What are Security Interests?
A security interest is a type of ownership interest in assets. It arises in a debt relationship between the debtor and creditor. The creditor makes a loan or extension of credit to the debtor. The debtor agrees to repay the debt pursuant to certain terms. To provide the creditor additional security that the debtor will repay the debt, the creditor takes a limited ownership interest in some assets of the debtor. That is, the debtor pledges a security interest in her assets (“collateral) to secure the debt. The loan is now a secured loan, as apposed to an unsecured loan that does not provide the creditor a security interest in any assets. The extent of what can be collateral is discussed further in a separate lesson.
How does the pledge of security interest in the collateral provide additional security to the creditor?
If the debtor fails to repay the debt in accordance with the debt agreement, the creditor may repossess or take possession of the collateral. The creditor may then sell the collateral to obtain cash (liquidate the asset). The creditor may pay expenses of the sale, then apply proceeds to pay off the debt. Any proceeds from the sale left over after paying the debt is returned to the debtor.
The creditor’s ability to seize and sell the collateral securing the debt provides a great deal of security to the creditor. The secured creditor can feel more comfortable that she will be repaid for the loan or extension of credit made to the debtor. An unsecured creditor cannot directly repossess assets of the debtor who fails to repay the loan or extension of credit; rather, they have to sue the debtor and attempt to recuperate their money through the judicial system.
Article 9 of the UCC
The Uniform Commercial Code (UCC) provides model laws governing commercial transactions in goods. Every state has adopted the UCC, with little change, as the statutory law of the the state. Article 9 of the UCC provides the laws governing security interests and secured transactions. The remainder of this lecture series will reference Article 9 provisions concerning security interests.
What is a Lien and how does it relate to a security interest?
A security interest is a type of lien. A lien is a debt that is specifically attached to an asset and provides the lien holder with a security interest in that asset. A security interest generally arises at the time of lending money through agreement. A lien, however, may arise through a number of methods. Other examples of liens include:
- Mechanics Liens
- Materialman’s Liens
- Judgement Liens
For example, a mechanic’s lien arises when a workman performs services on the assets of a third party. If the third party fails to pay for the work, the workman may enforce a lien and retain the asset until it is paid. Likewise, a worker who works on a home or piece of real estate may place a materialman’s lien on the property. Lastly, suing someone may result in a judgment against that individual. The holder of the judgment may attach the judgment to property of the liable defendant. The judgment holder now has a judgment lien on the assets. In all of these situations, the holder of the lien may repossess the property and sell it at auction. The proceeds from sale are used to pay the cost of sale and the debt owed. Any exceed proceeds are returned to the debtor.