Robbins: Secured and unsecured interests
Everyone wants to be secure.
All Eliza Dolittle wanted was a room somewhere, far away from the cold night air, and one enormous chair.
Most of us want more. Especially when it’s our money on the line.
Security can mean different things to different people. But when it comes to the law, security has a particular meaning.
In simple terms, a security interest refers to the legal right that creditors and lenders have over the property or assets of a borrower. This right acts as collateral and provides a guarantee that lenders can recover their funds in the event of default or non-payment. It gives lenders a priority claim over the specified property, allowing them to seize and sell it to recover the debt owed to them.
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Let’s take a peek at a pretty common example.
Say, even in this crazy real estate market, you want to buy a home. Say, crazier still, you can qualify to do so. You’ve scrimped and saved and my how your nest egg has grown. You approach a lender saying, “If I put in my nest egg 鈥� 20 percent of the purchase price 鈥� will you put in the rest?”
The potential lender cogitates. “Well, yes,” they might say, “So long as you meet our soul-crushing and oppressive criteria, jump through some hoops, pledge your first-born child and 鈥� provide sufficient security.”
“Say what?”
What the lender is saying when they raise the matter of security is that they don’t want to take any chances on you. Sure they’ll lend you the money but only (if you prove to be a deadbeat or are otherwise unable to pay the money back), they can glom onto the home, sell it and recoup what they have into it.
That’s what 鈥� Eliza Doolittle notwithstanding 鈥� security is all about.
The bank or other lender will require legal instruments giving them the right to claw back their investment by way of foreclosure and sale of the asset (in this case, the home), to ensure that they do not take a loss.
That said, in a market that turns down, there is still a risk of loss. Just presume that you buy the house of your dreams for a cool million dollars. The banks lends you $800,000 to make your dream come true. Both your personal circumstances and the market collapses. You are unable to repay the debt and the home, once worth six zeroes is worth half of that. What’s a lender to do?
What they will likely do is sell the home, recoup what they can and gesture, threaten, claw and sue in hopes of recovering the remainder. Still, even though those circumstances are not pretty for anyone, the lender’s security in the home affords at least some buffer against risk.
In many cases, security interests are created through agreements such as mortgages (as in the above example), vehicle loans, or business financing arrangements. These agreements ensure that the lender’s interest in the property is registered through appropriate channels, such as filing a financing statement with the appropriate government authority. This registration helps protect the lender’s interest and serves as notice to other potential creditors of both the existence of the debt and the lender’s priority to recover if things one day go south.
Almost always, a secured interest requires a written instrument memorializing the agreement and detailing the what-ifs. Something else essential is a clear description of the asset to be secured; is it this home and not that, the Porsche and not the Chevy Volt? Lastly, you cannot just willy-nilly latch on to someone’s assets; consent is an absolute requirement.
What about the other part, an unsecured debt?
In law, we see this all the time. One party lends another money in exchange for the borrower’s execution of a promissory note. Now, promissory notes can be either secured or unsecured but in the latter circumstances, where no security interest is assured, the note amounts to little more than a promise to pay. While still enforceable if the note is breached, what is lost is the leverage of having an asset against which to proceed.
One last bit: The security offered in exchange for the provided funds or financing arrangement can be nearly as varied as the imagination: real property, vehicles, an investment portfolio, equipment, and accounts receivable. At the end of the day, it’s tit for tat; I’ll lend you the dough so long as you agree to pay me on these terms and, if not, I’m coming after what you have pledged to induce me into the deal.
Lots of chocolates for me to eat,
Lots of coal makin’ lots of heat.
Warm face, warm hands, warm feet.
Yep, lovely. But, when it comes to our hard-earned, most of us 鈥� especially those in suits 鈥� require more.
Rohn K. Robbins is an attorney licensed before the Bars of Colorado and California who practices in the Vail Valley with the Law Firm of Caplan & Earnest, LLC. His practice areas include business and commercial transactions; real estate and development; family law, custody, and divorce; and civil litigation. Robbins may be reached at 970-926-4461 or Rrobbins@CELaw.com. His novels, “How to Raise a Shark (an apocryphal tale),” “The Stone Minder’s Daughter,” “Why I Walk so Slow” and “He Said They Came From Mars (stories from the edge of the legal universe)” are currently available at fine booksellers. And coming soon, “The Theory of Dancing Mice.”
