Secured transaction
Encyclopedia
Generally, a secured transaction is a loan or a credit transaction in which the lender acquires a security interest
in collateral owned by the borrower and is entitled to foreclose on or repossess the collateral in the event of the borrower's default. The terms of the relationship are governed by a contract
, or security agreement
. A common example would be a consumer who purchases a car on credit. If the consumer fails to make the payments on time, the lender will take the car and resell it, applying the proceeds of the sale toward the loan. Mortgages and deeds of trust are another example. In the United States, secured transactions in personal property
(that is, anything other than real property
) are governed by Article 9 of the Uniform Commercial Code
(U.C.C.).
The law treats differently those creditors who are secured (i.e. have an authenticated, perfected security interest) from those creditors who are unsecured. An unsecured creditor is simply a person who is owed money and has not received payment according to the terms of the agreed upon transaction. Upon default
of a debtor who has multiple creditors, the distinction between being a secured creditor and an unsecured creditor is huge in the eyes of the law. The secured creditor will generally always have priority to getting his money before the unsecured creditors do. In other words, the unsecured creditor is at the back of the line of priority - his only remedy is to obtain a judgment from the court for the amount of the defaulted loan.
The following example is given:
A debtor borrows $10,000 from a car dealership to purchase an automobile, using the automobile itself as collateral
for the loan (in other words the dealership retains a right to repossess the automobile in the event the debtor defaults on the loan). The dealership makes this loan using an authenticated security agreement
- a signed agreement giving the dealership the secured right to repossess the car in the event of default of the debtor. The debtor also has two unsecured creditors who have made loans of $1000 each to the debtor. Neither of these creditors has a security agreement - their only method of recovering their money in the event that the debtor defaults on the loan is through the judicial system, whereas the secured creditor can simply repossess the car at his option (This is called self-help repossession and is completely legal provided the secured creditor does not breach the peace in doing so). The debtor is in debt $10K to the secured creditor and $2000 to the unsecured creditors. Assume the debtor defaults and his only asset is the automobile. The dealership can repossess the auto and sell it to satisfy its debt. Two things can happen here: 1) The dealership sells the collateral (car) for more than the amount of the debt (let's say $15K). In this case, the debtor would receive the excess $5K (surplus) which he would use to satisfy the debts of his unsecured creditors (and then would have $3K left over). 2) The dealership repossess the car and sells it for less than the amount of the debt, let's say $9K (more likely scenario). In this case, the secured creditor dealership keeps the $9K, and the remaining $1K (deficiency
) that the dealership is owed becomes unsecured - it is on the same level of priority as the other two unsecured loans. Those three unsecured claims of $1K each will be paid off equally. Thus, if the debtor has $1500 to satisfy its debts - each unsecured creditor would get $500 (1/2 of amount each). The remaining debt will probably never be repaid because, in cases such as these with the debtor having multiple loans on default, the debtor has most likely filed for Ch. 7 Bankruptcy
.
It is crucial, if you are a lender, to have a security agreement in collateral that you are confident is worth at least as much as the amount of the loan you made to the debtor. If not, your deficiency in that amount is unsecured. In the previous example - the dealership loaned $10K on a car that had a fair market value
of only $9K. Thus, they were deficient $1K which becomes unsecured.
Security interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
in collateral owned by the borrower and is entitled to foreclose on or repossess the collateral in the event of the borrower's default. The terms of the relationship are governed by a contract
Contract
A contract is an agreement entered into by two parties or more with the intention of creating a legal obligation, which may have elements in writing. Contracts can be made orally. The remedy for breach of contract can be "damages" or compensation of money. In equity, the remedy can be specific...
, or security agreement
Security agreement
A security agreement, in the law of the United States, is a contract that governs the relationship between the parties to a kind of financial transaction known as a secured transaction...
. A common example would be a consumer who purchases a car on credit. If the consumer fails to make the payments on time, the lender will take the car and resell it, applying the proceeds of the sale toward the loan. Mortgages and deeds of trust are another example. In the United States, secured transactions in personal property
Personal property
Personal property, roughly speaking, is private property that is moveable, as opposed to real property or real estate. In the common law systems personal property may also be called chattels or personalty. In the civil law systems personal property is often called movable property or movables - any...
(that is, anything other than real property
Real property
In English Common Law, real property, real estate, realty, or immovable property is any subset of land that has been legally defined and the improvements to it made by human efforts: any buildings, machinery, wells, dams, ponds, mines, canals, roads, various property rights, and so forth...
) are governed by Article 9 of the Uniform Commercial Code
Uniform Commercial Code
The Uniform Commercial Code , first published in 1952, is one of a number of uniform acts that have been promulgated in conjunction with efforts to harmonize the law of sales and other commercial transactions in all 50 states within the United States of America.The goal of harmonizing state law is...
(U.C.C.).
The law treats differently those creditors who are secured (i.e. have an authenticated, perfected security interest) from those creditors who are unsecured. An unsecured creditor is simply a person who is owed money and has not received payment according to the terms of the agreed upon transaction. Upon default
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
of a debtor who has multiple creditors, the distinction between being a secured creditor and an unsecured creditor is huge in the eyes of the law. The secured creditor will generally always have priority to getting his money before the unsecured creditors do. In other words, the unsecured creditor is at the back of the line of priority - his only remedy is to obtain a judgment from the court for the amount of the defaulted loan.
The following example is given:
A debtor borrows $10,000 from a car dealership to purchase an automobile, using the automobile itself as collateral
Collateral (finance)
In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
for the loan (in other words the dealership retains a right to repossess the automobile in the event the debtor defaults on the loan). The dealership makes this loan using an authenticated security agreement
Security agreement
A security agreement, in the law of the United States, is a contract that governs the relationship between the parties to a kind of financial transaction known as a secured transaction...
- a signed agreement giving the dealership the secured right to repossess the car in the event of default of the debtor. The debtor also has two unsecured creditors who have made loans of $1000 each to the debtor. Neither of these creditors has a security agreement - their only method of recovering their money in the event that the debtor defaults on the loan is through the judicial system, whereas the secured creditor can simply repossess the car at his option (This is called self-help repossession and is completely legal provided the secured creditor does not breach the peace in doing so). The debtor is in debt $10K to the secured creditor and $2000 to the unsecured creditors. Assume the debtor defaults and his only asset is the automobile. The dealership can repossess the auto and sell it to satisfy its debt. Two things can happen here: 1) The dealership sells the collateral (car) for more than the amount of the debt (let's say $15K). In this case, the debtor would receive the excess $5K (surplus) which he would use to satisfy the debts of his unsecured creditors (and then would have $3K left over). 2) The dealership repossess the car and sells it for less than the amount of the debt, let's say $9K (more likely scenario). In this case, the secured creditor dealership keeps the $9K, and the remaining $1K (deficiency
Deficiency
A deficiency is generally a lack of something. It may also refer to:*A deficient number, in mathematics, a number n for which σ A deficiency is generally a lack of something. It may also refer to:...
) that the dealership is owed becomes unsecured - it is on the same level of priority as the other two unsecured loans. Those three unsecured claims of $1K each will be paid off equally. Thus, if the debtor has $1500 to satisfy its debts - each unsecured creditor would get $500 (1/2 of amount each). The remaining debt will probably never be repaid because, in cases such as these with the debtor having multiple loans on default, the debtor has most likely filed for Ch. 7 Bankruptcy
Chapter 7, Title 11, United States Code
Chapter 7 of the Title 11 of the United States Code governs the process of liquidation under the bankruptcy laws of the United States...
.
It is crucial, if you are a lender, to have a security agreement in collateral that you are confident is worth at least as much as the amount of the loan you made to the debtor. If not, your deficiency in that amount is unsecured. In the previous example - the dealership loaned $10K on a car that had a fair market value
Fair market value
Fair market value is an estimate of the market value of a property, based on what a knowledgeable, willing, and unpressured buyer would probably pay to a knowledgeable, willing, and unpressured seller in the market. An estimate of fair market value may be founded either on precedent or...
of only $9K. Thus, they were deficient $1K which becomes unsecured.
See also
- Secured transactions in the United StatesSecured transactions in the United StatesSecured transactions in the United States are an important part of the law and economy of the country. By enabling lenders to take a security interest in collateral , the law of secured transactions provides lenders with assurance of legal relief in case of default by the borrower...
- Security interestSecurity interestA security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
- Chattel mortgageChattel mortgageChattel mortgage, sometimes abbreviated CM, is the legal term for a type of loan contract used in some states with legal systems derived from English law....