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Professional Legal Training Course 2022

Practice Material
Business: Commercial

Recent Contributors:
Amir Ghahreman
Alex McCrae
Edward J.T. Wang

Practice Material Editors:

Susan MacFarlane, Katie McConchie

September 2022

A requirement for admission to the bar of British Columbia, the Professional Legal Training Course is
supported by grants from the Law Society of British Columbia and the Law Foundation of British Columbia.
© 2022 The Law Society of British Columbia. See lawsociety.bc.ca >Terms of use.
 BUSINESS: COMMERCIAL
CONTENTS

COMMERCIAL LAW
[§1.01] Introduction to These Materials 1
[§1.02] Glossary of Terms 1
[§1.03] Further Reading 2

BUYING AND SELLING A BUSINESS

[§2.01] Private Businesses 3
[§2.02] Stages in a Typical Transaction 3
1. Investigation Prior to the Transaction 3
2. Negotiating and Determining the Structure 4
3. Drafting and Signing the Agreement 4
4. Preparing for Closing 5
5. Closing 5
6. Post-Closing 5
[§2.03] Use of Checklists 5
[§2.04] Basic Structure of the Transaction 5
1. Identity of the Buyer 6
2. Subject Matter of the Transaction 6
3. Considerations in Price and Financing 6
[§2.05] Tax Considerations 6
1. Income Taxes 6
2. Sales Tax (GST and PST) 8
[§2.06] Due Diligence 8
1. Title, Liabilities and Encumbrances 8
2. Consents to Transfer 9
3. Minority Interests 9
4. Employee Considerations 9
5. Searches 9
[§2.07] Other Pricing Considerations 10
1. Agents’ Commissions 10
2. Conveyancing Costs 10
3. Goodwill and Intellectual Property 10
[§2.08] Financing 10
1. Financing Options 10
2. Payment Clause 11
3. Seller Financing 11
[§2.09] Three General Drafting Considerations 12
1. Identifying the Parties 12
2. Defining Terms 12
3. Describing the Subject Matter 12

Business: Commercial
 (ii)

[§2.10] Contents of an Asset Purchase Agreement 12

1. Reasons for Buying Assets 12
2. Description of Assets 13
3. Exclusions 13
4. Allocation of the Purchase Price 13
5. Assuming Liabilities 13
6. Releasing the Seller 13
7. Determining the Purchase Price 13
8. Representations and Warranties of the Seller 14
9. Environmental Matters 15
10. Covenants of the Seller 15
11. Representations and Warranties of the Buyer 16
12. Covenants of the Buyer 16
13. Survival of Representations, Warranties and Covenants 16
14. Conditions Precedent to Closing 16
15. Documents Delivered at Closing 17
16. Tax Considerations in the Agreement 17
[§2.11] Contents of a Share Purchase Agreement 18
1. Identifying the Parties 18
2. Schedules 18
3. Purchased Shares 18
4. Price and Adjustments 18
5. Representations and Warranties 19
6. Survival of Representations, Warranties and Covenants 20
7. Indemnity Clauses 20
8. Conditions 20
[§2.12] Restrictive Covenants on the Sale of a Business 21
1. Purpose of a Restrictive Covenant 21
2. Enforceability of a Restrictive Covenant 21
3. Guiding Principles 21
4. Drafting a Restrictive Covenant 21
[§2.13] Impact of the Investment Canada Act 22
[§2.14] Impact of the Competition Act 22
[§2.15] Impact of the Family Law Act 22
[§2.16] Impact of the Indian Act 22
[§2.17] Impact of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act 23
[§2.18] Dispute Resolution 23
[§2.19] Closing Procedures 23

SECURITY IN COMMERCIAL TRANSACTIONS

[§3.01] Basic Concepts 24
1. Types of Security 24
2. Definitions 24
[§3.02] The Concept of Security 25
1. What is Security? 25
2. Granting Security 26
3. Kinds of Security 26

Business: Commercial
 (iii)

[§3.03] PPSA—Overview 27
1. Purpose of the PPSA 27
2. Substance Over Form 27
3. Deemed Security Interests 27
4. Scope of the PPSA 28
[§3.04] Attachment and Perfection 28
1. Attachment 28
2. Perfection 29
[§3.05] Collateral Description 31
[§3.06] Registration 32
1. Perfection by Registration 32
2. Notice System 32
3. Elements of a Financing Statement 32
4. Timing of Registration—Before Attachment 33
5. Amendments to Existing Registrations 34
6. Misleading Information 34
7. Section 18 Demands 34
8. Removing Invalid Registration 34
9. Registration Not Knowledge 34
10. Jurisdiction 34
11. Searches 35
[§3.07] Priorities 35
1. PPSA Determines Priorities 35
2. Nemo Dat Quod Non Habet 36
3. Residual Priority Rule—Section 35 36
4. Purchase Money Security Interests—Section 34 36
5. Buyers and Lessees of Goods—Section 30 37
6. Transferees of Negotiable Collateral—Section 31 37
7. Lien Holders—Section 32 37
8. Subordination Agreements—Section 40 37
9. Other Priority Rules—Sections 29, 36, 37, 38, 39 38
10. Bank Act Security 38
11. Fixtures 38
[§3.08] Enforcing Security Interests 39
1. PPSA Part 5 39
2. Contractual Rights—Section 58 39
3. Sale of Seized Collateral—Section 59 39
4. Payment of Sale Proceeds—Section 60 40
5. Voluntary Foreclosure—Section 61 40
6. Redemption and Reinstatement—Section 62 40
7. Receivers—Section 64 41
8. Consumer Goods—Special Enforcement Rules—Section 67 41
[§3.09] Guarantees 41
1. Why Get a Guarantee? 42
2. Guarantee or Indemnity 42
3. Co-Guarantors (Joint and Several Liability) 42
4. Preparing a Guarantee 42
5. Enforcement of a Guarantee 43
6. Defences to the Creditor’s Claim 43
7. Assignment of Security and Liability 43
8. Guarantor’s Rights Against a Principal Debtor 43

Business: Commercial
 (iv)

[§3.10] Due Diligence 44

1. Corporate Power and Capacity 44
2. Indian Act—Section 89 44
3. Searches 44
[§3.11] Common Pitfalls 44

APPENDICES – NOT AVAILABLE IN ONLINE VERSION

Appendix 1 – Guarantee 46
Appendix 2 – General Security Agreement 49
Appendix 3 – PPSA Conceptual Schematic 55

INTRODUCTION TO FINANCIAL ACCOUNTING AND FINANCIAL

STATEMENTS
[§4.01] Interpreting Financial Statements 56
[§4.02] Financial Statements—Generally Accepted Accounting Principles and Assumptions 56
1. Generally Accepted Accounting Principles 56
2. The Going-Concern Assumption 56
3. The Stable Unit of Measure Assumption 57
4. The Periodicity Assumption 57
5. The (Historical) Cost Principle 57
6. The Revenue Principle 57
7. The Matching Principle 57
8. The Objectivity Principle 58
9. The Consistency Principle 58
10. The Conservatism Principle 58
[§4.03] Financial Statements 58
1. The Balance Sheet 58
2. The Statement of Income and Retained Earnings 59
3. The Statement of Cash Flows 59
4. Notes to Financial Statements 60
5. Comparative Information 60
[§4.04] Accountants’ and Auditors’ Communications 61
[§4.05] Financial Statement Analysis 65
1. Comparative Analysis 65
2. Ratio Analysis 65
3. Liquidity Analysis 65
4. Solvency Analysis 66
5. Profitability Analysis 67
[§4.06] Conclusion 67

APPENDICES – NOT AVAILABLE IN ONLINE VERSION

Appendix 4 – Acme’s Financial Statements 68
Appendix 5 – Acme’s Ratios 72

Business: Commercial
 1
Chapter 1 “Amortization”: Dividing the total principal and interest
owing on a loan into equal amounts payable over the
term of the loan.
“Assets”: Resources that have monetary value to the
1
Commercial Law owner (see also “Current assets” and “Fixed assets”).
“Balance sheet”: Reports the company’s assets, liabilities
and equities at a particular date. Assets should equal
liabilities and shareholders’ equity.
[§1.01] Introduction to These Materials
“Book value”: Value of an asset as recorded in the
The practice of a commercial lawyer necessarily involves company’s “books” or financial statements. The book
several areas of law. A commercial lawyer provides legal value of a company is its total assets minus total
advice on the buying and selling of a business either by liabilities. That value appears on the balance sheet as
way of assets or shares. In addition, a commercial lawyer shareholders’ equity in the company.
is often asked to advise on or to document transactions “Canadian-Controlled Private Corporation”
involving partnerships, joint ventures, employment is- (“CCPC”): a company that is neither public nor
sues, intellectual property issues, commercial leases, li- controlled by non-residents. A CCPC can obtain a
cence agreements, and security documents. It is, however, “small business deduction,” which reduces the
the buying or selling of a business that forms an integral corporate income tax it otherwise must pay.
part of the practice of many commercial lawyers.
“Capital cost allowance” (“CCA”): A statutory form of
This Practice Material: Business: Commercial reviews depreciation available under the Income Tax Act.
some essential considerations for a commercial lawyer.
This chapter starts with a glossary of terms (additional “Cash”: Cash on hand and balances in current bank ac-
terms pertaining to security are defined in Chapter 3). counts.
Chapter 2 reviews basic considerations when advising the “Cash-flow statement”: Report of where income came
seller or the buyer in the purchase and sale of a business. from and what the company paid money for over a pe-
Chapter 3 canvasses security in loan transactions, with a riod of time.
focus on secured transactions involving the Personal
Property Security Act. The final chapter looks at financial “Contingent liabilities”: Liabilities that depend on future
statements. The chapters also include appendices with ex- events, such as pending lawsuits.
amples of a guarantee, a security agreement and financial “Cost base”: The amount the company paid for the asset
statements, among other things. (see also “Cost of goods sold”).
Specialized areas such as transportation, oil and gas or in- “Cost of goods sold”: Total expenses incurred in produc-
tellectual property are beyond the scope of these materi- ing the goods that were sold.
als. For assistance in these areas, consult the reference
materials published by the Continuing Legal Education “Current assets”: Cash and resources that will turn into
Society of BC (www.cle.bc.ca), including those men- cash within the company’s accounting cycle, typically
tioned at the end of this chapter, and publications by other one year from the balance sheet date.
legal publishers. “Current liabilities”: Debts due to creditors within one
year.
[§1.02] Glossary of Terms
“Current ratio”: See “Working capital.”
“Accounts payable”: Amounts due to creditors sold on “Depreciation”: Amount of diminished value. On a bal-
open account. ance sheet it represents the diminished value of assets
over the past year.
“Accounts receivable”: Amounts due from purchasers.
“Depreciable Capital Property”: property in respect of
“Accrual basis of accounting”: Revenue reported when
which taxpayers are entitled to claim capital cost al-
it is earned or payable, not when it is received (as in
lowance. It includes tangible assets that are used to
the “cash accounting” method).
gain and produce income, such as buildings, machin-
“Accrued liabilities”: Amounts owed, perhaps for ex- ery and software (compare to “Non-depreciable capi-
penses or losses, and not yet paid. tal property,” below).
“Eligible capital property”: property that entitles tax-
payers to deductions that are similar to capital cost al-

1
This chapter was last updated by PLTC in 2021.
Business: Commercial
 2
lowance but generally only half as generous. This in- statement on which the operating expenses are rec-
cludes goodwill, customer lists, patents and trade- orded.
marks.
“Public companies”: corporations whose shares are
“Expenses”: Decrease in asset value to generate revenue. listed for trading on a securities exchange.
“Fair market value”: A price that an independent pur- “Prepaid expenses”: Advance payment for expenses that
chaser would consider to be reasonable. have not yet been incurred. It is recorded as an asset
on the balance sheet.
“Financial statements”: Typical financial statements in-
clude at least a balance sheet, an income statement, a “Recapture”: A gain from selling an asset where the ven-
cash-flow statement and notes to the financial state- dor had already calculated depreciation on the asset’s
ments. value. Recapture occurs if the taxpayer sells the asset
for more than its residual depreciated value.
“Fixed assets”: Tangible assets that depreciate, such as
equipment and buildings, but not land. “Retained earnings”: Net profits that are not distributed
to shareholders.
“GAAP”: Generally Accepted Accounting Principles. It
is a widespread accounting standard having some re- “Security”: Financial instrument that the holder can sell
gional variations. or pledge for value (see also “Marketable securities”).
“Goodwill”: Value in a business that is in addition to its “Shareholders’ equity”: The value of a company’s assets
other assets. It is a subjective calculation of the value minus its liabilities (see “Book value”).
of things such as brand recognition, managerial excel-
“Shareholder loan”: Corporate financing where a share-
lence or customer loyalty.
holder advances money to the company on terms.
“IFRS”: International Financial Reporting Standards are
“Shares”: Partial holdings in the ownership of a com-
accounting standards to ensure global uniformity.
pany.
Canada’s GAAP for all publically accountable enter-
prises conforms to IFRS. “Working capital”: Current assets minus current liabili-
ties. Current assets divided by current liabilities is the
“Income statement”: A report of income and expenses
“working capital ratio” or the “current ratio,” which
over a period of time. It might be prepared annually,
measures the company’s liquidity and its ability to
quarterly, or monthly.
meet its debt obligations.
“Inventory”: Goods a company owns and intends to sell.
“Write-down”: Reduction in asset value where the fair
“Liabilities”: Debts or obligations (see also “Accrued li- market value falls below the book value, often due to
abilities,” “Contingent liabilities” and “Long-term lia- external factors such as economic downturn, obsoles-
bilities”). cence or lower market demand.
“Long-term liabilities”: Obligations that are payable af-
ter the current year (see “Current liabilities”). [§1.03] Further Reading
“Loss carry-forward”: A company that has losses in the The Continuing Legal Education Society of British Co-
current year might choose not to apply those losses to lumbia publishes relevant material:
offset its profits in the current year, but apply those
losses to offset profits in future years, to reduce its tax Advising BC Businesses (loose-leaf and online)
liability in those future years. Buying and Selling a Business—Annotated Prece-
“Marginal tax rate”: the percentage tax rate imposed on dents (loose-leaf and online)
the next dollar of income earned by a taxpayer. Commercial Leasing—Annotated Precedents (loose-
“Marketable securities”: An equity or debt instrument leaf and online)
where there is a ready market and it can easily be sold. Due Diligence Deskbook (loose-leaf and online)
“Non-capital loss”: Net losses from business or employ- Use of Financial Statements for Legal Professionals
ment, as opposed to losses from the sale of capital (May 2019)
property.
BC Personal Property Security Act Practice Manual
“Non-depreciable capital property”: property for which (loose-leaf and online)
no depreciation or capital cost allowance deductions
are available; includes land and shares in corporations.
“Operating expenses”: Costs of a company’s normal op-
eration over the period of time covered by the income

Business: Commercial
 3

The purchase and sale of a business may also require the

Chapter 2 consent of third parties. For example, the buyer may
need approval from the Commissioner of Competition
under the Competition Act, R.S.C. 1985, c. C-34.
A business transaction may be structured in a number of
Buying and Selling a Business 1 different ways. This chapter focuses on the most com-
mon forms—share purchases and asset purchases. Other
methods of acquiring a business (not discussed in this
chapter) include a hybrid of an asset and share purchase,
amalgamations of a seller and buyer corporation, corpo-
[§2.01] Private Businesses rate arrangements, and takeover bids. The client often
needs advice on how the purchase should be structured,
This chapter reviews the processes involved in buying and the lawyer or client might look to other professional
and selling a business (a private business in particular). advisors in determining the appropriate structure. The
This chapter looks at general concerns in buying and way the purchase is structured will have immediate cost
selling a business, then looks at particular concerns for consequences and will influence how the ongoing busi-
sellers and for buyers. Additional concerns in buying ness operates.
and selling public companies are not addressed in this
chapter.
[§2.02] Stages in a Typical Transaction
For most clients, the purchase and sale of a business is a
significant event. Clients should be aware that the trans- In general terms, a purchase and sale transaction can be
action process is complex and often requires significant broken down into the following distinct parts:
time and resources. It will also involve not only the cli-
 structuring the transaction;
ent and lawyer but other professional advisors, including
accountants, lenders, and business valuators, who are  investigation;
called upon to conduct specific due diligence. All of
 drafting of documents;
these parties need to work together to ensure that the
client’s interests are protected and the transaction is  negotiation;
completed efficiently.
 preparation for closing;
The transfer of a business raises a number of special
 closing; and
considerations that may not apply to other types of
transactions. For example, the buyer will typically need  post-closing.
a reasonably high level of certainty about the status of
The structure of the transaction is generally settled early
the business. This is usually accomplished by the seller
in the process as the choice of structure will affect
making representations and warranties about matters
investigation, drafting, and negotiation, and determine
such as the nature of the seller’s ownership of the busi-
the steps that must be taken to implement the
ness, the accuracy of the historic financial reporting, the
transaction. Investigation and negotiation will take place
status of major contracts affecting the business, and the
concurrently, at least in part. Drafting of documents,
transferability of major assets.
including the principal agreements, takes place during
As this chapter outlines, a key component of any the “negotiation” phase, and will be informed by the
acquisition transaction is investigating the target and its results of investigation. We will explore each of these
assets and operations. A buyer wants to know whether transaction components in this chapter.
there are any issues with what the buyer is buying,
whether the seller or target company has title to the 1. Investigation Prior to the Transaction
assets, and what liabilities the buyer is assuming.
The first step is for the seller to decide to sell its
business and to find a buyer who wants to purchase
1 Alex McCrae, Pearlman Lindholm, Victoria, revised this chap- the business.
ter in December 2020, September 2019 and May 2017. In June
Often the parties enter into a “letter of intent” or
2022, the Solicitors’ Legal Opinions Committee of British Co-
lumbia reviewed parts of this chapter relating to solicitors’ legal
similar form of non-binding agreement, stating the
opinions and provided suggested edits. This chapter was previ- parties’ intentions and the material terms of the
ously revised by Alex McCrae and Lindsay Ross (2013); Lisa transaction, including price and conditions.
Eastwood (2011); Valerie C. Mann (2008 and 2010); and Rita
C. Andreone (1996–2006). James Reynolds provided comments
The seller will disclose information to the buyer.
about the Indian Act in June 2001. The portions of this chapter Often, the buyer, the buyer’s lawyer, and the buy-
dealing with tax issues in relation to commercial buying and er’s accountants are all involved in checking that
selling were drawn from former Chapter 7, contributed by Ed information. The lawyer’s retainer should be clear
Kroft, QC, in 1989 and updated by the author until 2009.

Business: Commercial
 4

about what responsibilities fall on the lawyer in the  Be aware of Law Society Rules 3-98 to 3-110
due diligence process and what responsibilities fall regarding client identification and verification,
on the client and its other advisors. Usually the including the requirements that apply when a
lawyer will help the client determine what type of lawyer provides legal services for a “financial
due diligence to conduct. transaction” (defined in Rule 3-98). Note that
in addition to verifying the client’s identity,
When acting for the buyer, turn your mind to the
the lawyer must obtain information about the
following at an early stage in the transaction:
source of the money in relation to a financial
 Review several years of the seller’s financial transaction, and must periodically monitor the
statements before committing to the transac- professional business relationship with the cli-
tion. The statements should report on the com- ent. (See Practice Material: Professionalism:
pany’s most recent financial period. If they do Practice Management, Chapter 7.)
not, consider requesting current statements.  Express any doubts about the transaction early
The buyer’s accounting advisors should pro- on and ask questions as they arise.
vide input on the financial statements.
 When a material portion of the business’s rev- 2. Negotiating and Determining the Structure
enue is generated from only a few customers The parties will meet to decide how the transaction
or clients, caution the client that it is vital that should be structured, who the buyer and seller will
these contracts continue after the sale. be, what the price will be, and how the price will be
 Document the seller’s initial representations paid.
and warranties about matters such as the accu- Ideally, the parties will seek legal and accounting
racy of financial statements, capital expendi- advice about the structure of the transaction early in
tures, status of contractual arrangements, and their negotiations. However, parties will sometimes
status of any legal actions. These notes will present their lawyers with a general agreement or a
help keep the negotiations consistent through- letter of intent, having already determined the struc-
out the transaction. (These essential represen- ture of the transaction. Even if the parties have an
tations and warranties should be included in agreement, the lawyer should fully advise the client
the final agreement of purchase and sale.) of the implications of the agreement and, if neces-
 Consider whether any aspect of the transaction sary, make changes.
should be conditional on the business achiev- The parties are working toward developing what is
ing certain sales or profits within an agreed- usually called a term sheet: a list of the terms for
upon timeframe. Clarify definitions of terms the transaction.
like “sales” and “profits” early in the negotia-
tions. 3. Drafting and Signing the Agreement
 Familiarize yourself and the parties with the The buyer’s lawyers often draft the term sheet
key players (the subject business’s account- outlining the main terms of the transaction.
ants, bankers, and other advisors) and the key Whether you act for the buyer or the seller, you are
subject matter (the subject business’s assets typically in a better position if you control the
and any important contracts, including em- documentation.
ployment contracts and collective bargaining
agreements). At this stage, you may or may not want to have a
form of agreement that is legally binding on the
 Early in the negotiations, contact anyone else parties. A letter stating the intention of the parties
whose consent to the transaction may be re- can be prepared. Take great care when drafting the
quired so that their response will not delay the option or letter as it will form the basis for the de-
closing. This could include governmental au- tailed agreement and may contain binding terms. If
thorities, the buyer’s, auditors, directors, con- you intend to have a binding agreement at this
trolling shareholders, or others. stage, avoid including terms that contemplate the
 Consider any initial tax issues, such as the letter being followed by a more formal agreement,
seller’s tax residency. as such terms may make the agreement non-binding
(see Denison Mines Limited v. BP Resources Can-
 Consider whether the Proceeds of Crime ada Limited, [1991] B.C.J. No. 3563 (S.C.), and
(Money Laundering) and Terrorist Financing Canlan Investment Corp. v. Gettling, [1996] B.C.J.
Act, S.C. 2000, c. 17 imposes any obligation No. 1803 (S.C.), aff’d 1997 CanLII 4126
upon you or your client (or any other party to (B.C.C.A.)).
the transaction).

Business: Commercial
 5

The agreement should set out the essential elements petition Act, or a consent from a lender or landlord.
of the transaction. It may balance the interests of all The parties may want to fix an outside date by
parties or be more one-sided. If your approach is which time the transaction must have occurred, and
the latter, be prepared to defend that approach both if the date passes, then the transaction will termi-
to the other party’s lawyers and to your own client, nate. Such a clause may be motivated by an actual
who may not appreciate your over-complication of need to complete the transaction before a specific
the transaction, particularly if the deal is lost. date, or may just serve to provide some certainty
about the time of completion. If necessary, the par-
If you use precedents, you must review them care-
ties can renegotiate a later closing date.
fully and critically. Make sure that you turn your
mind to all the matters that are relevant to the At closing, the parties will ensure that all the condi-
transaction. The agreement should deal with repre- tions of closing are satisfied. The property being
sentations as to the state of facts at present, cove- purchased will be transferred to the buyer and the
nants as to what the seller and buyer will do before purchase price will be paid to the seller. Typically,
the closing date, conditions of the obligations to the exchange requires lawyers’ undertakings. For
close, and other matters. example, the buyer’s lawyer often disburses closing
funds to the seller’s lawyer on the seller’s lawyer’s
The buyers will want to obtain as many
undertaking to release financial charges against the
representations, warranties, covenants and
business.
indemnities as possible. The buyers may also want
security to protect them for a period of time
6. Post-Closing
following the closing (and sometimes indefinitely).
The sellers will want to limit the representations, Usually, the buyer’s lawyers will register the
warranties, covenants and indemnities, and will conveyancing documents and complete any
prefer a limited scope and duration. financing arrangements. Each party typically makes
numerous covenants that must be completed after
4. Preparing for Closing the closing.
The buyer will complete its investigation, ensure
that the conditions for the buyer’s obligation to [§2.03] Use of Checklists
close have been satisfied, complete its financing
arrangements, formulate its takeover plan, and Checklists are essential in commercial transactions. Re-
approve and sign all necessary documents. fer to the Practice Checklists Manual, available on the
Law Society of BC’s website (www.lawsociety.bc.ca).
The seller will ensure that it has complied with all
Of particular interest are the following checklists:
its covenants and will approve and sign the
necessary documents.  Asset Purchase Procedure
The seller may need to hold directors’ or share-  Asset Purchase Agreement Drafting
holders’ meetings (or both) in advance to approve
 Share Purchase Procedure
the sale, or may need to circulate a resolution to be
signed by all persons entitled to vote on the matter.  Share Purchase Agreement Drafting
Third party consents may also be required. Obtain-  Commercial Lease Procedure
ing the required approvals and consents can require
 Commercial Lease Drafting
significant time, effort and expense. Take this into
account so that the deadlines and costs for complet-  Security Agreement Procedure
ing matters are realistic.
 Security Agreement Drafting
It is useful to track the steps of a transaction with a
closing agenda. The closing agenda is usually a list
[§2.04] Basic Structure of the Transaction
of all documents, consents, and steps necessary to
complete the transaction. The parties’ lawyers de-
You should determine the basic structure of the transac-
cide amongst themselves who is responsible for
tion at an early stage of the transaction:
preparing each of the necessary documents.
 Who will buy what from whom?
5. Closing
 What will the price be?
The agreement should provide a certain date on
 Where will the purchase money come from?
which the closing will take place. This may be a
calendar date or a stated number of days following
the occurrence of a particular event, such as the ex-
piry of applicable waiting periods under the Com-

Business: Commercial
 6

1. Identity of the Buyer The first step in the tax analysis is to determine the
tax impact of buying assets or shares. In other
Whether the buyer decides to make the purchase as
words, which route will minimize the amount of tax
an individual or through a company often depends
dollars paid to taxation authorities? Next, you must
on income-tax consequences, or considerations
consider other tax factors that are relevant only to
such as limited liability.
the seller or buyer.
2. Subject Matter of the Transaction In considering the tax factors, note that the pur-
chase and sale of a business (whether an asset or
It is essential to the transaction that the lawyer de-
share deal) may be affected by the general anti-
termine what is being bought. Two main possibili-
avoidance rules (“GAAR”) in s. 245(2) of the In-
ties exist: the first is for the buyer to buy the assets
come Tax Act, R.S.C. 1985, c. 1 (5th Supplement),
of the business; the second is for the buyer to buy
and s. 274 of the Excise Tax Act, R.S.C. 1985, c. E-
the shares of the company that owns the business.
15. The provisions may apply to deny the seller or
In an asset transaction, the parties are able to the buyer a tax benefit resulting from a transaction,
choose the assets that will be acquired, as well as unless the transaction can reasonably be character-
the obligations and liabilities, if any, that will be ized as undertaken primarily for bona fide business
assumed by the buyer. purposes, and does not result in an “abuse or mis-
use” of the Income Tax Act or Excise Tax Act.
In a share transaction, the buyer is buying the
shares of the company, which owns assets and is (a) The Seller’s Position—Assets or Shares
responsible for obligations and liabilities. Unless
The seller will want to compare the net after-
the parties take steps before the closing to strip the
tax proceeds from an asset deal with the net af-
company of certain assets, all the assets and all the
ter-tax proceeds from a share deal.
liabilities of the company are the indirect subject
matter of a share transaction. (i) Asset Deal (Corporate and Personal)
There are many considerations to take into account A corporation is a separate legal person
when deciding whether the subject matter of the subject to taxation. When a corporate seller
sale should be shares or assets, and these are dis- sells assets, the net after-tax sales proceeds
cussed in the remainder of this chapter. Note that in received by the corporation will be taxed
reviewing the sections that follow, it may be help- again when the corporation distributes
ful to refer to the glossary in Chapter 1. those proceeds to its shareholders. There-
fore, depending on whether and how pro-
3. Considerations in Price and Financing ceeds are distributed from a corporation to
the shareholders, there will often be addi-
Often it is preferable for the buyer to buy assets and
tional tax payable by the shareholders.
for the seller to sell shares. Advantages to the buyer
usually are offset by corresponding disadvantages The purchase agreement should document
to the seller. Therefore, a seller may demand a the purchase price and how much of that
higher price to offset reduced net proceeds. purchase price is allocated to each of the
various assets being sold. In practice, this
Other key considerations in pricing include the
step is usually done with an accountant, but
value of the underlying assets, which will involve
it is important for lawyers to be generally
due diligence in reviewing financial statements and
aware of the issues.
security agreements as well as conducting searches,
described in more detail in §2.06 below. Considerations include the timing of divi-
dends (to obtain a payout over time), the
Another key consideration in setting the price is
possibility of winding-up the corporation
how the transaction is being financed, or where is
and distributing the proceeds; and whether
the money coming from, which is described in
the seller is a non-resident of Canada such
more detail in §2.08 below.
that withholding taxes apply.
The CRA can apply s. 68 of the Income
[§2.05] Tax Considerations Tax Act to reassess the parties to the trans-
action and reallocate the price in accord-
1. Income Taxes
ance with what it concludes is commercial-
The income tax consequences are often a determin- ly reasonable. However, when the parties
ing factor in structuring the transaction. Tax impli- are dealing with each other at arm’s length,
cations should be reviewed early in the negotia- and actually document the allocation of the
tions. price, the CRA will generally not challenge

Business: Commercial
 7

their agreed-upon allocation of the pur- volved in the buyer’s analysis usually in-
chase price. clude the following:
(ii) Share Deal Step 1—Review Tax Status of Assets
To see which is the better deal, the seller of Review the market value of all underlying
shares must compute any taxable gain and assets (or classes of assets) owned by the
the tax payable on that gain, and then com- target company to be purchased in the
pare the net yield from the sale of shares share deal. If shares (not assets) are being
with the after-tax amount that would be purchased, the transaction loses the finan-
payable in an asset deal. cial value of any increase to the adjusted
cost base of the assets.
Individuals often prefer to sell shares be-
cause of the lifetime capital gains exemp- Depreciable capital property and eligible
tion available on the disposition of “quali- capital property (e.g. goodwill) are two
fied small business corporation shares.” A common types of assets in which the asset
“qualified small business corporation cost base should be carefully considered
share” is essentially a share of a Canadian- and adjusted, to benefit the company in
controlled private corporation where the future tax deductions and costs.
seller owned the share for at least
Step 2—Review Tax Accounts
24 months before the sale and was carrying
on an active business in Canada. Review the corporation’s tax-free ac-
counts, loss carryforward balances, and
(b) The Buyer’s Position—Assets or Shares
tax credit carryforward balances (e.g. in-
(i) Asset Deal vestment tax credits). This includes re-
viewing whether the buyer can use these
An asset transaction has the following
amounts, as discussed below in Step 3.
advantages from the buyer’s point of view:
Step 3—Review Loss Carryforwards
 The buyer does not inherit the seller’s
tax problems (although tax liens can at- Consider if the target company has a loss
tach to the assets). carryforward balance.
 The buyer can be selective in choosing Non-capital losses (from a company los-
which specific assets are acquired. ing money) may be carried back three
taxation years and forward 20 taxation
 The buyer can write up assets to their
years. They are deductible against any in-
fair market value, giving a higher depre-
come source.
ciable base (subject to certain anti-
avoidance rules). In other words, the Net capital losses (usually resulting from
buyer can write off the purchase of the a company selling a capital asset for less
assets over time. than it paid) may be carried back three
taxation years and forward indefinitely.
The advantages to the buyer tend to be
They are only deductible against taxable
offset by corresponding disadvantages to
capital gains.
the seller. Therefore, a seller may demand a
higher price to offset reduced net proceeds. Step 4—Review Tax Liabilities
At the same time, the buyer may be willing
Analyze the corporation’s potential tax
to pay more for assets than shares because
liabilities and adjust the purchase price
the buyer may obtain a higher cost base on
accordingly. This analysis will include
which to claim capital cost allowance
the following:
(“CCA”). This means the buyer can claim
depreciation from its own adjusted cost  requesting a clearance letter from the
base. Therefore, when negotiating the CRA and other tax authorities;
purchase price, the buyer should consider
 reviewing prior tax payments to ensure
the present value of future CCA claims for
that payments, installments, collec-
the assets being purchased.
tions and remittances are up to date for
(ii) Share Deal all federal, provincial and foreign tax-
es including GST, withholding taxes,
The tax aspects of a share deal are more
capital taxes, and employee withhold-
difficult to assess than those of an asset
ings (including CPP and EI);
deal. The buyer must analyze each of the
company’s underlying assets. The steps in-

Business: Commercial
 8

 ensuring all tax returns and tax elec- By contrast, the sale or transfer of shares will not
tions are filed to date; and trigger the payment of sales tax, so the buyer will
not have to pay this tax.
 determining any exposure to uncertain
or contingent tax liabilities in connec-
tion with ongoing reassessments or for [§2.06] Due Diligence
potential reassessments of tax returns
in “open years” (that is, the years dur- 1. Title, Liabilities and Encumbrances
ing which prior returns may be subject
In an asset transaction, the buyer should ensure that
to reassessment). Returns may be sub-
the buyer’s title to the assets is free of any encum-
ject to reassessment for up to seven
brances and any other rights of other parties to the
years for some corporations, and in-
assets, except for those agreed to by the buyer. The
definitely in circumstances of fraud or
buyer should search title to registered assets, and
misrepresentation.
obtain warranties and indemnities from the seller
These items are often the subject of rep- confirming that the seller owns those assets and can
resentations and warranties in a share sell them.
purchase agreement. Note that the value of warranties and indemnities is
Step 5—Consider Structure and Financing limited by the financial strength of the seller—if
the seller has no financial resources, then the buyer
Consider the buyer. Is it your client? A may not be able to recover anything from the seller
new corporation? For example, the buyer if the warranties turn out to be misrepresentations.
may choose to acquire the shares of the
corporation through a holding company. If encumbrances (such as mortgage debt) exist and
will not be paid-out by the seller, the buyer should
Financing is often necessary to fund the hold back part of the purchase price. If this is not
purchase price. In some circumstances, a appropriate, the buyer may want to seek a guarantee
seller might assist the buyer in financing from a financially viable party on behalf of the sell-
the purchase price. Alternatively, the er, such as an individual shareholder or corporate
parties may negotiate an earn-out or parent of the seller.
reverse earn-out arrangement. An earn-
out arrangement means the selling price In getting a guarantee, review the applicable corpo-
will depend on future profits from the rate legislation or the company’s constating docu-
business sold. In any event, the buyer will ments to check for restrictions on providing finan-
seek to deduct any financing costs, cial assistance.
including interest. In a share transaction, the buyer should ensure that
The seller may also request payment for the company has title to the assets that the buyer
any non-competition clause requested by thinks it is buying (indirectly). The buyer will also
the buyer. The amount received will be be concerned about title to the shares, claims
fully taxable except in limited situations. against the shares by any third parties, and the ex-
istence of encumbrances on the shares. The buyer
2. Sales Tax (GST and PST) should obtain representations and warranties on
these matters and review the company’s minute
The impact of sales tax is an important factor. book (the record book where all material corporate
The sale of assets usually triggers the payment of decisions are recorded). The buyer should also ex-
sales tax. The Provincial Sales Tax Act, R.S.B.C. plore all disclosed and undisclosed liabilities of the
2012, c. 35, imposes sales tax (PST) on tangible company. This is because the buyer is buying the
personal property and fixtures, as does the Excise business with all its assets and liabilities, including
Tax Act, R.S.C. 1985, c. E-15 (GST). Both statutes historical liabilities or obligations.
contain exemptions and elections, which may re- The buyer should review financial statements and
duce or eliminate the imposition of these taxes. obtain warranties and representations about the ac-
In some circumstances, the buyer and seller elect to curacy and completeness of those statements, in-
not have GST apply to the sale of the assets. Such cluding with respect to the liabilities of the compa-
election applies where the seller is selling “owner- ny. Be wary if the books and records of the busi-
ship, possession or use of all or substantially all” ness are incomplete, or if the corporation is in-
(usually interpreted to mean 90% or more) of the volved in other ventures (which may or may not be
property required to carry on the business (or part similar to the existing business of the company). If
of the business). This is a joint election which re- the financial statements have not been audited or
quires signatures from both the buyer and seller. contain errors, there may be significant undisclosed
liabilities, and an asset purchase may be preferable.
Business: Commercial
 9

The possibility of a significant unknown liability, collective bargaining agreement in place, a succes-
such as product liability, professional negligence, sorship application will likely be made under s. 35
or environmental hazards or liability, may dictate of the Labour Relations Code, R.S.B.C. 1996,
an asset purchase. c. 244 and the Labour Relations Board will likely
hold that the union agreement binds the new buyer.
2. Consents to Transfer
Note that an employer who intends to terminate the
In an asset transaction involving leases, timber li- employment of 50 or more employees at a single
cences, utility commission authorities, liquor li- location within any two-month period must give
cences, other licences or permits, or certain agree- advance notice of that intention as set out in the
ments, it is usually necessary to obtain the consent Employment Standards Act (s. 64), and cannot alter
of the party granting the lease, licence or permit. the terms of employment during the notice period
This is because most of these are not transferable without consent of the employees involved.
without consent, and if consent is not given, the
transaction may be jeopardized. Applications for 5. Searches
consent are generally not processed quickly, and
the third party may require the buyer to post securi- The following is a list of common searches con-
ty for the obligations under the licence or permit. ducted by the buyer’s lawyers:
The amount of security may be significant. (a) Registrar of Companies, for notice of articles
In a share transaction, the transfer of certain leases, and amendments; registered and records offic-
licences, authorities, permits, and agreements also es; annual reports; directors and officers;
requires consent, if the control of the party holding whether company was struck off the register
them changes. and subsequently restored; certificate of good
standing.
3. Minority Interests (b) Personal Property Registry, for notices of en-
In an asset transaction, the company must not sell, cumbrances on personal property.
lease or otherwise dispose of all or substantially all (c) (i) Land Title Office, for charges on title of
of its undertaking unless it does so in the ordinary land owned by the seller; copies of leases.
course of its business, or as authorized by a special
resolution (Business Corporations Act, S.B.C. (ii) Indian Land Registry, if the seller leases all
2002, c. 57, s. 301). In addition, the dissenting or part of the land used in the business and
shareholders might have the right to be bought out the land is situated on a reserve.
(Business Corporations Act, ss. 237–247). (d) Municipal offices, for business tax arrears.
In a share transaction, the buyer typically wants to (e) Civic and municipal offices, for licensing by-
buy all of the outstanding shares. This may be diffi- laws.
cult if there are minority shareholders who do not
want to sell their shares. The compulsory acquisi- (f) City, municipal or provincial offices, for land
tion provisions of the Business Corporations Act taxes, and zoning or restrictive bylaws.
may have to be used so that the buyer can buy even (g) Provincial government offices—for workers’
if some minority shareholders do not want to sell compensation, sales tax, corporation capital
(s. 300). tax, stumpage and other fees. The seller must
submit a request in writing, or give written con-
4. Employee Considerations sent if the buyer is the party making the re-
In a share sale, the buyer inherits the workforce of quest.
the business and all of the obligations of the em- (h) Canada Revenue Agency, for income taxes, in-
ployer to the various employees. Under s. 97 of the cluding employee deductions and GST. The re-
Employment Standards Act, R.S.B.C. 1996, c. 113, quest must be in writing and include the seller’s
a person’s employment is deemed continuous, not- business identification numbers. The request
withstanding a change in ownership of the compa- can be made by the seller or by the buyer with
ny. Accordingly, under the Employment Standards the seller’s written consent.
Act the terms of employment simply continue (e.g.
salary, bonuses, and notice of termination). (i) Insurance agent, confirming placement of ade-
quate new insurance.
In an asset sale, the buyer may be able to select the
workforce for the business and leave any severance (j) Bankruptcy and Official Receiver’s Office.
or other obligations with the seller, to the extent (k) Sheriff’s offices, for actions and executions.
permitted under the Labour Relations Code and the
Employment Standards Act. However, if there is a (l) Court Registry (BC Online), for litigation.

Business: Commercial
 10

(m) Employment Standards Branch, for certificates [§2.07] Other Pricing Considerations
for unpaid wages.
1. Agents’ Commissions
(n) Better Business Bureau, for filed complaints.
In an asset transaction, commissions are often pay-
(o) Superintendent of Motor Vehicles (depending
able on land and other assets, reducing the return to
on the nature of the business).
the seller.
(p) Records office, for review of minute book (in In a share transaction, agents’ commissions are
share purchase agreements), looking for any usually not payable unless a broker has been used.
matters of concern as follows:
2. Conveyancing Costs
 Identify mortgages, debentures and loans.
In an asset transaction, an extensive set of convey-
 Review articles to determine whether they ancing documents may have to be prepared, as set
restrict the transfer of shares and to deter- out in the Law Society’s “Asset Purchase Proce-
mine the procedure for executing docu- dure” checklist in the Practice Checklists Manual.
ments. There may also be substantial registration costs that
 Examine share registers, share certificates, would not be incurred in a share transaction, such
waivers of preemptive rights, and as property transfer tax payable on the transfer of
resolutions authorizing issuance, transfer real estate, or other taxes payable on the transfer of
and buy-back of shares. The purpose of this chattels and personal property.
search is to determine if shares are validly In a share transaction, normally only a few con-
allotted, issued and fully paid, and how veyancing instruments need to be prepared—see
they are to be transferred and redeemed. the Law Society’s “Share Purchase Procedure”
 If there are recent share transfers from checklist.
spouses, consider entitlements to family
property arising under the Family Law Act, 3. Goodwill and Intellectual Property
S.B.C. 2011, c. 25 (see §2.15). In an asset transaction, you can allocate part of the
 Determine if directors’ and shareholders’ purchase price to goodwill or to intellectual proper-
meetings have been properly constituted ty. In a share transaction, the buyer may pay more
and the directors validly appointed. for the shares than the sum of the values of the as-
sets because of the goodwill or intellectual property
 Determine if every transaction and material of the company.
contract has been properly authorized.
In an asset transaction, it can sometimes be diffi-
(q) Consider searches for any special assets being cult to transfer the corporate name and other intan-
acquired (for example, the Office of the Gold gibles that affect goodwill. In a share transaction,
Commissioner for certain mineral claims or the buyer acquires the business and trade names,
leases). subject to any contractual rights that can be termi-
(r) Fees and payments under provincial legislation. nated on the transfer of the company.
(s) Credit searches including Dun and Bradstreet
and Credit Bureau. [§2.08] Financing
(t) Ministry of Environment, to determine whether 1. Financing Options
a target company or piece of property is subject
to a pollution abatement order or has been the The purchase price may be payable in cash, through
subject of investigations by the Ministry. the assumption of debt, or by the buyer giving other
property to the seller.
(u) Consider the impact of the Family Law Act, the
Investment Canada Act, the Competition Act Generally, the buyer finances the payment in one of
(that is, mergers and notifiable transactions), the following ways:
the Excise Tax Act, R.S.C. 1985, c. E-15, and  by deferring the payment of part of the pur-
any other relevant legislation. chase price to the seller (“seller financing”);
For detailed checklists on searches conducted by the  by borrowing from third parties; or
buyer’s lawyers, consult the Practice Checklists Manual
and the Due Diligence Deskbook (Vancouver: CLEBC).  by equity financing (finding additional inves-
tors willing to put money into the business by
way of share capital).

Business: Commercial
 11

For a discussion of borrowing from third parties,  In an asset sale, if payments to the seller
see Practice Material: Business: Commercial, secured by a mortgage of real estate are to
Chapter 3 (Security in Commercial Transactions). be based on a sinking fund plan or on a
For a discussion of equity financing, see Practice blended payment of principal plus inter-
Material: Business: Company, Chapter 5 (Finance). est, the rate of interest calculated yearly
or half yearly (and not in advance) must
2. Payment Clause be set out in a statement contained in the
mortgage. Otherwise, no interest shall be
Payments over CAD$25,000,000 must be made
chargeable, payable or recoverable on any
through the Large Value Transfer System
part of the principal advanced (Interest
(“LVTS”). Lawyers should ensure that the purchase
Act, s. 6).
agreement authorizes a payment through the LVTS
where necessary. The LVTS is an electronic wire (b) Acceleration Clause
transfer system operated by Payments Canada.. The
The agreement may provide that a default in
requirement to use the LVTS applies only to pay-
payment or a default in any other covenant of
ments in Canadian dollars, and cannot be circum-
the buyer will render the balance of the pur-
vented by issuing multiple payments for lesser
chase price immediately due and payable. De-
amounts.
pending on the terms of the agreement, the un-
The LVTS operates on a cycle from 8:00 a.m. to paid balance of the purchase price may also ac-
4:30 p.m. Eastern Time. All transfers are settled on celerate upon the insolvency or bankruptcy of
the books of the Bank of Canada at the end of the the buyer, and may be automatic or upon no-
cycle (subject to certain exceptions arising from tice.
force majeure type events).
(c) Security
Though it is beyond the scope of these materials to
The seller should secure the unpaid amounts in
address details of the LVTS system, lawyers must
some way. This means that the unpaid amounts
consider LVTS restrictions early in the transaction
attach to some kind of asset. If the buyer de-
to determine if they will impact the transaction.
faults on repaying the seller, the seller can seize
and sell (or keep) the asset. The security pro-
3. Seller Financing
vided by the buyer to the seller can be anything
If the seller is willing to wait for payment of part of that the seller is willing to accept, but often the
the purchase price, seller financing is often the buyer will mortgage back to the seller what the
most convenient way to finance the purchase. It buyer has acquired from the seller.
gives the buyer a holdback in case the seller has
In an asset transaction, the security agree-
made misrepresentations. The agreement must pro-
ment(s) will often charge the land, the major
vide for when and how the seller is to be paid, and
items of equipment, and the other assets of the
for any security for the unpaid purchase price.
company. The security could also include other
(a) Interest assets of the buyer.
When the seller is financing the sale, the fol- In a share transaction, the security will often
lowing considerations often arise concerning take the form of security over the shares and
interest on the payment price: security over the personal property of the
company and the buyer itself.
 Is the interest rate fixed, or based on the
prime commercial rate of a particular (d) Guarantees
bank?
The buyer’s principal shareholder, parent
 Should the price be negotiated on the ba- company, or another party may give a
sis of a relatively low interest rate with an guarantee to the seller, as the whole security or
increase in the rate upon default? (But see in addition to a mortgage of the shares or
below on mortgages). assets. The party giving the guarantee (the
“guarantor”) can also give a mortgage of
If the sale is to be secured by a mortgage of real
property as collateral security to the guarantee.
estate, note the following requirements under
the Interest Act, R.S.C. 1985, c. I-15: Generally, a company may give financial assis-
tance for any purpose by means of a loan, a
 Section 8(1) prevents a higher rate of in-
guarantee, the provision of security, or other-
terest being taken on principal that is se-
wise (Business Corporations Act, s. 195). If the
cured by a mortgage of real estate when
acquired company is going to guarantee the un-
the lender is in default.
paid portion of the purchase price and mortgage

Business: Commercial
 12

its assets as collateral to the guarantee, disclo- 2. Defining Terms

sure will likely be required (see s. 195). This is
It is usual to define terms at the beginning of the
often a useful tool in providing security to the
agreement that, if repeated in full throughout the
seller.
agreement, would make the agreement long and
(e) Covenants tedious. The defined terms usually include: the
parties; the purchased assets or shares; the business
It is important that the buyer give positive cov-
of the subject corporation; the financial statements
enants as to what it will do with the business
of the subject corporation which the buyer is
and negative covenants as to what it will not
relying upon; the time and date of closing; the
do, or permit the acquired company to do, so as
purchase price; and any other concepts that require
to protect the seller’s security. For example, if
some explanation and that arise more than once in
the buyer is allowed to run the business so as to
the agreement.
affect it or the assets adversely before the pur-
chase price is paid in full, the seller’s security
3. Describing the Subject Matter
in the business will be of little or no value. De-
fault of these covenants should permit the seller The seller must agree to sell and the buyer must
to realize on its security. In addition, the seller agree to purchase the assets or shares of the subject
should ensure that there is some way it can corporation. The assets or shares should be de-
monitor the buyer’s activities in the company, scribed with sufficient detail to ensure that there
to make sure the buyer is complying with the will be no confusion as to the subject matter of the
covenants. purchase.
These are some of the matters that should be
considered: [§2.10] Contents of an Asset Purchase
 the right to dividends;
Agreement
 the right to redeem shares; 1. Reasons for Buying Assets
 the right to issue additional shares; Tax considerations often are the principal reason
for purchasing assets rather than shares, but there
 the right to reduce capital;
may be other reasons favouring an asset purchase.
 the right of the seller to receive a notice If the buyer suspects that the target company has
of meetings and financial statements; and significant liabilities that are not disclosed on its
balance sheet, such as a potential product warranty
 the right to sell, mortgage or otherwise
claim or a potential tax assessment, the buyer may
dispose of the shares or assets.
prefer to purchase assets. This is so that the buyer
(f) Default can limit the liabilities it is assuming to those
agreed upon and reflected in the purchase price.
If one of the parties defaults, the property that
was sold may need to be reconveyed to the The buyer may also consider an asset purchase if
seller. For instance, in a share sale, the seller the buyer is doubtful of persuading all of the share-
may have to become the registered owner of the holders to sell their shares, but is confident that suf-
shares again. In an asset sale, the assets may ficient shareholders are willing to sell so that a spe-
have to be transferred back to the seller. The cial resolution can be passed under s. 301 of the
agreement should provide for this. Also, the Business Corporations Act authorizing the directors
parties must decide whether the seller has any to sell. However, a seller may be reluctant to pursue
right to the balance of the purchase price or to a special resolution because, if it is passed, share-
damages if the property has been returned, and holder dissent rights may be triggered under ss. 237
whether the buyer has any right to the return of to 247 of the Business Corporations Act.
monies that have been paid.
Another advantage to an asset purchase is that the
buyer deals with only one seller, rather than poten-
[§2.09] Three General Drafting Considerations tially dealing with many shareholders.
However, an asset purchase has its disadvantages.
1. Identifying the Parties
Asset purchases will inevitably require more docu-
The parties to the agreement must be described in mentation, and produce greater frustration, penaliz-
precise detail to ensure that they are easily identifi- ing both buyer and seller with higher legal and ac-
able. Corporations should include reference to the counting costs. For the buyer, it will create sales tax
incorporation number. obligations on tangible assets purchased, and prop-
erty transfer tax and registration fees on real estate

Business: Commercial
 13

purchased. Not only must conveyances, bills of sale required to) accept the allocation agreed on by the
and assignments be prepared, but some transfers parties if the parties are at arm’s length and the al-
will require the consent of third parties whose con- location is reasonable.
sent may not be easily gained. In order to properly
advise either a buyer or seller on the feasibility of 5. Assuming Liabilities
an asset purchase agreement, the lawyer must ex-
“Assumed indebtedness,” “assumed debt,” or “as-
amine the material contracts, leases, tenures and
sumed liabilities” are the seller’s monetary liabili-
other rights in order to assess the ease or difficulty
ties, such as current accounts payable and bank
of obtaining all of the necessary consents.
loans, which the buyer will be responsible for after
Assuming that the preliminary investigations and closing. The assumed liabilities should represent a
assessments indicate that the party should proceed credit against the purchase price.
by way of an asset purchase, the respective lawyers
Assumed debt will be identified by the seller in
must then settle the form of the asset purchase
writing at the time of closing. The list of assumed
agreement. This chapter reviews clauses typical in
debts should include the creditor and the amount
an agreement designed to transfer a business as a
for each liability.
going concern, with the buyer not only acquiring all
of the assets used in the business, but also assuming The buyer may also wish to assume certain contrac-
some, though not all, of the indebtedness and obli- tual obligations in existence at the time the agree-
gations of the business. ment is entered into. These can be identified in a
“Schedule of Material Contracts” attached to the
2. Description of Assets agreement. For greater certainty, the agreement can
also expressly exclude certain contracts and com-
While general words might be used, the preferred
mitments.
practice is to provide a detailed description of all
the assets being purchased, set out with sufficient As will be discussed later, the buyer will generally
certainty so that the same descriptions can be in- want the seller to agree to carry on the business in
corporated into the documents of transfer. This can the ordinary course between the date of the agree-
best be accomplished through the use of schedules. ment and the time of closing. The buyer will want
the benefit of any contracts entered into during that
Since the buyer is not purchasing the corporation
time period that benefit the business (e.g. agree-
but only its assets, the buyer must specifically
ments for the purchase of supplies). The agreement
purchase the benefits of any contracts, agreements
should therefore restrict the seller’s authority to in-
or leases of the seller. Ordinarily, these agreements
cur future obligations to those incurred in the ordi-
will be assigned at closing, but the buyer should
nary course of business between the date of the
ensure in advance that the necessary consents are
agreement and the date of closing (or those agreed
obtained.
to in writing by the buyer), and commit the buyer to
assuming those obligations. The agreement can also
3. Exclusions
include further restrictions on the type, amount, or
It is necessary to expressly exclude any assets not duration of future obligations that can be incurred
being purchased, because the description of the as- without the buyer’s written consent.
sets is generally all-inclusive. Typical exclusions
include: life insurance policies or leased vehicles 6. Releasing the Seller
for executives who will not be employed by the
The seller will want to be released from all “as-
buyer; surplus funds held in the form of cash, de-
sumed liabilities” and other obligations being as-
posits or marketable securities; insurance claims for
sumed by the buyer. The agreement should require
past losses or damage to assets not being pur-
the buyer to assume these agreements and enable
chased; security posted to secure obligations under
the seller to be released from these obligations. To
leases, permits, licences and prepaid expenses; and
the extent that the seller cannot obtain releases, the
lawsuits against others that are of no benefit to the
seller will want the buyer to indemnify the seller
buyer.
against any claims for breach of these agreements.
4. Allocation of the Purchase Price
7. Determining the Purchase Price
In an asset sale, the parties may agree to allocate
Arriving at the purchase price for a business can be
the purchase price to particular assets. This section
a complicated matter. Often, the price is based on
of the agreement is crucial when determining the
an estimate at closing and a final determination
true cost of the transaction to the buyer and the
made after closing, once such things as current as-
seller because of the tax consequences that follow
sets and current liabilities can be determined at the
from the allocation. The CRA is likely to (but is not
time of closing. For example, a purchase price

Business: Commercial
 14

might be a “net price” comprised of a fixed sum certified extract of a directors’ resolution au-
payable for all assets other than the accounts re- thorizing the execution and implementation of
ceivable, the inventories and the prepaid expenses, the agreement, and a certified copy of a special
together with the actual value of the accounts re- resolution of the shareholders authorizing the
ceivable, inventories and prepaid expenses as they directors to enter into and implement the
exist at the time of closing. From that total, the as- agreement of sale. There is a similar require-
sumed debt will be deducted to arrive at the amount ment for shareholder approval in ss. 189(3)–(9)
of the purchase price payable, in cash, on closing. of the Canada Business Corporations Act.
It can be difficult to determine the value of current (c) Default Provisions
assets such as accounts receivable and inventories.
The seller is usually required to represent that
For instance, the parties may disagree on whether
the sale will not result in a default under any
obsolete or slow-moving inventory should be in-
agreements or give rise to the forfeiture of any
cluded in the valuation. If such current assets form
assets. On an asset sale, that representation
a significant part of the seller’s aggregate assets,
should be qualified where consents of lessors
the parties should agree on the accounting princi-
and other contracting parties are required in or-
ples that will be followed in arriving at their value.
der to assign contractual or other rights.
Either the seller’s or buyer’s accountants will be re-
sponsible for determining the net book value of the (d) Pension Liabilities
current assets in accordance with the agreed-upon
Whether purchasing assets or shares, the buyer
accounting principles. The party not preparing this
must be wary of employment matters, including
determination should have their own accounting
assuming pension or benefit plans for employ-
advisor review and approve the calculations.
ees of the business. For example, if a pension
If the parties want the price to be determined before plan contemplates that the employees have the
the closing date, then an “Effective Date” can be right to future benefits in the form of a mini-
chosen as of which all price determinations are mum retirement allowance or in some other
made and the final purchase price decided. Provi- form, then the buyer must ensure that the plan
sions are then included so that the seller will con- is adequately funded as of the date of closing,
tinue to operate the business from the Effective to meet its future liabilities. When drafting the
Date until the closing with all profits or losses be- agreement, there should be a representation by
ing for the account of the buyer. Where the pur- the seller to produce at closing the certificate of
chase price is being determined as of an Effective an independent firm of actuaries certifying that
Date, the seller may insist that interest be paid upon the plan is fully funded.
the net purchase price from the Effective Date until
Under an asset purchase agreement, any short-
the closing.
fall then can be treated as an assumed debt and
credited against the purchase price. Under a
8. Representations and Warranties of the Seller
purchase of shares, the shortfall cannot be
The representations and warranties will be similar treated as a credit and instead the seller should
to those contained in a share purchase agreement: be obliged to fully fund the plan as a condition
of closing.
(a) Title to Assets
(e) Residence of the Seller
Typically the sellers warrant that they have
good and marketable title to the assets, free and If the seller is not a resident of Canada under
clear of all encumbrances (or subject to speci- the Income Tax Act, then the buyer is obliged to
fied encumbrances). comply with the withholding provisions of
s. 116 of the Act.
(b) Authority to Sell
Section 116 applies to the disposition by a sell-
If the seller is a British Columbia company, its
er of “taxable Canadian property” as defined in
directors cannot validly authorize the sale of all
s. 248 of the Act. “Taxable Canadian property”
or substantially all of the assets without the ap-
includes real property situated in Canada, as
proval by special resolution of its shareholders
well as interests in corporations, trusts and
(s. 301 of the Business Corporations Act). The
partnerships that can hold real property, and
approval should either be obtained before exe-
units or interests in trusts resident in Canada.
cution of the asset purchase agreement, or be-
come a condition of the agreement that must be Section 116 provides a system by which a non-
satisfied before the time of closing. Normally, resident seller of taxable Canadian property is
the buyer will want the seller to deliver, at clos- required to report the disposition or proposed
ing, evidence of its authority in the form of a disposition of such property to the CRA either

Business: Commercial
 15

before the disposition or within ten days after, 10. Covenants of the Seller
and prepay tax on account of the actual income
The following are typical covenants of the seller.
tax payable as a result of the disposition. This
is accomplished either by the seller making the (a) Conduct of the Business
estimated prepayment of tax, in which case a
The covenant of the seller to carry on the busi-
certificate of compliance (“Clearance Certifi-
ness in the normal course between the date of
cate”) is issued by the CRA certifying that this
the agreement and the time of closing is the
has been done, or by the buyer withholding an
same for a sale of assets or shares.
amount from the proceeds paid to the seller on
account of such tax. Payments of tax sent to the The draftsperson must keep in mind the proba-
CRA by the seller or the buyer are credited to ble length of time between those dates. Normal-
the account of the seller until the seller files an ly a closing can be scheduled to occur as soon
income tax return for the year. When s. 116 is as the documentation and audit requirements
not satisfied, the buyer may be liable for the can be met, which is usually about 30 days af-
unpaid tax. Accordingly, the buyer should ter the date of the agreement
withhold sufficient amounts from the proceeds
(b) Change of Name
paid to the seller until the buyer receives a copy
of a Clearance Certificate certifying that the If the buyer is acquiring the goodwill of the
seller has prepaid the required amount of tax. seller, and if the goodwill is in part attributable
to the name of the seller, then the buyer will re-
In an agreement, it is customary to require a
quire the seller to covenant to change its name
representation that the seller is a resident in
immediately after closing. Alternatively, the
Canada for the purposes of the Income Tax Act,
buyer might require that certified copies of a
but this does not relieve the buyer from the ob-
special resolution authorizing the change of
ligation to conduct reasonable inquiries. De-
name are delivered at closing so that they can
pending on the circumstances of the transac-
be filed with the Registrar of Companies im-
tion, it may be necessary to obtain statutory
mediately after closing.
declarations from principal shareholders or
from the corporate secretary of the seller. (c) Consents to Assignment
It is usual to require the seller to exercise all
9. Environmental Matters
reasonable commercial efforts to acquire all
A buyer of assets or shares must be satisfied that consents necessary to effectively assign con-
the seller and its predecessors have complied with tractual rights; however, the seller may want a
environmental regulation. The cost of environmen- reciprocal obligation from the buyer to cooper-
tal clean-up can be unexpectedly high and can sig- ate in obtaining those consents and to enter into
nificantly affect the viability of a purchase. For in- assumption agreements if such are required.
stance, the contaminated sites regulations can im- Buyers should be aware of whether they will be
pose retroactive and joint and several liability on required to provide personal guarantees in
those who have or had an interest in land, or those place of a seller guarantee or other financial
who possess or possessed land (see Part 4, Divi- commitments to lenders, lessors or landlords.
sion 3 of the Environmental Management Act,
(d) Termination of Employees
S.B.C. 2003, c. 53, and Part 7 of the Contaminated
Sites Regulation, B.C. Reg. 375/96). An area of concern to both seller and buyer un-
der an asset purchase agreement is that con-
Searches with public authorities may reveal known
tracts of employment will necessarily be inter-
environmental concerns or issues. However, the
rupted and are not assignable.
environmental authorities and the seller may not be
aware of latent or historical contamination. It is im- The buyer may want to choose from among the
portant to obtain representations from the seller seller’s employees instead of hiring all of them.
about the business’s compliance with environmen- If the employees and managers of the seller’s
tal regulation, historical and present uses of the business are a desirable asset to the buyer, the
subject assets, and the extent of any known envi- agreement should be structured so that the sell-
ronmental contamination or liability. In addition, it er is obligated to assist the buyer in negotiating
is increasingly common for buyers to commission employment contracts with those persons. The
or require an environmental audit of the land to de- buyer will want the seller to terminate the em-
termine the nature and extent of any contamination. ployment of the employees that the seller does
not want to select, and to be solely responsible
for their severance claims.

Business: Commercial
 16

Conversely, the seller will want the buyer to (a) Offer Employment
agree to hire all of the employees of the busi-
As noted earlier, to minimize the risk to the
ness in order to minimize the risk to the seller
seller of severance claims, the seller will want
of severance claims. Whether the buyer agrees
a covenant by the buyer to offer employment to
is a matter of negotiation between the parties.
employees of the seller. The seller may require
As noted earlier, it may not be possible for the a commitment by the buyer not to terminate
buyer to selectively assemble the workforce. If employment without cause for a certain period
there is an existing union certification or col- after the closing.
lective bargaining agreement, the union will
(b) Consents
likely invoke the successorship provisions in
the Labour Relations Code and the Labour Re- For the reasons already mentioned, the seller
lations Board may hold that the existing certifi- will usually require a covenant obligating the
cation and collective agreement bind the new buyer to assist in obtaining consents of third
buyer. parties to the assignment of contractual rights.
This will normally require the buyer to enter
(e) Covenant of Indemnity
into assumption agreements and to provide in-
The buyer will want recourse against the seller formation about its operations and net worth.
if, after the closing, it turns out that the busi-
(c) Assumption of Liabilities
ness has been misrepresented or the assets are
subject to liabilities that the buyer did not agree The seller will require the buyer’s covenant to
to assume. assume and pay the liabilities agreed to be as-
sumed, and to indemnify the seller against
The buyer will typically require the seller give
those liabilities.
indemnities for misrepresentation or breaches
of covenant. In addition, indemnities can be (d) Covenant on Continuation of the Business
negotiated for unassumed liabilities, pre-
If the seller is providing financing to the buyer,
closing tax matters and responsibility for envi-
and is looking to the continuation of the busi-
ronmental issues. Indemnification should cover
ness as the source of repayment, then the seller
not only the loss suffered by the buyer (directly
may require both positive and negative cove-
in an asset purchase or indirectly as the share-
nants from the buyer with respect to the opera-
holder of the target company in a share pur-
tion of the business. The usual practice, how-
chase) but also the costs incurred by the buyer
ever, is to include those covenants in any secu-
in enforcing its indemnification rights.
rity agreement entered into between the seller
There is always a risk that the seller company and the buyer.
is or will become a “shell” with no assets, or be
wound up after the closing, and that any re- 13. Survival of Representations, Warranties and
course against the seller alone will be illusory. Covenants
One solution is for the buyer to insist that the
The buyer will want the seller’s representations,
principal shareholders of the seller join in the
warranties and covenants to survive the closing,
covenant of indemnity. The shareholders on the
particularly where they relate to the existence of li-
other hand will likely seek to limit their liabil-
abilities that will affect the ongoing business.
ity under the agreement.
Whether the seller is able to negotiate a limit on the
duration and amount of that liability will depend on
11. Representations and Warranties of the Buyer
the circumstances and the seller’s bargaining posi-
The buyer’s warranties usually are limited to such tion. A common starting point for negotiating the
basic matters as the buyer’s capacity and authority appropriate time period is the amount of time it
to purchase, but may be extended depending on the would take to complete a full audited year of busi-
circumstances of the transaction. For example, if ness. However, the survival periods will depend on
the buyer is issuing shares to the seller as part of its the subject matter and need not be uniform.
payment for the business, the seller will want repre-
The seller will want the buyer’s covenant to assume
sentations and warranties about the value of the
liabilities and material contracts to survive the clos-
shares.
ing and to remain in force for the duration of those
liabilities.
12. Covenants of the Buyer
14. Conditions Precedent to Closing
The following are typical covenants of the buyer.
An asset purchase agreement, like a share purchase
agreement, will contain conditions that must be

Business: Commercial
 17

satisfied before the buyer and seller are obligated to assets being sold must include outstanding
close. The buyer will usually try to expand, as far debts that have been or will be included in
as possible, the events which will allow it to not computing the seller’s income for the year or a
complete the transaction, while the seller will try to previous year, and the buyer and seller must
restrict these events. In addition to the standard make the election by filing a joint election in
conditions about the truth of the representations Form T2022.
and the performance of covenants, both the buyer
(b) Inventories
and seller will want a condition in their favour that
all necessary consents to assign the assets have The asset purchase agreement should clearly
been procured. That condition may have to be set out the purchase price allocated to invento-
qualified so that it cannot be used as a pretext for ry, because the sale of inventory has specific
avoiding the contract. For example, the seller must tax consequences.
show that it has exercised all “reasonable
Under s. 23 of the Income Tax Act, when a
commercial efforts” to obtain the consents, and that
seller sells all or part of the inventory of a
the buyer has not waived the requirements for
business as part of the purchase and sale of a
consent, before the seller can rely upon the
business, that inventory is deemed to have been
condition to avoid the contract. (Note that the
sold in the course of carrying on the business.
phrase “best efforts”, as opposed to “reasonable
As a result, payments that the seller corporation
commercial efforts” is often a negotiated point
receives for the sale of inventory are included
between counsel; the phrase “best efforts” has been
in the seller’s income.
judicially considered and imposes a more onerous
burden on the party agreeing to exercise them.) The buyer may prefer to allocate a large por-
tion of the purchase price to inventory, as this
15. Documents Delivered at Closing will result in a rapidly deductible amount for
tax purposes.
If the buyer purchases assets, a number of transfer
documents will need to be delivered. To the extent (c) Prepaid Expenses
that conveyances, assignments and other transfer
The seller may have prepaid certain expenses
documents must be registered or recorded at any of-
of the company. Section 18(9) provides that
fice or registry, the agreement may have to set out
expenditures made or incurred by prepaid rent,
the mechanics to be followed so that registration
interest, insurance, taxes and for services to be
can take place before the purchase price is deliv-
rendered in a subsequent taxation year are not
ered. Usually, the lawyers agree to perform the
deductible until the year to which the expense
necessary filings and registrations in accordance
relates—that is, the year in which the taxpayer
with normal conveyancing practices. These agree-
realizes the benefit of the prepaid expense.
ments and arrangements will be reflected in the
Therefore, the CRA administrative practice has
closing memorandum.
generally been to include any payments from
the buyer to the seller for prepaid expenses in
16. Tax Considerations in the Agreement
the income of the seller. The buyer will benefit
(a) Accounts Receivable from a corresponding deduction in the year that
the buyer realizes the benefit of the prepaid
When accounts receivable are sold, the sale
expense.
generally gives rise to a capital gain or a capital
loss for the seller, and results in the buyer hav- (d) Non-Depreciable Capital Property
ing to treat any subsequent gain or loss on the
The asset purchase agreement should stipulate
receivables as a capital item. To avoid those
what part of the purchase price is allocated to
consequences, the parties can file an election
non-depreciable capital property (e.g. land).
under s. 22 of the Income Tax Act. Most
agreements of purchase and sale will include a The seller corporation will likely want as much
covenant to file a s. 22 election. of the price as possible to be attributed to non-
depreciable capital property. This is because on
A s. 22 election is available where a taxpayer
the sale of non-depreciable capital property, the
has sold “all or substantially all” of the proper-
seller will realize a capital gain or capital loss
ty used in carrying on a business to a buyer
(depending on whether the consideration re-
who proposes to continue carrying on the busi-
ceived exceeds the cost base of the assets), re-
ness. The additional requirements for a valid
sulting in income taxable only at capital gains
s. 22 election are that the business to which the
rates. By contrast, proceeds attributed to depre-
receivables relate must have been carried on in
ciable capital property will result in income
Canada or the seller must have been subject to
income tax in Canada on the receivables, the

Business: Commercial
 18

taxable at full rates to the extent of any recap- to purchase, or that the seller has the capacity to en-
tured capital cost allowance (CCA). ter into an agreement to sell the shares. This is par-
ticularly important if the seller is an agent, a trus-
The buyer will usually want as little as possible
tee, or an executor under a will.
of the total consideration attributed to non-
depreciable capital property, because there is a
2. Schedules
greater tax advantage to attributing the consid-
eration to depreciable capital property (i.e. the The agreement usually provides a list of the materi-
availability of CCA deductions to offset in- als that are to be appended to it as schedules, and a
come in future years, described below). statement that those materials are incorporated into
the agreement by reference. Materials that ordinari-
The buyer must also consider property tax leg-
ly are attached to the agreement as schedules in-
islation, which may impose a tax on the pur-
clude the financial statements of the subject corpo-
chase of real property. In BC, property tax is
ration, descriptions of any contracts and insurance
payable under the Property Transfer Tax Act.
policies of the subject corporation, and descriptions
This tax is generally payable when the transfer
of any leases and real property owned by the sub-
of the property is registered in the Land Title
ject corporation. As well, certain important closing
Office.
documents, such as non-competition agreements,
(e) Depreciable Capital Property releases and employment contracts, are settled be-
fore the agreement is signed and attached as sched-
Depreciable capital property is property for
ules.
which the taxpayer can claim capital cost al-
lowance (“CCA”). CCA is a permissive deduc-
3. Purchased Shares
tion which allows a portion of the property’s
capital cost to the taxpayer to be deducted in The shares should be described precisely, to avoid
computing the taxpayer’s income for the year any confusion about the subject matter of the pur-
from business or property. chase. The description should include the number
and class of shares being purchased. If possible, the
The consideration attributable to depreciable
agreement should allocate a share price to each
capital property can have significant tax conse-
class of shares.
quences to the buyer and seller. The agreement
should clearly stipulate the prices attributed to In some cases, the seller may not own or control all
various categories of property. the shares of the subject corporation. In this situa-
tion, the seller may agree to cause the sale of the
The seller usually wants to minimize the con-
shares owned by minority shareholders.
sideration attributable to depreciable property,
to minimize recaptured CCA. The seller there-
4. Price and Adjustments
fore will usually want more of the considera-
tion allocated to goodwill or non-depreciable The price is usually the product of many hours of
capital property, because this will result in less investigation by the buyer or the buyer’s represent-
tax payable by the seller. atives, and intense negotiation between the parties.
It is often expressed as a fixed dollar amount but
In contrast, the buyer generally wants to attrib-
(as with an asset purchase agreement) may be ar-
ute a high portion of the price to depreciable
rived at by an estimate and post-closing adjustment.
property, because it will increase the amount of
CCA deduction available to the buyer in future As well, particularly with transactions where there
years and thereby reduce taxes payable. is significant lead-time between the execution of an
agreement and the closing, the financial position of
the company might change, and the parties should
[§2.11] Contents of a Share Purchase
consider if the price should be adjusted in that case.
Agreement
In other situations, the price may be determined at
Note: Much of the discussion in the preceding section on some future date, such as by way of an “earn-out”
Asset Purchase Agreements is relevant to the discussion formula whereby the purchase price depends on the
of Share Purchase Agreements,although not all of it is subject corporation earning profit in fiscal periods
reproduced in this section. after the acquisition. The earn-out formula is popu-
lar where seller shareholders will continue in man-
1. Identifying the Parties agement positions and the buyer wants to ensure
that they continue to be motivated to see the busi-
The buyer invariably will require a representation
ness succeed.
and warranty that the seller described in the agree-
ment is the owner of the shares the buyer proposes

Business: Commercial
 19

Paying the purchase price may take many forms, and that both the authorized and issued capital are
including the following: as stated. Often, the buyer will also require an opin-
ion of the seller’s lawyer to that effect. In certain
 cash;
circumstances, the seller may also require an opin-
 promissory notes or other instruments of in- ion of the buyer’s lawyer covering the same mat-
debtedness; ters, particularly when the buyer will have obliga-
 assuming liabilities; tions to the seller post-completion.
 issuing shares of the buyer; The buyer will invariably require a representation
 exchanging property; or and warranty from the seller that the seller is the
beneficial owner of the purchased shares free and
 any combination of the above. clear of all liens, charges and encumbrances.
If the purchase price is not fully paid on closing, The buyer generally requires that the seller give a
the buyer usually gives the seller security for the representation and warranty that the latest audited
rest of the price. This security may come in several financial statements have been prepared in
forms, including the following: accordance with generally accepted accounting
principles applied on a basis consistent with the
 holding the purchased shares in escrow, un- previous years’ financial statements. In some cases,
der an escrow agreement; the buyer will want similar representations and
 the buyer gives the seller a mortgage on land warranties with respect to the audited financial
or chattels of the buyer or subject statements of the subject corporation for previous
corporation, if assets are purchased; years, and any unaudited financial statements
prepared since the last audited statement. (The
 the buyer gives the seller a fixed and float- buyer should be wary if financial statements are not
ing charge debenture on the assets and audited, and should have an audit conducted before
property of the buyer or subject corporation; closing. The buyer’s auditors should also verify
 a corporation or individual acceptable to the financial information provided by the seller before
seller provides a guarantee for the buyer’s closing.)
indebtedness; or Other representations and warranties that the buyer
 any combination of the above. will want from the seller concern these topics:
 accounts receivable, including the accuracy
The buyer will try to minimize the security it gives
of their valuation and their collectability;
for the outstanding purchase price, whereas the
seller will want to be well secured in case the buyer  amounts of salaries, bonuses and other con-
does not succeed in the new endeavour. siderations paid to parties not dealing at
arm’s length with the subject corporation;
A buyer will ordinarily try to spread the payment of
the purchase price over as long a period of time as  agreements entered into by the subject corpo-
possible so that the purchase price can be paid out ration and whether they are in good standing;
of profits generated by the newly acquired business.
 pending or threatened litigation, or govern-
Even where the buyer has sufficient funds, the buy-
mental or regulatory proceedings;
er may prefer not to satisfy the whole purchase
price at closing because the subject corporation  the residency of the seller;
may need funds.
 the filing of tax returns and receipt of
Where a seller is not receiving all cash on closing, assessments;
it will generally require interest to be paid on the
 compliance with environmental law and en-
outstanding amount.
vironmental liabilities;
5. Representations and Warranties  approvals to the transfer of shares;
The buyer will attempt to obtain broad and com-  dividends or other distributions to sharehold-
prehensive representations and warranties from the ers;
seller to ensure that it is getting what it has paid for.
 liabilities incurred outside the ordinary
Typically, the buyer will attempt to get representa- course of business; and
tions and warranties from the seller that the subject
 claims by First Nations.
corporation is duly incorporated, organized and
subsisting under the laws of British Columbia and
in each jurisdiction where it carries on business,

Business: Commercial
 20

6. Survival of Representations, Warranties and  it will have permitted the buyer, through its
Covenants representatives, to investigate the records,
property and assets of the subject
The buyer generally tries to ensure that the repre-
corporation, among other things;
sentations and warranties of the seller, as well as
certain covenants such as indemnities, survive clos-  it will have delivered all ancillary agree-
ing indefinitely. The seller, on the other hand, in- ments required by the agreement, such as
variably attempts to limit the period for which the non-competition agreements, releases, res-
representations and warranties survive. As in an as- ignations of directors and officers;
set purchase agreement, survival periods in a share
 it will have delivered an opinion of counsel
purchase agreement may vary depending upon the
regarding such matters as title to any real
specific matter addressed by the representation,
property included in the subject corpora-
warranty, covenant or indemnity.
tion’s assets, the due incorporation and ex-
The buyer will also try to ensure that no monetary istence of the subject corporation, the due
limit is placed on the amount that the buyer may creation and issuance of the purchased
ultimately recover from the seller, while the seller shares and other matters;
will usually try to limit liability to a small portion
 it will ensure that the subject corporation
of the purchase price.
maintains all policies of insurance during
the period from the date of the agreement
7. Indemnity Clauses
to the date of closing;
The buyer will want recourse against the seller if,  it will have taken all necessary steps and
after closing, it becomes apparent that the busi- proceedings as approved by counsel for the
ness’s assets and liabilities were misrepresented or buyer to permit the purchased shares to be
that the shares of the company are subject to liabili- duly transferred to the buyer; and
ties that the buyer did not agree to assume.
 it will have furnished the buyer with
evidence that it is a resident of Canada
Consider whether an indemnity from the seller
within the meaning of the Income Tax Act.
alone is sufficient, especially when the seller may
become a shell company or otherwise not have the (c) No substantial damage by fire or other hazard
financial resources to satisfy a judgment against it. to the physical assets of the subject corporation
As discussed in the section on asset purchases, one will have occurred before the closing date.
solution is to insist that the principal shareholders
(d) All government approvals will have been ob-
of the seller or others with greater financial re-
tained, including, if necessary, under the In-
sources join in granting the indemnity; however,
vestment Canada Act or the Competition Act.
the shareholders will generally resist this or seek to
limit their liability under the indemnity agreement. (e) Any consents required for the transfer of leases
or contracts, triggered by a change of control in
8. Conditions ownership, will have been obtained.
The completion of the transaction contemplated in (f) The buyer will be satisfied with the financial
the agreement of purchase and sale is invariably condition of the subject corporation based on a
subject to conditions, for the benefit of either the report prepared by an accounting firm retained
buyer or seller, which must be fulfilled before clos- by the buyer.
ing. The buyer will usually try to expand the events
(g) The buyer will be satisfied that there have been
which will allow it to not complete the transaction,
no adverse changes in the affairs, assets, liabili-
while the seller will try to restrict these events.
ties, financial condition or business, either fi-
The following conditions are commonly found in nancial or otherwise, of the subject corporation
an agreement of purchase and sale for shares of a since the date of the last audited financial
corporation. statements until the closing date.
(a) The covenants, representations and warranties (h) The buyer usually has the right to rescind the
of the seller will be true and correct as of the agreement if a condition is not satisfied, or to
date of the agreement and the date of closing. waive a condition without prejudicing the buy-
er’s right to rescind the agreement if any other
(b) The seller will have complied with all cove-
conditions are not satisfied.
nants and agreements contained in the agree-
ment of purchase and sale, which commonly It is also common for the agreement to contain con-
include the following: ditions that the buyer must satisfy before closing.
For example, where the parties have entered into an

Business: Commercial
 21

escrow arrangement to finance the purchase, the 3. Guiding Principles

seller ordinarily will require that, at closing, the
Whether a restrictive covenant it is reasonable will
buyer deliver the share certificates, representing the
depend on whether the covenant goes beyond what
purchased shares duly endorsed for transfer.
is necessary to protect the particular business. In
assessing reasonableness there are three main areas
[§2.12] Restrictive Covenants on the Sale of of concern:
a Business
(a) The scope of trade restrained (that is, the ex-
1. Purpose of a Restrictive Covenant tent of the activity prohibited);

As part of the sale of a business (whether by share (b) The territorial area restrained; and
purchase or asset purchase), the buyer usually (c) The length of time that trade will be re-
wants the seller to refrain from competing with the strained.
business the buyer just acquired. To that end, the
parties will generally include a restrictive covenant For example, in British Reinforced Concrete v.
in the sale agreement. The purpose of a restrictive Schelff (1921), 2 Ch. 563 (Eng. Ch. Div.), the Court
covenant is to ensure that the buyer receives the found the restrictive covenant was too broad as to
benefit of the goodwill of the business purchased. scope of trade because it restrained the manufac-
ture as well as sale of goods, whereas the business
Restrictive covenants can be enforced by the courts being sold had only engaged in the sale of goods.
by way of injunction or damages, or both.
The general rule as to territorial area of trade re-
2. Enforceability of a Restrictive Covenant strained is that the area must not be more extensive
than the trading area of the business being sold.
Restrictive covenants may be difficult to enforce. Note that the requirement to include a territorial
A restrictive covenant is a restraint of trade. As limitation applies to non-competition clauses but
noted in Shafron v. KRG Insurance Brokers (West- not to non-solicitation clauses (see Payette v. Guay
ern) Inc., 2009 SCC 6, at common law, restraints Inc., in which the Court ruled that failure to include
of trade are considered contrary to public policy, a territorial limitation in a non-solicitation clause
but the recognition of freedom to contract requires did not support a finding that the clause was unrea-
exceptions to this rule. sonable, because in the modern economy customers
The test for enforceability of a covenant restrain- were no longer limited geographically).
ing trade is set out in the Supreme Court of Cana- An ambiguous restrictive covenant is prima facie
da’s decision in Elsley v. J.G. Collins Insurance unreasonable and unenforceable: see Shafron.
Agencies, [1978] 2 S.C.R. 916. An enforceable re-
strictive covenant protects a legitimate proprietary 4. Drafting a Restrictive Covenant
interest, is fair and reasonable as between the par-
ties and considering the public interest, and con- Because the purpose of the restrictive covenant is
tains clear and certain terms of restraint. to protect the goodwill of the business sold, the
drafter must understand such things as the nature of
The court will more closely scrutinize a restrictive the business, the area in which business is carried
covenant in a contract of employment than a re- on, the threat posed to the business if the seller
strictive covenant granted on the sale of a business. were to compete, and the length of time required
In making this distinction, the courts have recog- for adequate protection. The drafter must focus on
nized that there is often a power imbalance in the the business as it exists at the time of the sale,
employee-employer relationship, whereas there is rather than attempting to protect the business into
usually no such imbalance between vendors and the future. When drafting a restrictive covenant, the
purchasers in a commercial context. practitioner does the client a disservice by being
As well, the vendor has received payment for over-protective; it is a much sounder practice to
goodwill, and more latitude is required in interpret- protect no more than is necessary in the
ing commercial agreements to protect freedom of circumstances.
trade and the stability of commercial agreements In the past, it was common for lawyers to draft al-
(see e.g. Shafron, and Payette v. Guay Inc., 2013 ternative restrictive covenants, expecting that the
SCC 45). As noted in Elsley: “a person seeking to court could strike out any restrictions it deemed too
sell his business might find himself with an unsala- broad and leave in place what the court considered
ble commodity if denied the right to assure the buy- reasonable (described as “blue-pencil” severance).
er that he, the vendor, would not later enter into For instance, lawyers might draft a time restraint as
competition.” a covenant not to compete for (a) two years or
(b) eight years, in the expectation that if the court

Business: Commercial
 22

found eight years unreasonable the court would Canada up to 30 days after the investment occurs. If the
strike it out but enforce the two-year restriction. transaction is deemed to have cultural heritage or na-
However, subsequent decisions have cast doubt on tional identity implications, it will be subject to a de-
this approach. See, for example, Canadian Ameri- tailed review and assessment, with a specific review
can Financial Corp. (Canada) Ltd. v. King (1989), process for investments that might be “injurious to na-
36 B.C.L.R. (2d) 257 (C.A.), where Justice Lam- tional security.”
bert held that alternative restrictions in restrictive
If the buyer of shares or assets is a non-Canadian, the
covenants are not appropriate because the parties,
Minister’s approval will be required. Completion should
not the court, need to agree on one specific time re-
be made subject to that approval.
striction and one specific geographic restriction.
If the company that is being acquired formerly obtained
In a 4–3 split, the Supreme Court of Canada en-
approval from Investment Canada, check whether the
dorsed a contractual doctrine known as “notional
conditions of that approval bind a subsequent buyer,
severance”, which involves reading down a contract
even if the subsequent buyer is a Canadian company.
provision to make it enforceable (by substituting
one term for another): Transport North American
[§2.14] Impact of the Competition Act
Express Inc. v. New Solutions Financial Corp.,
[2004] 1 S.C.R. 249. In 2006, the British Columbia
Any person proposing to invest in or expand a business
Supreme Court applied this doctrine to a restrictive
carried on in Canada must consider the merger review
covenant and substituted a two-year restriction for
and notification provisions of the Competition Act,
the five-year restriction in the contract (Jones v.
R.S.C. 1985, c. C-34.
Prostar Painting and Restoration Ltd., 2006 BCSC
1034). However, note that the Supreme Court of Merger transactions are subject to review by the Com-
Canada has held that the doctrine of notional sever- missioner of Competition to determine if they substan-
ance does not apply to restrictive covenants in em- tially lessen or prevent competition, or are likely to do
ployment contracts (see Shafron). so. A “merger” is broadly defined as any acquisition or
establishment of direct or indirect control over, or a sig-
nificant interest in, a business (Competition Act, s. 91).
[§2.13] Impact of the Investment Canada
The Competition Tribunal has broad powers to intervene
Act
if a merger is likely to substantially prevent or lessen
competition, including by making orders preventing or
The Investment Canada Act, R.S.C. 1985, c. 28 (1st
dissolving the merger.
Supp.) regulates foreign investment in Canada. The gen-
eral scheme of the Investment Canada Act is to require Though all merger transactions are subject to review,
direct and indirect acquisitions of Canadian businesses Part IX (Notifiable Transactions) requires that parties
by foreign nationals to be reviewed by the Investment notify the Commissioner of Competition before com-
Canada Agency when the value of the acquisition is of a pleting certain transactions. A notifiable transaction
certain type and exceeding a certain amount. The must meet certain thresholds:
thresholds are adjusted annually.
 the size of the parties to the transaction and their
Governments of WTO member states, and entities con- affiliates exceeds CAD$400 million; and
trolled by them, have a special status. Indirect acquisi-
 the size of the transaction (generally, the assets
tions by WTO investors are subject to notification but
to be acquired in Canada or gross revenues from
are not reviewable, regardless of the value of the assets
those assets) exceeds CAD$96 million.
acquired.
For a reviewable transaction to be approved it must give Unless an exemption is available (see ss. 111–113), par-
a “net benefit” to Canada. The Minister of Innovation, ties to notifiable transactions must notify the Commis-
Science and Economic Development considers the fac- sioner, file certain information about the transaction
tors set out in the Investment Canada Act in deciding with the Commissioner, and wait for up to 30 days be-
whether the proposed investment is a “net benefit”, in- fore completing the transaction. Instead of filing a pre-
cluding the impact of the investment on the level of eco- merger notification, the parties can request an Advance
nomic activity in Canada, and the degree and signifi- Ruling Certificate. In either case a filing fee applies (in
cance of participation by Canadians in the business (see 2021, it was $74,905 plus GST).
Investment Canada Act, s. 20).
Except for investment in areas related to Canada’s cul-
[§2.15] Impact of the Family Law Act
tural heritage or national identity, investments by non-
The Family Law Act, S.B.C. 2011, c. 25 provides third
Canadians in new businesses are subject only to a re-
parties with little protection against the possibility that
quirement to file with the federal government a notice of
an individual seller’s spouse may have an interest in an
the investment. The notice must be filed with Investment
asset (for example, a share in a non-reporting company).

Business: Commercial
 23

One method of protection is for buyers to obtain a cove- mestic disputes, and the International Commercial Arbi-
nant of the seller to deliver the following statutory dec- tration Act, R.S.B.C. 1996, c. 233, applicable to interna-
larations: tional commercial arbitrations.
(a) a statutory declaration of the seller, on closing,
stating that the seller is not married or living in a [§2.19] Closing Procedures
common law relationship; or that the seller is mar-
ried or living in a common law relationship but has The following list summarizes some of the main closing
not separated; or that the seller was married or liv- procedures:
ing in a common law relationship that has been
1. If the seller is a company, obtain a directors’ reso-
terminated and all property matters between the
lution from the seller authorizing the sale. If sub-
parties have been resolved; and
stantially all assets of the company are being sold,
(b) a statutory declaration of the seller with a covenant obtain a shareholders’ resolution (Business Corpo-
to deliver a release of any interest in the assets in rations Act, s. 301).
question from any person to whom the seller has
2. If the buyer is a company, obtain a directors’ reso-
been married or with whom the seller has lived in
lution from the buyer authorizing the purchase.
a common law relationship, if the marriage or rela-
tionship has not been terminated and property mat- 3. Ensure that the agreement and documents of trans-
ters between the parties have not been resolved. fer and conveyance cover all assets purchased.
4. If the seller is a company, ensure that you obtain all
[§2.16] Impact of the Indian Act the signed acknowledgements that are required to
transfer properties in the Land Title Office.
If the business is situated on a reserve, consider the fed-
5. If bank accounts are being transferred, ensure that
eral Indian Act, R.S.C. 1985, c. I-5. Most reserve lands
new banking forms are prepared for filing with the
in BC are governed by the Indian Act, unless the Indige-
bank and that the bank is notified.
nous group has entered into agreements with the federal
government regarding reserve lands. (The Practice Ma- 6. Ensure that the buyer produces sufficient monies to
terial: Real Estate, §1.04 discusses types of interests in cover GST, if the buyer has warranted to do so.
reserve lands.)
7. If the seller is a non-resident of Canada, ensure that
The interest of the seller in any reserve lands governed a certificate has been obtained or monies withheld
by the Indian Act will be leasehold. You must review the under s. 116 of the Income Tax Act.
relevant terms of the lease and any head-lease to deter-
8. If notice of dissent under s. 301 of the Business
mine what consents are required for any assignment of
Corporations Act has been given, ensure that the
the seller’s leasehold interest. You should also obtain a
company has given shareholders notice of its inten-
full search from the Indian Land Registry in Ottawa, and
tion to act.
review all documents relevant to the seller’s interest.
9. If it is a share transaction, record the transfer in the
For the sale of a business on reserve land, consult CLE
share register, issue new shares, and cancel old
resources about searches under the Indian Act, such as
shares.
Chapter 17 (Searching Land Governed Under the Indian
Act) of the Due Diligence Deskbook. 10. Prepare employment contracts if they are required.
11. Prepare documents securing the unpaid purchase
[§2.17] Impact of the Proceeds of Crime price.
(Money Laundering) and Terrorist
12. Ensure payment follows the statement of adjust-
Financing Act
ments (the document calculating the adjustments to
the purchase price that the buyer and seller have
See Practice Material: Professionalism: Practice Man-
agreed to make under the purchase agreement).
agement, Chapter 7.
13. Obtain waivers of preemptive rights to shares, if
required.
[§2.18] Dispute Resolution
The lawyer’s legal opinion, confirming the execution of
Parties to a transaction might choose to specify in their and sufficiency of the previous steps may be the final
agreement that, in the event of a dispute, they will seek a step the lawyer takes on the file.
particular form of dispute resolution such as arbitration
For detailed checklists on closing procedures, consult
or mediation instead of resorting to traditional litigation.
the “Asset Purchase Procedure” and “Share Purchase
In BC, two statutes apply to commercial arbitration: the Procedure” checklists in the Practice Checklists Manual
Arbitration Act, R.S.B.C. 1996, c. 55, applicable to do- on the Law Society website: www.lawsociety.bc.ca.

Business: Commercial
 24
registering a security interest, priorities between
Chapter 3 secured creditors, and remedies. The PPSA is quite
technical. This chapter emphasizes the need for due
diligence and identifies some common pitfalls that
create difficulties for lawyers (see §3.11 for some
Security in Commercial examples). It is essential to read the legislation and
consider it in the context of each transaction.
Transactions1 This chapter defines some key terms below. It also
describes the Policy behind specific rules and con-
cepts, and contains italicized notes in text boxes to
emphasize key principles. At the end of the chapter,
[§3.01] Basic Concepts three appendices illustrate processes and forms used
in particular transactions:
1. Types of Security
 Appendix 1 is a sample guarantee;
Creditors may lend money without taking security,
but taking security places creditors in a stronger po-  Appendix 2 is a sample general security
sition to recover the debt. Secured creditors take an agreement; and
interest in the debtor’s assets. If the debtor fails to  Appendix 3 is a conceptual schematic.
repay the debt, the secured creditor can generally
seize the debtor’s assets and sell them.
2. Definitions
The Personal Property Security Act, R.S.B.C. 1996,
c. 359 (“PPSA”) provides a comprehensive and Section 1 of the PPSA sets out most of the Act’s de-
technical set of rules that govern the rights of credi- fined terms. While understanding all of the defini-
tors and debtors when personal property is used as tions is critical to using the PPSA, the following
collateral to secure payment of a debt. The statute excerpted definitions help explain how a creditor
creates one registration system, one set of priority takes a security interest.
rules and one set of rules governing the rights and Appendix 3 at the end of this chapter is a one-page
remedies of secured parties upon default by the schematic diagram that may be useful to refer to
debtor. when you review the definitions.
In advising a creditor concerning a transaction, con- “chattel paper” (formerly called a “chattel mort-
sider the following questions: gage”) means written evidence of both a monetary
(a) Does the PPSA apply to this transaction? obligation and a security interest in goods.
(b) If so, have appropriate steps been taken to “collateral” means personal property that is subject
protect the creditor’s security interest? to a security interest.
(c) What is the creditor’s priority as compared to “consumer goods” means goods that are used or
other creditors or competing claims to the acquired for use primarily for personal, family or
collateral? household purposes.
(d) Is the collateral investment property? If so, do “debtor” means, among other things,
special priority and perfection rules apply? (a) a person who owes payment or perfor-
mance of an obligation, whether or not that
(e) Ultimately, what are the creditor’s rights and
person owns or has rights in the collateral,
remedies if the debtor defaults?
(b) a person who receives goods from another
This chapter gives an overview of the PPSA, then person under a commercial consignment,
goes into detail about perfecting security,
(c) a lessee under a lease for a term of more
than one year, or
1 Edward J.T. Wang of Borden Ladner Gervais LLP reviewed (d) a transferor of an account or chattel paper.
this chapter in January 2021 and previously updated it in Febru-
ary and November 2019. In June 2022, the Solicitors’ Legal “default” means,
Opinions Committee of British Columbia reviewed parts of this
chapter relating to solicitors’ legal opinions and provided sug- (a) failure to pay or otherwise perform the ob-
gested edits. Previously updated by PLTC in 2018 (drawing on a ligation secured when due, or
2017 CLE presentation by Mark R. Davies, with permission); (b) an event or set of circumstances that, ac-
Tanveer Siddiqui (2014); Kendall Andersen and Edward Wang
(2012); and Vivian Tang, with the assistance of Eric Little
cording to the security agreement, causes
(2010). Kendall Andersen and Magnus Verbrugge contributed the security interest to become enforceable.
this chapter and updated it annually to 2009.

Business: Commercial
 25
“financing statement” means the document that (a) an interest in goods, chattel paper, invest-
describes a charge on property. It is a document ment property, a document of title, an in-
filed electronically with the Personal Property strument, money or an intangible that
Registry (“PPR,” see §3.06). secures payment or performance of an obli-
gation, and
“goods” potentially includes all tangible personal
property, fixtures, crops, and unborn young of an- (b) whether or not the interest secures payment
imals (note that crops are separately defined in or performance of an obligation, the inter-
s. 1(1)). It does not include chattel paper, docu- est of
ments of title, instruments, securities, money, trees (i) a transferee arising from the transfer
(until they are severed), or minerals or hydrocar- of an account or a transfer of chattel
bons (until they are extracted). paper,
A “good” is classified according to the use that the (ii) a person who delivers goods to anoth-
debtor makes of it at the time that the security in- er person under a commercial con-
terest “attaches” (“attachment” is discussed in signment, and
§3.04). For example, a computer may be inventory (iii) a lessor under a lease for a term of
if a merchant holds it for sale, equipment if it is more than one year.
used for business, and a consumer good if it is
used primarily for personal purposes. Classifica- Further to those definitions listed above, the PPSA
tion of goods matters for perfection and priority, has adopted some definitions found in the Securities
discussed in §3.04 and §3.07. Transfer Act (“STA”). Understanding the interplay
between the PPSA and the STA helps evaluate com-
These are important subcategories of “goods”: peting security interests in investment property.
 consumer goods These terms from the STA are relevant to the PPSA:
goods that are used or acquired primarily for “certificated security” means a security that is rep-
personal, family or household purposes; resented by a certificate.
 inventory “protected purchaser” is not defined in the PPSA
goods that are held for sale or lease, or are but in the STA, and it means a purchaser of a certifi-
raw materials, work-in-progress or materials cated or uncertificated security, or of an interest in
used or consumed in a business; and the security, who gives value and obtains control of
the security, without any notice of adverse claims to
 equipment the security.
goods that are neither consumer goods nor
inventory. “security” means (except as otherwise provided in
sections 10 to 16 of the STA) a medium of invest-
“intangibles” means personal property that is not ment, or an obligation of an issuer or a share that
goods, chattel paper, documents of title, money or can be traded on securities markets or exchanges.
investment property, but does include licences.
“security certificate” means a certificate represent-
“personal property” as defined in the Personal ing a security, but does not include a certificate in
Property Security Regulation for the purposes of electronic form.
both the Regulations and the PPSA includes:
“uncertificated security” means a security that is
(a) goods (including fixtures and crops); not represented by a certificate.
(b) chattel paper;
(c) investment property; [§3.02] The Concept of Security
(d) documents of title;
1. What is Security?
(e) money; or
(f) intangibles. “Security” is an interest in property given in
“secured party” means, support of a promise to pay or do something.
(a) a person who has a security interest, or
“Security” is collateral. It is a way of enforcing a
(b) a person who holds a security interest for
debtor’s promise to pay, or providing a creditor
the benefit of another person.
with compensation if the promise is not kept. If the
“security agreement” means an agreement that debtor does not pay the money or perform the obli-
creates or provides for a security interest. gation promised to the creditor, the creditor may
turn to the security pledged by the debtor, possibly
“security interest” means,
by seizing or selling it.
Business: Commercial
 26
Many, but not all, commercial transactions involve Debtors can offer virtually any property as security
security. Security is usually given to a creditor in in commercial transactions:
transactions where the debtor must pay money to
 A company might give a lender a security
the creditor after the transaction has closed.
interest in inventory and accounts receiva-
Many terms are commonly used to refer to an inter- ble to secure repayment of a line of credit
est in property given by the debtor as security for its from the lender.
obligations. These words are often used inter-
 A business might buy photocopiers on a
changeably, and may include charge, lien, security
“lease to own” basis whereby the vendor
interest, mortgage, hypothecation and pledge. For
retains title to the photocopiers to ensure
clarity, we will use the terms “charge” or “security
the lease payments are made.
interest” in most cases throughout this chapter.
 A purchaser who buys shares from the
shareholder who is selling them, but is una-
2. Granting Security
ble to pay the entire purchase price up
front, could grant the seller a security inter-
Virtually any property can be offered as security est in those shares, so the seller could re-
for any obligation. cover them if the balance of the purchase
price is not paid.
A creditor is not required to take security. Many
debt obligations are unsecured: a promissory note is  A bank will often provide credit to a cus-
an example. An unsecured creditor takes the risk tomer in exchange for the customer giving
that the debtor who fails to repay the debt might the bank security over everything the cus-
have no assets the creditor can pursue (or none that tomer owns now or acquires in the future
are free of charges by other creditors). until the debt is repaid in full.

Unlike unsecured creditors, secured creditors do not

need to obtain judgment before recovering assets 3. Kinds of Security
pledged as security. The secured creditor may simp-
ly take steps to realize on its security to satisfy the Property is either real property or personal
debtor’s obligations. property, and security may be either a “fixed”
or a “floating” charge.
Taking security usually involves signing a security
agreement. Section 9 of the PPSA provides: Most property falls into two general categories: real
“Subject to this and any other enactment, a security property, which is land, and personal property,
agreement is effective according to its terms.” which is essentially all property that is not land or
While the parties to a security agreement can an interest in land. Either kind of property can be
structure their deal according to terms they see fit, offered to a creditor as security.
many of the PPSA provisions are mandatory. To be
effective, the security agreement must comply with This chapter focuses on security interests in person-
the PPSA. For example, there are certain al property in British Columbia. The Practice Mate-
restrictions on security agreements for consumer rial: Real Estate, Chapter 7, deals with real
goods. The policy behind this restriction is that property security (mortgages of land).
consumers are vulnerable to “sharp” commercial Security may be either a “fixed” or a “floating”
practices, and without the protection of the PPSA charge. Under the PPSA, there is no need to
they might sign security agreements that are unfair. distinguish between fixed and floating charges over
While a security agreement could be short, in prac- personal property. However, a floating charge on
tice they are often very long, stretching to 20 pages real property could be subject to the PPSA.
or more. So long as the security agreement is signed (a) Fixed Charge
by the debtor, includes a clause granting a security
interest, describes the collateral in accordance with A fixed charge is a charge that exists on a
s. 10 of the PPSA, and describes the obligations se- specific piece of property (for example, a
cured, it will be enforceable according to its terms mortgage against specific land).
against the debtor and third parties. It is prudent (b) Floating Charge
practice to ensure that the security agreement sets
out events of default and the secured party’s reme- A floating charge is one that “floats” or “hov-
dies in the event of default. ers” over a certain category of property (for
example, all land owned by the debtor from
See Appendix 2 for a sample security agreement. time to time). A floating charge does not at-
tach to that property until an event occurs
(usually default by the debtor) that “crystal-
Business: Commercial
 27
lizes” the floating charge and causes it to be- its form and without regard to the person who has
come a fixed charge on the property. title to the collateral. The PPSA also applies to con-
ditional sales, floating charges, pledges, assign-
An uncrystallized floating charge on land may
ments, consignments, leases (other than those of
be registered in the PPR, according to the
real property), trusts and transfers of chattel paper.
Land Title Act, s. 203.
It could also apply to agreements that might not ap-
Two types of property do not fit nicely into the gen- pear to be security agreements, such as separation
eral categories of personal property or real property: agreements or shareholders’ agreements, if they in
substance create security interests.
(a) Fixtures—personal property that becomes
part of the land (for example, a boiler heater). Example: A tractor manufacturer sells a tractor to a
See §3.07(11). farmer under a conditional sale agreement, which
provides that the farmer will pay for the tractor in
(b) Property covered by other legislation or
monthly installments over five years. The agree-
common law—certain categories of property
ment provides that the sale of the tractor is condi-
like liens, property dealt with by federal legis-
tional upon all payments being made by the farmer;
lation, and certain assignments. See §3.10(3).
until all payments are made, title to the tractor re-
mains with the manufacturer. The manufacturer has
[§3.03] PPSA—Overview security to protect against the farmer failing to pay.
Accordingly, under s. 2 of the PPSA, the condition-
1. Purpose of the PPSA al sale agreement in substance secures the obliga-
tion to pay for the tractor, so is subject to the PPSA.
The PPSA promotes uniformity and predictability
— one set of rules for debtors and creditors — 3. Deemed Security Interests
and creates a registry of charges.
The Act deems certain transactions to create
Many business transactions are financed through
security interests, even though they do not secure
secured lending in various forms. A creditor who
payment or performance of an obligation.
wants to take security from a debtor takes comfort
in knowing that other creditors must follow the
same rules. The creditor also wants to know wheth- Policy: Some transactions between creditors and
er the property the debtor is offering as security is debtors might impair the debtor’s equity or title to
already subject to a charge or security interest in fa- collateral in ways that third-party creditors should
vour of another secured party. be alerted to. For that reason, some transactions
create deemed security interests.
With real property, the creditor can search the title
to the property at the Land Title Office. The title to Section 3 of the PPSA states that (subject to ss. 4
land owned by the debtor will disclose the other and 55 of the Act), the PPSA applies to a transfer of
parties who claim an interest in that land, whose an account or chattel paper, a commercial consign-
charges will be registered. For personal property, ment, and a lease for a term of more than one year.
the creditor’s task is not so simple. These transactions would not fall within the general
scope of the Act (as set out in s. 2), so under s. 3
The PPSA creates a notice system: the Personal they are deemed to be security agreements.
Property Registry (“PPR”). Secured parties give no-
tice of their security interests to other creditors by Since title to collateral does not determine any
registering their interests. Lawyers conduct online rights or obligations under the PPSA, some specific
PPR searches in order to advise clients whether oth- financing transactions can be misleading to third
er parties have filed financing statements giving no- parties who are dealing with a debtor. For example,
tice of their interest in collateral. Registration and where a debtor has leased goods or is a consignee
financing statements are discussed further in §3.06. under a commercial consignment, third parties
dealing with that debtor could reasonably think that
the debtor owns those goods.
2. Substance Over Form
Issues with the deeming provisions of the PPSA
usually arise with leases for a term of more than
The PPSA applies to every transaction and
one year. Essentially, the definition includes leases
agreement that creates a security interest, re-
that could extend for more than a year, but ex-
gardless of the form of the agreement.
cludes leases where the lessor is not ordinarily in
the business of leasing goods.
Section 2 of the PPSA states that the Act applies to
every transaction that in substance secures payment
or performance of an obligation, without regard to
Business: Commercial
 28
4. Scope of the PPSA provisions prevail in the event of any conflict be-
tween that Act and any other enactment (which
The PPSA, as a provincial statute, does not cov- would include the PPSA).
er common-law liens and charges, or security
interests under the Bank Act or other federal
acts. [§3.04] Attachment and Perfection
Policy: The PPSA does not apply where federal 1. Attachment
statutes govern security, due to the division of
powers under the Constitution and the principle of A security interest is perfected when the PPSA
paramountcy. The PPSA does not apply to interests requirements are met and it has “attached.”
in real property that are governed by a land
registry system. Liens and other interests in
personal property that arise at common law and Policy: The aim of the PPSA to provide certainty is
under other statutes also fall outside the PPSA. achieved, in part, by providing standard steps that a
creditor can take to ensure that its security interest
The PPSA governs all transactions that in substance is effective.
create a security interest in personal property under
BC law. The concepts of “attachment” and “perfection” go
hand in hand. Understanding them is necessary in
Section 4 of the PPSA sets out creditors’ interests order to understand how priorities are determined
that are not subject to the PPSA. These fall general- under the PPSA. Perfection matters when more than
ly under the following categories: one creditor claims an interest in the debtor’s col-
(a) Non-contractual liens, such as those imposed lateral (see PPSA s. 10).
by statute and common law. These include (a) Elements of Attachment
liens for unpaid wages under the Employment
Standards Act, construction liens, and liens in Attachment occurs when the security interest
favour of the Crown for unpaid taxes. in a particular piece of collateral comes into
existence. Without attachment, there is no
(b) Interests governed by federal legislation (for security interest in the property.
example, security under s. 427 of the Bank
Act or security in ships under the Canada Attachment determines the rights between the
Shipping Act, 2001). secured party and the debtor: if the security
interest has not attached, the secured party has
(c) Interests that arise in connection with land, no security interest in the property and,
including leases and rental payments. therefore, cannot exercise remedy rights under
(d) Certain assignments, such as assignments of the PPSA. Attachment also determines the
wages or assignments in bankruptcy. rights of third parties: if the security interest
has not attached, the debtor can transfer the
If the collateral includes investment property, con- debtor’s interest in the collateral to a third
sider the application of the Securities Transfer Act party (for example, other secured parties,
(STA). One of the purposes of the STA is to provide creditors of the debtor, or the debtor’s trustee
greater certainty with respect to the ownership and in bankruptcy).
transfer of investment property, such as securities
or shares that are traded on financial markets. The Section 12 of the PPSA outlines the rules and
STA came into force in 2007. At that time the PPSA requirements for attachment of security inter-
was amended (ss. 19.1 and 19.2) to include rules ests. Under s. 12(1), a security interest attach-
governing competing security interests in invest- es to collateral when the secured party gives
ment property. value to the debtor and the debtor has rights
in the collateral. For prioritizing claims be-
Some types of security are subject to other BC laws, tween the secured party and third parties,
or even international law. For example, collateral there is a further requirement for attach-
that includes aircraft may be subject to the Conven- ment—that the security interest must be en-
tion on International Interests in Mobile Equipment forceable under s. 10 of the PPSA.
(the “Cape Town Convention”) and the Protocol to
the Convention on International Interests in Mobile These three elements of attachment are dis-
Equipment on Matters Specific to Aircraft Equip- cussed in more detail below.
ment (the “Aircraft Protocol”). The Cape Town (i) Value Given
Convention and the Aircraft Protocol came into
force in BC on April 1, 2013 under the Internation- The value that the secured party may
al Interests in Mobile Equipment (Aircraft Equip- give is any consideration that would be
ment) Act, S.B.C. 2011, c. 12, which states that its sufficient to support any contract or
Business: Commercial
 29
agreement. Note that “value” is defined rity interest in after-acquired property attaches
in s. 1 of the PPSA. In many cases, value to that property in accordance with the terms
is given when the loan is made, but the of the security agreement, without any need
definition includes pre-existing debt or for a specific appropriation by the debtor, sub-
liability. Consequently, value can include ject to s. 12.
a previously unsecured debt, or even the
Example: A debtor signs a security agree-
creditor refraining from taking steps to
ment granting to a secured party a security in-
collect on an unsecured debt.
terest in all present and after-acquired
(ii) Debtor Has Rights in the Collateral computer equipment. Assuming the security
agreement is not discharged or released, if the
In order for a security interest granted by
debtor acquires computer equipment two
a debtor to attach to a piece of property,
years after the security agreement has been
the debtor must have rights (ownership, a
executed (and assuming the secured party had
leasehold interest, possessory rights, or
given value to the debtor as consideration),
otherwise) in that collateral, or the power
the security interest attaches to the computer
to transfer rights in that collateral to a
equipment once the debtor acquires rights in
third party. Put another way, a debtor
the computer equipment. The secured party
cannot grant a security interest in collat-
need not have the debtor execute a new secu-
eral if the debtor has no interest in it.
rity agreement granting a security interest in
The principle nemo dat quod non habet the newly acquired computer equipment.
(one cannot give what one does not have)
Section 13(2) of the PPSA provides two spe-
is discussed further in §3.07(2). cific exceptions with respect to attachment of
Subsections 12(2) and 12(3) of the PPSA security interests in after-acquired property.
prescribe specific situations in which the First, s. 13(2)(a) provides that a security inter-
debtor is considered to have rights in col- est cannot attach to after-acquired property
lateral. Under s. 12(3), a debtor has no that is a crop where it becomes a growing
rights in crops until they become grow- crop more than one year after the security
ing crops; the young of animals until agreement has been made. This exception is a
they are conceived; minerals or hydro- matter of policy, providing reprieve to farmers
carbons until they are extracted; or trees, so that when they have a bad year their crops
other than crops, until they are severed. for future years are not subject to a pre-
existing security. Second, s. 13(2)(b) provides
As discussed in §3.02(3), a floating that a security interest cannot attach to after-
charge on personal property is treated as acquired property that is consumer goods, un-
a fixed charge on the collateral of the less the security interest is a purchase money
debtor, pursuant to s. 2 of the PPSA. Ac- security interest (“PMSI” is discussed in
cordingly, a floating charge effectively §3.07(4)) or is a security interest in replace-
attaches to collateral as it comes into the ment collateral.
debtor’s possession.
2. Perfection
(iii) Enforceable Security Interest
Pursuant to s. 10 of the PPSA, a security Perfection occurs when a secured party has tak-
interest is enforceable against third par- en all steps necessary to ensure that its security
ties if the secured party possesses the col- interest is effective to compete for priority with
lateral or the debtor has signed a security third parties, which also may have an interest in
agreement that contains an adequate de- the collateral.
scription of the collateral charged. The
PPSA requirements for an enforceable A security interest may either be perfected or unper-
security interest are discussed in §3.05. fected. When the security interest is perfected, the
secured party enjoys priority rights under the PPSA.
(b) Time of Attachment When a security interest is unperfected, the PPSA
Section 13 addresses the time of attachment of provides that, in most situations, the unperfected
a security interest in after-acquired property. security interest will be subordinate to the interests
This section is intended to facilitate financing of other persons who have an interest in the collat-
through inventory, accounts receivable and eral. For example, see Re Giffen, [1998] 1 S.C.R. 91
other forms of property that the debtor does and Re Perimeter Transportation Ltd., 2009 BCSC
not own when the security agreement is 1458, affirmed 2010 BCCA 509.
signed, but which the debtor will acquire in
the future. The section provides that the secu-
Business: Commercial
 30
If a security interest is not perfected, it ranks lower strument, a negotiable document of title, and
in priority (under PPSA s. 20) than claims by these money (all defined terms in s. 1 of the PPSA)
parties: may be perfected by possession of the collat-
eral. Possession must be actual possession.
 an unsecured creditor who has seized the
collateral or obtained charging orders or When the collateral is in the actual or appar-
equitable execution respecting the collateral; ent possession or control of the debtor or the
debtor’s agent, s. 24(2) provides that the se-
 a sheriff who has seized or obtained a right to
cured party does not have possession of the
the collateral;
collateral. This exception exists because third
 a trustee in bankruptcy or the liquidator under parties may be misled and reasonably believe
the Winding-Up and Restructuring Act that the collateral is not subject to a security
(Canada); and interest perfected by possession if the collat-
eral appears to be in the control or possession
 a bona fide transferee for value without
of the debtor.
knowledge of the prior security interest (if the
collateral is a chattel paper, a document of If the secured party takes possession by sei-
title, an instrument, money, an intangible, or zure or repossession, the interest is not per-
goods). fected under s. 24.
Section 19 of the PPSA provides that a security in- Again, the main policy behind ss. 24 and 24.1
terest is perfected when (a) it has attached, and is the general goal of predictability in the pri-
(b) all steps required for perfection under the Act ority rules under the Act. The debtor must
have been completed, regardless of the order in give possession (or control) voluntarily; oth-
which the steps occur. erwise, a secured party who simply forgets to
register a financing statement to perfect a se-
A secured party may perfect an attached security in-
curity interest could gain priority by seizing
terest in personal property by taking possession of
the collateral (i.e. an action usually reserved
the collateral, by registration of a financing state-
for after default). Actual possession is re-
ment in the PPR, or by “temporary perfection” (all
quired to satisfy the requirement that third
discussed further below).
parties be able to see that the debtor has vol-
A security interest in personal property may be per- untarily given the secured party possession.
fected in more than one way, depending on the kind
A security interest that has been perfected by
of personal property. A security interest in a good
possession will only remain perfected while
may be perfected by registering a financing state-
the secured party possesses the collateral
ment and by the secured party obtaining possession
(subject to rules about temporary perfection in
of the collateral. In most circumstances where the
PPSA s. 26). If the secured party intends to re-
secured party takes possession of collateral to per-
turn possession of the collateral to the debtor,
fect a security interest, it is prudent for the secured
the secured party should ensure that a financ-
party to also file a financing statement to perfect the
ing statement has been filed in the PPR before
security interest.
returning the collateral to the debtor.
When the STA came into force, PPSA sections 19.1
(b) Perfection by Registration—Section 25
and 19.2 were added to deal with perfecting
security interests in securities accounts, futures Registration of a financing statement in the
accounts and investment property. For the purposes PPR is the most common method for perfect-
of perfection, it is always important to consider the ing a security interest in any kind of collateral.
special priority and perfection rules that apply to See §3.06 for more on registration.
investment property.
However, for some kinds of collateral—for
Section 23 provides that no matter which way example, money, chattel paper, negotiable
perfection has been achieved, the time of perfection documents of title, and instruments—
will be the first date the security interest was perfection by registration will not give the se-
perfected, if there was no intermediate period cured party the greatest protection available
during which perfection lapsed. under the PPSA. Section 31 of the PPSA pro-
vides that a bona fide purchaser of these kinds
(a) Perfection by Possession or Control—
of collateral will have priority over a security
Sections 24 and 24.1
interest that is perfected by registration. Con-
Pursuant to s. 24, the secured party (or the se- sequently, the secured party should perfect its
cured party’s agent) may perfect many kinds security interest by taking possession (if pos-
of personal property by obtaining possession sible) for those kinds of collateral.
of the collateral. Chattel paper, goods, an in-
Business: Commercial
 31
It should be noted, however, that the PPSA or other instruments. If the secured party au-
does not limit the rights that a protected pur- thorized the dealing, then the security interest
chaser of a security has, or the priority of a will be lost as against the original collateral,
prior security interest that a protected pur- but it will attach to the proceeds. If a financ-
chaser has, under the STA (s. 31.1). ing statement describing the proceeds in ac-
cordance with s. 28(2) has been registered, no
The term “protected purchaser” is not defined
other steps are necessary to perfect the securi-
in the PPSA but is defined in the STA to mean
ty interest against the proceeds. However, if
“a purchaser of a certificated or uncertificated
the proceeds have been perfected in any other
security, or of an interest in the security, who
way (that is, by possession or by temporary
(a) gives value, (b) does not have notice of
perfection), then the secured party has only a
any adverse claim to the security, and
temporary perfection against the proceeds for
(c) obtains control of the security.”
15 days after the collateral has been dealt
(c) Temporary Perfection—Sections 5 to 7.1, 26 with.
and 29
When a security interest is taken in collateral
The PPSA provides that a secured party’s in- and perfected by registration of a financing
terest may be temporarily perfected in various statement, it is prudent to include the phrase
situations. When a secured party appears to “all proceeds, whether goods, investment
have an unperfected interest, the lawyer who property, instruments, documents of title,
acts for the secured party should be aware that chattel paper, intangibles, money and licens-
the collateral may be subject to temporary es” in the description of collateral that appears
perfection interests set out in PPSA ss. 5 to in the financing statement. This ensures that if
7.1, 26 and 29. the original collateral is sold, the secured par-
ty’s security interest in the proceeds will be
Sections 5 to 7.1 of the PPSA set out certain
perfected by registration.
periods when a secured party will be tempo-
rarily perfected if the collateral is moved out-
side British Columbia or the debtor is located [§3.05] Collateral Description
outside British Columbia. The rules for de-
termining the location of the debtor have re- To make a claim to a debtor’s collateral, the secured
cently changed; see §3.06(10). party must have an enforceable security interest in
Section 26 of the PPSA provides for tempo- collateral that is clearly described.
rary perfection if a secured party has perfected
its security interest by possession and later re- The PPSA s. 10 sets out the criteria and protocol for es-
turns the goods to the debtor. tablishing an enforceable security interest. For a security
interest to be enforceable against a third party, the col-
Section 29 of the PPSA addresses a debtor
lateral either must be in the possession of the secured
selling goods subject to a security interest
party (s. 10(1)(a)) or the debtor must have signed a secu-
where the goods are later repossessed or re-
rity agreement containing specific descriptions.
turned to the debtor.
The PPSA s. 10(1)(d) sets out four basic ways to de-
(d) Proceeds
scribe the collateral:
“Proceeds” are defined in s. 1(1). Essentially,
(i) By item or kind: the collateral can be described
proceeds are identifiable and traceable per-
either as a specific item (for example, a red 2002
sonal property derived from any dealing with
“Lance Armstrong Edition” Trek road bike) or by
the collateral.
kind (all present and after-acquired bikes).
Under the PPSA s. 28, when collateral is sold,
(ii) By one of the following categories: goods, in-
leased, or otherwise dealt with so that it gives
vestment property, instruments, documents of ti-
rise to proceeds, a perfected security interest
tle, chattel paper, intangibles, money, crops or
in the collateral continues in both the collat-
licences (all of which are defined terms in s. 1 of
eral and the proceeds, unless the secured party
the PPSA).
authorized the dealing.
(iii) All PAAP: if the secured party wants to take a
Example: a secured party has a security inter-
security interest in all of the personal property of
est in a wholesaler’s inventory. When the in-
the debtor, present or future, then the security
ventory is sold, it gives rise to proceeds. The
agreement must state that a security interest is
proceeds may take the form of money, goods
taken in “all of the debtor’s present and after-
(if the wholesaler accepted a trade-in), chattel
acquired personal property” (generally referred to
paper (such as a conditional sale agreement)
as “All PAAP”).
Business: Commercial
 32
(iv) All PAAP “except”: the security agreement can 2. Notice System
be for All PAAP with a “carve-out”: it can pro-
The PPR is simply a notice system. Registration in
vide that the secured party will take a security in-
the PPR does not create a security interest, nor does
terest in all of the debtor’s present and future
it determine whether a creditor has valid security. A
property except property described by item or
creditor may register an electronic financing state-
kind, or referred to by one of the categories set
ment, which simply gives notice that the secured
out in (b) above.
party may have a security interest in a debtor’s per-
It is not necessary to include serial numbers in descrip- sonal property (as described). Only financing
tions of general collateral in the security agreement. statements and financing change statements (and
Some goods, however, are identified in the Regulation as court orders) may be filed in the PPR: the secured
“serial numbered goods” and their serial numbers must creditor does not register a copy of its security
be registered (PPSA s. 35(4)). Serial numbered goods agreement.
include motor vehicles, manufactured homes, trailers,
While a financing statement filed in the PPR is used
boats, aircraft and outboard motors. (See §3.06(3)(c)
to perfect (by registration) a security interest under
below for more on serial numbered goods.)
the PPSA, the PPR is also used to register liens un-
In addition to properly describing the collateral, the se- der a number of provincial statutes, such as the
curity agreement must specify what obligations are se- Family Law Act, Land Tax Deferment Act, Manu-
cured by the security interest. The description of the factured Home Act, Miscellaneous Registrations
obligations secured will depend on the transaction. The Act and Repairers Lien Act.
description of obligations secured can be either general
or specific. For example: 3. Elements of a Financing Statement
General—All past, present and future obligations A financing statement is an online form. It is filed
of the debtor to the secured party. online by being completed and submitted for
registration.
Specific—All obligations of the debtor to the se-
cured party pursuant to a specified agreement, A financing statement must include the name and
promissory note, guarantee, etc. address of the secured party, the name and address
of the debtor, the term of registration, and a descrip-
tion of the collateral. Remember that the PPR
[§3.06] Registration serves as a notice registry. Consequently, a secured
party must be accurate in the descriptions provided
The Personal Property Registry (“PPR”) is a for each field so that those searching the system
notice system; it does not create or validate a secu- have the best chance to obtain accurate information
rity interest. (see §3.06(6)). The secured party should take care
to provide accurate information.
1. Perfection by Registration (a) Secured Party
As noted in §3.04(2), a secured party may perfect a A financing statement must contain the secured
security interest by registration (s. 25). Of the three party’s current name and address so that it is
methods of perfection, registration is the only one clear who is registering the security interest.
that may be used for all kinds of collateral. This information is also necessary because oth-
To perfect by registration, the secured party must er creditors are entitled to demand to inspect the
file a financing statement in the PPR. The PPR is a security agreement pursuant to s. 18 of the
computerized notice registry for registration of all PPSA.
charges against personal property (other than cer- (b) Debtor
tain charges governed by federal law, such as Bank
Act s. 427 security (see §3.07(10)), or mortgages on The debtor’s name must be accurately spelled
ships). and complete. The Personal Property Regula-
tion provides specific rules and requirements
The forms and technical procedures for registering for setting out the debtor’s name when the
in the PPR are set out in the PPSA and the Personal debtor is a corporation, partnership, trust, indi-
Property Regulation. General procedures are de- vidual, etc. It is important to review the Regula-
scribed in the “Personal Property Registry System tion before filing a financing statement. Two
User’s Guide” available from BC OnLine: rules are commonly overlooked:
www.bconline.gov.bc.ca/pdf/personal_prop.pdf.
 Section 6(c)(i) of the Personal Property
The following are some key features of the PPR Regulation provides that when the debtor is
system. a business debtor (not an individual),
commas and periods must not be entered as
Business: Commercial
 33
part of a debtor’s name. For example, a “Serial numbered goods” are defined in
registration against “A.B.C. Company, the Regulation (s. 1(1)) as motor vehicles,
Inc.” should be entered as “A B C Compa- manufactured homes, boats, outboard mo-
ny Inc”; however, see the discussion in tors, trailers and aircraft. While other
§3.06(6). A court would not likely find that types of goods may have serial numbers,
a registration including commas and peri- only goods in the defined list are “serial
ods was “seriously misleading.” numbered goods” for the purposes of the
PPSA. Descriptions of these goods must
 Section 8(5) of the Personal Property Regu-
include serial numbers in the separate data
lation provides that when the debtor is a
field on the financing statement. This is
corporation and the name of the corpora-
significant to searchers because serial
tion is spelled at least two ways using Eng-
numbered goods are searchable by serial
lish and French, or a combination of the
number, while general collateral is not
two, all spellings of the debtor’s name must
(see s. 48 of the PPSA).
be entered separately. To satisfy this rule,
some practitioners include these separate When the collateral is consumer goods
debtor names in the financing statement: that are serial numbered goods, s. 9(1)(a)
(i) English, (ii) French, (iii) English/French of the Personal Property Regulation
and (iv) French/English. Others use the requires the registering party to describe
combined name exactly as it appears in the the collateral by serial numbers. When the
corporation’s constating documents. debtor holds serial numbered goods as
equipment, the registering party must
(c) Collateral Description
describe the goods using the serial number
It is important to consider ss. 10, 30 and 35 of if the party is to have priority in the
the PPSA together with ss. 1(1) and 9 to 11 of following situations:
the Regulation when completing a financing
 over a buyer without notice of the se-
statement. Combined, these provisions provide
curity interest (PPSA s. 30(6) and (7));
the best base for ensuring that the financing
and
statement contains accurate and complete in-
formation about the type of collateral.  over other secured creditors pursuant
to the residual priority rule in s. 35 of
On a financing statement, there are two “data
the PPSA (see discussion in §3.07(3)).
fields” where information regarding the collat-
eral charged may be entered: the general collat- When the debtor holds goods that have se-
eral description, and the serial number rial numbers as inventory, the registering
description. party should not register against serial
numbered goods.
(i) General collateral
(d) Term
A description of general collateral in a
financing statement that does not refer to When registering, the registering party selects
the item or “kind” of collateral is inade- the period of registration—from one to
quate (s. 10 of the PPSA and ss. 9 to 11 of 25 years, or for perpetuity. Cost varies accord-
the Regulation). “Kinds” of collateral are ing to the period of registration.
goods, investment property, instruments,
documents of title, chattel paper, intangi-
4. Timing of Registration—Before Attachment
bles, money, crops or licences. Note that
the term “equipment” is not a kind, and is A secured party can register notice of its security
inadequate for a collateral description interest before the security interest attaches and
without further reference to the kind of even before it has been granted.
collateral.
Section 43 of the PPSA allows a secured party to
(ii) Serial numbered goods
file a financing statement against a debtor before a
All goods under the PPSA are classified as security agreement has been signed and before the
consumer goods, inventory or equipment. security interest attaches. Since the general priority
The PPSA provides that some types of rule (see discussion in §3.07) is that the secured
goods, in certain circumstances, must be party with the earliest registration has priority, it is
described by the serial number in the fi- advantageous for a secured party to register a fi-
nancing statement that is registered in the nancing statement as soon the secured party knows
PPR. These are “serial numbered goods.” that the debtor intends to grant it a security interest.

Business: Commercial
 34
5. Amendments to Existing Registrations ty. Section 18 of the PPSA imposes an obligation
upon the secured party to provide the debtor and
Financing change statements are used to make any other person who has an interest in the collat-
changes to an existing financing statement. eral with a copy of the security agreement and other
relevant information, within 10 days of demand.
A secured party files a financing change statement
to modify, amend, renew or discharge the existing 8. Removing Invalid Registration
registration, such as when the debtor changes its
Since the PPSA allows anyone to file a financing
name (PPSA s. 51), the debtor transfers its collateral
statement against any name, the PPSA also permits
to a third party (PPSA s. 51), the secured party
a debtor named in a financing statement to dispute
transfers its interest (PPSA s. 45), or the registration
that the secured party in the financing statement is
is about to expire (PPSA s. 44(2)). The procedure
entitled to the registration. Section 50 of the PPSA
and requirements for a financing change statement
sets out the process under which a debtor may have
are as rigid as they are for a financing statement, so
a financing statement removed or amended where
the secured party should ensure that it complies
the secured party does not have a valid security
precisely with the PPSA (ss. 44(2), 45, 50 and 51)
interest in the debtor’s collateral or the registration
and the Personal Property Regulation (Part 3 and
is overly broad.
Part 4) when filing a financing change statement.

9. Registration Not Knowledge

6. Misleading Information
Note that while the PPR is a notice system, s. 47 of
The information on a financing statement or a fi-
the PPSA provides that registration of a financing
nancing change statement must be clear, accurate
statement does not by itself mean that parties know
and complete. There has been a great deal of litiga-
what has been filed. Registration does not constitute
tion over faulty registrations in the PPR.
express, constructive or implied notice to any per-
Section 43(6) of the PPSA provides that the validity son of the financing statement or the security
of the registration of a financing statement is not af- agreement.
fected by a defect, irregularity, omission or error in
Many rules in the PPSA that give priority to inno-
the financing statement or in the registration of it
cent purchasers consider whether the purchaser had
unless the defect, irregularity, omission or error is
actual knowledge of a security interest. For the pur-
seriously misleading. The test for whether the de-
poses of those sections, the registration of a financ-
fect is “seriously misleading” is an objective test:
ing statement is not deemed to be notice or
pursuant to s. 43(8), it is not necessary to prove that
knowledge of a security interest.
anyone was actually misled by the defect. The
PPSA does not set out what defects are seriously
misleading. Several cases consider this issue. 10. Jurisdiction
The decision of the Supreme Court of British Generally, a secured party must perfect in the
Columbia in Alda Wholesale Ltd. (Trustee in jurisdiction in which the collateral is located.
Bankruptcy), 2001 BCSC 921 has imposed stricter There are exceptions, including for intangibles
requirements on collateral descriptions. Alda says and mobile goods.
that registrations that do not include “after-
acquired” language only perfect security interests Sections 5 to 8 of the PPSA deal with conflicts of
that have attached as of the date the financing laws and jurisdictional issues. Generally, the law
statement is registered. Alda is also authority that governing a security interest is the law of the juris-
any defect in a financing statement may invalidate a diction where the collateral is located at the time the
registration, if it would mislead a reasonable security interest attaches.
searcher.
However, different rules apply when the collateral
is an intangible or a mobile good (basically, a good
7. Section 18 Demands used in more than one jurisdiction). Under s. 7, the
law that applies in this case is the law of the juris-
Parties with an interest in the collateral may diction where the debtor was located at the time
request a copy of the security agreement to that the security interest attached. The rules for de-
which a financing statement relates. termining the debtor’s location were amended ef-
fective June 1, 2019.
The financing statement does not refer to the securi-
ty agreement, and it does not disclose the amount Under the old rules, the debtor’s location was de-
outstanding to the secured party. Interested parties termined by its place of business, its chief executive
may request this information from the secured par- office if it had more than one place of business, or
Business: Commercial
 35
the debtor’s residence if there was no place of 11. Searches
business. (The amendments include transition rules
Searches are conducted online, either by debtor
for security interests perfected under these rules.)
name or by serial number.
Under the current rules, the location of the debtor
If the registering party made an error when record-
depends on the type of debtor. These rules are
ing the name or serial number in the financing
summarized in the following table.
statement, and then the searcher conducts a search
only by the correct name or serial number, the
search results will indicate that there are no exact
Summary of Debtor Location Rules matches. The defective registration may show up as
Type of debtor Location of debtor a close or inexact match. It is prudent, therefore, to
search the correct legal name of the debtor as well
Individual The debtor’s location is where as any trade names the debtor commonly uses. It is
the individual’s principal also necessary to select, print and review results
residence is located. that are noted to be exact but also those noted as
Partnership (other The debtor’s location is the close matches to the debtor’s name or the serial
than a limited province whose laws govern number.
partnership) the partnership, according to
the partnership agreement. PPR search results will not indicate or absolutely
determine priorities. Since the PPSA provides for
Limited partnership The debtor’s location is the many priority rules, the order in which secured par-
province the limited ties appear on the PPR search result does not neces-
partnership was created in. sarily indicate which secured party has priority.
Provincially The debtor’s location is the
incorporated province the corporation was
company incorporated in. [§3.07] Priorities
Other organization The debtor’s location is the 1. PPSA Determines Priorities
that is organized province the organization was
under the laws of a organized in. The PPSA provides a set of rules to determine
province and the ranking, or priority, of claims of creditors
whose organization who have security interests in the same
must be disclosed collateral.
in a public record
Federally The debtor’s location is in the Once the secured party has registered notice of its
incorporated jurisdiction where the security interest by filing a financing statement in
corporation registered office or head office the PPR, the lawyer must ensure that, to the extent
is located, (i) as stated in the possible, the secured party will have priority to the
constating instrument under
which the debtor was collateral if the debtor defaults. Most litigation un-
incorporated, continued, or der the PPSA involves disputes between secured
amalgamated; or, if that does parties over priority to certain collateral. The gen-
not apply, then (ii) in the eral rule is that a secured party who has a security
debtor’s bylaws. agreement with the debtor and gives notice of that
security interest by filing a financing statement will
Trustee acting for a The debtor’s location is (i) the
have priority over competing secured parties who
trust province that the trust
instrument states the trust is file financing statements later. However, the “first
governed by, or, if that does to file” principle is a general rule only, and there are
not apply, then (ii) in the a number of important exceptions to it that fre-
jurisdiction where the trustee quently apply in commercial transactions.
principally carries out the
A debtor will often grant a security interest in the
administration of the trust.
same collateral to more than one secured party to
If none of the The debtor’s location is the secure more than one obligation. If the debtor de-
above apply jurisdiction where its chief faults on its obligations, the secured parties will all
executive officer is located. want to realize on their security to recover the
amounts owing to them. In addition, there may be
other creditors of the debtor who are unsecured (for
example, judgment holders and unsecured lenders)
or who have a lien on the collateral.

Business: Commercial
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The PPSA sets out rules for determining the ranking the first correctly perfected security interest in the
of each secured party who has a security interest collateral may enjoy priority over another party
that is governed by the PPSA, as well as special who actually owns the collateral.
cases (such as bailees).
If a creditor asserts priority based upon a lien under 4. Purchase Money Security Interests—Section 34
a provincial statute, it will be necessary to refer to
The PPSA creates a special type of security interest
the provincial statute in question and the jurispru-
called a purchase money security interest (“PMSI”)
dence to determine priority.
(s. 1(1)). A PMSI is created when a secured party
There are many priority rules under the PPSA, with provides the credit or financing that allows the
several exceptions to each rule. However, one debtor to acquire the collateral.
common approach is first to determine whether any
A PMSI also includes the interest of a lessor of
special priority rule applies in the circumstances; if
goods under a lease for a term of more than one
not, the residual priority rules of s. 35 apply.
year and the interest of a consignor under a com-
mercial consignment.
2. Nemo Dat Quod Non Habet
A PMSI cannot be taken in investment property.
A debtor cannot give a secured party a greater Policy: The PMSI enables a debtor to acquire new
interest in the collateral than the debtor has. collateral where the debtor has existing debt. The
debtor who has given a security agreement that
The rule of nemo dat quod non habet means that
contains an after-acquired property clause would
one cannot give more than one has, or a debtor
likely be unable to obtain further financing without
cannot give a greater interest in the collateral than
this “super-priority” rule. Lenders would not pro-
the debtor has. Where a secured party takes a
vide further financing, knowing they would rank af-
security interest in collateral that is already subject
ter the existing creditor. Furthermore, the prior
to a charge that is outside the scope of the PPSA
secured party that has a general security interest
(s. 4), the rule will apply and subordinate the PPSA
was not relying on this new collateral when it ex-
security interest to the other security. For example,
tended credit secured by the previous collateral
where collateral is charged by a lien granted under
and, therefore, is not misled or disadvantaged by
the Builders Lien Act, and the PPSA security
the rule.
interest attaches to the collateral after the builder’s
lien, the lien security will have priority over the Note that no special language (other than the simple
PPSA security. grant of a security interest) is necessary to create a
PMSI. A PMSI arises when the secured party’s se-
curity interest meets the definition in the PPSA.
3. Residual Priority Rule—Section 35
The PPSA provides a super-priority to a secured
The residual priority rule (the general rule applied
party with a PMSI if the secured party complies
where no special priority rule applies) is set out in
with the requirements in s. 34 of the PPSA. A PMSI
s. 35 of the PPSA, as follows:
has priority over any other security interest in the
 Between two perfected security interests, same collateral granted by the same debtor in all of
priority goes to the secured party who is the the following circumstances:
first to register a financing statement, to
 The security interest in the collateral (other
perfect its security interest by possession or
than inventory or intangibles) is perfected
delivery under s. 24, or to temporarily perfect.
within 15 days of the debtor obtaining posses-
 A perfected security interest has priority over sion of the collateral (s. 34(1)(a)).
an unperfected security interest.
 The collateral is intangibles, and the security
 Between two unperfected security interests, interest is perfected within 15 days of the secu-
priority goes to the first security interest to at- rity interest attaching to the intangible (be-
tach to the collateral. cause intangibles are not capable of being
possessed) (s. 34(1)(b)).
The residual priority rule will apply only if no other
rule for determining priorities under the PPSA  The collateral is inventory, the security interest
applies. (The residual priority rules under s. 35 do is perfected on or before the date the debtor
not apply to collateral that is investment property. obtains possession of the inventory, and the
Instead, conflicting interests in collateral that is secured party gives notice of the PMSI in the
investment property are governed by the priority inventory to all other secured parties who have
rules set out in s. 35.1 of the PPSA.) Since title is previously registered a financing statement
not determinative of priority, a secured party with

Business: Commercial
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containing a description of the same item or 6. Transferees of Negotiable Collateral—Section 31
kind of collateral.
For negotiable (and quasi-negotiable collateral)
There are a few important issues to note in respect such as money, instruments, securities, chattel pa-
of PMSIs: per, and negotiable documents of title, s. 31 of the
PPSA provides that a bona fide purchaser of these
(a) In order for a secured party to have a PMSI,
kinds of collateral who takes possession of the col-
the secured party must have evidence to show
lateral will have priority over security interests that
that the secured party financed the collateral.
are not perfected by possession. Essentially, for a
(b) A PMSI (and the super-priority created secured party to obtain the highest degree of priori-
thereby) only extends to the financed portion ty over these kinds of collateral, it is necessary to
of the collateral. If only $1,000 of the perfect its security interest by taking possession. As
financing supplied by the secured party was noted earlier, nothing in the PPSA limits the rights
actually applied towards the debtor acquiring or prior security interest that a protected purchaser
rights in the collateral, the secured party will of a security has under the STA.
only have a PMSI for $1,000.
Policy: These kinds of collateral are negotiable,
(c) Where two PMSIs exist in the same collateral and innocent third-party transferees should be able
granted by the same debtor, s. 34(4) of the to rely on receiving possession of the collateral.
PPSA provides that the seller, lessor, or con-
signor has priority over the other PMSI. (The
7. Lien Holders—Section 32
other PMSI holder may be, for example, a fi-
nancier who supplied the down payment on Section 32 of the PPSA provides that a lien on
the collateral.) (Note that a policy decision goods that arises due to provision of materials or
was made to create certainty by favouring the services in respect of the goods (e.g. a repairer’s
supplier of the collateral.) lien) has priority over a perfected or unperfected se-
curity interest in the goods, unless the statute pro-
(d) A PMSI only has priority over security inter-
vides otherwise. It is important to review the statute
ests in the same collateral granted by the same
creating the lien to determine whether it indicates
debtor.
that the lien is subordinate to the security interest.
Section 34 includes additional rules for PMSIs in
Policy: The materials and services the lien holder
proceeds, including giving priority to PMSIs that
provides increase the value of the collateral. If the
finance new value over PMSIs that financed inven-
secured party were to have priority, the secured
tory since turned into proceeds. This section of the
party would obtain an unfair windfall.
PPSA also gives super-priority to secured parties
that provide new value to the debtor for the purpose Section 32 of the PPSA is an exception to the gen-
of raising livestock or growing crops. eral rule in s. 4(a), which provides that the PPSA
does not apply to a lien, charge or other interest
given by a rule of law or by another statute.
5. Buyers and Lessees of Goods—Section 30
A buyer or lessee of goods sold or leased in the or-
8. Subordination Agreements—Section 40
dinary course of the seller or lessor’s business has
priority over any security interest (perfected or un- Section 40 permits a secured party to contractually
perfected) granted by the seller or lessor, unless the subordinate its security interest to any other inter-
buyer or lessee knows that the sale or lease is a ests. The agreement to subordinate may be in the
breach of the security agreement (s. 30(2)). security agreement itself or in another agreement.
Section 40 alters the common law by allowing a
Section 30(3) provides protection to a purchaser of
third party to take the benefit of the subordination
consumer goods who has no knowledge of a securi-
(even where the third party is not a party to the
ty interest when the market value of the consumer
agreement), if the third party is the person or one of
good is less than $1,500. The sale under s. 30(3)
the class of persons for whose benefit the subordi-
does not have to be in the ordinary course of busi-
nation was intended. A subordination agreement
ness of the seller.
may be registered under s. 45(6), although it will be
Policy: Bona fide purchasers need to be protected effective even if it is not registered. A subordination
when they purchase collateral in the ordinary or postponement agreement does not create a secu-
course of business. rity interest by virtue of the subordination or post-
ponement alone (s. 40(2)).

Business: Commercial
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9. Other Priority Rules—Sections 29, 36, 37, 38, 39 Bank Act security (often referred to as s. 427 securi-
ty) involves a transfer of legal title in the currently
The PPSA also provides special priority rules for
owned collateral, and an equitable assignment of
fixtures (s. 36) (see §3.07(11) below), crops (s. 37),
the future collateral. Title vests in the bank, and the
accessions (s. 38), processed or commingled goods
bank may take possession of and sell the goods. The
(s. 39) and returned or repossessed goods (s. 29). It
rights of the bank are void as against other creditors
is important to review these sections when dealing
and subsequent bona fide purchasers of the collat-
with these types of collateral or collateral in these
eral, unless a notice of intention has been filed with
types of situations.
the Bank of Canada before the security is granted
Under the PPSA, crops are treated as personal prop- (but not more than three years before).
erty even though they are still growing and there-
Bank Act security has limited utility in British
fore attached to land: see the definition of “crops”
Columbia since the enactment of the PPSA, as it
in s. 1(1). The priority rules with respect to crops
gives the bank very few rights that it could not
contained in s. 37 parallel the rules with respect to
obtain by taking regular PPSA security. There is
fixtures (s. 36).
one area, however, in which Bank Act security can
In s. 1(1) “accessions” are defined as goods that are be very useful to a bank—in a priority dispute with
installed in or affixed to other goods. At common a distraining landlord. A landlord has the right to
law, accessions became part of the whole and, as distrain for arrears of rent against a tenant’s
such, ownership vests in the owner of the whole. By property. The landlord’s right of distraint takes
contrast, s. 38 permits the preservation of a security priority over secured parties (other than PMSI
interest in goods after they have become accessions. holders) who have an interest in the tenant’s goods,
Section 38 recognizes the ability to take a security so long as the goods are located on the leased
interest in goods attached to other goods. premises. However, if the tenant’s collateral is
subject to Bank Act security, the bank will defeat
Section 38 treats security interests in accessions in
the landlord’s right of distraint, because title to the
the same way that s. 36 treats security interests in
collateral has legally passed to the bank and is
fixtures, except that there are no additional registra-
therefore not property of the debtor upon which the
tion requirements (as there are with fixtures).
landlord can distrain.
Section 39 applies when goods, such as raw materi-
als or ingredients, are combined into one product so
11. Fixtures
that their identity is lost in the product. Where two
separate quantities of goods, each subject to a secu-
Fixtures are personal property that has become
rity interest held by two different secured parties,
affixed to real property. Whether something is a
are commingled so as to produce a new product, the
fixture is determined at common law.
secured parties lose their security interest in the
original goods but are given a prorated statutory se-
curity interest in the end product. A fixture is personal property that becomes affixed
to real property. The PPSA does not define “fix-
ture” except to say that a fixture does not include
10. Bank Act Security
building materials. Accordingly, the common law
tests for determining whether collateral is a fixture
Bank Act security can only be taken by chartered
are relevant. See Northwest Trust Co. v. Rezyn De-
banks and in certain types of collateral; it effec-
velopments Inc., 1991 CanLII 939 (B.C.C.A.); La
tively transfers title in the collateral to the bank.
Salle Recreations Ltd. v. Canadian Camdex Invest-
ments Ltd., 1969 CanLII 740 (B.C.C.A.).
Section 427 of the federal Bank Act permits a
The PPSA provides specific rules governing securi-
company to charge, among other things, its
ty interests in fixtures. The rules determine whose
inventory and manufacturing equipment in favour
claim to the fixtures has priority in various circum-
of a chartered bank. When you are acting for a
stances. Generally, a person whose claim attached
creditor who proposes to take security from a party
to the personal property before it was affixed has
that borrows money from a bank (for greater
priority before a person with a claim in the land,
certainty, not including provincial credit unions), it
subject to the rules under PPSA s. 36.
is important to conduct a Bank Act search of the
debtor’s name and all predecessor names of the Section 49 provides the procedure and form for fil-
debtor. When you are acting for a bank lender, it is ing a Fixtures Notice against title to the real proper-
common for the bank to require Bank Act security ty. Where a secured party takes a security interest in
from its corporate borrowers. a good that becomes a fixture, a Fixtures Notice
should be filed against title to the land to ensure the
secured party maintains its priority to the fixture.
Business: Commercial
 39
[§3.08] Enforcing Security Interests rights, and may relieve parties from compli-
ance with Part 5 if it would be just and rea-
1. PPSA Part 5 sonable to do so.
Part 5 of the PPSA governs the rights and rem- (e) When the same obligation is secured by an in-
edies of the secured party and the debtor upon terest in land and a security interest under the
default by the debtor. PPSA, the secured party can choose to pro-
ceed with enforcement under the PPSA with
Most security agreements contain a provision respect to the personal property, or proceed
itemizing the various things that will constitute a against both the personal property and the
default, triggering the secured party’s rights to land as if the personal property were land.
enforce its security interests. The usual event of This is why, in real property foreclosure pro-
default is when the debtor fails to pay or perform its ceedings, a mortgagee might foreclose on land
obligations. Other common events of default and personal property at the same time.
include bankruptcy, receivership, or insolvency of
the debtor, a material adverse change in the debtor’s
2. Contractual Rights—Section 58
financial situation, another creditor commencing
enforcement proceedings against the debtor, or a The secured party may seize or repossess goods
judgment being issued against the debtor. by any method permitted by law, unless the
Part 5 of the PPSA provides a range of usual reme- security agreement otherwise provides.
dies for secured parties, and deems those remedies
to become available if a debtor defaults. Therefore, Part 5 does not apply to agreements that do not in
neither default nor remedy sections are technically substance create a security interest (that is, s. 3
required in a security agreement. security interests that do not secure payment or
There are some general principles to keep in mind performance, including a lease for a term of more
when considering the secured party’s options under than one year and a commercial consignment).
Part 5: Where Part 5 does not apply, creditors’ rights must
be contained in the contract governing the lease or
(a) Section 56 makes Part 5 of the PPSA a com- consignment.
plete “code” for enforcing security interests.
The enforcement rules may only be modified The debtor and secured party may agree in the secu-
to the extent allowed in Part 5. A secured par- rity agreement on their respective rights and reme-
ty’s rights and remedies against a debtor are dies on default. Unless otherwise agreed, the
limited to the rights provided in the security secured party may enforce the security agreement
agreement, the rights and remedies in Part 5, by any method permitted by law, unless:
rights of removal of fixtures (ss. 36(6) and  the collateral is fixtures, crops, or accessions,
(7)) and rights to seize and dispose of crops in which case ss. 36 to 38 of the Act must be
(s. 37) and accessions (s. 38). followed; or
(b) The secured party’s rights and remedies are  the collateral is consumer goods and the debtor
all subject to the requirement in s. 68(2) that has paid at least 2/3 of the obligation secured
they be exercised in good faith and in a com- (s. 58(3), and see §3.08(8)).
mercially reasonable manner.
(c) With a few exceptions, debtors cannot waive 3. Sale of Seized Collateral—Section 59
or vary any of their rights under Part 5 until
after default. After default, debtors may, in The secured party may dispose of collateral af-
writing, waive their rights under s. 59 to ter giving 20 days’ notice to specific parties.
 notice of disposition of the collateral by
the secured party, and Policy: Before a secured party disposes of collat-
eral, other parties with interests in the collateral
 the right to redeem the collateral by paying that will be extinguished by the disposition need to
the obligation secured. have notice, so that they can take steps (if neces-
(d) Sections 63 and 70 of the PPSA deal with the sary) to protect their interests.
supervisory jurisdiction of the court in situa- A secured party may dispose of collateral by public
tions where a secured party is enforcing its or private sale, either as a whole or in parts. If the
security agreement. If there is any dispute security agreement permits it, the collateral may al-
over the timing or manner of enforcement, the so be disposed of by lease. The secured party’s rea-
court has broad powers to make directions re- sonable costs of seizing and disposing of the
garding the exercise of Part 5 remedies and collateral may be deducted from the proceeds of
Business: Commercial
 40
disposition, before applying the proceeds to the ob- 5. Voluntary Foreclosure—Section 61
ligation secured.
If the collateral is worth less than the obligation
The secured party must give at least 20 days’ writ-
secured, a secured party may wish to conduct a
ten notice of disposition to the debtor, anyone else
voluntary foreclosure, in which the collateral is
known by the secured party to have an interest in
taken in full satisfaction of the obligations.
the collateral, any subordinate secured parties who
have registered a financing statement, and anyone Sometimes, after the debtor defaults, it becomes
who gives the secured party notice of an interest in clear that the collateral is worth much less than the
the collateral before the notice of disposition is obligations secured, or there is no ready market for
sent. the collateral, or the secured party wants to keep the
Sections 59(7) and 59(8) set out what must be in collateral. In these cases, the secured party can give
the notice of disposition, including the amount notice (to everyone entitled to notice of disposition
owed to the secured party. Anyone who receives under s. 59) of its intention to retain the collateral in
the notice of disposition can redeem the collateral full satisfaction of the secured obligations.
by paying this amount, often called the “redemption
amount” (see §3.08(6) below). A party who pays it The debtor may, of course, disagree that the collat-
steps into the shoes of the enforcing secured party. eral is worth less than the debt, and may even sus-
pect that the secured party is trying to “scoop” a
In some circumstances the notice of disposition is valuable asset. Accordingly, the debtor, or any other
not required (s. 59(17)). Notice of disposition is not party who receives notice of a voluntary foreclo-
given to secured creditors with priority over the se- sure, has 15 days to deliver a notice of objection to
cured party’s security interest because the collateral the secured party, in which case the secured party
will be sold subject to those security interests. must dispose of the collateral under s. 59.
This procedure ensures that the debtor and other in-
4. Payment of Sale Proceeds—Section 60 terested parties will be able to recover the surplus, if
any, after sale of the collateral. If the secured party
Any surplus must be paid to other perfected se- really does believe that the collateral will not bring
cured creditors before the debtor can receive enough at sale to satisfy the obligations secured, it
any of the surplus money. may apply to court for a determination that the no-
tice of objection was improper or unwarranted.
Although it is unusual, sometimes there is surplus
money remaining after the secured party has dis- 6. Redemption and Reinstatement—Section 62
posed of the collateral and applied the proceeds to
the outstanding obligations. If there is a surplus, the After default, the debtor can (in certain circum-
secured party must first pay it to subordinate se- stances) reinstate the security agreement, and
cured parties whose security interests were perfect- any party who receives a s. 59 notice of disposi-
ed by registration or possession at the time the tion can redeem the collateral.
collateral was seized. If there is still money left, the
surplus must be paid to persons who have given no- If a secured party has taken steps to realize on the
tice to the secured party of an interest in the collat- collateral, either by sending a s. 59 notice of dispo-
eral. Once these parties are paid, the remaining sition or a s. 61 voluntary foreclosure notice, every
surplus, if any, may be given to the debtor. party who receives that notice can “redeem” the
collateral by paying the obligation secured, plus the
Section 60(4) allows the secured party to pay any reasonable expenses of the secured party in seizing
surplus into court if there is a question as to who is and preparing the collateral for disposition.
entitled to it. A secured creditor will usually take
this step if there is any concern that the funds might The amount that must be paid to redeem the collat-
be paid to the wrong party: a secured party will eral (usually called the “redemption amount”) is set
want to avoid attracting possible liability for giving out in the notice of disposition. “Redeeming” the
the money to the wrong person. Once surplus funds collateral means that the collateral is freed from the
have been paid into court, they can only be released secured party’s security interest, and remains in the
upon the summary application of a person claiming hands of the debtor, subject to other parties’ contin-
entitlement to them. uing interests in that collateral.
If the collateral is consumer goods, s. 62 provides
that the debtor may reinstate the security agreement
by paying all amounts actually in arrears (not in-
cluding any accelerated amounts), plus the secured
party’s reasonable expenses.
Business: Commercial
 41
7. Receivers—Section 64 mentioned earlier (§3.08(2)): s. 58(3) of the PPSA
says that, if at least 2/3 of a debt for consumer
A secured party may appoint a receiver to en- goods has been paid, those goods are not subject to
force the security agreement and dispose of the seizure. Another of those limitations is found in
collateral. s. 67, which deals with enforcement of security
agreements involving consumer goods.
Most security agreements, in their provisions deal-
A secured party who is entitled to seize consumer
ing with the secured party’s rights on default by the
goods must make a choice with respect to its
debtor, provide for the appointment of a receiver. If
remedies. The secured party may bring an action for
a receiver is appointed under a security agreement,
judgment against the debtor for the amount of
this is called a “private appointment” or “instrument
obligation secured; alternatively, the secured party
appointment”; s. 64(1) requires that any such re-
may enforce its interest in the collateral by seizure
ceiver be a licensed trustee in bankruptcy under the
(s. 58), possession (s. 61) or surrender of the
Bankruptcy and Insolvency Act (Canada).
collateral by the debtor. This choice of remedies in
Section 64(2) sets out the qualifications for “court- dealing with consumer goods is usually referred to
appointed receivers” (who do not need to be bank- as “seize or sue.”
ruptcy trustees). There are a number of reasons why
If the secured party seizes or accepts surrender of
court-appointed receivers are often used instead of
the collateral, the debtor’s obligations under the se-
instrument-appointed receivers. Sometimes a secu-
curity agreement are extinguished, even if the col-
rity agreement does not provide for the appointment
lateral is worth less than the obligation secured.
of a receiver; sometimes the debtor is uncooperative
(The obligations of a guarantor or indemnitor of the
and refuses to allow an instrument-appointed re-
debtor’s obligations are also extinguished.) If the
ceiver to have access to the collateral; sometimes
secured party elects not to proceed against the col-
there is no licensed bankruptcy trustee available;
lateral, but seeks judgment instead, then the security
and sometimes the secured party simply wishes to
interest in the consumer goods is extinguished and
have a receiver put in place pursuant to a court or-
the secured party must discharge any registration
der. It is more expensive to put a court-appointed
relating to the security interest within one month.
receiver in place, so in acting for a secured party,
use an instrument appointment where possible. In acting for a client who seeks to enforce a security
agreement involving consumer goods, review the
Section 65 contains a number of reporting and ac-
exceptions to the “seize or sue” rule carefully.
counting requirements for receivers. Section 66
There are three important exceptions:
provides various court remedies relating to receiv-
erships, including the appointment, removal or re- (a) the consumer protection provisions do not ap-
placement of a receiver, directions as to the duties ply if the debtor is a company, partnership or
of the receiver, approval of the receiver’s fees and joint venture;
accounts, and so on. You should read these sections (b) the obligations of the debtor and guarantor are
carefully if you are acting for a receiver or a se- revived if the seized consumer goods are re-
cured party who has appointed a receiver. turned to the debtor within 20 days; and
Most of the provisions of Part 5 apply to receivers (c) if the debtor has engaged in wilful or reckless
in the same way that they apply to secured parties. acts or neglect that caused substantial damage
or deterioration to the goods, the secured par-
ty may obtain a court order that some or all of
8. Consumer Goods—Special Enforcement
the rights or remedies in s. 67 do not apply.
Rules—Section 67
In the case of consumer goods, a secured party [§3.09] Guarantees2
must either seize the collateral or sue the
debtor. The secured party cannot do both. While guarantees are referred to colloquially as security,
a guarantor agrees to be responsible to pay a debt owed
by another person (Rowlatt on the Law of Principal and
Policy: As between consumers and secured parties, Surety, 4th ed., p. 1). The terms “guarantor” and “surety”
secured parties are presumed to be more sophisti- are essentially the same and accordingly, a contract of
cated and to know enough to beware of lending surety is the same as a guarantee.
where the value of the collateral will not cover the
debt and interest.
Parties to a security agreement enjoy freedom of 2 This section contains extracts from materials prepared by James
contract, subject to certain limitations in the PPSA A. Titerle for CLE in 1984 and 1985, and by James F. Dixon
that are designed to protect vulnerable parties in and Rodney Massel, with the assistance of Daniel LeDressay, in
commercial transactions. One such limitation was 1984. This section has been updated by editors of the chapter.
Business: Commercial
 42
1. Why Get a Guarantee? Without express agreement or necessary inference
to the contrary, when each co-guarantor is equally
A guarantee may be used whenever a party other
liable with respect to the same obligation, each of
than the borrower is willing to be at risk for all or
them is liable to the other co-guarantors collectively
part of the borrower’s obligations. A guarantee is
for the sum of the total obligation divided by the
commonly taken from the principal shareholders of
number of co-guarantors. For further reading on
a corporation to support a debt obligation of the
contribution, see BC Creditors’ Remedies—An An-
corporation. (This is one way for lenders to get
notated Guide (Vancouver: CLEBC).
around the limited liability of the shareholders of
the corporation.) A guarantee is also often required
4. Preparing a Guarantee
from the parent of a subsidiary corporation to sup-
port a loan to that subsidiary. It is important to consider the following when a
transaction involves a guarantee:
While guarantees are not security, in certain situa-
tions a guarantor will grant security to the lender to (a) Business Corporations Act
secure payment or performance of the guarantee.
Under the Company Act—the predecessor to
Therefore, if the principal debtor defaults and the
the Business Corporations Act, S.B.C. 2002,
lender looks to the guarantor for payment of the
c. 57—a company could not give a guarantee if
debt, the lender will be secured and will be in a po-
the company was insolvent (s. 102). Under both
sition to realize on its security. It is also common
the Company Act and the Business Corpora-
for an individual guarantor to grant a mortgage on
tions Act, when the directors are considering
their real property to secure a guarantee.
whether a company should provide a guarantee,
they must believe that giving the guarantee is in
2. Guarantee or Indemnity
the best interests of the company (BCA, s. 142;
A guarantee is collateral to another agreement, Company Act, s. 103). Therefore, it is usual to
which is what distinguishes a guarantee from an in- require that a company giving a guarantee pro-
demnity (Morin v. Hammond Lumber Co., [1923] vide both a certified copy of a directors’ resolu-
S.C.R. 140). An indemnity is an agreement to en- tion stating that, in the directors’ opinion,
sure the lender does not suffer a loss if the debtor giving the guarantee is in the best interests of
does not pay. An indemnity is an independent obli- the company, and a certificate from an officer
gation and does not depend on the relationship be- of the company confirming that the guarantor is
tween the principal debtor and the creditor: not insolvent.
…a contract of guarantee is a collateral contract A lender should not ignore evidence of insol-
to answer for the default of another person, and vency, even if an officer gives a certificate stat-
thus is a contract that is ancillary or subsidiary ing that the guarantor is not insolvent.
to another contract, whereas an indemnity is a
contract by which the promisor undertakes an Section 195 of the Business Corporations Act
original and independent obligation (20 Hals., provides that a company can give financial as-
4th ed., 54). sistance to any person for any purpose. Howev-
If conflict arises and a court is called upon to decide er, when financial assistance is given to
whether a contract is an indemnity or a guarantee, someone “related” to the company, the compa-
the courts will attempt to discern the intent of the ny must disclose this to its shareholders, in cer-
parties as evidenced by the document itself. In other tain circumstances.
words, it does not matter what the contract is called: (b) Opinion Letter
what matters is whether it is in substance a guaran-
tee or an indemnity. It is usual to obtain an opinion letter from the
lawyer who acts for the corporate guarantors,
3. Co-Guarantors (Joint and Several Liability) which states that the guarantors have the corpo-
rate power and capacity to guarantee the debts
Often, a lender will obtain guarantees from more of the borrower and grant the guarantee, and
than one guarantor. Provided the guarantee is joint that the guarantee has been duly authorized, ex-
and several (generally, guarantees granted by more ecuted and delivered by each of the guarantors.
than one guarantor provide that the obligation of When the guarantee is from individuals, it is
the guarantors is joint and several), the lender may common to obtain either a solicitor’s certificate
recover the full amount outstanding from any of the with respect to the identity and capacity of the
guarantors upon a default by the debtor. guarantor or, now less common, an opinion let-
A joint or joint-and-several guarantor is entitled to ter from the individual guarantors’ lawyers stat-
an equitable right of contribution from other joint ing that each of the individual guarantors has
guarantors (s. 53(3) of the Law and Equity Act). duly executed and delivered the guarantee.

Business: Commercial
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(c) Certificate of Independent Legal Advice there has been a material alteration of the prin-
cipal contract. This rule is subject to the con-
Often the individual guarantors of a borrower’s
tract and is usually precluded by standard-form
indebtedness derive a real benefit from the loan
guarantees.
to the borrower, as is the case where a principal
of a company gives the loan to the company. (b) Alteration of the guarantee instrument itself.
However, when the individual guarantor is not
(c) Release of the guarantee by giving time to the
directly related to the business of the company
principal debtor.
that is obtaining the loan (e.g. the spouse of the
principal of the company) it is important for the (d) Release of the guarantor by impairment of the
lender to obtain a certificate of independent le- security.
gal advice with respect to the guarantor and the
(e) “Seize or sue.”
guarantor’s giving of the guarantee. The certifi-
cate of independent legal advice will provide A guarantor may be discharged as a result of
evidence against any claim that the guarantor the “seize or sue” provisions in s. 67 of the
was unduly influenced, or was under duress, as PPSA (see discussion in §3.08(8)).
well as claims of non est factum and fraud. (f) Foreclosure.
5. Enforcement of a Guarantee Section 32 of the Property Law Act, R.S.B.C.
1996, c. 377, extinguishes the covenant of the
Upon default by the borrower, the lender may look mortgagor upon the mortgagee taking an order
to the guarantor to repay the debt. The lender need absolute of foreclosure. If a creditor forecloses
not attempt to collect the debt by suing the borrow- upon real property and obtains an order abso-
er or by enforcing other security it holds for the lute, that creditor will lose the claim against the
debt before proceeding against the guarantor (un- guarantor.
less the parties have contracted otherwise). There is
no need to demand payment from the guarantor be- (g) Questioning the validity of the contract.
fore starting proceedings against the guarantor, un- A guarantee is a contract. Defences that are
less the guarantee provides otherwise. Normally, normally available for any contract are availa-
however, the lender will write to the guarantor de- ble to a guarantor. Hence, it is not uncommon
manding payment. If payment is not received, the for a guarantor to raise defences of misrepre-
lender will then proceed to sue the guarantor under sentation, non est factum, fraud and mistake.
the guarantee. When the lender has taken security
from the guarantor to support the guarantee (for ex- 7. Assignment of Security and Liability
ample, a mortgage on the guarantor’s home), the
If a guarantor or the co-guarantors pay to the credi-
lender may proceed to realize on its security with-
tor the entire debt, and the debt was secured by se-
out first suing the guarantor.
curity given by the debtor to the creditor, the
guarantor or guarantors are subrogated to (they “in-
6. Defences to the Creditor’s Claim
herit”) the rights of the lender against the debtor
The courts tend to relieve guarantors from liability and are entitled to a transfer, assignment or convey-
under guarantees more readily than they excuse ance of the security from the creditor. They may
parties to primary contracts. Accordingly, many of then enforce that security against the debtor.
the clauses in guarantees are intended to counter
When a guarantor has given the creditor security for
defences the guarantor may make against a claim
the guarantee, and the liability of the guarantor
on the guarantee. There are common defences put
under the guarantee is fully discharged, the guaran-
forth by guarantors:
tor is entitled to a release of the security from the
(a) Release of the guarantor by variation of the lender.
principal contract.
8. Guarantor’s Rights Against a Principal Debtor
By definition, the contract of guarantor is pred-
icated on the existence of a contract between Generally, a guarantor is not entitled to relief until
the creditor and a third party, namely the prin- the guarantor is obliged to pay. Therefore, the guar-
cipal debtor. Variation of the contract with the antor may not negotiate payment terms with the
principal debtor will thus have an effect on the creditor before the debt is due, nor may the guaran-
contract of guarantee absent provisions in the tor accelerate its right to seek a remedy against the
contract of guarantee itself, which preserve the debtor by paying the debt before it is due.
guarantor’s liability if the principal contract is The guarantor must show that a definite sum is
altered. This includes novation of the principal payable. It is insufficient to show that a demand has
contract. A guarantor may also be released from been made on the guarantor and that it may eventu-
obligations when the guarantor can prove that ally be found that a debt is due.
Business: Commercial
 44
The guarantor has an immediate right of action It is prudent to obtain certified copies of directors’
against the principal debtor for each periodic pay- resolutions that authorize borrowing, granting of
ment the guarantor pays under the guarantee in re- security, or guaranteeing debt.
lief of the principal debtor, unless the terms of the
2. Indian Act—Section 89
guarantee otherwise provide.
When the security being granted is from a Band or
A guarantor against whom an action is brought may
sometimes obtain indemnification by issuing a third a Status Indian, it is important to consider the effect
party notice against the principal debtor. When the of s. 89 of the Indian Act, R.S.C. 1985, c. I-5.
guarantor uses this remedy in order to enforce an Section 89 restricts the ability of any person who is
express contract by the principal debtor to not an Indian under the Indian Act to take and en-
indemnify, the guarantor can obtain judgment force security from a Band or member if the collat-
against the principal debtor before anything has eral is located on a reserve.
been paid under the guarantee.
3. Searches
The guarantor has a right to full indemnification. It
is a right to recover the amount the guarantor has Searches in connection with encumbrances regis-
actually paid on behalf of the principal debtor. If tered against a debtor’s property and possible
there are several guarantors, each may maintain an claims against the company are recommended. For
action against the principal debtor for the amount a list of searches commonly made, see Chapter 2,
that each has paid on account of the principal §2.06, and the “Asset Purchase Procedure” and
debtor’s default. “Share Purchase Procedure” checklists in the Prac-
tice Checklists Manual on the Law Society of BC
website (www.lawsociety.bc.ca).
[§3.10] Due Diligence
There are many searches that may be performed to
When engaging in a commercial transaction that in- disclose other claims that may have priority over
volves a lender taking security, it is important for the PPSA security. It is also important to consider
lender to conduct a certain level of due diligence to en- whether there are statutes other than the PPSA that
sure that there are no competing interests of material govern the type of security being taken. Another
concern that may compromise the security to be taken by statute may set out different requirements for the
the lender, its value, or its intended priority. The range creation of security interests, or grant a lien or other
of due diligence will vary depending on the size of the interest in the property of the debtor, which would
transaction and the comfort the lender has with the debt- have priority over the PPSA security interest.
or and its assets. Some relevant legislation (e.g. Bank Act, Canada
1. Corporate Power and Capacity Shipping Act, 2001, International Interests in Mo-
bile Equipment (Aircraft Equipment) Act, etc.) was
A company entering into a transaction to borrow discussed earlier in §3.03(4).
money, grant security, or guarantee the indebted-
ness of another must have the corporate power and However, many claims that may have priority due
capacity to do so. to another statute are not required to be registered
and cannot be searched. It is important to explain to
Section 30 of the Business Corporations Act pro- a lender that there are occasions where it will not
vides that a British Columbia company has all of have first priority to the assets of the debtor.
the powers and privileges of an individual of full
capacity. Section 33 of the Business Corporations Because of the potential impact of such legislation,
Act provides that a company shall not carry on a lawyers in British Columbia do not give opinions
business or exercise a power that it is restricted with respect to the priority of security interests in
from doing under its memorandum or articles. Ac- personal property. (This is different from real prop-
cordingly, before accepting security from a compa- erty, where an opinion as to priority can be provid-
ny debtor, the lawyer acting for the secured party ed on the basis of searching the Land Title register.)
must review the memorandum and articles of the
company to ensure that it is not restricted from bor- [§3.11] Common Pitfalls
rowing money, granting security, or guaranteeing
the indebtedness of another. Note that there are ad- The general rules of the PPSA, and the policies on which
ditional considerations for companies that were in- they are based, account for the vast majority of situations
corporated before 1973, mining companies, and involving security. However, there are some tricky situa-
companies incorporated for a specific purpose. tions that arise fairly often. These are things to remem-
ber and to watch out for:

Business: Commercial
 45
 When entering a debtor’s name in a financing even if they have reserved title until the sale
statement, do not use commas or periods. price is paid: to have priority, they must com-
ply with the PPSA.
 Before filing a financing statement against a
debtor’s name (or conducting a PPR search of a  If you are asked to give a priority opinion for a
debtor’s name as part of your due diligence), security interest in personal property, refuse.
always do corporate searches to determine the There are too many liens and other charges that
debtor’s correct legal name. can exist against personal property and that are
not governed by the PPSA (for example, inter-
 A description of equipment without further ref-
ests excluded by s. 4) for you to be able to tell
erence to the “kind” of collateral is inadequate
that a client has priority simply by conducting a
in a security agreement and a financing
PPR search. There may also be secured credi-
statement.
tors registered after your client who still have
 When the secured party wishes to take a securi- priority (for example, PMSI holders).
ty interest in all of the debtor’s present and af-
 Many people mistakenly believe that a promis-
ter-acquired personal property located at a
sory note is security. A promissory note is
specific location, a description of the collateral
simply a negotiable instrument that creates an
charged in the security agreement and financing
obligation to pay. A creditor who has only a
statement as “all of the debtor’s present and af-
promissory note signed by the debtor is unse-
ter-acquired personal property located at, situ-
cured.
ate on, or used in connection with the following
lands…” is not acceptable. Instead, the collat-  Always register a financing statement for a se-
eral should be described by “kind” as follows: cured creditor as soon as possible, even if the
“all of the debtor’s present and after-acquired security interest has not yet attached or even
goods, investment property, instruments, doc- been granted. Remember, once the security in-
uments of title, chattel paper, intangibles, terest does attach, priority will be determined
money, crops or licenses located at, situate on, by the date the financing statement was filed,
or used in connection with the following so to reduce the risk of your client losing priori-
lands…” ty to another secured creditor, the earlier you
file, the better.
 If a secured party wishes to obtain a PMSI on
inventory, registration of a financing statement  If you are acting for a lessor who is entering in-
and a PMSI notice to prior secured creditors to “true” leases (that is, not financing leases)
must be completed before the debtor takes pos- with lessees, remember that if the lease is a
session of the collateral. PMSI notices are re- “lease for a term of more than one year” it is
quired for inventory but not for other collateral. subject to the PPSA (s. 3), and the lessor could
lose its whole interest in the leased goods, even
 Beware of “seize or sue” if there are any con- though it never intended to enter into a security
sumer goods included in the collateral covered agreement at all. On the issue of whether a
by the security interest. lease is a “true” lease or merely a security
 Include “all present and after-acquired” lan- lease, see Re Smith Brothers Contracting Ltd.
guage in collateral descriptions. (1998), 53 B.C.L.R. (3d) 264 (S.C.) and Re
843504 Alberta Ltd., 2011 ABQB 448.
 Do not include reference to the security agree-
ment, loan agreement, or any other agreement
in the collateral description of a financing
statement. You must describe the collateral in
accordance with s. 10 of the PPSA.
 Consider jurisdiction issues if the collateral is
mobile goods, intangibles (s. 7) or investment
property (s. 7.1). A secured party must protect
its interests pursuant to the law of the correct
jurisdiction.
 Consider the interplay between the PPSA and
the STA when dealing with collateral that is in-
vestment property.
 Remember, title is not relevant under the PPSA.
Never advise clients that they have priority to
goods supplied on conditional sales contracts,
Business: Commercial
 56
Chapter 4 The third topic introduces the general analytical tech-
niques used to interpret financial statements. How useful
financial statements are depends on the user’s ability to
draw informed conclusions from the data.
Introduction to Financial When considering these topics in practice, lawyers
Accounting and Financial should be alert to which accounting standards apply in a
particular situation. In Canada, as of 2011, all public
Statements1 companies must follow the International Financial Re-
porting Standards (“IFRS”) in preparing financial state-
ments. However, most private companies use accounting
[§4.01] Interpreting Financial Statements
standards for private enterprises (“ASPE”). From the
Accounting concepts and financial statements are com- lawyer’s perspective, the key is to recognize what set of
mon in the business world. Since the work of many law- accounting standards apply in a given situation, and en-
yers relates in some way or another to the business sure that the client discusses that aspect of the file with
world, you will likely encounter such topics in your legal accountants so that the file is conducted appropriately.
practice, especially if you work in family, corpo-
rate/commercial, securities, or general litigation. This [§4.02] Financial Statements—Generally
chapter is intended to provide you with a basic under- Accepted Accounting Principles and
standing of these topics. Of course, this chapter is not Assumptions
intended to prepare you to be an accountant or to resolve
accounting-related legal disputes. Where financial or 1. Generally Accepted Accounting Principles
accounting matters are involved, it is generally wise to
“Generally accepted accounting principles” or
have professional accountants on your client’s “team.”
“GAAP” include assumptions, rules and guidelines
This chapter discusses three topics: used to prepare financial statements. The following
concepts form the foundation of GAAP and will be
(1) components of financial statements (§4.02 and
discussed in greater detail below:
§4.03);
(a) Generally accepted assumptions:
(2) communications made by accountants and
auditors (§4.04); and  going-concern assumption
(3) analytical techniques used to interpret financial  stable unit of measure assumption
statements (§4.05).  periodicity assumption
The first topic introduces financial statements—these are (b) Generally accepted principles:
reports of the financial activities of a business (the terms  (historical) cost principle
“business,” “entity,” “enterprise,” “firm” and “company”
are used interchangeably in this chapter) presented in a  revenue principle
codified and fairly standard format. Users of financial  matching principle
statements must understand the principles and assump-  objectivity principle
tions that underlie them in order to appreciate the limita-
tions and implications of the data contained in them.  consistency principle
 conservatism principle
The second topic describes the types of communications
that accountants or auditors may include with financial Understanding these essential concepts will help
statements. Each type of communication conveys a dif- you better understand the limitations of financial
ferent degree of confidence in the fairness or truthfulness statements and accounting generally.
of the financial statements. The type of communication
included with the financial statements is often driven by 2. The Going-Concern Assumption
contractual or statutory requirements.
The “going-concern” or “continuity” assumption re-
1
fers to the assumption that an accounting entity will
Amir Ghahreman, C.P.A., C.A., LL.B., Bridgehouse Law continue to operate for a period of time sufficient to
LLP, kindly revised this chapter in August 2020, July 2019, De-
cember 2016, July 2012, and January 2011. Previously revised carry out its existing commitments.
by Stephen P. Wurz, C.A. IFA (2004); Stephen P. Wurz and This assumption allows preparers of financial
Derek M. Sanders (2001); Jeff P. Matthews, C.A. (1995–2000);
and Peter G.H. Weldon, C.A. (1993 and 1994). This chapter was
statements to report assets and liabilities at histori-
originally prepared for PLTC by Johan de Rooy of the UBC cal cost (or sometimes at “fair value”) in the bal-
Faculty of Commerce in October 1988; updated by the author to ance sheet, instead of reporting the current liquida-
April 1991. tion value of those assets and liabilities.

Business: Commercial
 57
The going concern assumption is justified in most At the time an asset is originally acquired, cost usu-
normal situations. However, it should be dropped ally represents the fair market value of the goods or
when it does not match the facts or when a contract services exchanged. Over time, however, the fair
specifies that a different assumption should be used. market value may differ from the historical cost.
For example, in reporting statements for a company For instance, the fair market value of land often in-
going into liquidation, the accountant drops the go- creases over time from its original historical cost.
ing-concern assumption in order to report, for as- Applying the (historical) cost principle, these later
sets, their liquidation value, and for liabilities, the changes in fair market value are generally ignored
amount required to settle the debts immediately. in the accounts, and the assets continue to be valued
in the balance sheet at historical cost (minus depre-
3. The Stable Unit of Measure Assumption ciation).
The “stable unit of measure” assumption assumes The (historical) cost principle is related to the prin-
that money, the basic measuring unit for financial ciple of objectivity, discussed later in this material.
reporting, is a stable unit of value. In other words, Objective evidence readily exists to support cost,
accounting mostly ignores inflation or the variable whereas evidence supporting market values is more
value of currency over time, unless some adjust- subjective and less readily available.
ment is expressly applied.
With the shift to applying IFRS, there are more ex-
Accountants might, for example, combine a ceptions to the cost principle for certain assets. Un-
$20,000 cost of equipment purchased in 1999 and a der IFRS, “fair value” measurement occurs fre-
$50,000 cost of similar equipment purchased in quently (with “fair value” defined in IFRS as “the
2019 and report the total as a $70,000 investment. price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction be-
However, the dollar is not always stable and the
tween market participants at the measurement
prices of goods and services change over time, so
date”). Also, during the transition from older Cana-
assuming a stable unit of measurement, particularly
dian GAAP to ASPE, private companies were per-
for historical figures, might have limited usefulness.
mitted, on a one-time basis only, to measure items
of property, plant and equipment at fair value as of
4. The Periodicity Assumption
the date of the transition, and to use that value as
Financial statements depend on some things contin- the deemed cost for those items going forward.
uing indefinitely (such as major capital assets or However, as this was a one-time option, over time
subsidiary businesses). However, the users of finan- there will again be a disparity between the cost in-
cial statements need periodic financial measure- dicated in the financial statements and the fair value
ments in order to make decisions. The “periodicity of items.
assumption” allows accountants to divide the life of
an entity into time segments, such as a year, and 6. The Revenue Principle
take measurements at these intervals.
The revenue of a business is the value or considera-
The need for frequent measurements creates chal- tion received when the business provides goods or
lenges for accountants. For example, accountants services to a third party. Revenue is measured by
must estimate the useful lives of depreciable assets the cash value of the goods or services exchanged.
and apply depreciation methods to those segments The revenue principle holds that revenue should be
of its life. Therefore, periodic measurements of net recognized by a business when it is earned, not
income and financial position are only informed es- necessarily when cash is received; the former refers
timates at best. Users of financial statements should to “accrual accounting” (required by GAAP) and
understand these limits when relying on periodic the latter to “cash accounting.”
accounting information.
7. The Matching Principle
5. The (Historical) Cost Principle
The matching principle holds that expenses directly
Both the balance sheet and the income statement are associated with earning revenues should be record-
affected by the (historical) cost principle. Applying ed in the same period in which the revenue is re-
this principle, accountants record assets in the com- ported, so that expenses are “matched” with the
pany’s accounts at cost and do not adjust this value revenue they generate. In other words, when reve-
later, except to allocate a portion of the original cost nue has been earned, the expenses incurred to gen-
to expense as the assets expire through “deprecia- erate that revenue should be offset (matched)
tion,” or, if applicable, to write-down the value of against that revenue to derive the net income from
certain short-term assets. the transactions. Expenses are matched as of when
they are incurred, not when they are paid.

Business: Commercial
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Together, the matching and revenue principles pro- Together, these components attempt to convey a finan-
duce the accrual accounting model, the model used cial picture of the business, subject to the limitations of
by all businesses for preparing external financial financial reporting. If any of these items is absent, the
statements. The accrual model calculates income as users of the financial statements will usually require an
revenue earned (not necessarily collected) minus explanation and view the statements with scepticism.
From the lawyer’s perspective, the balance sheet and
expenses incurred (not necessarily paid) to generate statement of income are the most relevant items.
that revenue. For that reason, net income will not
reflect a business’s actual cash position. The sections that follow use Acme Limited’s financial
statements to review the components of financial state-
8. The Objectivity Principle ments (except accountants’ and auditors’ communica-
tions, which are discussed in §4.04). Refer to the Acme
The objectivity principle holds that financial meas- Limited financial statements (Appendix 4) to ensure you
urements should be based on evidence that is objec- understand the concepts discussed.
tive—that is, unbiased and subject to verification by
independent experts. For example, price in an 1. The Balance Sheet
arm’s-length transaction is an objective measure of The balance sheet reports the financial position of
market value at the time of the transaction. Invoic- an entity at a particular point in time. Just like a
es, contracts, paid cheques, and inventory counts camera freezes an image in time, a balance sheet
are other examples of objective evidence. records a company’s assets, liabilities and equity
accounts as they are on the date for which the bal-
9. The Consistency Principle ance sheet was prepared. (For Acme, that point in
The consistency principle states that once a compa- time is December 31, in each of 2010 and 2009).
ny adopts a particular accounting method, it will not The balance sheet organizes the accounts under
change that method from period to period. This three broad categories: assets, liabilities, and equity.
principle allows users of financial statements to
compare financial statements from different periods Assets are items that the business owns or controls.
and to interpret changes in financial position. Assets are used to earn income or revenue in subse-
quent fiscal periods, and include the following:
If a company does change accounting methods, it
should disclose this in the notes to the financial  cash or cash equivalents;
statements.  future cash inflows (e.g. accounts receiva-
ble);
10. The Conservatism Principle
 future benefits (e.g. inventories, property,
The conservatism principle speaks to the risk-averse plant and equipment); and
nature of accounting. It means that when there is
uncertainty and estimates must be made, account-  unexpired costs (e.g. goodwill and prepaid
ants will avoid overstating assets, revenues and expenses).
gains, and avoid understating liabilities, expenses Liabilities and equity represent different methods
and losses. (This does not extend to deliberately for financing or paying for the assets.
understating assets, revenues and gains, or deliber-
ately overstating liabilities, expenses and losses.)  Liabilities represent monies or credit ex-
tended to the entity by non-owners to allow
[§4.03] Financial Statements the entity to acquire assets.
 Equity represents the funds provided by
A full set of financial statements includes six parts: owners (e.g. to purchase shares from the
(1) an accountant’s or auditor’s communication company) or by the business (e.g. retained
about the financial statements; earnings), and is also the residual interest
shareholders have in the enterprise as meas-
(2) a balance sheet (statement of financial position); ured in historical cost values.
(3) a statement of income and retained earnings; Anything that an entity owns (assets) must have
(4) a statement of cash flows; been paid for or financed from some source of
funds such as creditors’ money (liabilities), the
(5) notes to the financial statements; and owners’ money (capital stock) or the entity itself
(6) comparative information for the preceding fiscal (retained earnings). Consequently, a fundamental
period (usually displayed within the above five relationship between these accounts is expressed by
components). the following balance sheet equation:
Assets = Liabilities + Equity

Business: Commercial
 59
A review of Acme’s balance sheet reveals that on takes place over a period of time. The statement
December 31, 2009 and 2010, this equation was as provides the details of the revenues (the inflow of
follows: assets or reduction in liabilities) and expenses (the
outflow of assets or incurrence of liabilities) in-
December 31, 2009
curred to earn those revenues. The difference be-
$3,452,830 = $1,759,899 + $1,692,931 tween the revenues and expenses is net income (or
net loss) for that period.
December 31, 2010
The income statement typically divides revenues
$3,964,360 = $1,809,176 + $2,155,184 and expenses into categories that portray the major
The balance sheet also distinguishes between ac- activities of the business. A reader can therefore see
counts that are “current” and those that are “non- how different parts or sectors of the business are
current.” The purpose of this classification is to dis- performing.
tinguish figures and accounts that are part of the The statement of retained earnings presents the
short-term operation of the business (“current ac- changes in the retained earnings during the time pe-
counts”) from accounts that are not (“non-current” riod. “Retained earnings” refer to the income that
or “long-term” accounts). the enterprise has generated since inception, less the
The current accounts indicate the liquidity of the amount distributed to owners as dividends. Where
business. Current assets represent cash or cash in- this amount is negative, it is referred to as an “ac-
flows to be realized within in the upcoming year cumulated deficit” or a “deficit.” The statement of
(e.g. accounts receivable). Current liabilities repre- retained earnings reconciles the retained earnings at
sent the reverse, that is, cash to be paid out in the the beginning of the year (“opening retained earn-
upcoming year (e.g. accounts payable). If current ings”) to the balance at the end of the year (“closing
assets exceed current liabilities, it suggests that the retained earnings”).
entity is liquid and will be able to pay off liabilities Retained earnings are adjusted during the year by
as they come due. The reverse relationship indicates the net income earned minus the amounts distribut-
that cash outflows might exceed cash inflows, caus- ed to owners as dividends. This calculation is ex-
ing potential future financial difficulties for the pressed by the following retained earnings equation:
business.
Opening + Net – Dividends = Closing
Non-current assets represent the productive assets Retained Income Retained
of a business (e.g. the property, plant and equip- Earnings Earnings
ment used in the business’s operations). Non- for the for the
current liabilities represent the long-term financing period period
costs to acquire these assets, including cash out-
flows expected to be made one or more years later.
Equity, the residual interest of the owners in the In the case of Acme, this relationship for 2009 and
business, is a non-current item because the primary 2010 is:
way to convert equity into a cash outflow is to liq- 2009:
uidate the business, contrary to the going-concern $1,170,523 + $220,908 – $8,500 = $1,382,931
assumption.
2010:
2. The Statement of Income and Retained $1,382,931 + $373,253 – $11,000 = $1,745,184
Earnings
3. The Statement of Cash Flows
The statement of income and retained earnings con-
tains two subsets: The statement of cash flows is the most complex of
the statements prepared by accountants. It builds on
 a statement of income (or “income state- the information in the other statements and consoli-
ment”); and dates the data into a single report from a cash flow
 a statement of retained earnings. perspective. It also usually requires knowledge of
the entity’s transactions beyond what is reflected on
These statements are frequently presented as two the surface of the financial statements.
separate statements. Each component warrants spe-
cial consideration. For larger companies and for public companies the
statement of cash flows is very important, whereas
The income statement reports the results of a busi- many private or non-regulated businesses do not
ness operation over a particular time period, usually even prepare a statement of cash flows.
one year. If a balance sheet is like a photograph, an
income statement is like a movie which shows what

Business: Commercial
 60
A statement of cash flows classifies cash receipts 4. Notes to Financial Statements
and payments into three major categories:
The notes to financial statements complete the re-
(1) operating activities; porting process, providing qualitative information
to explain and support the quantitative information
(2) investing activities; and
in the financial statements. The notes also provide
(3) financing activities. more detailed quantitative data that cannot be pre-
sented on the other components of the financial
Grouping cash flows into these categories identifies
statements. Without these notes, the user cannot ful-
the effects on cash of each of the major activities of
ly understand what the financial statements suggest
a company.
about the entity.
(a) Operating Activities
The information in the notes to the financial state-
A statement of cash flows shows the transac- ments should:
tions that constitute the company’s operating
(a) summarize key accounting policies applied
activities. Generally, the cash effects of these
by the entity, to explain how the financial
transactions determine the net cash flow result-
statements’ balances were derived (see
ing from operating activities.
Note 1 to Acme’s financial statements);
The primary operating cash inflows are cash
(b) break down consolidated amounts (see
receipts from customers resulting from sales
Notes 2 and 3);
made or services rendered.
(c) describe events and conditions critical to de-
Typical operating cash outflows include cash
riving these amounts (see Notes 4 and 5); and
payments for merchandise purchases or set-
tling other accounts payable, cash payments to (d) describe contingencies and events subsequent
employees, cash payments to outside suppliers to the balance sheet data that have a signifi-
for various services and supplies, and cash cant continued effect on the entity (see
payments for taxes. Notes 6, 7 and 8).
(b) Investing Activities Most financial statements will explicitly refer to
these notes. For example, Acme’s balance sheet, in-
A company’s investing activities consist of
come statement, and statement of cash flows explic-
transactions involving the acquisition and dis-
itly state, “The accompanying notes are an integral
posal of plant assets and intangible assets, and
part of these financial statements.” Many of the ac-
the lending and subsequent collection of mon-
counts on the balance sheet also refer to the notes.
ey. The related cash receipts and payments ap-
Readers should review the notes closely and con-
pear in the “investing activities” section of the
sider how they affect the information reported in the
statement of cash flows. Cash inflows come
other financial statements.
from events such as cash sales of plant assets
and intangible assets, cash sales of investments
5. Comparative Information
in shares and bonds, and loan repayments from
borrowers. Typical cash outflows related to in- Under GAAP, external financial statements should
vesting activities include cash payments made provide comparative financial information (i.e. dol-
in order to purchase shares and bonds, and lar figures) for the preceding fiscal period. Compar-
cash loaned to borrowers. ative balances allow readers to evaluate the busi-
ness’s current performance and financial position
(c) Financing Activities
relative to another period in time. In particular,
A company engages in “financing activities” comparative information allows users of the finan-
when it takes money from owners, borrows cial statements to:
money from creditors, and repays amounts
(a) Identify changes in relative and absolute
borrowed. Cash flows related to these events
amounts.
are reported in the “financing activities” sec-
tion of the statement of cash flows. For exam- These differences allow users to consider
ple, this section would report cash received for whether the changes say anything about how
issuing shares or bonds, and cash paid out in well the business is being managed.
dividends or to reduce long-term debts. Among
(b) Predict future performance.
other things, reports on financing activities al-
low a user of the financial statements to assess Financial statements generally calculate past
whether the business relies heavily regularly results. Past results are a useful starting point
issuing shares or bonds to finance its opera- for future projections.
tions.

Business: Commercial
 61
(c) Isolate relationships between figures and terially incorrect. This type of report may be prepared
consider their implications. when shareholders have waived their right to an audit.
For example, the figures for Acme indicate Finally, a “Notice to Reader” or “Compilation Report”
that something is amiss with their inventory. cautions that the accountant has only received infor-
Acme’s sales increased by about 8% from mation from the client and arranged it into financial
2009 to 2010. Accounts receivable represents statements. The accountant has taken no steps to verify
the portion of sales that are uncollected as at or review the information, and provides no assurance
the balance sheet date, so a reader would ex- about it.
pect to see an equivalent increase there. The
Lawyers must understand how these types of reports
actual increase on Acme’s balance sheet is
differ so that they can advise clients accordingly. For
about 4%, which shows a reasonable harmo-
example, it would probably not be appropriate for a
ny between sales and accounts receivable.
small business to agree to provide an audit report as part
Inventory, the items ready to be sold, should
of the terms of a contract, due to the cost of doing so.
presumably also increase similarly with sales.
However, Acme’s inventories increased by The following paragraphs describe these communica-
34% during the year! Something appears tions in more detail.
amiss and further investigation is warranted.
(a) Audits
If this rate of increase continues, Acme will
soon face a liquidity problem if it continues Most limited companies are required by law to pre-
to invest in inventory (a non-cash asset). sent annual financial statements to their sharehold-
ers. Unless the shareholders waive this right, these
[§4.04] Accountants’ and Auditors’ statements must be audited by an independent Char-
Communications2 tered Professional Accountant. The auditor is re-
sponsible to the shareholders and reports to them. In
External financial statements produced by a professional addition, an audit may be required under a lending
accountant are covered by a “report” that tells the reader agreement or a contract.
the nature of the accountant’s involvement with the The objective of an audit is to obtain reasonable
financial statements. assurance that the financial statements as a whole
Three types of reports are used by accountants issuing are not materially misstated. Auditors do not guar-
financial statements to the public: antee the accuracy of financial statements; rather,
they render their professional opinion as to the
(a) an Auditor’s Report; overall fairness of the statements. “Fairness” means
(b) a Review Engagement Report; and that the financial statements are not misleading.
(c) a Notice to Reader (or “Compilation Report”). There is always a possibility that an auditor’s opin-
ion is in error, or that the auditor was intentionally
(See the end of this section for examples of these misled by management. Although the auditor exer-
reports.) cises due care and diligence in auditing the infor-
Each report explains the degree of assurance or credibil- mation, the Auditor’s Report clearly indicates that
ity that the accountant is adding to the financial state- management is ultimate responsible for the accura-
ments. cy of the information.
The highest level of assurance is provided by an “Audi- The audit usually involves inspecting financial rec-
tor’s Report,” in which the accountant states an opinion ords and operations, confirming with external third
on the fairness or truthfulness of the information parties the accuracy of balances due to or from the
presented in the financial statements. The Auditor’s Re- company, examining supporting documents to as-
port gives readers reasonable assurance that the state- sure authenticity, and evaluating the company’s in-
ments are free from material misstatement. ternal control procedures to ensure systems are in
place to safeguard the company’s assets and ac-
In a “Review Engagement Report,” the accountant does counting records. However, it is not practicable to
not render an audit opinion on the financial statements, verify all information, nor would it be affordable for
but provides only negative assurance that “nothing has most organizations to pay auditors to do so. There-
come to our attention” to suggest the statements are ma- fore, many of the auditor’s procedures are done on a
sample testing basis. Partly due to this, an audit
does not provide 100% assurance.
2
Part of the material in this section was kindly provided by the If the auditor disagrees with the company about the
Institute of Chartered Professional Accountants of British Co-
lumbia and adapted for PLTC.
accuracy or fairness of the financial information
presented, the auditor will qualify the report with

Business: Commercial
 62
specific reference to the disagreement. On those ra- INDEPENDENT AUDITOR’S REPORT
re occasions, the auditor must state the nature of the
disagreement and the impact of the disagreement on [Addressee]
the financial statements. Such disagreements might
involve the valuation of assets or the method of re- Opinion
cording revenue. We have audited the financial statements of ABC
(b) Review Engagements Company (the “Company”), which comprise the
balance sheet as at December 31, 20XX, and the
The objective of a review is to discover if the finan- statements of income, retained earnings and cash
cial statements are plausible, applying GAAP. As flows for the year then ended, and notes to the fi-
noted earlier, the Review Engagement Report pro- nancial statements, including a summary of signifi-
vides only negative assurance that nothing has cant accounting policies.
come to the accountant’s attention to suggest the
statements are materially incorrect. In our opinion, the accompanying financial state-
ments present fairly, in all material respects, the fi-
The review involves inquiry, analytical procedures, nancial position of ABC Company as at Decem-
and discussion about information supplied by the ber 31, 20XX, and the results of its operations and
company. The accountant must exercise due care in its cash flows for the year then ended in accordance
reviewing the financial statements. If anything with the applicable financial reporting framework.
comes to light that suggests the statements do not
adhere to GAAP or are misleading, the accountant Basis for Opinion
must disclose this fact in the Review Engagement We conducted our audit in accordance with Canadi-
Report. Accountants cannot be associated with fi- an generally accepted auditing standards. Our re-
nancial statements which they know or believe are sponsibilities under those standards are further de-
misleading or incorrect, and they must disassociate scribed in the Auditor’s Responsibilities for the
themselves from the statements if the company is Audit of the Financial Statements section of our re-
averse to changing them. port. We are independent of the Company in ac-
A review may be adequate for the needs of financial cordance with the ethical requirements that are rel-
statement users where there is limited risk exposure, evant to our audit of the financial statements in
or where the shareholders are involved in the day- Canada, and we have fulfilled our other ethical re-
to-day operations of the business. sponsibilities in accordance with these require-
ments. We believe that the audit evidence we have
(c) Notice to Reader or Compilation Engagements obtained is sufficient and appropriate to provide a
Accountants are often asked to compile financial basis for our opinion.
statements when there is no need for the assurance Material Uncertainty Related to Going Concern
provided by an Auditor’s Report or a Review En-
gagement Report. For instance, management may [where there is a material uncertainty about the en-
want financial statements for internal management tity’s ability to continue as a going concern]
purposes or for income tax purposes. We draw attention to Note X in the financial state-
In this case, the accountant receives information ments, which indicates that the Company incurred a
from the client and arranges it into a financial net loss of $X during the year ended December 31,
statement. The accountant is not required to verify, 20XX and, as at that date, the Company’s current
corroborate or review information supplied by the liabilities exceeded its total assets by $X. As stated
client. The accountant’s concern is simply that the in Note X, these events or conditions, along with
information is correctly assembled. The accountant other matters as set forth in Note X, indicate that a
gives no assurance that there is no reason to believe material uncertainty exists that may cast significant
that the financial statements are false or misleading. doubt on the Company’s ability to continue as a go-
ing concern. Our opinion is not modified in respect
The Notice to Reader is intended as a clear warning of this matter.
of the limited usefulness of these statements. For
decision-making purposes, readers of statements Other Information
prefaced by a Notice to Reader who do not have ac- [where applicable, such as for annual reports]
cess to other information should consider seeking
the assurance provided by an audit or review. Management is responsible for the other infor-
mation. The other information comprises the infor-
Examples of these reports follow below. Please note that mation included in [X report], but does not include
the accounting regulatory bodies have recently changed the financial statements and our auditor’s report
these reports, and the examples in this chapter may look thereon. Our opinion on the financial statements
different than the reports you may see for prior years.

Business: Commercial
 63
does not cover the other information and we do not We also:
express any form of assurance conclusion thereon.
• Identify and assess the risks of material mis-
In connection with our audit of the financial state- statement of the financial statements, wheth-
ments, our responsibility is to read the other infor- er due to fraud or error, design and perform
mation and, in doing so, consider whether the other audit procedures responsive to those risks,
information is materially inconsistent with the fi- and obtain audit evidence that is sufficient
nancial statements or our knowledge obtained in the and appropriate to provide a basis for our
audit or otherwise appears to be materially misstat- opinion. The risk of not detecting a material
ed. If, based on the work we have performed, we misstatement resulting from fraud is higher
conclude that there is a material misstatement of than for one resulting from error, as fraud
this other information, we are required to report that may involve collusion, forgery, intentional
fact. We have nothing to report in this regard. omissions, misrepresentations, or the over-
ride of internal control.
Responsibilities of Management and Those
Charged with Governance for the Financial • Obtain an understanding of internal control
Statements relevant to the audit in order to design audit
procedures that are appropriate in the cir-
Management is responsible for the preparation and
cumstances, but not for the purpose of ex-
fair presentation of these financial statements in ac-
pressing an opinion on the effectiveness of
cordance with the applicable financial reporting
the Company’s internal control.
framework, and for such internal control as man-
agement determines is necessary to enable the prep- • Evaluate the appropriateness of accounting
aration of financial statements that are free from policies used and the reasonableness of
material misstatement, whether due to fraud or er- accounting estimates and related disclosures
ror. made by management.
In preparing these financial statements, manage- • Conclude on the appropriateness of man-
ment is responsible for assessing the Company’s agement’s use of the going concern basis of
ability to continue as a going concern, disclosing, as accounting and, based on the audit evidence
applicable, matters related to a going concern and obtained, whether a material uncertainty ex-
using the going concern basis of accounting unless ists related to events or conditions that may
management either intends to liquidate the Compa- cast significant doubt on the Company’s
ny or to cease operations, or has no realistic alterna- ability to continue as a going concern. If we
tive to doing so. conclude that a material uncertainty exists,
we are required to draw attention in our au-
Those charged with governance are responsible for
ditor’s report to the related disclosures in the
overseeing the Company’s financial reporting pro-
financial statements or, if such disclosures
cess.
are inadequate, to modify our opinion. Our
Auditor’s Responsibilities for the Audit of the conclusions are based on the audit evidence
Financial Statements obtained up to the date of our auditor’s re-
port. However, future events or conditions
Our objectives are to obtain reasonable assurance
may cause the Company to cease to continue
about whether the financial statements as a whole
as a going concern.
are free from material misstatement, whether due to
fraud or error, and to issue an auditor’s report that • Evaluate the overall presentation, structure
includes our opinion. Reasonable assurance is a and content of the financial statements, in-
high level of assurance, but is not a guarantee that cluding the disclosures, and whether the fi-
an audit conducted in accordance with Canadian nancial statements represent the underlying
generally accepted auditing standards will always transactions and events in a manner that
detect a material misstatement when it exists. Mis- achieves fair presentation.
statements can arise from fraud or error and are
We communicate with those charged with govern-
considered material if, individually or in the aggre-
ance regarding, among other matters, the planned
gate, they could reasonably be expected to influence
scope and timing of the audit and significant audit
the economic decisions of users taken on the basis
findings, including any significant deficiencies in
of these financial statements. As part of an audit in
internal control that we identify during our audit.
accordance with Canadian generally accepted audit-
ing standards, we exercise professional judgment [listed entities only] We also provide those charged
and maintain professional skepticism throughout with governance with a statement that we have
the audit. complied with relevant ethical requirements regard-
ing independence, and communicate with them all

Business: Commercial
 64
relationships and other matters that may reasonably Conclusion
be thought to bear on our independence, and where
Based on our review, nothing has come to our atten-
applicable, related safeguards.
tion that causes us to believe that the financial
[listed entities only] The engagement partner on the statements do not present fairly, in all material re-
audit resulting in this independent auditor’s report spects, the financial position of ABC Company as
is [name]. at December 31, 20XX, and the results of its opera-
tions and its cash flows for the year then ended in
[Auditor’s signature]
accordance with [Canadian accounting standards
[Date of the auditor’s report]
for private enterprises].
[Auditor’s address]
[Practitioner’s signature]
[Date of the practitioner’s report]
INDEPENDENT PRACTITIONER’S REVIEW
[Practitioner’s address]
ENGAGEMENT REPORT
[Addressee]
NOTICE TO READER
We have reviewed the accompanying financial
To Management of ABC Company
statements of ABC Company that comprise the bal-
ance sheet as at December 31, 20XX, and the On the basis of information provided by manage-
statements of income, retained earnings and cash ment, we have compiled the balance sheet of ABC
flows for the year then ended, and a summary of Company as at December 31, 20XX, the statement
significant accounting policies and other explanato- of income and retained earnings for the year then
ry information. ended, and Note X, which describes the basis of ac-
counting applied in the preparation of the financial
Management’s Responsibility for the Financial
information [and other explanatory information]
Statements
(“financial information”).
Management is responsible for the preparation and
Management is responsible for the accompanying
fair presentation of these financial statements in ac-
financial information, including the accuracy and
cordance with [Canadian accounting standards for
completeness of the underlying information used to
private enterprises], and for such internal control as
compile it.
management determines is necessary to enable the
preparation of financial statements that are free We performed this engagement in accordance with
from material misstatement, whether due to fraud or Canadian Standard on Related Services (CSRS)
error. 4200, Compilation Engagements, which requires us
to comply with relevant ethical requirements. Our
Practitioner’s Responsibility
responsibility is to assist management in the prepa-
Our responsibility is to express a conclusion on the ration and presentation of the financial information
accompanying financial statements based on our re- of the entity.
view. We conducted our review in accordance with
We did not perform an audit engagement or a re-
Canadian generally accepted standards for review
view engagement, nor were we required to perform
engagements, which require us to comply with rele-
procedures to verify the accuracy or completeness
vant ethical requirements.
of the information provided by management. Ac-
A review of financial statements in accordance with cordingly, we do not express an audit opinion or a
Canadian generally accepted standards for review review conclusion, or provide any form of assur-
engagements is a limited assurance engagement. ance on the financial information.
The practitioner performs procedures—primarily
Readers are cautioned that the financial information
consisting of making inquiries of management and
may not be appropriate for their purposes.
others within the entity, as appropriate, and apply-
ing analytical procedures—and evaluates the evi- [Practitioner’s signature]
dence obtained. [Date of the practitioner’s report]
[Practitioner’s address]
The procedures performed in a review are substan-
tially less in extent than, and vary in nature from,
those performed in an audit conducted in accord-
ance with Canadian generally accepted auditing
standards. Accordingly, we do not express an audit
opinion on these financial statements.

Business: Commercial
 65
[§4.05] Financial Statement Analysis 3. Liquidity Analysis
“Liquidity” refers to the ability of an entity to meet
Financial statement analysis is the process of analyzing
its obligations to short-term creditors. Liquidity is
an entity’s financial statements to determine the entity’s
important because if the entity cannot meet its
financial position and to make decisions.
short-term debt-paying ability, it will not be able to
Various techniques are used in the analysis of financial maintain its long-term debt-paying ability, or to sat-
data. This material addresses only two of the most com- isfy its shareholders. Some liquidity ratios focus on
mon techniques: comparative (trend) analysis and ratio the company’s liquidity at a particular point in time,
analysis. while others (also called “activity ratios”) assess
how efficiently the company uses its current assets
1. Comparative Analysis to generate cash.
Comparative analysis involves looking for trends, Analyzing liquidity requires an understanding of
by comparing information about the entity from pe- “current assets” and “current liabilities.” To recall,
riod to period. current assets represent cash or cash inflows to be
realized within one year, and current liabilities rep-
Most financial statements include information for
resent cash to be paid out within one year.
the preceding year. Users of financial statements
can begin to form certain conclusions by identifying The ratios most commonly used to measure liquidi-
whether certain numbers have gone up or down, ty are the current ratio and the quick (or acid test)
particularly in light of other items that have ratio.
changed. For instance, have sales increased? If so,
The current ratio shows how many dollars of cur-
then the entity’s business has probably expanded
rent assets the company has for each dollar of cur-
somewhat. On the other hand, have sales decreased
rent liabilities. For example, as shown at Appen-
while expenses have increased? If so, something
dix 5, Acme had a current ratio of 1.92-to-1 in
may be awry.
2010. This means that Acme had $1.92 invested in
In Appendix 4, we see in Acme’s Balance Sheet current assets for every dollar in current liabilities.
that $5,000 of dividends were payable in 2009 but
The closer a company’s current ratio is to 1, the
$0 of dividends in 2010; that may be relevant. We
more likely the company will have difficulty in
also see that inventories have increased significant-
meeting its short-term obligations. In general, a cur-
ly on the balance sheet, from $1,174,702 to
rent ratio of at least 2-to-1 is desirable. However,
$1,575,438; the increase seems disproportionate to
whether a particular current ratio is acceptable de-
the change in sales. Why the change? As the lawyer
pends on the trend in the ratio over time and how it
you are not expected to answer such questions, but
compares with ratios for similar companies. Too
it will help to be able to identify relevant changes.
high a current ratio can also be undesirable—it can
indicate that the company has too much money in-
2. Ratio Analysis
vested in current assets, which are normally non-
Ratio analysis involves using numbers from the fi- income-producing, rather than in fixed assets,
nancial statements to obtain information about a which are income-producing.
company. This material focuses on three types of
Current assets normally consist of cash, marketable
financial ratios:
securities, accounts receivable, inventory, and pre-
(a) Liquidity ratios measure a company’s ability paid expenses. Of these items, inventory and pre-
to meet its current obligations (cash outflows) paid expenses are considered the least liquid assets,
as they come due. because they are the furthest from being converted
into cash—inventory must first be sold and the sales
(b) Solvency ratios measure a company’s ability
collected, and prepaid expenses cannot be readily
to pay the principal and interest on debt in the
sold for cash.
long term.
As a result, analysts often calculate an additional li-
(c) Profitability ratios measure a company’s
quidity ratio called the quick ratio to provide fur-
ability to generate income.
ther insight than the current ratio by removing in-
These types of ratios are among those most fre- ventory and prepaid expenses from current assets.
quently used, and lenders often require companies From a creditor’s perspective, the quick ratio more
to maintain certain ratio levels to keep their loans in meaningfully evaluates the company’s liquidity and
good standing. ability to meet payments when due. Acme’s 2010
quick ratio of .68 would normally be considered
poor, because it is less than 1 and indicates that the

Business: Commercial
 66
company has insufficient cash and cash equivalents
to meet its short-term obligations. 4. Solvency Analysis
Turnover or activity ratios measure how efficient- Business debt involves two obligations: to repay the
ly the company uses its assets. Acquiring and using principal and to pay interest while the principal is
assets is costly. If the assets do not generate suffi- owing. Solvency analysis measures a company’s
cient sales, overall profitability will suffer. Two ability to repay the principal and interest on debt in
commonly used activity ratios are accounts receiva- the long term (as compared to liquidity analysis,
ble turnover and inventory turnover. which focuses on the entity’s ability to repay short-
term debt). Creditors often want information about
Accounts receivable turnover indicates how many the solvency of a company in order to determine
times a year a company collects its receivables. The whether the company will be able to keep up on its
accounts receivable turnover ratio can be used to es- interest payments.
timate the average number of days required to col-
lect a receivable, commonly referred to as the “col- Solvency ratios are sometimes referred to as lever-
lection period.” At Acme, an account receivable age ratios. “Leverage” refers to the amount of debt
remained outstanding for an average of 52 days in a company uses to finance its assets. The more debt,
2010. Whether this number is acceptable depends the more highly leveraged the company. Leverage
on the company’s policy for granting credit. has advantages and disadvantages. Its main ad-
vantage is that by using someone else’s money,
Inventory turnover measures the number of times owners can maximize their returns. Its main disad-
a year that the company sells its inventory. Acme vantage is that leverage increases the company’s
turned over its inventory approximately 2.59 times exposure to risk: increased leverage means in-
a year, or every 141 days in 2010. Of course, a creased interest payments, and if a company starts
company could maximize its inventory turnover and to earn less than it pays out, the company can end
minimize inventory costs by keeping inventory low, up defaulting on its debts and going bankrupt.
but this policy could lessen sales and customer
goodwill. As a result, management wants to maxim- There are two approaches to assessing solvency:
ize inventory turnover while ensuring that enough  The debt ratio measures the company’s
inventory is available to meet customer needs. ability to carry debt, as indicated by the bal-
In sum, the formulas for these liquidity ratios are as ance sheet.
follows:  The times-interest-earned ratio measures
Current Ratio Current Assets the company’s ability to carry debt, as indi-
= Current Liabilities cated by the income statement.
Quick Ratio = Quick Assets * The debt ratio is calculated by dividing total lia-
(Acid Test) Current Liabilities bilities by total assets. The resulting number shows
the percentage of assets financed by debt. In 2010,
Accounts Receivable = Sales Acme financed 46% of its total assets with debt and
Turnover Average Accounts Receivable the rest, 54%, with equity. Acme’s 2009 debt ratio
(51%) shows that the company’s debt ratio has de-
Accounts Receivable = 365 creased. This is largely due to the fact that the com-
Turnover Accounts Receivable Turnover
pany financed its increase in assets in 2010 through
(In Days)
the company’s own retained earnings, as opposed to
Inventory Turnover = Cost of Goods Sold external debt.
Average Inventory The times-interest-earned ratio shows the margin
Inventory Turnover = 365 by which the company’s income (before interest
(In Days) Inventory Turnover and taxes) exceeds interest payments. It is calculat-
ed by dividing the income (before interest and tax)
by the interest expense. This figure shows how
* Calculated as either:
much income could decline before jeopardizing the
Cash + Marketable Securities + Accounts Receivable payment of interest. In 2010, Acme’s income avail-
or able to meet interest payments was 6.66 times the
Current Assets – Inventory and Prepaid Expenses amount of these payments—a good margin of safe-
ty. If the ratio were less than 1, it would indicate
that the income before interest was less than the in-
terest expense, resulting in a net loss. Repeated
times-interest-earned ratios of less than 1 suggest
that the entity’s financial demise is inevitable,

Business: Commercial
 67
whereas a repeatedly high ratio suggests that the en- Company B had a return on assets of 12.5%
terprise is not maximizing its use of debt financing. ($10,000/$80,000). Without relating net income to
some measure of investment—in this case, total as-
In sum, the formulas for the debt ratio and the
sets—a misleading picture of performance could re-
times-interest-earned ratio are as follows:
sult.
Debt = Total Liabilities
Despite the usefulness of return on assets, share-
Ratio Total Assets
holders are often more interested in determining the
return on their own investment. From the share-
Times = Income Before Interest Expense and Tax
holder’s vantage point, a company’s return on eq-
Interest Interest Expense
uity is of particular importance. Return on equity
Earned
measures the company’s ability to generate income
from its shareholders’ investments, and is calculat-
5. Profitability Analysis ed by dividing net income by total equity.
Profitability is the ability of the company to gener- In 2010, Acme’s return on assets was 9.4%; its re-
ate positive income. turn on equity was 17.2%. Why is this the case?
Take, for instance, a company with no debt or lia-
Profitability ratios are probably the most important
bilities. In such a case, the company’s total assets
ratios to financial statement users. Profits are im-
would equal its total equity, and return on assets
portant to shareholders because they derive revenue
and equity would be equal. To the extent that a
in the form of dividends, which are paid from prof-
company uses debt, the return on equity will differ
it, and increased profits can also increase the market
from the return on assets. For example, if a compa-
price of shares, leading to capital gains. Profits are
ny realizes a return on borrowed capital greater than
also important to creditors, because they are a
the amount of interest paid, return on equity will be
source of funds for debt coverage. Management is
higher than return on assets, because any excess re-
also interested in profit, as it is often used as a per-
turns accrue to the shareholders without the share-
formance measure.
holders having to increase their investment.
One indication of a company’s profitability is its net
To review, the profitability ratio formulas are as
income. However, net income alone is often
follows:
misleading in a performance evaluation because net
income is an absolute number when, in fact, profits Return on Sales = Net Income
should be evaluated in the context of the company’s Sales
size and competitive position. As a result, analysts
typically construct profitability ratios to compare Return on Assets = Net Income
net income with sales, assets, or shareholders’ Total Assets
equity. These ratios are described below.
Return on Equity = Net Income
The return on sales (also known as the profit
Total Equity
margin) measures how much the company earns on
every dollar of sales. In 2009, Acme earned approx-
imately $.048 on every dollar of sales, while in [§4.06] Conclusion
2010 the amount increased to $.077. Most retailers,
such as grocery store and department store owners, This chapter is intended to familiarize you with the key
have very small profit margins but high turnover. accounting terms and concepts that are frequently
Without this turnover, profits would be low. In con- encountered in the practice of law. However, the
trast, manufacturers of heavy-duty equipment, such accounting process and financial statements are much
as tractors and computers, have low asset turnover more intricate than this chapter might suggest. Just as
but high profit margins. Thus, each sale generates a accountants generally seek legal counsel when facing
significant profit for the company. situations requiring legal interpretation, when you are
dealing with financial information that is not
The return on assets measures how well the com-
straightforward, or where financial statements may be
pany is doing relative to its level of investment in
important to the matter you are working on, you should
assets. For example, assume Company A and Com-
consult an accountant.
pany B each had net earnings of $10,000 in YR1.
Company A had total assets of $100,000 while
Company B had total assets of $80,000. What can
we conclude from this data? All other things being
equal, Company B earned a greater return on its in-
vestment than Company A. Company A had a re-
turn on assets of 10% ($10,000/$100,000), while

Business: Commercial