 Hello, it's Waylon Chow. This is Secured Lending Module 5, Part B. In this part, we will look at secured loans and security interests, specifically nine different types of security interests. So we've already looked at the use of guarantees to make a loan safer for a creditor. Another common way of making a loan safer for a creditor is using a secured loan. So there would still be money that's lent from the creditor to the debtor, and the debtor is still making a promise to repay. But in addition to that, the debtor is providing a security interest to the creditor over assets that are owned by the debtor. So those assets are called collateral. There are many different ways of structuring a security interest in order to accommodate various legal, accounting, or practical business issues. We will look at nine different types. First, the pledge, a child mortgage, a real estate mortgage, a conditional sale, a consignment, a lease, an assignment of accounts receivable, a general security agreement, and a Section 427 Bank Act security interest. The simplest form of security interest is called a pledge. So let's go back to our simple example with me needing some lunch money. So may I borrow some money for lunch? And you say very kindly again, yes, sure, here's 20 bucks. So the 20 bucks goes over to me. And then I say, thanks, I promise to pay you back next week. You'll hear. I take my shoes in case I don't pay. So I take the shoes off my feet and hand them to you. So I use the money to buy my lunch and I eat it. Then next week rolls around and I say, sorry, I can't pay you back. So now you say, okay, I'm selling your shoes on Craigslist. So you're able to sell them and you get money for them and you keep that money to pay off the money that I owe you. Now that seems to work fine, but you know, think though, what's wrong with this transaction? It's a practical issue here. What's wrong is I have no shoes to wear while the loan is outstanding. I have to walk around barefoot. So here's the general description of a pledge. So we have the debtor and the creditor. The debtor does not have use of the collateral during the loan because the collateral is given to the creditor who has possession of it until the loan is repaid. So the collateral is given by the debtor to the creditor in exchange for the loan money. And the collateral, the type of collateral that is used is personal property. So it's not real estate. It's some kind of personal property. And it could be something like stocks, bonds, jewelry, precious metals, or life insurance policy. And once the loan is fully repaid, that collateral is returned by the creditor to the debtor. And if there is a loan default, just like with my shoes, the creditor can sell the collateral and apply the proceeds against the debt that's owing. Now the key here is that this type of security interest, a pledge, works only if the debtor does not need the use or possession of the collateral during the loan. And that's a practical issue. That the collateral has to be something that the debtor does not need the use or possession of during the loan. So that's why giving my shoes as a pledge, practically speaking, does not really work. But if you use something like a stock that you own or a bond or jewelry or precious metals or life insurance policy, those are things that you own. But you don't need to have them in your possession to have use or enjoyment of them. So those types of personal property would work for use as collateral in a pledge. The second type of security interest is called a chattel mortgage. And the chattel mortgage can be used to solve that problem that we had in our example with the shoes where I don't have the use of the shoes. So let's go through that example, but this time using a chattel mortgage. So here, me and that's you. I'm asking to borrow money again. And you're willing to give me the $20. $20 goes over to me. And now I say thanks. I promise to pay you back next week. You can have a chattel mortgage over my shoes in case I don't pay. So instead of giving you possession of my shoes, instead I'm giving you a security interest called a chattel mortgage. So the money is used for my lunch. And then a week later I say I can't pay you back. So now what you do is you repossess my shoes. So you take my shoes. So when I'm in default, you take my shoes and then you go ahead and sell them on Craigslist. So you convert them into money to pay off the debt. So the key here with the chattel mortgage is that I still get to wear my shoes while the loan is outstanding. So we've solved that practical issue using a chattel mortgage instead of a pledge. Here's the general explanation of a chattel mortgage. So we still have a debtor and a creditor. So the title of the personal property that's being used as collateral is given by the debtor to the creditor in exchange for the money that's being loaned. And when the loan is fully repaid, that title is returned by the creditor to the debtor. If there's a loan default, the creditor can seize the collateral, or in other words a repo or a repossession, and sell it to repay the loan. Similar to a chattel mortgage is a real estate mortgage, except now the collateral is not a personal property or a chattel but is real estate. The type of real estate mortgage that we'll be describing is one that is under the Ontario land title system, which is the predominant system in Ontario. With a real estate mortgage, the debtor is also called the mortgageor, the creditor is also called the mortgagee. So a loan is made by the creditor, or the mortgagee to the mortgageor. In exchange for that loan, the mortgageor provides first a personal covenant promising to repay that loan. A personal covenant is just another way or a legal way of saying a contractual promise to repay that loan. What is also provided in exchange for the loan is what's called a charge that is registered on the title of real property. So the land title system in Ontario is a registration system where the ownership of property is registered, and in that registration system you can register a charge against the title of a piece of real estate. Arising from this real estate mortgage, the mortgageor, the debtor, has the right to retain possession and use of the real property that's being used as collateral during the term of the loan. The creditor, the mortgagee, has this charge, which we've mentioned, that is registered on the title of that property, and that charge is only removed or discharged once the loan is fully repaid. So the significance of that charge being registered on title is that anyone who looks up the registration of the property will see that that charge or that mortgage is there, and if anyone buys the property with that mortgage still registered against the property, with that charge still there, they will be taking that property still being subject to that mortgage. A conditional sale is often used where there is a sale of an asset by a seller to the purchaser with that seller providing financing for the transaction. So the creditor is also the seller and the debtor is also the purchaser in this situation. On the sale of the asset by the creditor to the debtor, the debtor will take possession of that asset and the creditor retains legal title of the asset. Once there is full payment of the purchase price or in other words, the debtor or the purchaser has made all of the necessary payments so they could be monthly payments after all the monthly payments are done, the title of the asset is transferred from the creditor to the debtor. If there is a default, for example, the debtor has missed one of the monthly payments, the creditor has a legal right to seize the collateral and sell it to repay the loan. One exception is if the debtor is a consumer and at least two thirds of the price has already been paid, in that situation the creditor cannot seize the collateral without a court order. So this protection is provided by the Ontario Consumer Protection Act. Let's say you have some old clothing that you want to sell at a secondhand clothing store. So what you do is you bring your clothes to the store and you can sign your clothes to the store. So what that means is that you give possession of your clothes, the goods, over to the store. The store we call the consignee and you are the consignor. You give possession but not the title of the goods. When the store, the consignee sells the goods to one of its customers. It gives a portion of the proceeds it receives to you, the consignor, and at the time of the sale, front by the consignee to the customer of the store, the title of the goods at that time is transferred from you, the consignee, to the buyer of the goods. And that's what we call a consignment. A lease of a car or any other type of vehicle is not as simple as many people think it is. It is not just making monthly rental payments in order to get the use of the vehicle. What it really is, it is a secured transaction which is used to finance the purchase of the vehicle. Whether or not in the end you actually purchase it or not, it is still really a financing transaction, a secured financing transaction. So what a lease transaction is, it happens in a few steps. The first step is the seller of the car which is usually the auto dealership sells the car to a lease finance company. So if you're buying a Honda from a Honda dealership, the Honda dealership is selling the car not to you, the customer, but they're selling it to the lease financing company who we call the Les Sore. And it's the Les Sore that owns the title of the vehicle during the term of the lease. And then the lease agreement is between you, the customer, the Les E, and the lease financing company, the Les Sore. Under that lease agreement, the Les E is obligated to make regular payments, so they could be monthly payments, let's say, during the term of the lease. So if it's a three-year lease, you're making a monthly payment for a term of three years. And in exchange for those payments, you get to have possession and use of the vehicle. And then at the end of the term of the lease, so if it's a three-year lease after three years, you are given the option to purchase the title of the vehicle by making some kind of lump sum payment. Businesses that sell to its customers on credit will generate accounts receivables. Those accounts receivables are considered to be assets that have value. As such, they can be used as collateral for loans or lines of credit. The security interest that involves accounts receivables is called an assignment of accounts receivable. What that involves is that the creditor, which is usually a bank or some other kind of financing company, will provide a loan or a line of credit that is secured by having the accounts receivables of the debtor assigned over to the creditor. So while the loan or line of credit remains in good standing, in other words, as long as there's no default, it's business as usual. The debtor will collect its ARs in the usual course of its business. But if there is a default, the creditor takes over the collection of the ARs. A quick quiz question. Please pause this video so that you can read the question and consider the choices. Please feel free to look at a previous slide. Pharaohs carries on a wholesale electronics business. He sells to his customers on credit, giving them 20 days to pay. Pharaohs has applied for an operating line of credit and his bank has asked him to assign his accounts receivables to it as security. Which of the following is true? The answer is B. Pharaohs will be permitted to continue to collect his own receivables and carry on his business as usual unless he defaults on the line of credit. A general security agreement or GSA allows a creditor to take a security interest over all of the assets of a business. So the way it works is that the creditor provides a loan or it could also be a loan of credit to the debtor. And that loan or loan of credit is secured by a security interest that is attached to all of the debtor's current assets and also after acquired property. So assets that they acquire in the future will also be covered by this security interest. And the way the general security agreement is set up is that it still allows the debtor as long as there's no default to freely use, sell and buy assets in order to carry on its business. But if there is a default the creditor will have the legal ability to seize all the property owned by the debtor at that time. So since all the property is basically all the business the creditor has the ability on default essentially to take over the whole business. And that's what people typically call a receivership. The section 427 bank act security interest as the name suggests is only available to creditors who are banks that are regulated by the federal bank act. And also this type of security interest is also restricted as to the types of assets that it can apply to. It can apply to goods and retailers goods and wholesalers, goods and manufacturers and mining and forestry products. And then there are also goods or certain assets that this type of security interest cannot apply to. It cannot apply to consumers assets and assets of most businesses providing services. The main advantage of using a section 427 security interest is that the federal registration that's required can cover a debtor's assets wherever they are situated in Canada. In contrast, if we need to register under personal property security legislation it must be done in every province in which the debtor has secured assets. So if they have secured assets in ten provinces we need to do ten different provincial registrations. And this type of security interest is usually taken by a bank if it's possible to take it, if it's eligible in a particular situation, but they'll take it when they can in addition to other security interests namely the provincial personal property security interest which we will discuss in the next module.