When a lender makes a loan or extends credit to a borrower, the borrower makes a formal promise to repay this loan or else make the lender whole again by giving some sort of collateral in exchange for the loan. The borrower creates an interest in his collateral to guarantee that he will repay the lender. The document that memorializes this understanding is the security agreement. Incidentally, security agreements may be oral, but in such cases, the lender must be in possession of the borrower's collateral.



More often, security agreements are written, and they include several key articles. The agreement must describe the collateral. Further, the agreement must expressly demonstrate an intent by both parties to create a security interest, whereby the lender may foreclose on the collateral in the event of default. Another essential article—covenants—stipulates what the parties (usually only the borrower) may and may not do under the agreement. The default provision lays out the triggers for foreclosure and what happens if the borrower misses one or several payments. Default provisions often have acceleration clauses whereby a default makes the entire outstanding balance due. Lastly, the agreement must be authenticated by both parties through their signatures.

The predicate acts of the security agreement are that the lender gives value to the borrower and that the borrower has proper title or ownership of the collateral that he is putting up in the agreement. The borrower may offer title to a car or a house, or ownership of his inventory or his crops, depending on the situation and what he has that is valuable to a lender. Real property transactions are a special case, for real estate law differs among states. However, if the transaction in question deals with intangible property (securities), movable property (cars, boats, inventory), and fixtures, then Article 9 of the Uniform Commercial Code (UCC) applies nationwide. Article 9 is concerned with creating predictability between lenders and borrowers.

The lender's security interest is said to attach once the parties authenticate the agreement and after it has met all the other legal requirements delineated by the UCC. In addition to taking possession of or title to the collateral, the lender may also choose to perfect the agreement by recording it with a local government records office or with the state's office of the Secretary of State. Such an action puts other lenders on notice about the existence of this agreement. Perfection of the security creates order and rights in time, such that the first lender to perfect will be the first to be satisfied in the event of a foreclosure. Likewise, secured lenders will be paid before unsecured lenders.

Mortgages are types of security agreements, as are deeds of trust (this is where the trustee holds the collateral).

Once a borrower has repaid the secured debt, he typically requests from the lender a termination letter, attesting to the fact that the debt is no more. At the opposite end of the spectrum, the lender may decide to keep the collateral as repayment for the debt; this is called strict foreclosure. However, this may not be possible if other lenders have an interest in the collateral.

In short, the realm of secured transactions is very much one ruled by rights in time and by precedence, as well as the number of lenders and the type of transaction in question. UCC Article 9 goes a long way toward creating order, stability, and predictability in what could otherwise be complete chaos.