Debt finance

Some of the key areas affecting the giving of guarantees and security are as follows.

Capacity

It is important to check the constitutional documents of a corporation giving a guarantee or security to ensure it has an express or ancillary power to do so and there are no restrictions on the directors’ powers that would be preventative. Canadian creditors generally rely on the legal opinions of debtors’ counsel as to capacity and the enforceability of loan agreements and ancillary documents.

In Québec, the Civil Code of Québec provides various obligations pertaining to the right to grant a security, notably depending on whether the grantor is an individual or a business entity.

Insolvency

Guarantees and security may be at risk of being set aside under Canadian insolvency laws and under provincial fraudulent preference/conveyancing laws if the guarantee or security was granted by a corporation within a certain period of time prior to the onset of insolvency. This would be the case if the corporation giving the guarantee or security received considerably less consideration and, as such, the transaction was at an undervalue. Guarantees and security may also be challenged on other grounds relating to insolvency.

Common forms of guarantees

Guarantees can take a number of forms. Two common forms are performance bonds and payment guarantees.

Performance bonds

A performance bond describes a financial undertaking used to protect a buyer against the failure of a supplier to deliver goods or perform services in accordance with the terms of a contract. The issuer of the bond undertakes to pay to the buyer a sum of money if the seller fails to deliver the goods or perform the contracted services on time or in accordance with the terms of the contract.

Payment guarantees

A payment guarantee provides that the guarantor will be obligated to pay either all outstanding monies owed under the primary contract or an amount up to a fixed amount if the debtor or obligor fails to make such payments.

Common forms of security

The common types of security agreements are as follows.

General security agreements (GSAs)

A GSA normally charges all present and after-acquired personal property of the debtor, but can be limited to specific items of personal property and can include a floating or fixed charge against the debtor’s interest in real property. In Québec, the equivalent of a GSA is a hypothec which charges present and after-acquired movable property (ie personal property).

Pledges

Pledges require debtors to deliver certain assets, such as securities or negotiable instruments, to the creditor.

Mortgages

A mortgage charges the real property of the debtor. In Québec, the equivalent of a mortgage is a hypothec which charges immovable property (ie real property).

Additionally, it is possible to grant security over all of the assets of the debtor (which is called in Québec the universality of the assets of the debtor). Granting security over all of a corporation’s assets will tend to be achieved by way of a debenture which will include:

• a mortgage over real property (and, in Québec, that would be a hypothec over the universality of all the immovable assets);
• a fixed charge over assets which are identifiable;
• a floating charge over fluctuating and less identifiable assets; and
• an assignment by way of charge over receivables and contracts.

Giving or taking guarantees

To be valid, a guarantee needs to be in writing, signed by the guarantor and provided for good consideration.

Consideration for a guarantee is subject to general contractual principles. In the case of a guarantee, the underlying obligations will usually be the consideration for the guarantee and so it is advisable to execute the guarantee at the same time as executing the underlying obligations to avoid any suggestion of past consideration. Often the guarantee is included in the loan agreement and so this should not be an issue. Also, it can be difficult to establish consideration for a guarantee as the primary obligations are between the underlying obligor and beneficiary, for example between the borrower and lender. Guarantees can be executed as deeds to avoid any argument about whether good consideration was provided. Deeds have particular execution requirements which need to be observed.

In Alberta, personal guarantees require compliance with the Guarantees Acknowledgment Act (Alberta). In Saskatchewan, personal guarantees require compliance with The Saskatchewan Farm Security Act (Saskatchewan). Generally, the guarantor needs to appear before a lawyer in Alberta or a lawyer or notary public in Saskatchewan and:

• acknowledge that he or she executed the guarantee; and
• execute the prescribed guarantee certificate in the presence of the lawyer or notary public.

The lawyer or notary public, as applicable, then must complete the prescribed guarantee certificate. Failure to comply with the applicable Act will result in the personal guarantee being unenforceable. In Québec, guarantees or suretyships must comply with the Civil Code of Québec.

In most Canadian jurisdictions, corporate legislation permits a corporation to give financial assistance by way of guarantee or otherwise to any person for any purpose, provided it discloses material financial assistance to its shareholders. In some provinces and territories, the corporation must meet the prescribed insolvency test in order to provide financial assistance to an intercorporate group. Under certain circumstances, creditors and minority shareholders may challenge the granting of a guarantee under the oppression provisions of the applicable corporate legislation.

Giving or taking security

Once granted, security needs to be properly “perfected” before it is valid against third parties. Perfection formalities depend on the location and nature of property subject to the security and can range from having the secured asset delivered to the secured party, registering the security agreement or notice thereof in the applicable provincial registry system, providing notice of the security interest to third parties, or a combination thereof. The registry system and the requirements for registration vary among the provinces and territories. All of the common law provinces have enacted Personal Property Security Acts which have a great deal of similarity in purpose and content. The PPSAs are modelled on the U.S. UCC-9 provisions. Quebec has a comparable regime under the Civil Code of Quebec.

Additionally, the priority of a secured party’s security interest may be governed by various provincial and federal laws which deal with the taking, perfecting and enforcing of security interests. The determination of priorities among interests created under the various Acts can be a cumbersome process. Generally, a creditor will conduct searches to ascertain whether there are any secured parties who will have priority over its interests in all provinces and territories in which a debtor carries on business or has assets.

There may also be unregistered interests which may take priority over a secured party, including statutory liens. Statutory liens commonly arise from a debtor’s obligation to remit amounts collected or withheld on behalf of the government (eg employee deductions for income taxes, pension plan contributions, goods and services taxes, provincial sales taxes and property taxes). These liens are deemed trusts and are usually not registered in any registry system. As such, they may not be identified through conventional searches. Issues regarding statutory liens typically arise when a debtor becomes insolvent or commences a restructuring under the Bankruptcy and Insolvency Act (Canada) or the Companies’ Creditors Arrangement Act (Canada).

For security interests granted by individual debtors, creditors should consider the application of various provincial and territorial legislation which protects the rights of spouses. Such legislation may affect a secured party’s ability to enforce its security against a home or homestead. Generally, this risk can be mitigated by receiving the written consent of the spouse of the debtor at the time the debtor executes the security agreement.