Can a GSA secure indirect debt?

Skymark Finance v. Mahal Venture et al., 2023 ONSC 2354
Can a GSA secure indirect debt?

Mahal, the sole shareholder, officer and director of Golden Miles Food Corporation (“Golden Miles”), sought a declaration that his security interest in the personal property of Golden Mile was valid, enforceable and ranked in priority to any other security interests registered under the Personal Property Security Act, and secured repayment of principal advances in the amount of $2,182,914, plus interest and costs. In October 2020, Mahal, on behalf of Golden Miles, as borrower, executed a promissory note and a general security agreement to himself. The GSA was registered pursuant to the relevant provisions of the PPSA.

The Applicant, Skymark Finance Corporation (“Skymark”), opposed Mahal’s motion. In October 2021, Skymark brought an Application to put Golden Miles into receivership. Skymark was owed approximately $29.5 million. The Application was successful and KSV Restructuring Inc. was appointed Receiver over Golden Miles and another corporation owned by Mahal’s son. KSV also generally opposed the motion.
 
The onus to prove the validity and amount of a creditor’s indebtedness is on the creditor (i.e. Mahal). Thereafter, the creditor does not have to demonstrate that a claim is not an equity claim. Another creditor who chooses to assert such an argument must bear the onus of proving that an otherwise proven debt claim is more properly characterized as an equity claim.

Mahal made four advances after the execution of the Promissory Note and the GSA (collectively, the “Advances”). One advance (in the amount of $281,600.00) was made by him personally, and the other three (in the amount of $1,901,314) were made by corporations controlled by him (the “Mahal Corporations”). He argued that he was entitled to the principal amount of $2,182,914 plus interest and costs as secured by a valid and enforceable security interest made first in priority under the PPSA over Golden Miles’ personal property, excluding the prior-ranking security in favour of certain other creditors. In short, he submitted that the GSA secured both direct and indirect indebtedness owed by Golden Miles to Mahal and the Mahal Corporations.
 
KSV conceded that Mahal’s security was valid, properly registered and enforceable pursuant to the provisions of the GSA, and did not oppose Mahal’s personal claim in the amount of $281,600. It opposed the claims advanced by the Mahal Corporations in respect of the remaining $1,901,314 on the basis that such funds were advanced by companies not party to the GSA. Nor did the Mahal Corporations register PPSA financing statements. Accordingly, KSV stressed that there were no debt documents between the Mahal Corporations and Golden Miles.

Skymark relied on the submissions of KSV, except that Skymark also opposed Mahal’s personal claim of $281,600. Skymark argued that the money paid by Mahal could have been for any reason including repayment of debt, equity or some other obligation, and Mahal could not establish that the money he paid constituted a secured debt.
 
The Court accepted that the $281,600 directly advanced by Mahal, plus interest and costs, was secured by the GSA and registered first in priority under the PPSA, excluding the prior ranking security in favour of certain other creditors. However, the Court held that Mahal failed to establish that the Advances made by the Mahal Corporations were indirect debts owing to Mahal and secured by the GSA. The Promissory Note, based on its plain wording, did not create any evidence of indirect indebtedness to the Mahal Corporations. A debt owing by Golden Miles to one of the Mahal Corporations did not constitute an indirect debt to the shareholder of that corporation (i.e. Mahal). A shareholder’s interest in the accounts receivable of a corporation is not a debt claim. Shareholders are merely entitled to the residual equity value of a corporation after all creditors have been paid. To allow such a claim would cause considerable mischief wherein other parties, particularly creditors, could not understand a company’s secured debt obligations.

Accordingly, the Court allowed Mahal’s claim in the amount of $281,600 plus interest at the rate of five percent per year until paid, plus costs on an actual indemnity basis, as properly due and owing by Golden Miles, but otherwise dismissed the remainder of Mahal’s claims.

Judge: Justice McEwen

Counsel: George Benchetrit of Chaitons LLP for the Applicant, Lisa Corne and David Preger of Dickinson Wright for the Respondent, Santokh Mahal; Chris Burr of Blakes for KSV as Receiver and Trustee of Golden Miles Food Corporation; Dylan Chochla of Fasken for A&M as Receiver of Skymark Finance Corporation

By: Matilda Lici