How to Become a Secured Party Creditor

A secured party creditor is someone who holds a security interest in some goods or property of a debtor. A security interest is a legal term used to describe the right a secured party has to the property itself or the proceeds of the property under the security interest if the debtor fails to pay or otherwise fails to perform his obligations to the secured party.

This realm of law is governed by the jurisdiction's Uniform Commercial Code, specifically Article 9. It is an incredibly complex area of the law that mainly deals with sorting out the priority between two or more secured parties. Becoming a secured party is not overly complex; it involves writing a security agreement and filing that agreement with your state's Secretary of State.

Instructions

1. Enter into a security agreement with the debtor. A security agreement is a contract between the debtor and the secured party. No particular words or phrasing are required. However, the agreement must be authenticated by the debtor, and the agreement must sufficiently describe the collateral, which is the property in which the security interest is created.

   For example, assume Sam, the soon-to-be secured party, loans a sum of money to Doug, the debtor, so that Doug can buy a new car. To secure Doug's obligation to repay Sam, Sam requires Doug to grant him a security interest in the brand new high definition TV Doug purchased a couple of weeks ago. Assume that Doug has paid the entire purchase price of the TV and owns it outright. The security interest in the TV means that if Doug does not repay Sam, Sam can take Doug's TV or force a sale of Doug's TV and receive the money for it.

   To certify this deal, a contract (the security agreement) is written up. Doug agrees to the security interest and signs the document (thereby authenticating it). Sam gives Doug the money to buy the car. In the agreement, Sam should sufficiently identify the collateral (the television); a simple description of it will suffice (example: "Doug's brand new brand name high definition television located in his living room at his address").

2. Spell out the penalty for failing to pay and outline a repayment schedule in the security agreement. While this is not strictly required by Article 9 of the UCC, it is a smart step to take as it will clearly indicate both parties' obligations to one another and will protect the secured party if the debtor takes the document to court.

   In the example above, such an agreement may read: "Doug agrees to pay Sam $100 each month, payable on the 15th of each month, until the loan is repaid. If Doug fails to make a payment, Sam has the right to demand the entire amount due. If Doug cannot pay the entire amount due, Sam has the right to exercise his rights as a secured party under this agreement."

3. Prepare a financing statement. Financing statements are forms used to provide notice to other potential creditors that a security exists as collateral of a debtor. The form is commonly called "UCC-1." It is available at your local Secretary of State's office. Fill the form out according to its instructions.

   In the example above, Sam would prepare a filing statement indicating he has a security agreement with Doug and that he has a security interest in Doug's high definition TV. Sam would travel to his Secretary of State's office and fill the form out.

4. File the form with the Secretary of State. In order to give notice to all other potential creditors, and thereby protect your interest in the collateral, you must file the financing statement with your local Secretary of State's office. You must pay a filing fee, which varies by state.

   In our example, Sam is technically a secured party creditor as soon as the security agreement is entered into with Doug. However, to protect his interest, he should complete steps three and four and prepare and file a financing statement. Doing so will put all other creditors on notice that Sam has a security interest in Doug's TV. Therefore, if Doug goes bankrupt and can't pay his debts, Sam will have "first dibs" on the TV before other creditors (unless another creditor already had an interest in the TV; this situation is beyond the scope of this article).

Tips & Warnings

• Improper filings of security interests are a felony.

• This article was written for informative purposes only. It does not give legal advice and should not be relied on for such advice. People with serious legal concerns should seek advice from an attorney.

References

• Uniform Commercial Code Article 9
• "Secured Transactions"; Douglas Whaley, 2006