BLAW CHAPTER 9

Borrowing money from a lender is called a. equity financing. b. debt financing. c. secure financing. d. collateral financing.

B

Generix Company finds itself unable to pay its debts as they become due but it wants to avoid bankruptcy and continue to carry on business. Generix should consider a. voluntarily assigning its assets to a trustee in bankruptcy. b. petitioning for a receiving order. c. making a proposal to its creditors. d. avoiding creditors until it returns to financial health.

C

What is electronic banking?

Electronic banking is a term that describes the use of computers, public automated teller machines (ATMs or bank machines), and telephones by bank customers to perform many of their banking transactions, instead of having to complete paper documents and attend bank branches in person.

The payer of a cheque is always a financial institution.

False

What are the conditions under which you can sue a debtor in Small Claims Court in BC? What is a significant advantage of doing so?

In BC, if you are a creditor and the amount of the debt is under $25,000, you can sue the debtor in Small Claims Court. There are a number of advantages: the court fees are much lower; the process is simpler and faster; and the evidence rules are relaxed, which makes it easier to prove a case. In Small Claims Court, you can either represent yourself or hire an agent — rather than a lawyer — to represent you.

What is a general security agreement?

In a general security agreement, a borrower pledges all or most of its assets as collateral or security for a loan. Financial institutions may also require that the officers and directors of small businesses pledge their personal assets — their homes, for example — as security for the business's loan.

What are the differences between a secured loan and an unsecured loan?

In an unsecured loan, a lender advances funds to a borrower in exchange for a simple promise to repay the loan. If the borrower does not repay the loan, the lender's only legal recourse is to sue the borrower on his promise to repay. With a secured loan, the borrower promises the lender that he will repay the loan and provides the lender with rights in collateral. If the borrower does not repay the loan, the lender can still sue the borrower, but the lender may also seize the collateral and sell it, using the money from the sale to pay down the loan.

What actions are within a lender's rights in the circumstances of non-payment on a secured loan?

On default, most secured loan agreements permit the lender to seize control of the collateral and sell it without having to obtain a court order. The lender may recover the funds that she loaned the borrower — and the money she spent on selling the collateral — from the proceeds of the sale. If the funds obtained from the sale do not cover the loan, the lender can then sue the borrower for the balance still owing. If the funds obtained from the sale exceed what is owed to the lender, the borrower is entitled to the excess amount. Declaring bankruptcy constitutes a default under the terms of most secured loan agreements. Therefore, if a borrower goes bankrupt, the lender is entitled to take steps to recover her investment by seizing the collateral, which gives her interest in the bankrupt's property priority over the interests of the unsecured creditors of the bankrupt.

What is the purpose of the Bankruptcy and Insolvency Act? What advantages does it provide to both the bankrupt company and its creditors?

The general purpose of the Bankruptcy and Insolvency Act is to distribute a bankrupt's assets fairly among its creditors discharge the bankrupt from further responsibility and allow it to start over Prevent fraud and fraudulent preferences Punish those who seek to defraud creditors The Act operates by requiring bankrupt individuals and companies to turn over their assets to a trustee, who sells them and distributes the money from the sale to the bankrupt's creditors. A bankrupt who has not committed a fraud or other bankruptcy offence will be released from bankruptcy, with many of its assets gone, but with most of its debts discharged and cancelled. The bankrupt is then free to begin again, relieved of its load of debt. You might ask why bankrupts should be able to escape their debts in this way. A short answer is that a discharged bankrupt, if freed of old debt, will be able to resume the commercial activity that ultimately benefits the economy and the consuming public as a whole. Creditors will recover at least some portion of what is owed to them, and they too will be able to continue engaging in useful economic activities and contribute to economic growth.

What are the three types of negotiable instruments currently in use in a business context?

There are three types of negotiable instruments currently in use in a business context: cheques, bills of exchange, and promissory notes.

What are the most common financial institutions a small business is likely to form a relationship with in Canada?

To accomplish any of these goals, your business — or the business that you work for — needs an ongoing relationship with a financial institution. In Canada, that institution is likely to be a federally chartered bank, a federally or provincially chartered trust company, or a provincially chartered credit union.

Borrowing money from a lender is called debt financing, a concept that includes both short-term and long-term borrowing.

True

Credit cards are not negotiable instruments.

True

In British Columbia, if you are a creditor and the amount of the debt is under $25,000, you can sue the debtor in Small Claims Court.

True

What is debt financing? Give two ways that it may be accomplished.

With debt financing, the business borrows capital, usually from a financial institution. The business's obligation is to repay the loan, including interest, in accordance with the terms of the loan agreement. Debt financing may also be accomplished through the sale of bonds. Individual investors buy a business's bonds, thereby providing the business with capital in exchange for a fixed or variable rate of return over a number of years.

List and explain the elements of an effective business plan.

a. It tells potential lenders why the business needs money. b. It explains how you intend to use the money to improve operations and profitability. c. It describes the competence and industry experience of key company employees. d. It sets out the amount of money you need. e. It describes the sources and types of collateral that are available. f. It states when you will repay the loan.

Give three reasons why business people should familiarize themselves with banking, financing, and debtor-creditor law.

a. strengthen your position when dealing with them. Understanding that there is room for negotiation with banks and other financial institutions b. A sound mixture of debt and equity financing may be your business's recipe for success. c. If your business falls on hard times, sensible treatment of your creditors may keep you out of bankruptcy.

List the conditions usually required for a lender to provide unsecured credit. A lender rarely provides unsecured credit unless there is

• an ongoing relationship between the parties, • a high degree of trust, • a small loan, • a short repayment period, and • a high expectation that the loan will be repaid.

If a judge grants an absolute discharge from bankruptcy, obligations to pay ________ are relieved. a. any outstanding child support b. any orders for payment of restitution by the court c. any debts arising from a fraudulent act d. none of the above

D

Potential lenders inquiring into the credit history of a business may consider a. how the business's corporate bonds have been rated. b. the business's credit transaction history. c. existing security holders and details of their security interests. d. all of the above

D

The payee of a cheque may assign or transfer the right of payment to somebody else. In order to do so, the payee must _________ the cheque. a. deposit b. hold c. secure d. endorse

D

When a debtor defaults, which creditor has the right to be paid first is determined by a. whether the security interest was registered. b. when the security interest was registered. c. which creditor's debt was secured. d. all of the above

D

Under section 427 of the Bank Act, if the business gives the bank a collateral interest in an asset to secure continued financing, the bank acquires an ownership interest in the asset.

True

Unsecured creditors are those who extend credit in exchange for a simple promise by the debtor to repay the debt.

True

A secured creditor who wants to recover a debt a. may seize and sell property as soon as the debtor defaults. b. must wait until a writ of seizure and sale is obtained from the court. c. must obtain a court order to decide that a default has occurred. d. must sue the debtor for what is owed.

A

In ___________, a borrower pledges all or most of its assets as collateral or security for a loan. a. a general security agreement b. a proposal to creditors c. a floating charge d. equity financing

A

The debtor on a promissory note is called the a. maker. b. holder. c. payer. d. drawer.

A

What are the pros and cons of equity versus debt financing? How do most companies deal with this dilemma?

A company's "capital structure" refers to its mix of debt and equity financing. Achieving an appropriate capital structure usually requires consideration of a number of factors. It might appear that a business can minimize its risk by preferring equity financing over debt financing. However, a company may need to sell a lot of shares — thereby greatly expanding its ownership base — in order to raise the funding that it needs. If key shareholders control the management of a company, they will not be willing to share control with a group of dissatisfied shareholders, nor do they wish to set the scene for a successful takeover of the company. For these reasons, most companies opt for a mix of both debt and equity financing.

If a business defaults on its loan, the floating charge over all the pledged assets a. is extinguished. b. crystallizes. c. is discharged. d. executes.

B

If more than one unsecured creditor has obtained a judgment against a debtor the creditors will be paid as follows: a. in the order of when each creditor filed their writ. b. on a pro rata basis. c. by dividing the assets equally among them. d. in the order of the earliest registered interest.

B

Tim wrote a cheque that was named to Sally. Sally's bank has just returned the cheque to Tim's bank marked NSF. a. Tim is the payee. b. Tim's bank is the drawee. c. Sally is the drawee. d. Sally's bank is the drawer.

B

Using the ____________, a business is able to make a proposal to its creditors to restructure its debt while under the court's protection. a. Bankruptcy and Insolvency Act b. Companies' Creditors Arrangement Act c. Assignments and Preferences Act d. Bankruptcy Protection Act

B

What is a floating charge?

Because loans may be advanced in the future and may be in amounts not yet known, the general security agreement requires that a business — and possibly its officers and directors — pledge a pool of assets sufficiently large to cover its future debt. This pool of assets will vary from time to time. This pledge is called a floating charge. It is created because this business needs to be free to use its assets to earn income.

Generix Company owes Big Fish Inc. $15,000 and the account has been past due for three months. Despite this, Generix remains optimistic about its financial future and isn't considering declaring bankruptcy. Big Fish a. must wait until Generix voluntarily declares bankruptcy before it can take action. b. must file a writ of seizure and sale. c. may file a petition for a receiving order. d. must wait for Generix to make a proposal.

C

Where a creditor has an interest in collateral owned by the debtor, the creditor is known as a. an interested creditor. b. a registered creditor. c. a secured creditor. d. an execution creditor.

C

In what ways can common shares produce a return on investment for shareholders?

Common shares are the most widely traded shares. They can produce a return on investment for shareholders in two ways: • through dividends — that is, a company's distribution of its profits to its shareholders; and • through resale by shareholders to new investors at a higher price than originally paid.

A lender may consider providing unsecured credit if a. the relationship between the parties is new. b. the loan is significantly large. c. the loan is expected to be repaid over an extended period. d. none of the above

D

Before an unsecured creditor takes legal action to collect a debt, it may consider a _________ that states that the debtor has defaulted and that he must pay the full amount owing, including interest, by a given date, or face legal action. a. garnishment b. proposal c. notice d. demand letter

D

Briefly explain equity financing in the context of businesses in the private and public sectors.

Equity financing involves the contribution of funds by the shareholders. In the case of a privately held corporation, this may involve a contribution by the founders or it may involve an "angel investor" who invests in the business but does not get involved otherwise. In the case of public companies, equity financing involves issuing and selling shares to institutional investors and the public.

Explain equity financing.

Equity financing is arranged through the sale of shares in a business corporation. The shares give investors an interest in the business in exchange for providing capital. The value of a company's shares generally depends on how successful the business becomes. Shareholders must accept the risk that their shares may turn out to be valueless if the business fails. They cannot sue a company for the return of their capital in the same way that a lender can sue for repayment of a loan.

A company cheque is more secure than a bank cheque because it cannot be issued unless sufficient funds are available to the payer.

False

A late-coming secured creditor often recovers little or nothing from a bankrupt because the unsecured creditors with priority get in ahead and take the bankrupt's most valuable assets.

False

Businesses use credit cards for large purchases that they would otherwise have to pay for in instalments.

False

The rules that govern negotiable instruments in Canada are very different from those in the United States and the United Kingdom.

False

The unsecured creditor with the earliest registered interest in a particular item of collateral takes priority over secured creditors with interests in the same collateral.

False

Where a creditor has an interest in collateral owned by the debtor, the creditor is known as an unsecured creditor.

False

With a secured loan, the borrower promises the lender that he will repay the loan and may provide the lender with rights in collateral, although this is not required.

False

Explain the concept of collateral in the context of a secured debt.

If the debt is secured, the debtor — in addition to promising to repay the debt — backs up the promise by giving the lender a security interest in something of value owned by the debtor. The right or thing given as security is called collateral, and if the debtor fails to repay the debt, the lender has the right to seize and sell the collateral and use the sale proceeds to pay down the loan. Examples of collateral include land, machinery, the right to collect on account receivables, royalties, and inventory.

In the context of debt recovery, what advantages do secured creditors have over unsecured creditors?

If you are a secured creditor, you have simpler recovery methods at your disposal than if you are an unsecured creditor. You have the right to seize and sell the assets in which you have a security interest to recover what the debtor owes you. Once the sale is over, however, you have exhausted your security rights. If the sale of the security does not yield enough to pay the debt, you can still sue the debtor for the balance owing. In this suit, however, you are in the same position as any other unsecured creditor. You have no better claim against the debtor's remaining assets than anyone else. As a secured creditor, you enjoy a number of advantages over unsecured creditors. Often, you can take action to recover the debt sooner than other creditors because your security agreement will allow you to seize and sell property as soon as the debtor defaults. You do not need a judgment or a writ of seizure and sale. The security agreement may also define default as including actions other than non-payment of the debt. For example, it may define default as including misuse of the collateral by the debtor or the debtor's failure to pay a debt to another creditor. You are not required to obtain a court order in order to decide that a default has occurred. In the event that you choose to exercise a quick, self-help remedy, you can hire a private bailiff to seize and sell the collateral. Take care, however: where a secured creditor acts unfairly or oppressively, a court can void the security agreement between the creditor and debtor, and the creditor can be liable for damages.

Explain the advantages negotiable instruments have over money.

Negotiable instruments have certain advantages over money. They are more portable than large sums of cash, and they reduce the risk of theft because only the named payee can cash them. They can create credit by deferring the payment of funds from the date the instrument is created to another date specified in the instrument (consider a post-dated cheque, for example). They can also be transferred to third parties.

An act of bankruptcy includes either being unable to pay debts as they come due (and not having assets that can be sold to pay them) or committing fraudulent or evasive acts to avoid creditors.

True

An act of insolvency is being unable to pay debts as they come due (and not having assets that can be sold to pay them).

True

If the defendant in a Superior Court debt case fails to file a statement of defence, after a brief period the plaintiff may ask the court for a default judgment.

True

If there are insufficient funds in the account, the drawee bank may refuse to honour the cheque by returning it to the payee. The drawee bank is not liable to the payee for the amount of the cheque; the payee's only recourse is against the payer.

True

In Canada, negotiable instruments are regulated under the federal Bills of Exchange Act.

True

Like other bills of exchange, promissory notes often provide for the payment of interest after their due date.

True

Once a bond has been issued, its resale value will be governed by its rating and also by the economy generally.

True

Shareholders must accept the risk that their shares may turn out to be valueless if the business fails.

True

The payer of a cheque is always an account holder at that institution.

True

What is a secured creditor? What does this status entitle a creditor to?

Where a creditor has an interest in collateral owned by the debtor, the creditor is known as a secured creditor. A secured creditor can often register his interest in a public registry system. Registration gives notice to the world that the secured creditor has an interest in property owned by the debtor. This means that others who have no collateral interest in the debtor's property — or who have an interest but who registered or acquired it after the secured creditor acquired and registered his — cannot interfere with the secured creditor's right to seize and sell the collateral to pay down the debt. The secured creditor in this example is said to have priority over secured creditors who acquired or registered interests at a later date, or who had no security interest at all. In situations where there are multiple creditors and few valuable assets, a creditor's place in the priority sequence can make the difference between collecting on the debt and being out of luck.

List four terms that may be found in a current general account agreement made between a business and a bank.

a. The agreement covers all services that the bank offers at the time the business signs the agreement, whether or not the business uses them. Should the business decide to use these services in the future, it is bound by the terms applicable on the signing date. b. The bank may hold cheques — that is, refuse to make money available — for a specified period of time or until the cheque has been honoured by the drawer's bank. c. The bank can require seven days notice of a withdrawal from any account. d. The bank takes no responsibility for verifying signatures on a business's cheques. It will cash all cheques, even if they are fraudulent, unless the business can show that it took reasonable care to safeguard them and checked its transactions against its statement or passbook. The business must report all errors or incidents of fraud within 30 days of receipt of the bank statement. e. If the bank makes an error, or its account machinery malfunctions, or if a business suffers loss through any failure in the bank's service — even if the bank knew the loss was likely and even if the loss resulted from the negligence of the bank or its employees — the bank is not liable for any damages. f. The business is responsible for reimbursing the bank for any legal or other costs it incurs in recovering money owed by the business. g. The bank can close all of a business's accounts and can terminate the agreement without notice to the business.