the scope of the quebec commercial pledge...to various preferred rights of possession and custody of...

THE SCOPE OF THE QUEBEC COMMERCIAL PLEDGE

Martin Boodman *

1. Introduction

Innovation generates conflict. The introduction of new ideasentails not only the displacement of inconsistent precedents, butalso the reconceptualization of related, sustainable ideas.

Law as a dynamic theoretical construct and system of concepts,rules, standards and methods for regulating human behaviour isinherently innovative. Systems of law change constantly throughdoctrinal and judicial interpretation as well as legislative reform.The former interpretive processes are evolutionary in that they areconstrained by previously existing features of a legal system.Legislation, which is based on design rather than evolution, is themost adaptive component of legal change and potentially the mostradical. 1

The challenge of law reform through a legislative, as opposed tointerpretive, process is the effective integration of innovationwithin a legal system. The challenge is best met if the goals of lawreform are articulated in clear, simple legal principles formulatedwith advertence to their potential impact upon existing legalprinciples and the relevent practical or applied legal context.2 It isimpossible to anticipate all of the effects of law reform. None the

Associate Professor and Associate Dean (Academic), Faculty of Law, McGill University.I would like to thank Rod Macdonald and Benjamin Silver for their helpful commentsduring informal discussions at the 20th Annual Workshop on Commercial and ConsumerLaw, October 12-13, 1990, held at the Faculty of Law, University of Toronto, and RodMacdonald for comments on an earlier draft of this article. I would also like to thankJacob Ziegel and the Canadian Business Law Journal for having commissioned thisarticle. This article was made possible through a research grant from the Faculty of Law,McGill University. All errors and omissions are the sole responsibility of the author.See M.W.B. Sinclair, "The Use of Evolution Theory in Law" (1987), 64 U. Det. L.R.451; A. Watson, "Legal Evolution and Legislation" (1987), Brigham Young L.R. 353;R.P. Terrebonne, "A Strictly Evolutionary Model of Common Law" (1981), 10 J. Leg.Stud. 397, at p. 405.

2 See D. Stevens, "The Reform of the Law of Immoveable Security in Quebec", [1989]Meredith Memorial Lectures (Cowansville, Yvon Blais, 1990), 419 at p. 424.

Scope of Quebec Commercial Pledge 277

less, the degree and ease of integration likely varies inversely withthe scope and importance of the project. In other words, thegreater the potential impact of law reform, the more difficult itseffective integration will be.

Once the legislative formulation of a reform project iscomplete, the actual process of integration within a legal systemconsists of doctrinal and judicial interpretation, as well as practicalapplications of the new concepts. It is at this stage, which can lastas long as the new legal principles are in force, that the conflict ofideas occurs and the displacement and reconceptualization ofexisting legal principles is determined.

The purpose of this article is to consider the integration of thecommercial pledge within the Quebec model for security onmoveable property. In particular, I shall examine the interactionof the commercial pledge of equipment and machinery with theQuebec classification of property as immoveable by destination,and the effect of recent Quebec cases requiring a debtor/pledgorto be in possession of the collateral at the time of creation of acommercial pledge. These aspects of commercial pledge indicatethe existence of hidden and artificial formal requirements, inparticular as regards financing new equipment and machinery, andas regards a commercial borrower who owns the premises onwhich an enterprise operates. The anomaly of an unwritten sub-class of formalities raises questions about the intended scope andefficacy of the Quebec commercial pledge. This article will arguethat these problems are a direct result of an unsuccessful attemptby the Quebec legislature to adapt the French pledge ofequipment and machinery to a context different from that of itsorigin. The first part of the article will provide a brief overview ofthe substance and development of security on moveable propertyin Quebec, including the rationale for the legislative adoption ofthe commercial pledge.

2. Security on Moveables and Commercial Pledge in Quebec

Unlike most common law jurisdictions in Canada and theUnited States, Quebec has never adopted comprehensivepersonal property security legislation. 3 The present system of

3 There is, within the context of reform of the Civil Code of Quebec, a proposal to unifysecurity on property in the spirit of common law personal property security statutoryreform. The latest reform proposal was introduced in December, 1990. At present, it is

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278 Canadian Business Law Journal

security on moveable property in Quebec is a composite ofprinciples and security devices dating from the Codification in1866, and security mechanisms and procedures developed in apiecemeal fashion since that time to meet inter alia modernfinancing needs. 4

The present system of security on moveable property emergesfrom two principles which regulate debtor-creditor relations inQuebec. These principles are (i) universal patrimonial liability,i.e., that all of one's property is liable for fulfilment of one'spersonal obligations;5 and (ii) equality among creditors, i.e., thatall of one's property is the common pledge of one's creditors andwhere they claim together they share its price rateably, unlessthere are among them legal causes of preference. 6 These twoprinciples give rise to the major classifications of moveablesecurity devices in the law of Quebec into title transactions andlegal causes of preference.

The principle of universal patrimonial liability has been inter-preted to permit the manipulation of title to property in favour of aparticular creditor in order to take that property out of thepatrimony of the debtor, thereby insulating it from the claims ofother creditors. These title transactions include the installmentsale, conditional sale, sale with a right of redemption, leaseback,financial lease, double sale, etc. 7 In Quebec, non-consumer title

uncertain to what degree the proposed reform will be adopted. See Bill 125, Civil Code ofQuebec, 1st Sess., 34th Legisl. Que., 1990, arts. 2629 to 2789 regarding preferences andhypothecs, and arts 2918 to 3052 regarding the publicity of rights.

4 See R.A. Macdonald, "Privileges and Other Preferences Upon Moveable Property in theProvince of Quebec: Their Impact Upon the Rights and Recourses of ExecutionCreditors" in M.A. Springman and E. Gertner, eds., Debtor-Creditor Law: Practice andDoctrine (Toronto, DeBoo, 1982) 255; R.A. Macdonald and R.L. Simmonds, "TheFinancing of Moveables: Law Reform in Quebec and Ontario", [1981] MeredithMemorial Lectures (Don Mills, DeBoo, 1982) p. 246, at pp. 249 et seq.; R.A. Macdonald,"Modernization of Personal Property Security Law: A Quebec Perspective" (1985), 10 C.B. L.J. 182; M. Boodman, "The Myth of Harmonization of Laws" (unpublished), textaccompanying footnotes 81 et seq.

5 See art. 1980 c.c., para. 1, which provides:.. Whoever incurs a personal obligation, renders liable for its fulfilment all his

property, moveable and immoveable, present and future, except such property as isspecifically declared to be exempt from seizure.

6 See art. 1981 c.c., which provides:... The property of a debtor is the common pledge of his creditors, and where they

claim together they share its price rateably, unless there are amongst them legalcauses of preference.

7 See E.E. Saunders, "Pledge, Commercial Pledge, Sale with a Right of Redemption andSimilar Devices", [1967] Meredith Memorial Lectures (Montreal, Wilson & Lafleur, 1967)

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1991] Scope of Quebec Commercial Pledge 279

transactions are not subject to any special formalities relating totheir deployment as security mechanisms. They are unregulated assecurity devices in that their validity and enforceability dependsolely upon the general and special rules of contract applicable tothe particular form of the transaction. The result of this formal, asopposed to functional, approach is the existence in Quebec of non-possessory and unregistered security mechanisms based on title,i.e., in common law terminology, secret liens. 8

The second major type of security mechanism is the legal causeof preference which is stated explicitly in art. 1981 c.c. to be anexception to the principle of equality among creditors. As regardsmoveable property, the legal causes of preference include privi-leges or priorities for payment and the rights arising by virtue ofvarious consensual and non-consensual security devices. All of thelegal causes of preference are created by law and are limited innumber to those specifically enunciated in a codal or statutoryprovision.

A privilege is the right of a creditor to be paid by preference outof the proceeds of a judicial sale of the assets of a debtor.9 Privi-leges are awarded to specific creditors based on the nature of theactivity which gives rise to the debt ° or the secured status of the

p. 16, at pp. 21-5: G.E. LeDain, "Security over Moveable Property in the Province ofQuebec" (1956), 2 McGill L.J. 77, at pp. 89-95; Macdonald in Springman and Gertner,supra, footnote 4, at pp. 286-7, 324-37; Macdonald and Simmonds, supra, footnote 4, atpp. 24 9 ,264-5.

8 Title transactions in Quebec are enforceable against subsequent, competing creditorswith security under non-codal, statutory mechanisms such as s. 178 of the Bank Act(R.S.C. 1985, c. B-i), trust deed security under the Special Corporate Powers Act(R.S.Q. 1977, c. P.-16, ss. 27 to 30), transfer of property in stock (Bills of Lading Act,R.S.Q. 1977, c. C-53, ss. 11 et seq.) and documentary pledge. The absence of title by adebtor will not invalidate security in favour of a good faith pledgee, agricultural pledgeeor commercial pledgee if the security is considered a commercial matter. Further, a goodfaith purchaser in possession who has purchased in a commercial sale can oppose title to acreditor with security based on a prior title transaction. See arts. 1487 to 1489, 1966a, 2268c.c.; Y. Caron, "La vente et le nantissement de la chose d'autrui" (1977), 23 McGill L.J. 1and 380; Macdonald and Simmonds, supra, footnote 4, at pp. 265-7; M. Pourcelet, Lavente, 5th ed. (Montreal, Thdmis, 1987) pp. 55-72; A. Mayrand, "Nantissement de lachose d'autrui" (1943), 3 R. du B. 313; C. Demers, Traitd de droit civil du Qudbec, Vol. 14(Montreal, Wilson & Lafleur, 1950) pp. 15-7; M. Boodman, "The Prepaying Buyer ofCorporeal Moveables in Quebec" (1987), 47 R. du B. 871, at pp. 899-904.

9 See art. 1983 c.c.; Y. Goldstein, "The Quebec Law of Privileges" (1977), 22 C.B.R. 1, atpp. 2-3; Macdonald in Springman and Gertner, supra, footnote 4, at p. 287; LeDain,supra, footnote 7, at p. 79; P. Ciotola, Droit des saretis, 2nd ed. (Montreal, Th6mis, 1987)p. 221.

10 See, e.g., the privileges for law costs (art. 1994(1) c.c.), tithes (art. 1994(2) c.c.), funeralexpenses (art. 1994 (5) c.c.), expenses of a last illness (art. 1994(6) c.c.) and municipaltaxes (art. 1994(7) c.c.).


creditor as beneficiary of a consensual or non-consensual securitydevice." Besides providing a secured creditor with a privilege,consensual and non-consensual security devices may also give riseto various preferred rights of possession and custody of thecollateral, with or without rights of private realization.12

In synthesized and simplified form, the Quebec moveablesecurity model consists of legislatively assigned privileges or prior-ities for payment, various preferred rights arising from a finite listof consensual and non-consensual security mechanisms, and titletransactions. The application and interpretation of this technicalmodel, however, is influenced by several conceptual biases,largely of historical origin. First, as is evident from the restrictedlist of legal causes of preference, security mechanisms are excep-tional as regards the principle of equality among creditors.Second, according to civil law tradition, moveables are not suscep-tible of hypothecation 3 and possession of moveables creates apresumption of lawful title. 14 Hence, the archetypes for securityon moveables are pledge, a consensual, possessory securitydevice' 5 and the right of retention of a repairman, depositary,mandatary, etc. ,16 a non-consensual, possessory lien. Finally, thefact that all legal causes of preference, consensual and non-con-sensual, provide a privilege on judicial sale proceeds indicates a

11 See, e.g., the privileges of the unpaid seller (art. 1994(3) c.c.), pledge and retentioncreditor (art. 1994(4) c.c.) and lessor (art. 1994(8) c.c.).

12 See the possessory rights accorded the unpaid seller (arts. 1496,1497,1998,1999 c.c.),

pledgee (art. 1975 c.c.), commercial pledgee (art. 1979i c.c.), agricultural pledgee (art.1979c c.c.), transferee of property in stock (Bills of Lading Act, supra, footnote 8, s. 30)and trustee for bondholders (Special Corporate Powers Act, supra, footnote 8, s.30).Private realization rights are available to a commercial pledgee (art. 1979i c.c.), agricul-tural pledgee (art. 1979c c.c.), trustee for bondholders (Special Corporate Powers Act,ibid.), transferee of property in stock (Bills of Lading Act, ibid., ss. 33 to 35), and bankwith s. 178 security (Bank Act, supra, footnote 8, ss. 179(7) to (11)). See also Macdonaldin Springman and Gertner, supra, footnote 4, at pp. 337-49.

13 See art. 2022 c.c. which states:

... Moveables are not susceptible of hypothecation; except as provided in thetitles Of Merchant Shipping and Of Bottomry and Respondentia.

14 See art. 2268 c.c., para. 1 which provides:... Actual possession of a corporeal moveable, by a person as proprietor, creates a

presumption of lawful title. Any party claiming such moveable must prove, besideshis own right, the defects in the possession or in the title of the possessor who claimsprescription, or who, under the provisions of the present article, is exempt fromdoing so.

15 See arts. 1966 c.c. et seq. See also R.A. Macdonald, "Exploiting the Pledge as a SecurityDevice" (1985), 15 R.D.U.S. 551.

16 See arts. 441, 1713, 1812 c.c.

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civil law predisposition for realization through judicial seizure andsale.

In the present law of Quebec, this conceptual framework ishonoured more in the breach than in the rule. Most consensualsecurity devices available in Quebec are non-possessory and areperfected by registration.17 The diminished role of possession inthe Quebec moveable security model is also evidenced by thepossibility of security on future or after-acquired property. 18

Further, judicial seizure and sale can no longer be the presumptiverealization process for security on moveables given the variousforms of private realization legislatively available to specificsecured creditors under the current Quebec law. 19 In this regard, itmust be mentioned that creditors realizing privately are bound asregards higher ranking preferred creditors by the priority systemwhich would apply to the distribution of judicial sale proceeds. 20

While the traditional civil law framework as regards security onmoveables has not inhibited the development of non-traditionaltechniques, its influence resides in the characterization of securitymechanisms as exceptional law which must be interpreted restric-tively. Hence, recent developments in the Quebec moveablesecurity model tend to be directed towards specific financingsectors and are restricted as to the type of debtor and debtor'sassets or type of credit secured by the device. It is within thisframework that the commercial pledge was adopted by theQuebec legislature in 1962.21

Commercial pledge is defined by art. 1979e c.c. which provides:

17 See trust deed security under the Special Corporate Powers Act (supra, footnote 8, ss.28, 29), agricultural pledge (arts. 1979a, 1979b c.c.), commercial pledge (arts 1979e,1979g c.c.), security under s. 178 of the Bank Act (supra, footnote 8, ss. 178(1), (2) and(4)) and transfer of property in stock (Bills of Lading Act, supra, footnote 8, ss. 11 and22). See also non-registered, non-possessory title transactions described supra, textaccompanying footnotes 7 and 8.

18 See Special Corporate Powers Act, ibid., s. 27; agricultural pledge (art. 1979a c.c.);transfer of property in stock (Bills of Lading Act, ibid., s. 13); Bank Act, ibid., s. 178(2);assignment of book debts (art. 1571d c.c.).

19 See supra, footnote 12.20 See Trust General du Canada v. Marois, [1986] R.J.Q. 1029 (C.A.); Bills of Lading Act,

supra, footnote 8, s.42; Macdonald in Springman and Gertner, supra, footnote 4, at p.360. There is uncertainty in the law of Quebec as to whether a realizing creditor's duty torespect higher ranking privileges applies to all competing claims or only to those knownto the creditor at the time of realization. Further, it is uncertain whether there is any dutyto seek out competing preferred creditors. See Cie Montreal Trust v. Page, [1986] R.J.Q.2890, 64 C.B.R. (N.S.) 22 (C.A.).

21 See La loi relative au nantissement, S.Q. 1962, c. 57, which introduced arts. 1979e to1979k c.c.

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... A person carrying on a commercial business may pledge, as security fora loan or a line of credit which he contracts, for a term not exceeding tenyears, machinery and equipment pertaining to his business, while retainingpossession thereof. He shall then have, towards the creditor, the obligationsof a borrower of the effects pledged, but shall not be entitled to the cost ofpreservation and care.

The ostensible reason for the adoption of the commercial pledgewas to provide access to short and medium-term financing forcommercial enterprises through a non-possessory, registeredsecurity interest on equipment and machinery. 22 This innovativemoveable security device was inspired by an earlier Frenchequipment and machinery pledge. 23 Prior to 1962, commercialequipment and machinery could be collateral security in Quebecas moveable property under a possessory pledge, under a non-pos-sessory trust deed under the Special Corporate Powers Act 24 ornon-possessory title transaction or, as immoveable property,accessory to security on land or a building under a hypothec. 25 Thepledge is inappropriate because it deprives a debtor of thepossession and use of the collateral. Trust deed security andhypothec are long-term financing mechanisms which entailencumbering multiple categories of assets. Further, trust deedsecurity provides a low ranking preference and a hypothec presup-poses that a debtor has land or buildings to encumber.Commercial pledge as a security device restricted to equipmentand machinery isolates this type of collateral from other moveableor immoveable assets of a debtor.

The dichotomy between moveable and immoveable property inthe law of Quebec26 and the role of possession in commercialpledge raise serious questions regarding its scope and integration

22 See R. Comtois, "Une nouvelle Igislation: Le nantissment commercial" (1963), 9McGill L.J. 261, at p. 263; Ciotola, supra, footnote 9, at p. 124; Y. Desjardins, "Dunantissment commercial a l'hypoth~que mobilire" (1968-69), 71 R. du N. 87, at pp. 87-8: P.-Y. Marquis, "Nantissment commercial-Interprrtation de C.C. 1979e" (1971), 31R. du B. 539 at p. 540.

23 See Loi du 18 janvier 1951, J0., 19 janvier 1951; Comtois, ibid., at p. 263; J. Auger,"Les s0ret6s rdelles et personnelles A travers la jurisprudence r~cente", [1982] C.P. du N.123, at p. 168-9; Re: M. Filiaulh Co.: Hebertv. Simonelli, [1971] C.S. 335.

24 Supra, footnote 8.25 See arts. 379, 380 and 2017 c.c.; Re Paradis & Fils Ltde: Swidler v. International Trust

Co., [1984] C.S. 1246; Gauthier v. Auberge des Gouverneurs, [1977] C.S. 969; ReAmddde Leclerc Inc.: Thibault v. De Coster, 11965] C.S. 266. See also the discussion infraregarding immoveables by destination.

26 See art. 374 c.c. which provides:... All property, incorporeal as well as corporeal, is moveable or immoveable.

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into the Quebec moveable security model. In particular, thesequestions derive from the rule in the first paragraph of art. 1979hc.c. regarding immobilization by destination and recent casesrequiring a debtor to be in possession of assets at the time thecommercial pledge is created. The rule in art. 1979h c.c. andpossessory requirement will be examined separately.

3. The Rule in Article 1979h c.c.The first paragraph of art. 1979h c.c. provides:

..The privilege of the creditor under this chapter subsists if the thingpledged subsequently becomes immoveable by destination.

This provision has generated controversy in the Quebec legalcommunity as to whether commercial pledge applies to assetswhich are immoveable by destination at the time of the pledge.The issue has a serious impact upon the scope of commercialpledge because of the components of immobilization by desti-nation.

Immobilization by destination is a legal fiction which causesmoveables dedicated to the economic exploitation of land orbuildings to become conceptually and legally incorporated intothe land or buildings. 27 As accessories subsumed by the principalimmoveable to which they are linked, immoveables by destinationenhance the immoveable's value often to the benefit of creditorswith immoveable security and to the detriment of creditors withsecurity on moveables. There are four requirements for immobili-zation by destination: (i) the existence of both moveable andimmoveable properties; (ii) identity of ownership as regards theseproperties, i.e., the same person must own both; (iii) themoveable must be placed on the immoveable on a permanent basis

27 See art. 379 c.c., which provides:... Moveable things which a proprietor has placed on his real property for a

permanency or which he has incorporated therewith, are immoveable by their desti-nation so long as they remain there."

See also W. de M. Marler, The Law of Real Property: Quebec (Toronto, Burroughs,1932) pp. 5-11; P. Martineau, Les biens (Montreal, Thdmis, 1979) pp. 11-15; A.Montpetit and G. Taillfer, Traitd de droit civil du Quebec (Montreal, Wilson & Lafleur,1945) pp. 35-47; G. Desc6teaux, "La notion de l'exploitation en regard de la distinctiondes meubles at immeubles" (1965-66), 68 R. du N. 409, (1966-67) 69 R. du N. 147; R.Beaudet, "Les immeubles par destination" (1975), 35 R. du B. 339; J. Marunczak,"Immobilisation by Destination of Immoveable Industrial Machinery" (1966-67), 12McGill L.J. 330; G. Goldstein, "L'immobilisation des animaux par destination agricoleen droit civil qu6bdcois" (1987), 47 R. du B. 595.

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284 Canadian Business Law Joumal

or incorporated into it so as to contribute to its exploitation; and(iv) the moveable must remain on the immoveable, i.e., it isimmoveable by destination only as long as it so remains.

The first paragraph of art. 1979h c.c. expressly maintains therights and priority of a commercial pledgee over an hypothecarycreditor despite the subsequent immobilization by destination ofthe pledged property. It is argued, however, that exclusion ofassets which are initially immoveable by destination from thescope of commercial pledge would limit the security device todebtors who do not own the premises on which they operate. 28 Inother words, equipment and machinery owned by a debtor whoalso owns the land or building on which a commercial enterpriseoperates is immobilized by destination as long as it is on thepremises. J. Michel Deschamps argues that the commercial pledgewas intended to have this limited scope because debtors who owntheir operating premises could finance by hypothecating all orsome of their immoveable assets. 29 By contrast, Jacques Augerstates that it is inconceivable for the Quebec legislature to havecreated a new security device on equipment and machinery merelyto benefit commercial lessees. 30 While most authorities in Quebecindicate that commercial pledge applies only to moveable assetsand excludes assets which are immoveable by destination at thetime the pledge is created, 31 neither Michel Deschamps norJacques Auger pursues the analysis of art. 1979h c.c. far enough toexplain its inherent ambiguity.

The restriction of commercial pledge to moveable propertydoes not necessarily limit its scope as much as is suggested by theseauthors. First, as indicated above, a debtor who does not own thepremises upon which the pledged property is located will never bepledging equipment and machinery which is immoveable by desti-

28 See J.M. Deschamps, "Les sdiret~s sur les 6quipements et les stocks", [1987] C.P. du N.

125, at pp. 143-5; Auger, supra, footnote 23, at pp. 170-3. See also the allusion topotential problems in this regard in Macdonald and Simmonds, supra, footnote 4, at p.258; Ciotola,supra, footnote 9, at p. 129.

29 Deschamps, ibid., at p. 145. See also Ciotola, ibid.30 Auger, supra, footnote 23, at p. 173.31 Comtois, supra, footnote 22, at pp. 264, 270-1; Marquis, supra, footnote 22, at p. 540;

Ciotola, supra, footnote 9, at pp. 124, 127; Macdonald and Simmonds, supra, footnote 4,at pp. 257-8; Saunders, supra, footnote 7, at p. 19; Desjardins, supra, footnote 22; Caissepopulaire de Saint-Casimir v. Raymond, Chabot, Fafard, Gagnon Inc., [1983] R.L. 99(C.S.) at p. 103; Re Mocajo Construction Inc.: Freed v. Rodrigue, [1973] C.A. 509 at p.512.

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nation. As regards a debtor who owns the premises, the assets tobe pledged will be moveable as long as they are not physically onthe premises on a permanent basis or are not owned by the debtorat the time of the pledge. The ease or difficulty of fulfilling theseconditions and their desirability from a creditor's perspectivedepend upon whether or not the commercial pledge is intended tofinance the acquisition of the equipment to be pledged.

If the commercial pledge is used as a purchase money securityinterest, it is relatively easy for it to be constituted upon specificnewly acquired property before delivery to the debtor,presumably after ownership has transferred. 32 The only inconve-nience associated with a pre-delivery commercial pledge for acreditor would be the initial impossibility of inspecting andmonitoring the pledged property on a debtor's premises as part ofthe enterprise. However, this could be done after the constitutionof the pledge. In the context of a pre-delivery commercial pledge,the sale and transfer of ownership to the debtor would occurimmediately prior to the constitution of the pledge, which in turnwould immediately precede delivery. The time framework fordelivery and installation could be specified as a debtor's obliga-tions under the loan and security agreement. In this way, the merefact of delaying delivery until the commercial pledge is validlyconstituted should not create new incentives for manipulativebehaviour by the seller or debtor, and should not generate anysignificant increase in transactions costs.

Delaying the transfer of title to the equipment beyond theconstitution of a commercial pledge is more problematic thandelaying delivery. As a rule, ownership and the capacity toalienate are essential for the creation of secured rights. 33

According to art. 1966a c.c., however, the Quebec exceptions tothe nemo dat rule in sale validate as regards the true owner of thecollateral a commercial pledge of property not belonging to thepledgor. 34 In the present context, two exceptions are relevant.

32 See, infra, discussion regarding the formal requirement of possession by a debtor at thetime the commercial pledge is created.

33 See arts. 1966, 1972 and by analogy 2037 c.c.; Macdonald, supra, footnote 15, at p. 588;Mayrand, supra, footnote 8, at p. 313; Ciotola, supra, footnote 9, at p. 63; Boodman,supra, footnote 8, at p. 899, Demers, supra, footnote 8, at pp. 14, 35.

34 Art. 1966a c.c. provides:... Articles 1488, 1489 and 2268 apply to the contract of pledge.

Articles 1488, 1489 and 2268 c.c. create nemo dat exceptions in favour of a good faithbuyer where inter alia the seller who does not own the thing sold later becomes owner of

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First, the pledge is valid if the pledgor subsequently becomesowner of the property pledged. Second, it is valid if it is acommercial matter and the commercial pledgee acts in goodfaith. 35 The second exception would not apply here because theelement of good faith is lacking. It is assumed that the delay in thetransfer of title is knowingly arranged by and for the benefit of thelender and purchaser/borrower to avoid immobilization of thepledged property at the time the commercial pledge is created.Thus, both parties would be aware of the purchaser/borrower'sabsence of title and would be acting in bad faith. The firstexception would only validate the pledge vis-A-vis third partiesfrom the time of the pledgor's acquisition of title. Hence thecommercial pledge would not be enforceable as regards thirdparty rights arising prior to the transfer of ownership. The proba-bility of competing rights could be minimized by proximity in timeof the delivery, constitution of the commercial pledge and transferof ownership. The best method for doing so is for the contract ofsale to be a conditional or installment sale under which ownershiptransfers automatically upon full payment of the price and regis-tration of the commercial pledge.

Using a commercial pledge effectively as a purchase moneysecurity interest where the pledgor owns the operating premisesrequires the co-operation of the seller, buyer/pledgor andpledgee/creditor. The seller's incentive to co-operate is assuranceof full payment of the purchase price and elimination of the costsassociated with financing the buyer directly. Any added transac-

it, the seller is a trader dealing in similar articles or the sale is a commercial matter. See asregards the application of art. 1966a c.c., the authorities cited supra, footnote 8.

35 The decision in Re Bourcier: Super Marche Lefort Inc. v. Maheux Noiseux Inc. (May 23,1984), Montreal 500-11-001426-838 (C.S.) (J. E. 84-677), indicates that the sale or pledgeof a thing not belonging to the seller or pledgor is valid if the transaction is a commercialmatter, whether or not the buyer or pledgee acts in good faith. While a complete analysisof the good faith requirement is beyond the scope of this article, the decision in ReBourcier is of questionable validity for several reasons. First, it is contrary to the majorityof relevant authorities (see supra, footnote 8). Second, according to the facts of the case,the commercial pledgee was alleged to have acted in bad faith because at the time of thepledge it was aware that the pledgor was prohibited from pledging under the terms of asales contract with a third party. Good or bad faith in this context relates to knowledge ofdefects in the title of the pledgor. It is not certain whether knowledge of a contractualprohibition, the breach of which leads to a retroactive loss of title by the pledgor, issufficient to constitute bad faith. Further, this particular issue is not addressed in thedecision. Finally, by protecting third parties in good and bad faith, the decision in ReBourcier has the effect of promoting the trafficking of stolen property beyond the degreenecessary for the protection of commercial transactions.

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tions costs would likely be minimal and would be offset by thesavings of costs otherwise incurred where the seller finances theacquisition.

If the commercial pledge is used by a borrower who owns theoperating premises to raise capital based on previously ownedequipment and machinery there could be greater costs and incon-venience than where it is used as a purchase money securitydevice. In order to avoid the pledge of property which isimmoveable by destination, it would be necessary for the debtor toremove the equipment from the premises or to divest himself ofthe title to the moveables immediately prior to the creation of the-commercial pledge. The first option will not only be very costly asregards heavy equipment, it will also disrupt the pledgor'scommercial operations. Further, the temporary removal ofequipment might not demonstrate an intention sufficient to negatethe element of permanency in the notion of immobilization bydestination.

36

A debtor can easily eliminate the identity of ownership asregards equipment and premises through an appropriate titletransaction with the creditor/pledgee or a third party. Forexample, the debtor could sell the equipment to be pledged to theprospective commercial pledgee followed by a resale to the debtorvia conditional sale. The outstanding purchase price could betransformed into a loan by novation and the loan secured by acommercial pledge. 371n this scenario, the actual advance in favourof the debtor would arise with the first sale. A prospectivecommercial pledgor could also transfer title in the equipment to athird party, such as a wholly-owned subsidiary or holdingcompany, which would retransfer title immediately after thecreation of the commercial pledge in favour of the lender. Thesemethods of avoiding immobilization by destination are accom-plished through paper transactions with minimal costs.

These manipulations of title and possession in order to avoidimmobilization by destination and make the commercial pledgeavailable to borrowers who own their premises must raise doubtsabout the scope of the commercial pledge and, in particular, itsrestriction to moveable property. In fact, it is the fictitious nature

36 See authorities regarding immobilization by destination cited supra, footnote 27.37 See this example in Macdonald and Simmonds , supra, footnote 4, at note 31. See also

Ciotola, supra, footnote 9, at p. 129.

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of the techniques described above which warrants some re-exami-nation of the rule in art. 1979h c.c. The textual and functionalambiguity of art. 1979h c.c. results from its origin in the Frenchpledge of equipment and machinery, and from the fundamentaldifferences between that security device and the Quebeccommercial pledge.

The French non-possessory pledge of equipment andmachinery, the inspiration for the Quebec commercial pledge, isavailable only as a purchase money security interest.38 In otherwords, it can be used to supplement the non-consensual securitydevices available to an unpaid seller as regards the purchase priceor to secure a loan from a third party used to pay for the purchaseof the equipment and machinery pledged. The pledge can beconstituted before or after delivery of the newly acquiredequipment, but no later than two months after delivery. It isenforceable against a prior hypothecary creditor if the pledgecreditor serves the former with a copy of the contract of pledgewithin two months of its creation. The French law not only statesthat the privilege subsists if the pledged assets becomeimmoveable by destination, it also specifically exempts thoseassets from the rule that a hypothec applies to accessories to theimmoveable.

a9

Consequently, within the limits described above, equipmentand machinery which is immoveable by destination can be theobject of the French equipment pledge. The incursion of thisostensibly moveable security device into the realm of immoveablesecurity is severely restricted, however, by its role as a purchasemoney security mechanism. In fact, the security of priorhypothecary creditors will not likely be diminished by the pledgepriority because an initial immoveable evaluation will not likelyinclude future equipment and machinery. To the degree that itincludes future equipment acquired to replace or upgrade presentequipment, an hypothecary creditor can be protected under theloan agreement, for example by defining default to include sales ofpresent equipment and machinery, and by requiring notice of anysuch dispositions or changes in capital assets.

38 See A. Jauffret, "La loi du 18 janvier 1951 sur le nantissement de l'outillage et dumat6riel d'6quipement" (1951), 4 Rev. trim. dr. com. 201, at p. 208-9; C. Morel, "Nan-tissement de l'outillage et du mat6riel", Rp. dr. comm., Vol. 4 (Paris, Dalloz, 1974),nos. 10-16; M. Dagot, Les sdrets (Paris, Presses Universitaires de France, 1981), p. 233;R. Tendler, Les suretes (Paris, Dalloz, 1983), pp. 105,106.

39 See Jauffret, ibid., at p. 215; Morel, ibid., no. 59.

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Only an hypothecary creditor whose hypothec arose afterdelivery of the newly acquired equipment but prior to the creationof the equipment pledge would be adversely affected by it. Thiscould only happen if the hypothec and pledge arose within twomonths of delivery and if the hypothecary creditor was notified ofthe prior pledge within two months of its creation. This scenario isunlikely because it presupposes multiple financing within a verysmall time framework. None the less, if it did arise, the use ofdefault and notice clauses in the loan and hypothec agreementmight create a disincentive for a debtor as regards the constitutionof the pledge. This strategy would not, however, invalidate orprevent the priority of the subsequent equipment and machinerypledgee under French law. 40 In summary, in French law the non-possessory pledge of equipment and hypothec are probablymutually exclusive as regards collateral property, largely due tothe purchase money security nature of the former.

The transposition of the French security device to Quebec lawwithout restricting it to purchase money situations guaranteesfriction between commercial pledgees and hypothecary creditors,where a pledgee owns the operating premises, unless the manipu-lations of title and possession described above are deployed. InQuebec, therefore, art. 1979h c.c. is problematic. If it is inter-preted to exclude immoveables by destination from the scope of acommercial pledge, fictitious manipulations of title and possessionas described above are necessary. If it is interpreted to includeimmoveables by destination as in France, the commercial pledgemight have a significant detrimental impact on hypothecarycreditors who rely on the value of present accessories in theirvaluation of the primary immoveable security. All of this demon-strates that the Quebec legislature did not fully contemplate orcomprehend the effects of borrowing the structure of the Frenchsecurity device while changing its context and purpose. 41

40 This analysis raises doubts as to whether hypothecary creditors in France should rely onequipment which is immoveable by destination as part of the evaluation of immoveablesecurity. It seems that immobilization by destination, if anything, can provide anhypothecary creditor at the time of realization of security with an unexpected increase inthe scope and value of the collateral property. While the concept favours creditors withimmoveable security over those with moveable security, immobilization by destinationdue to its fictional nature does not change the physically moveable nature of equipmentand machinery. Nor, as explained in the text, does it prevent a debtor in France frompledging the equipment and machinery.

41 The desirability and feasibility of trans-systemic and trans-jurisdictional borrowing of

10-18 C.B.L.J.

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4. The Role of Possession

The incomplete integration of the commercial pledge in Quebecis also reflected in recent decisions regarding the role of a debtor'spossession at the time of constituting the pledge. The role ofpossession as a mechanism for the publication of rights inmoveable secured transactions is a complex subject which isbeyond the scope of this article. None the less, recent decisionsand doctrine in Quebec suggest that possession plays a specific roleas regards the constitution and, indirectly, scope of thecommercial pledge.

According to two recent decisions, 42 a commercial pledge isinvalid and unenforceable if the debtor/pledgor does not havepossession of the pledge property at the time of its constitution.The primary basis for this ruling is art. 1979e c.c., which permits aperson carrying on a commercial business to pledge equipmentand machinery pertaining to the business "while retainingpossession thereof". Most authorities interpret this language so asto restrict, and not expand, its scope because it is an exception tothe rule of equality among creditors, as well as that requiring atransfer of possession for the creation of moveable securityinterests. 43 Hence, the phrase "while retaining possessionthereof' is interpreted to be imperative, not merely permissive.This interpretation is also supported in two recent cases byallusions to the notion of equipment and machinery pertaining to abusiness, 44 and the limitation of commercial pledge to presentproperty. 45

legal institutions has been the subject of debate in comparative law. See, as regards the"Watson/Kahn-Freund" debate, 0. Kahn-Freund "On Uses and Misuses of Compar-ative Law" (1974), 37 M.L.R. 1; A. Watson, "Legal Transplants and Law Reform"(1976), 92 L. 0. R. 79; E. Stein, "Uses, Misuses and Non-uses of Comparative Law"(1977-78), 72 Nw. U.L. R. 198. Further, as regards the possibility for error in law reform,see M. Boodman, "The Seller's Revendication Remedy as a Fossil" (1989), 35 McGillL.J. 19.

42 Fiducie du Quebec v. Les entreprises R. Chainey & Fils Inc., [1983] C.S. 241; G. Doyon &Fils Inc. v. Gestion B. Rest Inc., [1986] R.J.Q. 2395 (C.P.). See also Deschamps, supra,footnote 28, at pp. 141-3.

43 See e.g. Comtois, supra, footnote 22, at p. 263; Auger, supra, footnote 23, at p. 169; S.Binette, "La rdalisation des garanties", [1983] C.P. du N. 135, at p. 163; Saunders,supra, footnote 7, at p. 19; Macdonald and Simmonds, supra, footnote 4, at p. 257;Marquis, supra, footnote 22, at p. 540; Les Constructions Rial Nadeau Inc. v. Caissepopulaire St-Isidore, [1987] R.J.Q. 2622 (C.S.); Banque Nationale du Canada v. Durand,[1981] C.S. 865; Caissepopulaire de Saint-Casimir v. Raymond, Chabot, Fafard, GagnonInc., supra, footnote 31; Re Ace Food Distributors Co. and Banque Royale du Canada,[19761 C.S. 1732.

44 See, as regards the notion of equipment and machinery in commercial pledge, Les

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As regards the narrow issue of a debtor's possession, thesedecisions are not persuasive. Other than the argument favouringrestrictive interpretation, no cogent reasons are enunciated for theimposition of the requirement. The discussion of the role ofpossession in secured financing is limited to an erroneous assimi-lation of commercial pledge to ordinary pledge, which entails atransfer of possession from the debtor to the pledge creditor. 46 Asfor the textual interpretation of art. 1979e c.c., the provision is notambiguous. The validity of commercial pledge, a non-possessorysecurity mechanism, should not depend upon the initial custody orpossession of a debtor. The traditional role of possession as ameans of publicizing rights has been replaced by registration of thecommercial pledge. The phrase "while retaining possessionthereof" in art. 1979e c.c. is obviously intended to permit theconstitution of a non-possessory, commercial pledge. While theprovision may be exceptional vis-A-vis the traditional role ofpossession, it is permissive and not imperative. 47

The problem of a debtor's initial possession or custody is real,however. It is another manifestation of the difficulties facingintegration of the French equipment and machinery pledge intothe law of Quebec. This larger problem, though not clearly articu-lated in the cases and doctrine, is evident in their allusions to thenotion of present equipment and machinery.

The notion of equipment and machinery pertaining to abusiness in art. 1979e c.c. implies that, at some time during acommercial pledge, the collateral must be used in relation to thedebtor/pledgor's enterprise and, thus, be in his custody. The realissue of a debtor's initial possession or custody, 48 therefore, can be

Constructions Real Nadeau Inc. v. Caisse populaire St-Isidore, ibid.; Re M. Filiault Co.:Hebert v. Simonelli, supra, footnote 23; Re J. C. Guay & Associates Inc.: Raleigh Accep-tance Corp. v. Miller (1972), 15 C.B.R. 155 (C.S.).

45 See, as regards the restriction of commercial pledge to present property, Re Ace FoodDistributors Co. and Banque Royale du Canada, supra, footnote 43.

46 See G. Doyon & Fils Inc. v. Gestion B. Rest Inc., supra, footnote 42, at p. 239 8 .47 See, as regards the traditional role of possession in secured transactions, Macdonald,

supra, footnote 15, at pp. 590-6.48 Given that art. 1966a c.c. permits the commercial pledge of property not owned by a

debtor/pledgor (see text, supra, accompanying footnote 34), in a strict sense, thequestion must be limited to a debtor's custody or physical control of the propertypledged. The notion of possession in civil law has two components: (i) corpus or physicalcontrol; and (ii) animus or the intention to exercise the powers and accept the responsi-bilities of a right of ownership over a thing. Constructive possession arises where thephysical control resides with a third party on behalf of the possessor. The possessoryrequirement restated in terms of use in a business is therefore really concerned withphysical control or custody.

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restated as to whether commercial pledge applies to equipmentand machinery which is not actually used for the exploitation of abusiness at the time of creation of the security. In other words,does the notion of "present" equipment and machinery refer onlyto its physical existence and identifiability or also to its use vis-A-visthe debtor's enterprise? In the first case, a debtor could pledgenewly acquired, but undelivered, existing equipment and therebyavoid immobilization by destination where he owns the operatingpremises of the business. If commercial pledge is limited to assetsused in the business at the time of the pledge, a debtor who ownsthe business premises could avoid such immobilization onlythrough the manipulation of title. As regards new equipment, thepledge would have to be constituted after delivery and prior to thetransfer of title.

Restricting commercial pledge to assets actually used in adebtor's enterprise does not reduce its scope as discussed inrelation to art. 1979h c.c. However, it does reduce the circum-stances in which it is available, and restricts the already artificialmeans by which immobilization by destination can be avoided, inparticular where commercial pledge is used to finance the acqui-sition of new assets. Hence, to the degree that a custodyrequirement imposes an added formality regarding the manipu-lation of title, even without a substantial increase in transactionscosts, it will be negative or neutral vis-A-vis a potential borrowerand lender. Further, a debtor's initial custody of equipment doesnothing to enhance the priority or enforceability of thecommercial pledge. 49 As stated earlier, the only advantage to a

49 A detailed analysis of the effect of a debtor/commercial pledgor's initial custody orpossession upon a commercial pledgee's status as regards potentially competingpreferred creditors is beyond the scope of this article. In simplified form, however, it canbe stated that the initial custody or possession of a debtor/commercial pledgor does notaffect the priority of a commercial pledgee in most cases. The only exception is thepossessory pledge.

A debtor's custody at the time of the creation of a commercial pledge indicates theabsence of a prior competing possessory pledge. A prior pledge will likely take prece-dence over a later commercial pledge. Thus, a custody requirement will, in theory,protect a commercial pledgee from a higher ranking possessory pledge. Yet, given theinconveniences for a debtor and pledge creditor of transferring possession of equipmentand machinery, it is extremely unlikely that a pledgee will compete with a commercialpledgee. In all other cases, whether or not a debtor has possession or custody at the timeof creating a commercial pledge will not affect a commercial pledgee's priority.

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commercial pledgee resulting from a custody requirement wouldbe the possibility of examining the collateral in its operating stateas part of the business prior to or at the time of the pledge, asopposed to later.

The imposition of a possessory requirement at the time of thecreation o f a commercial pledge, rationalized by recourse torestrictive interpretation, is not really justified by the text of art.1979e c.c. It is not consistent with the ostensible purpose under-lying the adoption of a non-possessory commercial pledge, i.e.expanded access to short and medium-term secured financingbased on equipment and machinery. Nor is the possessoryformality consistent with the informational role of possession inmoveable secured transactions in Quebec.

The problems of a debtor's initial custody and the notion ofpresent equipment and machinery arise, much like those inrelation to art. 1979h c.c. and immobilization by destination,because the Quebec commercial pledge replicates the structure,but not the restricted function and context, of the Frenchequipment purchase money security device. In France, theseproblems are finessed by limiting the creation of the pledge to aperiod of two months following delivery of the equipment to thedebtor/pledgor. Within this time framework, neither the absenceof a debtor's custody nor immobilization by destination affect thevalidity or enforceability of the security.

5. Conclusion

In Quebec, the imperfect integration of the commercial pledgehas several related consequences. First, it makes the issues ofcustody and immobilization fundamental to the apparent scopeand real usefulness of the security device. Second, it polarizes thejudiciary and commercial practice regarding the resolution ofthese problems. The courts use abstract and artificial interpretiverules to restrict the scope of commercial pledge. Commerciallawyers deploy equally artificial manipulations of title and custodyto circumvent the restrictions imposed by the judiciary and toavoid problems regarding uncertainty as to the scope of themechanism. Finally, and perhaps most important of all, theproblems attenuating the commercial pledge in Quebec raiseserious doubts about its adequacy as a moveable security device.

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the scope of the quebec commercial pledge...to various preferred rights of possession and custody of...

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