Secured transactions involve the use of collateral to secure a financing agreement. In most cases, the obligor (the creditor) provides a loan to the obligee (the borrower) in exchange for first rights to the secured property, should the obligee fail to uphold their obligation.
Secured transactions may involve many types of collateral. Most states, including Texas, have a Uniform Commercial Code that dictates how this collateral is secured.
It is crucial to have a reputable Houston attorney on your side when any agreement of this nature is created to ensure you are informed, protected, and that terms within the agreement are enforced.
What Assets Can Be Used as Collateral for Secured Transactions?
A variety of assets, both tangible and intangible, may be used as collateral to establish a security agreement. The Uniform Commercial Code (UCC) defines more than 20 categories of assets eligible for this purpose. Some examples include:
- Account receivables
- Mineral rights
- Farm products
The UCC defines how the above assets are managed during a secured transaction, but there are exceptions. Most notable is real property. Land and buildings are governed by the state’s property law. And in Texas, a deed of trust is used as the security agreement when real property is put up as collateral.
What is the Uniform Commercial Code in Texas?
The Uniform Commercial Code is one of the nation’s most expansive and oldest uniform acts, dating back to the 1950s. It is used to standardize certain aspects of commercial transactions. Specifically, the UCC governs the creation and administration of some business contracts and liens.
All 50 states have their own version of the UCC. There are minor variations between them, but in general, the UCC ensures commercial contracts and lien instruments are treated the same in every state.
Article 9 of the UCC addresses secured transactions and what requirements must be met before an obligor has established a security interest in the collateral. Most importantly, the obligor must submit a financing agreement and security agreement to the relevant government office – typically the Secretary of State.
The Role of Financing and Security Agreements in Secured Transactions
Before a creditor can claim rights or security interests with the collateral, the transaction must be “perfected.” In this context, perfection means the obligor takes the steps necessary to make the transaction official. In doing so, the lender asserts their first priority over the collateral in the event that the debtor fails to make payments.
There are a few ways to achieve transaction perfection, but the most common way to do it is to file a financing statement and security agreement under UCC provisions. Here’s a brief explanation of each:
- Financing statements – Also termed Form UCC-1, creditors file a financing statement to detail the parties involved in the transaction, along with the collateral that will be used to secure it. Form UCC-1 is used by government agencies and other creditors to track which assets have been secured by which creditors. Financing statements do not establish a security interest in the collateral. To do that, a security agreement must be submitted to the relevant government office.
- Security agreement – Security agreements give creditors a security interest in the named collateral. With this interest, the creditor may take possession of the assets should the debtor fail to meet the agreement’s terms.To establish a security interest, there must first be a security agreement. Put simply, there must be a written record confirming that both parties – the obligor and obligee – agree to granting the obligor a security interest in the property.Further, there must be a specified value associated with the collateral. This is usually defined when the creditor lends money or when the debtor begins payment. Finally, the debtor must have partial or total rights to the collateral.If the above prerequisites are met, the security agreement will serve as notice to other creditors that the creditor has first rights to the collateral.
An important note – security agreements are based on a “first file, first serve” basis. In other words, whichever creditor submits the security agreement and UCC-1 form first will be considered the priority creditor should the collateral assets need to be liquidated.
How an Attorney Can Help with a Secured Transaction
Secured transactions are an active part of law. As such, it’s highly recommended that both parties have legal counsel throughout the process.
A reputable attorney with experience in secured transactions should be on hand when the security agreement is initially formed, during closing, when payments are being made, and if any disputes arise while enforcing the contract. And disputes are extremely common.
Legal representation is especially important for creditors, for a couple of reasons:
- Protecting the creditor’s rights – An attorney can preserve as many protections as possible for both the debtor and creditor. On the creditor’s side, this protection is necessary to prevent any exposure to legal liability.For example, the UCC does not determine when a secured transaction has entered into default. This is something that must be specified in the security agreement so the creditor can engage in collections without violating UCC provisions.Another example – if a creditor does opt to liquidate collateral, it must do so in a “commercially reasonable” fashion. In other words, the creditor must make reasonable, provable efforts to extract maximum value out of the collateral.This is a gray area that regularly provokes litigation from the debtor’s side. An attorney can guide creditors through this process so they can demonstrate commercially reasonable efforts and avoid a lawsuit. Secured transactions are littered with potential legal liabilities like this, which is a primary reason why creditors seek legal counsel before executing one.
- Ensuring the security agreement is enforceable – A security agreement is not enforceable until it is properly drafted, written and perfected. Any minor mistake during this process can have major consequences. An attorney will provide counsel through this process to ensure the agreement is enforceable.For example, if the security agreement is not attached to the UCC-1 form when the contract is finalized, the collateral is not secured. Another creditor could jump in with their own security agreement claiming the same assets and attain first rights. Until the agreement is perfected, the debt is unsecured – which is a risky position to be in for a creditor.
An Attorney Can Help Your Organization Make Sense of Secured Transactions
Secured transactions are complex. If they aren’t executed in accordance with UCC provisions and aren’t perfected, it could expose your organization to excessive, and unnecessary, liability.
It’s important to work with a reputable attorney that is experienced with establishing secured transactions, including developing the security agreement terms and ensuring they are enforced. In short, this will ensure your organization is protected and entitled to the assets it has secured.
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