Banking & Finance Law
Secured Transactions: Which Party is Secure?
Americans know how hard it can be to get a loan. Even in good economic times, responsible lenders may be cautious about lending money if they are concerned about a borrower’s ability to repay the loan. Many lenders, therefore, decide to take a security interest in the personal property which is being purchased with the loan money. A loan that is issued with collateral that is taken in property, other than real estate, is called a secure transaction. Article 9 of the Uniform Commercial Code, as passed in each individual state, governs secured transactions.
What is a Security Interest?
A security interest, also known as collateral, provides a financial lender with more “security” than just a borrower’s promise that money will be repaid according to the terms of the loan contract. In order for a lender to have a security interest, the loan agreement must be executed to provide the lender with rights to certain personal property if the borrower defaults on the loan.
Consider, for example, a large dairy farmer who sells large quantities of ice cream, butter and milk to grocery stores. In order for the business to operate, the dairy farmer is going to need specialized equipment that likely cost more than the dairy farmer has in liquid assets to devote to the purchase of equipment. Accordingly, the dairy farmer applies for a loan to purchase the necessary equipment. A lender may agree to loan the dairy producer money to purchase the equipment with the caveat that the lender is taking a security interest in the equipment in addition to the dairy farmer’s promise to repay the loan. Then, if the dairy farmer defaults on the loan and does not make the required payments, the lender can repossess the equipment and use the value of the equipment toward the outstanding debt that the dairy farmer owes to the lender. The lender may then sue the dairy farmer for the remainder of the outstanding loan balance.
The Rights of Multiple Lenders with Secured Interests
It is important to note that a borrower, such as the dairy farmer in the above example, may have more than one lender with a security interest in the same property. In addition to defining what a security interest is and the rights that accompany having a security interest in personal property, Article 9 of the Uniform Commercial Code describes the rights of secured lenders with regard to one another. Generally, the first lender to properly record a security interest has priority over other lenders and so on down the line of secured lenders. However, secured transactions are not always that simple and the UCC provides guidance to lenders, borrowers and courts on how to protect the rights of all parties.
The rights of lenders become important when a borrower defaults on a loan or when a borrower enters bankruptcy. If you are a secured lender then you may have certain legal rights to the property of your borrower and you may be entitled to compensation if the borrower fails to repay the loan according to the loan agreement. A secured transaction, therefore, provides secured lenders with important “security” in their transactions.