Secured Transactions

• Author: Jeffrey Lehman, Shirelle Phelps

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Business dealings that grant a creditor a right in property owned or held by a debtor to assure the payment of a debt or the performance of some obligation.

A secured transaction is a transaction that is founded on a security agreement. A security agreement is a provision in a business transaction in which the obligor, or debtor, in the agreement gives to the creditor the right to own property owned or held by the debtor. This property, called collateral, is then held by either the debtor or the secured party to ensure against loss in the event the debtor cannot fulfill the obligations under the transaction.

The purchase of a car through financing is an example of a secured transaction. The car dealership or some other lender pays for the vehicle in return for a promise from the buyer to repay the loan with interest. The buyer receives the vehicle, but the lender retains the title to the car as security against the risk that the buyer will be unable to make the loan payments. If the buyer defaults on the payments, the lender, called the secured party, may repossess the car to recover losses from the default.

If the same transaction was unsecured, the buyer would receive the title to and possession of the car, and the lender would receive only the buyer's promise to repay the loan. If the buyer defaulted on the payments, the lender could sue the buyer, but the simple remedy of taking the property would not be available.

A security interest may be transferred, or assigned, to a third party. The party receiving the assignment becomes the secured party, and the original secured party no longer holds a claim to the collateral.

The law of secured transactions varies little from state to state because all 50 states plus the District of Columbia and the U.S. Virgin Islands have adopted Article 9, the secured transactions portion of the UNIFORM COMMERCIAL CODE (UCC). The UCC is a set of model laws written by lawyers, professors, and other legal professionals in the American Law Institute. In 1999 the institute, in conjunction with the National Conference of Commissioners of Uniform State Laws (NCCUSL), drafted a revised Article 9, which was adopted uniformly on July 1, 2001. The revisions marked the first comprehensive overhaul of Article 9 since 1972. They expand the scope of property and transactions governed by the UCC, clarify existing elements of the article, and provide guidelines for dealing with the growing phenomenon of electronic commerce.

Common Forms of Secured Transactions

Secured transactions come in many forms, but three types are most common for consumers: pledges, chattel mortgages, and conditional sales. A pledge is the delivery of goods to the secured party as security for a debt or the performance of an act. For example, assume that one person has borrowed $500 from another. Assume further that the debtor gives a piece of expensive jewelry to the creditor. If the jewelry is to be returned to the debtor after the debt is repaid, and if the creditor has the right to take full ownership of the jewelry if the debtor does not pay the debt, the arrangement is called a pledge.

A chattel mortgage is like a pledge, but in a chattel mortgage transaction, the debtor is allowed to retain possession of the property that

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is put up as collateral. If the debtor fails to repay the debt, the creditor may take ownership of the property.

A third type of secured transaction, the conditional sale, uses a purchase money security interest. A purchase money security interest arises when a creditor lends money to a borrower, who uses the money to purchase a particular item. To secure repayment of the loan, the creditor receives a lien on, or claim to, the purchased item. The lien gives the creditor a claim to the property that may be asserted if the borrower does not repay the loan.

Common Forms of Collateral

Any property accepted as security by a creditor can serve as collateral, but generally collateral falls into one of five categories: consumer goods, equipment, farm products, inventory, and property on paper. Consumer goods are items used primarily for personal, family, or household purposes. Equipment consists of items of value used in business or governmental operations. Farm products are items such as crops, livestock, or supplies used or produced in a farming...