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Benefits of a Security Interest in Collateral

2. What are the benefits of a security interest to creditors?

Taking a security interest in collateral to secure a debt reduces the risk to the creditor. It dissuades the creditor from defaulting on the loan for fear of losing the collateral. Also, it provides the secured creditor the ability to recuperate some or all of the debt by repossessing and selling the collateral. A security interest in property entails the secured party’s right to “repossess” and “foreclose” upon the collateral in the event of default. Foreclosure is the use of the property to satisfy the outstanding debt. There are two types of foreclosure:

•    Strict Foreclosure – Strict foreclosure is when a secured party repossesses and retains possession of the collateral in complete satisfaction of the outstanding debt. The secured party is required to provide written notice to the debtor of this intent and, if something other than consumer goods, notice to other creditors. The debtor or any creditor may object to a strict foreclosure and force the foreclosing creditor to undertake a foreclosure sale.

⁃    Note: This is generally only an option when the foreclosing creditor is the only secured party or when all creditors agree to the foreclosure. If other creditors agree, the foreclosing creditor acquires the property clear of liens and security interests.

•    Foreclosure Sale – A foreclosure sale is the process of selling the collateral in a private sale or at public auction. The foreclosing creditor must provide notice to the debtor and, if the goods are other than consumer goods, to other creditors. The sale must be carried out in a commercially reasonable manner.

⁃    Note: A purchaser at foreclosure sale acquires the property free and clear of all inferior security interests and liens. If, however, there is a superior security interest (one with higher priority) on the property, the purchase does not take the property free and clear. This can cause serious issues for individuals who purchase the collateral at sale and are unaware of the superior security interest or lien.

A debtor generally has the right to repay the outstanding debt and reclaim the property at any time prior to the creditor foreclosing on the property. This is known as a “right of redemption”. In some jurisdiction, debtors have a statutory right of redemption for a specified period following foreclosure. This is common in foreclosures of real estate.

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