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Copyright © 2004 McGraw-Hill Ryerson Limited 1 PART 7 THE DEBTOR CREDITOR RELATIONSHIP Chapter 31 – Security for Debt Prepared by Douglas H. Peterson, University of Alberta
Copyright © 2004 McGraw-Hill Ryerson Limited 2 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
Copyright © 2004 McGraw-Hill Ryerson Limited 3 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
Copyright © 2004 McGraw-Hill Ryerson Limited 4 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)
Copyright © 2004 McGraw-Hill Ryerson Limited 5 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
Copyright © 2004 McGraw-Hill Ryerson Limited 6 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
Copyright © 2004 McGraw-Hill Ryerson Limited 7 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
Copyright © 2004 McGraw-Hill Ryerson Limited 8 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
Copyright © 2004 McGraw-Hill Ryerson Limited 9 CONDITIONAL-SALES AGREEMENT 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)
Copyright © 2004 McGraw-Hill Ryerson Limited 10 CONDITIONAL-SALES AGREEMENT 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
Copyright © 2004 McGraw-Hill Ryerson Limited 11 CONDITIONAL-SALES AGREEMENT In case of default - breach of contract remedies Retake goods (repossession) Buyers Rights – gets surplus from sale
Copyright © 2004 McGraw-Hill Ryerson Limited 12 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
Copyright © 2004 McGraw-Hill Ryerson Limited 13 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
Copyright © 2004 McGraw-Hill Ryerson Limited 14 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
Copyright © 2004 McGraw-Hill Ryerson Limited 15 PERSONAL PROPERTY SECURITY LEGISLATION Three main purposes of PPSA Registering and searching for security interests Determining priority of security interests in same collateral Enforcement
Copyright © 2004 McGraw-Hill Ryerson Limited 16 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
Copyright © 2004 McGraw-Hill Ryerson Limited 17 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
Copyright © 2004 McGraw-Hill Ryerson Limited 18 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”
Copyright © 2004 McGraw-Hill Ryerson Limited 19 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
Copyright © 2004 McGraw-Hill Ryerson Limited 20 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
Copyright © 2004 McGraw-Hill Ryerson Limited 21 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
Copyright © 2004 McGraw-Hill Ryerson Limited 22 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
Copyright © 2004 McGraw-Hill Ryerson Limited 23 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
Copyright © 2004 McGraw-Hill Ryerson Limited 24 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
Copyright © 2004 McGraw-Hill Ryerson Limited 25 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
Copyright © 2004 McGraw-Hill Ryerson Limited 26 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
Copyright © 2004 McGraw-Hill Ryerson Limited 27 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
Copyright © 2004 McGraw-Hill Ryerson Limited 28 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
Copyright © 2004 McGraw-Hill Ryerson Limited 29 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
Copyright © 2004 McGraw-Hill Ryerson Limited 30 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
Copyright © 2004 McGraw-Hill Ryerson Limited 31 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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