When acquiring a business, due diligence is often described as the buyer’s best defense against hidden liabilities. It is a process designed to uncover risks, confirm ownership of assets, and ensure that the purchase price reflects the true value of the target enterprise. Yet, even the most rigorous due diligence can be undermined by statutory rules that create priorities invisible to standard searches. One such rule lies in British Columbia’s Commercial Liens Act (“CLA”), specifically, Section 20, which governs the priority of liens over other interests.

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This provision introduces two significant challenges for buyers:

1. Unperfected liens can outrank unperfected security interests, even if those security interests were created before the lien arose.
2. Unregistered liens perfected by possession outrank registered security interests, if the possession of the goods occurred before registration of the security interest, despite a lack of available methods for the secured party to identify whether perfection by possession has occurred.
3. Unregistered liens perfected by possession can defeat bona fide purchasers without notice, leaving buyers exposed even when they have acted diligently and in good faith by conducting registry searches.

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These rules create a unique risk profile for transactions involving tangible assets such as equipment, vehicles, or inventory.

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The Legal Landscape: Liens and Security Interests

To understand the problem, it is important to distinguish between liens and security interests. A commercial lien arises when a service provider such as a repair shop, storage facility, or transporter, performs work on goods and remains unpaid. Under the CLA, the lien attaches as soon as the services begin and can be perfected either by possession or by registration in the Personal Property Registry.

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By contrast, security interests under the Personal Property Security Act (“PPSA”) are typically consensual arrangements, such as general security agreements granted to lenders. PPSA rules generally reward early registration: the first to perfect usually wins. However, Section 20 of the CLA disrupts this logic by granting liens a super-priority status in certain circumstances.

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Section 20: A Statutory Trap for Buyers

Section 20 provides that a lien (whether perfected or unperfected) takes priority over a security interest that attached before the lien, unless the security interest is subsequently perfected prior to perfection of an initially unperfected lien. This means that a lender who acquired its security interest in tangible goods but experienced a minor delay in registration, during which the tangible goods were sent for repair in the ordinary course of business, can find its position subordinated to a lien in favour of the repairing service provider quite easily. For buyers, the implications are:

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1. Lender’s may require more due diligence prior to advancing funds to a buyer to facilitate their business acquisition, as confirmation that all service invoices in respect of vehicles, machinery, and equipment have been paid and no such assets are going for service at the time of closing may be required to ensure no initially unregistered liens exist that could take priority over their security interest.
2. A buyer who assumes that clearing PPSA registrations eliminates all encumbrances, such that they can receive goods unencumbered and in compliance with their lender’s requirements, may suddenly find that they are in breach of their obligations to their lender if a service provider commences services before the lender’s security interest is registered, despite the fact that services may have been commenced after the lender’s security interest attached.

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The second, and arguably more troubling, aspect of Section 20 is its treatment of liens perfected by possession. If a lienholder retains possession of goods, that lien has priority even against a bona fide purchaser for value without notice of the lien. In practical terms, if equipment is in a repair shop on closing day and the repair bill is unpaid, the buyer (and their lender) acquires the equipment and security interest, respectively, subject to that lien, even if the buyer had no knowledge that the lien existed.

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Why Due Diligence May Not Be Enough

Traditional due diligence measures, such as registry searches, site inspection, and review of financial statements, cannot fully mitigate these risks. Unperfected liens do not appear in the registry, and possessory liens may not be disclosed by the vendor, whether through oversight or omission. Even a physical inspection of the premises may fail to uncover equipment that is off-site for servicing or storage.

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Practical Strategies for Managing the Risk

While the statutory framework cannot be changed by contract, buyers can take steps to reduce exposure:

1. Expand Enquiries: Request a detailed list of all equipment, including its current location, and confirm whether any items are off-site for repair or storage.
2. Contractual Protections: Include strong representations and warranties regarding the absence of liens, coupled with indemnities for any losses arising from undisclosed liens or encumbrances.
3. Escrow or Holdbacks: Retain a portion of the purchase price to cover potential lien claims discovered after closing.
4. Direct Verification: If equipment is off-site, contact the service provider to confirm that all charges have been paid.
5. Physical Inspections: Where possible, verify that key assets are in the vendor’s possession before closing.

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Conclusion

Section 20 of the CLA creates a risk that cannot be fully addressed through conventional due diligence. By granting priority to liens, even unperfected ones. over prior security interests, and by protecting possessory lienholders against bona fide purchasers, the Act introduces a layer of uncertainty that buyers must actively manage. The lesson is clear: due diligence must go beyond the registry. It requires targeted questions, contractual safeguards, and practical verification steps to ensure that the assets being acquired are truly free and clear. Failure to take these precautions can result in unexpected liabilities, additional costs, or even the loss of critical equipment after closing

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