Royal Bank of Canada v. Cow Harbour Construction Ltd., 2012 ABQB 59

Court of Queen ’ s Bench of Alberta Citation: Royal Bank of Canada v. Cow Harbour Construction Ltd., 2012 ABQB 59 Date: 20120123 Docket: 1003 11241, 1003 05560 Registry: Edmonton Between: Royal Bank of Canada Plaintiff - and - Cow Harbour Construction Ltd. and 1134252 Alberta Ltd. Defendants And Between: Docket: 1003 05560 BKCY Action No: 24-115359 In the Matter of the Bankruptcy and Insolvency Act , R.S.C. 1985, c. B-3, as amended In the Matter of the Companies ’ Creditors Arrangement Act , RSC 1985, c C-36, as amended And in the Matter of a Plan of Arrangement of Cow Harbour Construction Ltd. _______________________________________________________ Reasons for Judgment of the

Honourable Mr. Justice K.D. Yamauchi _______________________________________________________ I. Nature of the Matter [ 1 ] Various equipment lessors (collectively, the Applicants) have applied for what they claim to be their proportionate share of funds that PricewaterhouseCoopers Inc. (PWC) currently holds, pending this Court’s determination of whether their leases were subject to

section 11.01 (

a) of the Companies' Creditors Arrangement Act , RSC 1985, c C-36 ( CCAA ). PWC is the court-appointed receiver and manager of the assets, property and undertaking of Cow Harbour Construction Ltd. (Cow Harbour). II. Procedural History [ 2 ] On April 7, 2010, Cow Harbour obtained a stay of proceedings against it (Initial Order) under CCAA s. 11.02. This Court extended the Initial Order from time to time by a number of subsequent court orders.

Pursuant to the Initial Order, this Court appointed Deloitte LLP as monitor under the CCAA (Monitor). [ 3 ] Cow Harbour’s primary business consisted of overburden removal and general contracting services for oil extraction companies in Fort McMurray, Alberta. Its assets consisted mainly of earth moving and hauling equipment.

Much of the equipment that Cow Harbour used in its operations was leased from various parties. [ 4 ] On May 21, 2010, this Court directed the Monitor to provide all interested parties with a list of those leases which it had classified as ones entitling the respective lessors to receive ongoing monthly payments pursuant to CCAA s. 11.01.

This Court gave any party who claimed to have such a lease, but whose claim was not included in the Monitor's list, until June 2, 2010 to advise the Monitor that it was disputing the classification, failing which it was barred from subsequently asserting that its lease entitled it to those ongoing monthly payments. [ 5 ] Disputes were registered in relation to a total of 58 leases (Disputed Leases). [ 6 ] Also on May 21, 2010, this Court directed Cow Harbour to pay over to the Monitor’s counsel monies representing all monthly payments from April 1, 2010, that Cow Harbour would have paid to lessors under the Disputed Leases, or leases which had not yet been categorized (Disputed Lease Funds).

This Court directed the Monitor’s counsel to hold the Disputed Lease Funds pending resolution of disputes pertaining to categorization of the Disputed Leases. [ 7 ] It became clear as matters progressed that Cow Harbour was not going to be able to restructure it affairs through refinancing, compromise or an equity restructuring. Rather, the proceedings evolved into a liquidation. PWC was appointed as transaction facilitator to assist the various parties in their negotiations. Acting in that capacity, PWC negotiated a potential sale of certain of Cow Harbour’s assets to Aecon Group Inc. (Aecon).

On August 10, 2010, PWC’s acceptance of Aecon’s letter of intent received this Court’s endorsement, subject to the parties later applying for court approval of an asset purchase agreement and vesting order. [ 8 ] On August 25, 2010, the Royal Bank of Canada (RBC) successfully applied for a receivership order, pursuant to which this Court appointed PWC as receiver and manager of the assets, property and undertaking of Cow Harbour (Receiver). This Court then approved the asset purchase agreement and granted a vesting order in Aecon’s favour.

The transaction contemplated by the asset purchase agreement closed on August 26, 2010.

[ 9 ] The Disputed Lease Funds were transferred to the Receiver pending resolution of the disputes over classification of the Disputed Leases. [ 10 ] RBC was paid out in full through the CCAA and receivership proceedings. The secured creditor holding the next general security over Cow Harbour’s assets, property and undertaking is GE Capital Equipment Financing G.P. (GE). [ 11 ] The Receiver has settled many of the issues between Cow Harbour and various third parties, including many of the lessors under the Disputed Leases.

However, it continues to hold back a portion of the Disputed Lease Funds until this Court’s determination of entitlement to those funds. III. Issue [ 12 ] The Applicants ask this Court to determine which of the remaining Disputed Leases fall within CCAA s. 11.01(a). This, in turn, will determine which party or parties are entitled to a portion of the Disputed Lease Funds. IV. Law A. Legislation [ 13 ]

Section 11.01 (

a) of the CCAA provides: 11.01 No order made under

section 11 or 11.02 has the effect of (

A) prohibiting a person from requiring immediate payment for . . . use of leased . . . property or other valuable consideration provided after the order is made. [ 14 ]

Section 11.02 of the CCAA provides for a stay of proceedings. It states: 11.02(1) A court may, on an initial application in respect of a debtor company, make an order on any terms that it may impose, effective for the period that the court considers necessary, which period may not be more than 30 days, (

a) staying, until otherwise ordered by the court, all proceedings taken or that might be taken in respect of the company under the Bankruptcy and Insolvency Act or the Winding-up and Restructuring Act ; (

b) restraining, until otherwise ordered by the court, further proceedings in any action, suit or proceeding against the company; and (

c) prohibiting, until otherwise ordered by the court, the commencement of any action, suit or proceeding against the company. B. General Legal Principles [ 15 ]

Section 11.02 of the CCAA allows a court to order a stay of proceedings on an initial application under the CCAA in respect of a debtor company. This is in keeping with the general policy underlying the CCAA , which is to allow a debtor corporation to restructure its corporate or financial affairs in a way that will permit it to continue on as a going concern, without being hampered by those who wish to enforce their previously bargained for rights. As the Ontario Court of Appeal commented in Re Nortel Networks Corp. , 2009

ONCA 833 at para 16, 59 CBR (5th) 23 [Nortel], “[t]he primary instrument provided by the CCAA to achieve its purpose is the power ofthe court to issue a broad stay of proceedings under s. 11. That power includes the power to stay the debt obligations of the company”(emphasis added). Courts have given the CCAA a wide and liberal construction to facilitate this policy objective (see e.g. Chef ReadyFood Ltd. v. HongKong Bank of Canada (1990), (BC CA), 51 BCLR (2d) 84 (CA)). [16] While a debtor corporation is proceeding through the CCAA restructuring process, it must still carry on its business.

It hardlyseems fair to require a person to continue to supply the debtor corporation with goods or services, or to allow the debtor corporation tocontinue to use leased property, without that person being compensated for those goods, services or use.

Section 11.01(

a) of the CCAAallows for that compensation. [17] As noted in Re Smith Brothers Contracting Ltd. (1998), (BC SC), 53 BCLR (3d) 264 at para 3 (SC)[Smith Brothers], Parliament added what is now s. 11.01 to the CCAA as part of a set of amendments proclaimed in force on September30, 1997. Suche J. in Re Winnipeg Motor Express Inc., 2009 MBQB 204, 243 Man R (2d) 31 [Re Winnipeg], leave to appeal to CArefused, 2009 MBCA 110, [2009] 12 WWR 224, suggested that Parliament may have added this provision to clarify the point made inQuintette Coal Ltd. v.

Nippon Steel Corp. (1990), (BC CA), 51 BCLR (2d) 105 (CA) [Quintette], that a stay wouldnever be used to enforce the continuous supply of goods or services without payment for current deliveries. She also commented that theamendment brought the CCAA in line with the Bankruptcy and Insolvency Act, RSC 1985, c B-3 [BIA], which contains a similarprovision relating to proposals. [18] To further facilitate the policy objective of the CCAA, courts have given CCAA s. 11.01(a), which is an exception to the stayprovision, a narrow construction (Nortel at para 17).

They have differentiated between a “true lease,” in which the debtors’ corporation ispaying for use of the property, and a debt obligation clothed in the guise of a lease, i.e., a financing lease in which the debtors’corporation is “earning equity” in the property. Courts and writers have used the term “financing lease,” “security lease,” “financialleasing arrangement” or similar terms to describe the latter type of arrangement (referred to here as a financing lease).

It is only thedebtor corporation’s obligations under a true lease that courts have excepted from the stay of proceedings, not its obligations under afinancing lease (Smith Brothers at para 61). [19] Canadian courts have accepted the conclusion of Bauman J. (as he then was) in Smith Brothers that a true lease, being abailment of property, falls within the CCAA s. 11.01(

a) exception, while a financing lease does not. They also have endorsed his approach to distinguishing between the two types of arrangements (see e.g. Re International Wallcoverings Ltd. (1999), 28 CBR (4th)48 (Ont Ct Jus (Gen Div)) [International Wallcoverings]; Re Sharp-Rite Technologies Ltd., 2000 BCSC 122.

In Re PSINET Ltd. (2001), (ON SC), 26 CBR (4th) 288 at para 19 (Ont SCJ) [PSINET], Swinton J. stated: In my view, Smith Brothers Contracting Ltd. was correct in determining that [CCAA s. 11.01(a)] is to apply to payments for the use ofproperty provided after the stay order — that is, where a party provides new credit to the debtor following the stay. The payments underthe leases here are not that type of payment. These leases are clearly financing arrangements, whose purpose is to secure a loan whichwas provided before the stay order was made, and the payments owing are repayments for that loan.

Therefore, the leases here do notfall within [CCAA s. 11.01(a)] of the Act, and the order of Farley J. which prohibits the company from making payments under them isconsistent with the purpose of the Act. Any other determination would give the RBC an unfair advantage when compared to othercreditors of the applicants, who are bound by the stay. [20] While initially having questioned in oral reasons on August 25, 2010, whether it might be worthwhile to re-examine theapproach that Bauman J. took in Smith Brothers, this Court concluded the approach was sound, given that CCAA s. 11.01(

a) is to benarrowly construed. The substance and not the form of the arrangement between the debtor corporation and the other contracting party isof importance and, unless there is a sound policy reason for doing so, the court should not give an advantage to one creditor over another. [21] Why did this Court initially question the reasoning in Smith Brothers? [22] Bauman J. relied heavily on Professor Ronald CC Cuming’s article, “True Leases and Security Leases Under CanadianPersonal Property Security Acts” (1983) 7 Can Bus LJ 251, in arriving at his conclusions. As is apparent from the title, ProfessorCuming’s

article dealt with differentiating leases for purposes of personal property security legislation, not insolvency legislation. [23] The CCAA does not expressly incorporate personal property security legislation concepts. Unlike such legislation, the CCAAdoes not distinguish between a true lease and a financing lease.

[ 24 ] The way in which courts have used personal property security legislation concepts when they are dealing with CCAA proceedings, and the tension that this approach creates, was discussed by Professor Roderick J. Wood in his article, “The Definition of Secured Creditor in Insolvency Law” (2010) 25 BFLR 341. [ 25 ] Professor Wood recognized that the CCAA does not expressly deem a lessor in a financing lease transaction to be a “secured creditor” rather than an owner of the goods. He remarked that the

definitions of “secured creditor” and “security interest” in insolvency law (the CCAA and BIA ) do not adopt personal property security legislation terminology (at p 347). He noted that courts have held that the broader definition of the term “secured creditor” in the Income Tax Act , RSC 1985, c one (5th Supp.) ( ITA ) does not encompass lessors under a financing lease.

Professor Wood recognized the difficulty in interpreting the definition of “a secured creditor” in the CCAA as including a lessor under a title retention device such as a financing lease, given that courts have not done so in the context of the broader definition in the ITA . He expressed the view that the best way to resolve this tension would be for Parliament to clarify federal insolvency legislation, suggesting at p. 356 that: It would also produce a proper dovetailing of the federal insolvency provisions.

For example, the insolvency statutes provide that a stay of proceedings does not prevent a lessor from requiring immediate payment for use of the leased property. This gives the lessor the ability to collect post-commencement lease payments. Courts have held that this provision only applies to true leases and not to security leases. The latter are treated in the same manner as other security interests and the debtor is able to retain possession of the goods without the need to satisfy the post commencement payments.

This further demonstrates that the division between true leases and security leases that is produced by the application of the substance test of the PPSA is being recognized in insolvency law, and that an amendment of the definition of secured creditor to reflect this fact is the most sensible solution. [ 26 ] When examining Smith Brothers closely, it appears that Bauman J. was simply saying that the logic that Professor Cuming applied when differentiating between true leases and financing leases in the context of personal property security legislation applies equally to CCAA proceedings.

Said differently, CCAA s. 11.01(

a) protects parties who provide goods and services to the debtor corporation after a court grants an initial order, but not “creditors” to whom the debtor corporation has “debt obligations.” This would put the latter in a better position vis-a-vis the debtor corporation than the debtor corporation’s other creditors. [ 27 ] As previously stated, this Court is of the view that Bauman J’s decision with respect to this issue is in keeping with the CCAA ’s underlying policy objectives. [ 28 ] It is arguable, however, that Blair J. in International Wallcoverings left the door open for a court to find that a financing lease could fall within CCAA s. 11.01(a), when he said at para 4: While I would not go so far as to say, [ CCAA s. 11.01(a)] requires payment under all leasing arrangements, or (on the other hand) that it could never encompass a financial leasing arrangement, I am satisfied that in the particular circumstances of this case the reasoning of Smith Brothers is applicable and that the arrangements in question are more akin to equipment purchase financing arrangements . . . [ 29 ] He used the Smith Brothers true lease/financing lease analysis in reaching his conclusion.

He did not speculate as to the type of situation where CCAA s. 11.01(

a) might encompass a financing lease arrangement. [ 30 ] Winnipeg Motor could be considered one such case, and, as the result, is contrary to what might be expected when using the Smith Brothers analysis. [ 31 ] Winnipeg Motor dealt with the proper distribution of interim financing and administrative charges incurred after the court granted an initial order under the CCAA . The monitor recommended that the charges be distributed among the secured creditors based on a pro rata recovery. Two parties claimed to be true lessors.

The court referred to the distinction made in Smith Brothers between true leases and financing leases. It commented that the exclusion of financing leases from CCAA s. 11.01(

a) makes perfect sense based on the notion of ownership, as a financing lessor cannot seek the benefits of ownership when it has given it away (assuming the lessee has been acquiring equity in the leased goods). It also suggested that the narrow construction of CCAA s. 11.01(

a) as limiting the obligation of the debtor to make payments for “use” is consistent with the idea that a supplier cannot be expected to continue to provide its product without payment.

[ 32 ] The court in Winnipeg Motor noted the financing lessors’ complaint that they had been unduly prejudiced by the stay of proceedings. They argued that not only were they not being paid while the debtor corporation was using their assets for the benefit of the other stakeholders, but the debtor corporation was deteriorating their underlying security in the process. They maintained that this violated one of the fundamental objectives of the stay of proceedings: preventing one creditor from obtaining an advantage over other creditors during the stay period.

The court at paras 60-62 suggested that the fact true lessors were entitled to be paid aggravated the problem, stating: It is difficult to know how this situation can be remedied, given that the whole point of the CCAA is to relieve a company of ongoing financial burden to allow it the opportunity to restructure. In this case, for example, [the debtor corporation] would not have succeeded had it been obliged to pay for its equipment during the entirety of the restructuring. On the particular facts of this case, this issue became somewhat easier to address given the nature of [the debtor corporation’s] business.

Equipment to a transportation company is akin to raw goods to a manufacturer, and I was of the opinion that if [the debtor corporation] was going to be viable, at a certain point it would have to demonstrate it could pay for the essential means of production. Otherwise, there would be no purpose to continue the stay. Accordingly, I ordered that financing leases would be paid as of August 1, 2008. I say all this not to justify or revisit the basis for my earlier decision, but to get to the point that in considering what is equitable, undue prejudice is a reason to adjust what would otherwise be a uniform approach.

I am satisfied that equipment lessors in a business operation such as [the debtor corporation’s] do suffer undue prejudice. In this case, however, the equipment lessors were paid as of August 1. Being financing leases, those payments were not just for use, but included some amount on account of equity.

I conclude, then, that the undue prejudice suffered has been recognized, albeit not totally, perfectly or precisely, but, in my view, in an amount sufficient amount to justify the uniform application of the methodology proposed by the monitor. [ 33 ] Of interest, the court in Winnipeg Motor required one of the debtor corporation’s true lessors to contribute to the court- ordered charges, as it had derived the same benefit from the CCAA proceedings as the financing lessors. [ 34 ] In Re Clayton Construction Co.

Ltd. , 2009 SKQB 397 , 59 CBR (5th) 213 [ Clayton Construction ], the debtor corporation sought an extension of a CCAA stay of proceedings. Rothery J. granted the extension, but also allowed the payment of interest that the debtor corporation owed to nine of its equipment lessors as a means of compensating them for the use and depreciation of their equipment. The debtor corporation required the equipment to complete its contracts. The court determined that the monthly interest payments to the equipment lessors would not prejudice the other creditors.

The major secured creditor had benefited from the accounts receivable generated by the debtor’s use of the equipment and the unsecured creditors likely would not have received any benefit, had the equipment lessors withdrawn their support for the restructuring process. [ 35 ] Winnipeg Motor and Clayton Construction might be responses to the non-peer reviewed journal articles that criticize the Smith Brothers approach that courts have taken to the issue before this Court (see e.g. Steven J. Weisz, Linc A. Rogers & Stacy McLean, “Striking an Imbalance: The Treatment of Equipment Lessors Under

Section 11.3 of the CCAA ” (2003) 20:5 Nat’l Insolv Rev 45 at 48-49; Jeffrey C. Cahart, “Should There be Special Rules in Commercial Reorganizations for Equipment Lessors?” (2002) 15:2 Comm Insol R 13; Harvey G. Chaiton and John R. Hutchins, “Equipment Lessors in Restructurings: Hostage Lenders” (2009) 21 Comm Insol R 3). [ 36 ] One of the themes that runs through these articles is that it is unfair for courts to allow creditors that hold general security to gain a benefit from the debtor corporation’s use of the leased equipment during the stay period.

Cahart commented at p. 15: ... it is simply unfair to allow a debtor to continue to use (and to depreciate) a piece of (perhaps essential) equipment which the debtor only has because of the equipment lessor's financing while the debtor pursues a reorganization and/or a sale as a going concern (as has happened in so many CCAA cases) possibly over a very extended period. Again, unlike lenders with more general security, equipment lessors (usually) only have recourse to a specific asset.

Is it fair to allow, for instance, a mining company under CCAA protection to continue to use a specialized leased truck, continue to wear it down and to diminish its value, for 11 months for free, while the company pursues sale as a going concern and/or reorganization based on the company's going concern value? Among other things, the availability of the truck to the company over time: (

i) contributes to the going concern value of the company (and the preservation of which is at the heart of what the CCAA is trying to achieve); and (ii) allows the company to produce product which is turned into cash and which goes

to pay down an operating lender. Yet under the current jurisprudence, the relevant equipment lessor probably receives nothing during thestay period – not even its regular monthly payments, let alone any kind of “premium” for its contribution to the going concern value or tothe ability of the company to generate cash. [37] The problem, however, is that one creditor should not receive “an unfair advantage when compared to other creditors of theapplicants, who are bound by the stay” (PSINET at para 19). If some creditors are to be bound by the stay of proceedings, all creditorsmust be bound.

Any contrary approach invariably would lead to every creditor attempting to argue that its interests are being prejudicedby the stay of proceedings in one way or another, with the end result that the stay of proceedings would prove meaningless. [38] Smith Brothers concluded that courts must differentiate between true leases and financing leases. Is this what the legislationsays? [39] If certain portions of CCAA s. 11.01(

a) are emphasized, the legislation could be read differently. For example, CCAA s.11.01(

a) might be read as stating that: “No order made under

section 11 or 11.02 has the effect of prohibiting a person from requiringimmediate payment for . . . use of leased . . . property . . . provided after the order is made” (emphasis added). In other words, the phrase“provided after the order is made” might refer to “leased property.” In that case, lessors of pre-stay leases, whether true or financing,would be subject to the stay of proceedings. Only lessors of property leased post-stay could demand that the debtor corporation make itslease payments. This would be in keeping with judicial

interpretation of the balance of CCAA s. 11.01(a). For example, a supplier mayprovide goods or services to the debtor corporation post-stay on the basis of “cash on delivery.” [40] This type of

interpretation would not be unusual, as Canadian courts, including the Alberta Court of Appeal, have taken such agrammatical-interpretative approach when they have considered, for example, BIA s. 178(1)(d). That

section provides: 178(1) An order of discharge does not release the bankrupt from . . . (

d) any debt or liability arising out of fraud, embezzlement, misappropriation or defalcation while acting in a fiduciary capacity . . . [41] The question has arisen whether the words “while acting in a fiduciary capacity” qualify only the word “defalcation” orwhether they qualify all of the listed factors, including fraud, embezzlement, misappropriation and defalcation. Courts have held that thelatter is the proper

interpretation (see e.g. Confederation Life Insurance Co. v. Waselenak, (AB KB), [1998] 5WWR 712, 57 Alta LR (3d) 38 (QB), affd 2000 ABCA 136; 166404 Canada Inc. v. Coulter (1998), (ON CA), 4CBR (4th) 1 (Ont CA), leave to appeal to SCC refused (1998), 223 NR 395 (note); Ross & Associates v. Palmer, 2001 MBCA 17, 22CBR (4th) 140; Re Brant (1984), 52 CBR (NS) 317 (Ont SC)). [42] Including all pre-stay leases in the stay of proceedings would be in keeping with the broad and liberal

interpretation that courtshave given to the CCAA, which is to provide the debtor corporation with “breathing space” in which to determine whether it is in aposition to restructure its affairs and to facilitate its survival. Including only post-stay leases under CCAA s. 11.01(

a) also would be inkeeping with the narrow

interpretation of transactions that are excepted from the stay of proceedings. It would simplify CCAAproceedings involving equipment leases. [43] This

interpretation, however, does not give weight to the word “use” in CCAA s. 11.01(a). In making the true lease/financinglease distinction, Bauman J. in Smith Brothers and courts in subsequent cases have sought to do just that. They have read the

section asstating, “No order made under

section 11 or 11.02 has the effect of prohibiting a person from requiring immediate payment for . . . use ofleased . . . property . . . provided after the order is made” (emphasis added). In other words, it is “use” of the leased property which isprovided after a court makes the initial order. [44] A true lease, in essence, is a bailment contract such that ownership of the leased goods remains with the bailor/lessor and thebailee/lessee pays for “use” of those goods. In Punch v. Savoy’s Jewellers Ltd. (1986), (ON CA), 54 OR (2d) 383 atpara 17 (CA), the court defined bailment as follows:

... Bailment has been defined as the delivery of personal chattels on trust, usually on a contract, express or implied, that the trust shall beexecuted and the chattels be delivered in either their original or an altered form as soon as the time for which they were bailed haselapsed. It is to be noted that the legal relationship of bailor and bailee can exist independently of a contract. It is created by the voluntarytaking into custody of goods which are the property of another. (See also Visscher v. Triple Broek Holdings Ltd., 2006 ABQB 259, 399 AR 184 at paras 27-28; Letourneau v.

Otto Mobiles Edmonton(1984) Ltd., 2002 ABQB 609, 315 AR 232 at para 23). [45] The central character of a true lease is "payment for use." Bauman J. in Smith Brothers at para 48 adopted the followingstatement in Professor Cuming’s above-referenced

article to expand on this principle: Under a true lease, the lessor surrenders his possessory right in chattels to the lessee in return for an undertaking by the lessee to performcertain acts which usually involve the payment of money to the lessor. The lessee has obligations, but the transaction cannot becharacterized as a security agreement because the interest of the lessor is not related to those obligations. In other words, the lessor doesnot remain owner merely to ensure or to induce performance of the lessee's obligations.

He remains owner because a bailment contractdoes not involve the transfer of ownership to the bailee. [46] Bauman J. concluded in Smith Brothers at para 61: It is only payments for the use of leased property that are excepted from a s. 11 stay order under [CCAA s. 11.01(a)]. Payments for useand equity are not. Similarly payments for use and equity and an option to purchase are not.

This is another reason to conclude . . .[CCAA s. 11.01(a)] is not inclusive of all forms of lease. [47] This is a curious statement inasmuch as it might be seen as suggesting that a court should identify what portion of the leasepayments made under the instrument is for use rather than for acquisition of equity (and, perhaps, of the option to purchase). Thisapproach is not in keeping with other statements that Bauman J. made in Smith Brothers. In this Court’s view, the instrument is either afinancing lease or a true lease.

There is no room for finding the instrument to be a hybrid of the two, as this unnecessarily confuses theissue. [48] As acknowledged by Suche J. in Winnipeg Motor at para 31, “ . . . the true nature of arrangements involving the supply ofequipment can be very difficult to peg.” There can be a fine line between what is considered a true lease and a financing lease. [49] The determination of whether an arrangement is a true lease for purposes of CCAA s. 11.01(

a) involves a functional analysisof the relationship between the parties based on substance as opposed to form (Smith Brothers at para 26; Re Philip Services Corp.,(1999) (ON SC), 15 CBR (4th) 107 at para 2 (Ont SCJ [Commercial List] [Philip Services])). [50] Professors Ronald CC Cuming and Roderick J. Wood in their Alberta Personal Property Security Act Handbook, 4th ed(Toronto: Carswell, 1998) at 53 [Handbook] emphasized the need to examine the relationship between the lessor and lessee to determineif it reflects indicia of a financing arrangement.

They noted, however, that they were not referring to the traditional indicia prescribed bythe common law, but rather those which would be relevant to someone examining the economic realities of the transaction. [51] In Smith Brothers at para 67, Bauman J. referred to the following non-exhaustive list of considerations mentioned by MasterPowers sitting as a Registrar in Bankruptcy in Re Bronson (1995), 34 CBR (3d) 255 [Bronson], aff’d (1996), (BCSC), 39 CBR (3d) 33 (BCSC).

This list includes factors considered by American courts in determining whether a document is a truelease or a security agreement, as summarized in Teaching Material for Personal Property Security Transactions Governed by PersonalProperty Security Acts by Professor Cuming in September 1991: 1. Whether there was an option to purchase for a nominal sum;

2. Whether there was a provision in the lease granting the lessee an equity or property interest in the equipment; 3. Whether the nature of the lessor's business was to act as a financing agency; 4. Whether the lessee paid a sales tax incident to acquisition of the equipment; 5. Whether the lessee paid all other taxes incident to ownership of the equipment; 6. Whether the lessee was responsible for comprehensive insurance on the equipment; 7. Whether the lessee was required to pay any and all licence fees for operation of the equipment and to maintain the equipment at his expense; 8.

Whether the agreement placed the entire risk of loss upon the lessee; 9. Whether the agreement included a clause permitting the lessor to accelerate the payment of rent upon default of the lessee and granted remedies similar to those of a mortgagee; 10. Whether the equipment subject to the agreement was selected by the lessee and purchased by the lessor for this specific lease; 11. Whether the lessee was required to pay a substantial security deposit in order to obtain the equipment; 12.

Whether the agreement required the lessee to join the lessor or permit the lessor by himself to execute a UCC financing statement; 13. Whether there was a default provision in the lease inordinately favourable to the lessor; 14. Whether there was a provision in the lease for liquidated damages; 15. Whether there was a provision disclaiming warranties of fitness and/or merchantability on the part of the lessor; 16.

Whether the aggregate rental approximated the value of purchase price of the equipment. [See also PSINET at para 12 .] [ 52 ] Other courts have added that the right of the lessee to an “option to purchase” can be established through the course of conduct between the parties, if not expressly provided for in the document itself ( Philip Services at paras 4-5).

As well, leases that are “bundled together” for financing purposes may be construed as financing transactions and not as true leases, because the transactions really involve payment for financing the acquisition of the assets rather than payment for use ( Philip Services at para 9). [ 53 ] Neither Professor Cuming nor the court in Smith Brothers said that a lease must contain all of the foregoing indicia to be classified as a financing lease. Indeed, the main factor on which Bauman J. relied in deciding that the arrangement before him was a financing lease was the default clause.

[ 54 ] A court may use some or all of the Smith Brothers factors when assessing whether a particular transaction is a true lease or a financing arrangement. It is the substance of the transaction that is determinative. [ 55 ] Michael E Burke, in his

article “Ontario Personal Property Security Act Reform: Significant Policy Changes” (2009) 48 Can Bus LJ 289 at 291-97, undertook an empirical review of the authorities and discussed the relative weight courts have placed on these factors. He stated at 291-92: First, from the universe of factors or indicia that have been mentioned in the jurisprudence, some factors or indicia (referred to in this paper as "primary factors") are clearly more important than other factors or indicia (referred to in this paper as "secondary factors").

Second, the presence of a primary factor in a lease will often be determinative of the characterization of the agreement. Third, secondary factors generally have a corroborative value and are not in and of themselves determinative of the characterization. Accordingly, the presence of a number of secondary factors that are indicative of a characterization that is contrary to the characterization indicated by the primary factor will not be sufficient to overturn the weighting given by a court to the primary factor.

Fourth, in those situations where the primary factor is ambiguous or absent, then the relative weighting given by a court to the secondary factors will be relevant in determining the characterization of the lease in question. [ 56 ] Topolniski J. in Re 843504 Alberta Ltd. , 2011 ABQB 448 at para 63 , 80 CBR (5th) 177 [ 843504 ] identified what Burke at 292-94 referred to as “primary factors:” (

a) Relevance of the purchase option price - whether the purchase option price is nominal or reflective of fair market value. (

b) Mandatory purchase options - whether there is a mandatory purchase option that obligates the lessee to purchase the equipment at the end of the term. (

c) Open-end leases/guaranteed residual clauses - whether the lessee is liable for any deficiency in the sale of the equipment at the end of the term. (

d) Sale-leaseback transactions - whether the transaction is structured as a sale and leaseback. [ 57 ] Topolniski J. then identified (at para 65) what Burke (at 295-98) referred to as “secondary factors”: (

a) The ability to replace/exchange leased equipment is indicative of a true lease. (

b) The lessor's ability to accelerate payments and the residual value are generally inconsistent with a true lease. However, it is equally consistent with a true lease if the acceleration clause limits the lessor's damages to the present value of the remaining rents, plus the present value of the residual value at the end of the term, minus the value of net proceeds from a sale of the assets. If the acceleration clause is more narrowly crafted, it favours a security lease. (

c) A full payment lease may be indicative of either form of lease, depending on the language of the provision. (

d) A security deposit is indicative of a security lease. (

e) A substantial down payment is indicative of a security lease.

(

f) Covenants relating to maintenance, insurance and risk of loss can be indicators of either type of lease. They are weak evidence of a security lease. (

g) Whether the lessor uses different forms for different types of transactions may be some evidence of intention. [ 58 ] Burke also identified (at 297) some factors, such as the exclusion of warranties on the lessor’s part, as “red herrings” because their presence (or lack of presence) in a lease is equivocal: see also Weisz, Rogers & McLean at 48-49. [ 59 ] On an application for leave to appeal this Court’s assessment that a particular agreement at issue in these proceedings was a financing lease, the Alberta Court of Appeal in De Lage Landen Financial Services Canada Inc. v.

Royal Bank of Canada , 2010 ABCA 394 at para 60 [ De Lage Landen (CA) ], refusing leave to appeal 2010 ABQB 637 , 37 Alta LR (5th) 82 [ De Lage Landen (QB) ] expressly rejected the suggestion that there should be a hierarchy of factors that a court should use to determine if a lease is a true lease or a financing lease. In denying the leave application, Ritter J.A. stated at para 15: The applicant points to a British Columbia decision which suggests in obiter that there should be a hierarchy of factors used to determine if a lease is a true lease or a financing lease.

In my view, this obiter runs contrary to current trends about how to weigh the factors in a legal test and about the deference afforded to courts of first instance in this respect. If one factor trumps the others, there is simply no point in including the others in the test . [Emphasis added]. [ 60 ] During the present hearing before this Court, counsel spent a significant amount of time attempting to rationalize 843504 and De Lage Landen (CA) . In this Court’s view, there is no conflict between the two.

Topolniski J. in 843504 cited the Court of Appeal’s decision in De Lage Landen (CA) and quoted (at para 60) this Court’s observation in De Lage Landen (QB) at para 32 that: ... no one factor “is the sine qua non for determining whether a document is a true lease or a financing lease.

One must look at the whole document to get a flavour of the [parties'] intentions . . .” While Topolniski J. referred to Burke’s discussion of how courts weigh certain factors and outlined the results in her case of applying his “primary” and “secondary” factors, she did not necessarily endorse the view that there is a “hierarchy” of factors in every case. [ 61 ] Topolniski J. considered (at para 64) a provision in the lease before her which provided that: · the lessee could return the vehicle at the end of the six-month minimum lease term; · once the lessee returned the vehicle, the lessor would sell the vehicle; · the lessee would keep the surplus if the sale proceeds exceeded the termination book value; and · if the sale proceeds did not exceed the termination book value, the lessee would be liable for the shortfall.

She found this provision was indicative of a security lease since it rendered the lessee liable for a deficiency on the vehicle’s sale at the end of the term. [ 62 ] Topolniski J. also applied Burke’s “secondary” factors to the lease that was before her. There would have been no point in her doing so had she accepted that the lessee’s liability for the deficiency trumped any and all secondary factors. She concluded that the

secondary factors were not determinative of the proper characterization of the lease (at para 67). The presence of some secondary factorswas insufficient to outweigh the clear effect of the primary factors in her case. [63] GE suggests that Topolniski J. acknowledged that the presence of a primary factor often can be determinative of thecharacterization, while absence or ambiguity in respect of the primary factors can make weighing of the secondary factors more relevant.In fact, Topolniski J. did not make such a statement. She simply quoted the Burke

article where Burke made that argument. [64] GE argues that while the presence of one of Burke’s “primary” factors is significant, absence or ambiguity in respect of aprimary factor is not determinative. It simply means that other factors will be more important in the analysis.

For example, GE submitsthat the presence of an option to purchase at nominal value is a primary factor, and while its presence likely will result in the agreementbeing characterized as a financing lease, the absence of such an option or, indeed, the presence of an option to purchase at fair marketvalue, means that focus must be directed to the other factors.

GE suggests that this approach is consistent with authorities which hold thatagreements without an option to purchase may still be classified as financing leases when the other indicia of financing leases arepresent. [65] The proper approach is more holistic than the one advocated by GE. While the presence or absence of one or more factorsmay loom larger than others, in all instances the inquiry remains focussed on determining the intention of the parties and is based on aninterpretation of the entire agreement.

As stated by the Alberta Court of Appeal in De Lage Landen (CA), one factor cannot trump othersin terms of the legal test. Courts must review the entire agreement and they must consider all factors. That is not to say, however, thatcertain factors may not have greater probative value than others in terms of the particular agreement before the court. In such a case, thecourt might give those factors greater weight.

In all cases, the court must examine the various Smith Brothers factors and any otherfactors it considers material and relevant, balance those factors in the context of the entire agreement, and make a determination as towhether the agreement before it as a financing lease or a true lease.

This is not a scientific exercise. [66] Counsel for several of the Applicants argue that payments that Cow Harbour made under leases containing an option topurchase were payments for “use,” as the “purchase price” was not due and payable until Cow Harbour exercised the option to purchaseor the lease came to an end and the lessee chose to pay the purchase price at a nominal sum. They cite Ed Miller Sales & Rentals Ltd. v.Alberta (1982), (AB KB), 42 AR 350 (QB) [Ed Miller] in support of this position. Purvis J, in that case, relied in turnon Ramsay v.

Pioneer Machinery Co. (1981), 1981 ABCA 56 , 28 AR 429 (CA) [Ramsay]. [67] The issues in Ramsay were whether a transaction fell within the Conditional Sales Act, RSA 1970, c 61 and, if it did, whetherthe conditional seller could recover the purchase price through the sale of the equipment or by suing the conditional buyer. This wascalled the “seize or sue” provision. The Alberta Court of Appeal stated at para 20: ... Until the option is exercised the lessor is not pursuing his “right to recover the purchase price”.

If he chooses to recover the chattel heis exercising his right of possession on default, which is a right independent of any money claim. I have no hesitation in saying that [theseize or sue provision] is not applicable unless the lessor is seeking to recover the purchase money and he cannot seek to recover thepurchase money until the option is exercised.

It may be that a “lessor” who is found to be, in substance, a “conditional sales vendor”should be treated as a vendor claiming his purchase price within the section, but that is not this case. [68] In Ed Miller, the court considered whether lessors holding leases with options to purchase could maintain a priority claim to abuilders’ lien fund.

The court applied the analysis in Ramsay in finding that until the lessees exercised the options to purchase, thelessors were not “sellers” under the Conditional Sales Act and, “ . . . [t]hey are not attempting to recover a purchase price, but areattempting to establish priority against a lien fund for rental for equipment” (at para 49).

As a result, the court held that the lessors’claims were not for payment of purchase moneys but for rental and, as a result, they were entitled to advance a claim for a lien for areasonable and just rental of the equipment while used on the contract site (at para 50). [69] The now repealed Conditional Sales Act contained specific provisions concerning registration and remedies available toconditional sellers. The courts, when considering that statute, were more interested in the structure of the transaction than the parties'intention.

In fact, the court in Ed Miller commented, “Stevenson J.A. [in Ramsay] found that it was sufficient to bring the transactionwithin the relevant sections of the Conditional Sales Act if it was established that the lessee merely had it within his power to acquireownership. It was not necessary to establish intention” (at para 43).

[ 70 ] When a court undertakes the true lease/financing lease analysis under the CCAA , substance, including the parties' intention, is one of the paramount considerations. The form the transaction takes is not. The “all or nothing” argument advanced by certain of the Applicants could just as easily result in all lessors of true and financing leases being precluded from receiving anything during the stay of proceedings. [ 71 ] Accordingly, it is of the utmost importance that this Court examine each lease individually to determine whether it falls within the category of a true lease or a financing lease. [ 72 ] Finally, it is a fundamental principle of contractual

interpretation that a court must interpret an agreement as at the date it was made, as the exercise is intended to discern the intention of the parties at the time the contract was formed ( McDonald Crawford v. Morrow , 2004 ABCA 150 at para 72 , 348 AR 118). V. Specific Leases A. Scott Capital Group Inc. (Scott Capital) Leases 1. The leases [ 73 ] Five of the Disputed Leases are between Cow Harbour and Scott Capital. The lease details are as follows: Lease number Date day/month/year Term (months) Capital Cost of Items Monthly Rental Option Price Security Deposit 6049520

Schedule 001 1/10/2009 60 $559,951 $10,469 25% of original capital cost $55,995 = 10% of original capital cost 6049520

Schedule 002 30/10/2009 48 $801,250 $18,184 20% of original capital cost $160,250 = 20% of original capital cost 6049520Schedule 003 18/12/2009 48 $234,000 $5,295 Fair market value $46,800 = 20% of original capital cost 6049520Schedule 004 4/2/2010 48 $664,832 $16,717 Fair market value $132,966 = 20% of original capital cost

6049520Schedule 005 5/2/2010 48 $286,020 $7,190 Fair market value $57,204 = 20% of original capital cost [ 74 ] All of the Scott Capital leases are subject to the terms of the Scott Capital Master Equipment Lease that the parties entered into on October 1, 2009 (Scott Master Lease). Scott Capital’s affiant deposed that the Scott Master Lease had been in effect for 30 years, with the last revision having been made about ten years ago. He confirmed that Scott Capital used the same form for what Scott Capital intended to be true leases and financing leases.

The number 6049520 refers to the Scott Master Lease to which all of the Scott Capital leases being considered are subject. This Court will refer to each lease by its

Schedule number. [ 75 ] Scott Capital leased eight pieces of heavy equipment or vehicles to Cow Harbour under these five leases. It entered into all of these leases with Cow Harbour within six months prior to Cow Harbour's CCAA filing. In the case of the

Schedule 001 lease, the equipment was only commissioned for use by Cow Harbour in July 2010, which was well into the CCAA proceedings. [ 76 ] The evidence of Scott Capital’s affiant was that Cow Harbour sourced the equipment, negotiated the sale price and approached a broker to seek assistance with acquisition of the assets. The broker then contacted Scott Capital and the equipment went straight from the third party vendor to Cow Harbour. [ 77 ] Scott Capital’s affiant deposed that Scott Capital generally structured its leases as true leases.

His due diligence on Cow Harbour suggested that Cow Harbour might be in a precarious financial position. As a result, Scott Capital had no intention of providing “financing leases” to Cow Harbour. He deposed that Scott Capital made it clear to Cow Harbour, and Cow Harbour accepted and acknowledged at the time they negotiated the leases, that the lease options to purchase were to be at fair market value. [ 78 ] All of the leases identify the option price as being fair market value. In three of the leases, that value is not specified.

In the other two, the fair market value of the equipment is pre-estimated and agreed by the parties to be a particular percentage of the original capital cost of the equipment (25 percent in the

Schedule 001 lease and 20 percent in the

Schedule 002 lease). [ 79 ] The security deposits that Scott Capital required Cow Harbour to pay under the leases amounted to 10 percent of the capital cost of the equipment in the case of the

Schedule 001 lease and 20 percent of the capital cost of the equipment in the other four leases. 2. Lease-specific arguments of the parties (

a) Scott Capital [ 80 ] Scott Capital asserts that it did not structure its leases in such a way that Cow Harbour was financing its purchase of the equipment or accruing equity in the equipment over the lease term. Rather, Scott Capital structured the leases to ensure that the use, condition and value of the equipment were being controlled and maintained, as Scott Capital expected that Cow Harbour would return the equipment to it at the end of the lease terms. As the affiant stated on cross-examination: A. You will see that the terms on these leases are different.

And part of that is because we feel that certain equipment may be perhaps more abused. Certain equipment naturally has a different life than other equipment. But that type of an analysis is factored into whether or not we will enter into a 48-month lease or perhaps a 60-month lease. If we think that equipment will be used gingerly, then we will perhaps enter into a longer-term lease. If we think that equipment will be used harshly in harsh conditions, we want to put it on a shorter-term lease. There always has to be value on that equipment in the event that it's returned.

[Transcript of the cross-examination of Brian Jagt, 26 October 2010, p. 20, ll 21-34.] [ 81 ] The

Schedule 003,

Schedule 004 and

Schedule 005 leases, in addition to other detailed terms concerning the maintenance and condition of the equipment, specified usage maximums in the return provisions of the lease. Scott Capital did this with specific care and concern for the equipment’s condition, having regard to how Cow Harbour intended to use the equipment. The affiant explained that Scott Capital was concerned about the number of hours that Cow Harbour intended to use the equipment, rather than the number of kilometres of recorded use, as Scott Capital anticipated that the buses and trucks would be running constantly but not travelling great distances. [ 82 ] The purchase option prices set out in the

Schedule 001 and the

Schedule 002 leases (25 and 20 percent, respectively, of the original capital cost of the equipment) were not arbitrary figures. Rather, Scott Capital determined those prices and Cow Harbour agreed to those prices as a reasonable pre-estimate of the equipment’s fair market value at the end of the lease term, based on Cow Harbour’s anticipated use and the nature of the use. [ 83 ] Scott Capital points out that the present value of the rentals under each lease was less than 90 percent of the original equipment cost. (

b) Monitor [ 84 ] The Monitor suggests that the

Schedule 001 and

Schedule 002 leases are best characterized as financing leases because, among other factors, the end of term purchase option price appears to be arbitrary and bears no direct connection to the actual value of the leased equipment at the time Cow Harbour was to exercise the option. In other words, Cow Harbour appears to have acquired equity in the leased equipment because the fair market value of the leased equipment at the time Cow Harbour was to exercise the option may exceed the purchase option price. [ 85 ] In addition, the

Schedule 001 and

Schedule 002 leases overwhelmingly exhibit other indicia of a financing lease, as discussed in Smith Brothers , which militates against them being considered true leases. Specifically, the leases contain the Smith Brothers financing lease factors 3 to 10 and 13 to 16. [ 86 ] The Monitor points out that the aggregate rental under the

Schedule 001 and

Schedule 002 leases approximated the value of the purchase price of the equipment, factoring in interest and carrying costs ( Smith Brothers factor 16), as the equipment in the

Schedule 001 lease originally was valued at $559,951 plus applicable tax, while the total amount to be paid by Cow Harbour during the course of the term was $628,140 plus applicable tax. In the

Schedule 002 lease, the equipment originally was valued at $801,249.96 plus applicable tax, while the total amount to be paid by Cow Harbour over the course of the term was $1,033,079.83 plus applicable tax. [ 87 ] In the

Schedule 003,

Schedule 004 and

Schedule 005 leases, the end of term purchase option was referred to as “fair market value” (with no approximated value of what that value might be). While this factor militates in favour of each such lease being characterized as a true lease, the Monitor notes that, as in Bronson , these leases contained default provisions which guaranteed to Scott Capital the residual value of the equipment. These three leases contained financing lease Smith Brothers factors 3 to 10 and 13 to 15. (

c) GE [ 88 ] GE takes the position that the Scott Master Lease bears the indicia of a financing lease as Smith Brothers factors 4 to 11 and 13 to 15 are present. [ 89 ] It says the present value of the rental payments is irrelevant. The more important factor is that the aggregate cost of the rental payments exceeded the value of the equipment at the commencement of the lease.

[ 90 ] GE points to the evidence of Scott Capital’s affiant that the amount of the security deposit that Cow Harbour paid at the outset of the

Schedule 002 lease was equal to the amount of the purchase option at the conclusion of the term. It contends this was equivalent to a nominal purchase option price and suggestive of a financing lease as Cow Harbour, at the outset of the lease, paid the amount of the purchase price due at the conclusion of the lease. [ 91 ] GE maintains that, if this Court accepts Scott Capital’s assertion that the purchase price options in the

Schedule 003,

Schedule 004 and

Schedule 005 leases were for fair market value, it would be accepting form over substance. Scott Capital’s affiant confirmed that the amount of the security deposit that Cow Harbour paid in respect of each of these three leases at the outset of the leases was equal to Scott Capital's internal estimate of the remaining value of the equipment at the conclusion of the leases. Said differently, Cow Harbour, at the outset of the lease, paid what was estimated to be the equipment’s remaining value at the conclusion of the lease, leaving Cow Harbour with a nominal purchase option. 3.

Decision [ 92 ] Applying the Smith Brothers criteria to the five Scott Capital leases reveals the following: 1. Whether there was an option to purchase for a nominal sum - No, the purchase price was reflective of fair market value (see discussion below). 2. Whether there was a provision in the lease granting the lessee an equity or property interest in the equipment - No. 3. Whether the nature of the lessor's business was to act as a financing agency - The affiant acknowledged financing leases are a small portion of its business. 4.

Whether the lessee paid sales tax incidental to acquisition of the equipment - Yes. 5. Whether the lessee paid all other taxes incidental to ownership of the equipment -Yes. 6. Whether the lessee was responsible for comprehensive insurance on the equipment - Yes. 7. Whether the lessee was required to pay any licence fees for operation of the equipment at its expense - Yes. 8. Whether the agreement placed the entire risk of loss on the lessee - Yes. 9.

Whether the agreement included a clause permitting the lessor to accelerate payment of rent on default by the lessee and granted remedies similar to those of a mortgage - Yes. 10. Whether the equipment subject to the agreement was selected by the lessee and purchased by the lessor for this specific lease - Yes. 11. Whether the lessee was required to pay a substantial security deposit in order to obtain the equipment - Yes. 12. Whether the agreement required the lessee to join the lessor or permit the lessor by himself to execute a UCC financing statement -

Not applicable. 13. Whether there was a default provision in the lease inordinately favourable to lessor - Yes. 14. Whether there was a provision in the lease for liquidated damages - Yes. 15. Whether there was a provision disclaiming warranties of fitness and/or merchantability on the part of the lessor - Yes. 16. Whether the aggregate rentals approximated the value of the purchase price of the equipment - Yes. [93] What do these results establish? [94] Scott Capital’s affiant conceded that Cow Harbour sourced the equipment and then approached a broker to seek assistancewith acquisition of the assets.

The broker would then contact Scott Capital. The way in which the leases came about is more reflective ofa financing lease transaction than a true lease situation. However, it is important for this Court to examine the structure of eachtransaction to characterize properly the agreement. [95] All of the leases had purchase options. This Court must attempt to value the purchase price option as at the date Cow Harbourand Scott Capital executed the lease agreements.

As stated in the Handbook at 55: A clause in a lease giving the option to purchase the goods at less than their expected market value (as determined at the date ofexecution) indicates that the lessee has acquired an equity in the goods not unlike that which he would have acquired under an instalmentpurchase contract. [Emphasis added.] [96] In Re Ontario Equipment

(1979) Ltd. (1981), (ON SC), 33 OR (2d) 648 at para 9 (HCJ), aff’d (1982), (ON CA), 35 OR (2d) 194 (CA), Henry J.considered the nature of the option to purchase to be a critical factor indistinguishing between true leases and financing leases in personal property security legislation cases, stating: The test in determining whether an agreement is a true lease or a conditional sale is whether the option to purchase at the end of the leaseterm is for a substantial sum or a nominal amount ...

If the purchase price bears a resemblance to the fair market price of the property,then the rental payments were in fact designated to be in compensation for the use of the property and the option is recognized as a realone. On the other hand, where the price of the option to purchase is substantially less than the fair market value of the leased equipment,the lease will be construed as a mere cover for an agreement of conditional sale. [97] Whether a purchase option price is nominal is fact-specific. A purchase option for a nominal sum is indicative of a financinglease.

On the other hand, a purchase option at fair market value is highly suggestive of a true lease.

The rationale, according to Burke, isthat, “[i]f the lessee is required to pay the actual value of the property at the end of the lease at a time when the property still has value,then the lease payments cannot reasonably be said to have been payments towards an equity interest in the property” (at 293). [98] However, as noted by the Master in Bronson at para 55 and confirmed by the British Columbia Supreme Court in that case(at para 7), the mere existence of a fair market value purchase option price in the agreement is not necessarily determinative of whetherthe agreement is a true lease or a financing transaction. [99] In Smith Brothers, Bauman J. commented that simply because the lessee can purchase the equipment at its fair market valueat the end of the lease does not prevent a court from characterizing the transaction as a financing transaction if the end of the lease termis roughly equivalent to the end of the equipment’s useful life (at para 76).

[ 100 ] Professors Cuming and Wood explained in their Handbook at 55 that: A clause in a lease giving the lessee the option to purchase the goods at less than their expected market value (as determined at the date of execution) indicates that the lessee has acquired an equity in the goods not unlike that which he would have acquired under an instalment purchase contract. The economic reality is that it is quite predictable the lessee will pay this amount to the lessor. Consequently, the transaction is likely to be characterized as a security agreement.

However, the fact that at the end of a lease term roughly equivalent to the useful life of the goods the lessee can purchase the goods at their then market value does not prevent characterization of the transaction as a security agreement. If one or more of the major indicia of a security agreement are present, the transaction may be a security agreement.

Accordingly, if the lease is for all or the greater part of the useful life of the leased equipment and the lessee is obligated to pay rental equivalent to the capital cost of the goods and an appropriate credit charge, the fact that the lessee is given the right to buy the goods at the end of the term for their then small market price should play no role in the characterization process. A consideration of the option price is relevant to the characterization of the transaction only if the option can be exercised at a time when the goods have significant commercial value.

It may be possible to show that the option price was not designed to ensure that the lessor is fairly compensated for his interest in the goods, but was included for some other purpose (such as satisfying income tax authorities). This provides strong evidence that the parties recognize that by the time the option is exercised the lessor has been fully compensated through rental payments and that it matters little to either the lessor or the lessee that the option is or is not exercised. [ 101 ] In the

Schedule 001 and

Schedule 002 leases, the purchase option price was expressed to be the “fair market value” of the equipment, pre-estimated and agreed by the parties to be 25 percent and 20 percent, respectively, of its original capital cost. These percentages equated to purchase prices of $139,987.75 (Schedule 001 lease) and $160,249.99 (Schedule 002 lease).

These are not nominal amounts. [ 102 ] Scott Capital’s affiant deposed that Scott Capital used a “combination of past experience, extensive equipment knowledge, market knowledge and the application or intended use of the equipment to determine the value of any purchase option at lease end such that it is a reasonable estimate of fair market value.” [ 103 ] The

Schedule 003,

Schedule 004 and

Schedule 005 leases all stated that the purchase option price was “fair market value.” There is no evidence to suggest that the parties meant or intended otherwise. [ 104 ] This Court finds that the options were for fair market value or a reasonable pre-estimate of such. [ 105 ] There was no evidence that 60 months in the case of the

Schedule 001 lease or 48 months in the case of the

Schedule 002,

Schedule 003,

Schedule 004 and

Schedule 005 leases was roughly equivalent to the end of the useful life of the equipment involved in those leases. In fact, Scott Capital’s affiant stated that Scott Capital structured the leases to ensure there was value in the equipment at the end of the lease term. [ 106 ] These leases did not contain any mechanism, either in a default situation or at full term, whereby the surplus value of the equipment would go to Cow Harbour. If, at the end of the term of each lease, Cow Harbour did not exercise the purchase option to acquire the equipment, Cow Harbour had to return the equipment to Scott Capital.

Scott Capital could then deal with the equipment as it saw fit for its own benefit and account. Cow Harbour was not responsible under any of these leases for any deficiency or shortfall on the sale of the equipment at the end of the term. [ 107 ] The Scott Master Lease s 13(

f) contained a default clause allowing for liquidated damages to consist of the present value of rents owing to the end of the term, plus the present value of the residual value of the equipment “which Lessor expected to receive at the expiry of the term of the lease, which is equal to the Fair Market Value of the Equipment as set out in the Equipment

Schedule ...,” minus the net proceeds from a sale or lease of the equipment. The lease schedules stated that if Cow Harbour defaulted in its obligations under the lease, Scott Capital would retain the security deposit as liquidated damages. [ 108 ] The default provisions in DaimlerChrysler Services Canada Inc. v. Cameron , 2007 BCCA 144 [ DaimlerChrysler ], rev’g 2006 BCSC 1992 , 32 CBR (5th) 188 were similar (other than retention of the security deposit). The court found that the lease secured the

payment of the residual value by the lessee in the contingency of default (at para 28). The court went on at para 37 to say: ... the basis for calculating damages does not distinguish a true lease from a security lease. The ability to claim accelerated damages in Langille was not a consequence of the character of the lease, i.e., a true lease or a security lease. Rather, it was simply the proper measure of damages for breach of a chattel lease. Generally, the basis for calculating damages can provide only some insight as to whether an impugned lease secures payment or performance of an obligation.

I emphasize that it cannot serve as a decisive factor. [ 109 ] The Chambers Judge had concluded in DaimlerChrysler that the transaction was a security lease, following Bronson , which found that the default clause secured payment of both the lease payments and the option price.

On appeal, the court determined that the chambers judge had placed undue weight on the default provision as it can have only corroborative effect (at para 46). [ 110 ] According to Burke at 294: If, however, the lessee’s residual value guarantee only applies in the case of an early termination of the lease, whether voluntarily by the lessee or by the lessor as a result of the occurrence of a default, but not at the end of the scheduled lease term, then such a residual value guarantee will not constitute a primary factor that is indicative of a security lease. [ 111 ] In the case before this Court, the default provisions contained in the Scott Capital leases are equivocal. [ 112 ] The aggregate of rental payments for each of these leases is greater than the original capital cost of the equipment.

Professors Cuming and Wood expressed their view in the Handbook that if the lessee must pay the equivalent of the lessor’s capital investment plus a credit charge at the rate existing at the date of the agreement, there is strong but not conclusive evidence of a secured sale ( at 54 ).

However, Burke commented at 296: If a lessee is required to pay what is the equivalent of the original cost of the leased property (i.e., the lessor ’ s capital investment), plus a finance charge based on the rate existing at the date of the lease agreement, it does not necessarily follow that such an agreement is a security lease, especially if the lease contains a true fair market value purchase option. In such a lease, it is possible that the lessee has simply agreed to pay a premium for the use of the leased property. [ 113 ] The

Schedule 003,

Schedule 004 and

Schedule 005 leases contain specific use limitations with corresponding excess use charges. In DaimlerChrysler , the Chambers Judge found that excess kilometre charges and maintenance obligations were indicative of a true lease as they protected the lessor against reduction of market value on expiry of the lease term due to excess “wear and tear” (at para 25). Burke, however, considered such provisions equally consistent with a financing lease, as they suggest that the lessee bears some risks of ownership (at 296).

This Court finds that those provisions are equivocal in the case of the Scott Capital leases. [ 114 ] All five Scott Capital leases required substantial security deposits. The evidence of Scott Capital’s affiant on cross-examination was that for four of the five Scott Capital leases, the amount of the security deposit was equivalent to the purchase option price in the lease or the anticipated purchase option price (transcript of the cross-examination of Brian Jagt, 26 October 2010, pp 43-45). He explained that in terms of the

Schedule 003,

Schedule 004 and

Schedule 005 leases (which have purchase options simply stated to be at “fair market value”), the security deposit was based on the “estimated” fair market value of the equipment, but that this was just Scott Capital’s internal estimate (transcript of the cross-examination of Brian Jagt, 26 October 2010, pp 39-42). Scott Capital did not provide this information to Cow Harbour.

Cow Harbour had the ability to purchase the equipment at the end of the term of the lease for the “fair market value,” irrespective of whether that amount turned out to be less than, equal to, or greater than the amount of the security deposit. [ 115 ] During cross-examination, the Scott Capital affiant gave the following evidence: Q. And would I be correct in stating as well that typically if a purchaser or if a lessee does exercise an option to purchase the equipment at the end of the lease, the deposit will be utilized in some fashion to acquire the equipment?

A. It depends on the customer. Some customers want us to reimburse in the form of a cheque their security deposit, and then they pay us a separate cheque for the full amount if they purchase it. And other customers just tell us to net it against their purchase option, making sure that the bill of sale records the correct gross purchase price and then with the reflection that the other amount has been applied. Q.

And was there any discussion with Cow Harbour at any point in time with respect to how the deposit, whether the deposit would be utilized for the purchase price of the asset if Cow Harbour did exercise an option to purchase? A.

There was no discussion with Cow Harbour. [Transcripts of the cross-examination of Brian Jagt, 26 October 2010, p 25, ll 8-26.] [ 116 ] This Court finds that Scott Capital’s estimated fair market value at the end of the lease term was a reasonable “security deposit” amount to protect against its risk that Cow Harbour might not return the equipment to it when the lease ended because of some total loss event or that Cow Harbour would return the equipment to Scott Capital in such poor condition that the equipment no longer had value.

In such cases, the security deposit would have served its stated purpose of being a recourse for Scott Capital's damages under the lease. [ 117 ] There are certainly indicia of a financing arrangement. There are hypothetical situations under which Cow Harbour could indeed have built up equity and paid only the residual amount of the equipment’s capital cost plus a financing charge; e.g. if it defaulted in its obligations under the leases.

Those hypothetical situations did not occur, however, and based on the wording of the leases, Cow Harbour was paying for use of the equipment. [ 118 ] Although the security deposits are relatively substantial, there was no obligation on Cow Harbour’s part to forfeit the security deposits at the end of the lease term. It could simply return the equipment and demand the security deposits (less any additional charges that it had incurred in the meantime). This is especially so with respect to the

Schedule 001 lease, where the purchase option price was 25 percent of the equipment’s original capital cost, while the security deposit was ten percent. Although Burke suggested (at 296) that a substantial security deposit is indicative of a financing lease in that the lessee is required to post collateral to obtain the equipment, considering the whole of the Scott Capital lease agreements, this factor is not determinative and, in fact, it assists Scott Capital in its position. [ 119 ] For the foregoing reasons, this Court concludes that the Scott Capital leases are true leases. B.

Caterpillar Financial Services Limited (CFSL) Lease 1. The Lease [ 120 ] Cow Harbour leased a Caterpillar off-highway truck from CFSL pursuant to a lease dated March 27, 2006. According to CFSL’s affiant, the original cost of the truck was $2,235,456. The amount shown in the floating rate addendum was $500 more, which CFSL’s affiant explained was a fee payable by Cow Harbour (transcript of the cross examination of Renee Bertha Fournier, 21 October 2011, p. 7, ll 32-41). The lease term was 60 months. The lease required Cow Harbour to pay irregular monthly payments pursuant to the terms of the irregular payment

schedule attached to the CFSL lease (6 months at $100,000 and 54 months at $28,397.86). The aggregate amount of those rents was about $2,133,485. [ 121 ] If Cow Harbour exceeded the maximum hours of use of the equipment, it was to pay an excess hour charge.

[ 122 ] The CFSL lease contained an end of term purchase option price of $524,535. 2. Lease-specific arguments of the parties (

a) CFSL [ 123 ] CFSL argues that the most probative factor is that the purchase option price was neither a nominal sum nor arbitrarily selected. Rather, it calculated the purchase option price after considering factors such as depreciation, historic resale market for like equipment, application, exchange rate and annual hours of usage.

The purchase option price represented 102 percent of the standard residual amount, which CFSL calculated to be $514,250, and was more than 15 percent of the value of the truck at the commencement of the term. [ 124 ] According to CFSL, the purchase option price was an amount intended to represent a reasonable pre-estimate of the fair market value of the truck at the end of the lease term.

It relies on the statement by Burke (at 293) that, “[i]f the lessee is required to pay the actual value of the property at the end of the lease at a time when the property still has value, then the lease payments cannot reasonably be said to have been payments towards an equity interest in the property.” CFSL says that the term of the lease did not exceed 75 percent of the economic useful life of the truck, which it estimated to be 120 months. [ 125 ] The net present value of the rental payments is $1,865,621.73, which is less than 90 percent of the equipment’s value at the beginning of the term.

CFSL points out that the rental payments could not be applied in satisfaction of the purchase option price. [ 126 ] CFSL maintains that other factors point to this being a true lease, including: · the lack of any requirement for a security deposit or down payment · Cow Harbour was not required to pay the equivalent of the original cost of the truck, plus a financing charge based on a rate existing at the date of the CFSL lease · Cow Harbour was required to maintain certain minimum standards of repair with respect to the truck.

CFSL submits that the latter factor is consistent with it attempting to protect its interest in the residual value of the truck on its return at the end of the lease. [ 127 ] Cow Harbour was not required to make a residual payment at the end of the lease term or to guarantee residual value.

Cow Harbour could exercise the option or return the truck to CFSL. [ 128 ] CFSL asserts that the presence of other factors, such as the inability of Cow Harbour to exchange or replace the truck; a default provision favourable to CFSL; and the inclusion of the floating rate addendum, should be given less weight in comparison with the fair market value option to purchase.

Equipment lessors are in the business of making money and the floating rate addendum simply reflects its cost of capital or a return of investment. [ 129 ] CFSL relies on DaimlerChrysler in arguing that the acceleration of rent on default is equivocal. [ 130 ] CFSL submits that given Cow Harbour’s operations, the specialized equipment it was leasing and the relatively remote location of the oil sands site where it was working, it was only logical that CFSL would impose the obligation for insurance, maintenance and the risk of loss on Cow Harbour. Accordingly, these are neutral factors.

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b) Monitor [ 131 ] The Monitor contends that the CFSL lease is best characterized as a financing lease because, among other factors, the end of term purchase option price (approximately 23 percent of the original value of the equipment) appears to be arbitrary and bears no direct connection to the actual value of the leased equipment at the time Cow Harbour exercises the option. In other words, Cow Harbour appears to have acquired equity in the leased equipment because the fair market value of the leased equipment at the time when the option could be exercised might exceed the purchase option price.

This leads to the conclusion that the lease is a financing agreement and/or a lease pursuant to which payments are made for “use and equity.” [ 132 ] The Monitor suggests that the CFSL lease exhibits other indicia of a financing lease, as discussed in Smith Brothers , which militates against it being considered a true lease. Specifically, Smith Brothers factors 4 to 6, 8, 9 and 13 to 16 are present in the CFSL lease.

The Monitor notes that the equipment originally was valued at $2,235,956 plus applicable tax, while the total amount that Cow Harbour was to pay during the course of the term was $2,658,019.44 plus applicable tax. Therefore, the aggregate rentals approximated the value of the purchase price of the equipment factoring in interest and carrying costs. (

c) GE [ 133 ] GE focuses on the floating rate addendum, which provided that the rental payments were subject to an interest rate adjustment. It says this resulted in the lease operating like a credit or loan agreement. GE notes that: · CFSL charged interest to Cow Harbour e

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