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The Power of Security in a Financial Transaction

Friday, 6 May 2016

by Staff, Spaulding Law

Not long ago someone died leaving a nice estate to the heirs. Some of the assets included some land that was undeveloped. On other parcels there were buildings, some of which were old, and some of which were not worth as much as the land they were built upon. Also in the estate was a promissory note (“Note”), promising to pay an amount over time. However, the Note was “unsecured”, meaning that it was 100% reliant on the ability of the person who signed the Note to make the payment, and was not “secured” with “collateral.”

A Note is a promise to pay an amount of money which is made by the signer, normally referred to as a “Maker”, to someone normally referred to as a “Holder”.

The Note will typically contain terms such as the number and frequency of payments, an interest rate charged for the duration of the Note (until all payments are made and the debt is retired), and terms of delinquency or default. If a Note is secured it will typically indicate that it is secured and will be accompanied by a companion document. In Utah, if the Note is secured by a house or land, for example, the security document is called a Deed of Trust, or a Trust Deed. Anyone who has financed the purchase of a home in Utah has seen and signed a Trust Deed. The Trust Deed allows the Holder of the Note to commence foreclosure proceedings to sell the house if the terms of the Note are not met.

A Note can be secured by other types of collateral, including shares in a corporation or a limited liability company or by other assets like a car. A lien on a car title is security for a Note made by a purchaser. According to the terms of the Note, upon a failure by a signer to make a car payment, the car can be repossessed and sold according to the terms of the security documents, with the debt reflected by the Note to be paid with the sales proceeds.

The Note which was a part of the estate of the man who died, was signed by someone who owned both real property and land worth well over $1 million. Therefore, there were sufficient assets to “secure” the amount promised to be paid under the Note. However, because the Note was signed without requiring any “security” the risk to the estate is that it may never be able to collect the significant amount due under the Note, because upon a default there is no claim to the property owned by the Maker, just a claim on the Maker.

Securing a Note has other advantages as well. For instance, an unsecured Note is less likely to be paid in full if the Maker files for bankruptcy. In a bankruptcy, if an obligation is secured by property the Holder will normally be allowed to foreclose on the security. On the other hand, if the debt is not secured, the Holder is grouped with other unsecured creditors who must wait until the secured claims are paid in full. If there are still assets remaining for a payment to unsecured creditors after the secured creditors are paid, the unsecured creditors can share remaining assets pro-rata with each other. Another benefit of securing a debt is that if the borrower decides he wants to sell the property used to collateralize the loan, he must first contact the Maker and make arrangements to either pay off the debt or negotiate a favorable resolution. In either event, security places the lender in a more-secure position to be repaid.

The point is that when someone loans a substantial amount of money, whether to a family member, a friend, or a business associate, it is important to consider how best to document the transaction. The advice of a capable attorney can help you best understand how to protect yourself financially with “security” if you choose to make a loan or finance the sale of an asset.

This information is made available by Spaulding Law for educational purposes only and not to provide legal advice. By using this website, you understand that there is no attorney-client relationship between you and Spaulding Law, unless you have entered into a separate representation agreement. This information should not be used as a substitute for competent legal advice from a licensed professional attorney.

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