Canada: Spotlight On Security Documents: Reflecting Your Subordination

Subordination agreements, inter-creditor agreements and priorities agreements come in a variety of forms (each, a Subordination Document). Although some are unilateral in nature with all subordination covenants granted in favour of one secured party, it is not uncommon for some Subordination Documents to feature mutual subordinations by multiple secured parties to the extent necessary to give effect to the different priority rankings over different assets that they have agreed upon.

Section 50 of the Ontario PPSA¹ provides a useful tool to reflect on the Ontario PPSA register the existence of a subordination of rank pursuant to any Subordination Document. This section states that where a security interest is perfected by registration and that security interest has been subordinated by the secured party to any other security interest in the applicable collateral, a financing change statement may be registered at any time during the period that the registration of the subordinated interest is effective.² Mechanically, the financing change statement is registered as an "Other" change to the subordinated creditor's registration (the Subordination FCS) and details of the subordination or the applicable Subordination Document are inserted in Lines 25 to 28 of that financing change statement, all in accordance with the terms of Section 12 of the Minister's Order.³

It should be noted that Section 50 is permissive rather than mandatory, so it is not necessary for every subordination or Subordination Document to be recorded. However, even if a senior secured creditor's filing appears on the Ontario PPSA register prior to that of the subordinate creditor, it may be a good idea to register a Subordination FCS against the registration held by the subordinate creditor. Although Subordination Documents will typically include a clause binding the successors and assigns of the subordinated creditor, the subordinated creditor may inadvertently or purposely fail to disclose the existence of the subordination to a potential assignee. The proposed assignee will however likely conduct an Ontario PPSA search to verify the existence of the registration, and in doing so will acquire actual knowledge of the existence of the Subordination Document. In most cases, the proposed assignee will make inquiries following its search as to the terms of that Subordination Document, which will typically include a series of covenants that extend beyond a simple subordination. Thus, registering a Subordination FCS might serve to avoid costly litigation with the assignee alleging that it was unaware of the subordination terms.

To facilitate the completion of the Subordination FCS, a clause can be added to the Subordination Document outlining the specific text of the description to be used in Lines 25 to 28 of the Subordination FCS, and authorizing the senior secured creditor's counsel to make the registration on behalf of the subordinated creditor. In this way, the senior creditor does not have to pursue the subordinated creditor post-closing, or obtain its further co-operation in order to complete the registration.

Footnotes

<sup>1. Personal Property Security Act, R.S.O. 1990, c. P. 10, as amended ["Ontario PPSA"]
2. Ontario PPSA, Section 50.
3. Minister's Order made under the Ontario PPSA, dated June 5, 2007 [the "Minister's Order"]</sup>

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