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In the realm of financial transactions, the concept of priority holds significant sway over the protections afforded to various stakeholders and the remedies available to them at law. The importance of securing one’s position in the creditor hierarchy cannot be overstated. As a business owner, it is crucial to understand the intricacies of creditor rankings and the importance of perfecting a security interest, as these concepts can make or break your venture.

The Importance of Security in Ontario’s Legislative Framework

The Personal Property Security Act (“PPSA”) is an Ontario statute that governs the security interests of personal property (otherwise known as movable property), which are not fixed to land or real estate. It establishes a system for registering and prioritizing these interests, providing clarity and protection for lenders and borrowers in case of default or insolvency.

Generally, the PPSA provides that a lender and other creditors can obtain priority over other creditors against a debtor by obtaining security. This security can be over specific assets, such as a vehicle or all of the debtor’s personal and real property. Security gives a creditor certain rights against some or all of the debtor’s assets in priority to the debtor’s other creditors when the security becomes enforceable.

However, obtaining security is not enough to rank above other creditors or other entitled parties at law. The secured creditor must also take steps to “perfect” the security interest.

Perfecting a Security Interest

If the security falls under the regime governed by the Personal Property Security Act, the legislation provides the necessary procedures for perfection.

To summarize, the PPSA requires that “attachment” has occurred and either a financing statement has been registered or the secured creditor obtains possession of the collateral. Attachment refers to the process by which a security interest becomes legally enforceable against a debtor’s collateral (movable property) and other potential creditors. There are three key elements to attachment:

  1. There must be an agreement between the debtor and the secured party (a written security agreement), which must be signed by the debtor and must describe the collateral;
  2. The secured party must provide some value in exchange for the security interest, such as a loan; and
  3. The debtor must have rights in the collateral, either through ownership or another legal right whereby the debtor has the authority to grant a security interest.

Perfecting a security interest through possession or control is also possible.

Priorities of Perfected Security Interests

The Personal Property Security Act provides a general rule that where priority is to be determined between two or more perfected security interests, the order will be determined by the first to register, not to perfect.

The PPSA also provides that where priority is to be resolved between a security interest perfected by registration, or a security interest perfected by non-registration, such as possession, the priority will be determined by the registration date, not perfection. The legislation also makes it clear that the registered perfected security interests will take priority over non-perfected or registered security interests. Additionally, the priority will generally be determined by the time and date of registration.

Nevertheless, there can be situations where the priority contest is between creditors who have either not registered their interests, or have not perfected them. In the former contest, the priority will be determined by the first to perfect their security interest, otherwise known as the “first to perfect” rule. In the latter contest, the priority will be determined by the first to attach, for example, when all three elements above are complete or satisfied.

Unperfected Security Interests

There are significant consequences for failing to perfect a security interest. In addition to ranking subordinate to creditors who have perfected their security interests in the same collateral, an unperfected security interest ranks below the following:

  1. An individual or creditor with a lien granted by another statute or legal principle;
  2. An individual or creditor who has the collateral seized through execution, attachment, garnishment, charging order, etc.; and
  3. An individual or creditor entitled by the Creditors’ Relief Act or otherwise to participate in the distribution of the property seized through the above means.

An unperfected security interest is also largely ineffective against other individuals in bankruptcy. For example, it is ineffective against a trustee-in-bankruptcy, a transferee of chattel paper, or a transferee of other intangibles.

Exceptions to the Priority Rules

The legislation specifies that there may be exceptions to the general rules set out above, such as:

  1. Purchase-Money Security Interest (“PSMI”) – A PSMI is a security interest in specific collateral that the creditor financed for a borrower’s purchase. Per the Personal Property Security Act, the PMSI will have priority over pre-existing security interests in the same collateral.
  2. Fixtures and Accessions – The Personal Property Security Act provides special considerations for fixtures and accessions. For fixtures, security interests that have been attached before the goods became a fixture have priority as to the fixture over any person with an interest in the real property. For accessions, a security interest in goods that attached before the goods became an accession has priority to the accession over the interest of any person with an interest in the whole of the good. Essentially, the priority of security interests in these types of collateral is based on the first-to-attach rule, with important distinctions.
  3. Investment Property – The rules regarding investment property priorities are complex as it is based on the concept of “control,” which trumps perfection for this type of collateral and rank in time compared to each other.

Contact the Corporate Lawyers at Bader Law for Trusted Advice on Corporate Finances

At Bader Law, our business lawyers provide comprehensive advice to clients seeking to safeguard their interests and minimize their exposure to legal risk. Whether you are a creditor seeking to secure your loans or a borrower aiming for clarity in your financial dealings, our experienced legal team is here to guide you through the complexities of security interests. We work with clients to organize their business, manage information technology and licensing, and effectively address shareholder disputes. We work diligently to help our clients optimize their business by choosing the best structure and legal composition for their operation. Contact us online or at (289) 652-9092 to schedule a confidential consultation.