Dueling PMSIs in acquisition financing in Ontario

28 September 2017


A lender financing the acquisition of assets by its borrower may intuitively believe that it will acquire a purchase money security interest (a "PMSI") over the purchased assets, and enjoy the benefits of the super-priority bestowed by the Ontario PPSA[1] over other security interests in the same collateral granted by the same debtor.

However, acquisition transactions can frequently involve the deferred payment to the vendor of a portion of the purchase price, with such payment being secured by certain vendor take-back security being granted by the borrower/purchaser over the purchased assets ("VTB Security"). In that situation, such a security interest would also constitute a PMSI in favour of the vendor.

So which of the two PMSIs has priority? Acquisition financing lenders should be aware that in such circumstances, the Ontario PPSA contains a special priority rule pursuant to which the vendor and the VTB Security will have priority over the acquisition lender and its security.[2]

Thus it is essential for an acquisition lender to obtain a subordination and postponement agreement from the vendor that includes an unconditional subordination of any VTB indebtedness and any VTB Security held therefor in favour of the acquisition lender and all amounts owed to it and any security held by it. Without the subordination, the vendor will have priority. In addition, the subordination agreement is needed even when the VTB Security is registered under the Ontario PPSA second or subsequent to any registrations made in favour of the acquisition lender as this statutory provision overrides the "first to register" priority system.

Acquisition lenders should also be aware that their PMSIs do not give them protection against security interests in the purchased assets held by any secured creditors of the vendor itself. As those security interests were granted by the vendor (as opposed to the borrower/purchaser) they were not granted by the same debtor and therefore are not subject to the acquisition lender's PMSI super-priority. All such Ontario PPSA registrations in favour of secured parties of the vendor will require discharges or no interest letters in respect of the purchased assets to ensure that the purchased assets are transferred to the borrower/purchaser free and clear of any security interest granted by the vendor.

[1] Personal Property Security Act, RSO 1990, c P.10 [Ontario PPSA].

[2] Ontario PPSA Section 33(3). Many of the other common law provinces also have provisions in their PPSAs addressing the priority as between two PMSIs, but so far as we are aware they do not have a clause specifically granting the vendor priority.

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