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Note that the decision in Drummond was rendered not pursuant to set-off principles in the common law tradition, but rather in the context of Quebec's civil law compensation principles; "compensation" is the civil law equivalent of common law "set-off." (79) Also note that the SCC was specifically concerned with the term "security interest", not as defined in the PPSA, but as defined in subsection 224(1.3) of the Income Tax Act.
(81) While Rothstein J accepted the conventional view that a bare right of contractual set-off does not create a security interest, he was of the view that the addition of a series of contractual encumbrances designed to maintain or preserve the deposit account balance for an effective set-off, pushes the transaction, as a matter of substance, over the threshold: (82)
Unlike a bare right of contractual set-off, the flawed asset arrangement is not a "truncated" form of security.
In the previous subpart, I described the flawed asset arrangement as the contractual preservation of an account through a restriction on withdrawal, coupled with the remedial mechanism of set-off. Consider the following two excerpts in which P Wood furnishes an alternate account of the flawed asset arrangement, which he refers to as a "conditional debt":
I suspect, however, that a Canadian court, faced with the above questions, would force a pro tanto set-off of the Bank's loan balance against the notional deposit account balance on the basis that Al has some equitable or reversionary entitlement to the latter.
Without set-off, then each debt would continue to accrue interest.
Indeed, the very essence of the flawed asset arrangement is the assurance it provides to the account debtor (under the flawed asset) that he or she will be paid on his or her reciprocal account via the remedial mechanism of set-off.
The analytical exercise undertaken in Part IV.B establishes that the security interest threshold is not crossed via non-contractual set-off (Scenario A) or bare contractual set-off (Scenario B).
For instance, it is not entirely clear from Justice Rothstein's reasons whether a right of contractual set-off, coupled with a negative pledge clause but absent a preservation element, crosses the transactional threshold.
(111) Indeed, whether flawed asset provisions or bare contractual set-off provisions, such provisions constitute "terms of the contract between the account debtor (the depository bank) and the assignor (customer)" which, pursuant to PPSA paragraph 41(2)(a), supersede a competing security interest.
The PPSA does not treat set-off and security interests as mutually exclusive.
One could argue that, by virtue of putting a flawed asset arrangement in place, a depository bank elects to relinquish, or forfeit, its freestanding contractual set-off rights.