The Basis of a Security Interest
A security interest occurs when a debtor, which can be a person or business, borrows money from a creditor or more specifically a secured party and they agree to execute a security agreement. The loan between the debtor and the secured party is secured by collateral. Collateral can include equipment, inventory, deposit accounts, vehicles, property, investment accounts, paper investments, etc. U.C.C. § 9-102(12).
When a security agreement is executed, a secured party receives a security interest in the collateral the debtor is securing the loan with. In the event the debtor defaults by not paying back the loan or by violating a provision in the agreement, the secured party can seize the collateral and may sell it to satisfy the debt.
In order for a creditor to become a secured party and have the legal right to take possession of the collateral if the debtor defaults on the loan, the security interest must attach. Additionally, a secured party must perfect the security interest if it wants to fully ensure its legal rights against a third-party claim.
How to Attach a Security Interest?
Under the Uniform Commercial Code (“UCC”), a security interest attaches to the collateral when it becomes enforceable against the debtor with respect to the collateral. U.C.C. § 9-203(a). A security interest is enforceable against the debtor and third parties with respect to the collateral only if:
- Value has been given;
- Debtor has rights in the collateral or the power to transfer rights in the collateral to the secured party; and
- The debtor authenticates the security agreement, or the secured party receives possession or control of the collateral
First, value has to be given in exchange for the collateral. U.C.C. § 9-203(b)(1). Just like a contract there must be an exchange of consideration between the parties. Value is usually given when the bank loans the debtor money.
Second, the debtor must have rights in the collateral by either owning the collateral prior to the secured transaction or by purchasing the collateral as part of the secured transaction. U.C.C. § 9-203(b)(2).
Third, a debtor must authenticate a security agreement or provide the secured party with possession or control of the collateral. U.C.C. § 9-203(b)(3). A security agreement is authenticated when there is a written agreement that has (1) the debtor’s signature and (2) a description of the collateral. U.C.C. § 9-203(b)(3)(A). The UCC allows the debtor to sign the agreement electronically. U.C.C. § 9-102(7). Additionally, the UCC indicates that the description of the collateral cannot be super generic. U.C.C. § 9-108(c). The description in the security agreement cannot state “all the debtor’s asserts” or “all the debtor’s personal property.” U.C.C. § 9-108(c). Instead, the security agreement must reasonably identify what is described. U.C.C. § 9-108(a).
Furthermore, if it is possible a debtor may provide possession of the collateral to the secured party. U.C.C. § 9-203(b)(3)(B-C). If the secured party has possession of the collateral, then a security agreement does not have to be authenticated.
See our next blog post to learn how you can perfect a security interest.