Ontario Purchase Money Security Interests: Attractive, But Don’t Just Sit on Them

By Jide Babalola

A Purchase Money Security Interest (PMSI) is a special kind of security interest that gives a creditor rights over specific personal property used as collateral, usually the same asset they've helped the debtor buy or finance. It is used to secure either the purchase price or a loan tied to that asset. PMSIs are attractive to both creditors and debtors because they offer a significant advantage to financiers of personal property, but only if taken timely and in accordance with the provisions of law. Debtors also find PMSIs appealing because they allow them to acquire essential assets needed to run their businesses, even if they have already granted prior security to other lenders over all of their present and future assets such as under a General Security Agreement.

Scope of PMSIs

A PMSI can be taken by a creditor who has financed the acquisition of specific collateral, or  by a seller who has sold such collateral to the debtor on credit, to secure its purchase price. A PMSI is also available to a lessor who leases personal property to a debtor for a term of more than one year. For example, a supplier of clothes to a retail store on credit may take a PMSI over the clothes, an employer who provides a loan to an employee to acquire a vehicle may take a PMSI over the financed vehicle. PMSIs can be taken over all types of specifically financed tangible or intangible personal property including vehicles, inventory, equipment and software rights, but exclude categories such as investment property (stocks, bonds et al.) and sale and leaseback arrangements. When duly perfected, a PMSI  generally grants the creditor super-priority status over specific collateral which ranks ahead of any prior security interest in the same collateral held by another creditor.

Taking a PMSI – What to keep in mind

While a PMSI offers clear benefits, including super priority over other claims, it is subject to strict rules set out in the Personal Property Security Act (PPSA). Super-priority is only available if specific legal steps are followed within the timelines prescribed by the PPSA. These general requirements are summarised as follows:

1. Intangibles (such as software rights)

   To obtain PMSI priority over financed intangibles, the creditor must perfect the security interest by registering a PPSA financing statement (clearly describing the financed intangible asset), before or within 15 days after attachment. Attachment occurs when all of the following three conditions are satisfied: (a) a security agreement is signed; (b) value is given to the debtor; and (c) the debtor acquires rights in the collateral.

2. Non-Inventory Tangibles (such as vehicles, equipment)

   To obtain PMSI priority over financed tangible collateral that is not inventory, the creditor must perfect the security interest by registering a PPSA financing statement (clearly describing the financed tangible asset) before or within 15 days after the debtor (or a third party at the debtor’s request) takes possession of the collateral.

3. Inventory (such as stock for retail)

   To obtain PMSI priority over inventory, the creditor must first perfect the security interest by registering a PPSA financing statement that clearly identifies the inventory. After that, the creditor also needs to send a PMSI written notice (in prescribed form) to any other secured creditors who already have a registration covering the debtor’s inventory or accounts. Information about existing secured creditors can be obtained through a PPSA search.

   With inventory, it gets a bit tricky because both of the foregoing conditions must be completed before the debtor (or a third party at the debtor’s request) takes possession of the collateral. Otherwise, the PMSI priority status is lost.

   In summary, timing is critical. For tangible collateral, the key factor is when the debtor takes possession. For intangible collateral, it is about when the security interest attaches. Missing the timing can mean losing out on PMSI priority.

4. Other considerations
   It is not impossible that there are competing PMSI security interests as between two or more PMSI creditors. These may also need to be assessed. For instance, where there are competing PMSIs over the same collateral, the seller generally has priority unless alternative contractual arrangements, such as subordination agreements, are negotiated between the creditors to re-order the PMSI priority.
   
   In addition, a creditor holding a PMSI must remain vigilant by monitoring the collateral and the overall status of the credit. Has the debtor changed name? Has the collateral been moved to another province? Has the financed collateral changed state? Is the registered financing statement nearing expiry?
   
   These changes may have an impact on the priority status of a PMSI if certain prescribed steps are not taken. For example, if collateral is permanently moved from one province to another, a new registration in the new province may be required to maintain priority. It is therefore reasonable for loan/security agreements to contain appropriate reporting obligations and covenants requiring the debtor to keep the creditor informed of changes and to obtain prior consent before taking steps that may jeopardize the creditor’s interest in the collateral.

Conclusion

While PMSIs are attractive, their status vis-a-vis various competing interests and how they are perfected requires a keen understanding of the applicable rules. For instance, in the case of tangible personal property, creditors often allow debtors to take possession of the collateral too early, such that by the time they register the PMSI or issue PMSI notices (in the case of inventory), the PMSI status is lost.

Are you considering taking a PMSI over specific personal property you are financing? One word: timing and vigilance is key. It is a good idea to engage counsel at the initial stage of the process to ensure that PMSI super-priority status is acquired  and to determine strategies to keep that status for as long as the PMSI is required over the collateral.