Legalese: Security agreements

Entering into a contract for goods or services always brings some risk to both parties. The other side may not complete its duties or obligations under the contract. If this happens to you, you may be left facing expensive litigation to attempt to recover what is owed to you. The question is, what steps can be taken to make recovery easier and more cost efficient?

In this column, we will take a look at the Personal Property Security Act of Manitoba. If you are located in another province there may be significant differences with your local legislation. If you are interested in using your local legislation to take out a security interest in personal property, you should consult an attorney in your jurisdiction. That said, the Manitoba PPSA is fairly representative of the kind of legislation that exists in Canada and a look at how it works may give you a sense of how this area of the law works.

The PPSA was created to help lenders take security over borrowers’ assets. This encourages people and companies to lend money, as they feel comfortable that they will be able to recover at least some of the loan in the event of a debtor defaulting on repayment obligations.

The first step to securing your credit is attachment. To create a security interest under the PPSA you need to specify which assets of the debtor you are taking an interest in. This can be as broad an interest as “all present and after acquired property.” This is a common phrase that grants an interest in all the personal property of the debtor. The issue with this sort of interest is that there are often many creditors who have the same interest, which can pose some difficulties.

Everyone wants to achieve perfection. “Perfection” under the PPSA means that you have registered your interest with the Personal Property Registry. This involves filling out paperwork and filing it with the PPR. It is important to ensure that the names of all the parties and the involved assets are accurately described. For example, if you are taking an interest in the assets of “Bill Smith” but his legal name is actually William Joseph Smith, your interest might be invalidated due to this inaccuracy.

Perfection establishes priority. Priority under the PPSA determines who gets paid first. The order of priority is established based on who perfected their security interest first. For example, Joe and Carl both have an interest in the property of Donnie the Debtor. Joe attached his interest to “all present and after acquired property” of Donnie five years ago but didn’t perfect his interest by registering it with the PPR. Carl comes along and creates the same security interest two yeas ago.

Carl perfects his interest immediately. Joe decides to perfect his interest the day after Carl perfected his interest. Under the priority rules of the PPSA, Carl will have priority over Joe if Donnie goes into default and his assets need to be divided up.

Depending on the value of the assets, Carl might completely recover his debt while Joe will be left to recover partial cents on the dollar. So remember, perfect your interest as soon as possible or risk the consequences!

A Purchase Money Security Interest (PMSI) is a special security interest with higher priority than pre-existing security interests. The interest is taken when money is lent for the purchase of something new. For example, Donnie the Debtor has taken out a lot of loans from his local credit union. They refuse to lend him any more money for his business. But Donnie needs to buy some more supplies. So he goes to the bank, which gives him money for supplies, on the condition that they have top priority on these freshly purchased supplies (and only these supplies). While at first glance this may seem unfair, the reason that PMSIs exists is to encourage lending. The pre-existing creditors are not any worse off because these new supplies wouldn’t be purchased without the PMSI, so the pre-existing creditors wouldn’t have an interest in them anyway.

And it actually increases the overall value of the debtor’s asset pool, which is a plus for pre-existing creditors.

So the next time you are thinking of extending credit to someone, make sure you create a security agreement and protect your interest!