Bankruptcy Security Agreement Enforcement

A secured transaction is created when a person or business borrows money to acquire property and enters into an agreement allowing the lender to take the borrower’s collateral in the event the loan cannot be repaid. The security interest created in a secured transaction is sometimes referred to as a “lien.”

Secured transactions that create a security interest in personal property such as equipment, machinery, and vehicles are governed by Article 9 of the Uniform Commercial Code (UCC) and state contract law. Secured transactions involving real property, such as a mortgage, do not fall under Article 9.

If a borrower is unable to repay the loan and files for Chapter 7 bankruptcy liquidation the secured debt will receive better treatment than that of the unsecured creditors. This is because bankruptcy does not eliminate a secured creditor’s right to seize a debtor’s property if it has been used as collateral.

Should the defaulting borrower file for Chapter 11 bankruptcy reorganization, a secured creditor can obtain an order that grants it relief from the automatic stay. If the property is not necessary for an effective reorganization, the creditor may also seek permission from the Bankruptcy Court to seize it.

Under Article 9, for a security interest to be enforceable against the debtor or a third party it must meet three requirements. Those requirements are that the collateral was exchanged for value, the debtor was able to convey rights in the secured collateral, and the security agreement was authenticated by the debtor.

Article 9 security agreements must be in writing, but there is an exception for when the security interest has been pledged. A pledge occurs when the borrower gives the collateral to the lender in exchange for the loan. Additionally, in some limited circumstances, a court may find there was an Article 9 transaction based on other documentation when no security agreement exists.

For a party holding an Article 9 security interest to gain priority over other parties with regard to collateral, the security interest must have been perfected. The most common way for lenders to perfect a security interest is to file notice in a public office. Each state has a UCC filing office and when a lender files there it puts other creditors on notice of its attached security interest.

Should the borrower default on the loan or declare bankruptcy, it is important that the lender have a perfected security agreement because it gives the lender priority in the collateral over any third-party creditors. While the general rule is that the perfected security interest will have highest priority, Article 9 does lay out several exceptions to the rule. Three of the most commonly used exceptions are for purchase-money security interests in goods, inventory, and fixtures.

The laws governing secured transactions are complex and can be made even more complicated when the borrower files for bankruptcy. Fortunately, the attorneys at the Thomas H. Curran Associates law firm have experience working with the issues faced by secured creditors and know how to protect their rights to collateral. Our attorneys can assist your business with everything from drawing up an Article 9 security agreement to representing the secured creditor in bankruptcy proceedings.