Security

by Nicholas Walsh, PA

A client loaned an employee $15,000 to buy a truck. The guy paid a few thousand. Then he quit the job. He quit paying the loan, too.

We’re suing him. Client says to me, “The loan was for a truck, so we can grab the truck, right?”

The loan was on a handshake. The only paper was a cancelled check for $15,000 and a series of payment checks, good enough to make the case for a debt unpaid. There was no promissory note, however. Had I been asked to paper the loan, I’d have prepared a note with a repayment schedule. In case, as happens with informal loans, payments became irregular in frequency or amount, I’d have added the so-useful phrase “in any event the note shall be due and payable by” some specific year and date. I’d have included the interest to be charged, if any, and I’d absolutely have written “if lender must enforce his right to payment, borrower shall be liable for costs of collection, including attorney’s fees.” And I’d have had the borrower grant my client security (collateral), in the form of a lien position on the truck.

For my client to be able to grab the truck, it would have been necessary for the borrower to have given him a grant of security in the vehicle. The note might have said, “To secure repayment of this obligation, borrower grants to lender a security interest in” and then the truck would be identified by year, make and model, and ideally by Vehicle Identification Number (VIN). Without that express grant of a security interest, my client has no security.

Generally speaking, it’s not enough that the words imply or suggest a security interest: the borrower must specifically grant it. For example, suppose my client’s borrower had given him a signed writing that said “so that borrower can buy a certain 2013 Chevy Silverado, lender will lend borrower $15,000.” I doubt very much a court would deem those words to create a security interest in the truck, even assuming the truck was more specifically identified. There are no words by which the borrower grants the lender the security.

Security in collateral isn’t much good unless the value of the collateral is sufficient. Banks prefer collateral to be considerably in excess of the loan amount, both to cover the costs of foreclosure and because banks know that when property sells at bank auction it sells low. That’s why commercial lenders require an appraisal of any real estate, vehicle or other non-liquid asset being put up for loan collateral. (“Non-liquid” means an asset that will take some time to sell and for which only the market can give its true price. Real estate is a non-liquid asset; so is an ownership interest in a small corporation or LLC. A certificate of deposit, a cash value insurance policy and shares in a publically traded company are examples of liquid assets.)

Before a bank will accept security in an asset it wants to know if it will be first in line if the bank must sell the asset. You should have this concern, too. Suppose you are going to lend a friend $15,000 and he’s going to give you a security interest in his new truck. Sounds good, unless your security will be “second” to some other lender’s. If your friend runs into financial trouble and stops paying his truck loan, the bank will take and sell the truck. Probably the truck sells for less than the loan arrearage plus accrued interest, costs of sale etc. That leaves nothing for you. So you either want to be in a “first position” or you want to make the loan knowing full well you will be junior to another lienholder but willing to lend the money regardless of the impaired security.

You find out about prior liens by looking in the place where liens of that type are recorded. Liens and mortgages on real property are recorded in the registry of deeds for the county where the property is located. The Bureau of Motor Vehicles records liens on cars and trucks. The Coast Guard records liens on documented (federally registered) boats. The UCC Section of the Secretary of State records liens on state-registered boats, on equipment of every kind, and on some closely held stock shares and other securities. You will look in the appropriate office to see what sort of prior liens the proposed borrower may have. If you go ahead with the loan, you will “perfect” your security interest by recording the lien in the appropriate office, so someone else looking will find your lien.

If this sounds complicated, that’s because it often is. Even pretty good lawyers can get tripped up by not finding a prior lien or, much less commonly, by not using the right magic words to create the grant of security. And I have not even touched on other important aspects of security interests, such as the desirability of having the borrower buy insurance on the collateral, with the lender named as a “loss payee.”

Lots of moving parts here, folks. If you are lending real money, and you think you want collateral for your loan, you owe it to yourself to talk to a lawyer. Remember, frequently the cost of your lawyer can be rolled into the loan, so the borrower ends up paying the legal bill.

Nicholas Walsh is an attorney practicing in Portland. He may be reached at (207) 772-2191, or at nwalsh@gwi.net.