The Quest For Perfection: Getting Security Right

Terry Jessop & Bitner Newsletter

Issue 32, May 2016

To make sure borrowers pay their debts, creditors use "security interests." A security interest is nothing more than a legally-binding ownership right that a creditor holds in property belonging to the debtor. If the debtor can't pay or chooses not to pay, the creditor with such an interest is entitled to take the secured property. A security interest is usually the only chance for repayment in a bankruptcy filed by the borrower. Any property can be made subject to a security interest. It could be a CD or accounts, a patent or stock, a boat, a car, the house, future receivables, credit card payments or anything else. If the debtor owns it, a creditor can use it to secure a debt. Security interests are governed by statutes that must be complied with in order to be binding.

Security Interests Have Three Components

Security interests are comprised of: 1) an obligation owed by one party to another; 2) a grant or pledge by the party obligated on the debt, conveying an interest in specific property to the lender; and 3) the final component called "perfection." It is surprising how many agreements are missing one of these three components. We typically think of the second component as the security agreement. The critical language is that the owner of collateral "conveys," "transfers" or "pledges" property to the creditor as security for the specific obligation. State law requires a holder of a security interest to engage in additional acts which serve to perfect the security interest, and protect it from attack by the debtor or other claims of third parties. Call us if you are not sure your security agreement complies with Utah Law.

Make Certain Your Parties are the Same

Creditors can easily get into trouble when collateral is owned by more than one party. If the security interest is signed by less than all of the owners of the collateral, the creditor will only have a lien in the interest held by those who actually signed the agreement. Sometimes the collateral ends up in a different name than the borrower. Motor vehicle dealers may title vehicles in whatever name the debtor says at the point of sale. If the title is not in the same name as the lender's security interest there may be no security interest whatsoever. Sometimes the property is held by a corporation, LLC or trust. Once again, unless the owner of the property pledges the collateral, there is no binding security interest. When title is held by two owners like Mr. John Smith and Mrs. Becky Smith, a signature by just one of the two parties in insufficient to convey the entire interest because of the "and" separating the names.

Perfection Requires Another Document

Although the first two elements of a security agreement (the obligation and the pledge) can be incorporated into one agreement, perfection usually requires something more. In the case of motor vehicles, the creditor's name must appear on title. In the case of real property, it requires a mortgage or a trust deed recorded with the county recorder. For most other interests, perfection is accomplished with the filing of a UCC-1 or financing statement with the Division of Corporations at the State of Utah. If you would like assistance in securing an obligation, or collecting on the collateral, please give us call.

© Terry Jessop & Bitner May 2016