Arrangements with third-party creditors: No Interest Letters vs PPSA Estoppel Letters

Hi my name is Richard Dusome and I'm a Financial Services lawyer at Gowling WLG and you are watching video three of our Arrangements with Third Party Creditors video series.

In this video we're going to review some of the action items to be undertaken once you have completed searches under the Ontario Personal Property Security Act (also known as the PPSA), on the proposed borrower and guarantors (known under the PPSA as the debtor or debtors).

As mentioned in video two, PPSA searches will determine the identity of other secured parties with competing claims to the personal property assets of the debtor which will form the foundation of your security package.

You should certainly expect the search report to reveal some pre-existing PPSA registrations of other secured parties. Many of those registrations will continue to exist after your new senior financing is put in place.

Naturally these prior registrations will rank in priority to any PPSA registration that you or your counsel might make in respect of the new financing.

In many cases, a prior secured party may not have included what is known as a General Collateral Description (or a GCD) on its PPSA Financing Statement. A GCD is a description of the assets subject to the security interest.

Perhaps the secured party has included a GCD that is very broad in nature. Or perhaps the GCD does not limit the scope of the security interest perfected by their Financing Statement to specific assets of the debtor. In those cases you may need the secured party to provide you with either a PPSA Estoppel Letter or a No Interest Letter depending upon the personal property assets you are intending to take security over.

So when exactly are these documents needed and how are they different?

Let's start with the PPSA Estoppel Letter also known as the PPSA Acknowledgment.

PPSA Estoppel Letter

A PPSA Estoppel Letter is a letter issued by one prior secured party on the PPSA Register to another secured party that confirms or acknowledges the scope or other details of the security interests perfected by the first or prior secured party's PPSA registration against a debtor.

Once issued, the first secured party is prevented or "estopped" from claiming its PPSA registration perfected a security interest in a larger class of collateral than has been set out in the letter.

PPSA Estoppel Letters are really only needed in Ontario. That is because the Ontario PPSA operates on a "Check the Box" System. So what is the "Check the Box" system? It means that when preparing a Financing Statement for electronic registration, the secured party literally checks different collateral classification boxes in order to claim a security interest in those classes in accordance with its security agreement. The boxes that can be chosen are "Accounts", "Inventory", "Equipment", "Motor Vehicles", "Consumer Goods" and "Other."

There is no obligation upon a secured party to include a General Collateral Description to supplement the boxes that have been checked. This is very different from other provincial jurisdictions in Canada which require the secured party to include a full description of the assets in which it claims a security interest.

If a new Lender ignores a prior registration that is not properly limited or restricted in its GCD, it runs the risk of the prior secured creditors claiming a security interest in a broader class of collateral than the new Lender had thought. In addition, future security interests might be sheltered under the initial prior registration.

Estoppel Letters are most useful in a situation where the registrations are intended to only cover a part of the debtor's personal property assets, but that limitation is not reflected on the Financing Statement. This is most frequently encountered with registrations made in respect of equipment leases or motor vehicle leases.

The goal of the Estoppel Letter is to restrict the scope of the equipment or motor vehicles covered by the security interest perfected by the secured party. The Letter should either limit the scope to those assets listed in a schedule (known as the Specified Assets). Or alternatively it should generally limit the description of the Specified Assets to those assets financed by, or leased by, or supplied by the secured party to the debtor, and no other assets.

It is also important for the secured party to confirm that its registration will not be used in the future to perfect a security interest granted in any other assets, or granted under a subsequent security document that may be entered into.

Now let's consider the other option, the No Interest Letter.

No Interest Letter

A No Interest letter serves an alternative purpose to the PPSA Estoppel Letter which as mentioned earlier limits the scope of a secured party's security interest. Rather, a No Interest Letter is a letter from a secured party confirming that its security interest does not extend to a specific group of assets, or that it has no interest in a specific group of assets.

It is best used in a situation where you are only financing a select group of assets from a debtor, and where another secured party claims a broader interest or general security interest in the debtor's assets. It is also useful when you are financing the acquisition by your borrower of a group of assets from a target corporation where the target has previously granted a full security package to its own lender. You need that other lender to confirm that it consents to the sale of the assets being acquired by your borrower, and that it has no further interest in the assets being acquired by the borrower with your funds.

Limitations

Remember that PPSA Estoppel Letters and No Interest Letters do have their limitations. In some cases there will be multiple PPSA registrations involved or more complicated arrangements. Then you will need the benefit of a more fulsome subordination agreement, inter-creditor agreement or priorities agreement. We invite you to our subsequent videos on those topics and points.