Secured Transactions

To be valid, a secured transaction must contain an express agreement between the debtor and the secured party. The agreement must be in writing, must be signed by both parties, must describe the collateral, and must contain language indicating a grant of a security interest to the creditor. Furthermore, something of value must be given by one party to the other party. This can be a binding commitment to extend credit, the satisfaction of an already existing claim, the delivery and acceptance of goods under a contract, or any other exchange of value sufficient to create a contract. Once these formalities have been completed, the security associated with the principal agreement is said to attach. Attachment simply means that the security side of the agreement is complete and legally enforceable.

To completely secure a secured transaction, or perfect the security, the secured party should file a financing statement with the local public records office, SECRETARY OF STATE, or other appropriate government body. Perfecting the security makes the secured party's claim official, puts the rest of the world on notice as to the creditor's rights in the property, and gives the creditor the right to take advantage of special remedies in the event the debtor does not repay the loan. A financing statement is a document that fully describes the secured transaction. The written document that created the agreement may serve as a financing statement, but the law on financing statements varies from state to state. A state may require the secured party to file a financing statement in addition to a copy of the agreement.

In most states financing statements are effective only for a limited duration, such as five years. A secured creditor may extend the length of perfection by filing a continuation statement before the designated time period has expired. If a secured creditor fails to continue the perfection, the security is not lost, but other creditors may claim the property. The secured creditor may file another financing statement, but this would require another signature from the debtor.

Amendments may be made to a financing statement. A secured party may file a statement of release on some of the collateral once the debtor has made payments equal in value to the value of the released collateral. If the amendment adds collateral, the security for the new collateral is effective from the date of the amendment, and not the date of the filing of the original financing statement.

One exception to the filing rule occurs when the secured party has possession of the collateral. In this situation the creditor's security is complete once the parties have agreed to the primary transaction. Another exception is the purchase money security interest in consumer goods other than building fixtures and motor vehicles. The filing of a purchase money security interest for such consumer goods is optional. If a secured party to a conditional sale does not record or file the agreement, however, he may lose the security if the buyer sells the goods to a third party.

Failure to perfect the security may have drastic consequences for the secured party who does not possess the collateral, although such failure does not automatically mean that the security will be lost. If, however, another party later stakes a claim to the collateral and files the proper papers, the secured party may lose his or her claim to the property because claims that have been properly recorded or filed have priority. Thus a secured party is wise to file a financing statement and other required documents to perfect the security and protect against claims by other creditors of the debtor.

Article 9 of the UCC is primarily concerned with protecting the secured party's right to the collateral. Many sections of Article 9 delineate who has the first right to a debtor's property if multiple claims arise. Precisely who has the first right to the debtor's property depends on a number of factors, including whether the security was perfected, who the other claimant is, and the time that the claims arose.

If a security interest has not been perfected, the secured party's claim to the collateral property may be subordinate to any number of creditors. A person who has a lien on the property takes before the secured party, as does a person who has received a court order for attachment of the property. If a person buys the collateral from the debtor and did not know of the security interest, the secured party loses the property if the security was not perfected. This is true only if the buyer purchases the property in the ordinary course of business from a person who is in the business of selling goods of that particular kind. A pawnbroker, for example, is not such a seller because a pawnbroker will sell almost anything if the profit is worth the time and trouble.

The identity of the buyer may influence the outcome of a dispute between a buyer of secured goods and the secured party. Generally, a merchant, or a buyer who purchases property for a business, is held to a higher standard than a person who buys an item for personal use. Merchants are more familiar with markets than are ordinary consumers, and they may be expected to know that a seller was insolvent and that the goods being sold were subject to claims from other parties. In any case, if any buyer knows that another party has a security interest in the property at the time the buyer made the purchase, the secured party retains the first claim to the property and may keep the property out of that buyer's possession until the debt associated with the secured property is fully paid.

If two parties have a security interest in the same property, the party who filed first takes first. If the competing security interests are both unperfected, the party who was first to attach the property as collateral has priority.

Other creditors of a debtor may have the first claim on secured property. However, the federal government has priority in some instances for collection of federal tax liens. Most states have artisan's lien statutes, which give servicers of property the right to hold the property in their possession as security for payment of the service bill. If the bill remains unpaid, the servicer has priority even over a secured party who has perfected his or her interest. Once a servicer or repairperson is paid for his services, he must release the goods to either their owner or the party with the security interest in the goods.

If the debtor to a secured party defaults, the secured party who has failed to perfect the security interest may lose first claim to the secured property to a receiver or an assignee for the benefit of creditors. A receiver is a party who is appointed by the BANKRUPTCY court to manage the finances of the debtor for the benefit of the debtor's creditors. An assignee for the benefit of creditors is a person chosen by the debtor to manage all or substantially all of the debtor's property and to distribute it to creditors. A secured party who has perfected the security interest has priority over an assignee or a receiver, but even a secured party who has perfected may not receive all of the debt owed under a security agreement by a bankrupt debtor. Federal bankruptcy laws are designed to distribute the assets of an insolvent debtor in a fair and ratable manner among all of the debtor's creditors.