A general security agreement (GSA) is the most common form of personal property security used in the Atlantic Provinces to secure commercial loans and other business obligations owed to a financial institution or other creditor (Secured Party).  A GSA is an effective and efficient way to obtain security over business assets to secure commercial obligations. Despite its common use, however, the legal requirements for this security and the supporting documentation are often complex and Secured Parties can still fall into traps using GSAs.  Here are seven of the most common traps – and tips on how to avoid them.

1. What’s the form & scope of a GSA?

A GSA will secure any type of present or future obligation, including loans and guarantees, of the party who signs it (Debtor).  Laws in the Atlantic Provinces do not require Secured Parties to use a particular form or style of GSA; however, many financial institutions have their own preferred forms. A GSA normally includes:

• The Debtor’s representations, warranties and covenants.
• A description of the personal property assets secured by the GSA.
• The terms and conditions of the GSA.
• The enforcement rights in the event of default.

The trap?  Sometimes the provisions of the GSA aren’t consistent with the commitment letter or the loan agreement. This can lead to uncertainty and litigation. The tip?

Review for Consistency.  When tailoring a GSA to a transaction, it’s important to review both the GSA and the commitment letter or loan agreement to ensure they’re consistent. This includes making certain the GSA secures the full scope of the personal property assets over which the Secured Party requires security, consistent with the requirements of the commitment letter or the loan agreement.

2. Who can give a GSA?

In business borrowing, a GSA is usually provided by a corporation.  However, other types of business entities such as partnerships (general or limited), co-operatives and, rarely, individuals can also give GSA security.

The trap?  Regardless of who or what kind of entity provides the GSA, a court may disallow GSA security if the Debtor’s name on it is incorrect.  It is therefore essential to ensure that the name of the Debtor executing the GSA is legally correct and that the related registration is made in accordance with the regulations under the applicable Personal Property Security Act (PPSA).  The tip to avoid this trap:

Proof of Name.  The Secured Party (or lawyer) preparing the GSA should obtain a certificate of status for the Debtor from the applicable public registry to verify the Debtor’s name and legal status. In the case of individuals, the Secured Party can obtain a birth or change of name certificate or other proof mentioned in the relevant PPSA regulations.

3. What types of assets can a GSA secure?

A GSA can secure most types of personal property, both present and future, including:

• Machinery and equipment the Debtor uses in carrying on its business.
• Inventory.
• Accounts receivable.
• Trademarks and other intellectual property.
• Securities such as stocks, bonds and investment accounts.

Often, a GSA states that it secures all of the Debtor’s present and after-acquired personal property, followed by a list of specific categories of personal property charged; this is legally acceptable. Here are a few traps into which a Secured Party can fall in relation to the scope of the assets secured by a GSA and tips to avoid them:

Equipment.  Use of the term “equipment” in the GSA or the related registration is inadequate to describe the assets secured without further describing the item or kind of equipment secured.

Shares & Investment Accounts. The Securities Transfer Act is now in force in each of the Atlantic Provinces.  The Act amends the relevant PPSA in each case.  The resulting trap?  If the collateral charged by a GSA in such Atlantic Provinces includes shares, bonds or investment accounts, the GSA must comply with the amended PPSA provisions.  To avoid this trap, follow these tips:

• Privately Held Companies.  In the case of shares or other securities where the Debtor has possession of the certificates (common in the case of privately owned companies), the description of the collateral in the GSA should include the shares being secured. The Secured Party should take physical possession of the share certificates, signed by the registered holder for transfer or accompanied by a signed transfer power.
• Publicly Traded Securities.  In the case of securities issued by a publicly traded entity, an investment dealer probably holds the securities. The Secured Party should obtain a control agreement from the Debtor and the investment dealer to restrict the withdrawal of the securities from the investment account while the GSA remains in place, and to give the Secured Party control over the account and the securities if the Debtor defaults and the Secured Party has to enforce the GSA.
• Financing Statement. In the Atlantic Provinces, the practice is to register a financing statement over Securities Transfer Act type collateral in addition to perfecting such security by control.
• Additional Provisions or Separate Pledge Agreement. If the shares, bonds or investment account have significant value, the Secured Party should consider adding representations, covenants and default provisions specifically related to Securities Transfer Act type collateral (for example, entitlement to dividends and voting rights), but that are often not included in a general form GSA.  Another option is to take a separate pledge agreement in addition to the GSA.

Real Estate.  A Secured Party might assume that the Debtor’s “property” includes its real property.  The trap?  In the Atlantic Provinces, a GSA cannot secure interests in real property.  The tip? Land, leasehold interests in land, rents and leases must be secured using real estate security such as a mortgage, debenture, assignment of lease or assignment of rents rather than a GSA.

4. How is a GSA Authorized?

A GSA is a significant contract for both the Debtor and Secured Party.  The trap?  If the GSA isn’t legally authorized, other creditors of the Debtor or a receiver or trustee in bankruptcy might successfully challenge the GSA on the basis it wasn’t properly authorized. The tip? Obtain proper written authorization from the Debtor:

• Directors’ Resolution.  The Debtor’s directors (and in certain cases its shareholders) should authorize the GSA by written resolution. If the Secured Party is the Debtor’s regular banker, the banking resolutions likely suffice, but should be checked to be sure.
• Shareholders’ Agreements.  An agreement among the Debtor’s shareholders can restrict the Debtor’s right to give GSA security. The Secured Party should therefore determine whether the Debtor’s shareholders have entered into any agreement restricting the Debtor’s authority to give such security and, if so, obtain the requisite additional approvals.

5. What about registration?

The Secured Party must register a notice of the security interest created by a GSA by filing a financing statement in the appropriate provincial Personal Property Registry (PPR), and perhaps also under the US Uniform Commercial Code or elsewhere depending on the nature of the assets charged. The Secured Party might have to make multiple registrations in different provinces depending on the types of assets secured, where they are located and the jurisdictions in which the Debtor carries on business. Depending on the circumstances, a GSA that secures rents might have to be registered in the PPR in addition to registering the related assignment of rents in the land registry.

The trap?  If the Secured Party doesn’t register properly, it can lose the benefits of the GSA. The legal rules governing such registrations are often complex to apply to a particular situation. A Secured Party should seek legal advice to ensure proper registrations are made in all appropriate jurisdictions.  Some tips?

Debtor’s Legal Name. It’s critical to ensure that the financing statement includes all forms of the Debtor’s legal name.  For example, if the Debtor has a French or combined English/French or French/English form of name, the PPSA regulations require that the Secured Party include all such forms of the name, not just the Debtor’s English or French name, on the financing statement.

Serial Numbered Goods.  If the Debtor’s property includes equipment that are “serial numbered goods” (as defined by the PPSA regulations) either when the GSA is signed or at a future date, but the PPSA registration doesn’t include serial numbered descriptions, then the priority of the GSA with respect to such equipment can be jeopardized. Tips to avoid this trap:

• Description. If the Debtor’s equipment includes vehicles, trucks, trailers, aircraft or certain other “serial numbered goods” (as defined by the PPSA regulations), the PPSA registration should include their serial numbers and a specific description of these assets.
• Periodic Review.  The same applies to such assets that the Debtor subsequently acquires.  The Secured Party (or legal counsel) should therefore periodically review the PPSA registration to ensure that it continues to secure the full scope of the Debtor’s assets, including after-acquired serial numbered goods.

Financing Statement Renewal.  The Secured Party must periodically renew the financing statement to ensure that its registration remains valid. The Secured Party might also need to amend the financing statement if the Debtor changes its name, is involved with an amalgamation, or the Debtor transfers the secured collateral to a third party and the Secured Party wants to retain its security against the transferred assets.

Intellectual Property.  Canadian federal laws govern trademarks, patents and certain other forms of intellectual property.  Many of these laws are unclear about whether a Secured Party is required to register GSA security on such assets federally, in addition to registration in the PPR.  Parties should seek legal advice on this issue.

6. What Legal Opinions should a Secured Party obtain?

A Secured Party taking a GSA should obtain an appropriate written opinion from a lawyer on the legal issues related to the GSA. Here are some tips:

Due Diligence & Corporate Action. The Debtor’s lawyer should provide an opinion stating that they have undertaken all necessary legal due diligence, and the Debtor has taken appropriate corporate action to authorize the GSA. This includes a review by the lawyer of all relevant laws related to the GSA, such as corporate financial assistance laws that in some provinces prohibit a Debtor from giving such security unless it satisfies certain complex financial tests.

Registration. Depending on the transaction, the lawyer for the Debtor or the Secured Party should provide a legal opinion confirming that a financing statement has been properly registered for the GSA and report on searches conducted in public registries.

Transaction Specific.  There’s no one “form” of legal opinion appropriate for all situations. The lawyers acting for the Secured Party and the Debtor have to tailor the legal opinion to the business transaction and agree upon its content. The Debtor’s lawyer will usually want to provide a bare bones legal opinion; the Secured Party’s lawyer will want the opinion to cover all appropriate legal issues necessary to properly protect the Secured Party. However, the practice in Canada is for the Debtor’s lawyer to provide the legal opinion.

7. How should a Secured Party protect itself?

A GSA is an effective and efficient way to obtain security over personal property business assets to secure commercial obligations. However, the legal requirements and the supporting documentation are often complex and varied. Some of the traps aren’t obvious. Secured Parties can hold a false sense of security from having an executed GSA in hand. Sound legal counsel with experience in this increasingly specialized area can help a Secured Party to avoid some of the less obvious traps that this deceptively complex area presents and the potentially significant costs of falling into one.

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Please contact your McInnes Cooper lawyer or any member of our Banking & Financial Services Team @ McInnes Cooper to discuss avoiding falling into one of these GSA traps.