To understand the importance of security interests, it is first important to understand the legal process involved when a lender does not have a security interest (i.e., is unsecured) in relation to the borrower. If a lender makes an unsecured loan and the debtor defaults, the lender must sue in court and obtain a judgment. However, this judgment by itself is worth nothing: suitable only for framing. Since the debt is unsecured, there is no specific property backing the debt, so the unsecured lender must obtain a writ of execution, which allows the local sheriff or federal marshal to seize upon any property of the debtor’s that can be found. If the debtor has filed for bankruptcy, the creditor will likely end up with nothing. As you can imagine, trying to recover on a bad unsecured debt can be an expensive, time-consuming and often fruitless exercise in frustration for the unsecured creditor.
Consequently, a lender will often require a debtor to agree to the creation of a security interest in order to protect that creditor. The security interest is the right of the lender to sell specific property in order to satisfy the debt should the borrower default. One of the most common security interests is found in a mortgage for real estate, but is also regularly seen in personal property transactions, both tangible and intangible. Tangible personal property includes cars, motorcycles, kitchen appliances and pretty much any movable physical property you can imagine. Intangible personal property includes things like accounts receivable, securities, and promissory notes. Generally speaking, the law of secured transactions is governed by Article 9 of the Uniform Commercial Code.
As a lender, making sure your debt is secured through the proper creation of a security interest often only gives you minimal protection. This is because the property referenced as collateral in the security interest may have been used by the borrower as collateral for other debts as well. In the case of a mortgaged real estate property, you will often see many secured interests: a first mortgage, a second mortgage, a security interest in a fixture such as a swimming pool or a garage, or perhaps a judgment lien from a lawsuit the debtor lost. As a lender, understanding your relative priority against other secured interests in a specific property and maximizing your place in that pecking order will sometimes make all the difference between getting something rather than nothing out of a bad debt. That process of enforcing your security interest against other creditors is known as perfection. Perfection involves putting the rest of the world on notice that you have an interest in the debtor’s asset.
As mentioned previously, the UCC typically governs the rules regarding security interests generally and issues of perfection specifically, and is beyond the scope of this modest article. That being said, what you should know as a lender right here and right now is that the where and the when of filing for perfection of your security interest is of the utmost importance. Generally speaking, if you’re dealing with movable personal property like appliances and HDTVs, you will perfect your interest by filing a UCC statement with your state’s Secretary of State office. If your security interest is a fixture attached to real property, generally speaking that perfection notice will be filed with your county registrar of deeds. If the secured property is a motorcycle or automobile, your state statutes may provide that perfection is handled through a certificate of title. The law can vary from state to state, so please check your own state’s statutes.
Filing for perfection in the right office will generally be sufficient to put other creditors on notice of your interest. However, you must also be aware of the priority of your interest in relation to those other creditors. More often than not, that priority is determined by who filed for perfection first. In short, you are in a race with other creditors, and the sooner you file for perfection, the better. Be aware, too, that a creditor can often file for perfection even before the security interest itself is filed with the appropriate office. Delays can be costly to you, so don’t tarry! Lastly, keep in mind that in limited cases, you may lose the priority battle among creditors, even if you were the first to file for perfection. Generally, you will see this when a repairman claims a mechanic’s or workman’s lien for work done on the property in question. However, state law again can vary some in this area, so if in doubt please consult with a knowledgeable attorney in your jurisdiction.
My goal here is not to offer a solid tutorial in security interests and perfection, and it is certainly not to provide any legal counsel or advice. Instead, my hope is that after reading this article you will be adequately informed as a consumer in the legal marketplace when it comes to establishing and protecting your security interests. Some knowledge regarding creating security interests, and where to go to perfect those interests, should help you as a future creditor in maximizing peace of mind now and avoiding legal headaches later. Please engage the services of an attorney competent in commercial law should the situation call for it.
~David Williams, Class of 2013~