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
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SECURITY FOR DEBT
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Introduction
Forms of Security for Debt
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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
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Bulk Sales Act
Mechanic’s lien
Copyright © 2004 McGraw-Hill Ryerson Limited
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INTRODUCTION
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Security
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Creditor
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Any interest in property that is of value to the lender
Either real property or personal property
Someone who agrees to provide something to a debtor
to be paid in the future
Risk Management
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To reduce the risk of non-payment the creditor may
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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
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Historically
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2 types used
Mortgage transaction
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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
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General Methods
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Chattel Mortgage
Conditional Sales Agreement
Bill of Sale
Assignment of Book Debts
Bank Act
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Each provides creditor a security interest in the property
enforceable by creditor
Special forms
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Liens
Bulk Sales
To certain types of creditors or creditors in certain
circumstances
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CHATTEL MORTGAGE
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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
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Much like land mortgage
Transfer of title to mortgagee for duration of
indebtedness
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Bill of sale given to creditor
Mortgagor retains possession
Right of re-possession upon default
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Sell by public or private sale
Proceed with foreclosure
Mortgagor liable for deficiency
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CHATTEL MORTGAGE
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Notice to third parties via registration
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Consent required for further sale of goods
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Failure to register renders chattel mortgage void
against purchaser for value and without notice of
mortgage
Mortgage still valid between mortgagor and
mortgagee
Buyers take subject to mortgage
Should search registry
Mortgagee may assign without consent
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CONDITIONAL-SALES AGREEMENT
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Hire-purchase
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Series of lease payments followed by exercise of option
to purchase by balloon payment
Title passes with balloon payment
Conditional Sales Agreement
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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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CONDITIONAL-SALES AGREEMENT
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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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CONDITIONAL-SALES AGREEMENT
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Assignment of conditional sales agreement
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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
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CONDITIONAL-SALES AGREEMENT
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In case of default - breach of contract
remedies
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Retake goods (repossession)
Buyers Rights – gets surplus from sale
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BILL OF SALE
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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
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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
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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
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Accounts receivable pledged as security for
loan
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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
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PERSONAL PROPERTY SECURITY
LEGISLATION
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Personal Property Security Act (PPSA)
Single Statute enacted in most jurisdictions:
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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
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PERSONAL PROPERTY SECURITY
LEGISLATION
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Three main purposes of PPSA
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Registering and searching for security interests
Determining priority of security interests in same
collateral
Enforcement
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IMPORTANT CONCEPTS (PPSA)
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Security Interest – interest that secures payment or
performance of an obligation
Registration – the process of recording a security
interest in a public registry system
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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
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CREATING SECURED RELATIONSHIP
(PPSA)
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Purpose
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Secured creditors are those who have a secured interest
Secured creditors have priority over unsecured creditors
PPSA is a registration system
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As a general rule priority is based on date of registration
Steps to creating a Secured Relationship
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Parties enter contractual agreement
Secured interest is attached to collateral
Secured interest is perfected
Copyright © 2004 McGraw-Hill Ryerson Limited
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CREATING SECURED RELATIONSHIP
(PPSA)
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Attachment
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Attachment can occur after registration or
possession
Perfection = Attachment and Creditor either:
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Debtor signs written security agreement with description
of collateral
Creditor give value to debtor
Debtor gets rights in collateral
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
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PURCHASE MONEY SECURITY INTEREST
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Purchase Money Security Interest (PMSI)
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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
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All present and after acquired property
Copyright © 2004 McGraw-Hill Ryerson Limited
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PURCHASE MONEY SECURITY INTEREST
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Requirements
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Supplier must perfect by filing financing statement
before or within 10 days of debtor obtaining possession
of goods or
if inventory
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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
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Lends money to debtor to acquire goods
Money used to acquire goods
Copyright © 2004 McGraw-Hill Ryerson Limited
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SECURED LOANS UNDER THE BANK ACT
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Bank loans against yet-to-exist collateral
Act sets out types of assets and debtors
Registered under a separate system from the PPSA
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Usually at Bank of Canada office closest to debtor
Types of Assets
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Farming, forestry, fishing, manufacturing industries
Includes crops, animals, fish, trees, minerals
Equipment and machinery used in such industries
Copyright © 2004 McGraw-Hill Ryerson Limited
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SECURED LOAN UNDER THE BANK ACT
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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
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Not security instruments in themselves but provide
security of payment to merchant
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Two separate agreements
Contract between retailer and bank (accept
card/pay)
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Payment security for retailer (like certified cheque
Bank guarantees payment and merchant pays small
percentage charge
Contract between bank and customer (credit/pay)
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Customer compensates bank (monthly payments)
Bank is an unsecured creditor
Copyright © 2004 McGraw-Hill Ryerson Limited
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BONDS, DEBENTURES, AND FLOATING
CHARGES
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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
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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
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STATUTORY PROTECTION OF CREDITOR
SECURITY
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Legislation under which creditors of certain
debtors have special statutory rights
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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
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BULK SALES ACT
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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
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Buyer must follow procedure set out in act or sale may
be deemed void
Prevents liquidation of firm and absconding debtorseller
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MECHANICS’ OR CONSTRUCTION LIEN
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Worker’s right to claim security interest in
property to ensure payment for labor or
materials
Creature of statute
2 types of Liens
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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
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MECHANICS’ OR CONSTRUCTION LIEN
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Registration - regulations stipulate the
nature and process of registering liens
Against chattels (mechanic’s lien)
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Repairer of chattel may retain it until paid for
labor and materials
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STATUTORY PROTECTION OF CREDITOR
SECURITY
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Against land (construction lien)
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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
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SUMMARY
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Business requires credit in order to operate
Creditors require security in order to lend
goods or money on credit
Various debt instruments available
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Chattel Mortgage
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Transfer of title to creditor
Conditional-sales agreement
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Seller retains title until paid in full
Copyright © 2004 McGraw-Hill Ryerson Limited
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SUMMARY
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Corporations raise capital based on security of
assets
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Other
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Bonds and Debentures
Floating charge
Assignment of book debts
Bank Act
Bulk Sales Act
Mechanics’ Lien
PPSA
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Legislative system for registering and enforcing security
agreements
Copyright © 2004 McGraw-Hill Ryerson Limited
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