10. 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 debtor’s 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 debtor’s property, including the collateral already securing existing debts. These parties are effectively claiming an interest in the collateral that competes with the original secured party’s 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 party’s entitlement to the proceeds of sale.
• 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?