Security Issues – A Rose by Any Other Name …

The Ontario Court of Appeal released a decision last Friday that may be of interest for small business owners.

A fairly typical practice is for an entrepreneur to incorporate a company and then to advance loans to the company for startup capital. If this is seen as pure “equity” then if the company goes under the entrepreneur runs the risk of losing whatever he/she put into the company. To try and avoid this problem, it is not uncommon to see the company give security over various assets to the owner so that if the company goes under the owner can try and get repaid his/her investment from the assets. (At this point I should mention that while this is somewhat effective, it is often undermined by the fact that most lenders will require the owner to “subordinate” his/her security to that of the lender so that the lender gets the first crack at the assets’ value to satisfy the debt owed to the lender.)

The difficulty is that the personal property security regime in Ontario is stringent and this fact was emphasized again by the Court of Appeal. In that case, the company was incorporated with the name “Friction Tecnology Consultants Inc.” Note that “Tecnology” was misspelt with the letter “h” missing from the word. It is not clear whether this was an oversight or was intentional. In any event, the company dealt with the rest of the world under the name “Friction Technology Consultants Inc.” – that is, with the correct spelling of the word “Technology”. Friction factored its receivables and then obtained a loan from a bank. When Friction failed financially, the factor and the bank fought over who had priority to the assets. Why did this matter? Because the factor had registered its security against “Friction Technology Consultants Inc.” – with an “h” – while the bank had registered against the company name as it was properly registered – that is, without the “h”.

The Court of Appeal upheld the lower court decision that since the properly registered name did not have the letter “h”, then only the bank had properly registered its security and it won the priority fight. A harsh lesson for the factoring company.

So why should you care? The simple reason is because many small businesses either seek to do incorporations by themselves or else have “quickie” incorporations done to save money. There is nothing wrong with this, but you should ensure that there are no discrepancies like existed in the recent case. The reality is that once the incorporation takes place, the entrepreneur rarely ever looks again at the articles of incorporation and over time may simply assume that there is nothing wrong or different between the “real name” and the name being used by the business. But this type of oversight could very well create problems for you in the future if it turns out that your security is in the wrong name and now whatever protection you thought you had turns out to be nothing.

Something to think about.

[Meanwhile, as a little post-script, I have to say that this particular post was probably my most fun to write as I got to do so using my new iPad. It's a welcome addition to my technology lineup. And it's kind of a fun "toy" at times as well. ;-) ]

CALC

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