Ontario Superior Court Rules on Securitization Transactions and the Bulk Sales Act

In a decision that simplifies the process of entering into certain securitization transactions, Justice David Brown of the Ontario Superior Court of Justice recently found that the Bulk Sales Act (BSA) does not apply to a proposed lease and equipment securitization transaction. The decision, Cle Leasing Enterprises Ltd. (Re), has the potential to remove a significant cost to such transactions in Ontario: obtaining a court order exempting transactions from compliance with the BSA.

The purpose of the BSA, first enacted in 1917, is to protect the interests of creditors whose debtors have disposed of all or substantially all of their assets outside the usual course of business, “leaving creditors in the lurch.” All provinces other than Ontario have repealed their bulk sales legislation on the basis that it imposes significant transaction costs on businesses to achieve aims that are largely addressed by other legislation, such as the Bankruptcy and Insolvency Act.

Ontario's BSA applies to a “sale in bulk,” which is defined as “a sale of stock in bulk out of the usual course of business or trade of the seller.” “Stock” is broadly defined to incorporate a wide range of assets. Accordingly, most sales of assets in bulk in Ontario are subject to the BSA unless the sale is in the usual course of business.

If a seller fails to comply with the BSA, a sale in bulk is voidable and the buyer may be required to reimburse the creditors of the seller for the value of the stock in bulk.

As a result of the broad definition of “stock,” whether the BSA applies to lease securitization transactions depends on whether the sale of assets is in the “usual course of business or trade.” Given the severe penalty for failing to comply with the BSA and the lack of judicial authority on whether these transactions were in the usual course of business, a practice had developed in Ontario to obtain BSA exemption orders for lease securitization transactions.

The applicants in the Cle Leasing matter lease equipment to small and medium-sized businesses and offer lease financing. The applicants entered into agreements to effect a lease securitization transaction whereby they would sell to a related general partnership, from time to time, certain leases and equipment at fair market value for the purposes of obtaining financing.

The applicants initially applied for a BSA exemption order that would extend not only to the initial sale of leases and equipment, but also to the future sales contemplated by the transaction. If a blanket order was not granted, the applicants would be required to incur the significant cost of returning to court every time they undertook one of their periodic financings.

In a decision released February 27, 2012, Justice Brown granted the BSA exemption order for the initial sale of assets but would not grant a blanket order for future sales. He advised the applicants that any further application for a BSA exemption order should be brought before him on notice to the Attorney General for Ontario for a determination as to whether the BSA applies to this transaction.

Accordingly, prior to the closing of a subsequent financing, the applicants brought a further application on notice to the Attorney General seeking a declaration that the BSA does not apply to this transaction.

The Attorney General did not oppose the relief sought and advised the Court that the applicability of the BSA to securitization transactions has been referred to the Ministry's Policy Division.
In the leading case on the BSA, National Trust, the Supreme Court of Canada stated that to be out of the usual course of business a sale would have to be of “all or substantially all” of the assets of a business. As the proposed transaction on the second application was of only 7.5 per cent of the applicants' combined assets, a determination could be made on that basis alone that the transaction was not a “sale in bulk” as defined in the BSA.

However, in his decision released June 4, 2012, Justice Brown went beyond this basic test and determined that the transaction did not fall within the BSA's definition of “sale in bulk” because it is “for the purpose of raising financing in the ordinary course of the operations of the applicants' business.” The Court stated that the BSA “was not intended to regulate, nor by its terms does it result in the regulation of, an ordinary course financing technique such as the type of asset securitization involved in the Proposed Transaction.”

Subject to any clarification from the Ontario Government, the clearly written and conclusive decision in Cle Leasing provides securitization lawyers with comfort that BSA exemption orders are not required to proceed with lease securitization transactions of the type at issue in this case.

Douglas Harrison, Mark McElheran and Daniel Murdoch of Stikeman Elliott LLP represented the applicants.

James Kendik represented the Attorney General of Ontario.