The law of secured transactions in the United States covers the creation and enforcement of a security interest. Usually, a secured transaction happens when a person or business borrows money for the purpose of acquiring property, including real estate, vehicles or business equipment. A security interest exists when a borrower enters into a contract that allows the lender, or secured party, to take collateral the borrower owns in the event that the borrower cannot pay back the loan. The term "security interest" is often used interchangeably with "lien" in the U.S.
Purpose of secured transactions
A security interest promotes economic security because it provides the lender with the promise of repayment: if the borrower defaults on the loan, the lender should be able to recoup the loan amount by taking the agreed-upon asset used as collateral and selling it. A security interest can be particularly valuable in bankruptcy, because secured creditors will be able to collect their debts before creditors without a security interest.
What law governs secured transactions?
A security interest generally is created with a security agreement, which is a contract governed by Uniform Commercial Code (UCC) Article 9, as well as other state laws governing contracts. The UCC has been adopted, with some modifications, by every state, as well as the District of Columbia, Guam and the U.S. Virgin Islands.
Article 9 of the UCC governs any transaction that is voluntary and commercial and which creates an interest in personal property. Personal property may include fixtures, which are personal property that is attached to real property, such as a furnace.
Real property secured transactions, such as for a real estate mortgage, are not governed by Article 9 but by real property laws that can vary from state to state. Statutory liens, which may arise from certain laws that provide for a right to retain property against its owner as security for obligations, are generally governed by the statute that creates them.
How is a security interest created under Article 9?
In order for a security interest to be enforceable against the debtor and third parties, UCC Article 9 sets forth three requirements: Value must be provided in exchange for the collateral; the debtor must have rights in the collateral or the ability to convey rights in the collateral to a secured party; and either the debtor must have "authenticated" a security agreement with a description of the collateral or the creditor must be in possession of the collateral. When all three of these formalities are met, the security interest "attaches" to the collateral and becomes enforceable.
Usually, a borrower and lender sign a security agreement. Such an agreement usually includes a description of the borrower's collateral, a description of the obligation it secures, an identification of what constitutes a default, the rights of the creditor if the borrower defaults, the requirements of the debtor with respect to the care of and insurance maintained on the collateral, and any other obligations of the parties to the transaction.
A statute of frauds within UCC Article 9 requires the security agreement be in writing. An exception to this requirement is when a security interest is pledged. This happens when a borrower gives the collateral to the lender in exchange for a loan, such as when an individual provides goods to a pawnbroker in exchange for a cash loan.
If a security agreement does not exist, and the security interest is not pledged, but the transaction appears to be an Article 9 transaction, the court may recognize it as such by applying the composite document rule. The court will consider a series of documents evidencing the security agreement, and will create an enforceable security interest by reading the documents as a whole. However, the documents specified in this rule must be authenticated by the parties; if this proves impossible, the security agreement will fail.
The perfection of a security agreement allows a secured party to gain priority to the collateral over any third party, should the borrower default on the loan. Perfection becomes important if other creditors have an interest in secured property, because a secured creditor's obligation will be satisfied before any other liens. This is known as priority. The creditor with the highest priority will be repaid before others if the borrower defaults and foreclosure occurs. Three exceptions exist for filing for perfection: automatic redemption, possession, and taking control of a deposit account.
The most typical way to perfect a security interest is by filing notice in a public office. The filing of a public notice puts other creditors on notice of the attached security interest in property of the creditor. The required filing most frequently is a financing statement. For a financing statement to be valid, it must include the debtor's name, the secured party's name or the name of the secured party's representative, a description of the property covered by the statement. If any of those three elements are missing from a financing statement, the security interest will not be perfected. A financing statement is valid for five years from the date it was filed and can be extended.
The United States does not have a central place for filing. Each state has a UCC filing system; though the filing office varies from state to state, most commonly, it is the Secretary of State's office. For the most part, each county in the U.S. has a real estate recording office where Article 9 fixture filings can be done.