In recent years, there has been a noticeable increase in the volume of Canadian receivables being factored cross-border by U.S. factors. I believe the primary reason for this is that growing numbers of more and more U.S. factors are becoming comfortable with both the risk parameters of Canadian obligors in general, as well as the underlying Canadian legal and tax rules.
It therefore appears timely to outline a number of the issues that frequently arise, from a Canadian legal standpoint, when a U.S. factor purchases, from a Canadian client, receivables that are owed by Canadian obligors.
Will a court treat the factoring transaction as an absolute conveyance of receivables, or as a loan under which the “seller” continues to own them? The good news is that it is generally easier under Canadian law to achieve a “true sale,” including recourse arrangements where the seller assumes the risk of non-payment. To attain this result, the factoring agreement’s “sale and transfer” language should be absolutely clear and consistent, and U.S. agreements often require massaging for this purpose.
As in the U.S., it can be a gray area as to when a factor’s activities in a province will cross the line and require licensing for “carrying on business” in that province. However, as noted below, a U.S. factor should be able to arrange its Canadian-related activities so that they do not trigger a licensing requirement. In any event, even if the factor is met with the defence that it cannot enforce a purchased account because it not licensed, it can usually resolve the issue by becoming licensed, at a modest cost, even after starting an action to collect the account.
Canadian usury legislation is essentially federal, and is set at the surprisingly high rate of 60%, although provincial laws on financing costs may also apply in some circumstances. The federal legislation defines “interest” extremely broadly to include most charges, expenses, fees and other amounts other than principal. While no case has as yet applied usury limits to factoring transactions, this cannot be ruled out. However, where the all-in financing costs have been held to exceed the 60% limit, there is a growing acceptance of requiring the financing party to disgorge only the excess rather than forgo the entire financing charge. Factoring agreements should disclaim an intention to charge or receive “interest” at a usurious rate, and should include an approach for dealing with prohibited amounts that have in fact been received.
All Canadian provinces and territories, other than Quebec, have adopted a Personal Property Security Act (PPSA), which is modelled on UCC Article 9. In these PPSA jurisdictions, perfection of receivable purchases, and of security interests, will generally proceed by filing financing statements, although the PPSAs have not yet caught up with Revised Article 9’s new place of registration rules. Quebec takes a different approach — notification to an account debtor will perfect an account purchase, while a security agreement on personal property (called a hypothec) must contain special civil law language and requires registration.
It is critical for the seller’s name on a financing statement to be accurate in all respects. Also, if a corporation has a French equivalent or alternate name in its articles or other constating documents, both French and English names must be included in the financing statement or the factor will be unperfected.
Priority rules throughout Canada are similar, although not identical, to those found under Article 9. As a noted exception, certain unregistered government liens will prime a security interest, although generally not a factor’s interest in a purchased account. These “priority payables” should be taken into account when determining how much reliance to place on supplemental security.
Accounts owed by many federal government agencies or corporations cannot be sold, or assigned as security, unless the factor obtains a prescribed form of consent and follows a prescribed procedure. Some provinces have similar requirements. The procedures are not particularly onerous, but can be time consuming.
Quebec does not have legislation that counters the effect of a clause in an agreement that prohibits assigning the agreement or amounts payable under it. More due diligence is therefore prudent when purchasing Quebec accounts, such as reviewing underlying contracts or purchase orders, or requiring written consent from account debtors.
U.S. factors will want to ensure that they are not subject to Canadian income tax on their profits from factoring Canadian receivables. This should not be difficult since it is possible to do business with Canadians without doing business in Canada — if a factor and its employees and agents remain outside Canada, it should be possible to avoid the Canadian tax net. For example, communications could be by telephone or email rather than through on-site visits. However, if the factor appoints its Canadian client as agent to collect factored receivables, the factor could be viewed as carrying on business in Canada through the agent — even in this case, however, the factor may be able to rely on the Canada-U.S. tax treaty to avoid Canadian taxation on any profits that may be attributable to its Canadian collection activities.
U.S. factors should be aware of other possible Canadian taxes. While Canada has virtually abolished withholding tax on cross-border interest payments, certain unique interest clauses may still attract withholding tax. Lease payments, dividends, royalties and certain other cross-border payments may also be subject to withholding tax, although none of these taxes should apply to a plain vanilla trade receivable. If an account receivable includes any provincial sales tax (PST), which should not be the case if the receivable arose from a sale of goods for resale, the PST should normally be excluded from the factored receivable since PST may not be assignable.
There is a 15% withholding tax on payments to non-residents for services rendered in Canada, and an additional 9% tax if the services are rendered in Quebec. This would apply, for example, if a U.S. consulting firm performs services in Canada for a Canadian customer — the customer should withhold the tax when paying its account, and the factor that purchases the account would be subject to this withholding. This should not pose a problem for factors that understand their clients’ business and obtain appropriate indemnities in their factoring agreement. Comfort may be available from the Canadian tax authorities as to whether the withholding obligation also applies to services provided by Canadians in circumstances where the receivable is assigned to a U.S. or other non-resident factor.
French Language Requirements
Standard form agreements entered into with Quebec residents must be available in French. This French language requirement should therefore not apply where a Canadian seller has an opportunity to review and negotiate the various terms of a factoring agreement. It would in any event be prudent for a factoring agreement with a Quebec seller to provide, both in English and French, that the parties have required the agreement, and all related documents, be drafted solely in English.
Canadian dollar receivables raise several issues that should be addressed. The factor should ensure that its U.S. banker is able to provide Canadian dollar advances to the Canadian seller, and to convert Canadian dollar payments from account debtors, all on a basis that is economically satisfactory to the factor. Alternatively, the factor may wish to open a Canadian dollar account with a Canadian banker, and use the account to make advances and receive payments, and thereby avoid going through daily currency conversions. Since Canadian courts only render judgements in Canadian dollars, the factoring agreement should indemnify the factor for any exchange-related losses it may suffer if exchange rates change between the date it obtains a judgement for a U.S. dollar obligation and the date the judgement is paid.
Canadian courts generally act favorably towards guarantors. Guarantees, particularly those taken from individuals, should clearly waive the numerous defenses that might be available to guarantors. Also, Alberta legislation requires individual guarantors to sign a prescribed notarial certificate, which must also be signed by a notary and attached to (or noted on) the guarantee.
Federal legislation requires that interest be expressed as an annual rate — such as 12% per year rather than 1% per month. A 360-day interest rate clause should therefore include a formula that permits calculation of the equivalent annual rate. In addition, any clause that provides for interest after maturity, on overdue interest, or on a judgement should be expressed particularly clearly.
Apart from the matters discussed above, and routine “Canadianization” of U.S. terms and statutes, few substantive changes are normally required to adapt a U.S. factoring agreement for use in purchasing Canadian receivables from Canadian sellers. One recommended addition would be a clause that permits the factor, following default, to appoint a receiver to take possession of and manage its client’s business, which can be extremely useful if it becomes necessary to enforce the factor’s security. As well, it would be advisable to replace references to the ACH system, which does not exist in Canada, with more generic electronic transfer terminology.
It is to be hoped that the foregoing will remove some of the mystery regarding the factoring of Canadian receivables, and help explain why a number of U.S. factors have begun to add Canadian receivables to their portfolios of factored accounts.
Martin Fingerhut is a partner in the Toronto office of Blake, Cassels & Graydon LLP and chair of its Structured Finance Group. He represents Canadian, U.S. and European factors, lenders, borrowers, issuers, investment bankers, conduits, credit enhancers, financial guarantee insurers, trustees, liquidity providers and rating agencies in domestic and cross-border factoring, lending, securitization, covered bond and other commercial finance transactions. Fingerhut is the vice chair of the American Bar Association’s Securitization and Structured Finance Committee, and was a member of the Expert Advisory Group to UNCITRAL on the Convention on the Assignment of Receivables in International Trade.
He is a fellow and president-elect of the American College of Commercial Finance Lawyers and an executive director of the Association of Commercial Finance Attorneys. He can be reached at 416- 863-2638 or by e-mail at email@example.com.