A loan is secured when the borrower puts up an asset
(or assets) of value as collateral, which you, as the creditor, can seize if
the borrower does not repay your loan. The bigger the loan, the more collateral
you will need to secure it.
A loan can be secured in many ways, including:
- a
security agreement against the borrower’s personal property;
- if you
are selling shares to the borrower, a share pledge agreement that gives you
rights to the shares if the borrower defaults;
- a
personal guarantee from a third party;
- a
mortgage against the borrower’s real property (land); and/or
- a life
insurance policy taken out by the borrower naming you as the beneficiary.
1. Security
agreement
A security agreement can either give you a security
interest in a specific asset, like a car or piece of equipment, or it can give
you a general security interest in all of the debtor’s personal property
(except for the borrower’s house or other real property). A security agreement
can either act as security for only the current loan, or, if you plan to loan
additional amounts to the borrower in the future, it can act as security for
the current loan and any future loans you may advance.
A security agreement should always be in writing,
and a security interest should always be registered in the Personal Property
Security Registry as quickly as possible after the agreement is signed. Otherwise,
unless you have physical possession of the collateral, another creditor may
register a security interest in the same assets ahead of you, giving them priority
over the collateral if the debtor defaults under their loan.
2. Share
pledge agreement
In a share purchase transaction where you have
provided financing to the purchaser (borrower), you may require the purchaser
(borrower) to sign a share pledge agreement. This type of agreement gives you
rights to the purchased shares if the borrower defaults, such as voting or
receiving dividends, as if you were still the owner of the shares, and/or
seizing and selling the shares to recover the unpaid balance of the loan. Be
aware that after the share purchase transaction closes, there is always a risk
that the purchaser (borrower) will deplete the business, diminishing the value
of the shares that have been pledged.
3. Personal
guarantee
If the
borrower is a newly established company or an individual with limited assets, it
may be to your benefit to require one or more third parties (guarantor(s)) to
guarantee the loan (e.g. if the borrower is a corporation, this could be a
majority owner, or if the borrower is an individual, this could be a friend or relative
with deep pockets). A guarantor promises to repay the loan if the borrower defaults.
In a
share purchase transaction where you have provided financing to the purchaser
(borrower), you might require the corporation whose shares you just sold to the
purchaser (borrower) to guarantee the loan. You might also obtain a security
interest in the corporation’s personal property or a mortgage over the
corporation’s real property to reduce the risk of the purchaser (borrower)
depleting the company of its assets before your loan is repaid.
Be
aware that certain circumstances can make it difficult to enforce a personal
guarantee, such as when a guarantor goes bankrupt.
4. Mortgages
You can also negotiate for a mortgage over the borrower’s
real property. In an asset purchase transaction where you have provided
financing to the purchaser (borrower) and where real estate is among the assets
sold, you might require the borrower to grant you a mortgage over that particular
asset.
5. Life
insurance
Another
option for security, sometimes used in a share transaction with vendor
financing, is to require the borrower to take out a life insurance policy
against his/her life, for the term of the loan and name you as the beneficiary.
This can offer extra protection in the event that the borrower passes away
before the loan is repaid.
Conclusion
Before you sign a loan agreement or a purchase and
sale agreement with vendor financing, it is important to have a lawyer carefully
negotiate the terms of the loan or transaction and to obtain appropriate security
on your behalf, so you will have peace of mind that your loan will be repaid.
