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In: Economics

Discuss when a promissory note will be considered a security including a detailed discussion of the...

Discuss when a promissory note will be considered a security including a detailed discussion of the family resemblance test.

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Expert Solution

Dear Student,

In following condition promissory note will be considered as security, also importance of family resemblance test

As per  Section 1(1) under the Securities Act (Ontario) (the "Act") -The Act plainly provides that a "security" includes any "note or other evidence of indebtedness".

As a practical reality, promissory notes and other debt instruments are used in a whole range of financing situations. Examples include promissory notes issued in consumer financing, debentures issued in connection with a mortgage of real estate, notes or debentures secured by a lien on a business or specific assets of a business, personal notes issued to a financial institution, short term notes secured by a receivables assignment, and open account notes incurred in the ordinary course of business.ertain promissory notes may possess a markedly different character

* In following condition promissory note can not be considered as "Securities"

Case Nr.01 "In Tiffin, a private company sought to raise funds from a handful of existing clients. All told, six clients extended $700,000 of debt financing on the strength of fourteen promissory notes, all of which were secured by a claim against certain assets."

The Court adopted the "family resemblance test" put forward by the United States Supreme Court in Reves v Ernst & Young. Under this test, every promissory note is initially presumed to be a "security" unless it bears a strong resemblance to one of a judicially-crafted family of instruments that are not typically considered to be securities. The essence of the "family resemblance test" is one of context and purpose

In this conclusion court found that promissory note will not be considered a "Security" because

(i) the promissory notes were issued largely without regard to any future upside of the company,

(ii) the promissory notes were secured against the company's assets, and thus more closely resembled a typical secured financing, with appropriate remedies on loan default which sufficiently protected the lenders,

(iii) there was no expectation of a secondary market in the notes, and finally because

(iv) the investors were existing clients of the company, already intimate with its affairs, and not members of the public, suggesting that the transaction lacked a sufficiently public aspect for securities law application.

Thank You !!

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