Why would a bank refuse to lend when the seller is taking back a note?

A lender may decline because the seller’s note interferes with something the loan needs. Seller financing is not ruled out in itself: BDC says a financing structure may combine your own investment, a business loan and seller financing. The points to check are the ranking of security, the way a program treats the vendor-financed amount, and what happens if the note is missed. Ask the lender to name its reason, because each one has a different fix. The guide to the purchase agreement shows where the note’s terms sit.

Security ranking

If the seller takes security over the same assets the bank wants, the two rank against each other. Under Ontario’s Personal Property Security Act, if no other provision applies, priority between interests perfected by registration follows the order of registration (s.30(1)), and a purchase-money interest has its own rules under s.33. The federal Canada Small Business Financing Program’s guidelines say that when a term loan finances the purchase of real property or equipment, the security must be a valid and enforceable first charge on the assets financed. A seller registered first may therefore be asked to postpone.

How a program treats the note

The CSBF guidelines say that when a vendor finances part of the purchase price, the amount of that financing is not eligible for a CSBF loan. They also say that where a prior charge flows from an after-acquired clause in a security document such as a general security agreement, held by the lender or another creditor, the lender must obtain the postponements of rank for the assets the loan finances. A lender outside that program applies its own policy, so ask what it is.

Repayment and default terms

A seller’s note adds a second repayment obligation alongside the loan. Ask the lender whether it wants to see the note’s payment schedule, whether the note’s payments must depend on the loan being current, and what the seller could do on default. Bring a draft of the note’s terms to the first meeting rather than describing it loosely.

What to do next

• Ask for the refusal reason in writing.
• Ask whether a postponement or subordination agreement from the seller would change the answer.
• Ask whether a different loan program treats seller financing differently.
• Have a lawyer review both documents together so they do not conflict.