Securing debt obligations

March 24, 2017

Lenders are usually focused on ensuring the debtor paying debt owed, but should also be focused on securing debt obligations. The lender will be thankful for its security if the debtor ever encounters financial difficulties. To do so, a lender must ensure its security is properly registered and perfected. The Ontario Personal Property Security Act (PPSA) governs the registration of financing statements for perfecting security.

A lender must first review a debtor’s assets to determine the appropriate security based on the debtor’s circumstances. There are several different types of security, including real or personal, tangible or intangible, and inventory, equipment or accounts. The lender must next enter into a security agreement with the debtor. In other words, a lender is granted an interest in one or more specific assets of the debtor, thereby securing payment or performance of an obligation. The security agreement grants the security, defines the collateral that is the subject of the security, and clearly details the rights and remedies available to the security holder.

The most common form of a security agreement is a General Security Agreement (GSA). In a GSA, the borrower grants a security interest over all present and after-acquired property, assets and undertakings of the debtor, of whatever kind and wherever located. A GSA cannot properly grant security over real property, however.  In the case of real property security, a charge/mortgage is required.

Whatever form the security agreement takes, it will be of vital importance to “perfect” the security. In other words, the presence of a security agreement is not enough to protect the lender. In order to perfect the security, a financing statement must be filed. A financing statement is registered in the PPSA system against the legal name of the debtor. The registration of a financing statement allows the lender to register notice of the security interest it has over the particular assets of the debtor.

Upon filing a financing statement, it will be assigned a reference file number and a registration number. The registration number displays the date and order of registration, which will be important when determining a secured party’s priority over other secured parties. When filing, the debtor’s information must be stated accurately. Incorrect birth dates and middle names have created significant issues for lenders in the past. The financing statement must also classify the collateral in appropriate categories. The financing statements can be registered for any period from one to 25 years, or perpetually. A registration can be renewed by filing a financing change statement.

If there is a mistake in any of the steps above, the lender may not have proper security for its loan. Therefore, the lender’s security may become subordinate in priority to other perfected security interests. If an error or omission is discovered in the financing statement, and if a reasonable person is likely to be misled materially by it, then the registration may be invalid. If an error is discovered, it will be important to correct it as soon as possible. As stated above, the date and order of registration is of utmost importance for secured parties.

A financing change statement must also be filed if the debtor transfers its interest in the collateral or if the debtor changes its name. If a financing change statement is not filed within a certain period of time, there will be a loss of perfection.

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