| | Introduction – Purpose of this Publication
The topic of security and the laws affecting debtors and creditors is complex. This is perhaps why it is easy for business owners, when the business is running smoothly, to fall into a pattern of simply signing documents. This guide provides a general overview of security and security agreements, and should give farmers and their advisors a better understanding what they are signing and enable them to negotiate the extent of the security they give where it is possible and appropriate.
Basics of Security Agreements
What is Security?
Security is an interest a debtor gives a secured creditor in the debtor’s property. Its purpose is to protect the creditor if the debtor does not pay what they owe or if they commit some other default under their agreements with the lender.
A debtor who has given one creditor security in a certain property can give more security in the same property to others, although it might be a default under the debtor’s agreement with the first secured creditor to do that. Secured creditors with security in the same property generally do not share it equally if the debtor defaults.
Instead, each creditor’s rights over the property depend on the rank (“priority”) of their particular security. Priority among secured creditors depends on such circumstances as when their security was obtained, when and how it was registered and the type of security.
Why use Security?
At the time debtors are borrowing money or acquiring goods or services on credit, most fully intend to pay what is owed when due. Unfortunately, good intentions may not be accomplished. The market for products may shrink, weather may destroy crops, disease may strike livestock, interest rates, inflation, or the cost of supplies may rise dramatically.
Prudent creditors try to protect themselves against such uncertainties by taking security. When a debtor defaults, the ability to seize or foreclose and sell property will generally result in quicker and better recovery than seeking and collecting on a money judgement.
In certain cases, it may be beneficial for the debtor to agree to give security. Sometimes a debtor cannot obtain credit at all without giving security. Or, providing security may mean a more favourable interest rate, since the creditor’s risk is lessened.
When it makes good business sense, any creditor – whether a farmer, a banker, or a supplier – should take security from a debtor. Some factors for debtors and creditors to consider include:
- Can the creditor afford to lose the amount of the loan if the debtor does not or cannot pay?
- Is this the sort of credit for which other creditors would normally seek security?
- Which property should the security cover? The creditor should conduct a search against the debtor and relevant property to determine if anyone else is registered as owner or secured creditor.
- How much property should security cover? There should be a sensible balance between the amount of the credit and the amount and type of property the security covers.
It is important to ensure that the security documents are properly prepared, signed, and
registered. Having security that does not work against the debtor and other creditors is worse
than not taking security at all as the creditor is lulled into the false belief that they are protected.
Granting Security Agreements
It is important to understand any agreement you sign. Agreements you think provide the lender with limited security may in fact contain clauses giving the lender security over all your assets, similar to a general security agreement. Recognising this before signing any agreement permits you to negotiate with your lender about reducing the amount of security required. Before signing any agreement a borrower should know the answer to the following questions:
- What must I do under this agreement? What can I not do?
- What can happen to my property and me if I can’t live up to my promises in the agreement?
- Are there any practical cost effective changes that are likely to be acceptable to my creditor that will make the deal or the documents better for me?
Most security agreements now in use by institutional lenders are standard forms, many being in “plain language” which debtors can understand if they actually read the agreement they are presented with. They will vary to some extent in internal content, but all of them will contain the following:
- Names and addresses of debtor and creditor.
- Either an amount that is the maximum amount owed for which the security is given or a statement that it is given for all sums and debts owing at any time by the debtor to the creditor.
- Obligations of each of the debtor and the creditor.
- What things are “default”.
- What rights the creditor will have upon default.
- Provisions for signing and certification of signing by the debtor (and the creditor in limited
cases).
Many creditors, especially large institutions, will be unlikely to change their standard security agreements at the request of one customer. However, they may be willing to reduce the amount of property the security will affect, or to restrict the part of the indebtedness for which security is required.
If you do decide to give your creditor security, make sure you get an exact copy of every security agreement and other documents you sign. Keep these copies in your farm records.
These will act as a reminder for you to contact your creditor about discharging security when you’ve paid everything you owe, and a cross-check on what discharges must be obtained, or to whom proceeds must be paid, when you dispose of affected property.
Knowing what Security Exists
It can be challenging for business owners to keep track of all agreements signed in the course of business and their specific effects. The common types of security agreements depend to some extent on the nature of the creditor involved. A list of some common security agreements based on the creditor follows – it is not a complete list nor does it suggest that all these agreements are used in each case.
- Banks, credit unions, Farm Credit Canada (“FCC” – a federal crown corporation),
Agriculture Financial Services Corporation (“AFSC” – a provincial crown corporation):
can use the full range of agreements including mortgages, general security agreements, purchase money security interests, assignments, and guarantees.
- Livestock feeder co-operatives: Purchase Money Security Interest (“PMSI”) and Inventory interests.
- Vehicle and equipment dealers: PMSI.
- Agricultural Suppliers: Input interests.
“Term” or “Demand” Debt
Examples of demand debt are usually found with operating loans or lines of credit. Demand debt has no fixed due date for full repayment but must be repaid when the lender makes such a demand. When the lender decides to “call” the loan, borrowers are sometimes surprised that this can happen.
Term debt is repaid on a schedule with a fixed date at which total repayment is due. This is typical of mortgage loans or equipment loans. A lender cannot seek full repayment by calling the loan before the fixed term date, unless the debtor defaults.
Default
“Default” most commonly means that payments are missed, but there are almost always other
events set out in the loan or security agreement that are considered to be defaults. Some
examples are:
- Failure to maintain insurance or adequate insurance;
- Failure to pay property taxes;
- Failure to maintain or repair collateral;
- Judgements or enforcement action by other creditors;
- Failure to maintain value to loan ratios; and
- Dispose of collateral without payment to or consent of the lender.
In any circumstance of default, the lender can proceed with all, or any, of the enforcement actions which are outlined in the security agreement or generally available in law. It is important for the borrower to read and understand all of their obligations. If some items seem impossible to honor or unreasonable in the circumstances it may be possible to negotiate some alterations before the agreements are signed.
Formal demand in writing before acting on a default may or may not be required. In the case of any debtor who is a “farmer”, as defined in the Farm Debt Mediation Act, a secured lender must serve a prescribed form of notice of intention to enforce security on the debtor and wait 15 business days after doing so before any enforcement action can be taken. This requirement cannot be avoided by the lender or waived by the debtor.
To view more information and full publication click and download pdf
Summary
There is no doubt that the issues around security can be complex. Nor is there any doubt that security arrangements are necessary in obtaining the significant financing agricultural operations need. Because of these realities it is important that farm business owners manage and monitor their credit arrangements. One component of good management is reviewing and understanding in advance the security documents they sign.
This publication is intended as general information and not as specific advice concerning individual situations. Though it outlines some of the legal considerations of security agreements, it should not be considered as either an interpretation or complete coverage of any of the various statutes and regulations or common law affecting security agreements. The Government of Alberta neither accepts nor assumes any responsibility towards persons using it as such. All security agreements should be reviewed and discussed with a qualified lawyer before they are signed.
Acknowlegement
- Adapted from
A Guide to Agricultural Security Agreements
Factsheet - ISSN 1198-712X - Copyright Queen's Printer for Ontario
Agdex#: 817 (Ontario)
Written by: R.W. Gamble - Finance and Business Structures Program
Lead/OMAFRA; G. Edward Oldfield - Barrister and Solicitor/Hobson, Taylor, Oldfield,
Greaves and D'Agostino
- Reviewed and Prepared by
Ian Logan and David Archibold, Barristers & Solicitors
Sharek Logan & van Leenen LLP
Edmonton Alberta
- Prepared by:
Alberta Agriculture & Forestry
Livestock Research and Extension Division
Livestock and Farm Business Branch
7000 – 113 Street, Room 200
Edmonton, Alberta T6H 5T6
Rick Dehod, Farm Financial Specialist |
|