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Companies selling or distributing their products in the United States and Canada must recognize the importance of taking security to increase the prospect of financial recovery when the purchaser is unwilling or unable to honour its payment obligations. Both the United States and Canada have developed extensive rules and legal precedents regarding securitization, and it is the application of these rules that is critical to securing your priority position for payment.

Both countries operate on the legal principle that a secured creditor ranks in priority to unsecured creditors, even if the unsecured creditor’s indebtedness is more substantive and can be traced back to an earlier transaction. This is achieved through Section 9 of the Uniform Commercial Code or “UCC” in the United States and the Personal Property Security Act or “PPSA” in most provinces in Canada. In this article, the UCC and the PPSA will be referred to together as “Securities Legislation”.

Securities Legislation provides a “security interest” in the goods being sold. Even though a purchaser/distributor may be in possession of the goods being sold, the seller’s interest in the goods is secured by allowing them to act as security, or collateral, for payment. In the case of payment default by the purchaser/distributor, a secured creditor has the ability to repossess and resell the goods. Where the purchaser/distributor files for bankruptcy protection, the Securities Legislation grants the secured creditor a priority claim in these goods over all unsecured creditors and other secured creditors.

In order to take advantage of the rights granted under Securities Legislation, precise steps must be taken, failure of which could result in your claim for priority payment being rejected.

The securitization process begins with a determination and assessment of existing security interests. By assessing the competing security interests, the appropriate strategy can be undertaken to achieve a top priority position. This enables you to strengthen your priority position should the purchaser/distributor go into default.

Securing your interests under Securities Legislation involves two key events: attachment and perfection.

Attachment creates the security interest in the goods being secured, and occurs when an enforceable agreement setting out your rights in the goods (a security agreement) is signed by the seller (or “secured party”) and the purchaser (or “debtor”). The Security Agreement defines default, outlines creditor remedies and specifies costs that the debtor must bear when default occurs.

The three principal requirements for attachment are:

1. The secured party must extend value for the security interest;

2. The debtor must acquire rights in the collateral; and

3. There must be a written security agreement signed by the secured party and the debtor, in which the secured property is sufficiently identified.

Attachment, however, is only the first step, as it does not protect your interest in the property against claims to the same property by third parties.

Perfection establishes the secured party's priority in relation to the debtor's other creditors. Perfection occurs when a financing statement is filed or registered with the appropriate governmental body. Although there are other ways of perfecting a security interest in certain types of property, filing is the most common means of perfection for goods and equipment.

It is imperative that perfection occur as soon as possible, either prior to, or immediately following the entering into of the security agreement. When two or more creditors claim a perfected interest in the same property, the priority between the various creditor claims is generally determined by who perfected their interest first.

Purchase-Money Security Interests

Securities Legislation also provides special priority rules for what are called "purchase-money security interests" ("PMSI"). A PMSI is the interest taken in goods to secure payment of all or part of the purchase price for those goods. A PMSI enables a seller of goods to extend credit to an upstart company, a financially unstable business or heavily secured debtor who has already pledged its assets.

A PMSI that complies with the requirements of Securities Legislation gives the PMSI-secured party priority in the specified goods over any other person who claims an interest in the debtor’s assets. The PMSI rule exists in order to ensure that a debtor wishing to make additional purchases of property will be able to obtain credit from the seller without the consent of existing secured parties and without the risk that the goods will not form the collateral for another of the purchaser’s secured creditors. Recognition is given to the fact it is only by extending credit that the debtor’s pool of assets increases, and you are able to look to the goods sold to the debtor to satisfy your claim for payment before other creditors can claim an interest in those goods.

Conclusion

Both the UCC and PPSA provide a straightforward and reliable system whereby sellers and suppliers can secure the payment obligations of their US and Canadian purchasers/distributors, and extend credit to facilitate increased business. By securing these sales, greater confidence in your business in the United States and Canada can be realized.

* DISCLAIMER: This article has been prepared for general informational and educational purposes, and is not intended as legal advice or legal opinion and is not a substitute for specific legal advice. You should obtain competent legal advice on anything discussed in this article and not rely upon the explanations of the law set out in these materials. While every effort has been made to make these materials as accurate as possible, the matters discussed here are complex and these materials are necessarily simplistic and incomplete. Neither the author nor Neufeld Legal P.C. will be responsible for any errors or any application of the contents of this article.