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Chapter 23 - Law 603.doc

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Ryerson University
Law and Business
LAW 603
Andre Serero

Chapter 23 – Secured Transactions  Risk Management Strategies for Creditors • 2 main ways of managing risk: security interest & guarantees • Security interest –allows a creditor to seize some of a debtor’s personal prop if a debt is not repaid, usually w.o the delay & expense of going to court. Suppose u want to borrow $ 4m a bank to buy a new delivery truck. Bank will decide whether to lend u the $ based largely on ur ability to repay the loan. If it found u couldn’t it would give u credit if u gave permission to seize & sell the truck if u failed to repay the loan. This permission = granting a security interest in the truck. Property that is subject to a security interest is called collateral. Creditor that has a security interest is called a secured party. • Security interest – gives the bank advantages over an ordinary creditor. Bank has a security interest in the truck, it is entitled to seize the collateral, dispose of it, & use the $ it gets to pay off ur debt. If the bank didn’t have a security interest, it would have to sue u 4 the unpaid debt & then get an order to seize ur prop. Lawsuit = time &$. Bank may not be able to seize the prop if it is subject to a security interest held by another creditor. • Security interest can be given over any type of property to any type of creditor. Personal prop includes tangible & intangible assets, life ins polices, some kinds of license & intellectual property • Another way for a creditor to reduce the rrdk associated w. non pmt is to obtain a guarantee – contractual promise by a 3 party, guarantor to satisfy the principal debtor’s obligation if that debtor fails to do so. EX. U persuade a friend to act as the guarantor of the loan u got 4m the bank to buy the truck. If u fail to repay that loan, bank can demand pmt 4m ur friend. Some situations, law recognizes that the debtor & creditor may act in ways that unfairly hurt the interests of the guarantor. EX. If the debtor agrees to pay a higher rate of interest on the debt, guarantor’s potential liability is increased. If that occurs after the guarantee is signed &w.o the guarantor’s consent, law may release the guarantor 4m liability. How Security Interests are Created • Pawn/pledge. In return 4 a person lending u $, u give them temporary possession of some of ur prop as security 4 the loan. U agree tht if u fail to pay the loan, the lender can sell the prop & apply the money received against ur debt. If u repay the loan, u get ur prop back b/c this form of secured loan transaction requires the physical transfer of a piece of prop, there is a natural limit on its use. Debtor often needs to use the prop given as security in its bus. Law develop to allow the creation of security interests by contract that didn’t require a transfer of possession. Granting a security interest in a specific asset • When debtor transfers title in a specific asset to a secured party, transaction is called “chattel mortgage” - transaction in which a debtor gives a creditor title to some specific personal prop to secure the performance of an obligation it owes to the creditor. • Security interests may also be created in specific assets w.o transferring title/ownership to the creditor. Conditional Sales • Occurs when the seller retains ownership of the goods to secure pmt of the purchase price by the buyer. • Buyer is often allowed to postpone paying @least part of the purchase price. As security 4 that debt, the seller may retain an interest, usually in the form of ownership, in the goods tht r being sold. Buyer gets possession of the goods immediately, but they don’t own them until they pay the full price. = conditional sale • Very common in consumer transactions where a person buys furniture/other household items but defers pmt until some time in the future. Also common where 2 bus have a ongoing relationship 4 the purchase of goods. EX. Manufacturer may retain a security interest in the equipment that it supplies to a distributor. The security interest is taken to secure the pmt of the purchase price. If the buyer defaults, seller can take back the goods. Buyer is responsible 4 any damage to the goods, buyer may be required to buy ins. to cover the goods while pmt is pending. Seller may require that they be named as the beneficiary under that ins policy. Special Cases – similar to conditional sales which r often used to create sec interest: consignment & lease a) Consignment – occurs when the owner of goods transfer possession, but not ownership to someone else. Owner = consignor. Person who gets possession of the goods = consignee. Reasons for consignment : I. Consignee may be examining the goods 4 possible purchase II. Consignee may have agreed to try to sell the goods on the consignor’s behalf; usually meant when goods r held by someone “on consignment”. Children’s used clothing store may take clothes on consignment 4m a parent, offer them 4 sale, then pay the parent a % of the purchase price if the clothes r sold. • True consignment, consignee isn’t bound to pay 4 the goods until they do something, such as selling them to a 3 party. But the term “consignment” is also sometimes used to refer to a situation in which the “consignee” has already agreed to pay 4 the goods & “consignor” holds on to ownership to secure full pmt of the price. That transaction is a conditional sale, not a true consignment. Retention of ownership under the consignment is a form of security interest. b) Lease – operate like a conditional sale & as an alternative to a secured loan. Suppose u want to buy a truck 4 $50000, u could acquire the truck in @least 3 diff kinds of secured transactions, including a lease: I. Seller might agree to a conditional sale in which it gives u time to pay but retains ownership of the truck until u have paid the full price + int, in 60m installments of $1000 that blend pmt of the price &int. II. U could borrow $50000 4m a bank, agreeing to repay that amt, + int, in 60 blended monthly installments of $1000. Security 4 ur promise to pay those monthly installments, u could give the bank an interest in the truck. III. U could acquire the truck in a financing transaction set up as a lease. Under a lease, lessor retains ownership of an asset but gives possession of it to the lesse 4 a period of time in return 4 the lessee’s promie to make reg pmts. When used for financing, lessor’s ownership of the leased asset is a security interest. Its purpose is to secure the lessee’s obligation to make the lease pmts & help the lessor manage the risk of default. To acquire the truck in a lease financing transaction, u could enter into an arrangement w. a lessor, who would buy the truck that interest u. In order for u to acquire the truck, the lessor would then agree to lease tht vehicle to u for 4m in exchange 4 ur promise to make monthly pmts of $1000. Lessor would give u an option to purchase the truck @ the end of the 60m. Since u have paid the full purchase price + int, option price could be nominal, $1. • The bank financing, u get ownership of the truck @ the outset, which u use as collateral for the bank loan. Bank makes its decision to lend $ to u based on 2 factors ; 1) assessment of ur ability to make the loan pmts 2) assessment of its own ability to acquire & sell the truck if u fail to mke the pmts. • Lease financing & conditional sale, u don’t get ownership of the truck @ the outset. Lessor/seller owns the truck. U do get the right to possess & use the vehicle, just as if u were the owner. Conditional sale u get ownership when u have made all the pmts. Lease u have an option to obtain ownership after making all the pmts. Lessor & conditional seller will make their decisions to enter into a transaction w. u based on the same 2 factors as the bank: 1) ability to make monthly pmts 2) their own ability to acquire & sell the truck if u fail to make those pmts. • Lease same financial characteristics as a conditional sale/secured bank loan to fund the purchase of the asset: a) Same amt of credit is extended to u in each transaction b) Obligated to repay the price of the truck _ int. c) Give up an interest in the vehicle to secure ur pmts d) Will own the truck @ the end of the arrangement. One distinctive characteristic of lease financing is that u must actually exercise ur option to buy the vehicle for $1. Of course, it would be economically irrational for u not to exercise that option less the truck was so badly damaged and it worth less than $1. Assignment of AR • Asset, which can be used as security if the bus wants to borrow $. Business can give the bank an assignment of AR, which would allow the bank to collect the debts (book debts) owing to the bus if the loan isn’t repaid. • When debtor makes an assignment of AR to a creditor, debtor is allowed to collect their own AR and to carry on bus as usual. Creditor steps in & demands pmts 4m the debtor’s customers only if the debtor fails to fulfill their obligations to the creditor. Granting a security interest in all of the debtor’s assets • To get max protection against a debtor’s failure to pay, banks & other financial institutions often take a security interest in all of the debtor’s assets w. a general security agreement. Security interest in such an agreement typically covers assets of the debtor @ the time that the security agreement becomes effective & assets that the debtor acquires after tht time. • Before modern provincial personal property security legislation (PPS legislation) was created creditors often used a floating charge to take security in after acquired property. Floating charge –security interest that hovers above the debtor’s assets until some event causes the charge to become fixed or crystallized on those assets. Contract creating a floating charge usually states that the charge descends & becomes fixed only if the debtor misses a pmt & a notice of default is given by the creditor. Until then, debtor can carry on bus, including buying & selling assets, w.o regard to the floating charge. However, once the relevant event occurs, debtor can sell its assets only subject to the creditor’s charge. Purchaser of the debtor’s assets doesn’t own them outright – creditor’s interest continues to exist in them. • Floating charges rnt often used anymore b/c PPS legislation allows a creditor to take a similar but more effective sort of security interest. A secured party’s interest can attach to all of the debtor’s current & after acquired property as soon as the prop is acquired by the debtor w.o any requirements 4 crystallization. Interest continues to exist even if the rd debtor disposes of their prop to a 3 party. Since it is not in either party’s interest to freeze the debtor’s operations but the debtor will be given permission in the security agreement to carry on bus as usual, incl. selling inventory & replacing worn-out equipment. Ppl who buy 4m the debtor in these circumstances get the goods free of the security interest of the creditor. Special security interests of banks • Canada, banks can be incorporated only under the federal Bank Act. S. 427 the act allows banks to take a special kind of security in certain types of asset, which other creditors cant take. • Banks may take s.427 interest in addition to the other sorts of security interests described above, often do take more than 1 type of security interests 4 a single obligation. • Banks may take sec 427 security interests only in the type of assets listed in the Act. Include the goods of retailers, wholesalers, manufactures, as well as mining & forest products. Banks cant take this special kind of interest in either consumers’ assets/ the assets of most businesses providing services. • Under the act, there is a special registration system 4 these interests. For the registration to be effective, the bank must get the debtor to file a “notice of intention” to give security to the bank @ the branch of Bank of Cad closest to the debtor’s place of bus. • Main adv of 427 security interest 4 banks is that a single registration applies to all the debtor’s assets, no matter where they r located. Contrast PPS legislation of a province is effective only w. respect to assets in that province. Sec 427 security interest is less burdensome to register if the debtor has assets in several provinces. Another adv. is that they will prevail over some other forms of security interests in the same collateral. SUMMARY 1. Conditional sale – seller of goods retains title, or some other forms of security interest, to secure future pmt of the purchase price by the buyer 2. Security interest in a specific asset – debtor gives a security interest in some of their personal property to a creditor to secure performance of an obligation owed by the debtor (chattel mortgage) 3. Assignment of AR – a person (assignor) who is owed a debt (AR) assigns it to someone1 (bank) to secure performance of an obligation owed by the assignor to the bank. 4. Security interest in all of the debtor’s assets, including after acquired property – debtor gives a security interest in all of their personal property, including all property acquired by the debtor after the date that the security agreement is created, to a creditor to secure performance of an obligation owed by the debtor (general security agreement) 5. Special security interests of banks created under the Bank Act – debtor gives a bank a security interest in certain types of property described in the Act. A single registration protects this interest in the debtor’s assets wherever they are in Canada. Provincial Rules for Secured Transactions • Creating a security interest: to give the creditor an interest in the debtor’s property to secure the debtor’s performance of an obligation; each method helps the creditor to manage the risk that the debtor will fail to perform. • Diff types of sec. int had to be registered in diff places. That situation was inconvenient 4 a bus. considering extending credit 4 @least 2 reasons: a) Even within a single province, a potential creditor who wanted to know whether a debtor had already given a security interest in a particular asset to another creditor had to search separate registries 4 each type of registered interest. b) Secured party had to search 4 security interests separately in every province where the debtor had assets that it offered as security. • Still necessary 4 secured parties to search in every province where the debtor has assets that they have offered as security. May be difficult to tell which provincial laws apply, such as when a truck that is collateral moves btwn provinces. Within each province, PPS legislation now integrates the CL & statutory rules 4 security int into a single system. Most security interests r now governed by1 set of provincial rules under the provinces PPS legislation. Facilitating Risk Management for Creditors • Unified approach under PPS legislation allows creditors to assess & manage risks more easily & accurately. Provides a simple & inexpensive system 4 secured parties to register their int. • Provincial registers can be searched online to determine wht sec int a debtor has granted & PPS legislation establishes a clear set of rules 4 determining the priority, or ranking of competing claims to the same collateral. • Provincial legislation also provides a single system of default rights that applies to almost all types of sec int; PPS legislation provides greater certainty 4 creditors. Scope of Application • PPS applies to all sec int in personal prop created by agreement btwn a debtor & secured party. • Security int – simply as an int in personal prop that secures the pmt/performance of an obligation; int created by conditional sales, assignments of AR and general sec agreements. Leases • Lease of goods can be used a a sub 4 a secured loan to finance the acquisition of goods. REAL LEASE: lessor simply grants the lessee temp possession in return 4 fixed reg pmts over some period of time. • Lessor’s title functions as a sec int depends upon the terms of the lease & circumstances of the transaction. PPS avoids the prob of determining when a lease creates a sec int by providing that any lease of personal prop that has a term of over 1 year is subject to the province’s PPS legislation. • If lease is subject to PPS, priority of the lessor’s sec int is determined by the legislation. • If lease isn’t subject to PPS, lessor’s ownership of the leased assets typically gives it a claim ranking ahead of all other creditors of the lessee, including those who have registered under the legislation. Lessor’s preferred result. Exceptions • Most important statutory rights: PPS DOESN’T APPLY a) Landlord under a commercial lease of real prop usually enjoys the right of distress/distraint; if tenant hasn’t paid its rent. Right of distress/distraint- allows a landlord to seize property that is on the rented premises & belongs to the tenant, sell it, use the sale proceeds to pay the o/s rent. This right cant be used against non- commercial tenants. b) Deemed trusts – r created under some statutes for the benefit of the govt r exempt 4m the application of provincial PPS legislation. Some assets of a bus. r deemed as a matter of law to be held 4 the benefit of the govt & can’t be used 4 the bus. Most impt deemed trust is the provision of the Income Tax Act – states that tax deductions 4m EE wages by ERs r deemed to be held in trust 4 the govt. Govt beneficially owns the funds, and must be remitted to the CRA. c) Liens – allows a person who hasn’t been paid to retain possession of goods that the person has repaired/stored until pmt is made. They r 4 ppl who provide repair/storage services r usually excluded 4m PPS. Person who is in possession of personal property 4 the purpose of either repairing/storing it can retain the prop until the owner pays the price of the repairs/storage. EX. Mechanic who fixes ur car can keep the vehicle until u pay the repair bill. Mechanic’s right against ur car is like a sec int since it is used to reduce the risk that the mechanic’s bill won’t be paid. DIFF 4m sec int b/c it arises w.o, as the debtor, consenting. LIEN usually exists only if the person providing the goods/services is in possession of the prop; non possessory lien may be available. • Creditors with these claims don’t have to register under PPS and most cases have priority over sec int that r subject to legislation. • Int of banks under sec 427 of Bank Act rep a sort of hybrid. ON, courts have said that a bank may register these int under PPS & take adv of w.e rights registration may provide in terms of priority over other creditors. BANKS don’t have to register but they may choose to under special system set up under the Bank Act and enforce their rights under that stat. Protecting Security interests under PPS legislation • Contracts usually can be enforced only against those who r parties to them. Rule of
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