Chapter 27
Secured Transactions
and Security Interests in Personal
Property
© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman
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Secured Transaction
A transaction that is created when
a creditor makes a loan to a debtor
in exchange for the debtor’s pledge
of personal property as security.
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Basic Terminology
• Debtor – The party who owes
payment or other performance of
the secured obligation.
• Secured Party – A seller, lender, or
other party in whose favor there is
a security interest, including a
party to whom accounts or
chattel paper has been sold.
• Security Interest – An interest in
personal property or fixtures that
secures payment or performance
of an obligation.
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Basic Terminology (continued)
• Security Agreement – The
agreement between the
debtor and the secured
party that creates or provides
for a security interest.
• Collateral – The property
subject to a security interest,
including accounts and
chattel paper that have
been sold.
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Security Interest in Personal
Property
• Tangible personal property
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–
–
–
–
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Equipment
Vehicles
Furniture
Computers
Clothes
Jewelry
• Intangible personal property
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–
Securities
Patents
Trademarks
Copyrights
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Personal Property and Credit
• Personal property is often
sold on credit
– Unsecured credit
• No interest in collateral
• If debtor defaults, creditor must
sue debtor
– Secured credit
• Purchaser pledges collateral
– Creditor may recover collateral in
case of default
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Secured Transaction
• Creditor extends credit to
debtor and takes security
interest.
• Secured party is seller, lender,
or third party.
• Secured party can foreclose
on collateral if debtor fails to
pay.
• Governed by Revised Article
9 of the UCC.
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Two-Party Secured Transaction
Sale of Goods on
Credit
Seller-Lender
Secured Creditor
Buyer-Debtor
Secured Interest in
the Goods
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Three-Party Secured Transaction
Sale of Goods
Buyer-Debtor
Loan of
Funds
Seller
Security
Interest in the
Goods
Lender-Secured
Creditor
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Personal Property Subject to a
Security Agreement
•
•
•
•
•
•
Goods
Instruments
Chattel paper
Documents of title
Accounts
General intangibles
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Personal Property Subject to a Security
Agreement
• Goods, including:
– Consumer goods bought or
used primarily for personal,
family, or household purposes
– Equipment bought or used
primarily for business
– Farm products including crops,
livestock and supplies used or
produced in farming operations
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Personal Property Subject to a Security
Agreement (continued)
• Goods (continued)
– Inventory held for sale or lease,
including work in progress and
materials
– Fixtures affixed to real estate so
as to become part thereof
• Instruments, such a checks,
notes, stocks, bonds, and
other investment securities
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Personal Property Subject to a Security
Agreement (continued)
• Chattel paper, such as a
conditional sales contract
• Documents of title, including
bills of lading and warehouse
receipts
• Accounts, such as accounts
receivable
• General intangibles, such as
patents, copyrights, money
franchises, and royalties
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Written Security Agreement
The agreement between the debtor
and the secured party that creates
or provides for a security interest.
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Written Security Agreement
To be valid, a written security
agreement must:
1. Clearly describe the collateral
so that it can be readily
identified.
2. Contain the debtor’s promise
to repay the creditor,
including terms of repayment.
3. Set forth the creditor’s rights
upon the debtor’s default.
4. Be signed by the debtor.
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Attachment
• Debtor must have current or
future legal right in or right to
possession of collateral.
• Rights of secured party
attach to collateral.
• Creditor has enforceable
security interest in property.
• Debt can be satisfied out of
collateral.
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The Floating-Lien Concept
• A security interest in property
that was not in possession of
the debtor when the security
agreement was executed.
• A floating lien can attach to:
– After-acquired property
– Future advances
– Sale proceeds
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Perfecting a Security Interest
•
Establishes the right of a
secured creditor against
other creditors who claim
an interest in the collateral.
•
Perfection is a legal
process.
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Perfection of a Security Interest
(continued)
The three main methods of
perfecting a security interest
under the UCC are:
1. Perfection by filing a
financing statement
2. Perfection by possession of
collateral
3. Perfection by a purchase
monetary security interest in
consumer goods
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Perfection by Filing a Financing
Statement
• A document filed by a secured
creditor with the appropriate
government office that
constructively notifies the world of
his or her security interest in
personal property.
• Financing statements are
effective for five years from the
filing date.
• State law specifies where the
financing statement must be filed.
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Perfection by Possession of Collateral
• If a secured creditor has physical
possession of the collateral, no
financing statement has to be
filed.
• The creditor’s possession is
sufficient to put other potential
creditors on notice of his or her
secured interest in the property.
• A secured creditor who holds the
debtor’s property as collateral
must use reasonable care in its
custody and preservation.
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Perfection by a Purchase Money
Security Interest in Consumer Goods
• An interest a creditor
automatically obtains when it
extends credit to a consumer to
purchase consumer goods.
• The creditor does not have to file
a financing statement or take
possession of the goods to perfect
his or her security interest.
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Summary: Methods for Perfecting
a Security Interest
Perfection
Method
How Created
Financing
statement
Creditor files a financing statement with
the appropriate government office.
Possession of
collateral
Creditor obtains physical possession of
the collateral.
Purchase money
security interest
Creditor extends credit to a debtor to
purchase consumer goods and obtains a
security interest in the goods.
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Termination Statement
• A document filed by a
secured party that ends a
secured interest because the
debt has been paid.
• Must be filed within one
month after the debt is paid
or 10 days after receipt of the
debtor’s written demand
(whichever occurs first).
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Priority of Claims
•
•
Priority – The order in which
conflicting claims of
creditors in the same
collateral are solved.
The priority of claims is
determined according to:
1.
2.
Whether the claim is
unsecured or secured
The time at which secured
claims were attached or
perfected
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UCC Rules for Determining
Priority
Secured versus Unsecured
Claims.
1.
•
A creditor who has the only
secured interest in the debtor’s
collateral has priority over
unsecured interests.
Competing Unperfected
Secured Claims.
2.
•
If two or more secured parties claim
an interest in the same collateral
but neither has a perfected claim,
the first to attach has priority.
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UCC Rules for Determining
Priority (continued)
3. Perfected versus
Unperfected Claims.
•
If two or more secured parties claim
an interest in the same collateral
but only one has perfected his or
her security interest, the perfected
security interest has priority.
4. Competing Perfected
Secured Claims.
•
If two or more secured parties have
perfected security interests in the
same collateral, the first to perfect
has priority.
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UCC Rules for Determining
Priority (continued)
5. Perfected Secured Claims in
Fungible, Commingled
Goods.
•
If a security interest in goods is perfected,
but the goods are later commingled with
other goods and the goods become part
of a product or mass and lose their identity,
the security interests rank equally,
according to the ratio that the cost of
goods to which each interest originally
attached bears to the cost of the total
product or mass.
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Exceptions to the Perfection-Priority Rule
• Purchase money security interest:
inventory as collateral
• Purchase money security interest:
non-inventory as collateral
• Buyers in the ordinary course of
business
• Secondhand consumer goods
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Default
Failure to make scheduled payments
when due, bankruptcy of the debtor,
breach of the warranty of ownership
as to collateral, and other events
defined by the parties to constitute
default [UCC 9-501(1)].
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Default and Remedies
• Upon default by the debtor,
the secured party may
reduce his or her claim to
judgment, foreclosure, or
otherwise enforce his or her
security interest by any
available judicial procedure.
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Default
• The debtor will be considered
in default if they:
– Fail to make scheduled
payments.
– File for bankruptcy.
– Breach the warranty of
ownership as to the collateral.
– Are in violation of any event
defined in the security
agreement.
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UCC Remedies for Default (
1.
2.
3.
The UCC provides the secured
party with the following
remedies:
Taking possession of the
collateral
Relinquishing the security interest
and proceeding to judgment on
the underlying debt
Security agreements covering
real and personal property
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Repossession
• The secured party may cure
the default by taking
possession of the collateral.
– The secured party may then:
• Retain the collateral.
• Sell or dispose of the collateral and
satisfy debt from proceeds.
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Retention of Collateral
• The secured creditor may
retain possession.
– Must notify debtor, unless
debtor renounced rights in
writing.
• Secured creditor may not
retain property if:
– There is a written objection.
– The goods are consumer goods
and the debtor has paid 60
percent of the cash price or
loan.
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Disposition
• The creditor may dispose of
goods in any commercially
reasonable method.
• The proceeds must first be
applied to:
– Reasonable expenses of
retaking, holding, and
preparing collateral for sale.
– Satisfying balance owed.
– Satisfaction of any subordinate
claims.
– Debtor gets surplus.
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Deficiency and Redemption
• The secured party may bring
an action to recover any
deficiency.
• The debtor or another
secured party may redeem
the collateral before the
lienholder has disposed of it,
entered into a contract for
sale, or discharged the
debtor’s obligations.
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Relinquishing the Security Interest
• The creditor may relinquish
his security interest and
proceed to judgment to
recover underlying debt.
– Usually chosen when value of
collateral has been reduced
below value of secured
interest.
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Surety Arrangement
• Third person (surety or codebtor) agrees to be liable
for payment of another
person’s debt.
• Surety is also called
accommodation party or
cosigner.
• Surety is primarily liable for
paying principal’s debt.
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Guaranty Arrangement
• Third person (guarantor)
agrees to pay debt of
principal debtor if he
defaults.
• Guarantor is secondarily
liable on debt.
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Defenses of a Surety or Guarantor
• Guarantor or surety may
allege the same defenses
that the principal debtor has.
• The defense of fraudulent
inducement to enter as
guarantor/surety may be
alleged.
• Duress may be alleged.
• Guarantor/surety may not
assert debtor’s incapacity.
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