What is priority of a security interest?

The priority of a secured party regards the party's right to payment in the event of default by a debtor. If a debtor defaults, a secured party with a security interest in collateral will have a claim of ownership in the collateral. As such, she can repossess the collateral, sell it, and use the proceeds to satisfy the debt. Many issues arise, however, when there are multiple creditors of the debtor. The situations gets more complicated when there are multiple secured parties claiming an interest in the subject collateral. This is when the concept of priority is most important.

Priority - Priority establishes the order of who has the highest claim to assets or the proceeds from the sale of those assets. A secured party with the highest priority in collateral will receive payment of her claim before any other creditors receive payment. Subordinate secured creditors will only receive payment once the highest priority secured creditor is paid in full. Once the highest priority creditor is paid, the next highest priority creditor is paid, and so on.

Note: The secured party with the highest priority faces the lowest risk of nonpayment. The terms of secured-party lending reflects the risk associated with the borrowers priority.

How Does Priority Affect Risk and Creditor Status?

The lower the priority of a creditor, the greater the risk that she will not receive any money from the sale of the collateral in the event of default. If a creditors claim is not paid in full, she becomes an unsecured creditor of the debtor. Unsecured creditors generally have the highest risk of non-payment. This is particularly troublesome if the debtor files for bankruptcy protection. In the event of debtor bankruptcy, unsecured creditors generally receive a fraction, if anything, of their claim amount. Secured creditors, on the other hand, must either be paid in full or they can force the sale or surrender of the collateral securing the obligation.

Note: A debt to an unsecured creditor that is not paid in full from the debtors bankruptcy estate is discharged. This means the debtor cannot later seek payment from the debtor and must accept the loss.

The following rules apply to unperfected security interests:

• Perfected vs Unperfected - A perfected security interest in collateral has priority over an unperfected security interest in the same collateral. This is true regardless of the timing of attachment of the security interest.
• Lien Creditors vs. Unperfected - An individual who becomes a lien creditor prior to the perfection of a security interest by a secured party has priority over the secured party.
• Buyers of Collateral - Buyers who provides value and takes possession of the collateral in many situation takes the collateral free of the security interest if it has not been perfected.
• • Note: The purchase must have no knowledge of the security interest and given value before it is perfected.

Each of these scenarios are discussed in greater detail in subsequent lectures.

Related Topics

• Secured Transactions Law (Intro)
• What is a Security Interest?
• Collateral 
• Pledge as Collateral
• Collateralize
• Cross Collateralization
• After-Acquired Collateral
• Unsecured Loan Definition
  
• Unencumbered Asset
• What is a Secured Creditor?
• Unsecured Creditor
• What are the benefits of security interests for creditors?
• Limited Recourse Debt
• Uniform Commercial Code - Article 9
  
• What are the common types of security interest in real property (land)?
• What is a mortgage?
• How does a security interest protect the mortgage holder?
• Lis Pendens
• Deficiency Judgment
• What is a Deed of Trust or Security Deed?
• What is a Land Sale Contract?
• What is a security interest in personal property?
• How does one establish a security interest in personal property?
• What is Perfection of a security interest?
• What are the methods of perfecting a security interest in personal property?
• UCC-1 Statement
• How does one establish a security interest in real property (land)?
• Register of Deeds
• What is Automatic Perfection of a security interest?
• What is a Purchase Money Security Interest (PMSI) in consumer goods?
• What is a Purchase Money Grace Period for a PMSI in non-consumer goods?
• How does one continue perfection of a PMSI in non-consumer goods?
• What is Temporary Automatic Perfection in Proceeds from the sale of goods?
• How is a security interest created in Assignment of Accounts Receivable and Contract Rights?
• How does one perfect a security interest by Possession of the collateral?
• How does on perfect a security interest by Control of collateral?
• How does one perfect a security interest by Filing a Financing Statement?
• What authorization is required to file a financing statement?
• Where is the appropriate office to file a financing statement?
• Defeasance
• Continuation Statement
• What is Priority of a security interest?
• What role does perfection play in establishing the Priority of a secured party?
• What are the common conflicts arising as to priority of a security interest?
• What is the priority of parties secured by common law and statutory liens?
• Lien - Definition
• Blanket Lien Definition
• Unperfected Lien
• Possessory Lien 
• Non-Possessory Lien 
• Tax Lien
• Mechanics Lien Definition
• Construction Lien
• Cloud on Title
• What is the priority of a buyer of collateral that is subject to a security interest?
• What is required to be a buyer in the ordinary course of business?
• How does 9-320(b) protect consumers who purchase goods from other consumers?
• What is the Shelter Principle?
• What are the general Priority Rules for Conflicting security interests?
• Subordination Agreement
• Who has Priority in Proceeds from the sale of collateral?
• What is a secured party's priority in future advances to a debtor?
• What is the priority of a PMSI in goods (other than inventory and livestock)?
• What is the priority of a PMSI in inventory?
• What is the priority of conflicting PMSIs?
• What is the priority of security interests in fixtures?
• What is the scope of fixture priority rules?