Vendor Take-Back Mortgages and Seller Financing in Business Sales

Buyers often ask the seller to finance part of the price. This is called a vendor take-back, or seller financing. Instead of receiving all the money at closing, you accept a promissory note and the buyer pays you over time, usually with interest.

That can help close a deal and may widen your pool of buyers, but it also leaves you exposed if the business struggles. This article explains how sellers commonly protect repayment through security, PPSA registration and careful default terms, and where the legal limits sit.

How seller financing works

In a typical arrangement, the buyer pays part of the price at closing and signs a note for the balance. The note sets out the amount, the interest rate, the payment schedule and what happens if a payment is missed. Without security, you are relying mainly on the buyer's promise to pay, so how well you are protected is worth confirming with a lawyer.

The form of security depends on what you sold and what the buyer owns. How it ranks against other lenders depends on your situation, so it is worth confirming with a lawyer.

Many sellers combine several of these. Which mix makes sense depends on the deal, and a lawyer can help you choose and draft it.

Registering your security under the PPSA

Taking security over business assets is only the first step. Ontario's Personal Property Security Act has its own registration rules, and how they apply to your deal is worth confirming with a lawyer. Registration is a detail where small errors can be costly.

• Registration period: the period is a whole number of years from 1 to 25, or a perpetual period.
• Perpetual registration: it is shown on the financing statement by the number 99.
• Extensions: a registration can be extended by a whole number of years from 1 to 25, or made perpetual.
• Diarize the expiry date: a seller holding a security interest should diarize the expiry date and renew before it lapses.
• Exact name: a business debtor's name on a financing statement is limited to 121 characters, so enter the buyer's exact legal name correctly.

These rules come from the Minister's Order under the Personal Property Security Act, which was made on October 6, 2015 and came into force on November 16, 2015. Other PPSA rules also matter, including how priority works against a bank, and whether the note is paid off in stages. Ask a lawyer to confirm the right registration for your deal before closing.

Interest rates and default charges

It is tempting to set a high rate on the note to compensate for the risk. There are limits. Under the Criminal Code, a criminal rate is an annual percentage rate of interest, calculated using generally accepted actuarial practices, that exceeds 35 per cent on the credit advanced. A seller-financing note that charges interest above this can raise criminal interest issues unless an exemption applies.

If the buyer is an individual, or if you take a personal guarantee, the exemption may not apply the same way. Have a lawyer check the structure before you set the rate.

For a mortgage on real property there is a second limit. The Interest Act says no fine, penalty or rate of interest that has the effect of increasing the charge on arrears of principal or interest secured by a mortgage on real property above the rate payable on the principal not in arrears may be stipulated for or exacted. A contract may provide for interest on arrears, but it may not exceed the rate payable on the principal not in arrears. In practice, this limits default-rate or penalty clauses in a vendor take-back mortgage on real property.

If the buyer defaults

Default terms should say what counts as a default, such as a missed payment, a sale of key assets or the buyer's insolvency, and what you can do about it. Your remedies come from both the agreements and the law, and you should not act on assets before getting advice.

If the buyer is insolvent, federal bankruptcy law adds a step. A secured creditor who intends to enforce security on all or substantially all of an insolvent person's inventory, accounts receivable or other property used in business must first send a prescribed notice of intention to enforce. This applies to a seller holding security over the buyer's business assets after a seller-financed sale if the buyer is insolvent.

• Waiting period: the secured creditor generally cannot enforce the security until 10 days after sending the notice, unless the insolvent person consents to earlier enforcement.
• No advance waiver: consent to earlier enforcement cannot be obtained before the notice is sent, so a waiver of the 10-day period in the security agreement is ineffective.
• Receiver in place: the notice requirement does not apply where a receiver is already in place for the insolvent person.

Other rules, including those in the Personal Property Security Act, also govern how security is enforced, so the steps depend on the type of security and the facts.

What to do next

• Decide how much you are willing to finance and for how long before negotiations begin.
• Ask for security over the business assets, and over real property if it is included in the sale.
• Consider a personal guarantee from the buyer's owner.
• Have your lawyer register the financing statement with the buyer's exact legal name, and choose the registration period.
• Diarize the PPSA expiry date and renewal well in advance.
• Check the interest rate and any default charges against the criminal rate rules and the Interest Act.
• Include clear default terms, and get advice before you send any notice or act on assets.

Frequently asked questions