Chapter 23 Secured Transactions

Class notes from August 10, 2009

Chapter 23 – Secured Transactions

Debtor :- owes

Creditor: --

• Entitled to $ at a future date
• 2 ways to reduce risk:
  1. security interest
  2. guarantee

Security interest

• Allows Creditor to seize Debtor’s personal property if debt is not paid.
• With respect to Security Interest Creditor could only sue for $

Guarantee –

• A TP contractually promises to pay the debt if not paid
• Guarantor may have some remedies

Part 1 PPSA LAW

• Provincial
• Purpose – make it easier for secured creditors to acquire enforceable SI

Process

• Secured Creditor can REGISTER its Security Interest
• REGISTER Security Interest takes PRIORITY OVER:
  1. all UNREGISTERED INTERESTS in same collateral; and
  2. ANY SI REGISTERED LATER

PART 2

Conditional Sales –

• Conditional sales occurs when Seller retains ownership of personal property to secure payment of price by Buyer
• Examples
  1. Buyer buying furniture from a Store
  2. Manufacturer selling to a distributor

• Buyer responsible for any damage to Property
• Buyer may be required to maintain insurance (with S named as insured)
• If buyer defaults, seller takes back the property

Consignment & Leases

• Consignments & leases are similar to CS
• Consignments & leases can be used to create Security Interest (“SI”)

Consignment – Owner (consignor) of property transfers possession, but NOT ownership, to someone else (consignee)

Why consignment?

• Consignee is considering purchasing; or
• Consignee will try to sell property to a TP

Consignment (as Security Interest)

True Consignment – Consignee NOT bound to pay until it buys goods or sells them to a TP (Therefore, Consignee cannot give a Security interest in goods)

Not a True Consignment --- Consignor retains ownership until Consignee pays – this is a Conditional Sales. This is also a form of SI.

Case Study # 2 --- Since E-cash gave the ATM machines on consignment, therefore E-Cash has ownership over it and it should get them back. It’s an example of True Consignment. E-Cash wins the case.

Lease --

True Lease – Lessor retains ownership of asset, but gives possession to Tenant for a time period in return for payment of rent.

Lease as Security Interest – Lessor retains ownership until all rent paid & Tenant exercises option to purchase (usually nominal price) – this is a form of SI.

3 OPTIONS FOR A BUYER TO FINANCE THE PURCHASE OF PERSONAL PROPERTY

1. Conditional Sales
2. Borrow & from Bank & give Bank a Security Interest
3. lease with Option to purchase

· Bank or Consignor/Seller or Landlord assesses the transaction on:

1. Borrower/Buyer/Consignee ability to pay; &

2. its ability

Lease or conditional sale

· Buyer or Tenant do not get ownership

· If buyer pays full price or Tenant pays all rent (& exercises option to purchase) Buyer/Tenant will become owner

Security Interest can be created using:

1. Conditional sales contract
2. consignment as SI
3. lease
4. loan

Note: seller/banker/consignor must register Security interest to protect itself.

Case Study # 3 – Superior’s lease was not a True lease, it was a Security interest. Because Superior never registered FS therefore Bank wins and gets the ownership over the vehicle.

2, Granting a Security interest in Specific Assets

Secured Loan – Lender is granted a Security Interest in specific asset.

Chattel Mortgage -- D gives ownership of a specific asset to a C to secure loan payment (not used often)

General Security Agreement “GSA”

• C gets a SI in ALL D’s Assets
• Usually, D is entitled to carry on business including selling inventory & replacing equipment (until default)

Assignment of Accounts Receivables

• AR – money owed by customers to the business
• Assignment of AR
  • Allows a Creditor to collect AR (if Debtor defaults to Creditor)
  • Usually, Debtor is allowed to collect AR until Debtor defaults

After- Acquired Property

• Security interest apply to after-acquired property
• Before PPSA, floating charges were used

Floating Charge

· Security interest that hovers above debtor’s assets until a stipulated event (e.g. default & notice) causes the charge to become fixed or crystallized on the assets;

· Sometimes difficult to determine when crystallization occurred (before or after a sale or a Security interest granted)

· Today, floating charges are rare

· Today, GSA is used

GSA –

1. covers present & after-acquired property;
2. Security interest as soon as debtor acquires the property – no need for crystallization; &
3. security interest with property even if sold (unless exempted)

special security interest of Banks

Banks can take:

1. PPSA Security interest; &/or
2. section 427 Bank Act Security interest
   1. applies to GOODS (usually inventory) of retailers, wholesalers, manufacturers, & mining & forest products
   2. N/A to assets of consumers & service businesses
   3. D files “Notice of intention” to give Security interest at the Bank of Canada branch nearest the debtor’s place of business

Advantages of S. 427 B.A. SI

1. only 1 registration (not in every province
2. prevails over most other Security interest

part 3 Provincial PPS legislation

• Security interest give creditors in property to secure debtor’s performance
• PPSA creates simple & inexpensive system for:
  • Recording SI;
  • Searching for SI;
  • Determining priority among SI

Scope of Application

• Applies to all SI in personal property created by contract between debtor and creditor

Security Interest – is an interest in personal property that secures payment or performance of an obligation (e.g. conditional sales contract, assignments of AR, GSA, and leases intended as security, etc.)

Lease as a SI

• When does a lease create a SI?
• Depends upon facts & circumstances
• If a lease is a SI, Landlord must register under PPSA in order to protect its SI;
• If a lease is not a SI, landlord’s ownership defeats all other claims

Exceptions

PPSA does not apply to rights created by statue, such as:

1. RIGHT OF DISTRESS/DISTRAINT ( by landlord of commercial premises)

2. DEEMED TRUST (e.g. EI, CPP, income tax deductions)

3. LIEN FOR REPAIR OR STORAGE SERVICES

NOTE – 1, 2, 3 do not have to register under PPSA & usually have priority

Case Study # 1

CRA will be entitled to 50K first, because it doesn’t have to register under PPSA. It has priority over everyone else.

Case Study # 11

You have to have possession, because Sydney Auto repairer let the car go, he lost the security interest on the car. Bank will prevail here. Bank wins and therefore would have the first priority over the auto repairer.

Protecting SI under PPSA

• PPSA states that a PERFECTED security interest may be effective against TP

Perfected SI -- usually when:

1. Security interest has ATTACHED; AND secured party has REGISTERED FINANCING STATEMENT under PPSA

Attachment

• Debtor signs written security agreement containing description of collateral, or SP gets possession of collateral;
• SP gives some value (e.g. loan); and
• Debtor has some rights in collateral

Perfection

• Secured party must perfect SI to fully protect its priority ( attachment not enough)

SI perfected by registration has priority over all subsequently registered SI in same collateral but not previously registered SI.

Registration of Financial statement serves to:

• Determine order of priority
• Gives notice of SI to world
• Identify debtor & SP, nature of SI, & time period but the actual security agreement is not disclosed

Advantages of FS

• 1 FS can relate to many SI given by same debtor to SP
• FS can be registered before security agreement signed

Priorities

• Basic rule – 1^ST TO REGISTER HAS PRIORITY
• Registration date of FS is critical – attachment may come later

See Business Decision 23.1 (on page 547)

Unperfected SI is subordinate to:

1. any perfected SI
2. other unperfected SI that attached earlier
3. any lien created by law
4. any C who has both successfully obtained a judgement against the debtor & taken steps to enforce it by seizing the debtor’s property
5. unperfected SI are ineffective against a Trustee-in-Bankruptcy
6. perfected SI are effective against TIB

purchase money security interest “PMSI”

• SI in after-acquired property creates problems for a debtor that needs to buy other assets on credit.
• Special priority rule for PMSI

PMSI – SI in a particular asset given by a debtor to a SP that either sells that asset to the debtor or finances its acquisition.

· PMSI has priority over all other SI in the same asset given by debtor

· PMSI may be claimed by a lender if:

1. it lends $ to debtor to acquire that asset;

2. Debtor actually uses that $ to buy that asset; AND

3. Debtor uses asset as collateral for loan.

2 TYPES OF PMSI

1. PMSI in Collateral (other than in inventory)

• To get PMSI’s super priority SP must register SI before or within 10 days of debtor getting possession of the asset.

Example

• Debtor gives GSA to Bank with SI in present and after-acquired property
• Bank registers financing statement
• Debtor buys a car from a dealer on credit
• Dealer registers a FS within 10 days of D getting possession of car
• Who has the superior SI in car?

DEALER HAS SUPERIOR SI IN CAR

Case Study # 7

Metro Auto inc. will win as it registers FS within 10 days.

PMSI IN INVENTORY

• INVENTORY – goods held for sale or lease
• For PMSI in inventory SP must BEFORE DEBTOR GETS POSSESSION:
  1. register FS; and
  2. Give notice to any SP who previously filed a FS indicating an interest in inventory.

SI WHEN COLLATERAL IS TRANSFERRED/SOLD

• Generally, SI in property continues regardless of whether sold to a TP (with or without knowledge of SI)
• Generally, TP must search for SI before buying – this can be very cumbersome
• Exceptions

1. buyer gets property free of any SI (even if perfected) if:

• SP permits debtor to sell or otherwise deal with the property; or
• Debtor sells that property in the ordinary course of the debtor’s business.
• buyer doesn’t get property free of any SI if:
  • sale was in breach of SA; and
  • Buyer knew it.

Buyer takes property free of all unperfected SI that B did not know about

Enforcement of SI

• After default SP can take possession
• Default occurs when:

1. debtor fails to pay or to perform under SA; or
2. defined event of default occurs per SA.

• Event of default may include failure to:
  • Maintain property;
  • Maintain insurance.

SP Taking Possession

1. can’t use force
2. get court order if debtor resists
3. SP must take reasonable care of property once in possession
4. SP must give reasonable notice before taking possession (unless collateral at risk, etc.)

Disposition of collateral

1. few rules
2. SP must be “commercially reasonable”
3. SP must give at least 15 days notice of sale to debtor and others having interest in collateral.
4. Secured Party is not entitles to any proceeds over the debt & costs; excess paid to subsequent interest holders & then debtor.
5. debtor liable for any unpaid debt

Case Study # 4

Check red book value, get appraisal done, advertise it in Auto trader or on lot, try to get Fair value of vehicle. None of this was done; Erin would have legitimate complaint here as Davis motors

When a SP can keep collateral

• if SP keeps collateral, it gives up any claim for debt
• SP must give notice to debtor & other interest holders before electing to keep collateral
• If anyone objects the collateral must be sold

When a debtor can get collateral back

• Redeeming Collateral – debt or subsequent SP can recover collateral seized by a SP only if:
  • Debtor fulfills ALL secured obligations, &
  • Pays ALL SP’s reasonable costs

NOTE – in Ontario debtor does not have right to reinstate the collateral, that is pay only arrears & SP’s costs and get collateral back.

Guarantee

• Contractual promise by a TP to satisfy the principal debtor’s obligation if the debtor fails to do so
• Guarantee is usually an independent obligation – if debtor doesn’t pay , creditor can pursue guarantor rather than debtor.
• If guarantor pays debt he can sue debtor for $

Guarantor’s defences to liability

• Guarantor may be relieved of liability if guarantor’s risk is increased without the guarantor’s consent
  1. contract modified without gtor consent such that gtor’s risk increased (e.g. increased loan amount or interest rate);