At a glance: security interests and guarantees in Canada

Security interests and guarantees

Which entities in the organisational structure typically provide collateral and guarantee support for bank loan financings? Are there limitations on which entities in the organisational structure are permitted to provide such support?

Direct parents and wholly owned subsidiaries will commonly guarantee a bank loan financing by a borrower. Sister companies may also guarantee the financing, depending on the nature of the corporate group’s business and its organisation.

Financial assistance given by any corporation is regulated by the corporate statute that governs the corporation, and corporate statutes exist both at the federal level and in each Canadian province and territory. The financial assistance provisions formerly included in many corporate statutes, including the Canada Business Corporations Act and the Business Corporations Act (Ontario), have been repealed.

However, there remain a number of provincial corporate statutes that require that a solvency test be satisfied for a corporation to give financial assistance to related parties (subject to exceptions that generally include financial assistance provided by a wholly owned subsidiary to its parent or by a parent to its subsidiary). Certain corporate statutes also retain a prohibition on financial assistance by a corporation for the purposes of acquiring its own shares, subject to the same exceptions for financial assistance provided by a wholly owned subsidiary or by a parent to its subsidiary and, in some cases, subject to a solvency test. The constating documents of a special purpose corporation may also restrict its ability to provide financial assistance.

Further, every director and officer of a Canadian corporation, in exercising their powers and discharging their duties, must act honestly and in good faith with a view to the best interests of the corporation. Therefore, in authorising any financial assistance, the board of the Canadian corporation must conclude that providing the financial assistance is in the best interests of the corporation.

What types of obligations typically share with the bank loan obligations in the collateral and guarantee support? If so, are all such obligations equally and ratably covered by the collateral and guarantee support?

If the loan being provided is a revolving loan to be used for working capital and general corporate purposes, the administrative agent or the lenders (including through their affiliates) may also be willing to provide other facilities or services to the borrower, including cash management services, a credit card facility or a hedging facility. The lenders providing these other facilities will also expect them to be secured by the guarantee and collateral package. Typically, these other facilities will be secured with the loan facilities on a pari passu basis. However, it is fairly common that only the lenders (and not the creditors under these other facilities) may bring about the enforcement of the security so long as the loan facilities remain outstanding.

Which categories of assets are commonly pledged to secure bank loan financings? Describe any limitations on the pledge of assets.

A debtor’s present and future-acquired personal property is typically collateral for a bank loan financing. If the debtor owns valuable real property, or real property is being financed, its real property may also stand as collateral.

Typical carve-outs to a grant of security in all present and future-acquired personal property may include consumer goods and the last day of any real property lease, and there may be a carve-out or other arrangement negotiated by the debtor in respect of certain types of property to the extent that a grant of security in the property would result in the breach or termination of the property.

Describe the method of creating or attaching a security interest on the main categories of assets.

Personal property security legislation that applies to most types of personal property exists in each Canadian province and territory. Pursuant to that legislation, a security interest can be granted over present and subsequently acquired personal property pursuant to a single general security agreement. Subject to any agreement between the parties to postpone attachment, the security will attach immediately to personal property in which the debtor has rights and, on acquisition of rights therein, in subsequently acquired personal property.

In Quebec, the concept of a security interest does not apply. Instead, a debtor may hypothecate its movable property (ie, personal property) or immovable property (ie, real property) in favour of the secured party or a hypothecary representative. The hypothec may charge the universality of present and future property of the debtor, similar in effect to a general security agreement in the other Canadian jurisdictions.

In addition to property in Quebec (that may be the subject of a hypothec), real property, intellectual property, ships, aircraft, rolling stock and government receivables are examples of the types of property that may require specific security documentation.

What steps are necessary to perfect a security interest on the main categories of assets? What are the consequences of failing to perfect a security interest?

Generally, perfection of security over personal property in the common law provinces in Canada is governed by the Personal Property Security Act of the province in question (and, in Quebec, by its Civil Code). Perfection of security over real property in a province will be determined by the real property legislation in effect in that province, and other statutes will apply to specific types of property, such as ships, rolling stock and aircraft.

Different steps for perfection are required or recommended depending on the type of collateral and the jurisdiction where the collateral is located. Generally, a financing statement (or similar type of document) may be registered in the applicable personal property security registry to perfect security in most types of personal property. However, other potentially relevant steps for perfection may include registration in respect of real property security under the applicable registry or land titles systems, registration in respect of security in intellectual property with the Canadian Intellectual Property Office, registration in respect of aircraft in the International Registry of Mobile Assets and registration in connection with security over property governed by an act of the Parliament (eg, rolling stock and vessels).

Other actions may also be required for perfection in respect of specific types of assets, such as pledges of shares (which may require the consent of the board of directors or shareholders of the issuer), security in types of assets that may be best perfected by control and assignment of crown debts (in respect of which assignments are typically subject to special procedures and are in some cases not permitted).

Until perfected, a security interest in personal property is not effective against a person who represents the creditors of the debtor, including an assignee for the benefit of the creditors and a trustee in bankruptcy. An unperfected security interest in certain types of personal property may also be ineffective against certain transferees of that property and will be subordinate to a perfected security interest.

Can security interests extend to future-acquired assets? Can security interests secure future-incurred obligations?

A security interest may be granted over all personal property, whether existing or subsequently acquired (subject to certain exceptions, such as consumer goods and certain crops). Subject to any agreement between the parties to postpone attachment, the security interest will attach immediately to personal property in which the debtor has rights and, upon the debtor’s acquisition of rights therein, in subsequently acquired personal property. A security agreement over personal property may secure future advances and, subject to certain exceptions, the security interest will have the same priority in respect of future advances as it has in respect of the first advance.

Security over real property can also be structured to secure future-incurred obligations; however, a fixed charge or mortgage may not be effective in respect of property that was not owned when the charge or mortgage was granted or that was not sufficiently described.

Describe any maintenance requirements to avoid the automatic termination or expiration of security interests.

Depending on the nature of the registry where the security was registered, there may be a finite term associated with the registration. Where this is the case, the secured party may renew the registration in accordance with the rules of the particular registry.

In addition, if the debtor transfers any of the collateral or changes its name, chief executive office, jurisdiction of formation, type of organisation or the location of any of its collateral, additional registrations may be required.

Are security interests on an asset automatically released following its sale by the debtor? If so, are the releases mandated by law or contract?

A buyer of goods from a seller who sells in the ordinary course of business takes them free of any security interest given by a seller unless the buyer knew that the sale constituted a breach of the security agreement. Therefore, assuming a security agreement does not prohibit the sale of inventory in the ordinary course of business, if the debtor sells the asset in the ordinary course of its business, the buyer will typically take the asset free of any security interest of the secured party therein. The secured party’s security interest will continue in the proceeds of the asset in the hands of the seller.

What defences does a guarantor have against claims for non-fulfilment of guarantee obligations? Can such defences be waived?

Generally, any amendment or alteration of, or other dealing with, a guaranteed obligation that would prejudice the guarantor may constitute a defence to the guarantor’s obligation under its guarantee. Therefore, a guarantee will typically provide that any increase in or other amendment of the guaranteed obligations, any extension for the time of payment and any enforcement of, or failure to enforce, security provided by the borrower or any other guarantor will not affect the guarantor’s liability under its guarantee. A waiver of a specific defence will generally be effective, although a general waiver of all defences may not be effective.

Describe any parallel debt or similar requirements applicable in a secured bank loan financing where an agent acts for multiple investors.

No such requirement applies in Canada. Security may be granted to an agent (in Quebec, the agent may act as a hypothecary representative) for the benefit of multiple lenders.

What are the most common methods of enforcing security interests? What are the limitations on enforcement?

The most common procedures for enforcement include:

• notifying account debtors to make payments directly to secured parties;
• appointing a receiver (whether privately or through court appointment);
• taking possession of collateral;
• disposing of collateral; and
• foreclosing on collateral (ie, accepting the collateral in full satisfaction of the secured obligation).

There are numerous legal requirements that lenders must comply with when enforcing security. A high-level summary of some of the principal requirements includes the following:

• reasonable time to pay and reasonable notice must be provided following a demand or default and acceleration;
• a secured creditor must give 10 days’ prior notice under the Bankruptcy and Insolvency Act (Canada) if it is enforcing security on all or substantially all the inventory, accounts or other property of an insolvent debtor (and additional notice requirements apply under provincial personal property security legislation regardless of whether the ‘all or substantially all’ threshold is satisfied);
• the secured party may be the purchaser of the collateral, but in those circumstances, the sale must be effected through a public sale or auction, rather than a private sale;
• other parties have the right to redeem the collateral (where the secured party proposes to dispose of it) and to object to a foreclosure; if a valid objection is made, the secured party will be required to dispose, rather than foreclose;
• as a general principle, all aspects of the disposition of collateral, including collection of accounts, must be conducted in a commercially reasonable manner; and
• the Bankruptcy and Insolvency Act and the Companies’ Creditors Arrangement Act place certain restrictions on a secured party’s enforcement rights and provide some protections for debtors. If a debtor makes a proposal under the Bankruptcy and Insolvency Act or makes a voluntary assignment or is petitioned into bankruptcy, or obtains protection under the Companies’ Creditors Arrangement Act, the secured creditor’s ability to enforce security on collateral may be stayed or delayed.

Describe the impact of fraudulent conveyance, financial assistance, thin capitalisation, corporate benefit and similar doctrines on the structure of bank loan financings.

When structuring a loan transaction and determining which entities in a corporate group may be guarantors, consideration must be given to the laws relating to financial assistance. Depending on the applicable restrictions, financial assistance given in breach of those restrictions may not be enforceable. Banks and directors in the corporate group will, therefore, be concerned that any financial assistance restrictions and corporate benefit issues have been identified and complied with, whereas the borrower is likely to be concerned with thin capitalisation and other tax matters when structuring its financing.

Laws also exist both at the federal and the provincial levels that may nullify or void charges or other transfers of property made when a person was insolvent or on the eve of insolvency, or that were made with the intent to defeat creditors or other persons. These should also be considered by the lenders when determining the collateral that is required and otherwise structuring a security package.

Law stated date

Give the date on which the above content is accurate.

22 May 2020.