Who's first? Taking a PMSI in inventory

24 July 2019

In personal property security law, the goal of secured creditors is to have "priority" relative to other secured creditors who have taken security interests in the same collateral. Given this concern about priority, secured creditors are well advised to be familiar with the "purchase-money security interest" or "PMSI" rules which provide an important exception to the general priority rules. A secured creditor who complies with the PMSI rules obtains a "super priority" that beats all non-PMSI secured creditors, even if a non-PMSI secured creditor registered or otherwise perfected first. This article - tailored to the Ontario context - will address the significance of PMSIs to inventory financiers and set out a guide to obtaining PMSI super priority in inventory.



The definition of a PMSI: three ways to get super priority

The definition of a PMSI in the Personal Property Security Act (Ontario) contemplates three situations:

  1. The "seller clause" gives a PMSI to a seller who takes a security interest in collateral in order to secure payment of the purchase price.
  2. The "lender clause" gives a PMSI to a lender who gives value to the debtor to enable it to acquire the collateral, but only if the value is applied for this purpose.
  3. The "lessor clause" gives a PMSI to a lessor of goods under a lease for a term of more than one year.

However, meeting the requirements of these definitions is not enough to get PMSI super priority in inventory. To get that priority, further tests specific to the inventory context must be satisfied.

The test for obtaining a PMSI in inventory: perfection and notice

There is a two-part test that must be satisfied to obtain a PMSI in inventory.

(1) Perfection

The PMSI must be perfected when the debtor, or a third party at the request of the debtor, obtains possession of the inventory.

For the inventory financier, this means that they will have registered a financing statement and selected the appropriate collateral classification boxes (generally, "inventory"). A general collateral description is not required but may be advisable in some cases.

In addition, the inventory financier must have taken all steps necessary for their security interest to attach to the inventory. To briefly summarize, attachment requires that (i) the secured creditor has given value, (ii) the debtor has rights in the collateral, and (iii) the debtor has signed a security agreement that contains a description of the collateral sufficient to enable it to be identified.

(2) Notice

A written PMSI notice must be given to specified prior secured creditors before the debtor obtains possession of the inventory. This is the key requirement for a PMSI in inventory as opposed to a PMSI in other collateral.

This written notice requirement addresses the fact that prior perfected secured creditors are about to lose priority in the inventory over which they currently have priority. It is not sufficient that other secured creditors happen to have knowledge of the PMSI, they must be given a written PMSI notice.

(i) When to give the notice

The inventory financier must give the written PMSI notice before the debtor obtains possession of the inventory. If the secured creditor gives notice after the debtor takes possession of the inventory, the notification is ineffective as to those goods, but will be effective for subsequent deliveries of goods.

(ii) Who receives the notice

The inventory financier must provide written notice to every other secured party who has registered a financing statement that describes the collateral as, or as including:

  • Items or types of inventory, all or some of which are the same as the items or types of inventory that will be subject to the PMSI;
  • Inventory; or
  • Accounts receivable.

However, the classes of secured creditors entitled to receive a PMSI notice are limited to those secured parties who have registered a financing statement before the inventory financier has registered its financing statement. This means that, as against financing statements registered after the inventory financier's financing statement, the inventory financier's priority is not dependent upon the notification requirement, even though the particular collateral involved in a priority dispute may have been acquired after another party registered an interest in the same collateral.

(iii) What is in the notice

The inventory financier must state in the written notice that it has or expects to acquire a PMSI in the inventory of the debtor. In addition, the written notice must describe the inventory by item or type.

If the description is by item, then further notice may be required if the inventory financier sells a new additional item or type of inventory subject to the security interest. The new item or type of inventory will not get the benefit of super priority unless the inventory financier gives the further written notice.

If the description is by type, the inventory financier should ensure that it is sufficient to make identification of the inventory possible.  

(iv) How to give notice

The notice may be:

  • served by personal service;
  • delivered by prepaid courier, or sent by registered mail, to the most recent address of the secured party as shown in the financing statement or financing change statement;
  • sent by fax; or
  • sent by electronic transmission.

(v) When is the notice deemed to be received

If the notice was sent by registered mail, the addressee will be deemed to have received it when the addressee actually receives the notice or once 10 days have elapsed after the day of registration, whichever is earlier.

If the notice was sent by fax or electronic transmission, the addressee will be deemed to have received it when the addressee actually receives the notice or on the first business day after the day the notice was sent, whichever is earlier. Care should be taken to retain evidence that the written PMSI notice has been delivered. Without being able to give that evidence, a PMSI will not be perfected and the PMSI super priority will be lost.


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