Obtaining & Keeping a Secured Position as Creditor

When extending large amounts of credit for long time
periods, securing the amount strengthens your position if
your customer has financial problems in the future.  The
secured creditor has an immensely stronger position than
the unsecured or under-secured creditor.

To become secured, the creditor must obtain and maintain
the documentary requirements mandated under the
statues of the Uniform Commercial Code and the state law
in which the debtor is domiciled.  These pledges of
security usually consist of real estate security and
personal property.

The importance of filing these documents is paramount.  It
is important that well-trained personnel are handling and
filing credit documents, security agreements and financing
statements.  It is not necessary for a lawyer to look over
every document; but it is certainly advisable that they
periodically review the standard credit and security
agreements, financing statements and other procedures
that are being used.  This can be particularly helpful if a
large transaction is being contemplated, or if the
transaction is non-routine in nature.

THE UNIFORM COMMERCIAL CODE (UCC)

The UCC, now adopted by all 50 states, sets forth the
guidelines for such things as secured transactions, bulk
transfers, letters of credit, and a host of other credit-
related activities.

A summary of the UCC can be found at this link.

All persons involved in commercial credit should have a
working knowledge of the UCC provisions.  There are
numerous publications available at public libraries, most
corporate law departments and business book stores.

No secured transactions should be undertaken by anyone
not thoroughly versed in UCC guidelines.  If in doubt,
consult with legal counsel before undertaking the
transaction, or use a service company which specializes in
searching and filing UCC transactions.

Types of Security

There are four (4) basic types of assets that are usually
pledged as security:

1)  Real Estate
2)  Equipment
3)  Inventory
4)  Accounts Receivable

Real Estate as Security

Real Estate is usually one of the most favored forms of
security because:

(A) It stays in the same place, is not easily concealed; and

(B) It generally can not be easily damaged like inventory
or other fixed assets can.

(C) It also maintains its value relatively well – although we
did see a recent devaluation of real estate in the early
1990’s, this was largely due to over-appreciation of the
1980s.

Local title companies can provide a prompt and thorough
analysis of a property’s history, and any prior obligations
that may constitute a senior debt on the property.  
Inspection of real estate collateral is much easier than
inventory, equipment, and receivables.  In bankruptcy, the
lender secured by real estate may have a strategic
advantage over other creditors.  When the creditor’s
business is located on the real estate, the importance of
maintaining the real estate is amplified by their desire to
continue operating through bankruptcy proceedings in
most cases.

Equipment as Security

Equipment is defined by the UCC as goods “used or
bought for use in the business…if the goods are not
included in the definitions of inventory, farm products, or
consumer goods”.  Generally, equipment consists of
machinery and other business paraphernalia which is
used for business purposes and not held for sale or lease.

The creditor holding fixed assets such as equipment for
collateral should be aware that although it is easily
identifiable through serial numbers…it is prone to decline
in value (depreciate) and become obsolete.  That is why
experienced creditors usually tie the length of the loan to
the expected depreciable life of the equipment being
secured.

Equipment is usually easily obtained as collateral, but in
bankruptcy court it is also viewed advantageously, since a
debtor cannot continue to operate under bankruptcy
proceedings and generate cash flow without equipment.  
Thus, the lender can insist that his secured position be
adequately protected against depreciation, and be allowed
to exercise any foreclosure rights that were agreed upon.

Inventory as Security

Inventory is defined in the UCC as goods with are “held by
a person who holds them for sale or lease or to be
furnished under contracts of service, or…work in progress
or materials used or consumed in a business”.  Inventory
includes goods which are consumed and are held for sale
or lease to others.  Thus, it can be said that it is more
transitory in nature than real estate or equipment.  Since
the debtor is generating cash flow through the sale of
inventory, it is in a continual state of depletion.  A wise
credit grantor will not only secure presently owned
inventory, but also secure inventory that will be bought in
the future, work in progress, and the proceeds of the
inventory (accounts receivable).

Accounts Receivable as Security

(Accounts Receivable, Contract Rights, and General
Intangibles as Collateral)

Accounts receivable are defined as any right to payment
for goods sold or services rendered which are not
evidenced by an instrument or chattel paper.

Contract rights are similar, except that they are usually the
rights of payments for goods and services rendered under
a specific contract.

General intangibles include any personal property other
than goods, accounts receivable, chattel paper,
prepayments, instruments, and money.  It is usually a
phrase for legal rights to receive payment not arising from
the sale or lease of goods or services.  Tax refunds and
prepayment credits are sometimes regarded as general
intangibles.

The three (3)  types of collateral are separate and distinct,
and the creditor relying on them should take care that it is
granted accounts receivable, contract rights and general
intangibles, rather than just one of the three.
Sustainable Growth
Grow your business and
intelligently manage your
risk.  Use UCC-1 filings to
secure your accounts
receivables.
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