The Law of Commercial Leasing in Canada 1999

4. Third Party Rights and Priorities

4.1 Introduction

[119] The contractual aspect of a lease transaction dominates the determination of the parties rights and liabilities thereunder. However, their associated proprietary interests provide the basis for disputes arising from third party dealings with either the lessor or the lessee.

[120] At common law, the lessor is the owner of the goods leased and as such holds legal title thereto. The lessee acquires the rights of a bailee, which are surprisingly difficult to define. However, it seems that the lessee/bailee's right to possession is a limited form of proprietary right, sometimes called a "special property" as distinguished from the "general property" of the bailor.136 The proprietary rights of the parties to a bailment are described by one distinguished writer as follows,

A bailment gives rise to a form of property because it creates a division of interests in rem within the compass of a single chattel... The bailee obtains a legal interest in the form of possession, which is in many respects equivalent to an estate in land; and in the case of some bailments at least (such as pawns, liens and probably contracts of hire) this interest is preserved although the bailor disposes of his interest during the bailment to a third party. The bailor retains a reversionary interest.137

[121] At the inter partes level, the lessor's sale or encumbrance of her title may constitute breach of an express or statutorily implied term of the lease. Similarly, a transfer by the lessee that infringes upon the lessor's title or her right to return of the goods at the end of the lease constitutes a breach of contract on the part of the lessee. The general remedies of the parties for breaches of contract were discussed earlier.

[122] However, dispositions of this kind may also give rise to competing claims to the goods involving the third parties who have dealt with the lessor or the lessee. It is worth noting that the need to establish clear rules to resolve such disputes was not a primary concern in the move to promulgate a uniform leasing statute in the United States.138 In Canada, they can for the most part be resolved under the priorities provisions of the provincial Personal Property Security Acts. 139

4.2 Competitions Between the Lessor and Third Parties Dealing with the Lessee

[123] The provincial legislatures have, for the most part, already made the policy choice determining the appropriate statutory approach to resolution of priority disputes between a commercial lessor and third parties, through subjection of all leases for a term of more than one year to the provincial PPSA priorities regimes. 140 Ontario, Manitoba and the Yukon have yet to implement this approach. However, it is incorporated in the 1993 revision of the Manitoba Act,141 as yet unproclaimed, and has been recommended for adoption in Ontario in a recent Canadian Bar Association Report.S 142 In addition, leases that are in substance security agreements, whatever their duration, fall within the scope of the PPSA in all provinces.

[124] The practical effect of the choice to include commercially significant true leases within the scope of the PPSAs is that lessors must register their interest in the appropriate provincial personal property security registry to protect themselves against third party claims. Competing claims to the leased goods arising between a lessor (or lessor's assignee) and parties dealing with the lessee will be determined under the statutory priority rules. The third parties involved may be the lessee's secured creditors, transferees of the lessee, the lessee's judgment creditors or his or her trustee in bankruptcy. The applicable priorities rules are those generally governing a competition between a security interest and third parties. In other words, a lessor is, for purposes of determining priorities disputes, in the same position as the holder of a security interest. This means that a lessor who has failed to register its interest may be subordinated to the interests of any of the aforementioned third parties.143

[125] The desirability of requiring registration of true leases has been hotly debated.144 While that debate has in the United States been decided against the advocates of registration, the converse view has overwhelmingly been adopted in Canada, and nothing is to be gained by revisiting it.

[126] Although true leases having a term of less than one year do not fall within the scope of the PPSAs, significant third party issues are not likely to arise in connection with short- term leases.145 There is certainly no evidence of such disputes in the reported cases.

4.3 Competitions Between the Lessee and Third Parties Dealing with the Lessor

[127] The PPSAs provide that a lessee of goods leased in the ordinary course of business of the lessor takes free of any security interest given by the lessor.146 All commercial lessors fall within the scope of this provision, whether they are finance lessors or lessors of inventory. This means that a secured creditor of the lessor whose interest arises before the date of the lease cannot seize the leased goods from the lessee in the event of the lessor's default.

[128] Third party claims that come into being after creation of the lease will ordinarily flow from assignment of the lease by the lessor, or from the lessor's grant of a security interest in the leased goods or the chattel paper arising from the lease. Though such creditors may thereby become entitled to enforce the lease as against the lessee, they have no right to interfere with the lessee's possession and use, in the absence of a default.

[129] The PPSA reflects the rules of common law and equity relating to assignments, providing in effect that the rights of an assignee are subject to the terms of the contract between the lessor and lessee. 147 Similarly, a creditor who takes a security interest in the goods themselves can take no more than the lessor has to give. Since the lessor's interest is subject to the "special" proprietary rights of the lessee, a subsequent secured creditor cannot displace the lessee's rights.

4.4 Conclusions

[130] Article 2A of the Uniform Commercial Code contains a series of very complicated provisions regulating disputes between the parties to a lease and third parties. 148 Their application and meaning is, in the words of one commentator "not always clear". In view of the relatively comprehensive coverage of third party issues by the PPSAs, there is no apparent need to create a separate system of statutory priority rules specifically applicable to leases. The few disputes that fall outside the scope of the PPSAs may be resolved under the principles of common law.

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