LAW 603 Chapter Notes - Chapter 23: Nonpossessory Interest In Land, National Security Entry-Exit Registration System, Getter
Chapter 23: Secured Transactions
If you promise to pay later to get something now, you are a debtor, the person who
owes a credit obligation
The person who allows time to pass before requiring you to pay is the creditor
Credit in various forms is essential for many business reasons – a bank loan may be
necessary for a store to be able to add floor space and grow its business
Risk Management Strategies for Creditors
Two main ways of managing that risk:
oSecurity interests
oGuarantees
Security interests: allows a creditor to seize some of a debtor’s personal property if a
debt is not repaid, usually without the delay and expense of going to court
oGiving bank all your trucks as security to get a loan
Collateral: property that is subject to security interest
Secured party: creditor that has a security interest
Security interest gives the bank advantages over an ordinary creditor
oIf bank has security interest in the truck, it is entitled to seize the collateral,
dispose of it, and use the money it receives to pay off your debt – If the bank
didn’t have security interest, it would have to sue you for the unpaid debt and
get an order to seize your property
oEven if lawsuit successful, it would take time and money
The bank may not be able to seize the property if it is subject to a security interest held
by another party
A security interest can be given over any type of property to any type of creditor
Personal property includes both tangible property (assets that can be touched), such as
cars, and intangible property (assets that cannot be touched), such as corporate shares,
life insurance policies, some kinds of licenses, and intellectual property
Another way for creditors to reduce the risk associated with non-payment is to obtain a
guarantee: contractual promise by a third party, called a guarantor, to satisfy the
principal debtor’s obligation if that debtor fails to do so
oAsk a friend to act as guarantor of the loan you got from bank to buy truck – if
you fail to repay loan, the bank can demand payment from your friend
In some situations, the law recognizes that the debtor and the creditor may act in ways
that unfairly hurt the interests of the guarantor
oIf debtor agrees to pay a higher rate of interest on the debt, the guarantor’s
potential liability is increased – if that occurs after the guarantee is signed and
without the guarantor’s consent, the law may release the guarantor from liability
How Security Interests are Created
Early form of security interest was what we now call a “pawn” or “pledge”
find more resources at oneclass.com
find more resources at oneclass.com
In return for a person lending your money, you give them temporary possession of some
of your property as security for the loan – you agree that if you fail to pay the loan, the
lender can sell the property and apply the money received against your debt - if you
repay the loan, you get your property back
Because this form of secured loan transaction required the physical transfer of a piece
of property, there is a natural limit on its use
In practice, a debtor often needs to use the property given as a security in its use – so
the law developed to permit the creation of security interests by contract that didn’t
require a transfer of possession
oThis permitted a much wider range of efficient secured financing alternatives
Granting a Security Interest in a Specific Asset
In a lending transaction, the debtor often agrees to provide the creditor with ownership,
or some other form of security interest, in a specific piece of its personal property
oYou give the bank as interest in your truck
From creditor’s perspective, that arrangement is attractive because the collateral is
identified, making it easy to determine its value, and it is relatively easy to enforce the
security interest
oBank knows collateral worth $50 000 when you bought it and to enforce its
rights, it simply has to seize the vehicle if you fail to repay the loan
Chattel mortgage: when the debtor transfers title in a specific asset to a secured party
Security interests may also be created in specific assets without transferring title or
ownership to the creditor in the following ways:
Conditional Sale
oIn commercial world, a buyer is often allowed to postpone payment at least part
of the purchase price – as a security for that debt, the seller may retain an
interest, usually in the form of ownership, in the goods that are being sold
oConditional sale: the buyer gets possession of the goods immediately, but they
do not own them until they pay the full price
oThey are very common in consumer transaction where a person buys furniture
or household items but defers payment until sometime in the future
oAlso, common where two businesses have an ongoing relationship for the
purchase of goods – ex. Manufacturer may retain a security interest in the
equipment that it supplied to a distributor
oSecurity is taken to secure payment of the purchase price – if the buyer defaults,
the seller can take back the goods
oUsually buyer is responsible for any damages to the goods – sometimes, buyer
may be required to buy insurance to cover the goods while payment is pending –
seller may require that they be named as the beneficiary under the insurance
policy
oSPECIAL CASES: There are two kinds of transactions that are similar to
conditional sales which are often used to create security interests: (1)
consignment, (2) lease
find more resources at oneclass.com
find more resources at oneclass.com
oConsignment: occurs when the owner of goods transfer possession, but not
ownership, to someone else – the owner is called consignor – the person who
receives the possession of the goods is called the consignee
oMany business reasons for creating a consignment:
Consignee may be examining the goods for possible purchase
Consignee may have agreed to sell the goods on the consignor’s behalf. –
A children used-clothing store may take clothes on consignment from a
parent, offer them for sale, and then pay the parent a % of the purchase
price if the clothes are sold
oIn true consignment, the consignee is not bound to pay for the goods until they
do something, such as selling them to a third party
oThe term “consignment” is also sometimes used to refer to a situation in which
the “consignee” has already agreed to pay for the goods and the “consignor”
holds on to the ownership to secure full payment of the price – not a true
consignment, but a conditional sale
oRetention of ownership under the consignment is a form of security interest
oA lease can also act like a conditional sale as an alternative to a secured loan –
ex. You want to buy a truck for $50K. You could acquire the truck in three
different kinds of secured transaction, including a lease:
Seller may agree to conditional sale in which it gives you time to pay but
retains ownership of the truck until you’ve paid the full price, plus
interest, in 60 monthly instalments of $1000 that blend payment of the
price and interests
You could borrow $50K from bank, agreeing to repay that amount, plus
interest, in 60 blended monthly instalments. As security for your promise
you pay those monthly instalments, you could give the bank an interest in
the truck
You could acquire the truck in a financing transaction set up as a lease:
the lessor retains ownership of an asset but gives possession of it to the
lessee for a period of time in return for the lessee’s promise to make the
payments. When financing, the lessor’s ownership of the leased asset is a
security interest. Its purpose is to secure the lessee’s obligation to make
the lease payments and help the lessor manage the risk of default. To
acquire truck in a lease financing transaction, you could enter into an
agreement with a lessor, who would buy the truck that interests you – in
order for you to acquire the truck, the lessor would then agree to lease
that vehicle to you for 60 months in exchange for you promise to make
monthly payments of $1000 – The lessor would also give you an option to
purchase the truck at the end of the 60 months. Since you have paid the
full purchase price + interest, the option price could be nominal, $1
oAll three transactions are equivalent ways to finance your acquisition of the
truck
find more resources at oneclass.com
find more resources at oneclass.com
