A security agreement is a legal document, essentially a contract, wherein a borrower pledges certain assets as collateral in exchange for receiving a loan (aka “financing”). The security agreement creates a “security interest,” which means the creditor has certain legal rights in the event the borrower defaults (doesn’t pay) on the loan. Typically, those rights include the ability to seize the property pledged as collateral and either keep it or sell it to recover the amount of financing extended to the debtor.
Any commercial deal or transaction where the debtor pledges collateral in exchange for a loan is considered a secured transaction. If you’ve ever had a car note or mortgage, you’ve engaged in a secured transaction. In those situations, the house or car is the collateral, and if you fail to make your regular payments, the lender can take steps to repossess your car or foreclose on your house in order to get back the funds they loaned you.
Most secured transactions, other than mortgages, are governed by the provisions of Article 9 of the Uniform Commercial Code (UCC). Article 9, which has been adopted in whole or in part in all 50 states, applies to security interests in movable property (vehicles and equipment, for example), intangible property (such as copyrights, trademarks, and patents), and fixtures. Article 9 does not cover security interests in real property; those are governed by state mortgage laws.
Under Article 9, a security interest becomes enforceable as soon as it “attaches” to the collateral. Attachment has three prerequisites:
It’s non uncommon for a business to pledge the same collateral in exchange for financing from more than one source. In such a situation, disputes can arise regarding which security interest has first right to the collateral in the event of default. In general, under Article 9, to have priority over other creditors, a claimant must have “perfected” the security interest. While some types of security interests are automatically perfected upon creation, most require that the creditor take additional legal measures, which typically involve filing a financing statement (known as a UCC-1) with the proper state office.
At a minimum, a valid and enforceable security agreement requires the following terms:
Other provisions that often appear in security agreements include: