February 2003

Better Decisions
by Rob Gamble




Legal
by Michael Fitz-James




















January 2003


Legal

Watch out for liens on your property when dealing with contractors

The law says that anyone who improves your land has a right to register a lien against it -- even a subtradesman who hasn't been paid by the general contractor. So be sure to check the land registry after 45 days to ensure that you are in the clear
by MICHAEL FITZ-JAMES
Agricultural producers who plan any kind of construction or improvement for their farms will want to know about the construction lien, a powerful legal remedy which contractors and suppliers use to make sure they get paid.

Toronto lawyer Fabio M. Soccol, an authority on liens, told Better Farming Ontario's Construction Lien Act was created in 1983 as a successor to the old Mechanic's Lien Act. The statute basically gives any contractor, subcontractor or any materials or service supplier who improves a piece of land the right to register a lien against the land's title. That effectively makes the land unsaleable and incapable of being mortgaged until the lien gets discharged.

"They essentially get some kind of interest in the land or some security in the land to ensure they get paid," says Soccol. "The theory is that if you've added value to the land through materials and services, you're entitled to a lien for the value that's been incorporated into the land."

On a larger project, he points out, registering a lien usually will stop the work because the lender, who's paying out from a mortgage on the land itself, will not advance project funds in the face of a lien. "It freezes the hand of the paymaster," Soccol says. But suppliers and contractors who want to register liens must act within 45 days of the project's "substantial completion."

For larger projects, the clock starts ticking when a "payment certifier" publishes a notice of substantial completion in a construction industry trade publication. For smaller projects, however, the statute says that when the work is 98 per cent done, the clock starts.

Timely registration only preserves a lien right. To "perfect" a lien, the lienholder must sue the owner for payment within 90 days. In the face of a perfected lien, the owner can settle with the unpaid claimant, or pay the disputed money into court (along with a 25 per cent charge for interest and costs), and the lien will be discharged, says Soccol.

Harvey Kirsh, a lawyer at Toronto's Osler, Hoskin & Harcourt LLP (and author of A Guide to Construction Liens in Ontario), say agricultural producers should be aware that a formal written contract is not needed for a lien to be registered. When materials or labour are supplied on a handshake, that's enough.

Kirsh says the courts have even upheld liens on "quantum meruit" projects -- that's where a judge finds there never was a true contract, but the contractor is entitled, in all fairness, to be paid for the work he has done.

It's also important to be aware of "holdback rights," whereby an owner should keep 10 per cent of the contract price in his own pocket and not pay the general contractor until 46 days after the project's completed.

Kirsh advises the landowner to check the land registry after 45 days to ensure there have been no liens registered by unpaid subtrades. A wide variety of supplier and installers can register liens, some of whom may not be known to the owner. But if they have a deal with the general contractor and they haven't been paid, they can register their lien to the extent they have improved the land.

The holdback creates a fund to pay off the subtrades, if need be. If they haven't registered their lien claims by 45 days, they're out of luck and they'll have to go after the contractor without a lien.

Steve Tatrallyay, a construction law specialist at Toronto's Koskie Minsky, stresses the importance of maintaining the holdbacks and checking title 45 days after the project is complete.

Materials suppliers and subtrades who register liens have no obligation to notify the landowner that they've slapped a lien on his property -- "the registration itself is deemed to be notice to the owner," Tatrallyay says. Often, he points out, the first time an owner hears about a subtradesman's lien is when he's served with papers for that 90-day court action to perfect the lien.

"Make sure the people you've hired are paying their trades," says Tatrallyay. "If you get notice someone hasn't been paid, you're obliged to withhold the amount of his claim from the general contractor until such time as the notice is withdrawn. The tradesman doesn't even need to have a lien registered for that to happen."

David I. Bristow, a construction lawyer and arbitrator at Toronto's Fraser Milner Casgrain LLP, says the courts always look to the land's "improvement" when deciding who's entitled to register a lien claim. Improvement, he told Better Farming, raises three main questions:

  • Is the project a "fixture" on the land?
  • What's the connection between the services and materials supplied and the project?
  • Has the material or work "enhanced" the value of the land?
Portable buildings, such a temporary farmworkers' housing on cinder blocks, might not give a builder lien rights because it is not fixed to the land. The courts have ruled that the absence of sewage or water facilities can be a factor to consider.

An Alberta court has ruled that a large rolling irrigation system could not support a lien claim because it wasn't fixed to the land and was "in the nature of a farm implement." It's clear, however, that a below-ground tile-drainage system can give rise to a lien claim from the installer, says Bristow.

Snow removal is not itself lienable, but Bristow notes that if the snow is cleared to allow trucks access to a construction site, then a lien can be registered. The cost of explosives can also be subject to a lien, "provided they're used in construction, and not for clearing stumps from a field," says Bristow.

The courts have gone both ways on whether a well-digger can register a lien for a well. One Saskatchewan case refused to allow a well-digger to register a lien because the hole came up dry and there hadn't been any "improvement" to the land. But other cases says well-digging is an improvement even if there's no water found. Bristow says there can be a lien registered for the rental cost of a backhoe and operator for digging a farm pond, which is considered an "improvement."

Digging and excavation can be a tricky area, according to Soccol. When a contractor removes soil from one site, then dumps it on swampy farmland, he'd arguably have two potential liens to register -- one for the excavation improvement and a second for improving the swampy site by filling it in. He warns farmers to be careful about accepting fill on their land. And, he says, sometimes mere repairs to equipment could give rise to lien rights, "especially if the equipment's affixed to land."

Installation and repair of items like silo fans, feeders, mechanical hoppers, large-scale agricultural cooling systems, crop dryers and the computers to operate them could all give rise to lien claims. "See a good construction lien lawyer if you're in doubt," he advises. BF

Michael Fitz-James is a legal affairs writer based in Aurora.

© copyright 2003 AgMedia Inc..


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February 2003

Better Decisions

What you should know about promissory notes and guarantees

Signing a promissory note or guaranteeing a loan for someone may let you in for more than you think. Knowing the rules - and getting legal advice if necessary - can save you money and pain down the road
by ROB GAMBLE
Have you ever been asked to sign a guarantee? Or have you ever signed a promissory note? If not, the chances are pretty good that sometime in your farming career you will. In fact, these documents are quite common in farm transfers between parents and children. So what exactly are they?

Promissory notes and guarantees are sometimes called security agreements, but in reality they are not. This is because, in their basic form, they do not give an interest in property to a lender. The exception is when a security agreement is included with a guarantee.

Promissory Notes. A promissory note is, as the name suggests, a promise that the person signing it will pay a specific amount of money to the person named on the note. A promissory note can either be a "demand note" or a "term note." A demand note must be paid whenever the person named in the note demands to be paid. A term note must be paid at the particular time or times stated in it.

Since a promissory note does not give any security for the debt, the person who holds the note cannot seize particular assets of a borrower if they fail to repay the debt. The note is only evidence of the debt. The person holding the note has to sue in court to collect their money.

A promissory note can be signed by more than one person. If they sign "jointly and severally," the lender is not forced to sue each of them for that person's share of the debt. Instead, the lender can choose to collect the whole amount from any of them. Naturally, the lender will choose the one who appears to have some money (such as a bank account or salary) that can most easily be taken to pay the judgment. It will be up to that person to try to extract from the other debtors the shares they should pay.

Guarantees. A guarantee is an agreement between a guarantor (the person who is guaranteeing another person's debt) and a lender. The guarantor promises the lender to pay the money the borrower owes the lender if the borrower defaults. There are two important issues to be aware of with regard to guarantees.

The first is whether the liability granted in a guarantee is limited or unlimited. A limited guarantee means that the guarantor is liable only for the stated amount in the guarantee. The unlimited guarantee means that the guarantor is liable for the entire indebtedness of the borrower. In some cases, the guarantor may even be responsible for new debts that the borrower takes on, even though they may have only intended to guarantee the current debt. Obviously, it is critical to know which type you are agreeing to. A limited guarantee is always the preferred choice.

The second has to do with the order of collection. This point sometimes comes as an unpleasant surprise to someone holding a guarantee. Some guarantees state that the lenders do not have to exhaust their remedies against the borrower before suing the guarantor. The lender can bypass the original debtor and proceed to collect from the guarantor right away. In other words, if it is easier to get the money from you than the person you guaranteed, the lender can do that. Then you must try to get your money from the person you guaranteed.

A guarantee that states that the assets of the borrower must be liquidated in full before the lender may demand payment from the guarantor would be a much more desirable choice from a guarantor's point of view.

Security. Sometimes a guarantee also contains a security agreement. This means that the guarantor is giving the lender security over the guarantor's property for the money the guarantor will owe the lender if the lender has to call on the guarantee. Usually, the security is an assignment of all debts the original debtor owes the guarantor then or later, and a promise that the guarantor will not collect anything the debtor owes him or her until everything the debtor owes the lender is paid in full.

In addition, a lender may require the guarantor to give security on some or all of the guarantor's other property to support the guarantee. The security could be a mortgage on land or security in the guarantor's personal property.

Cancellation of a guarantee. If possible, it's a good idea to have a clause in the guarantee telling how you or your estate can cancel the guarantee you have given. A guarantee is not cancelled automatically upon death. Most guarantees will bind your estate.

Cancellation has a price. It may mean the lender can declare the borrower to be in default, or can cut back the amount of credit. Make sure to get the cancellation in writing from the lender. As soon as the debtor carries out the particular obligations you agreed to guarantee, contact the lender to get written confirmation that your guarantee has ended and you owe nothing under it. If you do not, you may find the lender will make a claim against you for some new obligation the debtor incurs.

As with anything you sign, if you're not sure what is obligates you to, take the time to find out. This usually means getting legal advice. A few dollars spent now could save a lot of heartache later on. BF

Rob Gamble is a Program Lead in Finance and Business Structures with OMAF. He can be reached at 1-888-466-2372, ext. 64350 or by email at rob.gamble@omaf.gov.on.ca

© copyright 2003 AgMedia Inc..


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March 2003

Better Decisions
by Rob Gamble




Legal
by Michael Fitz-James




















January 2003

Legal

Watch out for liens on your property when dealing with contractors

The law says that anyone who improves your land has a right to register a lien against it -- even a subtradesman who hasn't been paid by the general contractor. So be sure to check the land registry after 45 days to ensure that you are in the clear
by MICHAEL FITZ-JAMES
Agricultural producers who plan any kind of construction or improvement for their farms will want to know about the construction lien, a powerful legal remedy which contractors and suppliers use to make sure they get paid.

Toronto lawyer Fabio M. Soccol, an authority on liens, told Better Farming Ontario's Construction Lien Act was created in 1983 as a successor to the old Mechanic's Lien Act. The statute basically gives any contractor, subcontractor or any materials or service supplier who improves a piece of land the right to register a lien against the land's title. That effectively makes the land unsaleable and incapable of being mortgaged until the lien gets discharged.

"They essentially get some kind of interest in the land or some security in the land to ensure they get paid," says Soccol. "The theory is that if you've added value to the land through materials and services, you're entitled to a lien for the value that's been incorporated into the land."

On a larger project, he points out, registering a lien usually will stop the work because the lender, who's paying out from a mortgage on the land itself, will not advance project funds in the face of a lien. "It freezes the hand of the paymaster," Soccol says. But suppliers and contractors who want to register liens must act within 45 days of the project's "substantial completion."

For larger projects, the clock starts ticking when a "payment certifier" publishes a notice of substantial completion in a construction industry trade publication. For smaller projects, however, the statute says that when the work is 98 per cent done, the clock starts.

Timely registration only preserves a lien right. To "perfect" a lien, the lienholder must sue the owner for payment within 90 days. In the face of a perfected lien, the owner can settle with the unpaid claimant, or pay the disputed money into court (along with a 25 per cent charge for interest and costs), and the lien will be discharged, says Soccol.

Harvey Kirsh, a lawyer at Toronto's Osler, Hoskin & Harcourt LLP (and author of A Guide to Construction Liens in Ontario), say agricultural producers should be aware that a formal written contract is not needed for a lien to be registered. When materials or labour are supplied on a handshake, that's enough.

Kirsh says the courts have even upheld liens on "quantum meruit" projects -- that's where a judge finds there never was a true contract, but the contractor is entitled, in all fairness, to be paid for the work he has done.

It's also important to be aware of "holdback rights," whereby an owner should keep 10 per cent of the contract price in his own pocket and not pay the general contractor until 46 days after the project's completed.

Kirsh advises the landowner to check the land registry after 45 days to ensure there have been no liens registered by unpaid subtrades. A wide variety of supplier and installers can register liens, some of whom may not be known to the owner. But if they have a deal with the general contractor and they haven't been paid, they can register their lien to the extent they have improved the land.

The holdback creates a fund to pay off the subtrades, if need be. If they haven't registered their lien claims by 45 days, they're out of luck and they'll have to go after the contractor without a lien.

Steve Tatrallyay, a construction law specialist at Toronto's Koskie Minsky, stresses the importance of maintaining the holdbacks and checking title 45 days after the project is complete.

Materials suppliers and subtrades who register liens have no obligation to notify the landowner that they've slapped a lien on his property -- "the registration itself is deemed to be notice to the owner," Tatrallyay says. Often, he points out, the first time an owner hears about a subtradesman's lien is when he's served with papers for that 90-day court action to perfect the lien.

"Make sure the people you've hired are paying their trades," says Tatrallyay. "If you get notice someone hasn't been paid, you're obliged to withhold the amount of his claim from the general contractor until such time as the notice is withdrawn. The tradesman doesn't even need to have a lien registered for that to happen."

David I. Bristow, a construction lawyer and arbitrator at Toronto's Fraser Milner Casgrain LLP, says the courts always look to the land's "improvement" when deciding who's entitled to register a lien claim. Improvement, he told Better Farming, raises three main questions:

  • Is the project a "fixture" on the land?
  • What's the connection between the services and materials supplied and the project?
  • Has the material or work "enhanced" the value of the land?
Portable buildings, such a temporary farmworkers' housing on cinder blocks, might not give a builder lien rights because it is not fixed to the land. The courts have ruled that the absence of sewage or water facilities can be a factor to consider.

An Alberta court has ruled that a large rolling irrigation system could not support a lien claim because it wasn't fixed to the land and was "in the nature of a farm implement." It's clear, however, that a below-ground tile-drainage system can give rise to a lien claim from the installer, says Bristow.

Snow removal is not itself lienable, but Bristow notes that if the snow is cleared to allow trucks access to a construction site, then a lien can be registered. The cost of explosives can also be subject to a lien, "provided they're used in construction, and not for clearing stumps from a field," says Bristow.

The courts have gone both ways on whether a well-digger can register a lien for a well. One Saskatchewan case refused to allow a well-digger to register a lien because the hole came up dry and there hadn't been any "improvement" to the land. But other cases says well-digging is an improvement even if there's no water found. Bristow says there can be a lien registered for the rental cost of a backhoe and operator for digging a farm pond, which is considered an "improvement."

Digging and excavation can be a tricky area, according to Soccol. When a contractor removes soil from one site, then dumps it on swampy farmland, he'd arguably have two potential liens to register -- one for the excavation improvement and a second for improving the swampy site by filling it in. He warns farmers to be careful about accepting fill on their land. And, he says, sometimes mere repairs to equipment could give rise to lien rights, "especially if the equipment's affixed to land."

Installation and repair of items like silo fans, feeders, mechanical hoppers, large-scale agricultural cooling systems, crop dryers and the computers to operate them could all give rise to lien claims. "See a good construction lien lawyer if you're in doubt," he advises. BF

Michael Fitz-James is a legal affairs writer based in Aurora.

© copyright 2003 AgMedia Inc..


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March 2003

Better Decisions

Take the time to understand what you are signing

Knowing what your agreements require you to do, and what are the penalties if you don't live up to them, can make your relations with creditors much easier
by ROB GAMBLE
The topic of security agreements is a complex one. So complex that it's easy to understand why business owners, when the business is running smoothly, fall into a pattern of simply signing documents requested by creditors without taking the time to study their actual meaning. A good place for most farmers to start is to become familiar with some of the more common types of security agreements and when they are likely to be asked to sign them.

Many of you reading this column will likely have signed documents of this sort sometime in the course of your business financing. Table 1 lists some of these common security agreements and when they are used. Do you recognise any of them?

Before signing any agreements, a borrower should know the answer to the following questions:

  • What must I do under this agreement?

  • What can happen to me and my property if I don't live up to my promises in the agreement?
  • Are there any practical, cost-effective changes likely to be acceptable to my creditor that will make the deal or the documents better for me?
Type of Security agreement
When they are used
Conventional mortgage
  • Typically used to finance the purchase of the land

  • Consists of a document that gives the legal description of the land and the repayment terms of the mortgage, plus a document known as the "Standard Charge Terms."

  • This document is registered at the Land Registry Office where the bank's security interest is noted in the appropriate records
Collateral mortgage
  • Utilized by a bank to provide security over real estate when loans are provided for purposes other than the purchase of land

  • Could be used to secure an operating loan or the purchase of quota

  • Typically, it remains in place to secure fluctuating advances and new term-loan borrowing arranged when previous loans have been repaid.
General security agreement (GSA)
  • Unless it is amended to delete some types of property, a GSA will create a security interest in:

    • all personal property and fixtures the debtor currently has;
    • all other property and fixtures the debtor gets later (automatically as soon as the debtor gets them);
    • all proceeds flowing from the disposition of any of it

  • Some GSAs even create security in real property

  • The GSA defines property to include inventory, equipment, accounts, book debts, debts, deeds and contractual rights.
Chattel mortgage
  • This agreement is normally used to take security in a few specific items rather that in all the debtor's collateral

  • Read it carefully. The security interest may extend beyond the specific items to their proceeds, to all other property which replaces or is added to them.

  • Sometimes it may even extend to all other present and future property of the debtor. This additional security interest can make a chattel mortgage in effect no different than a GSA.
Personal money security interest (PMSI)
  • A "PMSI" (pronounced "pimsi") is designed to provide the supplier of goods with a security interest in that specific property.

  • As the name suggests, this security interest is available to lenders of money used to finance the purchase of personal property.

  • PMSIs are very valuable to creditors because they have super-priority over other security interests. This means that the lender is in furst place on that asset, even if other lenders have pre-existing security agreements.

  • One very common type of PMSI is used to purchase crop inputs. Within the PMSI contract, the farmer agrees to pay for crop inputs and to provide a security interest over the crops produced. After receiving the security instrument from the farmer, the creditor can supply fertilizer, seed, herbicide and other products.

Many creditors, especially large institutional ones, will be very unlikely to change their standard security agreements just because one customer asks them to. However, they may be willing to reduce the amount of property the security will affect, or to restrict the part of the indebtedness for which security is required.

Make sure you get an exact copy of every security agreement and other documents you sign. Keep these copies in your farm records. These will act as reminders for you to contact your creditor about discharging security when you've paid everything you owe.

Security is something you hope you never have to learn too much about -- no more at least than just signing a few documents. However it's still wise to take the time to understand what you are signing and to know how it could affect you in the future. And then, hope it never does. BF

Rob Gamble is a Program Lead in Finance and Business Structures with OMAF. He can be reached at 1-888-466-2372, ext. 64350 or by email at rob.gamble@omaf.gov.on.ca

© copyright 2003 AgMedia Inc..


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April 2003

Better Decisions

Understanding your credit score

How do lenders evaluate your credit worthiness? Here's a short primer
by ROB GAMBLE
Have you ever wondered how lenders interpret your loan application, determine your interest rate or decide that you need to provide more security for a loan? You're probably not alone in that. But one thing is for sure. It's not rocket science. It's called "Credit Scoring" and it is a method of scoring or rating new and current borrowers.

In this column, I will explain what credit scoring is and how it works. This is not to say that your lender does it exactly the way I will explain it. Many lenders have developed their own methods of scoring that reflect their past experience and lending criteria. But the principle is the same.

Why is credit scoring needed? Lending is not an exact science and you will often hear lenders talk about the "3 Cs" of credit -- Character, Collateral and Repayment Capacity. Sometimes they even throw in a fourth or fifth, depending on how good they are at coming up with banking terms that start with the letter C. But the three I mentioned are standards. How do you take these concepts and come up with a system that helps you evaluate a borrower? Enter credit scoring.

It's not a new concept. For years, financial management advisors have been telling producers to keep an eye on some of the key financial indicators. Why? Because they know the same thing lenders know. When those ratios are in certain ranges, they can be a signal that difficulties are on the horizon. Credit scoring assigns a score to various financial indicators, depending on what range they fall in. The indicators used are the ones that lenders believe are important to the success of the business. I have placed a score in each section in Table 1. A lower score means that the financial indicator is strong or positive. The best rating as a 1 and the worst is a 5.

Table 1 shows what a simple credit scoring worksheet might look like. Many lenders use different factors and criteria in their credit scoring systems, but I have kept it simple for this article. My example compares two farms that are not very different. They both want a loan of $200,000. Their liabilities are the same. I have scored them based on debt-to-equity, debt servicing capacity and a security ratio. Let's see how a credit scoring system might rank them.

Table 1
Details Farm A Farm B
Farm Assets 1,200,000 1,000,000
Farm Liabilities 350,000 350,000
Farm equity 850,000 650,000
Debt servicing capacity 35,000 33,000
Principal and interest payments 25,000 32,000
Loan amount 200,000 200,000
Amount of security given 300,000 225,000
Debt to equity ratio   
Total liabilities 350,000 =0.41 350,000 =0.54
Total equity 850,000 650,000
Score 1 2
Debt servicing capacity
Debt servicing capacity 35,000 =1.4 33,000 =1.03
Principal and interest payments 25,000 32,000
Score 1 4
Security ratio
Amount of security given 300,000 =1.5 225,000 =1.13
Loan amount 200,000 200,000
Score 5 5
Final Score using a Weighting Percentage
Farm A Farm B
Weighting percentage Rating Weighted total Rating Weighted total
Debt ratio 30% 1 3 2 6
Debt Servicing 40% 1 4 4 16
Security 30% 5 15 5 15
Weighted Score 22 37
Other Factors Farm A Farm B
Risk Score 22 37
Management issues
Environmental issues
Final risk related score Farm A Farm B
22 37
Better than average risk Higher than average risk
Risk rated score card
Score Risk description
<10 Extremely low risk
11-15 Very low risk
16-20 Low risk
21-26 Better than average risk
27-33 Average risk
34-39 Higher than average risk
40-46 Risk of possible problems
>46 High risk of problems

Debt-to-equity ratio. A lender would prefer not to own more of the business than you do. So ratios that get above 1 would generate a higher (poorer) score. Farm A in our example has $200,000 more equity, so it scores a 1 while Farm B gets a 2. In the end evaluations this gives Farm A a three-point advantage.

Debt servicing capacity. This is a big one. Can you cover your payments? In a perfect world for lenders, loan payments would always get paid first. But they know that people need to eat and usually will choose that first, so the repayment capacity is calculated by adding up all income, deducting business and living expenses, taxes etc., then comparing what is left to the principal and interest payments.

In our example, this is the major reason that Farm A will probably get a better loan rate than Farm B. Farm B just doesn't have the same room that Farm A has when it comes to fluctuations in cash flow. Farm A has $10,000 of room in its cash flow while Farm B has only $1,000. In this section, Farm A is rated as a 1 while Farm B is a 4.

Security ratio. Giving security to a lender means that the risk to a lender is reduced since, in the event of a business failure, they have security on the borrowers assets. In our example, both farms have provided security, but not enough to give them a preferred rating. In this case, a preferred security ratio would be in the range of 2.0 to 2.25, meaning that the security would be worth more than twice the loan value. Certain lenders might rate this factor differently. In our example, both farms rate a 5, the worst rating.

Weighting the scores. Experience will tell lenders that some factors are more important to the success of a loan. Therefore they will weight their scorecards so that ratios they consider critical will have a heavier weight in the final score. In our example, you can see that Debt Servicing has a 40 per cent weighting, while the others have 30 per cent. This has a large impact on the final score of Farm A and B, as you can see by the 12-point difference on this factor.

The final score shows that Farm B is rated "higher than average risk" while Farm A is "better than average." Other factors, such as management and environmental issues, can also be assessed.

The bottom line to all of this? Your financial numbers affect your credit but are also a very useful management tool for you. While you may be tired of listening to advisors telling you to watch your numbers, be assured that whether you do or you don't, your lender probably is. BF

Rob Gamble is a Program Lead in Finance and Business Structures with OMAF. He can be reached at 1-888-466-2372, ext. 64350 or by email at rob.gamble@omaf.gov.on.ca

© copyright 2003 AgMedia Inc..


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