





CITATION: C.I.F. Furniture
          Limited (Re) , 2011 ONCA 34



DATE: 20100118



DOCKET: C51633



COURT OF APPEAL FOR ONTARIO



Laskin, Armstrong and Juriansz JJ.A.



In the Matter of the Proposal of C.I.F. Furniture
          Limited



David R. Byers and Maria Konyukhova,
          for the appellant, Kari Holdings Inc.



Steven L. Graff, for the
          respondents, The VenGrowth Traditional Industries Fund Inc. and The VenGrowth
          II Investment Fund Inc.



Heard: October 28, 2010



On appeal from the order of Justice
          Geoffrey B. Morawetz of the Superior Court of Justice, dated January 21,
          2010.



Laskin J.A.:



A.

Introduction

[1]

This appeal concerns a priorities dispute between two
    secured creditors of an insolvent corporation.  The insolvent corporation is C.I.F. Furniture Limited.  The sale of its assets in a receivership did
    not generate enough money to satisfy its secured creditors.  The two competing secured creditors are Kari
    Holdings, the holding company of the corporations founders, Hans and Elizabeth
    Kamin, and The VenGrowth group of investment funds, which financed the purchase
    of Karis shares in 2004.

[2]

Kari claims priority for a $1 million secured note
    received as vendor take back financing on the sale of its shares.  VenGrowth claims priority for a $4.35 million
    senior subordinated debenture, used to finance the share purchase.

[3]

The case turns on whether a theory of complete
    subordination or a theory of partial subordination should be used to resolve
    the dispute.  Under the complete
    subordination theory, Kari succeeds; under the partial subordination theory,
    VenGrowth succeeds.

[4]

The motion judge, Morawetz J., applied a partial
    subordination theory and so found in favour of VenGrowth.  On its appeal, Kari submits that the motion
    judge erred in two ways.  First, having
    regard to the factual and contractual matrix, the motion judge erred by not
    applying a complete subordination theory.  Second, the motion judge erred in his application of s. 38 of the
Personal Property Security Act
(PPSA).

[5]

I agree with Morawetz J.s reasons, which I have
    appended to this judgment.  I add brief
    reasons of my own to address the arguments made in this court.  I will first briefly review the financing
    agreements that led to this dispute, then the two competing theories, and
    finally why I agree with the motion judge and reject Karis submissions.

B.

The Financing Agreements

(i)
Background

[6]

The
    Kamins started C.I.F. in the 1960s and incorporated their business in
    1969.  The corporation manufactured and
    supplied custom laboratory systems for laboratory and educational markets in
    North America.

[7]

In
    2004, the Kamins retired and sold their shares in Kari.  As part of the sale price, Kari took back a $1
    million secured note, in turn secured by a general security agreement.  The purchase of Karis shares was financed by
    VenGrowth funds, which included $4.35 million secured by a senior subordinated
    debenture.

[8]

On
    November 30, 2004 Kari perfected its security interest in the note by
    registration under the PPSA.  Two days
    later, on December 2, 2004, VenGrowth perfected its security interest in its
    senior debenture by registering its security interest under the PPSA.  However, Karis priority of registration
    under the PPSA was superceded by an inter-creditor agreement made at the end of
    December 2004.

(ii)      The
    inter-creditor agreement, December 31, 2004

[9]

On
    December 31, 2004, the Bank of Nova Scotia (C.I.F.s operating lender), Kari
    and VenGrowth entered into an inter-creditor agreement.  They agreed on the following priorities among
    them, regardless of the order of registration under the PPSA:

·

First,
    the Bank of Nova Scotia to the extent of its loans to C.I.F. (the bank was paid
    out in December 2006);

·

Second,
    VenGrowth to the extent of its $4.35 million senior subordinated debenture;

·

Third,
    Kari to the extent of its $1 million secured note;

·

Fourth,
    VenGrowth to the extent of the additional loans it had advanced on the purchase
    of Karis shares.

[10]

Thus,
    under the inter-creditor agreement, the VenGrowth senior debenture had priority
    over the Kari note, and the other VenGrowth debt was subordinate to the Kari
    note.  The priority dispute between Kari
    and VenGrowth arose in 2008 when Comerica Bank agreed to provide secured
    financing to C.I.F.

(iii)
        The 2008 financing of C.I.F.

[11]

In
    2008, Comerica Bank agreed to provide secured financing to C.I.F.  The financing took the form of a revolving
    credit facility.   To implement the
    financing, the parties signed several documents of which three are relevant to
    this appeal:  a commitment letter signed
    by Comerica, a credit agreement between Comerica and C.I.F., and, most
    important, an inter-creditor agreement between Comerica and VenGrowth.

(a)
The
    commitment letter

[12]

Comerica
    committed to provide a revolving credit facility to C.I.F.  The commitment letter contains two provisions
    on which Kari relies in support of its appeal.  First, the commitment letter expressly provides that the Kari $1 million
    note is to rank ahead of the Bank.  This
    provision reflects Karis prior registration under the PPSA.  Second, the commitment letter also required
    VenGrowth to provide Comerica with a $1 million guarantee, which would
    terminate on repayment of the Kari note.  VenGrowth delivered this guarantee to Comerica.

(b)
The
    credit agreement between Comerica and C.I.F.

[13]

Under
    this agreement, Comerica agreed to loan C.I.F. up to $2.5 million, secured by a
    general security agreement.  Comerica
    perfected its security interest by registering a financing statement under the
    PPSA.  At April 2009, the balance owing
    on Comericas loan was approximately $1.3 million.

[14]

The
    credit agreement, like the commitment letter, recognized the Kari $1 million
    note as a first priority lien and Comericas security interest as a second
    priority lien.  Moreover, Comericas
    obligations under the agreement were conditional on, among other things,
    delivery to it of the VenGrowth guarantee.

(c)       The 2008 inter-creditor agreement between Comerica and
    VenGrowth

[15]

Under
    this agreement, VenGrowth agreed to subordinate its security to Comericas
    security.

C.

The Dispute and the Two
    Competing Theories

(i)

The dispute

[16]

The
    various financing agreements created what has been called a circularity
    problem.  The problem arises because
    there is no document in which all three parties  Comerica, Kari and VenGrowth
     agreed among themselves on which security interest has priority.  Instead, the key agreements were entered into
    by one or two but not all three parties.  The three important agreements are the 2004 inter-creditor agreement to
    which Comerica was not a party, the 2008 creditor agreement to which neither
    Kari nor VenGrowth was a party, and the 2008 inter-creditor agreement to which
    Kari was not a party.

[17]

Under
    the 2004 inter-creditor agreement, the VenGrowth $4.35 million senior
    subordinated debenture has priority over the $1 million Kari note.  Under the 2008 creditor agreement (and the
    2008 commitment letter) the Kari $1 million note has priority over Comericas
    security.  Under the 2008 inter-creditor
    agreement, Comericas security has priority over VenGrowths security.

[18]

In
    short form, these three agreements provide:

·

V
    ($4.35 million) ranks ahead of K ($1 million)  2004 inter-creditor agreement

·

K
    ($1 million) ranks ahead of C  2008 creditor agreement

·

C
    ranks ahead of V  2008 inter-creditor agreement

[19]

How
    then is this priority dispute to be resolved?  Both sides accept that it should be resolved by applying either a theory
    of complete subordination or a theory of partial subordination.  The two theories are discussed in the reasons
    of the motion judge.  I will review how
    the application of each theory affects the priorities among VenGrowth, Kari and
    Comerica.

(ii)      Complete
    subordination

[20]

Under
    complete subordination, VenGrowth gives up its priority to Comerica:  in other words, VenGrowth agrees not to
    assert a claim against the fund generated by the sale of C.I.F.s assets until
    Comericas claim is satisfied.  But
    because Karis security interest was registered under the PPSA before
    Comericas security interest was registered, Comericas claim cannot be
    satisfied until Karis claim is paid.  Kari therefore benefits indirectly from the agreement between VenGrowth
    and Comerica:  Kari goes to first
    priority and VenGrowth falls to last priority.  If the theory of complete subordination is applied, the priorities are:

·

First,
    Kari;

·

Second,
    Comerica;

·

Third,
    VenGrowth

(iii)     Partial subordination

[21]

Under
    partial subordination, VenGrowth gives the benefit of its first priority to
    Comerica.  The amount of VenGrowths
    claim  $4.35 million  is set aside out of the fund.  That amount is used to satisfy Comericas
    claim.  If Comericas claim is less than
    $4.35 million, it will get all of its claim paid and VenGrowth will get the
    balance.  If Comericas claim is greater
    than $4.35 million it will get the entire $4.35 million, but will receive the
    remainder of its claim only after Kari is paid.

[22]

Partial
    subordination has no effect on Kari.  It
    remains in second priority after VenGrowths first priority to the extent of
    $4.35 million.  While under complete
    subordination, VenGrowth completely steps aside, under partial subordination
    VenGrowth steps aside only to the extent of Comericas claim.  Accordingly, if the theory of partial
    subordination is applied, the priorities are:

·

First,
    Comerica, to a maximum of $4.35 million, and then VenGrowth, to a maximum of
    $4.35 million less Comericas claim;

·

Second,
    Kari;

·

Third,
    Comerica for any claim in excess of $4.35 million;

·

Fourth,
    VenGrowth for all of its remaining claims.

D.

Discussion

[23]

The
    motion judge applied a theory of partial subordination for two main
    reasons.  First, partial subordination
    produced an equitable result because it meant Kari is neither burdened nor
    benefited by the 2008 Inter-Creditor Agreement, whereas complete subordination
    would result in a windfall benefit to Kari at the expense of VenGrowth.  Second, complete subordination could be
    justified only if supported by clear and explicit language, and such clear
    and explicit language is not found in the documents:  see paras. 50-51 of the motion judges
    reasons.

[24]

I
    turn to Karis two submissions.

1.
Having
    regard to the factual and contractual matrix, did the motion judge err by not
    applying complete subordination?

[25]

Whether complete or partial subordination should be
    applied turns on VenGrowths intention, as disclosed by the various
    agreements.  Do the agreements show that
    VenGrowth intended to wholly step aside and go to the bottom of the queue, or
    do they show that VenGrowth intended to step aside only to the extent of Comericas
    interest?

[26]

Kari submits that the agreements, and the factual
    context in which they were signed, show that VenGrowth intended to go to the
    bottom of the queue.  In making this
    submission, Kari relies mainly on five contractual provisions:  the negative covenant in s. 8.2(b) of the Kari
    note, repeated in Karis general security agreement; sections 4(d) and 11 of
    the 2004 inter-creditor agreement between Kari and VenGrowth; the 2008 credit
    agreement between Comerica and C.I.F.; the VenGrowth $1 million guarantee; and
    article 4 of the 2008 inter-creditor agreement between VenGrowth and
    Comerica.  I do not think that singularly
    or collectively these five contractual provisions support Karis position.

[27]

Section 8.2(b) of the Kari note contains a negative
    covenant precluding C.I.F. from granting additional encumbrances without Karis
    consent.  Kari says that the 2008 Comerica
    financing was done without its knowledge and thus breaches s. 8.2(b).  Whether the 2008 financing amounts to a
    breach of this covenant need not be decided on this appeal.  The important point is that VenGrowth was not
    a party to the note or to the financing in 2008.  They therefore do not speak to VenGrowths
    intentions; nor can they affect its priority position.  Karis corollary argument that VenGrowth
    arranged the financing is not supported in the record.

[28]

Sections 4(d) and 11 of the 2004 inter-creditor
    agreement stipulate that nothing in that agreement shall be construed as
    conferring any rights on a third party.  Comerica is a third party, and therefore Kari argues that these
    provisions precluded Comerica from taking the benefit of VenGrowths priority.  In my opinion, these provisions do not assist
    Kari.  The priority given to Comerica was
    conferred not in this 2004 agreement, but in the 2008 inter-creditor
    agreement.

[29]

Nor does the 2008 credit agreement or the commitment
    letter assist Kari.  As VenGrowth was not
    a party to this agreement, or to the commitment letter, their terms cannot
    demonstrate any intention on VenGrowths part to go to the bottom of the
    queue.  These documents do no more than
    acknowledge that the Kari note ranks ahead of Comericas security
    interest.  They do not establish any
    agreement between Kari and VenGrowth or between VenGrowth and Comerica that
    puts Kari in first priority.

[30]

Karis strongest argument rests on the $1 million
    guarantee given by VenGrowth in connection with the Comerica financing.  The guarantee stipulated that it would
    terminate on payment of the Kari note.  Kari contends that this guarantee and its termination provision make no
    sense under partial subordination.  Kari
    says that Comerica insisted on this guarantee because it did not have a
    subordination agreement with Kari.  Functionally, Kari says that the guarantee puts it in first priority
    until it is paid.

[31]

I do not accept Karis contention.  The record is silent on why Comerica insisted
    on this guarantee.  I agree with
    VenGrowth that banks ask for many pieces of security, some they need and some
    they may not need, to protect their position.  It is just as plausible that Comerica asked for this guarantee because
    the guarantee made its interest more secure.  Perhaps more important, there is no term in the guarantee from which one
    can say that by giving it VenGrowth intended to entirely cede its priority to
    Kari.

[32]

Finally, Kari relies on article 4 of the 2008
    inter-creditor agreement between Comerica and VenGrowth.  Article 4 states:

Priorities
    of Indebtedness; Subordination of Junior Creditor Indebtedness

Junior Creditor hereby subordinates, to the extent
    and in the manner provided in this Agreement, all of its rights of payment of
    all of the Junior Creditor Indebtedness to the full and final payment of all of
    the Senior Creditor Indebtedness and the termination of all financing
    arrangements and commitments between the Debtor, the Guarantor and the Senior
    Creditor.

[Comerica is the Senior Creditor and VenGrowth is
    the Junior Creditor.]

[33]

Kari submits that article 4 means VenGrowth is not to
    be paid until Comerica is paid in full.  However, because Karis security interest was registered before
    Comericas security interest, Comerica cannot be paid until Kari is paid.  So, implicitly, by article 4, VenGrowth
    agreed to step aside completely.

[34]

Karis submission does not give effect to the
    qualifying phrase in article 4, to the extent and in the manner provided in
    this Agreement.   Other provisions of
    the agreement show that VenGrowth did not intend to subordinate its entire
    priority position to Kari.  For example,
    articles 2 and 3 state that no third party  and Kari is a third party under
    this agreement  may benefit from anything contained in the agreement.  Article 7a explicitly recognizes that
    VenGrowth agrees to step aside only to the extent of Comericas interest:

Under any circumstances  the Collateral shall be
    applied first to the Senior Creditor Indebtedness until all of the Senior
    Creditor Indebtedness has been fully and finally paid and all of the financing
    arrangements and commitments between the Debtor, the Guarantor and Senior
    Creditor have been terminated, and then to the Junior Creditor Indebtedness.

[35]

For these reasons, I do not agree that the various
    contractual provisions on which Kari relies argue for complete
    subordination.  Moreover, there are
    several compelling reasons to apply partial subordination.

[36]

First, it would be unreasonable to find that VenGrowth
    intended complete subordination.  By 2008,
    Karis financing had already been spent.  Comerica was providing new financing to keep the corporation
    afloat.  As VenGrowth had a big
    investment in the corporation, it made sense for VenGrowth to subordinate its
    interest to Comericas interest.  By contrast,
    it would have made no sense for VenGrowth to subordinate its interest to Karis
    interest.

[37]

Second, as the motion judge pointed out, complete
    subordination would confer a windfall on Kari.  It would go from second to first priority.  Partial subordination leaves Kari in second
    position.  It gets exactly what it
    bargained for in 2004.

[38]

Third, there is no document where VenGrowth agreed to
    subordinate its interest to Karis interest.  Thus, to give effect to Karis position, one would have to infer that
    VenGrowth intended to go to the bottom of the queue.  To draw that inference, one would expect some
    clear and unequivocal language in one of the documents, or at the very least,
    an exchange of correspondence between VenGrowth and Kari.  Nothing of that sort exists.

[39]

I would not give effect to Karis main ground of
    appeal.

2.
Did
    the motion judge err in his application of s. 38 of the PPSA?

[40]

Section
    38 of the PPSA states:

A
    secured party may, in the security agreement or otherwise, subordinate the
    secured partys security interest to any other security interest and such
    subordination is effective according to its terms.

[41]

Section
    38 recognizes that a secured party can, by agreement, subordinate its interest
    to other security interests in the same collateral, and a third party, not
    privy to that agreement, can rely on and enforce that subordination.

[42]

Kari
    argues that as a third party, it can rely on section 38 to enforce what it
    claims is the priority given to it by the 2008 credit agreement between Comerica
    and C.I.F., and the 2008 inter-creditor agreement between Comerica and
    VenGrowth.  This argument simply recasts in
    the context of s. 38 of the PPSA, the main argument Kari advanced on this
    appeal, which I have already rejected.  The motion judge did not give effect to Karis argument under s. 38 and
    I would not do so either.

[43]

VenGrowth
    was not a party to the 2008 credit agreement, and therefore the parties to that
    agreement  Comerica and C.I.F.  could not by themselves subordinate the
    priority interest of the VenGrowth senior debenture to the Kari note.  Further, as I have already discussed, nothing
    in the 2008 inter-creditor agreement shows an intention on VenGrowths part to
    go to the bottom of the queue.  I would
    not give effect to this ground of appeal.

E.

Conclusion

[44]

The
    motion judge was correct in applying the theory of partial subordination to
    resolve the priority dispute between Kari and VenGrowth.  I would therefore dismiss Karis appeal, with
    costs fixed in the agreed upon amount of $17,500, inclusive of disbursements
    and applicable taxes.

RELEASED:  Jan. 18,
    2011                         John Laskin
    J.A.

JL                                                                           I
    agree Robert P. Armstrong J.A.

I
    agree R.G. Juriansz J.A.


Appendix A

CITATION:
C.I.F.
    Furniture Limited (Bankruptcy of), 2010 ONSC 505

COURT FILE NO.:
31-1194593

DATE:
20100121

SUPERIOR COURT OF JUSTICE 
    ONTARIO

(COMMERCIAL LIST  BANKRUPTCY
    AND INSOLVENCY)

RE:
IN THE MATTER OF THE PROPOSAL OF C.I.F.
    Furniture Limited, Applicants

BEFORE:
MORAWETZ J.

COUNSEL:
Steven L. Graff and Sandra A. Vitorovich, for The VenGrowth
    Traditional Industries
    Fund Inc. and the VenGrowth II Investment Fund Inc.

Paul G. Macdonald and Myriam M. Seers, for Kari
    Holdings Inc.

ENDORSEMENT

[
1
]       This
    matter involves a priority dispute arising from the sale of assets of C.I.F.
    Furniture Limited (CIF) for proceeds that are insufficient to satisfy the
    security interests of certain secured creditors.  The dispute is between
    Kari Holdings Inc. (Kari) and The VenGrowth Traditional Industries Fund Inc.
    (VenGrowth Traditional) and The VenGrowth II Investment Fund Inc. (VenGrowth
    Investment) and together with VenGrowth Traditional, (VenGrowth).

[
2
]       The
    parties are in agreement that a secondary issue, namely, whether the VenGrowth
    Security Interest only covered the principal amount owing to VenGrowth and does
    not include any payments of interest is moot and consequently need not be
    determined.

Summary of Facts

[
3
]       CIF carried on business for the
    manufacture and supply of custom laboratory systems for markets across Canada
    and the United States.

[
4
]       The business was established in the early
    1960s by Mr. Hans J. Kamin and his spouse, Mrs. Elizabeth M. Kamin.  In
    1969, the Kamins incorporated CIF to continue the business.

[
5
]       Upon retiring in 2004, the Kamins sold
    CIF to an affiliate of VenGrowth (the Purchaser) pursuant to a share purchase
    agreement dated November 23, 2004.  On the closing date (December 7,
    2004), the Purchaser and CIF amalgamated and continued as CIF.  The
    purchase price was $7,057,060.  At the time of closing, VenGrowth
    indirectly held 53% of the issued and outstanding shares in CIF.  At the
    time of the motion, VenGrowth was CIFs 95% majority shareholder and a
    substantial secured creditor.

[
6
]       As part of the share purchase, Kari (the
    holding company of Mr. and Mrs. Kamin) provided the Purchaser with $1,000,000
    in vendor take-back (VTB) financing (the Kari Note), secured by a general
    security agreement dated December 1, 2004 (the Kari GSA), for which a
    financing statement was registered under the
Personal Property Security Act
    (Ontario)
(PPSA) on November 30, 2004 (the Kari Security Interest).

[
7
]       VenGrowth also financed the share
    purchase by advancing the Purchaser the principal amount of $4,350,000, secured
    by a senior subordinated debenture dated December 2, 2004 (the VenGrowth
    Senior Debenture) for which a financing statement was registered under the
    PPSA by VenGrowth on December 2, 2004 (the VenGrowth Security Interest).

[
8
]       VenGrowth also advanced significant
    additional capital to CIF on a junior and/or subordinated basis to Kari, with
    certain of these additional advances being made in December 2004 to finance the
    share purchase.

[
9
]       Following the share purchase, Bank of
    Nova Scotia (BNS) agreed to be the operating lender of CIF.  All parties
    funding the share purchase recognized and agreed that BNS was in priority to
    all other secured creditors.  CIF repaid its obligations to BNS in
    December 2006.

[
10
]     Subsequently, Comerica Bank (Comerica)
    became the operating lender.  Pursuant to a credit agreement between
    Comerica and CIF dated November 28, 2008 (the Comerica Credit Agreement),
    Comerica provided CIF with a revolving credit facility to a maximum of
    $2,500,000.  The facility granted pursuant to the Comerica Credit
    Agreement was secured by a security agreement dated November 28, 2008 (the
    Comerica Security), for which a financing statement was registered under the
    PPSA on November 13, 2008 (the Comerica Security Interest).

[
11
]     Both VenGrowth Traditional and VenGrowth
    Investment guaranteed a portion of the Comerica facility pursuant to the
    following guarantees (the VenGrowth Guarantees):

(a)  
        a guarantee dated November
    28, 2008 granted by VenGrowth Traditional in favour of Comerica and limited to
    $462,571; and

(b)  
        a guarantee dated November
    28, 2008 granted by VenGrowth Investment in favour of Comerica limited to
    $537,429.

[
12
]     VenGrowth submits that the guarantee of
    VenGrowth Traditional was amended and restated by a guarantee dated April 29,
    2009 limited to $601,342 and that the guarantee of VenGrowth Investment was
    amended and restated by a guarantee also dated April 23, 2009 limited to
    $698,658.

[
13
]     The PPSA registrations are filed in the
    following order of priority:

(i)        Kari  November 30, 2004;

(ii)       VenGrowth  December 2, 2004;

(iii)     Comerica  November 13, 2008.

[
14
]     In 2004, CIF, Kari and VenGrowth entered
    into the following priorities agreements:

(a)       an inter-creditor agreement dated
    December 3, 2004 (the 2004 Inter-Creditor Agreement);

(b)       a subordination agreement dated December
    7, 2004 (the 2004 Subordination Agreement); and

(c)       separate postponement and subordination
    agreements in favour of Kari from each of VenGrowth Traditional, VenGrowth
    Investment, as well as various other CIF creditors, namely, Cinitel Corp.,
    Fallbrook Holdings Limited (Fallbrook), Mr. Bruce Andrew, Mr. Stephen Dulong
    and 1639662 Ontario Inc. (Holdco).

[
15
]     The 2004 Inter-Creditor Agreement granted
    the VenGrowth Security Interest, to the extent of the debt under the VenGrowth
    Senior Debenture, priority over the Kari Security Interest.

[
16
]     Under the 2004 Subordination Agreement,
    VenGrowth Investment and VenGrowth Traditional agreed to postpone and
    subordinate their security interests, pursuant to their respective security, to
    the Kari Security Interest, except that neither of VenGrowth Investment or
    VenGrowth Traditional postponed or subordinated the VenGrowth Security
    Interest.  As stated by counsel to VenGrowth, in other words, all
    advances made by VenGrowth, other than the VenGrowth Senior Debenture, were
    subordinated to Kari.

[
17
]     Comerica was not a party to the 2004
    Inter-Creditor Agreement.

[
18
]     In 2008, CIF secured financing from
    Comerica.  The terms of the financing were set out in a commitment letter
    dated June 5, 2008 pursuant to which Comerica committed to provide a $2.5
    million revolving credit facility to CIF (the Commitment Letter).

[
19
]     The Commitment Letter expressly states that
    the Kari Security Interest will rank in priority to the Comerica Security
    Interest and that the VenGrowth Security Interest will be subordinated to the
    Comerica Security Interest.

[
20
]     The Comerica Credit Agreement recognizes
    the Kari Security Interest as a first priority lien and that the Comerica
    Security Interest as a second priority lien.

[
21
]     The Comerica Credit Agreement included the
    Kari Note as a Permitted Debt, the Kari Security Interest as a Permitted Lien
    and required a subordination of the VenGrowth Security Interest but not the
    Kari Security Interest to the Comerica Security Interest.

[
22
]     VenGrowth was not a party to either the
    Commitment Letter or the Comerica Credit Agreement.

[
23
]     Also, on November 28, 2008, CIF provided
    Comerica with the Comerica Security Agreement.

[
24
]     The Comerica Security Interest also provides
    that each of the VenGrowth Guarantees will terminate upon the payment in full
    of the Kari Note.

[
25
]     On November 28, 2008, VenGrowth and
    Comerica entered into an inter-creditor agreement whereby VenGrowth agreed to
    fully subordinate the VenGrowth Security Interest to the Comerica Security
    Interest (the 2008 Inter-Creditor Agreement).

[
26
]     Kari did not know about the Comerica
    Security Interest until CIF served it with motion materials in these
    proceedings on April 21, 2009.

[
27
]     CIF is insolvent and on April 21, 2009 it
    filed a Notice of Intention to Make a Proposal under the
Bankruptcy and
    Insolvency Act
(the BIA).

[
28
]     On April 29, 2009, A. Farber & Partners
    Inc. (the Interim Receiver) was appointed interim receiver of CIF and by
    order dated May 15, 2009, the Interim Receiver was authorized to market and
    sell the assets.

[
29
]     There is no inter-creditor agreement to
    which Comerica, VenGrowth and Kari are all parties that set out the priorities
    among them.  There is no inter-creditor agreement or subordination
    agreement in which VenGrowth subordinates or postpones the VenGrowth Security
    Interest to the Kari Security Interest.

[
30
]     Kari and Comerica have not entered into any
    agreement between themselves which governs the relative priorities of the Kari
    Security Interest and the Comerica Security Interest.

Analysis

[
31
]     Kari submits that the Kari Security
    Interest ranks in priority to the Comerica Security Interest and the VenGrowth
    Security Interest by operation of the Commitment Letter, the Comerica Credit
    Agreement, the Comerica Security Agreement, the Comerica Security Interest and
    the 2008 Inter-Creditor Agreement (collectively the Comerica Agreements) and
    s. 38 of the PPSA.

[
32
]     Counsel to Kari submits that an objective
    interpretation of the relevant documents demonstrates that both VenGrowth and
    Comerica intended that, as a result of the Comerica Agreements, the Kari
    Security Interest would rank in priority to the Comerica Security Interest and,
    therefore, the VenGrowth Security Interest.  Counsel to Kari submits that
    this position is supported by the repeated references in the Commitment Letter
    and the Comerica Credit Agreement to the first priority position of the Kari
    Security Interest and VenGrowths voluntary agreement to step out of the
    priority queue and back in behind Comerica.

[
33
]     There is, in my view, a fundamental
    weakness in this argument.  VenGrowth is not party to either the
    Commitment Letter or the Comerica Credit Agreement.  These are contractual
    agreements between CIF and Comerica.  Although VenGrowth is the
    substantial controlling shareholder of CIF, this does not mean that the
    contractual agreements of CIF are agreements that bind VenGrowth.  There
    is no stated intention in any document that establishes that VenGrowth intended
    to cede its priority position in all respects to the Kari Security Interest.

[
34
]     When read together, the 2004 Inter-Creditor
    Agreement and the 2008 Inter-Creditor Agreement create a circularity issue as
    between Kari, VenGrowth and Comerica.

[
35
]     Professor Wood commented on this issue in 
Circular
    Priorities in Secured Transactions Law
 at pages 7  8:

The real controversy concerns the proper
    interpretation of the subordination agreement.  In the United States, the
    issue is framed as whether SP1 intended a complete subordination of its claim
    or only a partial subordination.  A
complete subordination
occurs
    if the subordination agreement is interpreted as an agreement by SP1 not to
    assert its claim against the collateral until SP3s claim is satisfied. 
    It does not involve an agreement by SP1 to turn over the benefit of its
    priority to SP3.  Rather, it is essentially an agreement by SP1 to step
    aside and not assert its claim until SP3s claim has been satisfied.  On
    this view, the competition is resolved by giving first priority to SP2, second
    priority to SP3, and third priority to SP1.  SP2 is the indirect
    beneficiary of the subordination agreement because SP3 cannot satisfy its claim
    until the claim of SP2 is fully satisfied.

Under the competing
partial subordination
    theory
, a subordination agreement is interpreted as an agreement under
    which SP1 agrees to turn over the benefit of its priority to SP3.  The
    priorities are therefore resolved in the following manner.  First, the
    amount of SP1s claim is set aside out of the fund.  Second, the fund is
    used to satisfy SP3s claim.  If there is anything left over, it is paid
    to SP1.  Third, SP2s claim is satisfied out of the fund.  Fourth,
    any remaining balance is distributed to SP3 and then to SP1.

[
36
]     The duelling approaches were also the
    subject of commentary by Professors Cumming, Walsh and Wood in
Personal
    Property Security Law
where the authors explained as follows:

The priority competition is resolved by setting
    aside the amount of SP1s claim.  From this fund, SP3s claim is
    satisfied.  If a surplus remains after SP3s claim is satisfied, it is
    paid over to SP1.  SP2s claim would next be satisfied from the remaining
    funds.  If there is anything left, it is then distributed to SP3, then
    SP1.  In other words, the subordination agreement between SP1 and SP3 is
    effective only as between those parties, and has no effect on the relative
    priority of SP2.

Most subordination agreements provide for a
    postponement of the subordinating creditors claim.  Under a step-aside
    agreement, a secured party may instead agree that it will not make a claim in
    respect of a subordinated debt until the benefiting creditor is paid in
    full.  If this form of agreement is used, there is a greater likelihood
    that it will have the effect of elevating the priority of an intervening
    party.  In the above scenario, SP1 would renounced its claim until SP3 is
    paid in full.  This would seem to have the effect of placing SP1 at the
    end of the queue, with the result that SP2 would obtain first priority followed
    by SP3.

[
37
]     At issue is whether the circularity problem
    should be resolved in favour of VenGrowth or Kari.  A resolution in favour
    of VenGrowth would require the application of the partial subordination
    theory.  A resolution in favour of Kari would require the application of
    the complete subordination theory.

[
38
]     In considering which of these two
    approaches should be applied in these circumstances, in my view, it is
    necessary to consider the impact of agreements to which VenGrowth, Kari and
    Comerica are parties.

[
39
]     As a result of the 2004 Inter-Creditor
    Agreement, the Kari Security Interest is subordinate to the VenGrowth Security
    Interest.  The issue is whether this situation changed as a result of the
    Comerica Agreements.  In my view, it has not.

[
40
]     VenGrowth entered into the 2008
    Inter-Creditor Agreement with Comerica, the result of which is that VenGrowth
    subordinated payment under the VenGrowth Senior Debenture to Comerica.  It
    does not follow that VenGrowth intended that its entire priority position would
    be subordinated to that of Kari.

[
41
]     The Commitment Letter states that the VTB
    from Kari in the amount of $1,000,000 is to rank ahead of Comerica.  This
    statement, at most, provides the understanding on the part of Comerica that
    Karis interest ranks ahead of Comericas position, but there is no agreement
    or acknowledgement by VenGrowth that the Kari Security Interest ranks ahead of
    the VenGrowth Security Interest.

[
42
]     Further, the Comerica Credit Agreement does
    not recognize or state that the Kari Security Interest shall constitute a
    priority claim to the VenGrowth Security Interest.

[
43
]     Section 38 of the PPSA provides that a
    secured party may, in the security agreement or otherwise, subordinate its
    security interest to any other security interest and the subordination is
    effective according to its terms and a third party who is not privy to the
    security agreement or other agreement which contains the subordination clause
    can enforce it.

[
44
]     Counsel to VenGrowth submits that s. 38
    applies only in instances where the secured creditor itself subordinates,
    explicitly or implicitly, its security interest vis-à-vis a third party. 
    Counsel cites
Sun Life Assurance Co. of Canada v. Royal Bank
,
37 C.B.R. (4
th
) 169 in support of
    this submission.  I agree with this position.

[
45
]     In this case, the Commitment Letter and the
    Comerica Credit Agreement are the documents that Kari submits evidences the
    intention of VenGrowth to subordinate the VenGrowth Security Interest to the
    Kari Security Interest.  I am in agreement with the submission of counsel
    to VenGrowth that evidence of an understanding involving Comerica and CIF in
    respect of the priority between Kari and Comerica does not establish a
    subordination agreement as between VenGrowth and Comerica in favour of Kari.

[
46
]     The only documents in the Comerica
    Agreement to which VenGrowth is a party are the 2008 Inter-Creditor and the
    VenGrowth Guarantees.  These documents, do not, in my view, result either
    clearly or explicitly, in a subordination of the VenGrowth Security Interest to
    the Kari Security Interest.

[
47
]     Counsel to VenGrowth submits that the
    effect of the 2008 Inter-Creditor Agreement is to provide that a portion of any
    fund paid by CIF to VenGrowth under the VenGrowth Senior Debenture would be
    paid by VenGrowth to Comerica and any funds available for payment by CIF after
    repayment of the amount owing under the VenGrowth Senior Debenture would be
    paid to Kari next in satisfaction of the indebtedness under the Kari
    Note.  A proper interpretation is that under the 2008 Inter-Creditor
    Agreement, any payments received by VenGrowth from CIF pursuant to the
    VenGrowth Senior Debenture (up to a maximum of the VenGrowth Indebtedness)
    would be shared as between VenGrowth and Comerica as follows:

(a)  
      first, payment would be made to Comerica in satisfaction of the
    Comerica indebtedness; and

(b)  
      secondly, the remaining funds, of the total of the VenGrowth Senior
    Debenture (inclusive of amounts paid in sub (a)), would be payable to VenGrowth
    in satisfaction of the VenGrowth indebtedness.  The total distributed
    under both sub (a) and sub (b) would not be greater than the VenGrowth
    indebtedness.

[
48
]     Counsel to VenGrowth submits that this
    interpretation is consistent with the analysis set out by Grant Gilmore in
Security
    Interests in Personal Property
, where he discusses a situation with three
    creditors, A, B, and C where A and C enter into a subordination agreement, the
    secured assets are sold and there are insufficient funds to satisfy the claims
    of all three creditors. The ensuing distribution was explained by Gilmore as
    follows:

There is a comforting unanimity, among courts
    and commentators, on the proper distribution of funds:

1.         Set aside from the fund the amount of A
    claim.

2.         Pay the amount set aside to

a)   C, to the amount of his claim;

b)   A, to the extent of any balance remaining
    after Cs claim is satisfied.

3.  
         Pay B the amount of the fund remaining after As claim
    has been set aside.

4.  
       If any balance remains in the fund after As claim has been set
    aside and Bs claim has been satisfied, distribute the balance to

a)   C,

b)   A.

Thus C, by virtue of the subordination
    agreement, is paid first, but only to the amount of As claim, to which B was
    in any event junior.  B receives what he had expected to receive: the fund
    less As prior claim.  If As claim is smaller than Cs, C will collect
    the balance of his claim in his own right, only after B has been paid in
    full.  A, the subordinator, receives nothing until B and C have been paid
    except to the extent that his claim, entitled to first priority, exceeds the
    amount of Cs claim, which under his agreement, is to be paid first.

[
49
]     Counsel to VenGrowth also referenced the
    decision of the Newfoundland and Labrador Court of Appeal in
Hickman
    Equipment
(1985) Ltd., Re
, 2006
    CarswellNfld 245, leave to appeal to Supreme Court of Canada refused,
[2006] S.C.C.A. No. 462.  Counsel to
    VenGrowth submitted in their factum as follows:

42.       The
    Newfoundland and Labrador Supreme Court was recently asked to decide whether by
    virtue of a subordination agreement between party A and C:  (i) C moved up
    to stand in the place of A and thereby gains priority over B; or (ii) while A
    ranks in priority behind C, nonetheless B retains priority over C.

43.       Quoting
    several texts, including the passage from Gilmore above, and Canadian
    jurisprudence, the Appellant in Hickman argued that the ranking of the claims
    and distribution of proceeds is determined apart from the operation of the
    subordination agreement with the subordination agreement applying to determine
    the extent of the share of the distribution that should be paid to the party in
    whose favour the subordination was granted.  Moreover, a creditor in
    second position (such as Kari) should not receive the benefit of a
    subordination agreement to which it is not a party and on which the parties to
    the subordination agreement intended the second position creditor to rely.

44.       The
    central proposition of the case of the Appellants in
Hickman
[and the
    position advanced by VenGrowth herein] was:

Where a subordination is enforced by the
    benefiting creditor [RBC] for its benefit, the amount secured by the
    subordinated security interest simply goes toward satisfying in whole or in
    part two claims as opposed to one:  the benefiting creditors claim
    [RBCs] and the subordinated creditors claim [CIBCs].  The benefiting
    creditor shall receive payment in full of its claim, before the subordinated
    creditor receives any payment on the subordinated debt.  Where there is an
    intervening security interest [GMAC], the result is equitable, because the
    intervening creditor will receive what it expected to receive, the fund less
    the amount secured by the higher ranking subordinated security interest. 
    Otherwise, the intervening creditor receives a windfall and the statutory
    rights bestowed on the subordinating creditor to subordinate its security
    interest and the benefiting creditor to enforce the subordination for its
    benefit are thwarted.

The court, finding the arguments set out by the
    Appellant persuasive, adopted the Appellants reasoning.

[
50
]     I am in agreement with the submissions of
    counsel to VenGrowth.  The 2008 Inter-Creditor Agreement can only have an
    impact on determining the extent to which the monies paid to CIF pursuant to
    the VenGrowth Senior Debenture should be paid in favour of Comerica.  In
    this manner, Kari is neither burdened nor benefited by the 2008 Inter-Creditor
    Agreement.  On the other hand, the argument put forward by counsel to Kari
    would result in a windfall benefit to Kari at the expense of VenGrowth. 
    The result preferred by VenGrowth produces, in my view, an equitable result.

[
51
]     It seems to me that the result preferred by
    Kari, namely, that of a complete subordination, could only be justified if
    there is clear and explicit language that would result in a complete
    subordination agreement.  Such clear and explicit language is not found in
    the documents.

Disposition

[
52
]     In this case, in the 2008 Inter-Creditor
    Agreement, VenGrowth subordinates only to and for the benefit of Comerica,
    while at the same time preserving its priority position as against third
    parties.  In my view, it is especially telling that s. 2 of the 2008
    Inter-Creditor Agreement provides that all agreements and representations are
    solely for the benefit of the creditors (VenGrowth and Comerica) and that no
    other parties are intended to be benefited in any way by the 2008 Inter-Creditor
    Agreement.  In the face of such explicit language, it seems to me that it
    cannot be said that there was the intention on the part of VenGrowth to effect
    a complete subordination in favour of Kari.  Rather, the effect of the
    2008 Inter-Creditor Agreement is that, with all the priorities remaining the
    same, VenGrowth is to set aside a portion of the funds it receives in trust to
    be paid to Comerica pursuant to the 2008 Inter-Creditor Agreement and that it
    will not receive its priority payment until Comerica has been paid in full from
    payments it receives in its position.

[
53
]     In the result, I find that the VenGrowth
    Security Interest is in priority to the Kari Security Interest to the extent of
    principal owing under the VenGrowth Senior Debenture.  The issue of
    whether priority extends to interest need not be determined.

[
54
]     VenGrowth is to have its costs of this
    motion, as agreed, in the amount of $42,500 inclusive of disbursements and GST.




MORAWETZ J.

Date:
January 21, 2010


