Prudential Finance Corporation v. Kutcheran et al’
Norman S. Kessner *
With the growth of the sale of household and personal goods on
the extended payment plan, the promissory note, the conditional sales
contract, and the finance company have become inseparable parts
of the procedure whereby the merchant realizes immediate cash from
the extended obligations of the purchaser. The very existence of the
seller’s business depends on his ability to convert these obligations
into cash, and the finance company standing ready and willing to
buy them has become an essential part of retail selling on the time
payment plan.2
The fact that our prosperous economy now depends so much on
consumer credit raises sharply the following important question.
What is the effect upon the holder of a promissory note, in fact
collateral to a conditional sale agreement, of his being assignee of
the agreement or even of his knowledge of its existence? In other
words is the finance company as holder of a note made by the pur-
chaser and payable to the seller, a holder in due course, or does the
mere knowledge of assignment of the agreement deprive him of that
status?
This problem has been the subject of recent extensive analysis
by those seeking a less favourable interpretation, to the holder, of the
relevant sections of the Bills of Exchange Act. Thus some decisions
especially of the Quebec courts have sought to make it extremely
difficult for a finance company taking as endorsee of the note to
qualify as a holder in due course. Other Canadian jurisprudence is
resisting this novel trend. The latter focuses upon a very definite
and decided line of thought which will profoundly affect the nature
of a relationship governing the sales organization and the finance
company. This critique will attempt to clarify the rationale under-
lying current jurisprudential trends and establish a more predictable
base for solving future problems.
An important decision of the Ontario Court of Appeal – Pru-
dential Finance Corporation v. Kutcheran et ai 3 poses the legal issue
of the Junior Board of Editors, McGill Law Journal, second year law student.
1 (1964) 45 D.L.R. 2d 402.
2 Federal Discount Corporation v. St. Pierre and St. Pierre, 32 D.L.R. 2d 86.
3 (1964) 45 D.L.R. 2d 402.
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CASE AND COMMENT
under discussion and provides its solution in a manner both logical
and consistent with sound principles.
Briefly the facts are:
Conditional sale purchasers, the defendants signed a promissory
note for the balance of the purchase price of a freezer chest. The
condition of sale endorsed on the contract and incorporated into it
by reference contained in these clauses.
5. Purchaser acknowledges that the agreement and the completion certifi-
cate constitute the entire contract and that there are no representations,
warranties or conditions, expressed or implied statutory or otherwise, other
than contained herein…
6. Purchaser takes notice that this agreement together with vendor’s
title to, property in and ownership of said goods and said note are to be
forwith assigned and negotiated to Prudential Finance Corporation and that
said corporation shall not be affected by any equities existing between vendor
and purchaser and that all payments are to be made to said corporation.
The defendant claimed that the vendor’s sales agent had orally
represented that they were entitled to rescind and return the goods
if they were not satisfied.
The trial judge held that the plaintiff could not sue as a holder
in due course because the promissory note was signed contempora-
neously with the conditional sales agreement in the usual terms and
was given as collateral thereto.
At this point it is most interesting to note an obiter judgment
by Casey J., in Elmhurst Investment Company v. Allard 4 which
states in essence that if the holder of a cheque finds his right to claim
in an agreement in writing seperate and distinct from the cheque,
he does not enjoy the advantages conferred by the Bills of Exchange
Act on a holder in due course and the drawer of the cheque is free
to urge any defence that may be open to him.
“If the plaintiff had the cheques and nothing else I would be obliged to
decide whether it was a holder in due course. But if the plaintiff finds its
rights to an agreement evidenced by a writing other than the cheques, it
cannot invoke the advantages given by the act to a holder in due course.” 5
These remarks might be qualified if applied to a specific case
based on its peculiar facts, but the statement that they apply in every
such case without exception destroys the concept of negotiability of
commercial paper. Our jurisprudence has constantly maintained that
although originally attached to a conditional sales contract which may
stipulate such agreement, the document sued upon is nevertheless
[1963] B.R. 236.
5 [1963] B.R. 244.
388
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a valid promissory note and a negotiable instrument, 6 and if the
action is based on the note, the holder is presumed by law to be a
holder in due course. 7
In Rapid Discount v. Foscolo,8 the court expounded a rather
strange principle; that is, if the finance company to whom the note
is negotiable does not become an assignee of the conditional sales
contract, the contract does not affect it, but if it purchases both
the note and the contract then, if the contract is in any manner
impugnable, so is the note.
“La demanderesse, avant d’acquCrir un billet… avait l’obligation de faire
une enqu~te minutieuse sur la nature du contrat qui accompagnait le billet
ndgoci6.” Un examen du contrat, de sa nature et des circonstances qui Pont
entour6 .. .9
Under similar circumstances, in City Loan Finance Corporation
V. Larocque,0 Jean J. held that a finance company, even though it
had knowledge of a contract to which the note was collateral, was
not obliged closely to investigate the circumstances of the contract,
and could as a holder in due course sue the maker.
In Rapid Discount Corporation v. Geintzer,” Trudel J., was of
the opinion that because in conditional sales contracts, both the
dealer and the finance company know that the cheques issued by
the purchaser are given as collateral to such contract, therefore the
validity of payment depends upon the legality of the sales contract.
This imputes to the finance company all the defects, risks and im-
perfections of the agreement. A similar view was advocated in Con-
sumer Acceptance Corporation v. Gendron.12
The latest of this line of decisions is Circle Acceptance Corpora-
tion v. Sigouin.13 There the court imposed upon the finance company
the onerous burden of investigating the circumstances of the con-
tract and even after the latter had ascertained the real nature of
6 Commercial Acceptance Corp. v. Cormier [1960] C.S. 161, Lecompte v. O’Gra-
dy [1930] C.S. 517.
7 Bank of Montreal v. Amibeault (1939) 65 K.B. 1, Duplessis v. The Edmonton
Portland Cement Company (1917) 55 S.C.R. 623, Killoran v. The Monticello State
Bank (1921) 61 S.C.R. 520, Laurentide Acceptance Company v. Corneau (1952)
S.C. 379, Standard Credit Corporation v. Poissant (1956) S.C. 83.
8 [1963] C.S. 615.
9 Ibid at p. 621.
10 [1963] C.S. 683.
11 [1963] C.S. 454.
12 [1962] C.S. 203.
13 [1963] C.S. 97. See case comment by Warren A. Black in (1964-65) 10
McGill L. J. 172.
No. 4]
CASE AND COMMENT
the transaction existing between its customer and the party who
entered into such a sales contract the finance company was still
subject to all equities as between its customer and the party.
Surely this general condemnation of the position of the finance
company not only is repugnant to legal principle, but taken seriously,
would deprive commercial paper of mercantile utility.
The rapid growth of consumer credit and with it the event of
the finance company makes it imperative to clarify the true inter-
pretation applicable in law, therefore it is essential to analyze the
ratio of the decision in Przdential Finance Corporation v. Kut-
cheran et al.’4
The Canadian Locus Classicus is the Supreme Court judgment
of Killoran v. Monticello State Bank.15 Duff J., (as he was then),
stated the relevant principle in these words:
“In each case there is it is true on the same piece of paper, one of these
instruments and a collateral agreement is no part of the instrument sued
upon. By its express terms indeed, it is not to qualify the absolute obligation
of the promissor or to affect the contractual rights of the parties in such a
way as to impair the negotiability of the note.” 16
It was held that the note stood separate and apart from the agree-
ment and unaffected by it even in the hands of a holder who knew
of the collateral agreement, and not withstanding that the notes in
the case had not been detached from the rest of the documents.
This case was followed and applied in Union Acceptance Corpo-
ration Ltd. v. St. Amour, 17 where it was held that a holder in due
course of a note was not precluded from suing the maker thereon
merely because the latter had given the note to secure the balance
of the purchase price of goods which turned out to be defective and
had to be taken back by the seller, a fortiori when the conditional
sales contract contained a stipulation that the note was given as a
negotiable instrument and the holder would not be affected by any
equities as between seller and buyer.
The law in the relevant Canadian cases is uniform. The finance
company, the holder of a note, relies on the presumptions of the
Bills of Exchange Act. Whatever the buyers’ complaint, short of a
real defence such as forgery, incapacity and non est factum, the
holder is entitled to succeed to the full value of the note. The facts
of concurrent execution and concurrent transfer of the contract (even
14 (1964) 45 D.L.R. 2d 402.
15 (1920-21) 19 S.C.R. 528.
10 Ibid at p. 531.
17 [1957] 0.W.N. 261.
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when the note and the contract are printed on the same sheet of
paper) 18 and of knowledge by officers of the finance company at the
time of the transfer that the seller has not then delivered the goods 10
or otherwise fulfilled his obligations under the contract have been
considered and held irrelevant to the rights of a holder of a note,
because the existence of fraud by which the seller induced the buyer
to purchase does not per se affect a holder without notice of the
fraud or of circumstances so suspicious that failure to inquire con-
stitutes bad faith. 20
Arrangements between the seller and buyer subsequent to the
transfer which qualify or nullify, as between seller and buyer, the
original obligation 21 and acceptance of payment by the seller, when
the documents call for payment directly to the finance company,22
are equally irrelevant.
Even though the endorsee takes an assignment of the contract
the most he will learn in the typical case is that the seller has obliga-
or that if the goods are
tions to perform –
defective the seller will have some duty to fulfill his obligation to
the buyer to deliver the goods of contract quality.
e.g. deliver the goods –
Even so the assignee –
endorsee is entitled to assume that the
dealer will in fact fulfill his obligation.
Complaints by the buyer that he has been a victim of fraud or
that he has not received the goods at the agreed time or at all, or
that the goods are defective etc…. will not arise until some time
after the assignment and negotiation to the finance company.
The Killoran 23 case is authority not only for the proposition that
a note is not affected by agreement, therefore in principle, the waiver
clause is superfluous, but also for the proposition that if there is a
is Killoran v. Monticello State Bank, Supra note 14, Aetna Factors Corp. Ltd.
v. Breau 1958, 15 D.C.R. (2d) 326. Bank of Nova Scotia v. Philpott (1930) 2
W.W.R. 128. Canyon Securities Ltd. v. McConnell 17 D.L.R. (2d) 730, Commercial
Acceptance Corp. v. Carrier [1960] S.C. 161, Union Acceptance Corp. Ltd. V.
St.Amour [1957] O.W.N. 261.
19 Canyon Securities Ltd. v. McConnell 17 D.L.R. (2d) 730.
20 Sheffield v. London Joint Stock Bank (1888) 13 A.C. at page 333, Jones v.
Gordon (1877) 2 A.C. 616.
21 Aetna Factors Corp. Ltd. v. Breau, Supra note 18, Rand Investments Ltd.
v. Wallberg (1961) 34 W.W.R. Standard Credit Corp. v. Poissant, 1956 S.C. 83,
Union Acceptance Corp. v. St. Amour, Supra note 18.
22 Traders Finance Corp. Ltd. v. Buffone [1960] O.W.N. 364, Chevalier v. Jette
[1956] S.C. 247.
23 (1962) 40 Can. Bar Rev. 461 Can. Acceptance v. Glovinsky (1931) 69 Que.
S.C. 206.
No. 4]
CASE AND COMMENT
waiver clause it binds the buyer in a question with the holder of
the note.
It is of the utmost importance to distinguish Prudential Finance
Corporation v. Kutcheran et a124 from Federal Discount Corporation
Ltd. v. St. Pierre and St. Pierre. In the former case there was no
close and intimate a relationship between the vendor and the plain-
tiff such as to fix the plaintiff with knowledge of the alleged col-
lateral agreement –
over and above the written conditional sales
contract – made between the salesman and the defendant. The
application of the principle derived from Federal Discount Corpora-
tion v. St. Pierre2 5 on its peculiar facts is extremely limited. In
that latter case, plaintiff finance company was fully aware of the
general course of operation employed by its associate, Yarncraft
Industries, of home knitting contracts-to purchasers whom plaintiff
itself undertook to finance in the resulting sales. The words, im-
pressed by a rubber stamp of the finance company on certain de-
fendant’s documents, “Note –
payments must be made regardless
of the amount earned from Knitting”,’2 6 proved that the plaintiff
knew that the purchasers of home knitting machines would be left
with the impression that the money to meet the installment of pur-
chase price would be forthcoming from earnings under the home
knitting contract.
Mere knowledge of a contract collateral to a promissory note
does not impose a burden upon the finance company to investigate
the circumstances. In Federal Discount the facts made it impossible
for the finance company to deny that it had knowledge of the stipu-
lations written into the contract from which it could be clearly
inferred that payment of the cheques was conditional upon the earn-
ings derived from the sale of knitted goods to a subsidary of Fair
Isle (the knitting machine company).
It is interesting to note that the leading Quebec case of Com-
modity Discount v. Briand27 closely resembles Federal Discount
Corporation Ltd. V. St. Pierre 28 and deals with the exact identical
knitting company scheme.
Although the contract contained clauses similar to those quoted
in Prudential Finance v. Kutcheran et al,29 there is an important
24 Op. cit., at p. 402.
25 Op. cit. at p. 86.
26 Ibid. at p. 99.
27 [1962] C.S. 543.
28 Op. cit. ,at p. 86.
29 Op. cit., at p. 402.
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distinguishing fact. The finance company, of its own volition, investi-
gated each contract to verify whether any customer had been prom-
ised something in addition to what was in that contract. This was
fatal as it fixed the finance company with knowledge that certain
transactions were indeed fraudulent, thereby imposing a strict legal
duty to investigate thoroughly each contract, but it was not the mere
assignment of the contract which placed upon the holder any duty
to scrutinize the transaction as between the immediate parties.
The reasoning followed by Batshaw, J. is directly applicable to
the circumstances depicted in that case but should not be applied
recklessly in deciding cases whose fact patterns bear no resemblance
to it whatsoever.
So long as there are no circumstances connected with the finance
company’s acquisition of the promissory note and collateral agree-
ment, of a nature to indicate to it or cause it to suspect that the
payee’s title may be defective the finance company is under no duty
of investigate the transaction between the immediate parties.
It is both reasonable and logical to expect regular arrangements
between the finance company and the sales company for the pur-
pose of discounting the latter’s commercial paper. To claim that the
sales company must search for a different independant finance com-
pany to discount a sales contract, each time a customer wishes to
purchase an article is ridiculous. In fulfilling its vital economic func-
tion, the finance company is entitled to the protection afforded a
holder in due course in the same manner as any other lender.A0
There can be no doubt that everyday commercial life demands
that the utility of Bills of Exchange be not impaired and that a
holder acquiring a bill in good faith should not be required to inquire
into its pedigree.
This protection is absolutly essential if commercial transactions
are to be carried on effectively in an economy which is irreconciliably
committed to the phenomena of consumer credit !
30 The latest jurisprudence is once again reflecting this interpretation Poncelle
Inc. v. Home [1964] R.L. Commodity Discount Ltd. v. Baker [1961] O.W.N. 277.
Imperial Investment Corp. v. Mazur [1963]S.C.R. Industrial Acceptance Corp. v.
Rochfort [1961] C.S. 421. Banque Mercantile dv. Canada v. Emond [1964] C.S.
591. Canadian Imperial Bank of Commerce v. Lessard et un autre. [1964] C.S. 57.
