08 March 2016

How is your exposure with your bank?

We all know that the Canadian banks have always had a conservative approach towards minimizing their exposure when it comes to extending secured credit to businesses. The factors that such businesses must take into account have multiplied in recent years, but the banks have never been very explicit in their documentation as to why such factors are critical. Here is an attempt to classify them, based on past experience and current awareness.

For simplicity, we will assume only one line of credit secured by a charge against all company assets, with regular reporting of credit exposure to the bank in order to determine availability for drawing down upon the line. The basic formula for determining maximum availability of funds is:

$ (R*a + I) - (D+L) $

where R is eligible receivables (usually after deducting amounts over a certain age and amounts due from the Crown), a is the availability percentage specified in the credit agreement, I is eligible inventory (more often than not just a flat amount),  D is the sum of all statutory deemed trusts, and L is the sum of any liens against the business.

Each of these factors deserves separate discussion.


How much you can get will depend on the creditworthiness of your customers, as well as the risk exposure of the sector you are in. These will influence the aging cutoff for determining the eligible amount, together with the overall percentage applied, against which the bank will extend funds.

Exclusion of debts due from the Crown is based on s. 67 of the Financial Administration Act, which states that, in general, "(a) a Crown debt is not assignable; and (b) no transaction purporting to be an assignment of a Crown debt is effective so as to confer on any person any rights or remedies in respect of that debt." Ontario does not have such a provision, but some other jurisdictions do. Further and more detailed discussion on this can be found here.


Amounts allowed under this are quite variable, and it all has to do with the risk exposure involved. I was involved in an asset-based financing arrangement several years back, and the amount granted was quite minimal as the assumption was that, if the bank had to call their security, any goods would be disposed at a distressed value. In addition, suppliers have a super-priority right to claim back goods that had been shipped within thirty days prior to a bankruptcy, if a demand is filed with the bankruptcy trustee within the first ten days of such bankruptcy.

Statutory deemed trusts

Federal and provincial statutes have been providing an expanding list of what amounts can fall within this category, but they fall within one of two categories: those which can survive bankruptcy, and those might not.

In the first group (more fully discussed here):
  • Payroll source deductions for tax/CPP/EI
  • Municipal taxes
  • Requirements to Pay issued under the Income Tax Act or the Excise Tax Act
  • Remediation orders issued by the Crown to recover environmental remediation claims
  • Current employer and employee contributions to pension plans
In the second group:



It is prudent to have your payroll service provider charge and remit your payroll source deductions every pay period, in order to minimize your ongoing exposure to this critical item.

Accounting systems allow for grouping of vendors, which will help to identify vendors that would be identified within any of the above items.

Vacation pay liability is a sleeper issue that deserves more attention than it gets. Most payroll systems track the accrual for hourly employees, but the liability with respect to salaried employees has historically been treated as a "pay as you go" arrangement. This is not quite right these days, as IAS 19 requires accrual for any liability. That could cause problems if many salaried employees have been discouraged from taking their vacation time, as has occurred too frequently in recent years. While ASPE does not explicitly call for such comprehensive treatment, it may only be a matter of time before materiality considerations call for similar treatment.


The bank will need to know about all that exist, but you will need to know what their nature is:
  • Possessory liens will trump a secured creditor's right in the same item, up to the amount required to satisfy the lien in full.
  • A non-possessory lien right also trumps a secured creditor's interest but only if the non-possessory lien is registered prior to the secured creditor's interest.
They can be in the form of:
  • tax liens
  • construction liens (including any holdbacks)
  • repair and storage liens
  • maritime liens
  • equitable liens
Needless to say, you should work to ensure that such amounts, in general, never arise to begin with. That is more a question of financial management as opposed to accounting, but holdbacks can be separately identified in most accounting systems.

Honesty with your lender

I have heard of other companies where the exposure reporting has been somewhat less than truthful, in order to squeeze out as much funding as possible. This is never ethical, and can attract significant liability when things go wrong. Several years ago, the Ontario Court of Appeal held that a CFO was personally liable to a lender for misrepresentations he had made about the financial viability of a subsidiary that was subsequently sent into CCAA proceedings. In its ruling, the Court quoted from prior jurisprudence:

"The consistent line of authority in Canada holds simply that, in all events, officers, directors and employees of corporations are responsible for their tortious conduct even though that conduct was directed in a bona fide manner to the best interests of the company, always subject to the Said v. Butt exception."

The exception mentioned concerned inducing a breach of contract. In any case, this emphasizes the duty that we have to ensure that we are dealing with lenders in good faith.