Chapter 16 Textbook Notes.doc

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Management and Organizational Studies
Management and Organizational Studies 2275A/B
Cristin Keller

Chapter 16- Priority of Creditors: - other than Federal Bankruptcy and Insolvency legislation, creditors’ rights are under provincial jurisdiction Methods of Securing Debt: - secured creditor: a creditor who has priority over other creditors in the event of bankruptcy or insolvency Personal Property: - both real & personal property can be used as security - real property: land or anything attached to land (buildings, fixtures) o mortgages often use real property as security - personal property: divided into chattels (tangible, movable things) & choses in action (intangible rights that re legally enforceable claims – example: promissory notes) - pledge: situation where a pawnbroker lends money and holds an item (ring, watch) as security until the loan is repaid. If loan isn’t repaid, pawnbroker gains right to sell the item - personal property security involves right to take possession upon default o default may occur when payment is missed OR when debtor fails to meet any obligations (such as maintaining sufficient insurance) The Traditional Approach: - historically, the seller (creditor) retains the title/ownership of the good until the last payment is made, in which the ownership is transferred to the buyer (debtor) o Sale of Goods Act applies to conditional sales even though the sale takes place over a period of time - Chattel mortgages differ from conditional sale  when debtor approaches bank to borrow money, the bank requires the transfer of the title of a good (car/boat) to the creditor as “collateral security” o With a chattel mortgage, when the last payment is made, the title of the goods secured as collateral returns to the debtor - with chattel mortgage, since there is no actual sale, the Sale of Goods Act does not apply - accounts receivable can be used as security for a loan  used when busi- ness has few tangible assets - leases are common method of securing relationship between creditor & debtor o operating lease: goods are rented out to the lessee to use during the lease period - lease to purchase also provides security to creditor o when title to the goods will be transferred to the lessee at the end of the lease period - with both operating lease and lease to purchase, possession of goods goes to lessee, while the title remains with the lessor, providing lessor with securi- ty - when manufacturer or supplier of goods leases them to lessee using a lease to purchase, transaction is like a conditional sale - when goods are sold to financial institution and then leased to lessee, rela- tionship is more like a chattel mortgage - today, personal property security act now in place to govern situations where personal property is used as security The Personal Property Security Act: - Personal Property Security Act creates common process for using personal property as security - PPSA allows less common forms of personal property (licenses, shares, bonds, & intellectual property) to be used as security - PPSA provides rules to determine ranking of various claims when several se- cured creditors have claims against assets - Secured transaction gives you right to take possession of goods used as se- curity even if they get into hands of innocent purchaser o If Lee purchases car under conditional sale agreement and defaults, the creditor has right to retake the car, even if it has been resold - Registration protects secured creditors and others Creating a Secured Relationship: - 3 stages to creating a secured relationship under PPSA o 1. Parties must enter into contractual agreement o 2. Secured interest must attach to collateral that has been identified to provide security o 3. Secured interest must be perfected - contract must be a security agreement - security must attach to collateral – attachment takes place when the debtor receives some value under the contract (ex. debtor receives the loan) o attachment gives the creditor a claim against the security in the event of default (ie. the right to take possession of the secured goods) - the obligations & remedies of the parties must be set out in the contract - attachment give creditors rights against debtor only  for protection is goods are sold or if another creditor becomes involved, secured transaction must be attached AND perfected - perfection: can be accomplished in 1 of 2 ways o 1. Registration of the security obligation at appropriate gov’t agency  single form (financing statement) is now used to provide notice of the security arrangement  requires complete name & address of parties, type & description of security used, and date & time of registration o 2. Creditor to obtain physical possession of the collateral (less com- mon)  appropriate when promissory notes or shares are used · original note/certification must be taken, not just photo- copy - purpose of registration is to inform others that the good is being secured as collateral Priority of Secured Creditors: - if more than one security interest is perfected by same collateral, usually first to register has priority o exception: purchase money security interest: will prevail over a gener- al security agreement covering all of a merchant’s assets – if regis- tered in specified time period o example: if a merchant receives a loan by securing all assets (including future assets) to the bank, but the supplier of the goods also has se- cured interest in the future acquired goods  the supplier selling the goods will have priority  since creditor knows that these goods will be sold in the normal course of business, innocent buyers are not affected (not bound) Rights and Remedies Upon Default: - upon default, creditor takes possession and can sell collateral  creditor must comply with contract & not violate the law in process - creditor typically hires a bailiff who goes onto debtor’s property and retrieves goods o if debtor won’t allow a bailiff access, the bailiff can apply for court or- der o if court order is not obeyed, debtor is guilty of contempt of court - creditor must take reasonable care of goods in possession o if goods require a repair to sell, the repair will be added on to amount owed by debtor - right to redeem: before goods are sold, debtor must be given notice and op- portunity to redeem goods by paying the amount owing - after possession has been taken, & notice period has expired, goods are sold, by private or public sale to satisfy the debt - if proceeds from sale don’t cover amount owing (principal + additional costs + interest), the debtor will be required to pay the difference (deficiency) o creditor can lose right to deficiency by failing to properly look after goods or by failing to get a fair price because they made a bad sale - when there is a surplus from that sale, debtor is entitled to surplus o if creditor sold car for $20,000, but the amount owing by the debtor was $17,000, the $3000 will be returned to the debtor (surplus) - in some jurisdictions, instead of selling collateral, creditor can take the goods & keep them, in full satisfaction of the debt (no deficiency or surplus taken into account) o notice must be given to all parties, and no objections can take place - example: when person borrows money from credit union using car as securi- ty, attachment takes place when loan is sent to debtor and contract is en- tered into. Perfection takes place when credit union files the financing state- ment with appropriate registry. An interested buyer or another creditor would search the registry to find that the car is already secured as collateral. If car is purchased & default takes place, credit union can recover the car. Once there is default, the creditor can either pursue normal breach-of-contract remedies, or take possession & sell the car Guarantees: - guarantor must pay debt when debtor defaults o if Mike borrows $5000 from bank with mother as guarantor, the mother must pay full amount if Mike defaults - guarantee involves a secondary or conditional obligation that arises only in event of default - indemnity: primary obligation when someone agrees to be directly responsi- ble for paying the debt of another - Statute of Frauds requires that guarantees be in writing to be enforceable - Guarantee is a separate contract, therefore all elements of contract must be present o Consideration = the advancement of funds o When guarantee is given after default on loan, consideration = credi- tor’s refraining from suing the debtor - Lending institutions usually require guarantees be given under seal (consid- eration is presumed) Rights and Obligations of the Parties: - Creditor should ensure the guarantor understands the agreement/guarantee o Guarantors often escape their obligation by claiming misrepresenta- tion, non est factum, or undue influence - Creditor must not weaken the position of the guarantor o changes to contract (advances more funds, or extends repayment date at higher interest rate) not approved by guarantor will release guaran- tor of obligations  simply not suing & giving debtor more time to pay is not consid- ered substantial change  guarantor still bound - guarantor also released from obligations when other forms of security (chat- tel mortgages (are released) - withholding of information from guarantor may also relieve guarantor of obli- gations - basic right & obligations are set out by contract between creditor and guar- antor, and they can be modified by contract as well - continuing guarantee: allows creditor to continue to advance funds up to pre-set amount & guarantor continues to be bound in case of default - when default occurs, creditor goes right to guarantor  guarantor who pays the debt is subrogated to the rights of the creditor (ie. guarantor steps into creditor’s shoes) - any defenses available to debtor are also available to guarantor o any info known to all parties at time of guarantee usually can’t be used as defense Other Forms of Security: The Bank Act: - allows banks flexibility in what they can take as security  growing crops, in- ventories, & goods in process of manufacture - Bank Act still important federal statute, but with PPSA, other lenders now have similar flexibility - Under Bank Act, security must be registered with Bank of Canada - Much confusion between federal Bank Act and provincial legislations Floating Charges: - used by creditors when dealing with corporations that are free to buy and sell the assets used as security (ex. Bonds usually secured by floating charges) - floating charges provide security but allow business to continue - it is only upon default that floating charge crystallizes, attaches to the specif- ic goods & becomes a fixed charge - floating charges less popular now that PPSAs allow inventory as security Builder’s Liens: - created to overcome problem in construction industry - Builder’s Lien Act gives suppliers of materials and work a claim for payment against the actual land & buildings enhanced by their goods and services o Since these workers typically contract with the contractor, they origi- nally had no claim against the owner of the land/building that was en- hanced by their services - Once the goods/services are provided, the suppliers & workers can register a lien - Effect of legislation is to prevent owner of property to unjustly benefit from goods/services that enhance their property’s value without paying for them - Holdback: the owner of the property retains a percentage of what she would otherwise pay to the general contractor (usually set at 10%) o if no liens have been registered, owner pays holdback to the general contractor o if liens have been filed, amount of lien is retained & made available to lien claimants - requirement of holdback applies to anyone in construction industry Negotiable Instruments: - cheques, bills of exchange, promissory notes often associated with secured transactions Letters of Credit: - letter of credit: commitment by the importer’s bank that the price stated will be paid upon presentation of appropriate documentation confirming delivery  used in international trade o provides assurance that exporter will be paid - exporter will often require a bank in his own country to be a confirming bank o importer & exporter’s bank communicate with each other & both agree to honour the letter of credit - can also guarantee proper performance, and if there is breach, the victim has recourse to the bank that has issued the letter of credit  called standby letter of credit Related Laws: Bulk Sales: - designed to prevent merchants from selling all, or majority, of their busi- ness’s assets before a creditor can take action to stop them  only exists in Ontario now - purchaser must obtain list of creditors, notify them of the sale, and pay pro- ceeds directly to them if they wish to sell - failure to comply will make sale void Landlord’s Right to Distrain for Rent: - when tenant fails to pay, ancient common law right called distress is avail- able to landlord - landlord has right to take the tenant’s assets on the rented property & even- tually sell them to pay for rent Fraudulent Transfers and Preferences: - if debtor hides property (giving of selling it to a f
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