|This information applies to British Columbia, Canada. Last reviewed for legal accuracy by Alison Ward in August 2018.|
A security agreement documents an intention to grant another party a security interest in personal property to make sure a loan is paid back or a promise is kept.
- 1 Client problems
- 2 Summary of the law
- 3 Information gathering
- 4 Solving the problem
- 5 Related topics and materials
- Client wants to know what a car dealer means when the dealer says it will take a “lien” over a car as part of a financing arrangement.
- Client is buying a used car and wants to be sure that there are no “liens” against the car.
- Client wants to know the difference between a sales agreement and a lease agreement for a car.
- Client is behind in car payments and wants to know their rights because the lender is threatening to repossess the car.
- Client’s car was repossessed because of missed payments and the client wants to know if anything can be done about it.
Summary of the law
When a buyer does not have the money to pay for goods at the time of purchase, there are two ways the sale can be financed:
- The seller extends credit to the buyer: This means that the seller and buyer agree that the buyer will pay for the goods over a period of time.
- The buyer borrows money to pay for the goods: The buyer may borrow from a lender such as a bank or credit union.
When a buyer borrows money from a lender, that lender wants to ensure that the full amount is repaid and may want more protection than just the buyer’s promise. Similarly, a seller who extends credit as part of a sale is concerned about eventually being paid in full for the goods.
In the nineteenth century, sellers who extended credit as part of a sale and lenders such as banks began to develop special contractual terms to ensure repayment. Those terms were part of the sale or lending contract. Generally, those terms said that the lender or seller had a direct remedy against specific property of the borrower if the borrower defaulted in payment. Sellers could take back the goods and sell them again. Lenders could take the goods and sell them to get their money.
When lenders and sellers (called “creditors”) got those rights against the borrower’s property, it was known as “getting security”. This term is still in use, although sometimes consumers use other language. For example, people talk of a lender taking collateral over property or a seller getting a lien over property. The actual legal meaning of these terms is not always the same. In many instances, these terms are very simple expressions for complex and very different legal arrangements. The term “getting security” is used here to mean the situations in which creditors get rights over a debtor’s personal property.
A creditor who gets security gets special legal advantages. The main advantage arises if the borrower defaults. Creditors who do not have security over a borrower’s property and who want to enforce payment must first sue the borrower and get a judgment. If they get a judgment, they can try to have the borrower’s property seized by a court bailiff. The court bailiff sells the property and gives the money to the creditor.
Security agreements allow the creditor to take the borrower’s property immediately upon default. The secured creditor does not have to sue the borrower first and wait to get a judgment before exercising its rights to take the property of the borrower. In practical terms, security agreements are often important because they allow a creditor first claim to the property of the borrower before creditors who do not have security.
Historically, the two most common forms of security agreements developed for consumer transactions were called “chattel mortgages” and “conditional sales agreements”. Typically, chattel mortgages are security that a lender takes, while sellers extend credit and obtain security through conditional sales agreements.
These types of arrangements facilitated sales and the extension of credit. In law, these arrangements allowed the lender or seller to have a “title” interest in the goods, and at the same time allowed the borrower a “possessory” interest. This possessory interest allowed the borrower to keep and use the goods as long as payments were not in default.
Problems arose with these arrangements when other parties became involved with the secured property. For example, sometimes a borrower sold the secured goods to another person without saying anything about the security agreement. In the early twentieth century, many Canadian provinces, including BC, passed laws to address the unfairness that often arose as a result of this legal principle. The basic idea of the laws was to ensure that sellers, lenders and all borrowers knew when goods were subject to a security agreement. The legislatures did this by setting up government registries to record security agreements such as chattel mortgages and conditional sales agreements. In BC, the registry used to be called the Central Registry. It is now called the Personal Property Registry (see below).
The laws required lenders and sellers to register their security agreements. Registration became important because if an agreement was not registered, anyone who bought the secured goods from the borrower and who had no personal knowledge of the security agreement got to keep the goods. In effect, sellers or lenders lost their title rights, including the right to take the goods if the subsequent purchaser defaulted on payment. However, sellers or lenders still had these rights against the original borrower. If that person were in default and still had the goods, the creditor could still take the goods.
The registration system also gave creditors and consumers some protection by allowing either of them to check with the registry to find out if goods were already subject to a security agreement.
The Personal Property Security Act
In the past few decades, many provinces have replaced their various security agreement laws with one comprehensive law. The BC law is called the Personal Property Security Act. It came into force on October 1, 1990.
This Act governs almost all personal property security transactions between creditors and individual consumers, and between creditors and businesses (section 2). It does not govern situations where the security is land (usually known legally as “real property”) or where the security agreement is governed by federal law (section 4). It is clear that security agreements (including those entered into by consumers), which would have been considered chattel mortgages or conditional sales agreements, are governed by the Personal Property Security Act. In addition, some consumer-type transactions (such as leases of personal property for longer than one year) are now governed by the Act (section 3).
There is a great deal of legal terminology in the Personal Property Security Act, and the Act defines many of these terms (section 1). The borrower is called a “debtor”. A creditor with security is called a “secured party”. The contract for security between the debtor and the secured party is called a “security agreement”. The property to which a debtor and a secured party make a security agreement is “collateral”.
The definition for “consumer goods” is very important. Consumer goods are defined in the Personal Property Security Act as “goods that are used or acquired for use primarily for personal, family or household purposes” (section 1). This definition was new with the Act. The language of the previous statutes made it possible, in some instances, for unincorporated businesses (that is, proprietorships and partnerships) to have consumer-rights protections. The definition of consumer goods in the Act appears to have eliminated this possibility. Now only individuals using collateral for personal purposes as defined in the Act have those rights.
Like the security agreement laws it replaced, the Personal Property Security Act governs how a creditor acquires security rights over a debtor’s property and how those rights can be enforced if there is default. The Act also details how priority rights are decided when more than one secured party claims a security interest in a debtor’s property.
Creating security interests
Section 19 is a key section in the Personal Property Security Act. It says that a security interest is “perfected” when it has “attached” to the property, and when “all steps required for perfection” under the Act have been completed. Perfection gives the secured party certain rights and remedies under the Act. Those statutory rights and remedies mean that the distinctions between title and possessory interests are not as important as under the old laws. It is important for creditors to ensure that they comply with the requirements of the PPSA to gain the statutory rights of a secured party.
“Attachment” (explained in section 12) is a technical concept under the Personal Property Security Act. At its simplest, it means that the secured party and the debtor enter into a written agreement. In most consumer transactions involving taking security, attachment requirements are met by written agreement with legal consideration (section 10). The specific term for consideration used in the Act is “value”.
The “steps required for perfection” under the Personal Property Security Act include registration. The secured party registers a document called a “financing statement” with the Personal Property Registry. The financing statement is a one-page form prescribed by government regulation. The essential terms of the agreement must be set out in the financing statement, which includes a description both of the parties and of the property over which security has been taken.
If anyone with a legitimate interest (such as another creditor) wants more detail about the full terms of a security agreement, the Personal Property Security Act gives that party a right to demand details of the particular security agreement from the secured party (section 18).
Priority of security interests
Setting priorities for competing security interests is an important, and complicated, part of the Personal Property Security Act. The following is a simple example of a priority issue, written using the terminology of the Act:
“Bank A and Bank B take security over the same collateral, a truck, from a debtor company called Mike’s Movers Ltd. Both banks have perfected their security by properly registering a financing statement. Mike’s Movers Ltd. defaults on both payment obligations. Who gets priority in taking the truck?”
The answer is fairly predictable: the secured party that was first to “perfect” takes priority. Assume Bank A was the first. It gets to have the full amount of its obligation paid before Bank B gets anything — there is no pro rata sharing. It is important to remember that secured parties generally take priority over any unsecured creditor. A creditor who has a judgment and who wants the court bailiff to seize the truck to pay a judgment only gets paid after both banks are paid in full.
The issue of priorities becomes complicated, in part because the Personal Property Security Act makes rules for a wide range of priority situations that can arise between secured parties, particularly in business transactions. The Act also creates several exceptions to these basic priority rules. The most relevant exception to consumer transactions is the “PMSI”. PMSI stands for “purchase money security interest”; the term is usually known by its acronym (pronounced “pim-zee”).
Here is an example of when a PMSI might be relevant:
“Bank C takes a security interest over all chattels (personal, moveable possessions) that a consumer owns now and might acquire in the future. (The Personal Property Security Act allows this type of agreement.) If the consumer owns household furnishings and one car now, and later buys a second car using cash, the second car becomes collateral under the Bank C security agreement. But, consider if the consumer only owned household furnishings when the security agreement with the bank was made. Suppose later the consumer wants to buy a car and does not have the cash to buy it. If a car dealership sells the consumer a car on credit, it will probably want security. (Or, if another creditor — such as a bank — gives the consumer a loan to buy the car, it too will probably want security.) When the car dealership searches the Personal Property Registry, it finds that Bank C has a security agreement that says it can claim collateral over the car that the consumer is about to buy.”
This situation is governed by the PMSI exception. The Personal Property Security Act says that, among other situations, where credit is extended to a debtor so that the debtor can buy specific collateral (such as the car), the creditor who is extending the credit can take a security agreement, and, when it is perfected (completed), that security agreement takes priority over an agreement already perfected, even though it has terms broad enough to include the specific property that the debtor is now buying. The example illustrates the fairness of the PMSI exception to the basic rule of priority by time of perfection. The car dealership is advancing credit to facilitate a specific purchase. It probably would not extend credit for the car knowing that Bank C has a priority right to take the car upon default under the bank’s agreement.
Default rights in consumer transactions
The Personal Property Security Act creates special rights where the collateral meets the definition of “consumer goods”. These are “goods that are used or acquired for use primarily for personal, family or household purposes” (section 1). These special rights apply to “security leases” of consumer goods, but not to “true leases”; for more on this distinction, see the Leases section.
The following are some examples of how the consumer goods protections apply under the Personal Property Security Act. In general, these rights cannot be waived by a debtor. In each example, assume that the security agreement was perfected, and that there are no competing secured parties (that is, there is no priority issue).
The seize or sue rule
In general, the seize or sue provisions in section 67 of the Personal Property Security Act for consumer goods mean the secured party has the option of taking the collateral and selling it, or suing the debtor for the whole amount owing. The Act says, essentially, that a secured party can take the collateral regardless of the debtor’s wishes. However, if the debtor wants to give up the property, but the secured party does not want to take it back, the secured party cannot be forced to take it back. The secured party must agree. If the secured party does agree to take it back, the Act calls this a “surrender”, and the seize or sue rules apply as if the creditor had taken the goods when the debtor did not want to give them up. In short, the secured party must accept a surrender — a debtor cannot simply drop the collateral at the creditor’s front door and automatically expect to get out of the whole contract.
The two-thirds rule
Section 58(3) of the Personal Property Security Act says that a secured party cannot repossess consumer goods where at least two-thirds of the total amount secured has been paid unless it can get a court order to do so under section 58(4). The Act says the court can consider factors such as the present value of the goods, the reason for default, and the future circumstances of the parties (section 58(5)). One potentially important fact about the future circumstances of the debtor is whether the debtor will be able to make any payment in the foreseeable future. For example, if a debtor was temporarily laid off from work but expecting to be back within a few months, the court might be more inclined to refuse the creditor’s request for seizure.
The right to reinstate
Where consumer goods have been seized, the debtor is entitled to get the goods back by making up the arrears payments and paying the reasonable expenses incurred by the creditor in seizing the goods (section 62(1)). Section 59(6) of the Personal Property Security Act also says that the creditor must give the debtor 20 days’ written notice of an intention to sell the goods, and the notice must contain a statement of how much must be paid (that is, the arrears payments and the secured party’s expenses) to reinstate the payments.
An important legal protection (part of the right to reinstate when the collateral is consumer goods) is that the secured party cannot insist on being paid the full amount owing under the agreement rather than just the arrears. The right to demand and sue for the full amount under a credit agreement when the debtor is in default of one or more payments is a standard term in most credit agreements. The Personal Property Security Act says, in effect, that a secured party cannot insist on the contractual right of acceleration against seized collateral when the default is for consumer goods.
Relevance of the PPSA to the Bankruptcy and Insolvency Act
Creditors who have security rights under the Personal Property Security Act also have special rights under the Bankruptcy and Insolvency Act (see the sections on Bailiffs, Court Bailiffs and Sheriffs and Assignments in Bankruptcy). In very general terms, creditors with properly registered security agreements can take themselves outside most of the effects of the Bankruptcy and Insolvency Act, including:
- where there is an assignment in bankruptcy, and
- when the debtor has made a consumer proposal.
With some limitations, secured creditors can choose to be included in or excluded from the assignment or proposal — whichever is to their advantage. In most instances, the secured creditor’s decision is based on financial considerations.
In many consumer assignments in bankruptcy, secured creditors choose to be excluded from the assignment because the return to creditors in most consumer bankruptcies is minimal. The creditor is usually able to recover more by choosing to repossess and sell the security, and, under the provisions of the Bankruptcy and Insolvency Act, the debtor’s exemption claim does not cover secured goods. This means that any goods covered by the security agreement can be repossessed.
In practice, the debtor can only avoid the repossession by entering into a new agreement with the creditor to “buy” the secured goods at their resale value.
Most client problems with secured goods involve the remedies of a creditor when the debtor has defaulted in payments under the security agreement. Be sure to get a copy of the security agreement from the client. (Note that security agreements — as distinguished from financing statements — are not filed in the Personal Property Registry, and copies are only available from the client or the creditor.)
Make sure you have the correct details about the client’s history of payment, including how much was borrowed, when payments were made, and when there were defaults (if any). Satisfy yourself that the amount claimed by the creditor is correct.
Assess the entire circumstances of the debtor. If there are other creditors, you may have to recommend a remedy that includes those creditors as well as the secured creditor. Assess whether the financial difficulties of the client are long term or short term, as this affects the type of approach to take with the secured creditor.
Solving the problem
Assuming the client’s only problem is with payments to the security agreement creditor, and assuming there has been default (and perhaps repossession), the approach to solving the client’s problem centres on the prospects of the client repaying the security agreement. If the client has some prospect for repayment, you may decide to ask the creditor for reinstatement of the agreement and the return of any repossessed goods. If the client has the financial ability to reinstate and the creditor refuses to agree to it, consider a court action for an order for reinstatement.
If the client is temporarily unable to pay but has future prospects for repayment, approach the creditor for an agreement to suspend enforcement for the short term. It may help if the client can at least make some small payment in the interim. A creditor may agree to renegotiate the agreement, taking smaller payments for the balance of the credit agreement.
If the client’s problems are more serious, either because there are other creditors to consider or because the client has a longer-term diminished ability to pay, you may need to review other remedies, such as those available under the bankruptcy legislation.
Finally, there may be some advantages for the client if they agree to surrender a security, such as a car. If there is a significant amount owing above the value of the security, and if there is an obvious inability to pay over the long term, it may be better for the client to give up the security. Use the seize or sue provisions to protect the client from any claim for a deficiency balance when the car is sold.
Related topics and materials
See other sections on mortgages and secured loans:
See related topics:
- Assignments in Bankruptcy
- Bailiffs, Court Bailiffs and Sheriffs
- Consumer and Ordinary Proposals
- Enforcing Judgments Against Chattels
- Types of Lenders and Creditors
See also “Consumer Protection”, a chapter in the manual used by the UBC Law Students’ Legal Advice Program.
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