Security Interest - United States (the Uniform Commercial Code)

United States (the Uniform Commercial Code)

In the late 1940s, the United States legal community arrived at a consensus that the traditional common law distinctions were obsolete and served no useful purpose. They tended to generate too much unnecessary litigation about whether the creditor had selected the correct type of security interest. There was a growing recognition that the different types of security interests had developed only because on the one hand, many judges thought there was something inherently wrong with allowing a person, either out of desperation or foolishness, to summarily encumber all his or her personal property as collateral for a loan, but on the other, debtors and creditors would attempt to reach a desired result by any means necessary, even if that meant resorting to creating multiple security interests to cover different types of personal property. There was also the problem of the above-mentioned early English cases that regarded such security interests as fraudulent conveyances and failed to recognize that they had legitimate uses in a modern industrial economy. Therefore, because the very history of security interests demonstrated that judicial resistance to enforcing broad security interests would not stop debtors from trying to give them as inducement to creditors to extend financing, and that they were socially useful under the proper circumstances, the better choice was to make the law of security interests as clear and simple as possible.

The result was Article 9 of the Uniform Commercial Code, which regulates security interests in personal property (as opposed to real property) and establishes a unified concept of a security interest as a right in a debtor's property that secures payment or performance of an obligation.

Article 9 was subsequently enacted in all 50 U.S. states as well as all U.S. territories. Article 9's core insight that the traditional distinctions were hopelessly obsolete was highly influential elsewhere and inspired the enactment of Personal Property Security Acts throughout Canada during the 1990s, followed by the New Zealand Personal Property Securities Act 1999 and then the Australia Personal Property Securities Act 2009.

Under Article 9, a security interest is created by a security agreement, under which the debtor grants a security interest in the debtor's property as collateral for a loan or other obligation.

A security interest grants the holder a right to take a remedial action with respect to the property, upon occurrence of certain events, such as the non-payment of a loan. The creditor may take possession of such property in satisfaction of the underlying obligation. The holder will sell such property at a public auction or through a private sale, and apply the proceeds to satisfy the underlying obligation. If the proceeds exceed the amount of the underlying obligation, the debtor is entitled to the excess. If the proceeds fall short, the holder of the security interest is entitled to a deficiency judgment whereby the holder can institute additional legal proceedings to recover the full amount unless it is a non-recourse debt like many mortgage loans in the United States.

In the U.S. the term "security interest" is often used interchangeably with "lien". However, the term "lien" is more often associated with the collateral of real property than with of personal property.

A security interest is typically granted by a "security agreement". The security interest is established with respect to the property, if the debtor has an ownership interest in the property and the holder of the security interest conferred value to the debtor, such as giving a loan.

The holder may "perfect" the security interest to put third parties on notice thereof. Perfection is typically achieved by filing a financing statement with government, often the secretary of state located at a jurisdiction where a corporate debtor is incorporated. Perfection can also be obtained by possession of the collateral, if the collateral is tangible property.

Absent perfection, the holder of the security interest may have difficulty enforcing his rights in the collateral with regard to third parties, including a trustee in bankruptcy and other creditors who claim a security interest in the same collateral.

If the debtor defaults (and does not file for bankruptcy), the UCC offers the creditor the choice of either suing the debtor in court or conducting an disposition by either public or private sale. UCC dispositions are designed to be held by private parties without any judicial involvement, although the debtor and other secured creditors of the debtor have the right to sue the creditor conducting the disposition if it is not conducted in a "commercially reasonable" fashion to maximize proceeds from the sale of the collateral.

Article 9 is limited in scope to personal property and fixtures (i.e., personal property attached to real property). Security interests in real property continue to be governed by non-uniform laws (in the form of statutory law or case law or both) which vary dramatically from state to state. In a slight majority of states, the deed of trust is the primary instrument for taking a security interest in real property, while the mortgage is used in the remainder.

The Canadian, New Zealand and Australian acts all followed the UCC's pragmatic "function over form" approach and borrowed extensive portions of Article 9's terminology and framework. However, New Zealand, as a unitary state, only needed to enact one act for the whole country and was able to create a single nationwide "register" for security interests. While the U.S. enacted Article 9 at the state level and Canada enacted its PPSAs at the provincial level, Australia, a federation, deliberately implemented its new security interest law at the federal level in order to supersede over 70 state laws and create a national register similar to New Zealand's.