Bulletin — January 2009

Valid and Enforceable Security
Canada Small Business Financing Regulations

Purpose

The purpose of this Bulletin is to provide further clarity to the Canada Small Business Financing (CSBF) Program's interpretation and application of the term "valid and enforceable security" under section 14 of the Canada Small Business Financing Regulations (CSBF Regulations).

Background

The September 2007 CSBF Bulletin stated that lenders must demonstrate that a valid and enforceable security interest was obtained in the assets of the borrower to secure the loan. Lenders have requested that the CSBF Program clarify its interpretation and application with respect to the term "valid and enforceable security".

Interpretation and Application

In determining whether "valid and enforceable security" has been obtained, the CSBF Program must assess the facts of each claim against: (i) in the case of provinces other than the Province of Québec, the applicable provincial personal property security and real property security legislation, (ii) in the case of the province of Québec, the Québec Civil Code as it relates to hypothecation of personal and real property as security; and (iii) across Canada, the federal Bank Act as it relates to loan security for banks.

In order to meet the requirements of the CSBF Program, each review requires the CSBF Program to determine whether:

• the security complies with the provincial personal property and real property security legislative requirements, including, without limitation, any requirements imposed by case law; and
• the security obtained meets any other legislated requirements specific to the type of asset secured.

The following factors, among others, may be considered in determining the validity and enforceability of security:

• the advancement of funds by the lender to the borrower;
• the registration of the security interest or charge over real or personal property in the appropriate provincial registry system;
• the signed security agreement by the borrower containing a description capable of identifying the collateral;
• the borrower having rights in the collateral. The determination of these rights will be based firstly, on accepted commercial practice, and secondly, on the unique facts in each claim.

Lenders are reminded that additional legislation (provincial, municipal or otherwise) may impose further obligations on a lender to ensure that valid and enforceable security has been obtained.

Claims Involving Potential Fraud

Lenders have requested clarification on claims where fraud may be suspected. Based on the above-noted criteria, below are 2 examples which set out how the CSBF program deals with this issue:

• Where there is unambiguous evidence that the borrower and the vendor of the assets conspired to defraud the lender, that is, where title in the assets was never intended to pass, or where the vendor did not have the legal right to convey title, the borrower cannot obtain sufficient rights in the collateral to grant a security interest. In such a case, the lender would not have valid and enforceable security and the Act and the CSBF Regulations do not provide a remedy enabling the Minister to pay such claims.
• There may be instances where the borrower, following the completion of the loan transaction, commits a fraudulent act (e.g., sells the assets without applying the sale proceeds to the CSBF consult their legal counsel to confirm that all necessary steps have been taken to comply with the requirements of section 14 of the CSBF Regulations and all other applicable legislation.

Additional Information

Lenders should note that for those loans where valid and enforceable security is an issue, they may be requested to provide additional information and/or documentation in order that a determination may be made as to the compliance of the security under section 14 of the CSBF Regulations.

Conclusion

The legislation for each province, and applicable federal legislation, imposes different requirements for "valid and enforceable security", and each claim involves unique facts. Lenders are urged to consult their legal counsel to confirm that all necessary steps have been taken to comply with the requirements of section 14 of the CSBF Regulations and all other applicable legislation.

If you have any comments related to any points raised in this Bulletin, please feel free to contact us.