Text 1 A Secured Transaction and a Security Interest

All purchases are made either by cash or by credit. No debt is involved in a cash transaction. In a credit transaction, however, payment is delayed and a debt, owed by the buyer to the seller, is created.

In a credit transaction, the buyer may agree to allow the creditor to have a superior position over other creditors of the buyer. This normally is done by giving the seller (creditor) a security interest in the goods sold. When a security interest is granted, the transaction is referred to as a secured transaction. Security interest may allow the creditor, upon debtor’s default, to sell the goods and use the proceeds of the sale to pay the debt. If there is any money left over, it goes to the other debtor’s creditor or to the debtor. This is true even if the debtor goes through the legal steps of bankruptcy. Therefore, the secured creditors, because of the priority of their claims brought about by the security interest, are much more likely to be paid.

In contrast, a creditor with an unpaid, unsecured claim must bring suit, get a court judgment, and then execute (put into force) that judgment against the debtor’s property. Other creditors of the debtor may have equal rights in that property.

Secured transactions are the only legal means of giving a creditor a security interest in another’s property. The creditor in such a transaction is the secured party, and the personal property subject to the security interest is the collateral. Only personal property can be a collateral. Contracts involving real property as security, such as mortgages and deeds of trust, are still governed by other laws.

A security interest can be created only with the agreement of the debtor. This agreement can be expressed either orally or in writing, depending upon which one of two basic types of secured transactions is being used.

When the Creditor Retains Possession of the Collateral

In the first type, the creditor retains possession of the collateral. This transaction, which may be based upon an oral or written agreement, is called a pledge. The debtor may be buying the property, or the property may already be owned by the debtor but is now being put up as security for a loan of money.

Upon default of the debtor in a pledge, the creditor has a right to sell the property. The creditor applies the proceeds of the sale to the debts. Any surplus is returned to the debtor. Any deficit remains an obligation of the debtor and may be collected through a lawsuit.