Perfection of a Security Interest
Recording the Security Interest
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What is Perfection of a security interest?
Perfection is the process of putting the entire world on notice that the secured party claims a security interest in the debtors collateral. Recall, a security interest is enforceable against the debtor at the time that it attaches. That is, the attached security interest will allow the secured party to repossess the assets of the debtor in the event of non-payment of the secured debt.
A problem arises when other creditors of the debtor seek to establish a security interest in the debtors property, including the collateral already securing existing debts. These parties are effectively claiming an interest in the collateral that competes with the original secured partys interests.
Secured parties must make certain that the security interest is enforceable as against third parties who claim a competing interest in the collateral. The security interest is only enforceable as against these third parties once it is perfected.
Perfection allows the secured party to maintain priority of payment or priority above other creditors in the event the collateral must be repossessed and sold to pay outstanding debts. The concept of priority of security interests is discussed further below.
Note: Any party with a security interest in collateral can repossess and sell the collateral upon default by the debtor. Priority establishes a partys entitlement to the proceeds of sale.
Next Article: Methods of Perfecting a Security Interest in Personal Property. Back to: SECURED TRANSACTIONS
When is a Security Interest Enforceable?
A security interest is enforceable against the debtor at the time when it attaches. Secured parties, however, must make certain that the security interest is enforceable against third parties. That is, the secured party wants to have priority of payment above other creditors in the event the collateral is repossessed and sold. The concept of priority is discussed further in separate lectures.
What is the Priority of Creditors?
To establish a secured creditors priority of interest in collateral above all other creditors of the debtor, the secured creditor must perfect her security interest. Being the first party to perfect her interest in the collateral gives her priority above any other creditors who later attempt to establish a secured interest in the collateral. In turn, failing to perfect a security interest allows a later creditor who perfect their security interest in the collateral to receive priority of payment from the sale of the collateral. 9-317(a). Most notably, an unperfected security interest is subordinate (lower priority) to a lien creditor (such as a plaintiff receiving a judgment against the debtor) or the trustee in the event of bankruptcy. The trustee represents all unsecured creditors, which has the effect of subordinating the secured party below all other creditors.11 U.S.C. 544(a)(1). In short, perfecting a security interest is essential to receive the benefits of the security interest.
What are the Methods of Perfecting a Security Interest?
Generally, Article 9 allows a secured party to perfect her security interest in multiple methods. Below are the primary methods for perfecting a security interest:
- Filing a financing statement in the appropriate public office;
- Take or retain possession of the collateral;
- Obtain or retain control of the collateral over the collateral; or
- In limited circumstance, automatic perfection of the security interest in the collateral
Each of these methods of perfecting a security interest are discussed further in separate lectures.
Discussion: What do you think about the ability of multiple secured parties to claim a security interest in the same collateral? Why do you think a secured party is required to perfect (provide notice to the world) of a security interest for it to be effective as against third parties?
Practice Question: Cienna sells a piece of equipment to Patrick and finances it over 12 months. She takes a security interest in the collateral to secure payment. She knows that Patrick has other loans, what should Cienna do to protect her interests?