Law of Secured Transactions
Professor Stephanie Gardner, J.D.
Textbook: Chapter 13
Unsecured Transaction
Handshake + Promise to Repay
Example: Student X agrees to lend Prof Gardner 20€ because
she’s short of cash. Prof Gardner promises to pay X back by the
end of the month.
Secured Transaction
Definition:
Agreement whereby Creditor requires Debtor to provide some
type of Security beyond mere promise to repay debt
Example: Times are tough. Student Y agrees to lend Prof Gardner
500€ but only if she provides her with some sort of collateral to
serve as a guarantee. Prof Gardner proposes to put up her
beautiful pearl necklace as a guarantee (+ certificate confirming
the value of the necklace). Y accepts and lends her the money. Prof
Gardner promises to pay her back by the end of the month, at which
point Y promises that she will return the necklace.
Secured Transaction
Wise lenders know that there is always a risk of default* however
strong the credit of the borrower looks.
At worst, there is a risk that the borrower will become insolvent
before he/she performs the personal repayment obligation.
Advantage of Secured Transactions:
A Secured Creditor is in favored position in event of Debtor’s
default or insolvency/bankruptcy
*Default: failure to fulfil an obligation under the contract, especially to repay a loan
Secured Transaction
Key to Secured Transactions:
A Secured Transaction is not a sale. It is not a gift. Rather, the
law of secured transactions governs the taking a “security” in
personal property (movables) in exchange for a loan.
This creates a “charge” or a “lien” against your property,
although you are still the legal owner. Your property is now
encumbered. Someone else has a “proprietary right” in your
property.
A Word about Mortgages
Secured transactions for real property (immovables) are typically
referred to as Mortgages (hypothèque/hypotheek).
All mortgages are recorded in the national land registry where the
real property is located.
Similar to Secured Transactions, a mortgage creates a “charge” or a
“lien” against your property, although you are still the legal owner.
Your property is now “encumbered” although you are able to live in
and enjoy your beautiful dream home (so long as you keep up the
payments to your bank)!
Unsecured vs Secured Creditors
· Q: What are the legal and practical
implications in the event of a default
(or worse, an insolvency)?
Security Interest
Definition: Form of interest in property which provides that the
property may be sold on default in order to satisfy the obligation
for which the Security Interest is granted, pursuant to a Security
Agreement
Any interest in property which secures payment or performance
of an obligation
Debtor vs. Secured Party
· Debtor: the party who owes payment or performance of
the obligation; may also be referred to as the Promisor,
or Pledgor when obligation is of a secured nature
· Secured Party: the lender, seller, or any other person in
whose favor there is a Security Interest
Collateral
· Property which is pledged as satisfaction
for debt
· Property that Debtor offers as security:
1) must be legally “owned” by Debtor
2) in which Debtor has legal interest, and
3) can include both Tangible and Intangible forms of
property
Tangible and Intangible
Forms of Collateral
· Tangibles: All things movable at time the
S.I. attaches
· Examples: consumer goods, equipment, farm products
& livestock, inventory, etc.
· Intangibles: Non-physical property that
exists only in connection with something
else
· Examples: stocks, bonds, certificates of deposit,
accounts receivable, contract right payments, patents,
copyright, etc.
Security Agreement
Definition: Agreement that creates or provides for a
Security Interest between Debtor and Secured Party
ie, an agreement between Debtor and Creditor which grants
Creditor (the “Secured Party”) a S.I. in Debtor’s property
Creditor’s 2 Primary Concerns
· Enforceable Security Interest:
In case of default, do I have an enforceable S.I. in
Debtor’s Property?
· Priority
If an enforceable S.I. exists, will my S.I. take priority
over other S.I.’s & other creditor’s claims?
Esp. important in bankruptcy!
Basis of the Law of Secured
Transactions
· Attachment
· Priority through Perfection
Attachment
Definition: The process by which a Security Interest in
the property of another becomes enforceable
· S.I. is not enforceable unless the Creditor’s
rights have “attached” to the Collateral
· Ensures that the S.I. between Debtor and
Secured Party is effective/enforceable
Attachment
How exactly does a S.I. “Attach” to Collateral?
· Possession - Creditor can take Possession of
the Collateral
· Physical Transfer of Collateral to Secured
Party
Alternatively,
1. If no possession of Collateral, there must be
agreement in writing (the Security Agreement)
2. Creditor must give Value to Debtor, and
3. Debtor must maintain Rights in Collateral (not
a sale/gift)
Attachment
Remember, 2 Concerns of all Creditors
1. Do I have an Enforceable S.I.?
Have my rights “attached” to the Collateral?
2. What is my Priority?
How to protect my claim?
How to Protect Your Claim?
Danger of 3rd Party Creditors:
Although S.I. has attached and is enforceable, sometimes
the Secured Party must ensure that additional steps have
been taken in order to protect his claim to the Collateral over
other claims (brought by 3rd parties).
Perfection of Security Interest
Definition: The legal process by which Secured Parties
protect themselves against the claims of third parties
who may wish to have their debts satisfied out of the
same Collateral
- Usually accomplished by the filing of a Financing Statement
with the appropriate government officials
- Know Local Rules !
Perfection of Security Interest
“Failure to Perfect”
No Priority + Not Opposable to 3rd Parties
= Unsecured Creditor
How to Perfect?
1. Possession – “Possession is Perfection”
2. Public Filing in Common Law Countries
Public notice of the S.I.: Puts the World on Notice
i) UK - Filing of Financing Statement at Companies House
ii) U.S. - UCC 1 Form at Secretary of State
iii) Other Common Law Jurisdictions – check local rules
See, especially:
Debtor’s jurisdiction + location of Collateral
+ governing law of Security Agreement
Financing Statement
Definition: A document prepared by Secured Creditor
and filed with the appropriate government official to
give notice to the public that the Secured Creditor
claims an interest in Collateral belonging to the Debtor
named in the statement
1. Signed by Debtor
2. Contains names & addresses of both Debtor & Secured
Party
3. Provides description of Collateral
Filing Issues
1. Collateral has been moved to another jurisdiction
2. Expiry of Filing Statement
3. Amendments - change of name, corporate form, etc.
4. Debtor’s often reluctant to file (especially from
Civil Law countries)
5. Beware of vague descriptions of Collateral!
Law of Secured Transactions
Your Turn :
A Closer Look at Security Interests
- The Problem with Proceeds -
