CIRCULAR NO.: 1989-2
OUR FILE NO.: 5840/S444
T.B. NO.: 809634
DATE: January 11, 1989
TO: Deputy Heads of Departments and Heads of Agencies and
Departmental Corporations
SUBJECT: Regulations Governing Security for Debts Due to Her
Majesty
SUMMARY
THIS CIRCULAR ESTABLISHES THE POLICY GOVERNING THE VALUATION, ACCEPTANCE,
RELEASE AND REALIZATION OF SECURITY FOR DEBTS DUE TO THE CROWN, AND FOR APPLYING
THE RELATED REGULATIONS.
POLICY OBJECTIVE
1. The policy and the attached Regulations were made to protect the Crown's
interests without imposing undue hardship on a debtor or the guarantor of a
debt. While existing statutes give Crown claims some general priority over the
claims of unsecured debtors, these Regulations allow the government to accept
specific guarantees. This policy is intended to encourage the repayment of debt
by obtaining specific guarantees; however, neither the Regulations nor this
policy oblige a debtor to provide security.
POLICY STATEMENT
2. Without imposing undue hardship on a debtor or the guarantor of a debt,
departments should actively seek security whenever it is consistent with good
business practices and would promote more timely repayment of debts owed to the
Crown.
3. Departments should take only enough security to ensure the debtor's
commitment to discharging the debt.
4. Departments must ensure that any substitution of security does not
inadvertently reduce the protection that was originally intended.
5. Departments are to take all reasonable precautions to ensure the future
enforceability of Crown's claim to the pledged asset.
6. The security value of assets is to be established in a consistent and fair
manner.
7. In case of default, departments should realize on the security only as a
last resort when all other collection methods have failed.
8. Departments should charge the debtor for any associated out-of-pocket
costs, with interest, and credit any recoveries against these expenditures
before reducing the debt(s).
9. As required, departments must obtain legal advice and assistance from
their Legal Services, which will confer, if necessary, with the appropriate
Civil Litigation section.
APPLICATION
10. The regulations and this policy apply to all organizations considered to
be departments within the meaning of section 2 of the Financial
Administration Act (FAA), (R.S. 1985).
11. The Regulations do not superseded authorities contained in statutes and
regulations now in existence; they complement them and provide authority where
none exists.
POLICY REQUIREMENTS
Security requirement
12. As a matter of general policy, and without regarding it as a substitute
for establishing a potential debtor's credit-worthiness, security should be
sought actively, consistent with good business practices, whenever:
(a) a debtor's future ability or willingness to discharge a debt in
accordance with the payment terms is uncertain;
(b) a debtor is not discharging a debt in accordance with payment terms, is
not in an immediate financial position to pay the amount owing and is unable to
borrow the amount from usual sources;
(c) the normal commercial practice for the type of transaction being
considered is to take security, such as a hypothec or a mortgage in the case of
the sale of real estate; or
(d) a debtor has enough real property or other assets to discharge a debt but
is temporarily insolvent, and it would be unreasonable to require the debtor to
sell assets to pay the amount owing.
Acceptable security
13. The Minister responsible for recovering or collecting a particular debt
due to Her Majesty may accept as security a charge, such as a pledge,
assignment, debenture, mortgage, encumbrance, hypothec or lien, on the assets of
a debtor or of a guarantor. Although not specifically mentioned in the
Regulations, other forms of security that constitute such a charge may also be
accepted. However, this does not mean that security can be accepted in lieu of
immediate payment when the duly approved terms and conditions of a sale call for
immediate payment.
14. In accordance with the Regulations, only charges
(a) on existing or future personal or real
property of a debtor, and
(b) on existing personal or real property of a
person who is the surety or guarantor of the debtor
are deemed to be a security for the purposes of paragraph 156(b) of the FAA,
(R.S. 1985).
While an assignment or the future wages of a debtor can be accepted as
security, a department is not authorized under the Regulations to accept an
assignment of the future wages of a guarantor. However, a charge on an asset
currently owned by either of these people can be accepted as security.
15. Departments should avoid situations where it becomes more attractive for
the debtor to give up the security than to discharge the debt. This is most
important when the asset being considered as security is used to generate the
revenue from which the debt would be discharged (for example, shares in a
privately-held business, or special-purpose buildings or equipment for which, in
fact, there is a limited, if any, market). The objective of taking security is
to ensure the payment of a debt, not to liquidate or acquire assets.
16. When considering offers of security, departments should give preference
first to security deposits or guarantees provided by banks or other financial
institutions, and then to unencumbered assets that are expected to maintain
their value or appreciate in value. Although less desirable, a second or
subordinate charge on an asset may be accepted as security when the sum of this
charge and all other charges with higher priority does not exceed the estimated
realizable value of the asset, net of realization costs.
Collections
17. Notwithstanding the acceptance of security pursuant to this policy,
departments are expected to take normal collection action consistent with good
receivables management without imposing under hardship on a debtor or a
guarantor.
Amount of security
18. Subject to other applicable regulations, policies and guidelines, and in
the light of the particular circumstances, departments should require only
enough security to ensure the debtor's commitment to discharge the debt. When
establishing security requirements, departments should determine whether
insurance must be maintained, at the debtor's expense, on the asset given as
security and whether the insurance should be made payable to Her Majesty.
19. Security that currently covers only part of the debt may be accepted when
no other security is available or less than full security is required. Such
action may be appropriate, for example, when:
(a) existing higher priority charges will be reduced in due course, thereby
providing the security sought by the government, or
(b) registering a right is warranted in order to prevent subsequent creditors
from gaining a higher-ranking claim.
Substitution
20. When the Crown has authority to substitute one asset held in security for
another, the net realizable value of the replacement asset must at least equal:
(a) the security value originally provided by the asset that it replaces, or
(b) the outstanding debt(s), whichever is less.
Enforceability
21. Legal advice should be obtained to ensure the validity and future
enforceability of the Crown's claim to the security being accepted and, when
security has been accepted, to register the Crown's interest in accordance with
the applicable provincial or territorial laws. Special attention must be given
to ensuring that:
(a) the asset offered as security is assignable and transferable to the Crown
(Canada Savings Bonds, for instance, are currently not transferable to a third
party and Registered Retirement Saving Plans are subject to limitations);
(b) the asset offered as security actually belongs to the person offering it;
and
(c) this person, or anyone acting on behalf of this person, has the authority
to act in this capacity.
These considerations are particularly important where "family"
assets are involved and giving security may require the consent of both spouses.
22. When considering whether to accept security from a surety or guarantor,
particularly a spouse or an elderly relative of the debtor, departments should
obtain evidence that the persons has received independent legal advice before
providing security. Defences based on the premise that such a person was unduly
taken advantage of could preclude enforcing the Crown's claim.
Valuation of security
23. To take into account the risk of future devaluations, the maximum
security value of any asset must be established in accordance with the attached
schedule. The valuation should be based on the lowest value of the asset. For
example, the current value of a piece of real estate must be used, not an
appreciated future value. If there is reason to expect that the asset may
depreciate to less than the attached schedule provides, its security value
should be discounted accordingly.
24. Departments should obtain a valuation from a qualified appraiser when:
(a) the security being considered is real property intended to cover a debt
of more than $100,000; or
(b) there is greater than usual doubt about the purported value, especially
about the future realizable value of the asset. This would usually apply to
precious metals and gems and, often, to equipment, other goods and chattels.
When the asset is precious metals and gems, at least two appraisals are
advised. They should be averaged to obtain the best estimate of the current
market value.
25. To ensure that the security they hold continues to provide the required
protection, departments should assess their portfolios at least once a year and
take prompt corrective action. As specified in note 2 of the attached schedule,
however, certain types of security require more stringent control.
Release or discharge of security
26. In accordance with paragraphs 3(a) and (b) of the Regulations, the
Minister responsible for recovering or collecting a debt due to Her Majesty may
execute and deliver any instrument that will effectively release or discharge
any security, either:
(a) in full, on total payment of the debt due to Her Majesty, or
(b) in part, on payment of the portion of the debt covered by security
accepted to cover the portion paid.
27. For greater certainty and clarity when the need for releasing part of the
security is anticipated, departments should include, after obtaining appropriate
legal advice, specific provisions in the security instrument(s) to address the
release or discharge of a portion of the security accepted. This could be done,
for example, by relating specific assets to specific portions of the debt(s).
From a legal perspective, it may also be preferable to execute a separate
security instrument for each portion of the debt.
28. Security may also be released or discharged when, as a result of another
form of settlement such as forgiveness, remission, or a duly authorized
compromise, the debt has, in the opinion of legal counsel, been extinguished.
29. When releasing or discharging a portion of the security, departments
should ensure that the Crown's claim to the remaining security is not impaired
in any way or the priority of its claim reduced.
Realization on security
30. Before realizing on a security, departments must first reasonably and
diligently exhaust all the other available recovery possibilities, which must
include set-off actions where possible and appropriate.
31. If all recovery actions are unsuccessful, the department responsible for
recovery or collection should try to realize on the security promptly under
appropriate legal advice. Departments must first ensure that this action will
not subject the debtor or, as the case may be, the surety or guarantor to undue
hardship. Departments should not therefore try to realize on security in cases
which, for legislative, administrative, humanitarian, or other special reasons,
are deemed by senior departmental officials, after close scrutiny, to be
unsuitable for such action.
32. Subject to paragraph 33, if a debtor commits an act of bankruptcy, but
has neither filed for nor been petitioned into bankruptcy, the department
responsible for the recovery or collection of the debt should, after obtaining
appropriate legal advice and with the written authority of its Deputy Head or of
a person authorized by the Deputy Head in writing for this purpose, pursue its
recovery responsibilities in accordance with the provisions of the Bankruptcy
Act in a manner consistent with this policy and the objectives of the
program under which the debt was incurred.
33. Unless counselled otherwise, a department should not seek to file a
petition for a receiving order against a debtor when it holds adequate security
unless:
(a) the action is expected to increase the chances of collecting the debt;
and
(b) the amount of the debt is significant.
In circumstances like these, however, prompt action may prevent the
disappearance of other assets that are required either to retire the debt or to
reduce the subsequent loss.
34. If the court has already issued a receiving order against a debtor, a
department should, after obtaining legal advice, consider executing its right to
realize on its security independently of other creditors and file with the
trustee a priority claim for any shortfall.
Cost of security
35. Except where legal counsel advises that it is prohibited by law, the
appraisal, registration, realization and any associated legal costs should be
charged, with interest, to the debtor. The interest must be calculated from the
time the costs are incurred until they have been recovered. Whatever proceeds
are received should be applied:
(a) first: to recovering the above costs,
paying first the interests on the costs and then the costs proper; and
(b) then: to the original debt or debts, first
paying any interest due on the debt.
36. To provide authority for charging such interest and to avoid disputes and
litigation, departments, under the guidance of legal counsel, must ensure that
the above considerations are reflected in the documents that establish the debt
and the security.
REFERENCES
37. The attached regulations were made by the Governor in Council on 14
August 1987, on the recommendation of the President of the Treasury Board and
the Minister of Finance, in accordance with section 156 of the FAA, R.S. 1985.
They were registered with the Clerk of the Privy council on 14 August 1987 as
SOR/87-505 and published in Part II of the Canada
Gazette on 2 September 1987.
38. This policy is effective immediately. It will be published in the Guide
on Financial Administration in a future amendment, at which time this
circular will expire.
ENQUIRIES
39. Enquiries about this circular should be directed to the:
Accounting and Costing Policy Branch
Office of the Comptroller General
L'Esplanade Laurier
West Tower, 8th Floor,
300 Laurier Avenue
Ottawa, Ontario
K1A 1E4
Tel: (613) 957-9671
J.Q. McCrindell
Deputy Comptroller General
Accounting and Costing Policy Branch
SCHEDULE
Maximum Security Value Assigned to an Asset
Accepted as Security for Debts Due to Her Majesty
(pursuant to paragraph 23 of the circular
and subject to the notes herein)
Type of Asset Canadian Dollar Equivalent
Maximum Security Value
(per cent of current market
value)
Unconditional Documentary Credit 100%
(i.e. letter of credit)
Cash (e.g. Certified Bill of Exchange or 100%
Cheque) or Collateral Deposit in a
Financial Institution
Government Debt or Government Guaranteed
Debt (i.e. of any country)
-Treasury Bill and other short-term paper 95%
- Bond
. maturity less than 5 years 95%
. maturity from 5 years to 10 years 90%
. . maturity greater than 10 years 85%
Other Securities
- Short term paper
. rated at least A-2, P-2 (or equivalent) 90%
. rated A-3, F-3 (or equivalent) 85%
. rated below A-3, P-3 55%
- Bond rated AA or higher
. maturity less than 5 years 95%
. maturity from 5 years to 10 years 90%
. maturity greater than 10 years 85%
- Bond rated A to BBB
. maturity less than 5 years 80%
. maturity from 5 years to 10 years 75%
. maturity greater than 10 years 70%
- Bond rated below BBB 50%
- Unrated bond (see note 4)
- Shares
. Listed and worth more than prescribed 50%
minimum value (see note 3)
. Not listed or below prescribed (see notes 3 and 4)
maximum value
Precious metals and gems
- other 50%
Real Property
- agricultural land and buildings, 75%
undeveloped land, principal residence,
commercial rental, or industrial -
general purpose
- industrial - special purpose 60%
- other residence (e.g. cottage) 50%
Equipment, other goods and chattels
- general purpose item 75%
- special purpose item (other than
collector's item) 50%
- recognized generally as a collector's
items 75%
Insurance Policy
- Net cash surrender value 100%
- Performance bond 100%
NOTE:
An insurance policy that covers risks that could reduce the value of property
being accepted as security does not constitute a security. The same applies to
an insurance policy on the life of the debtor. Only the net cash surrender value
can be considered as security. Any such policies should be made appropriately
payable to Her Majesty.
Future Wages
Subject to the restriction on accepting future assets as security imposed by
the attached Regulations and the guidelines on determining a debtor's ability to
pay (see Chapter 10.6 of the Guide on Financial Administration for Departments
and Agencies of the Government of Canada under the heading "Normal
Collection Process") an assignment of (future) wages by the debtor can be
accepted as security. The maximum security value of future wages, however, must
be assessed in relation to the degree that periodic wages will cover future
periodic payments. Therefore, only the debtor's current net income above the
Senate Committee Poverty Line, less the sum of the payments the debtor is
currently expected to make to all other creditors, should be considered as
security, and only up to the following percentages of the debtor's gross income:
- if debtor has a record of stable 35%
revenue from employment
- if debtor shows a record of 20%
uncertain revenue from employment
NOTES
1. The sole purpose of the schedule is to determine the maximum security
value of an asset being accepted as security. It does not determine an asset's
suitability as security. Preferred forms of security are discussed in paragraph
16 of the circular.
2. To maintain the expected security value, security based on types of assets
that are subject to frequent changes in value, because of market or exchange
rate fluctuations, need to be monitored at least monthly (and more frequently
when financial markets are volatile) and must be subject to calls for additional
security if the shortfall is equal to or exceeds 15 per cent.
3. Shares denominated in Canadian dollars must be listed on a Canadian stock
exchange and have been quoted at a minimum of Cdn $3.00 per share 90 per cent of
the time during the previous 3 months. Shares denominated in other currencies
must be listed on a stock exchange of the same country as the currency and have
been quoted at a minimum equivalent to Cdn. $4.00 per share 90 per cent of the
time during the past 6 months.
4. The current market value of bonds and shares that are not rated and/or
quoted on any market shall be subject to the advice of a qualified appraiser,
who shall be asked to consider particularly the risk of their devaluation over
the life of the debt. The maximum security value shall not exceed 50 per cent of
their current market value.
5. Credit ratings shall be from or consistent with those of Dominion Bond
Rate Service, Canadian Bond Rating Service, Moody's Investors Service or
Standard and Poor's. Where more than one rating is obtained, the lowest rating
shall apply.
6. Except where the debt to Her Majesty is payable in the same currency as
the security is valued, in which case no conversion is required, the maximum
security value of any asset not valued in Canadian dollars shall apply after
current market value has been converted to Canadian dollars.
7. Example:
DM 100,000, 4-year, non-government bond rated BBB by Moody's Investor
Service. (DM = West Germany's Deutsche Mark)
(a) Determine current market value, say: DM 99,417 (source may be Globe
& Mail, broker, etc.)
(b) Convert to Canadian dollars: DM 99,417 X 0.72940 = Cdn $72,515 (1 DM =
Cdn $0.7294; based on Bank of Canada exchange rate on the day of valuation).
(c) Establish maximum security value: Cdn. $72,515 x 89% = Cdn $58,012 (80% =
corresponding per cent of current market value as per schedule, i.e. rated A to
BBB, maturity less than 5 years)
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