Equity Among Secured Creditors:
Article 2049 (2) C.C. Re-examined
R.A. Macdonald*
Synopsis
Introduction
1. Conditions of Application of Art. 2049 (2) C.C.
A. A creditor who has a hypothec upon more than one immoveable
belonging to his debtor
B. All or more than one of the immoveables thus hypothecated be
sold
C. The proceeds have to be distributed
D. There are other subsequent creditors holding hypothecs upon
some one or other of such immoveables
E. Conclusion
II. Juridical Effects of Art. 2049 (2) C.C.
A. His hypothec is divided rateably
B. Upon so much of their respective prices as remains to be distributed
C. Conclusion
III. A Critique of Art. 2049 (2) C.C.: Distribution and Realization in
a Regime of Security on Property
A. Purchasing the Rights of Higher Ranking Creditors
B. Renunciations, Cession of Priority and Similar Devices
C. Strategies for Compelling the Application of
Art. 2049 (2) C.C.
D. Conclusion
*Of the Faculty of Law, McGill University. I would like to acknowledge the assistance
of my colleagues, Dean J.E.C. Brierley and Professors R.L. Simmonds and S.A. Scott in
the preparation of this essay.
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[Vol. 27
IV. The Future of Art. 2049 (2) C.C.: The Limits of Indivisibility
A. Towards a Reinterpretation of Art. 2049 (2) C. C.
B. The Proposals of the Civil Code Revision Office
Conclusion
Introduction
From the perspective of legal policy, the manner in which the
respective rights of competing creditors holding non-coextensive security
upon their debtors’ assets are integrated, constitutes one of the more
interesting issues in the law of security on property.1 A particular
example of this arises when a creditor with security over several assets
proposes to realize his guarantee upon collateral which is charged with
subsequent security, and not upon collateral over which no other secured
creditor has a claim. At least four distinct interests are involved: (1) the
interest of the first ranking secured creditor to realize efficaciously upon
his debtor’s assets; (2) the interest of lower ranking secured creditors to
derive the maximum utility from. their security whenever their debtor
becomes insolvent; (3) the interest of unsecured creditors to minimize the
preferential treatment of secured creditors in order to increase the mass of
property to be distributed to chirographic creditors; and (4) the interest of
the debtor to foreclose the possibility of realization upon all his assets
when he has fallen into default towards one creditor only. Moreover, the
framework within which these interests must be accomodated has two
separate elements: the law may simply elaborate principles of distribution
of the proceeds of any sale of a secured creditor’s collateral; or the law
may establish a mechanism controlling the manner in which secured
creditors may realize upon their debtors’ property. Determining both
which interests should prevail from a policy perspective, and which
juridical devices should be employed to effect this policy requires careful
analysis of the theory of secured financing.
The civil law of Qu6bec has not heretofore reflected a comprehensive
approach to the resolution of these issues, but rather has left the details of
the law of secured financing to be elaborated by debtors and creditors in
their individual agreements. One may trace the reasons for this result in
part to the general spirit of freedom of contract which pervades the Civil
Code; in economic matters, the law assumes that the best judges of the
‘For a general discussion see G. Gilmore, Security Interests in Personal Property
(1965), vol. 1, 1181-280.
19821
EQUITY AMONG SECURED CREDITORS
needs of contracting parties are the parties themselves. This result also
flows from the Code’s prohibition of non-possessory security on
moveable property; it is not frequently the case that ordinary debtors
possess a plethora of immoveables and deal with them in such a manner
that competing non-coextensive claims of secured creditors will arise.
Finally, the 1866 Code envisions the hypothec as the primordial legal
institution for obtaining security on property. Consequently, a competi-
tion between secured creditors is likely to arise only with respect to the
distribution of proceeds upon the sale of secured assets.
In view of these assumptions, it is not surprising that neither the
legislature nor the judiciary has shown much concern for problems of
integrating the divergent and typically conflicting claims of secured
creditors. The former has regulated the question of non-coextensive
securities exclusively in art. 2049 C.C. 2 The first paragraph of this article
confirms a consequence of the rule that hypothecs are indivisible.3 It
states:
A creditor who has a hypothec upon more than one immoveable belonging to his
debtor may exercise it upon such one or more of them as he deems proper.
Le cr6ancier qui a une hypothbque sur plus d’un immeuble appartenant
son
d6biteur, peut l’exercer par action ou saisie sur celui ou ceux de ces immeubles qu’il
juge h propos.
In other words, the Code contemplates that, in principle, neither the
debtor nor any other individual has a right to stipulate to a secured
creditor the particular assets upon which he may realize his security.
The second, and for present purposes more important, paragraph of
art. 2049 C.C. raises difficult questions of interpretation. While both
commentators and judges are divided as to its precise effect, all agree that
its general thrust is to establish an exception to the principle of
indivisibility. 4 This paragraph provides:
2The Code Napol6on has no such provision, although the doctrine and jurisprudence
seem to have arrived at a similar position. See, e.g., H., L. & J. Mazeaud, Lepons de droit
civil, 5th ed. (1977), T. 1, 440 et seq. Article 2049 is completed by the provisions of the
Code of Civil Procedure. See, in particular, arts 721-3 C.C.P. A recent elaboration of
their interrelation is contained in Bousco Inc. v. Motel St-Franpois Inc. C.S. (Montr6al,
500-05-004447-791), 8 January 1982.
‘Art. 2017 (1) C.C. provides:
Hypothec is indivisible and subsists in entirety upon all the immoveables made liable,
upon each of them and upon every portion thereof.
L’hypoth~que est indivisible et subsiste en entier sur tous les immeubles qui y sont
affect6s, sur chacun d’eux et sur chaque partie de ces immeubles.
4The principal doctrinal sources are: F. Langelier, Cours de droit civil de laprovince
de Quebec (1911), T. 6, 286-7; P. Mignault, Le droit civil canadien (1916), T. 9, 132-3;
W. Marler, The Law of Real Property (1931), nos 791 and 830; C. Demers, Traitg de
droit civil du Qukbec (1950), T. 14, 259-61; Y. Caron & S. Binette, “Des hypothques”
in Chambre des Notaires, Rgpertoire de droit [:] Sfirets (1980), nos 207-11 and 305-7.
Mc GILL LAW JOURNAL
[Vol. 27
If however all or more than one of the immoveables thus hypothecated be sold, and
the proceeds have to be distributed, his hypothec is divided rateably upon so much of
their respective prices as remains to be distributed, when there are other subsequent
creditors holding hypothecs upon someone or other only of such immoveables.
Si n~anmoins tous ces immeubles, ou plus d’un des immeubles hypoth6qu~s sont
vendus et que le prix en soit A distribuer, son hypoth~que se r~partit au pro rath de cc
qui reste A distribuer sur leurs prix respectifs, lorsqu’il existe d’autres cr6anciers
post~rieurs qui n’ont hypoth~que que sur quelqu’un de ces immeubles.
It might seem at first glance that here the Code sets out a limited right of
lower ranking secured creditors to direct higher ranking creditors to
specified assets when realizing upon their debtors’ property. In effect,
however, this paragraph merely establishes an order of collocation of
proceeds to be imposed upon certain secured creditors in specified
circumstances. It does not formulate a general theory about how secured
creditors may exercise their security.
Unhappily, neither paragraph of art. 2049 C.C. has generated an
abundant jurisprudence. Since the 1925 decision in Crown Realty Ltd
v. Putnam et Beriau5 this article has been mentioned in only one reported
judgment: Central Factors Corp. v. Imasa Ltd.6 In both instances the
Court of Appeal was required to determine the meaning of paragraph two
of art. 2049 C.C. and in both it came to the conclusion that the article
was not directly applicable to the case under consideration. Furthermore,
in both judgments the Court declined to elaborate a theory either of the
article or the problem it addresses. As a consequence the second para-
graph of art. 2049 C.C. remains an enigma and this aspect of the law of
secured financing retains an inchoate character.
Apart from the exercise of doctrinal exegesis –
itself an important
element of civil law methodology when laconic codal provisions have not
been jurisprudentially developed –
there are several other reasons for
re-examining art. 2049 (2) C.C. at this time. First, the structure of
secured financing has undergone considerable evolution since 1866. A
5(1925) 38 B.R. 331, rev’g Crown Realty Ltd et al. et Putnam (1924) 62 C.S. 199.
The judgment of the Court of Appeal is difficult to interpret since the official report
contains only extracts from the notes of four of the five judges who sat on the case:
Howard, Tellier, Letourneau and Greenshields JJ.A. The views of Allard J.A. and the
judgment of the Court are not reported, although the latter was drafted by Howard J.A.
and is available under file number C.A. (Montr6al, 531-163) 5 March 1925.
‘This reference was, however, only by way of comparison and did not influence the
disposition of the case: (1979) C.A. (Montreal, 09-000-245-779, 12 March 1979), affjg
Imasa Ltd v. Artitex Knitting Mills Inc. [1977] C.S. 531. This case involved a competi-
tion over the proceeds arising from the sale of moveable property between the assignee of
a s. 88 security, an unpaid vendor and the holder of security given under a trust deed. See
Payette, Les sfiretes mobilitres et le “Marshalling” (1979) 39 R. du B. 306.
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EQUITY AMONG SECURED CREDITORS
variety of legal institutions other than hypothecs are today routinely
employed as security devices; it is therefore important to consider
whether the principle of art. 2049 (2) C.C. is also applicable to these
other devices. Second, the commercial practice of secured financing has
evolved considerably in the past 100 years. The respective interests of
competing creditors can no longer be adequately protected by the simple
invocation of distributional principles after collateral has been seized and
sold. Secured creditors need to be able to assert some control over the
seizure and disposition of collateral prior to realization and distribution of
the proceeds of sale. Third, the Civil Code Revision Office has proposed
a radical revision of the law of security on property. With the extension of
hypothecs to moveable property the problem of competing creditors
becomes even more acute in that commercial debtors typically recur to
numerous financers; with the increased flexibility of the hypothec, its
mechanics of realization assume increased significance. Each of these
reasons suggests that a close analysis of the meaning of art. 2049 (2)
C.C. is desirable. Since the article has never been amended, a rethinking
or reformulation of its underlying theory also would not be misplaced.
To these ends this study will focus first upon the conditions of
application and the juridical effects of the present codal provisions.
Following an assessment of the role in a regime of security on property of
rules regulating the rights of secured creditors inter se, a critique and
suggested re-interpretation of the current law will be offered as a prelude
to analysis of the proposals of the Civil Code Revision Office. 7
Throughout, the discussion will attempt to highlight the functions of art.
2039 (2) C.C. and the evolution of secured financing since the Code was
promulgated in 1866.
I. Conditions of Application of Art. 2049 (2) C.C.
Presently, the Code elaborates four conditions essential for the
application of art. 2049 (2): (1) it is necessary that a creditor hold a
hypothec over more than one immoveable belonging to his debtor; (2) all
or at least more than one of the immoveables affected by the hypothec
must be sold; (3)
the proceeds of the sale or sales must remain to be
distributed; (4) there must be at least one lower ranking hypothecary
creditor whose hypothec affects some one or other of these immoveables.
Although these preconditions appear relatively straightforward, in view of
the absence of detailed doctrinal exposition and the paucity of juris-
prudence, it is helpful to examine each closely prior to assessing the
7By way of anticipation, it is worth noting that the Draft Civil Code proposes no major
modification to the text of the existing art. 2049 C.C.: see art. 423 of Book IV,
“Property”.
REVUE DE DROIT DE McGILL
[Vol. 27
effects of art. 2049 (2) C.C. Such an explanation is also useful in
exposing various lacunae in the conception and redaction of the article.
A. A creditor who has a hypothec upon more than one immoveable
belonging to his debtor
Implicit in the above proposition, drawn from the first paragraph of
the article, are several discrete limitations on the scope of art. 2049 (2)
C.C. First, the immoveable given as security must belong to the creditor’s
debtor. The sense of the word “debtor” may initially appear unclear
because there is no antecedant for the noun: does the article contemplate
debtors on the obligation guaranteed by the hypothec, or hypothecary
debtors? In the title “Of Privileges and Hypothecs” the Code customarily
distinguishes between debtors and holders.8 Debtors are bound both
personally and hypothecarily towards their creditor, whereas holders are
bound only hypothecarily. It would appear therefore that art. 2049 C.C.
envisions the more limited usage of the term “debtor”. This view is
confirmed in the examples given by Langelier,9 which expressly treat the
case where the collateral seized is in the possession of an individual who
is personally liable to the creditor. However, those offered by Mignault, 10
Marler,1″ and Caron and Binette 12 are not sufficiently elaborate to permit
a conclusion to be drawn on this point.
the principle of indivisibility might appear
If the term “debtor” were to limit the application of art. 2049 (2)
C.C. to only those immoveables held by an individual personally liable to
the creditor, as the usage of the Code would suggest, its effectiveness as a
to be
restriction on
compromised. There are at least three hypotheses where an immoveable
to a debt for which
of a holder could be affected by hypothec
immoveables of the principal debtor are also affected: (1) whenever an
immoveable is made liable for the payment of another’s debt as part of an
ordinary suretyship agreement in which the surety personally agrees to
fulfil the obligation of the principal debtor; (2) whenever an immoveable
is offered by way of real security as an additional guarantee for another’s
8In art. 2053 C.C., which refers to “debtor or other holder”, the term “debtor” seems
to be seen as a subset of the category holder. In arts 2062-80 C.C., however, the term
“holder” is used in reference to an individual who is in possession of an immoveable but
who is not indebted personally to the creditor. Throughout, the term “debtor” is used
exclusively in reference to those personally liable on the debt. One can conclude,
is to be reserved for those bound
therefore, that in principle, the term “debtor”
hypothecarily and personally.
9Supra, note 4, 286-7.
“Supra, note 4, 132.
I’Supra, note 4, no. 830.
12Supra, note 4, no. 306.
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EQUITY AMONG SECURED CREDITORS
debt; and (3) whenever an immoveable is sold by the debtor to a third
party who does not also assume the principal debt In each of these
examples, however, the principle of indivisibility would never be applica-
ble. In each case, other articles of the Code expressly override the
principle and direct the seizing creditor towards certain specific im-
moveables. Thus, a simple surety who has affected his immoveable in
guarantee of his suretyship obligation may compel the prior discussion of
the principal debtor’s property under art. 1941 C.C.13 The creditor would
be obliged to realize upon a hypothec granted by the principal debtor
prior to seizing the surety’s immoveable. Similarly, both the individual
who offers a hypothec on his immoveable as an additional guarantee for
the debt of another, and the third party acquirer who is a mere holder are
entitled to invoke the exception of discussion established by art. 2066
C.C.1 4 In these cases the creditor would be obliged to realize upon any
immoveables of the principal debtor prior to seizing the immoveable of a
third party. It follows that an interpretation of “debtor” which restricts its
meaning to individuals personally liable as principals upon an obligation
is most coherent with the theory of hypothecary recourses elaborated by
the Code. It is also most coherent with the likely expectations of other
creditors who have taken lower ranking security only upon the assets of
the principal debtor.
Of course, the applicability of art. 2049 (2) C.C. is also subject to the
various rules relating to undivided ownership, 5 conditional ownership, 6
or possession under insufficient title.1 7 Unless, by act of partition,
realization of a condition, or acquisition of sufficient title the principal
debtor becomes owner of an immoveable, it cannot be said to “belong” to
him in the sense required by art. 2049 C.C. for the purposes of seizure
and sale. Only where the individual in possession of an immoveable as
owner is a true debtor will art. 2049 (2) C.C. be applicable.
A second limitation on the scope of art. 2049 (2) C.C. may be
implied from the fact that the Code states that the security held by the
creditor must be a hypothec. While the codifiers may have contemplated
the hypothec as the sole means of obtaining consensual security over
property, there are today several means by which a creditor may achieve
a preference upon an immoveable: these include privileges, hypothecs, or
3Of course, the surety loses this right if he has bound himselfjointly and severally with
the debtor to the creditor. In such cases, however, art. 2049 (2) C.C. would be applicable.
14Once again, the third party will lose this right if he has bound himself personally to
the creditor. Here also, however, art. 2049 (2) C.C. would be applicable.
“Art. 2021 C.C.
16Art. 2038 C.C.
17Art. 2043 C.C.
Mc GILL LAW JOURNAL
[Vol. 27
security under certain provisions of the Bank Act.”‘ Moreover, creditors
may protect their right to assert an advantageous position upon
realization by having recourse, in a variety of cases, to other juridical
institutions which do not, strictly speaking, constitute a preference.
Among these are giving in payment clauses, resolutory clauses, sales with
a right of redemption, sale and leaseback, promise of sale, antichrtse and
the right of retention. Yet art. 2049 (2) C.C. mentions only hypothecs
expressly.
If literally construed, the article ought not to apply whenever the
higher ranking creditor has a preference resulting from the provisions of
the Bank Act 19 or a general privilege on immoveables, e.g., that for general
law costs, funeral expenses, expenses of the last illness and servants’
wages. 20 Nevertheless, several good arguments may be advanced
in
support of the proposition that art. 2049 (2) C.C. also applies to
privileges. First, like hypothecs, privileges are indivisible by their nature
under art. 1983 C.C. Second, the priority provisions of arts 2048 and
2051 C.C. which appear in the same section of the Code as art. 2049
C.C. may easily be made applicable to privileges. Third, the priority rules
of arts 2130 C.C. and 2094 C.C. speak generally of privileged rights,
thus assimilating privileges and hypothecs for the purpose of establishing
rank through registration. Finally, whenever a relative valuation under
arts 721-2 C.C.P. is required and there are general privileges ranking
18S.C. 1980-1, c. 40, s. 178 (1) (d) – (h).
19While some jurisprudence suggests that the bank’s security is hypothecary in nature
(see, e.g., Toronto Dominion Bank v. Druker [1957] C.S. 389, 391 per Demers J.), it is
clear that this characterization is misplaced. Moreover, the rights of the bank upon
realization are those provided for by the Bank Act and not those of the Civil Code, except
to a supplementary degree.
20Marler believes that the article also applies to privileges. See Marler, supra, note 4,
no. 791. He gives the following example: “A contractor has built for the proprietor under
the one contract, a number of houses, and has registered his privilege, as he may, for what
is due to him against the whole property. One of the houses is sold; the price is insufficient
to pay all the claims against it; the contractor is entitled to be paid his claim out of and to
the extent of the additional value given to that house by his work and materials, even
though, in consequence there is not enough left to pay the claims of subsequent creditors.
But if all of the houses or more than one of them are sold as a unit and the proceeds have to
be distributed, and the houses are charged with different claims, a relative valuation has to
be made so as to determine how much of the price represents the value of each house, and
how much of the price attributed to each house represents the additional value given to the
property by the claim of the privileged creditor who has registered it against the whole of
the debtor’s property, C.P. 805.” This illustration is poorly chosen. The construction
privilege is divided not because of art. 2049 (2) C.C. but in virtue of the rule that the
privilege is valid only for the value added to the immoveable. The problem is merely to
determine the “unit6 d’exploitation” in order to fix the situs of the privilege. See Munn
and Shea Ltd v. Hogue Ltte [1928] S.C.R. 398; Gadbois v. Boileau [1929] S.C.R. 587.
19821
EQUITY AMONG SECURED CREDITORS
higher than specific privileged claims the prothonotary must proportional-
ly attribute the proceeds of the sale. Yet no principle of distribution is
elaborated by the Code of Civil Procedure, and presumably the only
means to achieve a “relative” valuation is to prorate claims in the manner
suggested by art. 2049 (2) C.C.21 Consequently, it would seem that the
underlying principle reflected by art. 2049 (2) C.C. might well be
applicable to general privileges, even though the specific provisions of the
article only refer to hypothecs.
In any event, the article is clearly inapplicable in situations where a
creditor obtains security by other devices such as resolutory and giving in
payment clauses, promise of sale or sale and leaseback. For example, art.
2049 (2) C.C. could not be invoked if a creditor has a hypothec on one
immoveable and a resolutory clause on others; nor where the creditor has
a security other than a hypothec over several immoveables. In such cases
the article would not be capable of invocation because its mechanism –
presupposes the generation of monies. 22
the distribution of proceeds –
A third restriction on the range of application of art. 2049 (2) C.C.
arises because the Code speaks only to the case where the collateral
affected is an immoveable. The fact that the concept of a hypothec or
other non-possessory security over moveable property was unknown at
the time of codification undoubtedly explains this restriction in the codal
text.23 Today, however, the idea of non-possessory security on moveables
has been incorporated into the civil law,24 and it is arguable that at least
in the case of the Special Corporate Powers Act 25 the juridical institution
contemplated is the hypothec. In support of this view, one can cite the
text of s. 27 of the Act, which provides [emphasis added]:
2 1A similar relative valuation is necessary in the case of moveables. Arguments against
the applicability of art. 2049 (2) C.C. to privileges are all textual. (1) Articles 2050 and
2052 C.C. expressly mention privileges; if art. 2049 C.C. were to apply to privileges this
should be expressed. (2) The title of the section is “Of the order in which hypothecs rank”;
while the Code often uses the expression “privileged claim” to include both legal
privileges and hypothecs, it does not typically use the expression “hypothec” so as to
include legal privileges. (3) Article 1983 states that a privilege is indivisible by nature,
whereas art. 2017 C.C. provides merely that hypothee is indivisible; the consensual basis
of the latter is the reason art. 2049 (2) C.C. is required.
moveable property is not subject to hypothecation.
22See infra, Part I (D).
23Article 2022 C.C. contemplates that apart from the case of merchant vessels,
24Apart from title transactions such as double sales, sale and leaseback, conditional
sales and sales with a right of redemption, these are genuine security devices such as
commercial pledge defined in arts 1979e-k C.C., security under the Bank Act, S.C.
1980-1, c. 40, s. 178, or the Special Corporate Powers Act, L.R-Q., c. P-16, ss. 27-31.
25L.R.Q., c. P-16. Some argue that the commercial pledge is evolving in this direction.
See Desjardins, Du nantissement commercial &i l’hypothque mobilibre (1968) 71 R. du
N. 88. No one asserts, however, that the commercial pledge is now an hypothecary right.
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[Vol. 27
Notwithstanding any existing law, any joint stock company… may… hypothecate,
mortgage or pledge any property, moveable or immoveable ….
Nonobstant toutes dispositions A ce contraire, toute compagnie A fonds social…
peuvent… hypoth6quer, rantir ou mettre en gage,…
leurs biens mobiliers ou
immobiliers….
In other words, since the Act appears to contemplate a hypothec over
moveables and since the Code knew only of hypothecs over immoveables
in 1866, any reference in art. 2049 (2) C.C. to immoveables should not
be taken to so restrict the article, but only as a confirmation of the
existing law. While this argument has a certain appeal, ultimately it must
fail because the later provisions of s. 29 of the Act suggest that the word
“hypothec” in s. 27 is intended to apply only to immoveables and that the
security obtainable on moveable property is a privilege. 26 It follows that
art. 2049 (2) C.C. is only applicable where the collateral in question is an
immoveable.17
The upshot of the above analysis is that the Code explicitly envisions
an exception to the principle of indivisibility only in respect of a limited
range of persons (debtors), a
limited range of security devices
(hypothecs) and a limited range of collateral (immoveables). Neverthe-
less, as Louis Payette observes, the analogical spirit of exegesis may be
called in aid of a broader viewpoint:
L’article… [2049 (2) C.C.] ne r6f~re qu’aux hypoth~ques et ne vise que des
immeubles. Ce n’est done que par analogie qu’on peut recourir quant aux sairet~s
mobilinres. N~anmoins, comme c’est la seule r gle du Code sur le sujet on pourrait se
croire bien fond6 d’y recourir.28
This theme will be taken up later in Part IV of this essay.
B. All or more than one of the immoveables thus hypothecated be sold
In addition to restrictions on the scope of art. 2049 (2) C.C. arising
from the nature of the security taken and the collateral affected, several
limitations on this article appear to arise from the terms employed to
26L.R.Q., c. P-16, 29 (1) speaks of rights given by the hypothec or mortgage on
immoveables and establishes a ranking by date. Section 29 (2) speaks of a mortgaging or
pledge of moveables conferring a privilege and establishes a ranking by the nature of the
claim. In other words, the realization provisions of the Act differentiate between security
available over moveables and immoveables.
27The Court of Appeal decision in Central Factors, supra, note 6 supports this view.
Crete J.A. notes at p. 5 of his judgment that art. 2049 (2) C.C. is exceptional, that it
applies only to hypothecs and concerns only security over immoveables.
2 Payette, supra, note 6, 309. If Payette is merely suggesting that an analogy can be
drawn to art. 2049 (2) C.C. there can be no objection to his remarks. In fact this is
precisely how a ventilation of moveables, where there are both general and special
privileges, is effected.
19821
EQUITY AMONG SECURED CREDITORS
describe the manner in which a creditor may realize upon his security.
Because the Code envisions only hypothecs in this instance, it is not
surprising that art. 2049 (2) C.C. speaks solely to the case of seizure in
execution and sale of collateral; this is the mechanism established by arts
2057, 2061, 2075, 2077 and 2079 C.C. for pursuing an hypothecary
action. By contrast, various other juridical devices contemplate
alternative modes of realisation. For example, under the Bank Act or the
Special Corporate Powers Act, in addition to proceeding to judicial
seizure and sale a creditor may simply take possession of and administer
the collateral, deriving the fruits therefrom; or he may, after following the
required formalities, dispose of his debtor’s immoveable by private sale.
Again, under a right of redemption, a resolutory clause or a giving in
payment clause, a creditor may realize upon his security by exercising a
right to become absolute owner of the collateral. Finally, a creditor may
provoke a bankruptcy in order to have a trustee liquidate his debtor’s
property and collocate his claim under the Bankruptcy Act. 29
As noted, the Code contemplates only the situation where the
debtor’s immoveables are “sold”. It would seem to follow that the
exercise of a right of redemption, a resolutory clause, a giving in payment
clause or the simple taking of possession and administration under the
Bank Act or the Special Corporate Powers Act will not lead to the
application of art. 2049 (2) C.C. In none of these hypotheses can the
mode of realization appropriately be characterized as a sale; in none are
any proceeds generated for which the secured creditor will be held
accountable.
On the other hand, “sale” is an appropriate description of the mode
of realization under the Bankruptcy Act, under various statutes such as
the Winding-Up Act 0 which contemplate forced sales other than by
ordinary processes of execution, or under the Bank Act, Special
Corporate Powers Act, and Winding-Up Act where the creditor or trustee
proceeds to the private sale and disposition of the collateral. Neverthe-
less, sales by a trustee in bankruptcy would not lead to the application of
art. 2049 (2) C.C. since the Bankruptcy Act establishes its own scheme
of collocation and distribution which overrides any provincial priority
rules. 31
The situation in respect of forced and voluntary sales through which
security is realized is more complex. In Crown Realty Ltd v. Putnam et
29R.S.C. 1970, c. B-3. Since this hypothesis lies outside the framework of the ordinary
principles of civil law, it will not be considered at length in this essay.
30L.R.Q., c. L-4.
31See Larue v. Royal Bank of Canada [1928] A.C. 187 (P.C.).
Mc GILL LAW JOURNAL
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Beriau, a first immoveable was seized in execution and sold judicially; a
second immoveable later was sold as part of the process of winding up the
Crown Realty Company. The Court of Appeal found the principle of art.
2049 (2) C.C. to be applicable in such circumstances and ordered the
distribution of the proceeds of both sales to be made on apro rata basis.
Letourneau J. held that the article was applicable to all sales having the
effect of purging real rights.32 Thus, while certain public sales other than
by ordinary process of seizure in execution may be contemplated by
art. 2049 (2) C.C., by implication private sales in the course of
realization would not give rise to thepro rata distribution set out by the
article. It also follows that more than one immoveable must be disposed
of by a sale purging real rights; for example, if only one immoveable be
sold, and one or more other immoveables be taken in payment, art. 2049
(2) C.C. cannot apply.33
Although the Code requires that the immoveables be sold by sale
effecting a purge of real rights, it does not demand that the higher ranking
creditor with the hypothec on several immoveables himself seize his
debtor’s property and sell the immoveables. Once any creditor –
hypothecary, privileged or chirographic – provokes the judicial sale of
more than one immoveable, the principle of art. 2049 (2) C.C. is brought
into play.
These observations suggest that the protection afforded to lower-
ranking secured creditors by art. 2049 (2) C.C. can be illusory in the face
of many of the mechanisms by which secured parties customarily realize
upon the assets of their debtors. It follows that lower ranking secured
creditors typically are at the mercy of higher ranking creditors who have
taken security by way of a title transaction. Unless they are able to
provoke a judicial sale the practical utility of art. 2049 (2) C.C. as a
means for protecting their security is negligible.34
32Supra, note 5, 350-1. Howard J.A. also felt that the principle of the article should
apply, although the article itself envisions only the case of judicial sales in execution, at
pp. 344-7.
331f two immoveables be sold and a third taken in payment, the article remains
applicable. It is obvious that difficult problems of valuation arise in such cases since the
hypothec cannot guarantee an amount greater than the principal obligation. The solution
in such cases is to effect the proration on the basis of the amount owing to the creditor once
the value of the immoveable taken in payment has been subtracted. Of course, one
assumes here that the loan agreement provides that the giving in payment clause does not
totally extinguish the principal obligation. See Remy v. Gagnon [19711 C.A. 554.
34See infra, Part III (C) for an examination of techniques open to lower ranking
creditors to compel the application of art. 2049 (2) C.C.
19821
EQUITY AMONG SECURED CREDITORS
C. The proceeds have to be distributed
Two distinct difficulties of interpretation arise from this requirement:
is it necessary that the proceeds be generated from one and the same
judicial sale? And is it necessary that the total price of all sales remain to
be distributed at the same time?
Some authors seem to hold that the seizure and sale of the
immoveables must take place at the same time in order for the pro rata
distribution of money received envisioned by art. 2049 (2) C.C. to be
obligatory.3 5 While such a requirement is not set out in the Code itself,
the French text tends in this direction by its usage of the singular term “le
prix soit h distribuer”. Nevertheless, since the object of art. 2049 (2)
C.C. is the distribution of proceeds upon realization, it need not follow
that these be generated at one and the same time. If, for example, a first
immoveable is sold, but because the order of collocation is contested, or
because of a re-sale for false bidding, or for any other reason, the price
remains to be distributed by the prothonotary at the time the second
immoveable is sold, art. 2049 (2) C.C. may be invoked. This second sale
may occur even several years after the first sale.3 6
By contrast, it may be necessary for the total price of all the sales to
remain undistributed. The phrase “the proceeds have to be distributed”
appearing after the requirement that “all or more than one of the im-
moveables be sold” would suggest that all the proceeds be available for
distribution. In other words, since art. 2049 (2) C.C. envisions distribu-
tion, one should be contemplating a single order of collocation.3 7 In the
Crown Realty case the various judges were divided on the point.
Rinfret J. in the Superior Court and Tellier and Greenshields JJ.A. in
dissent in the Court of Appeal explicitly held that the distribution of all
the proceeds must occur in the same judicial order.38 Conversely, in the
Court of Appeal, Howard J.A. and presumably Allard J.A. concluded
that the underlying principle of art. 2049 (2) C.C., if not the article itself,
could be invoked in certain cases of a partial distribution. 39 Letourneau J.
3″Marler, supra, note 4, no. 830; Langelier, supra, note 4, 287. Semble Demers,
supra, note 4, 260; and Mignault, supra, note 4, 132.
“6In Crown Realty, supra, note 5, the first immoveable was sold on 8 March 1918 and
the second was sold at an indeterminate date between 13 January 1919 and 12 April
1921. Supra, note 5, 345 per Howard J.A.: “this paragraph [art. 2049 (2)] contemplates
the case where, in a situation such as that disclosed in this appeal, the two portions of the
property, both of which are affected by an overlying hypothec and each separately by
second hypothecs, are brought to sale at the same time or at least the proceeds are
distributed at the same time.” [Emphasis added.]
37The narrower hypothesis of art. 721 C.C.P. supports this viewpoint.
38(1924) 62 C.S. 199, 205 per Rinfret J.; (1925) 38 B.R. 331, 335 per Tellier J.A.
3″Supra, note 5, 345-6 per Howard J.A.: “[T]he first hypothec should be apportioned
rateably upon both portions of the hypothecated property even though they be brought to
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[Vol. 27
went so far as to hold that art. 2049 (2) C.C. was directly applicable even
to cases of partial distribution.40
Some support for the broader view can be garnered from the phrase
“upon so much of their respective prices as remains to be distributed”,
although the context of this provision more logically suggests that it
contemplates the remainder in the order of collocation, and not the
remainder after a partial distribution has occurred at an earlier date.4′ On
the other hand, the possibility of disrupting an already settled collocation
order to the prejudice of various secured creditors might seem to counsel
against the position adopted by the majority in the Crown Realty case.
However, insofar as the first ranking creditor is concerned, such a
disruption could never occur. By applying a pro rata distribution to the
second order of collocation the court could not affect the value of the
general hypothec; rather, it would be notionally augmenting the share
taken by the higher ranking creditor in that distribution and notionally
diminishing the share he took in the first distribution. This prorating could
only work to the benefit of secured and potentially unsecured creditors of
the first distribution as it would notionally generate more revenue to be
divided among them. Applying the principle of art. 2049 (2) C.C. to
partial distributions, however, could well prejudice a secured or
unsecured creditor looking uniquely to the proceeds of the second sale for
satisfaction of their claims.42 Balancing the equities between competing
lower ranking creditors on various immoveables thus requires close
analysis of ideas such as reliance and estoppel.4′
sale and the proceeds distributed at different times.” Caron & Binette, supra, note 4,
no. 305 accept this solution. They state: “Les tribunaux semblent accepter l’ide que les
ventes des immeubles diff6rents ne doivent pas n6cessairement se faire au m6me moment.
En effet l’article 2049 continue de s’appliquer tant qu’il y a encore de l’argent 4 6tre
distribu6 A mme le produit de l’une quelconque des ventes en justice.”
40Supra, note 5, 350-1 per L6tourneau J.A.: “Le cas qui nous est soumis n’est pas le
cas classique et simple…. [L]a seule condition d’application ne parait etre que tous les
immeubles aient W vendus, qu’il y ait une distribution de prix A faire et qu’il soit encore
possible d’appliquer les prescriptions du second alin~a de l’article 2049 C.C.”
41 See infra, Part 1 (B) for an elaboration of the meaning of the phrase “upon so much
of their respective prices as remains to be distributed.”
42These creditors may well have taken a lower ranking hypothec on the second
immoveable or brought it to sale at the moment selected on the basis of information about
the reduced amount of money still outstanding on the higher ranking creditors’ loan.
Nevertheless, given that hypothecs are indivisible and also given that their value is
specified in the contract, subsequent creditors should not advance monies on the
assumption that actual indebtedness is less than the face value of the hypothecary
obligation.
43For example, if the lower ranking secured creditor advanced monies on the basis of a
partial mainlev6e of hypothec in which the first ranking hypothecary creditor renounced
his hypothec up to the amount received from the prior sale, it would be inappropriate to
1982]
EQUITY AMONG SECURED CREDITORS
As the majority of the Court of Appeal in Crown Realty held, art.
2049 (2) C.C. would seem to apply even where monies are generated
from more than one sale, but only on the condition that the proceeds from
all the sales remain to be distributed by the same order of collocation.
Nevertheless, the Court appeared prepared to invoke the underlying
principle of art. 2049 (2) C.C. whenever any proceeds from any judicial
sale remain to be distributed.44 In this interpretation one can see a
tentative step towards a general theory of protection of the rights of
creditors holding non-coextensive security.45
D. There are other subsequent creditors holding hypothecs upon some
one or other of such immoveables
This final clause of art. 2049 (2) C.C. imposes several limitations on
the creditors who avail themselves of the benefit of a pro rata
distribution. First, it should be noted that the Code speaks only of
creditors who have a hypothec. Creditors holding other lower ranking
increase his claim on the proceeds of the second sale by applying the principle of art. 2049
(2) C.C. It would also be unfair to maintain the mainlev~e and apply art. 2049 (2) C.C. so
as to reduce retroactively the amount of money the first ranking creditor could claim.
44The following hypothesis illustrates an application of the principle apparently
enunciated by the Court of Appeal. Suppose that a first creditor, A, has a hypothec
affecting lots 1 and 2 for an amount of $100,000. A second creditor, B, has a hypothec
affecting lot 2 for an amount of $50,000. At the time lot 2 is sold for $75,000 creditor A
receives the whole price, and creditor B receives nothing. The first creditor then seizes
lot 1 and sells it for $150,000. If art. 2049 (2) C.C. is applied as written, A would get
$25,000 and $125,000 would be distributed to chirographic creditors, of which B is one,
for a claim of $50,000. But if one follows Crown Realty, supra, note 5, A would take
$66,666 from lot 1, i.e., two-thirds of his claim. Of this, A would get $25,000 (the amount
remaining to be paid on his $100,000 claim) and $41,666 would be distributed to lower
ranking hypothecary creditors on lot 2. In our example, since B’s claim is for $50,000 he
would receive all of it, and would be chirographic for $8,333. He would be collocated,
along with all other unsecured creditors, upon the $83,333 remaining from the sale of
Lot 2. Of course, any lower ranking secured creditors on Lot 2 would take their claims
from the $83,333 by preference over B and other unsecured security.
450ne should not extrapolate too far from the judgment of Howard J.A. He notes,
supra, note 5, 346, that although the first sale had taken place when the Crown Realty Co.
went into liquidation, the judgment distributing the proceeds of that sale postdated the
liquidation order. In other words, “If the liquidator, when taking over the assets of the
company in liquidation, had also taken over from the sheriff the proceeds of the sale of the
8th of March, which were then in his hands, the distribution of the amount realized from
the entire property covered by the appellant’s [sic] would have been governed by 2049
C.C., and there would have been no occasion for the present litigation.” An attempt to
develop a general theory along the lines suggested by Howard J.A. will be set out, infra,
Part IV.
McGILL LAW JOURNAL
[Vol. 27
security such as privileges registered out of time46 or not registered at all47
as well as creditors holding security over immoveables under the Bank
Act4 or a right of redemption, giving in payment clause or antichrkse,
presumably cannot invoke this article. However, if the argument raised in
Part I (B) is valid, a lower ranking privileged creditor might be able to
plead the principle of art. 2049 (2) C.C. by analogy.49
The Code also requires that the hypothec of these subsequent
creditors affect some one or other only of the immoveables seized and
judicially sold. If, for example, a first ranking creditor has a hypothec on
three immoveables, but only seizes two immoveables over both of which a
second ranking creditor has a hypothec, art. 2049 (2) C.C. cannot
apply. 0 Of course, one might argue that the lower ranking creditor ought
to be permitted to compel the higher ranking creditor to seize the third
immoveable, but the Code as currently drafted does not contemplate this
possibility.
A final requirement flowing from the above clause is that the creditor
who has the hypothec on some one or other immoveable occupy a
subsequent rank. Thus, a higher ranking creditor who believes himself
prejudiced by the actions of a creditor holding a general hypothec of
inferior rank cannot invoke art. 2049 (2) C.C. Since the Code appears to
contemplate the invocation of this article as an exception to the principle
of indivisibility only at the stage where proceeds are to be distributed, it is
difficult to see how lower ranking creditors with a general hypothec may
prejudice the rights of higher ranking creditors. Yet, in combination with
other procedural rules the principle of indivisibility can have this effect,
as the following example illustrates. Article 689 C.C.P. requires, as a
general principle, that the purchaser of an immoveable at a judicial sale
pay the purchase price within live days, and art. 730 C.C.P. contemplates
a resale for false biding if the value of superior claims is not paid within
five days of the homologation of a collocation. In other words, the Code
of Civil Procedure contemplates the expeditious payment of secured
claims. However, art. 689 (2) C.C.P. permits an hypothecary creditor who
registered will rank ahead of unregistered claims.
46Article 2130 (2)-(3) C.C. establishes their rank on a temporal basis so that
hypothecs having a prior registration date would rank ahead of those privileges with a
posterior registration date, when they are registered out of time.
47Article 2094 C.C. states that all privileged or hypothecary claims which have been
48S.C. 1980, c. 40, ss. 178-9 establish a temporal ranking of these claims.
49See supra, notes 20 and 21, and accompanying text.
“This is not an unfair result in any event since the lower ranking creditor’s position
could not be improved even were art. 2049 (2) C.C. to apply. The lower ranking creditor
would benefit from the distribution envisioned by art. 2049 (2) C.C. only when the first
ranking creditor’s hypothec may be partially spread to an immoveable over which he has
no rights.
19821
EQUITY AMONG SECURED CREDITORS
purchases an immoveable affected by his hypothec to retain money to the
extent of his claim until the judgment of distribution is served upon him.
Hence, if a claim is worth $500,000, and the creditor purchases the three
immoveables affected by his hypothec for $400,000 each he may invoke
the principle that hypothecs are indivisible to sustain his assertion that
the amount of his claim on each immoveable is $500,000. Since he need
not prorate his claim he is not required to advance any monies on the
$1,200,000 total purchase price until the judgment of distribution is
served upon him. The principle of indivisibility consequently means that
in certain hypotheses a higher ranking secured creditor must wait much
longer than the ordinary five days in order to be paid for his claim.”
Interesting problems of collocation can arise when a creditor
occupies a subsequent rank on some immoveables, but not on others. For
example, suppose that a first creditor has a hypothec on lots A, B and C,
registered against lots A and B on January 1 and against lot C on
January 3, while a second creditor has a hypothec on lots B, C and D
registered against all three lots on Jaunary 2. If a third creditor had a
hypothec registered on January 5 against lots B and C, it would appear
that in the event all four immoveables were sold this third creditor would
be entitled to invoke the distributional schema established by art. 2049
(2) C.C. and both higher ranking creditors conceivably be compelled to
prorate their claims.52
E. Conclusion
The above observations illustrate the restricted scope of art. 2049 (2)
C.C. as a device for ensuring equity between secured creditors in the
realization of their claims against their debtors’ property. In part as a
result of developments in secured financing and in part as a result of-
omissions or oversights in the text of the article itself the exception to the
rule of indivisibility of hypothecs which it establishes is more illusory
than real. Nevertheless, in one of the two Court of Appeal decisions in
which the article was raised, an attempt was made to view the article as a
specific example of a broader principle capable of being applied by
analogy in various circumstances. 3 This theme will be considered again
in Part IV.
II. Juridical Effects of Art. 2049 (2) C.C.
The effects of art. 2049 (2) C.C. are set out by the clause “his
hypothec is divided rateably upon so much of their respective prices as
51See Compagnie Montreal Trust v. Jori Investments Inc. (1980) 13 R.P.R. 116
(C.S. Qu6.) for an example of this hypothesis.
“2See infra, Part II (B) and supra, note 46.
“See supra, note 5; cf supra, note 6.
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[Vol. 27
remains to be distributed.” There is substantial disagreement, not to say
confusion, among commentators as to the scheme of distribution which
this article contemplates. Both the expression “divided rateably” and the
clause “upon so much of their respective prices as remains to be distri-
buted” are open to several interpretations. Each, therefore, requires
careful elucidation.
A. His hypothec is divided rateably
The phrase “divided rateably” reveals the true nature of art. 2049 (2)
C.C. as a principle of distribution. As such it is directed to the
prothonotary who draws up the order of collocation of the proceeds of the
judicial sale or sales. It presupposes that the sale of the immoveables has
produced sufficient money to pay the claim of the first ranking creditor in
full. 4 In such an event art. 2049 (2) C.C. requires the higher ranking
creditor to be collocated on apro rata basis upon each immoveable sold.
This rateable division takes place in proportion to the respective value of
the immoveables sold and is not influenced by either the number of lower
ranking creditors or the value of their claims.
An example will illustrate the scheme of distribution envisioned by
art. 2049 (2) C.C. Suppose that at ajudicial sale, immoveable A brings in
$100,000 and immoveable B brings
in $50,000. A first ranking
hypothecary creditor having a claim of $75,000 will be collocated on
immoveable A for $50,000 and upon immoveable B for $25,000. He
cannot, as the principle of indivisibility would have it, exercise his
hypothec for the amount he wishes upon each immoveable. A second
ranking creditor having a hypothec upon only immoveable B for $50,000,
will receive the remaining $25,000 of the sale price by preference and
will be a chirographic creditor for the other $25,000 owing on his debt.
The $50,000 remaining from the sale of immoveable A will fall into the
mass of property to be shared pro rata by all chirographic creditors.5
Nevertheless, some commentators seem to misconceive the sense of
the word “rateably” and advocate alternative principles of distribution.
For example, Mignault suggests that art. 2049 (2) C.C. operates a
cession of priority in the name of equity. As long as enough money
remains to pay the higher ranking creditor in full, he believes that, to the
extent possible, the first hypothec should be divided to maximize the
chances that lower ranking secured creditors can be paid in full. Thus, in
the example given above, Mignault would hold that the higher ranking
4If not, all the proceeds would be paid to the first creditor by virtue of his higher rank.
55This example illustrates the interpretation of art. 2049 (2) C.C. advocated by a
majority of authors. See Langelier, supra, note 4, 287; Marler, supra, note 4, no. 830;
Caron & Binette, supra, note 4, no. 306; and Payette, supra, note 6, 310.
1982]
EQUITY AMONG SECURED CREDITORS
creditor is obliged to take his $75,000 uniquely from the $100,000
brought in by immoveable A, in order that the second ranking creditor
receive his full $50,000 by preference from immoveable B.16 Although
certain considerations of equity might induce one to accept this solution,
it is contrary to the very terms of art. 2049 (2) C.C. which speaks of a
rateable division. 7 While the distribution actually ordered in the Crown
Realty case makes it difficult to know with certainty the precise method
of calculation adopted by the Court of Appeal it is clear that Mignault’s
theory was rejected. 58
An even more radical, and implausible, thesis is advanced by
Demers, who asserts that art. 2049 (2) C.C. establishes an absolute
cession of priority in favour of the second creditor, even where this may
mean that the first-ranking creditor cannot be paid in full.59 One can only
conclude that the author has misunderstood the meaning of the terms of
the Code. Although art. 2049 (2) C.C. appears in a section of the Code
entitled “Of the Order in which Hypothecs Rank” nowhere does the text
of the article suggest any modification to, or inversion of, the rank of
hypothecs established by arts 2046, 2047, 2050, 2051, 2052 and
2130 C.C. Such an inversion would totally undermine the whole theory
of security on property and is in no way inferable from the expression
“divided rateably”. 60
Article 2049 (2) C.C. must be regarded as a principle of distribution
which requires the prothonotary to divide the hypothec of the higher
ranking creditor in a pro rata fashion having regard to the proceeds
generated by each immoveable sold. Unlike the common law theory of
6Supra, note 4, 132. See also J. Deslauriers, F. Frenette & L. Poudrier-Lebel, Les
sfiret~s (1979), 257-8. In the 1980 edition, however, the view of Caron & Binette, supra,
note 4, is adopted.
s7Mignaultfs solution, supra, note 4, resembles the distributional principles of the
common law doctrine of “marshalling”. Marshalling requires a creditor having two funds
from which to realize his security to exhaust the fund not encumbered by a subsequent
security prior to seeking payment from the encumbered fund. Trimmer v. Bayne (1803) 9
Ves. Jun. 209, 32 E.R. 582 (Ch.). See Halsbury’s Laws of England, 4th ed. (1973), vol.
16, para. 1428. For a discussion relating to the law of Quebec see Payette, supra, note 6.
It should also be observed that the “marshalling” solution favours all preferred creditors
over all chirographic creditors, whereas the principle of art. 2049 (2) C.C. is applicable in
a uniform manner regardless of the value of subsequent secured claims. See also the
comments of Crete and Monet JJ.A. in Central Factors, supra, note 6, on the theory of
marshalling.
“sSupra, note 5, 346-7 per Howard J.A.
59Supra, note 4, 260.
“Nevertheless
in Central Factors, supra, note 6, the Court of Appeal cites only
Demers as a doctrinal source. Given that the Court found art. 2049 (2) C.C. not to be
applicable, one should not perhaps interpret this citation as an endorsement of Demers’
peculiar theory.
Mc GILL LAW JOURNAL
[Vol. 27
“marshalling”, its application with respect to the higher ranking creditor
cannot be affected by either the number of subsequent secured creditors
or by the respective value of their claims.
B. Upon so much of their respective prices as remains to be distributed
This clause sets out an important clarification of art. 2049 (2) C.C.
Here the Code provides that the rateable division is to be determined
according to the amount of the proceeds which remains to be distributed
to the creditor holding the general hypothec at the moment his claim is
collocated. It does not speak of the amount of the proceeds brought in by
the judicial sale.
The difference between these possibilities can be shown with the aid
of an example. Suppose a claim of $100,000 is guaranteed by a hypothec
affecting three immoveables. Upon judicial sale, immoveable A brings in
$100,000, immoveable B brings in $200,000 and immoveable C brings in
$300,000 for a total of $600,000. If there were no higher ranking security
the creditor holding the general hypothec would get one-sixth of his claim,
or $16,666 from the proceeds of immoveable A; one-third of his claim or
$33,333 from those of immoveable B; and one-half of his claim or
$50,000 from those of immoveable C.
However, a hypothecary creditor will never have a first ranking
security: law costs and other perfected privileges will always outrank his
claim. Therefore, let us imagine that after payment of higher ranking
creditors the prothonotary has the following amounts remaining to be
distributed to the creditor with the general hypothec: from the $100,000
brought in by immoveable A, a sum of $50,000; from the $200,000
brought in by immoveable B, also a sum of $50,000; and from the
$300,000 brought in by immoveable C, an amount of $200,000. Because
art. 2049 (2) C.C. states “so much of their respective prices as remains to
be distributed” the rateable division must be calculated on the basis of
respective valuations of $50,000, $50,000 and $200,000 and not on the
basis of the initial proceeds of $100,000, $200,000 and $300,000. Hence
the creditor with the general hypothec will receive one-sixth of his claim,
or $16,666 from immoveable A, a further one-sixth of his claim from im-
moveable B, and two-thirds of his claim or $66,666 from immoveable C.
From this principle it also follows that if a first ranking creditor
holding a general hypothec cedes or assigns priority upon one
immoveable to a subsequent hypothecary creditor, his pro rata share
upon that immoveable is calculated in relation to the amount remaining to
be distributed after the assignee has been paid.61
61See Marler, supra, note 4, no. 830, for analogus suggestions.
19821
EQUITY AMONG SECURED CREDITORS
C. Conclusion
It flows from the language of art. 2049 (2) C.C. that the exception to
the rule of indivisibility of hypothecs it elaborates is to apply only at the
time of collocation. Moreover, the distribution contemplated by the Code
is not designed to maximize in all cases the secured claim of creditors
holding lower ranking security. Rather, it is intended to establish apro
rata distribution so that the mechanism of collocation elaborated in art.
721 C.C.P. may be effected.62 To this end the article does not envision
either the absolute preference of secured creditors over unsecured
creditors implicit in the common law theory of “marshalling”, or any
direction to the first ranking creditor with respect to the means employed
to realize upon his security. He remains free to invoke the rule of
indivisibility in selecting the collateral which is the target of his seizure.
III. A Critique of Art. 2049 (2) C.C.: Distribution and Realization
in a Regime of Security on Property
The majority of commentators agree that art. 2049 (2) C.C. is poorly
drafted.63 Almost all have tried to explain its scope by means of examples
rather than through analysis of its underlying principles. None have
attempted to elaborate a general theory of the relationship between
competing creditors holding non-coextensive security upon their debtor’s
property. Nevertheless, in the interpretation of the article, two main
jurisprudential and doctrinal tendencies are present first, a strict thesis
which adheres to the language of the article itself and, seeing the
62The following table illustrates an application of this principle:
Immoveable A
$100,000
Sale price
1st creditor’s claim:
$100,000 hypothec on
immoveable A, B and C $16,666
Immoveable B
$200,000
Immoveable C
$300,000
$ 33,333
$ 50,000
$83,333 (balance) $166,666 (balance) $250,000 (balance)
2nd creditor’s claim:
$200,000 hypothec on
immoveable A and B
3rd creditor’s claim:
$100,000 hypothec on
immoveable A only
$66,666
$16,667 (balance) $ 33,333 (balance)
$133,333
$16,667
–
–
–
Chirographic creditors
In this example, the third creditor is chirograhic for an amount of $83,333 despite the fact
that a sum of $283,333 remains to be distributed from the price of the immoveables.
63See Mignault, supra, note 4, 132; Demers, supra, note 4, 260; Caron & Binette,
$ 33,333
0 (balance)
0
$250,000
supra, note 4, no. 211.
REVUE DE DROIT DE Mc GILL
[Vol. 27
provision as exceptional and one designed only to protect lower ranking
hypothecary creditors in very precise circumstances, advocates a narrow
interpretation of its terms;6 4 second, a more liberal view which sees in the
article “a broad, equitable principle” 65 which should be found to apply
whenever necessary to protect lower ranking creditors from the abusive
exercise of rights by a higher ranking creditor. Writing for the majority in
the Court of Appeal in the Crown Realty case, Letourneau J.A. accepted
the second view and held that the object of the provision was to “rendre
justice aux cr~anciers post~rieurs en 6tablissant en leur faveur un mode
6quitable de distribution lorsque la chose est possible. ’66
From the perspective of commercial financing, however, neither the
narrow nor the liberal thesis sets out an acceptable theory of secured
lending. For once it is accepted that the rule of indivisibility of hypothecs
should suffer an exception in certain instances of distribution –
and
given the practical requirements of preparing an order of collocation
under art. 721 C.C.P. one could hardly suggest otherwise –
the Code
should elaborate a general theory governing the attribution of secured
claims upon affected collateral. In other words, art. 2049 (2) C.C. should
be seen as merely a particular example of a more general principle, that
principle being that no secured creditor should be prejudiced solely
because another secured creditor attempts to invoke the rule of indivisi-
bility to select target collateral in a way that compromises his rights.
In this light, it should be irrelevant whether or not the creditor is secured
or chirographic, 67 whether or not the security taken by either party is
technically speaking a hypothec, whether or not the other party is a higher
or lower ranking creditor, whether or not the property affected
is
immoveable or moveable, and whether or not the proceeds of all the sales
remain to be distributed. Since none of the above requirements are
necessary to the ordinary operation of seizures in execution, from a
commercial point of view art. 2049
(2) C.C. reveals elliptical
draftsmanship if it is to be taken as the broadest conception of the
applicable principle.
But there is another level at which this article of the Code may not
have achieved effectively the goal of equitably regulating the relations
between creditors holding non-coextensive security. As drafted the article
4This viewpoint is shared by Rinfret, Tellier and Greenshield JJ.A. in Crown Realty,
supra, note 5; by Crte J.A. in Central Factors, supra, note 6; and by Marler, supra,
note 4, and Langelier, supra, note 4.
6sSupra, note 5, 346per Howard J.A.; Mignault, Demers and Caron & Binette seem to
66 bid., 350.
67 If the creditor is chirographic the principle of art. 2049 (2) C.C. makes no difference
since all the property of the debtor is the common pledge of his creditors: arts 1980-1 C.C.
share this perspective, supra, note 4.
19821
EQUITY AMONG SECURED CREDITORS
addresses only one of the two main issues which arise whenever secured
creditors attempt to realize upon their security, namely, how the proceeds
generated by a judicial sale are to be distributed. A second and perhaps
more important question relates to the manner in which a secured
creditor chooses to realize upon his security. Unless a creditor with
security on some one or other only asset of his debtor is able to bring
himself within the conditions of art. 2049 (2) C.C. (even as extended by
analogy) the rateable distribution of proceeds there contemplated is of no
use to him. In other words, unless a creditor has the means to compel the
seizure and sale of sufficient collateral to pay off all claims prior to his
own the principle of pro rata distribution is of little assistance. There is
now no mechanism short of obtaining judgment by which such a creditor
may provoke the seizure of assets other than those over which he himself
has security. Nor does the civil law permit a secured creditor to compel
other secured creditors holding general hypothecs to realize their security
either by simultaneously seizing all assets covered by the general
hypothec or by seizing only that collateral not affected to other secured
claims.68
the possibility of falling into default to his creditors
By tolerating a right of secured creditors to select without limitation
their target collateral upon default, the law facilitates machinations
between debtor and creditor or creditor and creditor which may have the
effect of unjustly prejudicing competing creditors holding non-coextensive
security. Two possibilities deserve special mention. A debtor who
foresees
is
encouraged by the current law to negotiate a default with creditors
holding general hypothecs, a pattern of realization which will profit
certain lower ranking secured creditors and prejudice others, or which
will insulate particular assets from immediate execution. 69 Similarly, a
higher ranking creditor with a general hypothec is encouraged to bargain
with lower ranking secured creditors and prejudice others, or which will
insulate particular assets from immediate execution. Similarly, a higher
ranking creditor with a general hypothec is encouraged to bargain with
lower ranking creditors for the most favourable pattern of seizure and
sale. 70 In either hypothesis the law facilitates manoeuvring between
various parties to security agreements designed neither to expedite
681t is to be noted that this particular problem will arise most often in commercial,
rather than real estate financing. The giving in payment clause is a principal reason.
69For example, a debtor may negotiate a default with a financer of certain equipment
not to realize until inventory has been produced and sold. Here, the raw materials fmancer
suffers while the accounts receivable financer profits.
“For example, an unsecured creditor may negotiate with a creditor holding a general
hypothec to realize exclusively on heavily encumbered property so as to reduce the claims
of lower ranking secured creditors to chirographic status.
McGILL LAW JOURNAL
[Vol. 27
lower
realization nor maximize proceeds generated, but simply to benefit or
oppress certain
ranking creditors holding non-coextensive
security. 1 It follows from this discussion that the principle of art. 2049
(2) C.C., even interpreted by analogy to its greatest breadth, is only
marginally successful in equitably regulating relations between creditors
holding non-coextensive security.
Of course, a secured creditor has a variety of recourses other than
that elaborated in art. 2049 (2) C.C. by which to protect his rights from
prejudicial realization, or execute upon his security in a most beneficial
fashion. One may highlight two which require elaboration: the outright
purchase of the oppressing creditor’s rights in order to exercise these in a
non-prejudicial manner; and the negotiation of a renunciation, a cession
of priority or a similar arrangement. Moreover, an apprehensive secured
creditor may adopt any number of strategies to bring himself within the
conditions of application of art. 2049 (2) C.C. Finally, he may petition
his debtor into bankruptcy in order to profit from the scheme of distribu-
tion set out in the Bankruptcy Act.72
A. Purchasing the Rights of Higher Ranking Creditors
A creditor who fears that his security may be compromised by the
manner in which another secured creditor proposes to realize upon his
guarantee may always attempt to purchase the rights of the latter. This
option is expressly recommended by Marler, 7 but Langelier7 4 seems to
suggest that such arrangements are not permitted. It is difficult to see
upon what basis this latter opinion is founded, since arts 1571 et seq.
C.C. impose no restrictions on the purchase of creditors’ rights. Thus, in
anticipation of default any individual may purchase a claim which is
secured by a hypothec, 75 and then invoke the principle of indivisibility to
exercise the rights so purchased in a manner most beneficial to himself.
71In Crown Realty, supra, note 5, 345-6, Howard J.A. clearly saw this issue. He
observed: “I cannot bring myself to believe that it was the intention of our codifiers to
leave the decision of the vital question, whether the holder of a second hypothec on one of
the separate portions of the property should be paid his claim in full or receive nothing at
all, to the mere chance that his security should be brought to sale before that of the holder
of the other second hypothec, and still less that it was their intention to penalize the one
who should act with the greater diligence in executing upon his security.”
7 R_ S.C. 1970, c. B-3. His rank will then be established according to that law, and not
73Supra, note 4, no. 830. See also Crown Realty, supra, note 5, 348,per Greenshields
4Supra, note 4, 287.
75Article 1574 C.C. See, however, the special rules relating to registration set out in
the Civil Code. This hypothesis will not be discussed here.
J.A.
art. 2127 C.C.
19821
EQUITY AMONG SECURED CREDITORS
That is, the purchaser would exercise the newly acquired hypothec
primarily, if not exclusively, on those immoveables not affected by his
original hypothec. 76
Would the situation be the same ii the first ranking creditor had
already seized the immoveable prior to the transfer of the claim? 77 In
Crown Realty it appears that the Court would have permitted the
purchase of a higher ranking creditor’s right even after the seizure of the
immoveable, as long as the order of collocation and distribution had not
been drawn.7 s In such a hypothesis, however, the purchasing creditor
would not immediately seize the second immoveable. Rather, he would
renounce the exercise of his new hypothec in order to have his original
claim paid first. Then, invoking the principle of art. 2049 (1) C.C. he
would seize another immoveable affected by the recently purchased
general hypothec in order to liquidate the claim it guaranteed.
It would appear, therefore, that a lower ranking creditor who fears
oppression from another secured creditor may purchase the latter’s rights
either prior to or after the seizure and sale of the immoveable affected by
his own hypothec. In both cases he will not be invoking the principle set
out by art. 2049 (2) C.C. but, on the contrary, that of art. 2049 (1) C.C.,
namely, that hypothecs are indivisible. A similar solution is to be recom-
mended whenever a first ranking creditor attempts to exercise a giving-in-
payment clause. Invoking art. 1040b C.C., the second creditor would
purchase the rights of the first creditor in order to avail himself of art.
2049 (1) C.C., as above.
All these solutions, however, have their inconveniences. First, the
lower ranking creditor must have enough money to buy out the first
ranking creditor. Second, apart from the case where art. 1040b C.C. is
applicable, it is necessary either to wait until seizure of the collateral, or
to obtain the co-operation of the first ranking creditor in order to
intervene. Third, each presupposes that no lower ranking creditor in a
similar predicament in respect of another immoveable has previously
taken the same step.
76Article 2049 (1) C.C. The purchaser will be subrogated in all the vendor’s right by
virtue of art. 1156 (1) C.C. See also arts 1986-7 C.C. to which art. 2052 C.C. refers.
77This is precisely what a third ranking creditor unsuccessfully attempted to do in
Central Factors, supra, note 6.
78In Crown Realty, supra, note 5, the Court of Appeal refused to permit this solution
because the second ranking creditor (the purchaser) did not renounce his rights in proper
form or in sufficient time. See the judgment of the Court by Howard J.A. (unreported), in
its second paragraph, which states: “[T]he renunciation made by the appellant… was not
made in proper time or form”.
REVUE DE DROIT DE McGILL
[Vol. 27
B. Renunciations, Cession of Priority and Similar Devices
A second path open to a lower ranking creditor who fears that his
rights may be prejudiced is to negotiate an agreement whereby the first
ranking creditor promises not to realize his security upon assets affected
to the lower ranking creditor’s guarantee in a manner prejudicial to the
latter. Probably the easiest manner of achieving this result is to have the
higher ranking creditor renounce his rights to invoke the indivisible nature
of his hypothec under art. 2049 (1) C.C. in the event of a seizure. While
there is some suggestion in Crown Realty that this is not permissible, no
article in the Code seems expressly to prohibit such agreements.
Another manner by which a lower ranking creditor may safeguard his
rights is through the mechanism of a cession of priority.79 Such a cession
could, of course, be arranged either prior to or after default and seizure.
In either event the first ranking creditor who cedes his rank would then
exercise his general hypothec on the other immoveables, rather than
wait to see what the results of a collocation on the first immoveable
might be.80
Once again, however, there are inconveniences to these solutions.
The existence of creditors of intermediate rank will compromise both
strategies. The first alternative, negotiating a renunciation from the
highest ranking creditor, is otiose if the intermediate hypothec is large.
The second alternative, cession of rank, will only be effective if the lower
ranking hypothec is for an amount less than that of the higher ranking
hypothec.81 Moreover, just as in the case where a creditor purchases the
rights of a first ranking creditor, the second creditor must have the
resources to do so and must of course have the co-operation of the
creditor holding the general hypothec. Finally, since neither of these
alternatives involves purchasing the higher ranking creditor’s claim,
subrogation under art. 1156 (1) C.C. cannot be claimed and the
purchaser cannot recover the amount of his payment to the vendor.8 2
C. Strategies for Compelling the Application of Art. 2049 (2) C. C.
The two hypotheses just mooted involve machinations by which a
lower ranking creditor fearing prejudice does not avail himself of the
distributional principles elaborated by art. 2049 (2) C.C. but rather,
undertakes various transactions through which he himself achieves a
79Article 2048 C.C.
“Again, some judgments in Crown Realty, supra, note 5, would suggest that such a
strategy is contrary to public order.
first ranking hypothec. See art. 2048 C.C.
“If not, the second ranking creditor can only protect his claim up to the amount of the
2 See also arts 1986-7 C.C.
EQUITY AMONG SECURED CREDITORS
19821
position from which he may invoke the principle of indivisibility to
greatest benefit. However, a second creditor who is not immediately in a
position to invoke art. 2049 (2) C.C. and who is not successful in either
purchasing the rights of a higher ranking creditor or in making alternative
arrangements is not necessarily in a precarious position. He can attempt
to bring himself within the conditions of applicability of art. 2049 (2)
C.C. so as to compel a proration of the higher ranking creditor’s claim.
Since the essential conditions of application of the article have already
been elaborated, it remains only to examine the means by which a
creditor may provoke its application in the two general situations of non-
applicability: (1) where only assets already affected to the lower ranking
creditor’s security are seized, and (2) where the oppressed creditor does
not meet the required description in that he is neither hypothecary nor
subsequent.
Article 2049 (2) C.C. will not apply if the higher ranking creditor
seizes only the immoveable or immoveables affected by the subsequent
creditor’s hypothec. In such a case, assuming the debtor to be in default
towards him,83 the second ranking creditor will bring an action on the
principal obligation, seize before judgment the other immoveables and
after obtaining judgment, sell these. At the same time he will be obliged to
restrain the sale, or if a judicial sale has already taken place, restrain the
distribution of the proceeds from the sale of the first immoveable. While
there appears to be a suggestion in Crown Realty that a rateable distribu-
tion may be ordered even if only proceeds of some immoveables remain
to be distributed, the only certain means of assuring the application of art.
2049 (2) C.C. is to seize and sell other immoveables affected by the
higher ranking hypothec prior to distribution of the sale price of the first
immoveable.
A second case where art. 2049 (2) C.C. will not apply can arise if the
creditor fearing prejudice does not have a hypothec or is not of posterior
rank. In order to be assured of provoking the application of art. 2049 (2)
C.C. he must himself obtain a subsequent hypothec upon the property
seized. However, in view of the provisions of art. 2023 C.C. such an
attempt is unlikely to be successful. Even if money is advanced to the
debtor, the lender would typically be found not to be in good faith.
8 While the Code of Civil Procedure provides in art. 716 for the collocation of the
claims of secured parties to whom the debtor is not in default, upon the sale of the
immoveable affected to their hypothec no general right to seize immoveables affected to
another creditor’s hypothec is given. Hence, a lower ranking creditor may only compel
such seizure by obtaining judgment after his debtor’s default. Various standard form
default clauses suggest themselves as a means of ensuring this possibility.
McGILL LAW JOURNAL
[Vol. 27
The above solutions are, of course, artifices contrived in order to
provoke the application of art. 2049 (2) C.C. as a principle of distribu-
tion. Each reveals the limits of the article as a device for ensuring a
rateable distribution of the claim of the creditor holding a general
hypothec upon the proceeds of a judicial sale.
D. Conclusion
The considerations reviewed in this section illustrate the inefficiency
of art. 2049 (2) C.C. as a mechanism for equitably regulating relations
among creditors holding non-coextensive security upon the property of
their debtor. Even were one to take the most liberal interpretation of the
underlying principle of art. 2049 (2) C.C. the fact remains that the
provision elaborates only a principle of distribution and not a principle of
realization. As such it only partially resolves the issues which a system of
secured financing poses, and in a very real sense frustrates rather than
facilitates the expeditious realization of security and the maximization of
proceeds generated for the benefit of secured creditors.
IV. The Future of Art. 2049 (2) C.C.: The Limits of Indivisibility
If one accepts the desirability of legislative intervention in the
market for security on property and if one accepts that some measure of
control should be exercised over the manner in which secured creditors
may realize upon their security, several issues of legal policy arise. The
analysis of art. 2049 (2) C.C. undertaken in this essay indicates that it is,
at best, a flawed juridical institution for regulating the rights of non-co-
extensive security holders. Five main criticisms may be directed to the
conception and redaction of the article.
First, as drafted, art. 2049 (2) C.C. simply envisions hypothecs.
Whatever may have been the case in 1866, it is clear that creditors today
obtain security by means other than hypothecs. If the principle of art.
2049 (2) C.C. is valid, it should be made applicable to other forms of
security as well.
Second, the article speaks only of immoveables. Once one admits of
non-possessory security on moveables, problems of competing non-
coextensive secured creditors may arise. Moreover, most secured lending
today occurs in the realm of sales financing. There is no reason therefore
to restrict the principle of the article to security over immoveables.
Third, art. 2049 (2) C.C. currently provides only for the protection of
lower ranking creditors. It may well be that the codifiers did not have in
mind the abuses which can be perpetrated by subsequent creditors
holding general hypothecs. Yet in view of the impact that the principle of
indivisibility may have on all secured creditors, there is a need to extend
the principle to all secured creditors regardless of rank.
19821
EQUITY AMONG SECURED CREDITORS
Fourth, this article appears to contemplate uniquely the case where a
hypothec affects the property of parties personally liable. Whenever
security is given to guarantee an obligation should the collateral affected
to the debt not be immediately open to seizure? Unless bargained away,
the right of secured parties not to postpone execution should not depend
on whether the owner of the collateral is personally liable to the creditor.
The relationship between holder and principal debtor is a matter for the
law of obligations and not the law of secured financing.
Fifth, the article only contemplates problems of equity which arise
among secured creditors at the time of distribution of the proceeds of a
judicial sale. It is silent as to problems of realization even though the
opportunity for oppression is equally present in the manner of realization.
In view of this inventory of defects one might wonder why the article
has not generated extensive litigation. Three reasons may be offered.
First, the fact that almost all real estate loan agreements today contain
either giving-in-payment or resolutory clauses with retroactive effect
means that upon default, a first ranking creditor may simply extinguish
lower ranking claims; in such an hypothesis the need for distributional
principles such as those set out in art. 2049 (2) C.C. never arises.8 4
Second, the limited hypotheses in which it is conceiveable for a higher
ranking creditor to have general non-possessory consensual security on
moveables has restricted the range of cases for which the need of a
principle such as art. 2049 (2) C.C. has been felt; the low rank of the
trustee for bondholders effectively means that the kind of conflict
envisioned by the article can only arise in limited cases between a bank
holding s. 178 security and an unpaid vendor or commercial pledgee.8 5
Finally, because the general structure of security on property elaborated
in the Code is one of priorities for payment, as opposed to security
devices implicating creditor supervision, attachment and tracing, and
preferential payment of proceeds advocates do not seem to have
generalized the specific example of art. 2049 (2) C.C. into a general
theory of secured financing; hence, several situations where the principle
of indivisibility leads to oppression of the sort mooted by the Code, go
unchallenged.8 6 In this section an attempt to illustrate the various
possibilities for applying the principle of art. 2049 (2) C. C. in a variety of
secured financing contexts will be undertaken.
4See SimcardLtde v. Planchers Modernes ChartierInc. (1980) 13 RP.R. 254 (Qu6.
C.A.).
85This was preccisely the claim raised in Central Factors, supra, note 6, which the
Court of Appeal stated did not give rise to the application of art. 2049 (2) C.C.
86An analogy to art. 2049 (2) C.C. was not even drawn by counsel in either Jori
Investments, supra, note 51, or in Central Factors, supra, note 6.
REVUE DE DROIT DE Mc GILL
[Vol. 27
A. Towards a Reinterpretation of Art. 2049 (2) C. C.
In view of the eventual reform of the law of security on property
proposed in the Draft Civil Code it might be thought otiose to suggest a
reinterpretation of the principle of art. 2049 (2) C.C. in the direction of a
general theory of secured financing. But if the above noted problems with
the current version of art. 2049 (2) C.C. are indeed real, ought not
advocates and judges seek to alleviate where possible these deficiencies
through analogy or reformulation? In this sense the viewpoint of Howard
J.A. in Crown Realty is preferable to that of Cr~te J.A. in Central
Factors.
In reconsidering the range of application of the principle of art. 2049
(2) C.C., one may start with the obvious point that the article is
misplaced in the Code. Rather than dealing with “The Order in
Which Hypothecs Rank” it treats the question of the effect of hypothecs
and the consequences of the hypothecary recourse. That is, it attempts to
elaborate the consequences of the principle that hypothecs are indivisible
at the time of distribution of the proceeds of a judicial sale. As such, the
article should be seen as setting out an exception to the principle of
indivisibility which applies regardless of the rank of the respective
hypothecs and regardless of the particular consequence of indivisibility in
view. It also follows that, if it is the principle of indivisibility which is
contemplated, art. 2049 (2) C.C. should be applied by analogy to other
forms of security, such as privileges, which attach to proceeds generated
at a judicial sale. Again, since all privileges, moveable and immoveable,
are indivisible, and since the idea of consensual non-possessory security
along the lines of the hypothec has been incorporated into the civil law by
the commercial pledge and the trust deed under the Special Corporate
Powers Act, the principle of the article can easily be extended to the case
of moveables. Finally, if art. 2049 (2) C.C. does not really address the
issue of rank of claims, but rather principles of distribution, it is not a
difficult intellectual step to make its principle applicable to all circums-
tances where the holder of a general security attempts to invoke the
principle of indivisibility to the prejudice of other creditors holding non-
coextensive security.
The remaining two policy problems with art. 2049 (2) C.C. cannot,
however, be overcome simply by analogical extension of the underlying
principle of the article. On the one hand, extension of the principle to the
case of holders not personally liable contemplates a substantial rethinking
of the hypothecary action. By permitting creditors immediate access to all
collateral upon their debtors’ default one would be eliminating one
element of a hypothec’s accessory nature.8 7 On the other hand, invoking
870f course, lenders may insist that all hypothecs be accompanied by personal
assumption of liability by the holder or by a renunciation of the benefit of discussion in
which case art. 2049 (2) C.C. would be applicable.
EQUITY AMONG SECURED CREDITORS
19821
art. 2049 (2) C.C. as a justification for controlling the manner in which
secured creditors may realize upon their debtor’s assets implies a new
conception of the rights as between debtor and creditor, or creditor and
creditor, both prior to and consequent upon default. Heretofore the civil
law has not been concerned with mechanisms of realization and in
consequence the chance order of seizure and sale will determine which
creditors will suffer in the distribution of proceeds.88
It is these latter two policy problems which most cogently illustrate
the limitations of the current civil law conception of secured financing.
While the principle of freedom of contract may be a valid operating
assumption in most commercial contexts, 9 the need for a comprehensive,
integrated and coherent scheme of realization of assets suggests that in
the realm of secured financing the law must take a more activist and
interventionist position.90 In particular, the law cannot simply apply
various prescriptions for distribution of proceeds but must elaborate a
mechanism for permitting secured creditors to direct other creditors
holding non-coextensive security to various assets affected to the latter’s
claim. 91
Of course, in developing a principle to this effect the legislator must
be cognizant of a variety of issues: in what circumstances should a first
secured creditor properly resist an attempt to compel execution on other
properties? What types of property make delays in realization inevitable?
In volatile markets should creditors be forced to realize when they are
unsure of the amount of proceeds likely to be generated? In view of these
problems it appears that the most viable mechanism for extending the
principle of art. 2049 (2) C.C. to realizations as well as distributions is
not to limit or restrict the right of higher ranking secured creditors to
181f the purpose of secured financing, from the debtor’s perspective, is to lower the cost
of money, the possibility that the utility of a security can be affected by the chance order of
realization will make the lending market more volatile. For an economic analysis of
secured lending see Jackson & Kronman, Secured Financing and Priorities among
Creditors (1979) 88 Yale L.J. 1143.
89See the debate as elaborated in J. Ghestin, Les Contrats (1979); C. Fried, Contract
as Promise: A Theory of Contractual Obligation (1981); and I. Macneil, The New Social
Contract: An Inquiry into Modern ‘Contractual Relations (1980).
90See Gilmore, supra, note 1; J. White & R. Summers, Handbook of the Law under
the Uniform Commercial Code, 2d ed. (1980), 1-21 and in particular 20-1; and
Ramsay, Book Review [Ontario Law Reform Commission, Report on Sale of Goods
(1979)] (1980) 57 Can. Bar Rev. 780-90.
9’ The common law doctrine of marshalling achieves this result indirectly. Rather than
permitting lower ranking creditors to force higher ranking creditors to seize particular
assets of their debtor, the common law permits the lower ranking creditor to have recourse
to the collateral over which he actually has no claim up to the amount realized by the first
creditor from the property over which he has security. See R. Megarry & P. Baker, Snell’s
Principles of Equity, 27th ed. (1973), 404-5.
McGILL LA W JOURNAL
[Vol. 27
freely select their target collateral. Rather, the law should extend the
principle of art. 1156 (1) C.C. so that legal subrogation may take place in
favour of a lower ranking secured creditor whenever a higher ranking
creditor holding non-coextensive security realizes upon the assets
affected to the lower ranking secured creditor’s claim. The lower ranking
creditor should be permitted to seize and sell all other collateral affected
by the first ranking creditor’s guarantee and to be preferred on the
proceeds generated for an amount up to the difference in the payment to
the first ranking creditor had art. 2049 (2) C.C. been applicable.92
B. The Proposals of the Civil Code Revision Office
The law of security on property undergoes nothing short of a radical
revision in the Draft Civil Code. 93 Notwithstanding this general tide of
reform, art. 423 (2) of Book IV of the proposed Code, which corresponds
to art. 2049 (2) of the present Code only slightly amends the current law.
The draft article provides:
If, however, all of such properties or more than one of them are judicially sold, and
the proceeds are still to be distributed, if other subsequent creditors hold hypothecs
on one of such properties, the creditor’s hypothec is divided in proportion to the
amount of the respective prices which remain (sic) to be distributed.
Si, n6anmoins, tous ces biens ou plus d’un de ces biens sont vendus en justice et que
le prix en soit h distribuer, l’hypoth~que se r~partit, proportionnellement fi ce qui
reste a distribuer sur leurs prix respectifs, lorsqu’il existe d’autres cr~anciers
post6rieurs qui n’ont hypothique que sur l’un de ces biens.
On its own, this article addresses only one of the difficulties noted
with the current art. 2049 (2) C.C.: art. 423 D.C.C. no longer requires
that the immoveable affected be that of the debtor of the obligation.94
However, in combination with the other reforms to the law of security on
property most of the criticisms of art. 2049 (2) C.C. have been met. For
example, in view of the proposed “presumption of hypothec” 95 the
principal of rateable division extends to all security on property other
than financing under ss. 179 (1) (a) –
(h) of the Bank Act, and
liquidations under the Bankruptcy Act. That is, because no form of
security on property other than a hypothec is to be permitted, the
92This principle also requires an amendment to the law of release so as to prevent
collusion between creditors through the prior release of security over non-seized property.
In this regard the provisions of arts 1032-3 and 1039 C.C. are of particular relevance.
93See, for comments, Lebel & Lebel, Observations sur le Rapport de I’O.R. C. C. sur
les sfzretds rdelles (1977) 18 C. de D. 833-96; Comtois, Le nouveau droit des silretds
r~elles [1978] C.P. du N. 75; Macdonald & Simmonds, The Financing of Moveables;
Law Reform of Quebec and Ontario (1980) 11 R. de D. 45.
9’Book IV, art. 423 (1) D.C.C. only requires that the hypothec affect more than one
property. The reference to “debtor” is removed.
95Book IV, arts 281-5 D.C.C.
1982]
EQUITY AMONG SECURED CREDITORS
language of art. 423 D.C.C. is comprehensive. Again, because the new
Code will permit hypothecs on moveable property, 96 the draft article is
directly applicable to the financing of moveables. Third, even though the
draft article speaks only of judicial sales, neither its scope nor its effect is
limited in the manner of the former art. 2049 (2) C.C. On the one hand, in
the new Code a non-judicial sale will not have the effect of purging real
rights;97 and on the other hand, the Code permits creditors to compel
another who has taken collateral in payment to proceed to a judicial sale
so that the collateral generates proceeds for distribution among other
creditors. 98 Finally, by means of the presumption of hypothec and various
imperative provisions,99 the Draft Civil Code will reduce the likelihood of
disingenuous attempts to oppress both debtors and subsequent creditors
such as that which produced the retroactive giving in payment clause
twenty years ago.
One may conclude, therefore, that the various provisions of the Draft
Civil Code, in combination with the revised version of art. 2049 (2) C.C.
elaborated by art. 423 (2) D.C.C., meet the majority of the criticisms
formulated in this essay against both the drafting and the interpretation of
art. 2049 (2) C.C. The only remaining difficulties lie with the fact that the
Draft Civil Code still envisions this provision uniquely as a principle of
distribution of the proceeds of a judicial sale: first, it continues to restrict
the creditors who are entitled to invoke it to those who are of
“subsequent”
rank; and second, it nowhere provides that a secured
creditor may either provoke the seizure of an immoveable over which he
has no security in order to compel the higher ranking creditor to prorate
his security or be subrogated in the anterior creditor’s rights for the same
purposes.
As argued earlier in this essay a coherent scheme for regulating the
relationship between creditors holding non-coextensive security over the
assets of their debtor is reflected best in the idea that the indivisible
nature of hypothecs should not be an instrument of oppression in the
hands of secured creditors and should not be permitted to justify
predatory realization tactics. Consequently, it is recommended that the
second paragraph of art. 423 D.C.C. be amended to expressly reflect this
idea. It would then read as follows (suggested modifications are
italicized):
96Book IV, art. 304 D.C.C.
97Book IV, art. 434 D.C.C. For a discussion of this point in a different context see
Payette, Charge flottante: Privilkge de la Couronne et saisie entre les mains du
fiduciaire (1980) 40 R. du B. 337.
98Book IV, art. 444 D.C.C.
“The
list of imperative provisions is set out in Book IV, art. 458 D.C.C.
REVUE DE DROIT DE McGILL
[Vol. 27
If, however, all of such properties or more than one of them are judicially sold, either
concurrently or successively, and any proceeds are still to be distributed, and if other
creditors hold hypothecs on some one or other, but not all of such properties seized
and sold the creditor whose hypothec affects more than one immoveable cannot
invoke the principle of indivisibility of hypothecs but must divide his hypothec in
proportion to the amount of the respective prices which would have been available
for payment of his claim.
Moreover, it is suggested that a third paragraph be added to art. 443
D.C.C. so that the principle of art. 2049 (2) may also be reflected at the
time of realization. This
third paragraph would be drafted in the
following terms:
If only that property or those properties over which another creditor also holds a
hypothec are seized and sold, such other creditor is subrogated in the rights of the
creditor whose hypothec affects additional property and may seize and sell this
additional property, imputing the proceeds of such sale or sales to the payment of
secured claims as if the previous paragraph were applicable.
Conclusion
The basic principle of art. 2049 (2) C.C. is necessary in any
sophisticated regime of secured financing. Yet, as this essay has shown,
the current view of the provisions of the Civil Code regulating the rights
of creditors holding non-coextensive security does not lead to optimism
that the courts will readily analogize its principle beyond the specific
codal text. While the Court of Appeal in the Crown Realty case did
attempt to broadly apply the article, in the recent Central Factors case,
the same Court unanimously declined to apply the principle of art. 2049
(2) C.C. to security over moveable property. Rather, it found the codal
text to be exceptional, and therefore meriting a narrow interpretation. 100
As noted, good arguments can be made for a liberal interpretation of
the current article, Central Factors notwithstanding; moreover, the Draft
Civil Code expressly corrects many of the more obvious defects in the
actual text Nevertheless, the utility of the present article and the pro-
posed codal provision as a mechanism for ensuring equity among credit-
ors holding non-coextensive security is limited by the fact that their
underlying conception is one of distribution of proceeds and not also a
mechanism of realization. In Part IV various reasons for reformulating
the law so as to accomplish both objectives, and a suggested amendment
to the Draft Civil Code for this purpose, were offered. It is to be hoped
that, within their respective provinces, both judiciary and legislature will
ensure that art. 2049 (2) C.C. and its successor promotes the goal of
equitably regulating the respective rights of creditors holding non-
coextensive security.
1’0 Paradoxically, the actual disposition of the appeal in Central Factors can only be
justified if the Court were applying some principle analogous to art. 2049 (2) C.C.
