The ultimate goal of a creditor is to be repaid for the credit that they advance to a debtor in accordance with the terms that they have agreed to lend funds to the debtor.  For example, a creditor who grants a loan to a debtor wants the debtor to repay the principal amount of the loan and any interest accrued thereon.  Unfortunately, sometimes debtors fail to make payments or otherwise fulfil their debt obligations.  When this happens, it is important that the creditor is able to act quickly to recover the outstanding principal, interest and any other costs permitted to be recovered under the terms of the loan documentation.  In this article, we will discuss three best practices when it comes to lending (although there are certainly many more).

Do Your Due Diligence

Before you agree to grant a loan it is important to get to know the debtor.  No, this doesn’t mean an evening of wine and appys chatting about their family, friends and hobbies.  It means collecting and reviewing due diligence on the debtor so that you, as the lender, has information to assess the risk associated with your loan.

Firstly, you will want to know who the debtor is. For example, is the debtor a person, partnership, sole proprietorship or company?  How and where does the debtor make money and how likely is this revenue stream likely to continue?  If the debtor is a company, you will want to confirm that they are in good standing with the applicable corporate registry and that the company actually has authority to borrow the funds and provide the requested security.  You may also want to know about the directors, officers and shareholders of the company to ensure that your contact is authorized to make decisions on behalf of the company.

Secondly, you will want to assess the debtor’s creditworthiness.  You will want to determine what assets are owned by the debtor, the value of such assets and the location of such assets.  You will also want to know how such assets are owned (ie. are the assets in the sole name of the debtor, joint tenancy or tenants in common?).  You will also want to look into the current liabilities of the debtor.  For example, you should know the amount of any existing debt, whether such debt is secured or unsecured and ideally the terms and conditions of any debt obligations with existing creditors.  We recommend requesting and reviewing the following (as applicable):

1.        a company search;
2.        the debtor’s financial statements;
3.        a search from the Land Title Office for each piece of real property (land) owned by the debtor; and
4.        a search from the Personal Property Registry in each province in which the debtor owns assets, has offices and does business.  Please note that you will require the full legal name of the debtor, and if the debtor or guarantor is a natural person, their birthday.

You will also want to confirm that the borrower is permitted to borrow money.  Consider whether entering into an agreement with you would put the debtor in default of existing debt agreements or other contractual obligations.  Also, if you are dealing with a company, you will also want confirmation that the company will not be acting contrary to their articles.

Document the Loan

When it comes to loans, written agreements are always preferable to oral agreements.  Depending on the complexity of the loan arrangement, the loan may be documented using a promissory note or a loan agreement.  Either way, the loan instrument should include basic information including, but not limited to, the debtor’s name, the creditor’s name, the principal amount, the interest rate (if any), the terms of payment and the due date.  In many cases, we recommend expressly setting out the events of default as well.

If you wish to secure your interest against assets of the debtor (see below) you will need to prepare and execute additional documentation.  If you wish to secure your interest against the debtor’s real property (ie. land), you will need to have a mortgage prepared for registration in the Land Title Office and be aware of the priority your mortgage holds with respect to other financial charges (there are some registered charges that will always take priority).  If you wish to secure your interest against the debtor’s personal property (ie. not land), you will need to have a security agreement prepared for registration in the Personal Property Registry in the relevant jurisdiction(s).

If the debtor is a company, you may wish to consider requiring one or more personal guarantees to fulfil the obligations of the debtor if the debtor is unable to do so.  In some cases, a personal guarantee may be secured by additional collateral whether real estate or personal property. You should also obtain a copy of a resolution of the director(s) approving the loan.

Securing your Interest

Securing your interest provides two main benefits to creditors:

1. in the event that the debtor defaults on your loan, you are permitted to repossess or foreclose on the collateral without first obtaining a judgement from the court; and
2. in the event that there are multiple creditors, your interest is granted priority to creditors who register/perfect their interests after you (subject to certain exceptions).

With regards to real property (ie. land), your security interest is secured by registering a Form B – Mortgage with the Land Title Office.  With regards to personal property (ie. not land), your security interest is “perfected” by obtaining possession of collateral or by registering a financing statement in the Personal Property Registry in each province in which the debtor owns assets, has offices and does business.

When it comes to documenting and securing your interest, it is better late than never!  Please let us know if you are considering lending funds or if you have questions about an existing loan.  The intricacies around documenting and securing the loaning of funds can be very specific and minor errors can be detrimental to the use of the documentation or security on an enforcement.

Author: Danielle (Dani) Brito

This information is general in nature only. You should consult a lawyer before acting on any of this information. This information should not be considered as legal advice. To learn more about your legal needs, please contact our office at (250)448-2637 or any of our lawyers practicing in the area of business law at the following: