Copyright © 2004 McGraw-Hill Ryerson Limited 1 PART 7 THE DEBTOR CREDITOR RELATIONSHIP Chapter 31...

Copyright © 2004 McGraw-Hill Ryerson

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PART 7 THE DEBTOR CREDITOR RELATIONSHIP

Chapter 31 – Security for Debt

Prepared by Douglas H. Peterson, University of Alberta


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SECURITY FOR DEBT

Introduction Forms of Security for Debt

Chattel mortgage Conditional sale agreement Assignment of Book Debts

Personal Property Security Act Bank Act Bonds, Debentures, and Floating Charges Statutory Protection of Creditor Security

Bulk Sales Act Mechanic’s lien


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INTRODUCTION

Security Any interest in property that is of value to the lender Either real property or personal property

Creditor Someone who agrees to provide something to a

debtor to be paid in the future Risk Management

To reduce the risk of non-payment the creditor may Security interest – an interest in the personal property of the

debtor to secure the debtor’s obligation to pay the creditor Seize - creditor may seize the property (collateral) if debtor

defaults on payment


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INTRODUCTION

Historically 2 types used Mortgage transaction

Physical transfer of possession Grant interest by transfer of title

Chattels – personal moveable property Chattel Mortgage Hire-purchase agreement Mechanics lien Personal Property Security Act (PPSA)


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FORMS OF SECURITY FOR DEBT General Methods

Chattel Mortgage Conditional Sales Agreement Bill of Sale Assignment of Book Debts Bank Act

Each provides creditor a security interest in the property enforceable by creditor

Special forms Liens Bulk Sales To certain types of creditors or creditors in certain

circumstances


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CHATTEL MORTGAGE

A mortgage in which the title to the chattel owned by the debtor is transferred to the creditor as security for the payment of the debt Much like land mortgage Transfer of title to mortgagee for duration of

indebtedness Bill of sale given to creditor Mortgagor retains possession

Right of re-possession upon default Sell by public or private sale Proceed with foreclosure Mortgagor liable for deficiency


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CHATTEL MORTGAGE

Notice to third parties via registration Failure to register renders chattel mortgage

void against purchaser for value and without notice of mortgage

Mortgage still valid between mortgagor and mortgagee

Consent required for further sale of goods Buyers take subject to mortgage Should search registry

Mortgagee may assign without consent


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CONDITIONAL-SALES AGREEMENT

Hire-purchase Series of lease payments followed by exercise of

option to purchase by balloon payment Title passes with balloon payment

Conditional Sales Agreement An agreement for the sale of a chattel in which the

seller grants possession of the goods, but withholds title until payment for the goods is made in full

Arises from sale only Governed by Personal Property Security Acts Payments are against ownership right from outset Title still does not pass until final payment made


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Registration Retailer gives good title if sale of NEW

goods in ordinary course of business Repossession maybe be limited or

prohibited if buyer has paid a substantial portion of price

Seller’s remedies must be exercised in strict compliance with legislation (if any applies)


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Assignment of conditional sales agreement Conditional seller is obligated to purchaser for

performance of the contract Seize or sue - applies to (“vender credit”) not

“lender credit” (3rd party) Recourse Financing – where assignee of a debt is

entitled to look to the assignor (original creditor) for payment if the debtor defaults in making payment

Cut-out Clause – provision whereby an assignee of a contractual debt takes free of any defenses that the original debtor may have against the original creditor


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In case of default - breach of contract remedies Retake goods (repossession) Buyers Rights – gets surplus from sale


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BILL OF SALE A contract in which title to the goods passes

to the buyer Where possession remains with seller after

sale, buyer must register bill for protection against third parties Time for registration varies with each province Must be a bona fide sale and not one with the

purpose of defeating seller’s creditors Purpose

Protects interests of buyer should seller attempt to sell to another unsuspecting buyer

Provides notice to world that title has passed to buyer


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ASSIGNMENT OF BOOK DEBTS

Accounts receivable pledged as security for loan Normal rules of assignment apply such as

notice Usually not acted upon unless merchant is

in default Very often, trade creditor continues to

collect accounts while not in default of loan (no notice)

Registration ensures accounts not pledged many times over without notice to trade accounts/assignee


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PERSONAL PROPERTY SECURITY LEGISLATION

Personal Property Security Act (PPSA) Single Statute enacted in most jurisdictions:

Replaces most other security legislation Covers most personal property credit

arrangements Has broader application Permits creation of all types of personal property

security interests Gives effect to contractual obligations of the

parties Only applies to assets in province Allows creditors to better assess and manage risk


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PERSONAL PROPERTY SECURITY LEGISLATION

Three main purposes of PPSA Registering and searching for security

interests Determining priority of security interests in

same collateral Enforcement


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IMPORTANT CONCEPTS (PPSA)

Security Interest – interest that secures payment or performance of an obligation

Registration – the process of recording a security interest in a public registry system Based on notice registration not document

registration (register financing statement) Security interest perfected against third parties

on registration of financing statement Financing statement – the document registered as

evidence of security against personal property After-acquired property – assets purchased

after a secured loan is granted


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CREATING SECURED RELATIONSHIP (PPSA)

Purpose Secured creditors are those who have a secured

interest Secured creditors have priority over unsecured

creditors PPSA is a registration system

As a general rule priority is based on date of registration

Steps to creating a Secured Relationship Parties enter contractual agreement Secured interest is attached to collateral Secured interest is perfected


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CREATING SECURED RELATIONSHIP (PPSA)

Attachment Debtor signs written security agreement with

description of collateral Creditor give value to debtor Debtor gets rights in collateral

Attachment can occur after registration or possession

Perfection = Attachment and Creditor either: Files financing statement; or Takes possession of collateral

Security interests enforceable against transferees of collateral and capable of being perfected if have “attached”


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PURCHASE MONEY SECURITY INTEREST

Purchase Money Security Interest (PMSI) Security interest taken in collateral by a

person who gives value for the purpose of enabling the debtor to acquire rights in the collateral

Supplier of goods gets priority over prior registered security interests in after-acquired property

Purpose: allows suppliers of goods to overcome an ALLPAAP clause in a security agreement All present and after acquired property


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PURCHASE MONEY SECURITY INTEREST

Requirements Supplier must perfect by filing financing

statement before or within 10 days of debtor obtaining possession of goods or

if inventory Perfect by filing financing statement BEFORE debtor

obtains possession of goods AND Give notice to all secured parties who have registered

interest in inventory

Person financing debtor’s acquisition of goods can also obtain PMSI in goods if Lends money to debtor to acquire goods Money used to acquire goods


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SECURED LOANS UNDER THE BANK ACT

Bank loans against yet-to-exist collateral Act sets out types of assets and debtors Registered under a separate system from the

PPSA Usually at Bank of Canada office closest to debtor

Types of Assets Farming, forestry, fishing, manufacturing

industries Includes crops, animals, fish, trees, minerals Equipment and machinery used in such industries


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SECURED LOAN UNDER THE BANK ACT

Registration gives bank priority against third parties and covers goods as-and-when acquired, born, dug, cut, caught, etc

“Notice of Intention” borrower pledges certain assets, both present and future

Must be registered by bank Property is assigned Remedies – broad powers can seize without

following Seizures Act Note: PPSA not apply, priority determined by

Bank Act


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BANK CREDIT CARDS

Not security instruments in themselves but provide security of payment to merchant Payment security for retailer (like certified cheque

Two separate agreements Contract between retailer and bank (accept

card/pay) Bank guarantees payment and merchant pays

small percentage charge Contract between bank and customer

(credit/pay) Customer compensates bank (monthly payments) Bank is an unsecured creditor


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BONDS, DEBENTURES, AND FLOATING CHARGES

Bonds – explicit assets pledged as security for debt, with hallmarks of mortgage (secured creditor) relationship

Debentures – a pledge over assets senior to unsecured creditors but subordinate to secured creditors

Floating charge – often a debenture, never a bond

While not in default, underlying asset class (e.g. inventory) can be bought and sold without consent. On default, charge crystallizes over all assets of class then on hand


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STATUTORY PROTECTION OF CREDITOR SECURITY

Legislation under which creditors of certain debtors have special statutory rights Usually where actions of debtor could

seriously affect the rights of creditors to payments

Bulk Sales Act Mechanics’ or Construction Liens


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BULK SALES ACT Sale by merchant outside the normal course

of business (e.g.: all inventory, or major productive assets)

Gives general creditors first claim on proceeds of sale

Seller must verify to buyer the payment or arrangements for payment of seller’s creditors before purchase price paid over, otherwise buyer liable for seller’s debts Buyer must follow procedure set out in act or sale

may be deemed void Prevents liquidation of firm and absconding

debtor-seller


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MECHANICS’ OR CONSTRUCTION LIEN

Worker’s right to claim security interest in property to ensure payment for labor or materials

Creature of statute 2 types of Liens

Lien against real property Lien against chattel

Some provinces use same statute, others use different statute

Protected contractors and sub-contractors


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MECHANICS’ OR CONSTRUCTION LIEN

Registration - regulations stipulate the nature and process of registering liens

Against chattels (mechanic’s lien) Repairer of chattel may retain it until paid

for labor and materials


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STATUTORY PROTECTION OF CREDITOR SECURITY

Against land (construction lien) Contractor or worker may claim against land itself

for unpaid labor/materials within 30/45/60 days of last supply (time varies by province)

Holdbacks - owner must holdback portion of contract price to satisfy potential liens

Where landowner has complied with legislation and “held back” funds from contractor, worker’s claim can be vacated on payment from holdback funds.

If no worker’s liens filed, contractor can be paid balance of fund after expiry of 30/60 day lien claim period


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SUMMARY

Business requires credit in order to operate

Creditors require security in order to lend goods or money on credit

Various debt instruments available Chattel Mortgage

Transfer of title to creditor Conditional-sales agreement

Seller retains title until paid in full


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SUMMARY Corporations raise capital based on security

of assets Bonds and Debentures Floating charge

Other Assignment of book debts Bank Act Bulk Sales Act Mechanics’ Lien

PPSA Legislative system for registering and enforcing

security agreements

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