Agricultural security agreements

Introduction

The topic of security and the laws affecting debtors and creditors is complex. This is perhaps why it is easy for business owners, when the business is running smoothly, to fall into a pattern of simply signing documents requested by creditors without taking the time to study the actual meaning of the documents.

This page provides a general overview of security and security agreements which allow farmers and their advisors to better understand what they are signing and enables them to reduce the security they give where it is possible and appropriate. Specific guidance on security agreements should be obtained by a lawyer.

Basics of security agreements

Security is an interest a debtor gives a secured creditor in the debtor’s property. Its purpose is to protect the secured creditor if the debtor does not pay what they owe or if they commit some other default under their agreement.

A debtor who has given one creditor security in certain property can give more security in the same property to others, although it might be a default under the debtor’s agreement with the first secured creditor to do that. Secured creditors with security in the same property generally do not share it equally if the debtor defaults.

Instead, each creditor’s rights over the property depend on the rank, or priority, of their particular security. Priority among secured creditors depends on such circumstances as when their security was obtained, when and how it was registered and the type of security.

Reasons to use security

At the time debtors are borrowing money or acquiring goods or services on credit, most fully intend to pay what is owed when due. However, this is not always possible. The market for products may shrink, weather may destroy crops, disease may strike livestock and interest rates, inflation or the cost of supplies may rise dramatically.

Prudent creditors try to protect themselves against such uncertainties by taking security. When a debtor defaults, the ability to take property may be faster, cheaper and more successful than starting a lawsuit against the debtor.

In certain cases, it may be beneficial for the debtor to agree to give security. Sometimes a debtor cannot obtain credit at all without giving security. Providing security may mean a more favourable interest rate since the creditor’s exposure is lessened.

Any creditor, whether a farmer, banker, creditor or supplier should take security from a debtor when it makes good business sense. Factors for debtors and creditors to consider include:

• whether the creditor can afford to lose the amount of the loan if the debtor does not or cannot pay
• whether the credit is the type that other creditors would normally seek security for
• which property should security cover (the creditor should conduct a search against the debtor and relevant property to determine if anyone else is registered as owner or secured creditor)
• how much property security should cover (there should be a sensible balance between the amount of the credit and the amount and type of property the security covers)

It is important to ensure that the security documents are properly prepared, signed and registered. Having security that does not work against the debtor and other creditors is worse than not taking security at all, as the creditor is lulled into the false belief that they are protected.

Signing security agreements

It is important to understand any agreement you sign. Agreements that appear to provide the creditor with limited security may contain clauses giving the debtor security over all their assets, like a general security agreement. Recognizing this before signing an agreement permits you to negotiate with your creditor about reducing the amount of security required. Before signing any agreements, a debtor should know:

• what they must do under the agreement
• what can happen to them and their property if they can’t live up to the promises in the agreement
• any practical, cost-effective changes that are likely to be acceptable to the creditor that will make the deal or the documents more beneficial

Many creditors, especially large institutions, will be unlikely to change their standard security agreements at the request of one customer. However, they may be willing to reduce the amount of property the security will affect or to restrict the part of the indebtedness for which security is required.

If you decide to give your creditor security, ensure you get an exact copy of every security agreement and other document you sign. Keep these copies in your farm records. These will act as reminder for you to contact your creditor about discharging security when you’ve paid everything you owe.

Common security agreements

Keeping track of the agreements you sign and their implications can be challenging for business owners. Table 1 lists common security agreements a business owner might sign and the creditors involved.

This is not an exhaustive list, nor does it imply that all these agreements are used in each case. Any of these agreements might be used if the creditor is a private individual or in a parent-child arrangement.

Defaulting on a loan

Debtors sometimes learn a creditor has decided to call (or demand repayment of) a loan. The creditor’s ability to call the loan depends on whether the debt is term or demand.

Demand debt must be repaid when the creditor demands the repayment. Examples of demand debt are an operating line or open promissory note.

Term debt, on the other hand, must be repaid according to the terms of the agreement. Examples of term debt are mortgages or equipment loans, which could be secured using a chattel mortgage or PMSI.

The only time a creditor can demand repayment of term debt is when the debtor defaults on the loan. Defaulting usually means a payment is missed, but there may be other circumstances included in the security agreement that constitute a default. After a debtor defaults, the creditor can proceed with action against the debtor to collect on the debt. The actions a creditor can take are outlined in the security agreement.

The Farm Debt Mediation Act states that a creditor must give farmers 15 business days notice before taking any action against them on secured loans.

Mortgages

Mortgages are agreements that give a creditor security over land in the registry system. The mortgagor is the person who mortgages the land. The mortgagee is the creditor to whom the mortgage is given.

Mortgages affecting land follow a simple concept regarding priorities. The indebtedness secured by a first mortgage has priority over the land that is subject only to property taxes. Therefore, if a creditor sells a farm, the creditor holding the first mortgage is entitled to be paid in full of the sale proceeds before any second mortgagee receives any money.

The two types of farm mortgages are:

• conventional mortgages, which are typically used to finance the purchase of land
• collateral mortgages, in which the land is used as security for other types of indebtedness

Conventional mortgage

The conventional mortgage registered against property consists of a document executed by a farmer outlining the legal description of the land and repayment terms of the mortgage and a document known as the standard charge terms. This document is registered at the land registry office where the creditor’s security interest is noted in the appropriate records.

Conventional standard charge terms often consist of several pages of very fine print. Fortunately, some financial institutions have started to use plain language mortgages that are easier to understand.

Standard charge terms outline the basic contract contained within a mortgage. It usually notes that a farmer charges their entire interest in the property to the debtor in exchange for a loan. If the business continues to meet the payments, few of the other standard charge terms will be relevant. However, standard charge terms are designed to protect the creditor if the farmer experiences financial distress, and accordingly, an array of contractual rights are provided to the debtor within its standard charge terms.

The standard charge terms usually outline the rights of the creditor if a default occurs. Those remedies include selling the farm by power of sale, foreclosure, suing the farmer for possession of the property or for the loan amount and appointing a receiver to manage the farm property. There is also a personal covenant that permits the creditor to sue a farmer for any shortfall that results if the farm is sold and the proceeds do not pay the loan in full.

Collateral mortgage

A collateral mortgage offers security over real estate when loans are provided for purposes other than the purchase of land. For example, a collateral mortgage could be used to secure indebtedness undertaken by a farmer through an operating loan or for the purchase of quota.

Typically, a collateral mortgage remains in place to secure fluctuating advances and new term loan borrowing arranged when previous loans have been repaid.

The first page of the collateral mortgage usually outlines the interest rates, names of the parties and legal description of the land like a conventional mortgage. The difference is found in the schedule registered with the front page of the mortgage. The schedule outlines those areas of the mortgage contract not contained within the conventional mortgage or standard charge terms. Usual differences include the:

• maximum amount of credit being inserted as the mortgage amount, (the mortgage must relate to the maximum credit granted to the farmer because in most cases the actual indebtedness will float up or down during the course of the year)
• interest rate being noted either as a fixed interest rate or floating rate
• mortgage notes that new loans obtained after the date of the mortgage being deemed to be secured by the collateral mortgage

If using a collateral mortgage means a farmer can obtain a more favourable interest rate than the creditor will provide without a mortgage, then using a collateral mortgage makes financial sense. However, there is a tendency among some creditors to use collateral mortgages to obtain security over land where the creditors would be well protected if its security was limited to the farmer’s other assets. In these situations, a collateral mortgage simply serves to provide a financial institution with security over all property and it limits the ability of a farmer to secure credit from other institutions.

Personal property security

Personal property is property that is not land. A variety of security instruments are available to a creditor.

The Personal Property Security Act (PPSA) is the provincial law governing security over personal property. The act has created a central registry system for the province that permits creditors to file a financing statement outlining the security. Once registered, the creditor filing the document has a secured interest in the property, which takes priority over all subsequent registrations pertaining to the same property.

To create a valid security interest in personal property, the debtor must execute a document that creates a contract. The terms of the contract outline the type of security provided to the creditor and the assets over which the security has been granted by the debtor. The relationship between the debtor and creditor is governed by the terms of the written contract.

Once the debtor signs the written contract, it is the creditor’s responsibility to register the financing statement pursuant to the PPSA. Notice of the financing statement is entered in the system and anyone who later searches the farmer’s name will be advised of the registered security.

Types of security agreements to which the PPSA applies

The PPSA applies to every transaction that, in substance, creates a security interest, no matter what name the creditor gives to the agreement, with specific exceptions such as liens and pawnbroking. A debtor should be aware that some documents they are asked to sign might not be clearly titled as a security agreement. It is important to understand what the document says.

GSA

Unless amended to delete some types of property, a GSA creates a security interest in all:

• personal property and fixtures the debtor has when they sign the GSA
• other property and fixtures the debtor gets later (automatically as soon as the debtor gets them)
• proceeds of disposition

The GSA defines property to include inventory, equipment, accounts, book debts, debts, deeds and contractual rights. Additionally, the agreement normally specifies the chattels owned by the farmer at the date of execution in a schedule attached to the agreement.

GSAs may be used as a first charge over property, or as a secondary charge to cover the equity in an asset that has been previously secured by other creditors.

In liquidation, the GSA gives the creditor the ability to seize and sell the farmer’s assets. If the creditor sells assets over which it has a first position, the creditor is entitled to keep the entire proceeds of sale. If the creditor sells security over which some other party has a prior charge, then the prior charge is paid in full before the creditor receives any funds from the sale of that particular asset.

General assignment of accounts

Like a GSA, a general assignment of accounts (GAA) covers the debtor’s existing and future property, but in this case only the debts others owe to the debtor and other property that relates to those debts. A GAA gives the creditor access to whatever the debtor is owed, including payments a farmer may not normally think of as accounts receivable, such as support payments for produce, the sale price of breeding stock and the monthly milk cheque. Debtors need to consider whether to exclude certain debts before signing a GAA.

Chattel mortgage

Chattel mortgages are normally used to take security in a few specific items rather than in the entire debtor’s collateral. Read it carefully. The security interest may extend beyond the specific items to their proceeds, to all other property that replaces or is added to them, and sometimes even to all other present and future property of the debtor. This additional security interest can create a chattel mortgage that is no different than a GSA.

PMSI

A PMSI (pronounced "pimsi") is designed to provide the supplier of goods with a security interest in that specific property. As the name suggests, this security interest is available to creditors of money to finance the purchase of personal property. PMSIs are valuable to creditors because they have priority over other security interests.

Creditors use PMSIs to enable debtors to buy goods. This can be a conditional sale or a loan enabling the buyer to buy from someone else. Both enjoy the status of the conditional seller under the PPSA for priority and other purposes. The rationale is that since purchase money creditors give debtors a new asset, they deserve priority.

PMSI priority only applies when a specific and identifiable asset is bought with it. It does not give a priority if the money is used generally in the debtor’s business.

One common type of PMSI is used to purchase crop inputs. Within the PMSI contract, the farmer agrees to pay for crop inputs and to provide a security interest over the crops produced. After receiving the security instrument from the farmer, the creditor can supply fertilizer, seed, herbicide and other products.

If a dispute arises between creditors regarding priorities, the PMSI will provide a first charge over the crops produced, even if a financial institution holds other security that purports to place the institution in first place over all the farmer’s property.

PMSI priority example

A debtor who has given a GSA to their bank over all their present and future personal property wants to buy a combine and finance it with the dealer rather than the bank. If the dealer takes and registers a conditional sale agreement in the regular way, the bank will get the combine ahead of the dealer if the debtor defaults because the bank’s security interest was perfected first. The dealer can get priority over the bank’s GSA by following the act’s PMSI rules and registering their financing statement in the required manner.

PMSI notification

On a practical basis, a secured party taking a PMSI in inventory who wants priority must give all other secured parties who have registered financing statements over inventory written notice of the PMSI, describing the inventory it affects.

Searches

The Personal Property Security computer and land registry records are public. Anyone who pays the fee can search them by debtor name. The search turns up only registrations that match the debtor name requested. Getting the name right, whether in a search or a registration, is critical.

Registrations

Registration protects the security interest against people who deal with the debtor. If a secured party doesn’t register properly, that won’t let the debtor out of their obligations. A secured party registers under the PPSA by paying the government fee and filing a financing statement. This can be done by mail, in person at one of the Personal Property Security offices or electronically.

The financing statement includes:

• the debtor’s:
  • name
  • address
  • birth date
• how many years the registration is to last
• the name and address of the secured party and any agent who registered the statement
• the PPSA classifications for the collateral (one or more of consumer goods, inventory, equipment, accounts and other)
• whether the collateral includes any motor vehicles
• occasionally, the principal amount owing, when it will be due or a specific description of the collateral

Bank Act security

Generally, property is the responsibility of the provincial government and is governed by the PPSA. Banks, however, are regulated by the federal Bank Act, which means both levels of government are involved in the security process affecting farmers.

The Bank Act gives banks the right to take security upon farm assets. This right is outlined in Section 427 of the act. This section authorizes the bank to lend money and make advances upon the security of property including crops, livestock and implements. The security covers property owned by the farmer when the documents are signed as well as property of the same kind acquired after signing.

For example, if security under the Bank Act is granted regarding cows, the security will cover all calves produced by the cows. The effect of Bank Act security is like a GSA. The bank is granted security over different types of personal property in exchange for loans provided to the farmer.

Before a bank can act on section 427 security given by a farmer, the bank must give the farmer the notice and wait the 15 business days as required by the Farm Debt Mediation Act. The bank may also have to give a section 244 notice and wait for 10 days under the Bankruptcy and Insolvency Act.

Promissory notes and guarantees

Although promissory notes and guarantees are often called security, they are not since they do not give the creditor any interest in the property of the person who signs them.

Promissory notes

A promissory note is a written promise by the person signing it to pay to another person a specific amount of money. The note can either be a:

• demand note where the person who owes money must pay it whenever the person named in the note demands to be paid
• term or instalment note where money is paid at the time(s)

A note is only evidence of the debt it refers to, not security for that debt. If the person who signed the note does not pay on time, the person who holds the note must sue in court to collect. A promissory note is a negotiable instrument. This means the person to whom it is given can sell it to someone else rather than keeping it until paid. That buyer can sell it again or collect under it and so on.

Although promissory notes do not provide security in any property to a financial institution, they are often used with security instruments as part of a financial package. One or more promissory note will outline the size of the debt at any given time, while a GSA, Bank Act security or other security instrument will provide the creditor with security over farm property.

More than one person can sign a promissory note. If they sign "jointly and severally", the creditor is not forced to sue each of them for that person’s share of the debt. Instead, the creditor can choose to collect the whole amount from any of them. Naturally, the creditor will choose the one who appears to have money (such as a bank account or salary) that can most easily be taken to pay the judgment. It will be up to that person to try to extract the other debtors’ respective shares from them.

Guarantees

A guarantee is a promise to accept responsibility for the indebtedness of the debtor. It is an agreement between a guarantor and a creditor in which the guarantor promises to pay the money that a particular debtor owes to the creditor if the debtor defaults.

Financial institutions often use guarantees when farm property is in the name of one spouse or a corporation, and the financial institution wants to ensure the other spouse or corporation owners are legally bound to repay the indebtedness.

There are several issues concerning the extent of liability, the order of collection and the cancellation of a guarantee that the guarantor should understand.

Limited and unlimited liability

The liability granted in a guarantee can either be limited or unlimited in nature. A limited guarantee means the guarantor is liable only for the stated amount in the guarantee. The unlimited guarantee means the guarantor is liable for the entire indebtedness of the debtor. It is very important to know which type is being signed. As a guarantor, always attempt to negotiate a limit on the guarantee.

Order of collection

Some guarantees state that the assets of the debtor must be liquidated in full before the creditor may demand payment from the guarantor, while other guarantee contracts state that the creditor shall not have to exhaust its remedies against the debtor before suing the guarantor. In the second case, the creditor can bypass the original debtor and proceed to collect from the guarantor right away.

Sometimes a guarantee also contains a security agreement. This means the guarantor gives the creditor security over the guarantor’s property for the money owing if the creditor must call on the guarantee. Usually, the security is an assignment of all debts the original debtor owes the guarantor then or later, and a promise that the guarantor will not collect anything the debtor owes them until everything the debtor owes the creditor is paid in full. It could also be a mortgage on land or security in the guarantor’s personal property.

Cancellation

Guarantee agreements should contain a clause outlining how to cancel the guarantee. A guarantee is not cancelled automatically upon death. Most guarantees bind estates so cancelling the guarantee may mean the creditor can declare the debtor in default or can cut back the amount of credit. The cancellation usually goes into effect within 30 days. You, or your estate, remain liable for all obligations the debtor takes on prior to that effective date. Be sure to get the cancellation in writing from the creditor.

As soon as the debtor carries out the obligations you agreed to guarantee, contact the creditor for written confirmation that your guarantee has ended and you owe nothing under it. If you do not, you may find the creditor will make a claim against you or your estate for some new obligation the debtor incurs, for which you may not have intended to provide a guarantee.

Co-signed loans

A loan is co-signed when a person who is not receiving the money agrees to sign the loan documents as a debtor. A typical example of a co-signed loan is if a parent signs a promissory note to help a young farmer obtain funds. The signature makes the parent responsible for the loan.

A co-signee is liable to repay the debt in the same fashion as the person who borrowed the money.

Accommodating security

An alternative to the guarantee may be accommodating security, which means property given as security by one person to a financial institution as part of the debt structure between another person and the institution. Usually, accommodating security occurs when a farmer’s child begins farming but does not have sufficient equity to obtain credit. The parents may be asked to provide their property as security for their child’s bank loans.

The benefit of pledging a specific asset instead of signing a guarantee is that the individual giving the accommodating security knows that their liability is limited to the value of the pledged asset. Be careful that the terms of the agreement outlining the accommodating security are accurate.

For example, if a parent is providing a mortgage over one parcel of land as accommodating security, the mortgage materials must state that the liability of the parent is limited to that piece of land.

Assignments and directions

Priority agreements

Secured parties can agree to let other secured parties, whose security would normally come after their claim, have priority ahead of them. This is done by deliberately signing a subordination or postponement agreement or adding a clause in their own security agreement that says certain kinds of security interests can go ahead of theirs.

For example, if a farming child has given security to their parents as well as the bank for money borrowed from each of them, the bank will usually require the parents to agree to subordinate their security to the banks.

Assignments and directions

Creditors use an assortment of assignments and directions to intercept a farmer’s income. The documents permit the creditor to obtain payment for loans before the farmer is given access to the income. Assignments can deal with any form of income.

Examples of assignments and directions include:

• assignments used by creditors to obtain payment of income directly from marketing boards to the creditor
• directions to elevators instructing them to pay funds generated from the sale of crops to the holder of PMSI security and assignments to Agricorp dealing with funds generated from production insurance
• AgriStability
• the Risk Management Program

Assignments and directions tend to be the most straightforward part of a farm security package because they are short documents written in plain English.

Agricultural quotas

Three Ontario Court of Appeal decisions determined that quotas are licences to produce commodities, not property. Therefore, a creditor cannot obtain a binding security interest in quota because quota is not property. As such, the security agreement cannot be enforced.

While quota is not security, it is secured by financial institutions through other documents relating to property. Financial institutions can use letters of direction to marketing boards to prevent a farmer from selling quota without the consent of the institution (refer to Assignments and directions). These are like other directions used by financial institutions that direct the payment of proceeds from the sale of milk to a creditor. Some farmers are also asked to execute documents preventing them from transferring the quota to any other person without the creditor’s consent. These documents are valid security documents in favour of a creditor and create a situation where the quota itself is not subject to any security, but all monies earned from the quota are secured in favour of a financial institution.

Quotas as properties vs. licences

The Ontario Court of Appeal had to determine whether quotas were property owned by the farmer or a licence to produce a commodity owned by a marketing board and granted to the farmer.

The fact that agricultural quotas can be bought and sold on a market provided a strong argument in favour of describing quotas as property. However, the statutes and regulations governing marketing boards that use quotas usually state that the purpose of the legislation is to provide for the complete control of the production and sale of certain agricultural commodities in Ontario. The concept of complete control through a licensing system conflicts with the concept of quotas as property.

This issue had significant implications for farmers who produce commodities controlled through quotas because many financial institutions traditionally treated quotas as property and provided loans secured by quota. Quotas are often listed as property within general security agreements or chattel mortgages and financial institutions relied upon the quotas to provide security.

Construction liens

The Construction Lien Act provides security for construction contractors. A contractor can take a lien upon the interest of the owner of property that has been improved by the labour or materials supplied by the contractor.

Within 45 days of the work begin substantially completed, a contractor may register their construction lien against the title to a farmer’s land if the contractor is not paid. A registered construction lien remains registered on title until:

• the contractor is paid in full and removes the lien
• a court orders the discharge of the lien following a trial or settlement if the farmer is disputing liability to pay the contractor
• the farmer places money in trust with the court or posts a construction lien bond

A construction lien can pose a significant problem to farm finance. If a lien is registered during a major construction project for which a creditor is providing financing as the construction proceeds, the creditor will insist the lien be removed from title before advancing more funds. Also, any financial institution providing ongoing financing is likely to feel uncomfortable with a construction lien registered on title (even if that lien is behind valid mortgages) unless the institution realizes that the lien is arising from a dispute regarding the quality of the contractor’s work as opposed to an inability to pay the bill.

Careful planning is the key to avoiding construction liens. Carefully analyze the cost of major construction projects before beginning construction and make allowances for cost overruns or extras not foreseen in the initial budget. This should avoid costly litigation and prevent an order to sell the land or to pay a contractor, if no other method of raising funds to satisfy the lien exists.

Disclaimer

This publication is intended as general information and not as specific advice concerning individual situations. Although it outlines some of the legal considerations of security agreements it should not be considered as either an interpretation or complete coverage of the Personal Property Security Act, the Bank Act or the various law affecting security agreements. The Government of Ontario assumes no responsibility towards persons using it as such. All security agreements should be discussed with your lawyer before they are signed.