It’s no secret that a secured creditor is in a much better position to be paid than a general unsecured creditor. For folks in the construction industry, the ability to secure the debt owed is automatic and built into the law, provided that the various formal requirements are complied with. But, what about companies not in the construction industry, or suppliers to suppliers who may not have lien rights in certain jurisdictions? There are other options available to parties for whom mechanics liens are not an options, whether because of the industry in which they work, or their role on a construction project. Mechanics liens are involuntary liens, that is they arise automatically as a matter of law provided certain requirements are met. Other security interests, however, are voluntary – these security interests arise out of an agreement by the parties. This type of agreement, fittingly, is called a security agreement.

Security Interests: What Are They, and How Can I Get One?

A security interest is a property interest, created either as an operation of law or by agreement, that secures the performance of an obligation by giving the beneficiary of the security interest preferential rights in the property subject to the security agreement. Generally, this means that the beneficiary of the security interest may seize and sell the property secured to satisfy the debt. The reason the security interest exists is generally to provide protection to a party extending credit. This protection may allow the interest rate to be lower, or even for credit to be extended in circumstances where it would otherwise not be.

Security interests in personal property (as opposed to real property) are governed by Article 9 of the Uniform Commercial Code (“UCC”), and are generally granted by a written security agreement and perfected by filing.

Security Agreement Overview

A security agreement is a contract outlining the relationship between the creditor and the debtor in a secured transaction, and governs the rights of each party with respect to the secured property. In order to have a valid security interest the creditor must have a security agreement with the debtor that meets certain specific requirements, namely, it must be signed, it must clearly state that a security interest is intended, and it must contain a sufficient description of the collateral subject to the security interest.

While these three components are mandatory, a security agreement does not need to be an overly complicated legal document in order to be effective. A letter or other basic document will be sufficient provided the above requirements are met. It may be beneficial, however, to include more than the basic bare-bones information that is absolutely necessary. At the least, it is likely a good idea to include that the creditor is allowed to file a UCC financing statement, as this clause can allow the creditor to file the financing statement to perfect the lien without getting an additional signature form the debtor. Other information on the form should be tailored toward the individual use and concern of the business involved. While a bit more information can be valuable, it should be balanced against filling the form full of language that may be off-putting to the other party.

The information that must be included in the security agreement must be specific to satisfy the requirements. The name of the debtor (and the owner of the property if those are different) must be exactly correct – an incorrect name can cause the security agreement to be ruled invalid, even if seems a simple mistake. The description of the collateral, likewise must be specific enough to properly describe the property subject to the agreement. Serial numbers, VINs, etc., are clearly sufficient for security agreements regarding that type of property. Other types of property require different levels of description, for example, a current inventory list will likely be sufficient for a security interest in inventory, and the same likely goes for fixtures. Finally, the security agreement must specifically state that a security interest in intended by this document. For this the words “security interest” should be included in the agreement.

UCC Financing Statement

Most security interests formed by a security agreement are perfected by filing a UCC financing statement. The statement contains basically the same information as that required on the security agreement and is filed in the state capital of the debtor’s state of incorporation (if the debtor is a corporation, or LLC). Generally, a form is used for the UCC financing statement and the same form is generally accepted in most states. If the security agreement states that a UCC financing statement may be filed, no addition signature of the debtor is required.

While a financing statement is generally needed to perfect a security interest of this type, security interests in certain situations and in certain types of collateral do not require the filing of a financing statement in order to be perfected. If the creditor has possession of the collateral (in certain situations), no financing statement is required. This works like a pawn shop, where the creditor takes the collateral in exchange for a short-term loan. Also, it is theoretically possible to take a security interest in accounts receivable without filing a financing statement, but practically speaking, this type of security interest is generally perfected by filing a UCC financing statement.

Securing your outstanding debt can be a critical part of your company’s overall credit management strategy, whether that security comes in the form of a mechanics lien, or by filing a UCC financing statement.