Laws Allowing Secured Debts

The most important of the laws protecting creditors allows the creditor to acquire a legal interest in (a right in or claim to) some specific property of the debtor. This interest is enforceable if the debtor defaults (fails to pay according to the terms of the agreement) and is called a security interest. The debt is referred to as a secured debt. A creditor, who holds a security interest, is a secured creditor.

When a creditor has a security interest in specific property, there is a lien against that property. A lien gives the creditor the right, if necessary, to sell the property and to use the proceeds from the sale to pay the debt.

Usually, the debtor keeps possession of the liened property as long as the debt is not in default. Mortgages on homes are very common examples of this type of secured debt. However, if there is a default, the creditor is allowed to peacefully repossess the secured property if it is movable.

Some secured debt arrangements permit the creditor to have possession of the property until the debt is paid. One such lien is the pledge, which arises when personal property is given to a creditor as security for the payment of a debt, or for the performance of an obligation. The property may be either goods or documents representing property rights (e.g. corporate stock). The pledger voluntarily gives up possession of the property. The pledgee receives possession.

In the pledge, the pledgee must treat the property with reasonable care. The property may be repledged to a third party on terms which do not impair the debtor’s right to get the property back. In the event of default by the pledger, the pledgee may sell the property after proper notice to the pledger. The pledgee has the right to make either a public or a private sale. However, the pledgee must act in good faith and in a manner, which is commercially reasonable. If the amount received, after the deduction of expenses and interest, is more than the amount of the debt, the excess must be paid to the pledger. If the amount is less, the difference still must be paid by the pledger. Upon performance of the obligation, the pledger has the right to the return of the property.

A pawn is a pledge of tangible personal property, usually of small size and high value. A pawnbroker is a person in the business of lending money at interest who requires such tangible personal property as security.

Goods that are pawned must be held for a certain length of time after the loan is due before they can be sold. Sometimes ownership passes to the pawnbroker at the end of a specified time.