By Nicolas Beaulieu, Lawyer and Partner at Gascon & Associés SENCRL.

In the context of commercial financing, businesses seeking credit or simply opening a bank account with a financial institution do not always fully realize the securities they may be granting. They would be well advised to pay closer attention, as the line between granting or not granting a hypothec on a bank account can be very thin.

Commercial lenders financing businesses could likewise find themselves with significantly less effective security if they have not conducted proper and efficient due diligence.

During the Strategic Days – Financing and Securities, organized by Open Forum on January 21, 2025, we participated as a speaker in the discussion on “Due Diligence Review of Specific Assets in a Financing Transaction and Its Impact on Securities”, addressing the complexities of movable hypothecs on monetary claims in commercial financing and how they can have unexpected impacts for both lenders and borrowers.

As a brief reminder, in Quebec, movable hypothecs take two forms: with delivery or without delivery.

In commercial financings, lenders usually opt for hypothecs without delivery, which require registration in the Register of Personal and Movable Real Rights (RPMRR) to be enforceable against third parties. This is particularly true for the universal hypothec on claims, a commonly used security because it covers all of the borrower’s claims, which is practical since an operating business regularly transacts its claims, which would otherwise be very complex for both lender and borrower if each were specifically hypothecated. However, in case of ranking conflicts, a hypothec on a specific claim takes precedence over a hypothec on the universality of claims, which limits the latter’s effectiveness.

What about a hypothec with delivery in the context of a commercial financing? What is its usefulness?

Its usefulness is crucial when it comes to bank deposits. It is possible to create a movable hypothec with delivery on monetary claims. While it may seem ironic to speak of delivery for an intangible asset like a monetary claim, the concept of control (bipartite or tripartite) was created to allow the holder to achieve delivery of the monetary claim.

Verification at the RPMRR is not enough. For monetary claims, those who limit themselves to such verification will likely face unpleasant surprises if they fail to conduct other essential verifications, such as reviewing the borrower’s existing bank accounts, any executed control agreements, and all current financing arrangements. This is more an investigation than a simple due diligence exercise, requiring sophistication from both lender and borrower or their advisors.

The Quebec Court of Appeal in Syndic de Montréal c’est électrique (2020 QCCA 1609) highlighted two important points we discussed above: a company may grant a hypothec on bank deposits without really realizing it, and a commercial lender must be diligent and competent to avoid ending up with an unsecured loan.

The facts in the Court of appeal ruling are the following:

The company organizing the Formula E race in Montreal obtained a credit facility from Caisse Desjardins secured by a movable hypothec without delivery. The City of Montreal guaranteed the company’s obligations. When the company defaulted, Caisse Desjardins requested the repayment of the loan, the City decided to pay the debt with subrogation and obtained the assignment of the Caisse Desjardins’ security.

Finally, the company ceases its operations and declares bankruptcy. At bankruptcy, the only realizable asset remaining was the creditor balance in the bank account at Caisse Desjardins.
The City of Montreal alleges that it holds a movable hypothec on the universality of all of the company’s property, including the monetary claims in the bank account.

The Court of appeal wished to remind that the deed of hypothec without delivery on the universality of movable property must contain a sufficient description of the universality of the property forming part thereof[1]. In fact, it is essential that the description of such universality be sufficient to remove doubts as to what is covered by such hypothec[2]. The Court decided that the deed of hypothec did not contain a sufficient description to conclude that the universality of claims was hypothecated.

Furthermore, the City did not benefit from a hypothec with delivery because control of the bank account was never obtained. As part of the conditions to obtain the control of a bank account, it is necessary to obtain the consent of the grantor opening the bank account that it agrees that the balance in the bank account is used to guarantee its obligations in favor of the financial institution[3].
A simple contractual clause allowing a right to set-off is not enough. Article 2713.3 CCQ states:
“A creditor obtains control of a monetary claim held by the grantor against it if the grantor has agreed that the claim secures an obligation to the creditor.”

This ruling by the Court of appeal is currently the most important decision on movable hypothecs on monetary claims. Because it is often much easier to understand with concrete examples, we thought we would propose two similar financing situations with results that are quite surprising.

Of course, all facts and names in these two illustrative scenarios are purely fictional.

Two Illustrative Scenarios

Case 1:

Bank A finances a technology company and registers a first-rank universal hypothec on all of its property. Two months later, Bank B lends money to the same company and obtains a hypothec on all of claims, and requires the company to open a bank account with it, including a consent for the account balance to secure the loan.

Who has priority over the account balance? Is it Bank A with its first rank hypothec on all movable property or Bank B?

Because Bank B holds a movable hypothec with delivery pursuant to the consent given by the company in its favor, such consent gives Bank B control over the account balance in the bank account and priority over the Bank A.

There is a reason why financial institutions offering credit require the opening of a bank account at their bank.

Case 2:

Same facts, but with a small variance to make it even more interesting.

The loan agreement with Bank A contains a negative covenant by the borrower not allowing it to obtain financing from another lender, without the prior consent of Bank A. Before finalising its financing with Bank B, the company informs Bank A in view of obtaining its consent to this new financing.

Having been made aware of the credit being offered by Bank B and the opening of a new bank account at Bank B, as a condition to provide its consent, Bank A requires Bank B to execute a tripartite control agreement between Bank A, Bank B and the company.

Who now has priority over the account balance in the bank account?

Bank B, as it benefits from a bipartite control agreement when the company agreed to borrow from this bank, despite the fact that Bank A benefits from a tripartite control agreement. In the event of a conflict, the bipartite control prevails over the tripartite control.

What should Bank A have done to obtain priority over the account balance in the bank account? Bank A should have obtained an assignment of rank over such monetary claims.

What needs to be remembered is that a situation may reveal itself complex for a lender if it does not realise that the holder of a first rank hypothec on claims may not be guaranteed that it will remain in this position when it comes time to enforce its security.

At the other end of the spectrum, the situation may be troubling for a borrower if it does not realise the full extent of certain loan agreements it entered into and as a result thereof, that certain hypothecated property may no longer be available to other lenders, limiting their credit availability.

In commercial financings, lenders will need to extend their due diligence work to another level and include their legal counsels with experience in these types of particular movable hypothecs. It will become essential for them to involve their legal counsel not only for due diligence matters when putting in place the financing, in the preparation of the loan agreements to include certain representations and warranties and covenants which may become important, in determining if an assignment of rank is required and also after the loan was granted, when the lender is examining the consequences of an additional financing on its own financing  and the outcome

[1] Syndic de Montréal c’est électrique, 2020 QCCA 1609, paragraph 24.

[2] Ibid

[3] Ibid, paragraphs 77 and 78