Secured creditors use collateral to protect their investments. Collateral can be a good form of financial protection, but the security only exists if creditors follow all legal requirements. If all legal requirements are not met, a secured creditor might not have priority over other creditors – or have no legal rights to the collateral at all. An experienced securities lawyer can help your business protect its assets by securing your transactions appropriately.
There are many ways that a creditor can gain priority over other creditors. Mortgage lenders, for example, file specific legal documents along with the recorded deed to ensure that they have a secured interest in the home if the borrower stops making required mortgage payments. These documents are made publicly available by the county recorder. As a result, the mortgage lender is able to claim priority over other claimants to the home and even secure priority in any bankruptcy proceedings the borrower might file.
The same principles apply to businesses that have a secured interest in collateral to protect their investments. Documents are drafted to conform to the Uniform Commercial Code. These “UCC filings” are then sent to the office of the Secretary of State to be recorded. These public records serve as notice to other creditors. Like a mortgage recorded at the county recorder’s office, the security is protected because other creditors have been notified that the secured creditor has priority.
Security Interest Versus Perfection of Security Interest
A creditor can obtain a security interest in collateral, but until that interest is perfected, it offers little protection to the creditor. Perfection of a security interest occurs when all legal steps have been taken to effectively prioritize the creditor’s interest over other competing claims to the collateral. In the example of a home mortgage, the lender’s security interest is perfected once the mortgage is formally recorded, and all other claimants have notice of the lender’s security interest in the property. Similarly, a company’s security interest in collateral is perfected once the business makes a formal UCC filing with the Secretary of State. These documents also give notice of the security interest to competing claimants.
So what happens to a security interest that is not perfected? The creditor still has a legal interest in the collateral. If, for example, the borrower stops making payments, the creditor could go to court to enforce the original lending agreement against the borrower. But an unperfected security interest cannot be enforced against third parties who had no notice of the interest. So if another creditor attempted to make a claim against the same asset, the secured creditor may not be able to claim priority. The court could liquidate the asset and use the proceeds to settle both debts. If there are not enough proceeds to cover both debts, the secured creditor could lose part – or all – of its initial investment. This is why it is so important to perfect a security interest in compliance with all state and federal laws that apply to it.
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The experienced securities at Structure Law Group know how to protect business assets. Call (408) 441-7500 or contact us online to schedule a consultation.