Canada: Two Recent Ontario Cases Act As A Reminder And Reconfirmation

1. Leases Over One Year Must be Registered in all Provinces Except Québec

In recent years the Ontario Personal Property Security Act ("PPSA") changed the scope of its application to include all leases for a term of more than one year, regardless of whether it is a "true" or "financing" lease. This is a different rule than exists in the United States and one often missed on cross border transactions. Simply stated, any lease for a term of one year or more must be registered to safeguard the lessor's rights in the property. Also note that the one year rule is broadly defined to include any renewals and possible renewals.

The requirement to register was highlighted in Re Scott, 2012 ONSC 4656 (Ont. S.C.J.), which confirmed a lease agreement itself is a security agreement for PPSA purposes. In this case, a lessor attempted to claim rights in a leased vehicle following the lessee's assignment into bankruptcy. The lease was for a term of more than one year and was not registered. During the bankruptcy process the lessor collected lease payments and seized the vehicle upon default. In accordance with s. 20 of the PPSA, which provides only perfected security interests in collateral will be effective against a trustee in bankruptcy, the lessor's interest was subordinate to the trustee. Further, the lessor had no right to lease payments received following its knowledge of the lessee's assignment into bankruptcy. 

Québec non-registration may not be fatal, but still lessors should register. An equivalent PPSA provision is found in all provinces except Québec. Registration in Québec merely makes the lease opposable by third parties; it is likely an innocent purchaser of an unregistered leased good may claim the property against a lessor. In Lefebvre (Trustee of); Tremblay (Trustee of) 2004 SCC 63, the Supreme Court of Canada stated a trustee in bankruptcy is not a third party, rather the trustee steps into the role of the lessee and thereby continues the lease. The decision of the Quebec Court of Appeal in 9089-3777 Québec Inc. c. Fischer  ("Fischer") follows this logic. In Fischer, a lessor had the right to claim vehicles subject to an unregistered lease that were seized by the lessee's unsecured creditors. Lessors should not confuse the rule in Québec with the rest of Canada, as failure to register a lease with a term over a year in all other provinces will cause the lessors rights to be subordinated to the trustee.

2. Present Value Termination Clauses are Upheld

Lease agreements may protect lessors through the inclusion of termination clauses which apply upon a lessee's default. An insolvency act by the lessee may be included as an event of default. There has been some debate about whether these clauses contained in standard form lease agreements are considered penalty clauses, and therefore unenforceable, or whether they are a "genuine pre-estimate" of damages incurred upon the lessee's default. The Ontario Superior Court shed some light on this issue in Action Auto Leasing & Gallery Inc. v. Boulding 2011 ONSC 7253 ("Action Auto").

At issue in Action Auto was a clause that stated if the vehicle was returned to the lessor the amount owing would be equal to the present value of the vehicle upon default by the lessee. Present value was to be calculated using a discount rate of 5% of the remaining lease payments, plus the residual value of the vehicle, less its wholesale value. It was found that this default clause provided a fair pre-estimate of damages and was therefore enforceable. Further, the court noted that its decision reflects the commercial reality that lessors of motor vehicles who must retail a vehicle upon a lessee's default incur expenses, including the maintenance of the lot on which the vehicle is displayed, the carrying costs of the vehicle prior to its sale, the maintenance of an office to service the lot and the payment of salespersons to market the vehicle.

Action Auto confirms what many in the leasing community already believed to be true: where a default clause reflects the present value of a leased car rather than the entire amount owing on the lease, courts will likely respect the clause.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.