interest. The collateral agent made the business decision that it would accommodate the Loan Parties on point and only require their commercially reasonably efforts to name the collateral agent as loss payee.

It is customary in secured transactions that the loan parties represent and warrant and covenant to ensure that the liens granted to the lender parties are perfected first priority liens on the collateral, subject to permitted liens. In the secured refinancing referred to above, such representation and covenant should provide for an exception for insurance claims and proceeds until the applicable action is taken to perfect the assignment of such claims and proceeds.

Canadian Court Permits Roll-up of Pre-petition Borrowing in Cross-border Canada-U.S. Proceeding

Steven Golick — Wed, 25 Apr 2012 15:10:19 -0500

This entry was written by Steven Golick and Patrick Riesterer.

Interim Financing Under the CCAA and “Roll-ups”

Section 11.2 of the Companies’ Creditors Arrangement Act (“CCAA”) gives the Canadian court explicit authority to grant a priority charge for amounts advanced by a lender to a CCAA debtor after the CCAA filing (a “DIP Loan”); however, the section provides that the charge may not be granted to secure an obligation that exists before the order is made. Section 11.2 effectively prevents a roll-up of pre-petition debt into a DIP Loan. A “roll-up” is an arrangement where all or a portion of pre-petition loans provided by a lender are “rolled-up” into the post-petition DIP Loan provided by the same lender, effectively giving the DIP lender the benefit of the DIP Loan charge for pre-filing obligations.

Roll-up Approved in Recent Cross-Border Proceeding

In the recent decision in Re Hartford Computer Hardware, Inc. et al., the Canadian court recognized an order of the United States Bankruptcy Court for the Northern District of Illinois Eastern Division (the “US Court”) granting a roll-up in a cross-border proceeding despite the prohibition on roll-ups in s. 11.2 of the CCAA.

Hartford Computer Hardware, Inc. and certain of its affiliates (collectively, “Hartford”) were subject to Chapter 11 proceedings in Illinois and those proceedings had been recognized in Canada as foreign main proceedings pursuant to Part IV of the CCAA.

Hartford had previously obtained from the Canadian court recognition of an Interim DIP Facility Order that had been granted by the US court. In a motion heard on February 1, 2012, Hartford sought approval of the Final DIP Facility Order. The Final DIP Facility Order contained a partial roll-up, whereby all cash collateral in the possession of Hartford on the day of the Chapter 11 filing or acquired afterward was deemed to have been remitted to the pre-petition secured lender for repayment of the pre-petition secured loan and a corresponding loan was deemed to have been made under the DIP Facility.

The Canadian court approved the Final DIP Facility Order despite the roll-up. In reaching this conclusion, the Canadian court considered the following facts:

the motion was for recognition of an order made in a foreign main proceeding;
the US Court had found that there was good cause to approve the Final DIP Facility Order despite hearing certain objections to it;
the Final DIP Facility Order was supported by the Unsecured Creditors’ Committee; and
the Canadian unsecured creditors would be treated no less favourably than US unsecured creditors.

One of the most significant factors in the decision was the fact that the order had been granted by the US Court in a foreign main proceeding.

After noting the prohibition on roll-ups in s. 11.2 of the CCAA, the Canadian court observed that s. 49 of the CCAA permits a Canadian court to make any order that it considers appropriate when recognizing an order of a foreign court, provided that the Canadian court is satisfied that the order is necessary for the protection of the interests of the debtor, a creditor or creditors.

The Canadian court also noted that s. 61(2) of the CCAA permits the Canadian court to refuse to recognize the orders of a foreign court where doing so would be contrary to public policy. The Canadian court decided that s. 61(2) of the CCAA should be interpreted restrictively, in light of the Guide to Enactment of the UNCITRAL Model Law on Cross-Border Insolvency. The Canadian court relied on the report of the Information Officer which it had appointed, which stated that there would be no material prejudice to Canadian creditors if the Canadian court recognized the Final DIP Facility Order, and that nothing was being done that was contrary to the applicable provisions of the CCAA. The Canadian court therefore found that the Final DIP Facility Order did not raise any public policies issues and recognized the Final DIP Facility Order.

It could be argued that the roll-up of Hartford’s pre-petition debt provided for in the Final DIP Facility Order was only a roll-up in theory, and not a roll-up in fact. The Canadian court observed that the cash collateral on hand as of the date of the Chapter 11 petition was effectively spent during the Chapter 11 proceedings and replaced with advances under the DIP Loan, so that all of the cash collateral available as of the date of the Final DIP Facility Order was cash advanced by the DIP Loan lender.

Co-operation Between Courts in Cross-Border Insolvencies

This case provides a window into the distinction between the orders that are available in a plenary case under the CCAA compared with the orders that can be recognized under Part IV. Clearly, the Canadian courts are very sensitive to the need for close cooperation between the US and Canadian courts in cross border insolvency matters.

Participatory Loan Agreements: Usury Provisions and Equity Sweeteners

Richard Borins — Tue, 03 Apr 2012 13:02:37 -0500

When lending to borrowers poised for growth, it is not uncommon for lenders to include mechanisms for them to capitalize on the future growth of the borrower, be it through warrants or other equity sweeteners (often known as participatory loan arrangements). In these circumstances, heed must be paid to section 347 of the Criminal Code’s definition of “interest” and its application. Lenders are often surprised to learn that warrants and other equity sweeteners may be subject to Canadian usury laws, and that they may quickly run up against a maximum rate.

Section 347 of the Criminal Code (Canada)

Section 347 of the Criminal Code makes it an offence to enter into an agreement for, or to receive, interest at a rate exceeding 60 percent per year. Section 347 applies to a very broad range of commercial transactions involving the advancement of credit, including secured and unsecured loans and commercial financing agreements. Section 347 has been employed where a borrower asserts the common-law doctrine of illegality to avoid or recover an interest payment.

Does Section 347 Apply? - An Advance of Credit

In determining whether section 347 applies, a preliminary issue arises: characterization of the agreement. The agreement must involve the advance of credit. To characterize an agreement, courts look to the intention of the parties as evidenced by their agreement; in other words, it is an exercise in contractual interpretation. Where an agreement has features of both debt and equity, courts look to the substance of the agreement; courts focus on the main thrust of the agreement and not on aspects which are only incidental or secondary in nature. The more contingent the equity aspects of the agreement, the more likely an agreement will be characterized as an advance of credit.

"Interest" Under Section 347

Assuming an agreement is characterized as an advance of credit, the prohibition contained in section 347 becomes an issue. Though it is unlikely that a sophisticated lender would enter an agreement which, on its face, provided for interest at greater than 60 percent, the definition of “interest” in the Criminal Code and its application may present issues when the total return to the lender includes warrants or other equity sweeteners.

Section 347 uses an extremely broad definition of interest. Interest is defined as the aggregate of all charges and expenses, in any form, that are paid or payable for the advancing of credit. This definition is extremely comprehensive, encompassing many types of fixed payments which would not be considered interest proper at common law or under general accounting principles. In determining what constitutes interest for the purposes of section 347, courts look to the substance, and not merely the form, of the transaction to determine whether the return the lender has received constitutes a cost incurred by the borrower to receive credit from the lender and is therefore, “interest”. For example, royalty payments on items manufactured by a borrower have been included in the calculation of interest for the purposes of section 347. Thus, warrants or other equity sweeteners may similarly be captured by the definition of “interest”.

The next issue is the time period for calculating the interest rate. In determining the amount of interest received by a lender, courts calculate interest over the period in which credit is actually available. Accordingly, if warrants or other equity sweeteners are captured by the definition of “interest”, they may be valued at the time of exercise rather than at the time when the agreement is entered into.

Remedies

Finally, if courts find that an agreement has breached section 347 they are free to employ judicial discretion to provide flexible remedies that are tailored to the contractual context before them. Where the arrangement contravenes section 347 and is otherwise unobjectionable, (e.g. it is not a loan-sharking arrangement), courts will typically employ the remedy of notional severance. Notional severance involves courts reading down the interest rate provisions of the agreement to avoid the illegality and thus partially enforce the agreement. Factors that have been cited as supporting the remedy of notional severance include:

whether the agreement inadvertently contravenes section 347;
whether the parties are experienced in commercial matters and negotiated at arm’s length;
whether the parties were of relatively equal bargaining power; and
whether the parties had the benefit of legal advice in the course of negotiations leading to the agreement.

This entry was authored by Richard Borins, Benjamin Leith and Michael P. Doris.

Payment Blockage in Intercreditor Agreements

Danielle Boyd — Mon, 02 Apr 2012 11:53:28 -0500

In a senior lender/junior lender scenario, the lenders will customarily enter into an intercreditor agreement to establish their respective rights when dealing with a common borrower. The intercreditor agreement will usually provide a restriction on the payments that the borrower can make to the junior lenders upon the occurrence of certain events of default under the senior lender credit agreement. These provisions are referred to as “payment blockage” provisions. If a payment blockage provision is triggered, all payments to the junior lenders will usually be blocked, even the payments the junior lenders may otherwise be entitled to receive, such as scheduled interest or ordinary course fees and expenses.

Payment blockage provisions usually require some negotiation in an intercreditor agreement. The following elements should be considered:

Triggering: when payment blockage will occur – eg. more material events of default such as a payment default, a financial covenant default or an insolvency event;
Blockage period: length of time the blockage will exist – eg. no more than 180 days in any one year or once per year;
Notice: whether or not notice is required to be given by the senior lenders to the junior lenders. Notice is most often required if the triggering event is a relatively less material designated blockage event of default.

It is important to note that, in the event that payments to the junior lenders are blocked, and the borrower makes payments to the junior lenders during the blockage period, the junior lenders will be required to pay any amount received from the borrower to the senior lenders pursuant to the “turnover” clause in the intercreditor agreement.

Task Force Releases Final Report on Canadian Payment Systems Overhaul

Stephen Clark — Wed, 28 Mar 2012 10:17:13 -0500

By Stephen D.A. Clark and Kashif Zaman.

On March 23, 2012, the Task Force for the Payments System Review (the Task Force) released its final report (the Report) entitled Moving Canada into the Digital Age. The Report is supplemented by four policy papers and four discussion papers. In this entry, we summarize the recommendations of the Task Force and make certain observations on a few issues that would be relevant to any overhaul of the Canadian payments system. The full text of the Report is available here.

Background and Mandate of the Task Force

Canada’s Minister of Finance announced the creation of the Task Force on June 18, 2010. In creating the Task Force, the Minister provided the following mandate:

Given the importance of a safe and efficient payments system and the need to ensure that the framework supporting that system remains effective in light of new participants and innovations, the government is appointing this task force to conduct a review of the payments system. Specifically, the task force will:

identify public policy objectives to be pursued in the operation and regulation of the payments system;
identify and assess the regulatory and institutional structures best suited to achieving these public policy objectives;
assess and report on the safety and soundness of the Canadian payments system;
assess the competitive landscape by identifying any potential barriers for new entrants and mechanisms to improve the competitive landscape of the domestic payments system;
assess the degree of innovation in the domestic payments system and report on the challenges and opportunities to bring new and innovative products to market in Canada; and
assess and report on whether consumers and merchants are well served by the domestic payments system.

Recommendations of the Task Force

In order to modernize Canada’s payments system, the Task Force notes that changes will be required in multiple arenas. In the Task Force’s view, because the industry has not implemented the necessary changes due in part to uncertainty and lack of coordination, the Canadian Government should lead the change.

In particular, the Task Force recommends that the Government should undertake the following actions:

implement electronic invoicing and payments (EIP) for all government suppliers and benefit recipients;
partner with the private sector to create a mobile ecosystem; and
propel the build of a digital identification and authentication (DIA) regime to underpin a modernized payments system and protect Canadians’ privacy.

The Task Force also calls on the Government to pass legislation to:

define a discrete payments industry and require payments service providers to become members;
encourage industry to create a broad-based, collaborative, self-governance organization including both providers and users to develop and implement strategy and standards for the payments industry;
reinvent the objects, governance, powers, business model and funding of the Canadian Payments Association; and
create a new public oversight body for the payments industry that will:
- protect the public interest as broadly defined through a principles-based approach;
- monitor the implementation of changes to the payments system, ensure that it continues to meet the public interest and propose adjustments where necessary; and
- provide redress, where necessary, when industry behaviour no longer inspires trust, or enables access, competition or innovation.

Observations

The Task Force speaks of what it perceives as a compelling need for a payments system overhaul but in its Report and policy papers that form part of the Report, it barely scratches the surface in terms of some of the major policy issues that confront such a system overhaul, including:

Consumer Protection – while there is a natural tendency in the Report to focus on the end result of “moving Canada into the digital age,” protection of the funds of consumers should be of significant concern. There is risk to consumers if an entity holding funds fails and such risk is heightened if the entity is not a regulated financial institution.
Anti-Money Laundering – Canada, like many countries around the world, continues to strengthen its anti-money laundering rules. Compliance with these rules by all players on a “level playing field” will be necessary.
Systemic Risk – the recent financial crisis has caused the G-20 countries (which includes Canada) to focus on all financial marketplace providers to determine which of them are integral to their financial system, whether or not currently regulated. Changes to the payment system need to take this into account as the financial system and the payments system are becoming more regulated, not less.
Amendment of Legislation – while one of the policy papers addresses legislation, changes to complex and, in some cases, significantly outdated legislation cannot be undertaken lightly. This legislation interweaves through a number of areas. The constitutional aspects of which level of government has the power will also be relevant.
Balance – as the Task Force notes, there are a number of players in the payments space – some of which are regulated and many of which are not. It will be a significant challenge to align and balance all of these players so that it is fair to all and competition takes place on a level playing field.If you would like to discuss this Final Report, please contact Stephen Clark or Kashif Zaman or any member of our Banking and Financial Services Team.

If you would like to discuss this Final Report, please contact authors Stephen Clark or Kashif Zaman or any member of our Banking and Financial Services Team.

Canada's Wage Earner Protection Program Act Amended

Steven Golick — Tue, 13 Mar 2012 15:40:45 -0500

The Wage Earner Protection Program (the “Program”) is a government-sponsored program in Canada that provides the higher of $3000 or an amount equal to four times an eligible employee’s maximum weekly insurable earnings under the Employment Insurance Act (Canada) to compensate such employees for unpaid wages where those employees are owed wages and lose their jobs as a result of their employer becoming bankrupt or becoming subject to a receivership. On December 15, 2011 Bill C-13, the Keeping Canada’s Economy and Jobs Growing Act, amended the Wage Earner Protection Program Act (Canada) (the “WEPPA”). The amendments to the WEPPA took effect retroactively to June 5, 2011. The amendments expand certain periods for which "eligible wages" can be recovered, as described further below.

Overview of the WEPPA

Eligible Wages are defined in subsection 2(1) of the WEPPA. Before June 5, 2011, Eligible Wages were defined as:

(a) wages other than severance pay and termination pay that were earned during the six month period ending on the date of the bankruptcy or the first day on which there was a receiver in relation to the former employer;

and

(b) severance pay and termination pay that relate to employment that ended during the period referred to in paragraph (a).

Thus, prior to the amendments, the WEPPA permitted an employee to receive Eligible Wages from the Program when the employer failed to pay wages, severance pay and termination pay and the employer was subject to a bankruptcy or a receivership. The Eligible Wages were those earned in the six months preceding the bankruptcy or receivership of the employer. The Government could recover $2,000 of this contribution as a priority creditor under sections 81.3 and 81.4 the BIA.

The Amendments

Bill C-13 amends the definition of “Eligible Wages” so that it reads as follows:

(a) wages other than severance pay and termination pay that were earned during the longer of the following periods:

(i) the six-month period ending on the first day on which there was a receiver in relation to the former employer, and

(ii) the period beginning on the day that is six months before the day on which a proposal under Division I of Part III of the Bankruptcy and Insolvency Act (Canada) (the "BIA") is filed by or in respect of the employer or the day on which proceedings under the Companies’ Creditors Arrangement Act are commenced and ending on the date of the bankruptcy or the first day on which there was a receiver in relation to the former employer; and

(b) severance pay and termination pay that relate to employment that ended during the period referred to in paragraph (a).

The period of Eligible Wages has therefore been increased in certain situations. The amendments attempt to address the situation of serial proceedings, in other words, where an employer first files for protection under either the proposal provisions of the BIA or Companies’ Creditors Arrangement Act (Canada) (the “CCAA”)(both being reorganization provisions, similar in concept to Chapter 11 in the U.S.). Where those attempts to restructure are unsuccessful, they can lead to a receivership, or a bankruptcy.

The amendment increases the period included in Eligible Wages to include the period commencing six months prior to a filing for protection under the proposal provisions of the BIA or the CCAA, and thus also the period during those proceedings up to the date of the bankruptcy or receivership. This is potentially a much longer period of time than the previous language which only protected the six months prior to a receivership or bankruptcy.

Although the amendment lengthens the period of time defined as Eligible Wages, it does not increase the total claim that may be made by each employee under the Program.

A Misstep

There appears to be a technical glitch in the drafting of the amendment.

Under the former definition of “Eligible Wages” in the WEPPA, Eligible Wages were earned in the six months immediately before either a bankruptcy or the appointment of a receiver. Thus, employees could recover from the Program where the employer was either placed into bankruptcy or receivership.

However, under the amendments there is no longer protection under the Program for unpaid wages accruing in the six months preceding a bankruptcy unless there is either a CCAA or BIA proposal filing preceding the bankruptcy. The effect of the change is that employees will no longer be eligible for the Program where the employer becomes bankrupt without either the employer first filing under the CCAA or the proposal provisions of the BIA.

This omission was likely inadvertent. It can be expected that the Federal Government will amend the legislation to rectify this.

This entry was authored by Steven Golick and Patrick Riesterer.

Financial Institutions and Cloud Computing: An Update from OSFI on Guideline B-10 - Reading Their Message Between the Lines

Stephen Clark — Fri, 02 Mar 2012 14:20:53 -0500

It would not be an exaggeration to say that a number of technology companies (and their customers) see Cloud Computing as an important development on the question of how to store ever increasing amounts of data at a reasonable price and at the same time permit the accessing of that data in an efficient manner. Not only will Cloud Computing affect consumers (witness the number of consumers who already use Apple’s recently introduced iCloud to store and access their music, videos and pictures) but Cloud Computing is also very attractive to large financial institutions which have significant storage and access issues associated with running such large businesses and therefore routinely outsource these technology services to third parties.

OSFI Issues Memorandum

Perhaps in recognition of the growing importance of Cloud Computing and other similar technologies, the Office of the Superintendent of Financial Institutions (OSFI) released a memorandum on February 29, 2012, in which it is reminding the financial institutions it regulates that, notwithstanding the benefits that technology-based services such as Cloud Computing can bring, such financial institutions should recognize that when considering the unique features of such services, they should also consider the associated risks and keep in mind their obligations under OSFI’s Guideline B-10 (Outsourcing of Business Activities, Functions and Processes) (Guideline B-10). For OSFI to issue such a memorandum/guidance is unusual and indicates the importance of this area to financial institutions but also OSFI’s concern as to the risks financial institutions should consider in relation to Cloud Computing and the applicability of Guideline B-10.

Cloud Computing

Cloud Computing refers to computing in which infrastructure services traditionally accessed using software deployed on a customer’s premises are instead accessed through the Internet. Common characteristics of Cloud Computing include delivery of services through shared, “multitenant” data centres; pay as you need pricing (similar to a utility); and rapid elasticity through which additional processing power and storage can be added quickly. Some of the well recognized benefits of Cloud Computing are: reducing capital expenditures and operational overhead; greater business flexibility (through access to hardware, software and storage capacity that can grow or contract with an organization’s needs); easier access to new technologies; and cost savings. All of these are very attractive to financial institutions.

Cloud Computing and OSFI Guideline B-10

In issuing Guideline B-10 in the first place back in 2001, OSFI recognized that financial institutions outsource business activities, functions and processes to meet the challenges of technological innovation, increased specialization, cost control, and heightened competition. However, OSFI also cautioned that outsourcing can also increase a financial institution’s dependence on third parties, which may increase its risk profile. In this most recent memorandum, OSFI has indicated that financial institutions should, in relation to Cloud Computing, consider their ability to meet the expectations contained in Guideline B-10 in respect of a material outsourcing arrangement to which Guideline B-10 applies, with a particular emphasis on certain concerns it has in relation to Cloud Computing and Guideline B-10, namely:

confidentiality, security and separation of property,
contingency planning,
location of records,
access and audit rights,
subcontracting, and
monitoring the material outsourcing arrangements.

Some financial institutions may find it hard to comply with a number of the obligations imposed under Guideline B-10 in the context of Cloud Computing and, therefore, advance planning and detailed dialogue with the technology service provider at the outset would be recommended. For example, Guideline B-10 requires financial institutions to obtain audit and access rights from the proposed service provider in respect of an outsourcing arrangement which comes under Guideline B-10. These audit rights are meant to enable the financial institution to evaluate the nature of the services provided to it both on an ongoing basis but also surface any concerns about the delivery of service by the service provider to other customers – in effect, an early warning system. In addition, the financial institution is also required to obtain audit and access rights from their service providers in favour of OSFI. Given that Cloud Computing could involve delivery of services through shared, “multitenant” data centres, some service providers may hesitate to grant such audit and access rights in deference to their obligations to their other customers. Guideline B-10 also requires that the outsourcing agreement should detail the physical location where the service provider will provide the services. Cloud Computing services may be provided from a number of different data centres located all over the world. It may not be possible for the service provider to disclose the exact location at the outset with a certainty that such location will not change on an ongoing basis. Secondly, a service provider may, for competitive or other reasons, not want to disclose such location.

Through its memorandum, OSFI has signaled that it is not prepared to back away from these requirements under Guideline B-10 no matter how attractive and beneficial Cloud Computing may seem to be to the financial institution. Before engaging any service provider for the provision of Cloud Computing, financial institutions should carefully assess their obligations under Guideline B-10 to ensure that such service providers are able to comply with such obligations.

This entry is authored by Stephen D.A. Clark and Kashif Zaman and will be published as an Osler Update.

Foreign Banks Lending to Canadian Borrowers

Scott Horner — Wed, 29 Feb 2012 13:31:39 -0500

From time to time, we receive inquiries from foreign banks that do not have a presence in Canada on whether there are any Canadian banking regulatory restrictions on lending to Canadian borrowers. Under the Bank Act (Canada), a foreign bank can lend to Canadian borrowers by:

establishing a presence in Canada by creating a Canadian subsidiary or a foreign bank branch pursuant to the Bank Act (Canada); or
structuring its activities so that it is not considered to be engaged in or carrying on business in Canada.

The focus of this blog entry is option 2. A determination of whether a foreign bank is engaged in or carrying on business in Canada is a question of fact. Generally speaking, it is unlikely that a foreign bank that lends to a Canadian borrower would be found to be engaged in or carrying on business in Canada if:

the foreign bank does not have a place of business in Canada;
the foreign bank does not have a phone number in Canada;
the foreign bank’s employees’ visits to Canada are for purposes of marketing; and
the loan documentation is negotiated and signed outside of Canada by the foreign bank.

Mortgage Prepayment under the Interest Act - More Exempt Entities

Ryan Therrien — Mon, 27 Feb 2012 12:57:57 -0500

On January 1, 2012, the Prescribed Entities and Classes of Mortgages and Hypothecs Regulations (the “Regulations”) under the Interest Act (Canada) (the “Act”) came into force.

The Regulations expand the class of “prescribed entities” that are exempted from the protections afforded by Section 10 of the Act.

Section 10 of the Act provides for mandatory prepayment terms for mortgages and hypothecs over real property with a term of more than 5 years. Such mortgages must provide that, at any time after the first five years of the mortgage term, the mortgagor shall have the right to pre-pay the full amount of the mortgage and any accrued interest outstanding at that time, subject to the payment of a penalty of three months interest. By providing these mandatory prepayment provisions, Parliament provided mortgagors with the ability to renegotiate long-term, high interest mortgages without having to pay unreasonable penalties imposed by lenders.

The Act provides exceptions to these protections – mortgages given by corporations and joint stock companies are specifically exempted from the prepayment provisions provided under section 10 of the Act. The policy behind the exceptions is to permit sophisticated commercial parties to negotiate their own mortgage terms. However, prior to the Regulations coming into force, enterprises not structured as corporations or joint stock companies occasionally had difficulty in securing long-term financing because prepayment terms were prescribed by the Act and some lenders were unwilling to advance funds with a prepayment penalty limited to three months interest.

The Regulations reflect the modern commercial reality that business enterprises are now structured in a variety of ways. As of January 1, 2012, in addition to corporations and joint stock companies, the following entities would be excluded from the mandatory prepayment protections under the Act:

Partnerships
Trusts that are settled for business or commercial purposes
Unlimited liability entities under corporate/company legislation in Alberta, British Columbia and Nova Scotia.

Note that in Ontario, section 18 of the Mortgages Act (Ontario) contains similar mandatory prepayment terms for mortgages longer than 5 years. This provincial legislation has not yet been updated to add exempt entities other than "corporations" or "joint stock companies" as mortgagors.

Anti-Money Laundering Legislation - Canadian Department of Finance Review

Janice Lao — Thu, 23 Feb 2012 16:20:23 -0500

In December 2011, the federal government launched a consultation aimed at updating Canada’s regime for combating money laundering and terrorist financing. The Department of Finance released a consultation paper setting out proposals to strengthen Canada’s anti-money laundering and anti-terrorist financing legislative framework, which is administered through the PCMLTFA. Comments on the consultation paper are requested by March 1, 2012.

The proposals in the paper are organized around the following key areas:

strengthening client due diligence standards;
closing gaps in Canada’s regime;
improving compliance, monitoring and enforcement;
strengthening information sharing in the regime;
introducing a list of potential countermeasures; and
updating reporting requirements.

Some interesting proposals include:

expanding the customer due diligence requirements and cross-border currency reporting requirements to prepaid access;
revising non-face-to-face identification measures for credit cards;
amending the definition of ‘politically exposed foreign person’ to include close associates of such person;
eliminating the threshold of $10,000 for reporting electronic fund transfers to FINTRAC, and requiring financial entities, casinos and money service businesses to report all electronic fund transfers entering or leaving Canada;
expanding the application of client identification and record-keeping requirements to life insurance companies and brokers beyond current requirements for certain annuities and policies;
clarify the exclusion of reporting requirements for accounting firms when acting as trustees in bankruptcy; and
expanding the list of designated information FINTRAC can give to law enforcement.

BIA and CCAA "Lookback Periods" for Preferential Transactions

Richard Borins — Fri, 10 Feb 2012 14:45:10 -0500

Lenders should be cognizant that the granting of security by a debtor may be subject to challenge as a fraudulent preference in the event the debtor subsequently files for liquidation or proposal proceedings under the Bankruptcy and Insolvency Act (Canada) (the “BIA”) or restructuring proceedings under the Companies’ Creditors Arrangement Act (Canada) (the “CCAA”). Such risk arises if the debtor is insolvent the time the security was granted. Accordingly, lenders would be prudent to request financial and other information from the debtor to ascertain the debtor’s financial health prior to entering into any such transaction.

Challenging a Transaction as Preferential

A Trustee in bankruptcy or a proposal Trustee may challenge the granting of security by an insolvent debtor as a fraudulent preference under Section 95 of the BIA. Similarly, a CCAA Monitor may also challenge such a transaction as the CCAA incorporates by reference the BIA preference provisions. In order to challenge any such transaction, the Trustee or Monitor must establish a prima facie case that the following three factors exist:

the debtor was insolvent at the time of the transaction;
the transaction took place during the applicable statutory review period; and
the transaction was taken with a view to giving that creditor a preference over other creditors as discussed in more detail below.

If the court is satisfied that this onus has been met, the onus then shifts to the transferee/creditor to rebut the presumption of a fraudulent preference. At that point the court will review the evidence adduced by the transferee/creditor to see whether it rebuts that prima facie case. To be successful, the transferee/creditor must convince the court, on a balance of probabilities, that at least one of the three factors did not exist when the debtor made the payment. If the court concludes that there has been a fraudulent preference, the transaction will be void as against the Trustee (or Monitor in a CCAA proceeding).

The Applicable Lookback Period

The applicable lookback period will be three months from the initial bankruptcy event (being the date of bankruptcy, BIA proposal proceedings or CCAA proceedings, as applicable) if the creditor receiving the alleged preference was dealing at arm’s length with the debtor, or one year from the initial bankruptcy event if the creditor receiving the alleged preference was not dealing at arm’s length with the debtor. Related persons are deemed not to be dealing at arm’s length with one another absent evidence to the contrary. With respect to unrelated persons, it is a question of fact whether they were dealing at arm’s length at any particular point in time. Two parties will be deemed to be related if they are under common de jure control of the same entity or group of entities.

In connection with arm’s length transfers, transactions that have the effect of giving a creditor a preference during the avoidance period are, in the absence of evidence to the contrary, presumed to have been made with a view to giving such creditor a preference. The transferee/creditor must establish that there was no dominant intention on the part of the debtor to prefer one creditor over another, based on an objective assessment of the debtor’s circumstances at the time the debtor made the alleged preference.

In connection with non-arm’s length transfers, the debtor’s intention during the avoidance period is irrelevant - one only considers whether the impugned transaction had the effect of giving the transferee/creditor a preference over other creditors.

In the ordinary course where security is taken in connection with a new lending relationship with a new advance and does not secure past indebtedness, preference risk is reduced.

Transfers at Undervalue – “TUV”

One should note that in addition to the foregoing, a Trustee (or Monitor in a CCAA proceeding) may also attempt to challenge the granting of security as a transfer at undervalue (“TUV”) in accordance with the test set out in Section 96 of the BIA and incorporated by reference into the CCAA. This TUV concept is still a relatively new one and it is unclear how broadly the courts will interpret its scope when considering transactions that are already covered by preference provisions. The applicable lookback period for TUVs is one year before the initial bankruptcy event, if the parties are dealing at arm’s length, the debtor was insolvent at the time of the transfer and the debtor intended to defraud, delay or defeat its creditors. For parties that are not dealing at arm’s length, the applicable lookback period is one year regardless or five years if the debtor was insolvent at the time of the transfer and intended to defraud, delay or defeat its creditors.

By Richard Borins and Andrea Lockhart

Securitization Available for Canadian Uninsured Conventional Residential Mortgages?

Peter Milligan — Mon, 06 Feb 2012 11:02:26 -0500

At the American Securitization Forum annual conference last month, a panel discussed the future of U.S. mortgage finance. Following the 2007 financial crisis and the collapse in U.S. housing values, there has been a transfer of U.S. mortgage funding from private sources of capital to government sources. At a basic level, the panel discussion was about the prospects for the return of private (as opposed to government) risk capital to the U.S. mortgage funding market. There was very little optimism that this transformation would take place in the foreseeable future.

Although with less intensity and clarity, the same debate is under way in Canada. Last month, CMHC announced limits on the amount of portfolio mortgage insurance it will provide. Portfolio mortgage insurance is used by Canadian banks and other mortgage lenders to insure conventional residential mortgages. The use of portfolio mortgage insurance for mortgages that are otherwise very low on the risk scale has been encouraged because of the favourable capital treatment it gives to regulated financial institutions holding mortgages and because it is a requirement for access to the federal government sponsored residential mortgage securitization programs. Directly or indirectly, portfolio mortgage insurance has been used to transfer mortgage funding risk to the federal government. This risk transference will now be reduced.

If this channel of mortgage funding is reduced, will other channels open up? One question to be answered is whether uninsured conventional residential mortgages will again be privately securitized in Canada? Will credit rating agencies, which operate globally, be willing to isolate Canadian experience from their world-wide experience? Should they? Questions that will be answered in the next year or so.

Perfection by Control of Deposit Accounts and Cash Collateral - Proposal to Amend The Ontario PPSA

Dale Seymour — Wed, 01 Feb 2012 14:20:42 -0500

A working group of the Personal Property Security Law Sub-Committee of the Ontario Bar Association’s Business Law Section has developed a proposal for amendments to the Ontario Personal Property Security Act to provide for perfection by control of deposit accounts and other forms of cash collateral. If approved by the Ontario Bar Association, the proposals will be submitted to the Ministry of Consumer Services for consideration. We understand that these proposals, if adopted, would amend the PPSA to create a new class of collateral – the “financial account” - and provide rights for secured parties to perfect a security interest in a financial account through control.

“Financial accounts” would be broadly defined to include deposit accounts and any other monetary obligation of a financial institution in respect of funds it holds or receives as security for an obligation. Consumer accounts would be excluded from the definition of financial account, an approach which is consistent with Article 9 of the UCC.

The proposed amendments would allow a secured party to perfect a security interest in a financial account by 1) registration (this is already provided for under the PPSA and is a departure from Article 9 of the UCC) and 2) control.

The means by which a secured party could obtain control are very similar to those currently in place for securities accounts as a result of the Securities Transfer Act, 2006 (Ontario). Those methods would include:

automatic control if the secured party is also the financial institution that is obligated to the customer under the financial account; and
a control agreement entered into by the customer, the secured party and the financial institution maintaining the customer’s financial account whereby the financial institution agrees to comply with instructions originated by the secured party in respect of the financial account without further consent from the customer.

A secured party with control of a financial account would have priority over a secured party that does not have control, as well as over a secured party that perfected its interest in the financial account only by registration.

Importantly as well, the PPSA choice of law rules for financial accounts would mirror those in UCC Article 9 for similar collateral, such that the jurisdiction for determining issues of validity, perfection and priority of a security interest in U.S. cross-border deals could be easily established.

Perfection and Priority: Dealing with Serial Numbered Goods

Danielle Boyd — Mon, 30 Jan 2012 11:03:13 -0500

Lenders should be aware that when taking security in certain goods with serial numbers in Canada, the rules regarding registration of financing statements vary across provincial jurisdictions; a detail that, if overlooked, could impact the priority of the lender’s security interest.

In Ontario, where the collateral includes motor vehicles (as defined in Ontario’s Personal Property Security Regulation 56/07), including the vehicle identification number will provide the lender with protections against: (i) purchasers or lessors of a motor vehicle that is proceeds and classified as consumer goods, and (ii) purchasers of a motor vehicle classified as equipment sold other than in the ordinary course of business of the seller.

In some other provinces, the rules regarding goods with serial numbers are broader and can include goods other than motor vehicles. These goods are referred to as “serial number goods” as defined in the personal property security regulations of some other Canadian jurisdictions. For example, in Alberta, “serial numbered goods” includes aircraft and boats; two types of goods not covered by Ontario’s definition of motor vehicle. For serial numbered goods that are classified as equipment, if a lender chooses not to register the serial number, the registration is valid; however, the lender will lose the priority of their interests in the equipment to purchasers and any other secured party who has included the serial number. In the case of a serial numbered good classified as a consumer good, the failure to register the serial number means the registration is invalid and leaves the registrant unperfected.

As the applicable rules vary from province to province, lenders should consult the applicable personal property security act when dealing with collateral that is located in several provinces. However, as a general rule, it is prudent to always include the serial number when registering against goods that fall within the definition of “serial numbered goods” or “motor vehicles”.

Limits on Interest Rates in Loan Agreements

Scott Horner — Thu, 19 Jan 2012 14:07:03 -0500

Loan agreements governed by Ontario law commonly include a provision that is intended to address the maximum effective annual rate of interest that is chargeable thereunder without contravening the usury provisions of the Criminal Code (Canada). For purposes of the Criminal Code (Canada), “interest” is defined as including ordinary commercial interest, fees (other than those required to be paid to governmental authorities in connection with perfecting security) and expenses (such as legal expenses, including a lender’s legal expenses if the borrower has agreed to pay them) and, therefore, is not limited to what most bankers think of when they refer to “interest”.

In U.S. law governed loan agreements, the provision limiting interest is usually framed that if interest at the stated rates would result in unlawful rates, then the interest rates shall be reduced to the maximum lawful rates. Canadian courts have refused to enforce such a provision on the basis that they would be required to rewrite the contract by determining which, and in what sequence, element(s) of “interest” should be reduced in order to attain an effective annual interest rate that does not exceed the lawful rate. The result of the Canadian courts’ refusal to enforce such provisions has been, in some cases, that lenders have been denied all “interest”.

Accordingly, to be enforceable, provisions limiting interest should specify the order in which the elements of “interest” shall be reduced so that the effective annual rate of interest provided for in the loan agreement will not be in contravention of the Criminal Code (Canada) (for example, the interest rate on the loan shall be reduced first, then fees shall be reduced etc. until the lawful effective annual rate of interest is attained).

Canadian Government Proposes Comprehensive Amendments to Anti-Money Laundering Legislation

Stephen Clark — Mon, 16 Jan 2012 16:26:19 -0500

On December 21, 2011, the Canadian federal government released a consultation paper (the Consultation Paper) containing certain proposals to strengthen Canada’s anti-money laundering (AML) and anti-terrorist financing (ATF) legislative framework, which is administered through the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLA) and related regulations (collectively, AML Legislation). The full text of the Consultation Paper is available here. The deadline for submitting comments on the proposed amendments is March 1, 2012.

On November 7, 2011, the Canadian federal government had released a consultation paper proposing certain amendments to the AML Legislation. Whereas the amendments proposed in November 2011 were limited to customer identification and due diligence and were meant to mainly address Canada’s rating of non-compliance with a recommendation of the Financial Action Task Force (FATF), the Consultation Paper released in December 2011 proposes a broader set of amendments. (See our Osler Update dated November 17, 2011.)

The key objectives of the Consultation Paper are stated to be the following:

reviewing Canada’s AML/ATF legislative framework in preparation for the upcoming Parliamentary review of the AML Legislation (this review is required by statute every 5 years);
addressing the recommendations of an independent consultant included in the Report of the 10-Year Evaluation of Canada’s AML/ATF regime, released in March 2011;
responding to stakeholder concerns, raised by both the private sector and federal regime partners, particularly law enforcement and intelligence agencies;
meeting Canada’s international commitments by improving Canada’s compliance with the recommendations of FATF;
responding to the interim report of the Special Senate Committee on Anti‑Terrorism, entitled Security, Freedom and the Complex Terrorist Threat: Positive Steps Ahead;
responding to the final report of the Commission of Inquiry into the Investigation of the Bombing of Air India Flight 182, entitled Air India Flight 182: A Canadian Tragedy; and
responding to the 2009 Privacy Commissioner of Canada’s Audit Report of the Financial Transactions and Reports Analysis Centre of Canada.

The amendments proposed by the Consultation Paper fall into the following categories, details of which are available by clicking "Continue Reading" below:

strengthening customer due diligence standards;
closing gaps in Canada’s regime;
improving compliance, monitoring and enforcement;
strengthening information sharing in the regime;
introducing a list of potential countermeasures; and
updating reporting requirements.

This entry is based on the Osler Update Canadian Government Proposes Comprehensive Amendments to Anti-Money Laundering Legislation authored by Stephen D.A. Clark and Kashif Zaman

1. Strengthening Customer Due Diligence Standards

In addition to the amendments proposed in the November 2011 consultation paper, the government is proposing additional amendments to address other issues relating to customer due diligence (CDD) raised by stakeholders.

a. Client Identification Records for Authorized Signers for Business Accounts

Financial entities are currently required to ascertain the identity of at least three authorized signers of a business account. A similar requirement applies to casinos. However, there is no related requirement for either financial entities or casinos to keep a record of the identity of those signers or the measures taken to ascertain their identity. To ensure that financial entities and casinos have the necessary information available to include in a suspicious transaction report, the government is considering requiring financial entities and casinos that ascertain the identity of an authorized signer to also keep a client identification record in respect of that signer.

b. Enhancing Customer Due Diligence Exemptions for Introduced Business

There are several situations in which one financial business may “introduce” (or refer) a client to another financial business (e.g., insurance brokers introducing their clients’ business to insurance companies or banks introducing their clients to securities dealers).

Under the current AML Legislation, there are two specific “introduced business” scenarios where one reporting entity can rely on the CDD performed by another reporting entity. These exemptions limit the duplication of procedures by reporting entities. In 2008, amendments were made to the AML Legislation to allow agents or mandataries to perform certain CDD obligations on behalf of a reporting entity. This differs from the introduced business exemptions in that it allows non-reporting entities to perform the CDD obligations on behalf of a reporting entity. Unlike the introduced business exemptions, there must also be a contractual agreement in place between the parties for the agency relationship to exist.

Under the current AML Legislation, there is no explicit requirement for financial institutions to obtain from the third party the necessary information concerning certain elements of the CDD process and satisfy themselves that copies of identification data are made available from the third party upon request without delay. In addition, the AML Legislation does not set out that the ultimate responsibility for customer identification and verification should remain with the financial institution relying on the third party.

The FATF has recommended that reporting entities be required to take more responsibility for CDD in introduced business scenarios. Canada received a Non-Compliant rating with the FATF’s Recommendation 9, which addresses introduced business.

The government is reviewing the current exemptions from CDD and record-keeping for scenarios involving introduced business, in order to improve the continuity of record-keeping and to clarify how responsibility for the CDD information is divided between the party introducing the business and the party receiving the business. In addition, the government is considering expanding the scope of introduced business scenarios that would qualify for an exemption from certain CDD obligations.

The government is seeking views from industry on these issues, including the following elements:

examples of “introduced business” scenarios where revising CDD and/or record-keeping requirements would eliminate a duplication of effort by the reporting entities involved;
current industry practices that may mitigate the risk of records being lost or destroyed in an “introduced business” scenario where the relationship between the recipient and introducer is terminated;
the feasibility of a reporting entity asking for and receiving documentation about the information used to verify a client’s identity from an introducer at the time of the commencement of the “introduced business” relationship; and
the feasibility of a reporting entity asking for and receiving documentation about the information used to verify a client’s identity from an introducer at the time when a relationship between the reporting entity and introducer is to be terminated.

c. Non-Face-to-Face Situations

In 2007, the government had made amendments to the AML Legislation to allow non-face-to-face client identification. In the Consultation Paper, the government recognizes that new technologies and business models are being developed by the financial sector in respect of which the current non-face-to-face client identification requirements may have to be modified. For example, various reporting entities have identified components of the existing non-face-to-face identification requirements that limit their ability to increasingly use evolving technologies to deliver financial products and services, without requiring an individual or entity to physically submit supporting documentation (e.g., a cleared cheque). The government is seeking feedback from the industry on these issues. For example, the government would like to receive comments from financial institutions regarding the security features that have been included in electronically provided bank statements and that would assist with determining the authenticity of such a statement.

Non-face-to-face Customer Identification Measures for Credit Card Companies

The government proposes to review the current non-face-to-face identification requirements for credit card companies in response to concerns related to the decreased usefulness of the telecommunications directory as a reliable independent data source to ascertain a client’s identity. Alternative independent data sources or methods will be considered but it is not intended that this review will provide reporting entities with access to government databases that are currently restricted under other legislation. The government is seeking views from industry on this issue, including the following elements:

explanations as to why the credit card industry is unable to use the other non-face-to-face identification methods specified under the AML Legislation;
explanations as to why financial institutions have not established a process to confirm directly to another financial intermediary that a client maintains a deposit account with that institution, where the client has consented to the disclosure of such information; and
information on other types of third party sources currently being used by credit card companies to assess account applications and whether these sources could be considered as an alternative to the telecommunications directory.

Record of Signing Authority

The government proposes to review the requirement that a hand-written signature card, or electronic image of a hand written signature, must be maintained by reporting entities for record-keeping purposes when accounts are opened. The government is seeking views from industry on this issue, including:

clarification as to what kind of technological information reporting entities would propose to maintain where the authority for an account holder to give instructions in respect of an account would be established by electronic means; and
the ability for a reporting entity to provide another reporting entity with a copy of a client’s signature card, where a client has consented to that information being shared.

d. Politically Exposed Foreign Persons

Politically exposed foreign persons (PEFPs) are defined in the AML Legislation as persons who are, or have been, entrusted with prominent public functions such as heads of state, senior politicians, senior government, judicial or military officials, senior executives of state-owned corporations and important political party officials. The AML Legislation requires certain reporting entities to determine whether a customer is a PEFP when they conduct designated financial transactions or open designated accounts. Reporting entities are required to implement enhanced measures in respect of their customers who are PEFPs.

The government has identified aspects of Canada’s PEFPs provisions that could be strengthened in order to assist Canada’s anti-corruption work, provide reporting entities with increased tools to better know their customers and to take appropriate measures based on the risk level of those customers, and to enhance Canada’s compliance with the current FATF Recommendation 6 on foreign politically exposed persons.

Amend the Definition of “Politically Exposed Foreign Person” to Include Close Associates

The government is considering the definition of “politically exposed foreign person” to include close associates of such a person.

“Politically exposed foreign person” is currently defined in the AML Legislation as persons holding or having held certain designated high-profile political positions, as well as the immediate family members of those persons. The proposed amendment would provide that, in circumstances in which reporting entities are required to take reasonable measures to determine if a customer is a PEFP, they would also be required to take reasonable measures to determine whether that customer is a close associate of a PEFP.

Require Life Insurance Companies to Determine if Persons are PEFPs when Opening Designated Accounts

The government is giving consideration to requiring life insurance companies and life insurance brokers and agents to take reasonable measures to determine if persons are PEFPs when opening an investment or loan account for a client, or in respect of existing clients who have investment or loan accounts. Where such persons are determined to be PEFPs, life insurance companies and life insurance brokers and agents would be required to implement all relevant PEFP obligations.

Requirement to Assess all Account-holders

The government is considering amending the AML Legislation to clearly provide that reporting entities would be required to assess whether “all” existing account-holders are PEFPs, where such a determination has not already been made. Currently, financial entities and securities dealers are required to take reasonable measures, based on the level of risk they have assessed, to determine whether persons who are existing account holders are PEFPs. The effect of these provisions is that, where customers have been identified as low risk, reporting entities are not required to determine whether those customers are PEFPs.

e. Lower Risk Situations

Currently, reporting entities are exempted from conducting customer identification and due diligence measures when they conduct certain transactions or interact with certain types of clients deemed to be at low risk of money laundering or terrorist financing. These exemptions exist primarily in respect of products that are well regulated and structured in such a way to make money laundering difficult or clients who are well-regulated and subject to stringent legislative disclosure obligations.

Under existing requirements, reporting entities are not required to keep records when conducting transactions with public bodies or corporations with a minimum of $75 million net assets whose shares are traded on a Canadian or other designated stock exchange. Listed corporations are considered to be at lower risk for money laundering and terrorist financing as they are subject to stringent disclosure obligations outside of the AML Legislation. The government is considering extending this exemption to all listed corporations without regard to the amount of net assets.

f. Ongoing Due Diligence

Reporting entities have the obligation to confirm the existence of a corporation for which they open an account or conduct a financial transaction. Currently, the existence of a corporation is confirmed by referring to a corporation’s certificate of corporate status or any other record that confirms its existence as a corporation (such as its published annual report or a letter or notice of assessment from a government). However, the AML Legislation does not specify how current these documents must be in order to qualify as proof of the existence of a corporation. The government is considering amending the AML Legislation to specify that any document that is used as proof of the existence of a corporation must be no more than one year old.

g. Identification of Third Parties

The AML Legislation requires reporting entities to take reasonable measures to collect third party information where a required client information record is created, or where a client conducts large cash transactions or opens an account. The Consultation Paper states that the existing legislative requirement for third party determination is often misunderstood by reporting entities because of conflicting understandings of the term “third party.” For the purposes of the AML Legislation, it is intended that third parties are those who provide instructions, whereas many reporting entities have interpreted third parties as being those who carry out those instructions. The government is considering amending the provisions that establish the third party determination requirements to replace the term “third party” with “instructing party.”

The government is seeking industry views on whether this change in terminology will provide clearer guidance as to what is required.

2. Closing the Gaps

a. Eliminating the Electronic Funds Transfers Threshold

Reporting entities are currently required to report to the Financial Transactions Reports Analysis Centre of Canada (FINTRAC) any electronic funds transfer (EFT) of $10,000 or more entering or leaving Canada. The government believes that the $10,000 threshold for reporting EFTs may not be optimal. For example, while money laundering frequently involves large sums of money, cases of terrorist financing may involve smaller amounts of money. The government is considering eliminating the threshold at or above which international EFTs must be reported to FINTRAC. This would require financial entities, casinos and money services businesses (MSB) to report all EFTs entering or leaving Canada. The government is seeking views on this issue, including the following elements:

operational impacts for reporting entities associated with eliminating the threshold;
given existing CDD thresholds and other relevant factors, the implications of applying different thresholds for different types of transactions or reporting entities (e.g., a higher threshold for MSBs than for financial entities as per the U.S. model); and
examples of any current industry practices, trends, or requirements in other jurisdictions where operations would be relevant to the discussion of an eliminated threshold.

b. Prepaid Access

Prepaid access encompasses a range of payment technologies, from prepaid cards (such as retail gift cards, or open-loop prepaid cards that could be used to withdraw thousands of dollars from automated teller machines (ATMs) worldwide) to mobile payment devices. There have been increased calls by law enforcement and others to address the potential money laundering and terrorist financing risks posed by prepaid access. For example, Canada’s Special Senate Committee on Anti-Terrorism recommended that the government examine whether to define prepaid access as monetary instruments under the Cross-border Currency and Monetary Instruments Reporting Regulations. This would result in an obligation for individuals to report the importation or exportation of $10,000 or more in prepaid access products. The FATF has also noted the lack of CDD requirements for prepaid access products. The Royal Canadian Mounted Police has acknowledged that gift cards represent a serious money laundering option, especially in the absence of any money laundering control at retail locations and has noted that there is nothing in force at the financial institution level that requires them to implement policies and procedures addressing new technologies when face to face identification is not possible.

Across the border, the United States has recently taken action on prepaid access. In July 2011, the Financial Crimes Enforcement Network passed a final rule requiring providers of certain types of prepaid access to perform CDD, keep customer information and transaction records, have an anti-money laundering program, and report suspicious activities and large cash transactions. In October 2011, the Financial Crimes Enforcement Network formally sought input on making certain prepaid access devices subject to cross-border reporting requirements.

The Canadian government is examining two potential ways to mitigate the possible money laundering and terrorist financing risks posed by prepaid access.

First, the government proposes to review CDD requirements to determine whether to extend these measures to prepaid access devices. The government is seeking views on this potential course of action, including the following elements:

types of prepaid access devices that should or should not be covered (including the rationale for including or excluding them);
who among the several parties involved in providing a prepaid card (e.g., financial institution, payment network, program operator, retailer) should bear the responsibility for the various CDD requirements; and
operational impacts for reporting entities associated with potential CDD requirements.

Second, the government is examining the issue of expanding the definition of monetary instrument for the purpose of cross-border currency reporting under the Cross-Border Currency and Monetary Instruments Reporting Regulations to include prepaid access. The government is seeking views on this issue, including the following elements:

types of prepaid access that should or should not be defined as a monetary instrument (including the rationale for including or excluding them);
potential obstacles that would prevent, and potential solutions that would allow, border services officers to identify and determine the value of prepaid access products (e.g., ability to recognize or read prepaid cards at the border); and
privacy considerations.

c. Customer Due Diligence and Record-Keeping Requirements for Life Insurance Companies and Life Insurance Agents and Brokers

In the Consultation Paper, the government notes that the current requirements imposed on life insurance companies and life insurance brokers and agents related to customer identification may fail to adequately address the money laundering risks of the financial products that are now commonly provided in this industry. For example, there is no legislative requirement for life insurance companies, brokers and agents to perform customer identification requirements with respect to loans they offer. These requirements are legislated for other reporting entities. As well, varying practices exist across insurance companies with respect to whether the existing CDD requirements apply to insurance-based investment products, such as segregated funds. Further, the government suggests that certain life insurance annuities and policies that are currently exempt from client identification requirements are at risk of being abused by criminals and should be subject to these requirements under the AML Legislation.

The government is considering amending the AML Legislation to expand the client identification and record-keeping requirements applicable to life insurance companies and life insurance brokers and agents beyond the specified purchase of annuities and life insurance policies. Client identification and record-keeping requirements would apply to transactions and account openings for investment and loan products offered by life insurance companies, agents and brokers that are not currently captured under the AML Legislation. The requirements would be comparable to those currently imposed by the AML Legislation on other financial entities and securities dealers. The exemptions for income tax purposes and the $10,000 threshold would be eliminated.

d. Large Cash Transaction Reports

Reporting entities are required to report to FINTRAC whenever they receive $10,000 or more in cash. The government notes that these requirements should be revisited to address existing gaps.

Extending Large Cash Transactions Reporting Obligations in the Life Insurance Sector

The government is considering amending the AML Legislation to limit the exemptions for large cash transaction reporting by life insurance companies and life insurance agents and brokers to only those transactions where the origin of funds may be easily identified and determined to be of low risk for money laundering, specifically those identified in paragraphs 62(2)(c) to (f) of the Proceeds of Crime (Money Laundering) and Terrorist Financing Regulation. The purpose of this proposed amendment is to close the gap resulting from the exemptions provided to life insurance companies and life insurance agents and brokers where the origin of funds to purchase specified financial products is unknown and, as such, there is a risk that they will be used for criminal purposes.

Expand the Application of Large Cash Transaction Obligations

The government is giving consideration to amending the AML Legislation to provide that reporting entities would be required to record and report large cash transactions of $10,000 or more, even where the cash would be received on behalf of the reporting entity by an agent or affiliated entity. This amendment would ensure that the chosen delivery channel does not lead to an unintentional exemption for reporting entities from their obligations to submit large cash transaction reports.

e. Dealers in Precious Metals and Stones and Accountants

Dealers in precious metals and stones (DPMS) and accountants are currently subject to the AML Legislation when they provide services or undertake activities that are specified in the AML Legislation. Although various activities are exempted from the reporting requirements in the AML Legislation, the government believes that certain activities performed by DPMS and accountants currently trigger reporting requirements beyond the original policy intent.

The government is considering excluding from reporting requirements activities undertaken by the DPMS sector related to the sale or purchase of metals and stones that are used in the manufacturing process and excluding from reporting requirements activities undertaken by accountants when providing trustee in bankruptcy services.

f. Clarifying the 24-Hour Rule

Reporting entities are currently required to file various reports for certain transactions performed by, or disbursements received by, individuals and entities. The AML Legislation sets out these single transactions to include both individual transactions above $10,000 as well as multiple transactions each under $10,000 but totalling $10,000 or greater undertaken by an individual within a 24-hour period. The government believes that there are deficiencies with the current descriptions of a single transaction under the AML Legislation, which limit the transactions that must be reported to FINTRAC, contrary to the objectives of the AML Legislation.

The government is considering amending the description of “single transaction” in the AML Legislation to include all transactions, regardless of their amount, conducted on behalf of the same person or entity within a 24-hour period where the combination of those transactions would total at least $10,000. The purpose of this proposed amendment is to provide greater certainty for reporting entities with respect to reporting multiple transactions.

3. Improving Compliance, Monitoring and Enforcement

a. Money Services Business Registration

MSBs have been required to register with FINTRAC since June 2008. In order to apply to register, an MSB must provide identifying information and specified business-related details. Once the initial registration has been accepted, the MSB’s registration must be renewed approximately every two years, on a date specified by regulations. In order to simplify the MSB renewal process and provide flexibility as to when within a 2-year period an MSB must renew its application, the government is considering amending the AML Legislation to reduce the type of information requested from MSBs applying to register with FINTRAC and revoking the requirements in the AML Legislation specifying the timing of MSB registration renewal.

The government is also considering amending the AML Legislation to ensure that individuals who have been convicted under certain repealed acts are also excluded from registering as MSBs. These acts would include the PCMLA, the Narcotic Control Act, and Parts III and IV of the Food and Drug Act. The AML Legislation does not allow individuals convicted under specified legislation to register as an MSB. However, current provisions do not reference convictions under repealed, older versions of relevant legislation.

b. Updating the Compliance Program

The government is considering amending the AML Legislation to provide FINTRAC with an additional tool to ensure that FINTRAC receives the reports that entities are required to submit under the AML Legislation.

Reporting entities may be subject to an administrative monetary penalty for failure to comply with a reporting obligation under the AML Legislation (for example, failure to submit a suspicious transaction report, a large cash transaction report, an EFT report or a terrorist property report). Currently, proceedings to address non-compliance with a reporting requirement would typically cease upon payment of the penalty. The proposed change would enable FINTRAC to direct a reporting entity to file a missing report that is required under the AML Legislation and that they have failed to report, even where an initial penalty has been imposed. Where the reporting entity subsequently fails to comply with the request for the report to be filed, FINTRAC would be entitled to impose additional penalties until such time as the reporting entity complies with FINTRAC’s request by filing the report.

c. Requiring the Documentation of Reasonable Measures

Reporting entities may be required to take reasonable measures to obtain particular information or to make a specific determination when performing due diligence. The government is considering requiring reporting entities to document and keep a record of any “reasonable measures” they are required to take under the AML Legislation.

d. Updating Reporting Forms

The AML Legislation prescribes the specific information that reporting entities are required to provide for various reporting and registration purposes. The government believes that the current framework narrowly defines the information that is required to be included on the form templates provided to reporting entities and limits the government’s ability to customize the forms to the specific or unique needs of individual industries. The government is considering amending the AML Legislation to provide the Minister of Finance with the authority to update the information requirements contained in reporting and registration forms that reporting entities are required to use when registering or submitting reports to FINTRAC. This would allow these forms to be updated in a timelier manner, to better reflect the needs of both FINTRAC and reporting entities.

e. Cross-Border Currency Reporting

Under the current requirements of the AML Legislation, individuals or entities are required to report to a Canada Border Services Agency (CBSA) officer the importation or exportation of currency or monetary instruments over $10,000. The AML Legislation currently requires individuals who have completed a cross-border currency report to respond truthfully to questions posed by a CBSA officer with respect to the information contained in the report. CBSA officers have indicated that it would be beneficial for them to also be provided with the authority to pose questions to individuals related to their compliance with the obligations of the AML Legislation, even when a report has not been completed. This would assist CBSA officers in performing their duties and responsibilities as specified under the AML Legislation. The government is considering amending the AML Legislation to provide the authority to CBSA officers to question passengers arriving in or departing from Canada with respect to their responsibilities under the AML Legislation and to compel passengers to answer these questions truthfully.

4. Strengthening Information Sharing in the Regime

a. Expanding Designated Information

The government is considering expanding the current list of designated information that FINTRAC can disclose to law enforcement and intelligence agencies to also include:

(a) an individual’s gender and occupation;
the grounds for suspicion developed by international partner Financial Intelligence Units;
information contained in the narrative section of cross-border seizure reports;
a description of the actions taken by reporting entities when making a suspicious transaction report; and
information setting out the “reasonable grounds to suspect” that FINTRAC has determined would enable it to make a disclosure.

The stated objective of expanding the information available in FINTRAC disclosures is to enhance the critical identifiers and investigative links that law enforcement and intelligence agencies can use to further money laundering and terrorist financing investigations while respecting the privacy and Charter rights of Canadians.

b. Expanding Information in Intelligence Products

The government is considering allowing FINTRAC to identify foreign individuals and entities in the intelligence products it provides to law enforcement, government institutions, or a foreign agency that has similar powers and duties, in those cases where the identification of the individual or entity would be important to the context of the financial intelligence.

c. Information Sharing to Detect and Deter the Funding of Terrorism Through Registered Charities

The AML Legislation does not contain provisions that permit the CBSA to share information with the Charities Directorate of the Canada Revenue Agency (CRA). The government is considering amending the AML Legislation to allow the CBSA to disclose to the CRA Charities Directorate cross-border seizure reports related to forfeited currency or monetary instruments suspected to be linked to the activities of a charity. The proposed amendment would allow the CBSA to proactively disclose directly to the CRA information obtained at the border that could assist with the determination of a charity’s registration status.

The government is also proposing to review the provision that enables FINTRAC to disclose to the CRA information related to registered charities in order to facilitate its ability to provide proactive disclosures. The proposed amendment would seek to clarify the conditions under which FINTRAC would disclose to the CRA activities of a charity in order to facilitate its ability to provide proactive disclosures.

d. Disclosures to Support Border Services

FINTRAC is currently required to disclose information to the CBSA when, in addition to a suspicion of money laundering or terrorist activity financing, it also determines that the information would be relevant to supporting the CBSA in performing its specified responsibilities related to administering immigration and customs programs. The CBSA has identified situations where FINTRAC disclosures could provide more information that would improve the efficiency of its investigations related to border services that support the government’s national security priorities.

The government is considering amending the AML Legislation to require FINTRAC to disclose information relevant to a money laundering or terrorist financing offence to the CBSA where it would also be relevant to an offence related to illegal exportations.

The government is also considering amending the AML Legislation to require FINTRAC to disclose designated information to the CBSA where there would be reasonable grounds to suspect that it would be relevant for the purpose of managing the access of people and goods to and from Canada that pose a threat to national security.

e. Disclosures of Information by FINTRAC

The AML Legislation currently requires that FINTRAC disclose information to an appropriate police force where there are reasonable grounds to suspect that designated information would be relevant to investigating or prosecuting a money laundering or terrorist financing offence. It is possible that information collected by FINTRAC could also assist with investigations where an individual’s life is in danger.

The government is considering allowing FINTRAC to disclose information to a police force that would assist with an investigation for the purpose of preventing the death of, or imminent physical injury to, an individual.

5. Countermeasures

Certain amendments to the AML Legislation were introduced as part of Budget 2010. These amendments introduced two new authorities for the Minister of Finance:

the authority to issue directives that require reporting entities to take countermeasures in respect of transactions originating from or destined to designated foreign jurisdictions and foreign entities; and
the authority to recommend that the Governor-in-Council issue regulations limiting or prohibiting reporting entities from entering into transactions originating from or destined to designated foreign jurisdictions and foreign entities.

The two new authorities for the Minister have not yet been brought into force. The new Ministerial authorities would be brought into force in conjunction with the regulatory amendments detailed in the Consultation Paper. In order to clarify the application of the Minister’s new authorities, the government proposes to implement regulations that will provide greater detail and certainty to reporting entities and other stakeholders as to how the use of these powers will be undertaken. These regulatory amendments would:

prescribe a list of specific countermeasures that the Minister, when issuing a directive, can require reporting entities to take in respect of a designated foreign jurisdiction or foreign entity;
define the term “foreign entity,” in order to provide further guidance to reporting persons and entities as to the types of entities that may form the subject of a directive or a regulation limiting or prohibiting business; and
update the existing AML Legislation to allow for administrative monetary penalties to be issued to reporting entities that are in violation of a directive or a regulation.

6. Other Proposals

a. Broadening the Requirement to Report Suspicious Transactions

The government is considering broadening the requirement to report suspicious transactions to encompass activities conducted for the purpose of a financial transaction.

The legislation currently requires reporting entities to report suspicious transactions. A suspicious transaction is any financial transaction that occurs or is attempted in the course of a reporting entity’s activities that gives rise to a suspicion of money laundering or terrorist financing. Under this proposal, the AML Legislation would be amended to set out that a suspicious transaction is any financial transaction that occurs or is attempted, including an activity undertaken for the purpose of a financial transaction, in the course of a reporting entity’s activities that gives rise to a suspicion of money laundering or terrorist financing. This would clarify that reporting entities would be required to submit a suspicious transaction report if, for example, an account application was considered suspicious.

b. Submitting Reports to FINTRAC

The government is considering requiring the CBSA to submit cross-border currency reports to FINTRAC both physically and electronically. The legislation currently requires the CBSA to submit to FINTRAC complete and incomplete cross-border currency reports they receive from individuals. Though it is not a legislative requirement, in practice, the CBSA has been providing FINTRAC with both the paper copies of these reports and the electronic transmission of the information included in these reports. This facilitates FINTRAC’s data collection by providing reportable information in a format that may be searched. This proposal would formalize this existing operational arrangement.

c. Amending the Threshold for Non-compliance Disclosures

The government is considering replacing the term “is evidence of” with “would be relevant to” in order to clarify the threshold that would enable FINTRAC to disclose compliance-related information to law enforcement by more broadly referencing information that it suspects on reasonable grounds would be relevant to investigating or prosecuting specified compliance-related offences. The government believes that the existing threshold for disclosing compliance information to law enforcement is inconsistent with the scope of FINTRAC’s mandate; it is not responsible for investigating or prosecuting contraventions of the provisions of the AML Legislation. As a result, while FINTRAC may make a determination on the relevance of information it collects to investigating and prosecuting certain offences, it is unable to determine whether that information could be used as evidence.

d. Amending Obligations Related to Client Credit Files

The government is considering amending CDD and record-keeping requirements to clarify that financial entities are required to create a client credit file when they enter into a credit arrangement with a client, and to repeal the obligation for MSBs to maintain a client credit file. This amendment would clarify that financial entities are required to both create, and keep records of, a client credit file when entering into a credit arrangement with a client. As well, this amendment would recognize that MSBs do not conduct credit arrangements and, therefore, should be excluded from this record-keeping requirement.

Standstill Periods in Intercreditor Agreements - What Factors Can Determine Their Length?

Jessica Foster — Tue, 10 Jan 2012 12:56:07 -0500

Intercreditor agreements often include a provision which prevents the junior creditor from taking enforcement action against collateral upon default under the junior debt for a specified period of time after notice of the default has been given to the senior creditor – this is described as the “standstill period”. The purpose of the standstill period is to give the senior creditor an exclusive period of time during which the senior creditor may assess its rights and, if the senior creditor determines that it will enforce its rights against the collateral, to so enforce such rights without interference from the junior creditor.

The length of the standstill period is usually negotiated, as the junior and senior creditors have competing interests. The junior creditor will usually favour a shorter standstill period, as it will be anxious to begin enforcement action upon default. However, the senior creditor will usually favour a longer standstill period, which will allow them more time to implement their own strategy for enforcement against the collateral. While the length of time of standstill periods vary, most are between 90 and 180 days. There are various factors specific to the circumstances of each transaction that can affect the length of time of the standstill period, including:

the type and location of the collateral;
the borrower’s business;
the amounts of the obligations owed to the junior and senior creditors under their respective credit facilities; and
the relative bargaining power of the parties involved in negotiating the standstill period (i.e. the junior and senior creditors).

Regarding the collateral, its type must be considered; specifically, whether it is perishable or could otherwise quickly diminish in value and how liquid and readily marketable it is. Perishable and liquid collateral usually justify a shorter standstill period. The location of the collateral must also be considered. If the collateral is located in multiple jurisdictions, a longer standstill period could be justified. For example, in a situation where the borrower’s collateral consists mainly of perishable inventory in a single warehouse which can easily be sold, the junior creditor can expect that the senior creditor will agree to a relatively shorter standstill period. However, if the collateral is mostly non-perishable equipment located in multiple jurisdictions, the senior creditor can expect that the junior creditor will agree to a relatively longer standstill period.

Licences as Personal Property Under Amendments to the British Columbia PPSA

Joshua Lam — Tue, 03 Jan 2012 16:25:52 -0500

The British Columbia (“BC”) legislature has introduced amendments to expressly identify transferable licences as personal property under the BC Personal Property Security Act (the “BC PPSA”). These amendments (the “Amendments”) received Royal Assent on November 24, 2011 and are expected to come into force by regulation in 2012. As a result of the Amendments, the BC PPSA will expressly permit the creation of security interests in transferable licences. In BC, this will facilitate the provision of credit on the security of licences provided as collateral.

The Amendments will expand the definition of “licence” under the BC PPSA to include any transferrable grant of rights entitling the holder of such rights to deal with or acquire personal property or provide services. The expanded definition is intended to capture transferable licences generally, including liquor, fishing and forestry licences, whether issued under a regulatory regime or by private contract.

By expanding the definition of “licences”, the Amendments will provide outcomes similar to the 2008 Supreme Court of Canada decision in Saulnier v. Royal Bank of Canada (“Saulnier”), in which a licence to participate in the fishery coupled with a proprietary interest in the fish harvested thereunder was ruled to be a “bundle of rights” sufficient to fit within the extended definitions of “personal property” in the Nova Scotia Personal Property Security Act.

The Personal Property Security Acts (“PPSAs”) of most other Canadian provinces and territories (including Ontario) do not have a definition for the term, “licence”; debtors and creditors in those jurisdictions must rely on the applicability of the factors in Saulnier to their particular circumstances in respect of any licences purported to be provided as collateral. The PPSAs of Saskatchewan, the Northwest Territories and Nunavut have definitions of the term, “licence” that are similar to that in the Amendments.

The Amendments will also provide that a licence provided as collateral may be disposed of, retained or held only in accordance with the terms and conditions of such licence and the terms and conditions applicable by law or contract to such licence. The Amendments will require any secured party who wishes to seize a licence on default to provide notice of such seizure to the relevant minister if the licence was granted pursuant to legislation or, in any other case, to the grantor of the licence; notice of seizure to the debtor will continue to be required, as is the case under the current BC PPSA.

It will be interesting to see if the inclusion of the defined term, “licence” in the PPSAs of BC, the Northwest Territories, Nunavut and Saskatchewan leads other Canadian jurisdictions to enact similar legislation.

Why "Record" Security Interests in Intellectual Property at the Canadian Intellectual Property Office?

Charles Zienius — Thu, 22 Dec 2011 10:35:16 -0500

In Canada, security interests in intangible property collateral are perfected (or published, in the case of Québec) by making a registration under the personal property security legislation (“PPSL”) of the province where the debtor is deemed to be located at the time the security interest attaches. Intellectual property, such as trade-marks, patents, industrial designs, or copyrights, whether registered or unregistered, is not treated any differently than other types of intangible property collateral in that regard.

However, each of the federal Trade-marks Act, Patent Act, Industrial Design Act, and Copyright Act also provide for, or permit, the “recording” (i.e. registration) at the Canadian Intellectual Property Office (the “CIPO”) of assignments or transfers of the types of intellectual property to which those statutes apply. None of them refer specifically to security interests or perfection, and there is no jurisprudence regarding the legal effect of recording a security interest with CIPO. Nevertheless, it is conceivable that a court might someday conclude (contrary to the current generally accepted view) that the PPSL priority rules do not apply to intellectual property applications or registrations maintained at the CIPO as a result of paramount federal legislation, and according that priority disputes in respect of intellectual property collateral are to be determined under common law. The recording at the CIPO of a security interest in registered intellectual property might then enable a secured party to demonstrate that notice of its security interest was properly given to competing secured creditors. Moreover, even outside the context of a common law priority dispute, a recording at the CIPO might help avoid potential litigation risk by putting other interested parties on notice (to the extent such other parties reviewed the applicable CIPO records).

Therefore, where registered intellectual property constitutes a significant part of the collateral, secured parties often record at the CIPO their security interest against the property in question (in addition to making appropriate filings under applicable PPSL). The recording process essentially involves the payment to the CIPO of a prescribed fee, and the filing of a copy of an executed security agreement (identifying in sufficient detail (including reference to application numbers or, where applicable, registration numbers) the intellectual property against which the security is granted) by the CIPO in the appropriate records. Recording may only be done after the security agreement is effective, and for confidentiality reasons secured creditors often prefer to record only an abridged (but fully executed) version of their “main” security document.