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A security agreement provides the secured party with a security interest in collateral in order to insure debtor's repayment. You may choose to include multiple debtors, secured parties, and co-signers depending on the requirements of the transaction. The information below will guide you through some of the important issues and considerations you will encounter when creating your security agreement.

Party Information

Begin by adding the name and address of each debtor and secured party. If a party is a business, be sure to include the full legal name of that entity, such as "eDemand, Inc." If you include multiple debtors, each debtor will be "jointly and severally liable" under the agreement. This is legalese meaning that each debtor will be required to repay the full amount of the debt should another debtor default on its obligation. However, if a debtor is ever forced to pay back part of another debtor's portion of the debt, often that debtor will be able to then obtain a judgment in court against the defaulting debtor for the money it is owed. Joint and several liability will also apply if you choose to include one or more co-signers, discussed below.

Transaction Details

Next, add the details of the transaction, including the principal amount owed, interest rate, and the date that interest will begin to accrue. When adding the interest rate, use the annual percentage rate (A.P.R.).

Payment Details

If the details of repayment are already included in a separate agreement—such as a promissory note or loan agreement—then simply indicate the name of the agreement and its effective date. If not, you may include repayment terms in your security agreement, including whether repayment will be made on a monthly basis, on demand of the secured party, or in a one-time lump sum payment.

You may choose to require a higher interest rate for any delinquent payments made after their due date. This will serve to help incentivize timely repayment.

Prepayment

Prepayment refers to the debtor's ability to repay the debt ahead of schedule. Often, debtors are prohibited from, or receiving a fee for, making prepayments because it prevents the secured party from receiving steady payments and from collecting a predictable amount of interest on the debt. If you choose to allow prepayment, you can then choose to require a fee for a percentage of the amount of the principal prepaid.

Collateral

"Collateral" is any property owned by the debtor used to secure the debt to the secured party. For example, in a mortgage agreement the collateral is the house itself. However, collateral is often other types of property, such as the debtor's inventory, equipment, accounts payable, or real estate. If the debtor defaults on repayment, the secured party will be able to keep or sell the collateral. It is often also a good idea to require the debtor to maintain insurance on the collateral. The secured party will be allowed to require insurance against any reasonable risks associated with the collateral, such as fire, theft, damage, and other losses.

Notary and Witness

Lastly, you will be asked whether or not you want to include spaces for a notary and/or witness to sign. It is always recommended to include a notary to help prove the validity of the document should there ever be a question. For the same reason, including a witness is helpful. If possible, it is a good idea to include both.

Personal Recourse

It is common for security and loan agreements to include personal recourse provisions. Personal recourse provisions state that, if the debtor defaults on its payments and if any pledged collateral is insufficient to repay the outstanding principal and interest amount still owed on the loan, then the secured party can hold the debtor personally responsible for the payment.

Co-Signer

Here you have the option to include one or more co-signers to guarantee the repayment of the debt should a debtor be unable to pay part or all of the outstanding debt. A separate co-signer agreement will automatically be included for each co-signer to sign along with the secured party and any notary or witness included.

As discussed above, each co-signer will be jointly and severally liable with each debtor and with each other co-signer for the full repayment of the debt. This helps assure that the secured party will be repaid first and in full, and then the other parties can sort out how much they owe each other after the fact, should the need arise.

Executing Your Security Agreement

After you are done filling out the form, simply have the debtor, secured party, and any notary and witness available sign the document. Again, although a notary and witness are not required in most jurisdictions, it is always a good idea to include them. When the document has been signed and witnessed, you are done! Make sure each debtor, secured party, and co-signer (if any) get a copy.

Perfecting Your Security Interest

Three things must be present in order for the secured party to obtain a protected security interest in the collateral: 1) the secured party must pay for or give something of value in exchange for receiving the security interest, 2) the debtor must own the collateral or have proper authority over the collateral in order to pledge the security interest, and 3) the debtor must sign a security agreement. Once all three items occur, then the secured party will rightfully have a security interest in the collateral. This process is called "attachment" of a security interest. Assuming the first two items are present, the secured party should have an attached security interest when the debtor signs the security agreement.

Next, the secured party needs to "perfect" its security interest. This means that the secured party has taken steps to ensure that no other creditor has a prior claim over the collateral and that the secured party will be able to claim the collateral in the event that the debtor becomes insolvent or declares bankruptcy. While taking the step to perfect a security interest is not required by law, it is often the only way that the secured party can rest assured that its interest in the collateral is safe from other creditors.

You can perfect your interest by simply filing a short document, called a financing statement, in the debtor's state or local jurisdiction. If the debtor is an individual, this is the state where the debtor resides; if the debtor is a business, this is the state where the business was formed. While the rules vary by location, a financing statement normally only requires identifying the parties and providing a description of the collateral. In most states you can easily provide this information by completing Form UCC-1 and filing it with the Secretary of State's office. You can find your state's requirements online or by calling your state office.

Frequently Asked Questions

What is a security agreement?

A security agreement consists of a contract between a borrower and a secured lender. Each agreement explicitly specifies which assets are to be used as security and the conditions under which the lender would be allowed to foreclose on that property. Typically, security agreements involve business owners who hope to secure commercial loans. This agreement outlines obligations and rights for both the debtor and the creditor, while also highlighting the form the collateral will take and what will happen if the debtor defaults.

What is collateral?

Collateral is any property or asset pledged by a debtor to secure repayment of a debt. It can take many forms, but generally involves some sort of property already owned by (or expected to be acquired by) the debtor. For example, in a mortgage agreement the collateral is the house itself. Under a security agreement, the debtor's personal property (non-real estate) and intangibles, such as intellectual property, are often used as collateral.

Accurate classification of collateral is critical for security agreements. Often, classification depends on how exactly the debtor uses a particular asset. For example, a titled vehicle primarily used for personal or family purposes may be classified as consumer goods. However, if the vehicle is held for sale, it may be deemed inventory. If the vehicle is regularly used for business purposes, it should be classified as equipment.

Other examples of collateral include inventory, equipment, machinery, farm products and crops, appliances, furnishings, fixtures, accounts receivable, deposit accounts, contract rights, and general intangibles. If the debtor defaults on repayment, the creditor (also called the secured party) will be able to keep or sell the collateral.

What is secured debt and how does it differ from unsecured debt?

A basic understanding of secured and unsecured debt is critical to grasping the scope and process of a security agreement. Many individuals and organizations take on both types of debt, but in different contexts.

Secured debt is tied to an asset such as real estate or stock. This asset serves as collateral; fail to pay up, and the creditor takes possession of or otherwise uses the collateral. Common examples of secured debt include auto loans and mortgages. Such assets are never fully owned until the debt has been completely paid.

Unsecured debt provides no rights to collateral for the creditor. If the debtor fails to make payments then the creditor must take other steps, such as working with a debt collector or suing in hope of garnishing the debtor's wages.

What is Article 9 of the Uniform Commercial Code and why does it matter?

Any basic examination of security agreements will ultimately lead to Article 9 of the Uniform Commercial Code (UCC). Designed to provide some semblance of uniformity in transactions involving secured debt, Article 9 is believed to play a significant role in stimulating economic growth in the United States' economy. Proponents believe that, when remedies for responding to default are available, lenders are more inclined to offer low interest rates and work with borrowers they might otherwise avoid.

While Article 9 explicitly covers all security interests, it may also cover arrangements that resemble security interest. In general, it governs all transactions in which debt is related to a creditor's interest in the debtor's property.

Is the Uniform Commercial Code the same everywhere?

The Uniform Commercial Code (UCC) has been adopted by all 50 states, as well as the District of Columbia and Puerto Rico. While the UCC is substantively the same across most jurisdictions, minor differences exist and are worth noting. For example, in some states, articles are referred to as 'chapters' or 'divisions.' In California, hyphens are not used for section numbers. In general, however, the basic concepts outlined in the UCC are universal, especially rights and responsibilities of both the lender and the debtor.

Are there any differences between debtors and obligors?

Often, the debtor and obligor is the same person. Technically, however, the term 'debtor' refers to anybody with ownership interest in the collateral, while the 'obligor' owes the debt related to the security interest.

A simple example: If a teenager hopes to purchase a vehicle, the parent may act as the obligor. While the teen technically owns the vehicle and might have to give it up in the event of default, the parent is ultimately responsible. This same concept can occur when one company takes on debt and another takes on the responsibility of paying off the loan.

How does priority work in security agreements?

Often, multiple parties will have interest in an individual's or organization's property. Generally, the first secured party to achieve perfection is granted priority interest in the debtor's collateral; hence the popularity of filing a financing statement, which quickly grants perfection while also putting other secured parties on notice of a given creditor's priority position.

Those with security interest may be referred to as the "first secured party," "second secured party," and so on, depending on when and how perfection of the security interest was achieved.

What are security agreement covenants?

Most security agreements include covenants, which outline everything from insurance requirements to repayment dates. Examples of covenants include the following:

  • The debtor cannot sell, transfer, or otherwise dispose of collateral property without express permission from the secured party.
  • The secured party is allowed to inspect, audit, or obtain valuation of the collateral.
  • The debtor must appropriately maintain the collateral and notify the secured party if it is damaged or a value reduction occurs.
  • The debtor should use the collateral in accordance with federal, state, and municipal regulations.

What is a promissory note, and how does it differ from a security agreement?

A promissory note is essentially a promise to pay; the document announces a debtor's intention to repay a creditor. Promissory notes can either be secured or unsecured. If a debtor defaults on a secured promissory note, the creditor may be able to satisfy the note via collateral, without filing a lawsuit.

Although promissory notes and security agreements technically hold the same intention—to make a record of the debtor's obligation and intention to pay back the creditor—security agreements are far more detailed. Additionally, while promissory notes can be unsecured, a security agreement by nature involves some sort of collateral and therefore is inherently a secured contract.

What does it mean for security agreement provisions to be 'negotiable'?

Parties involved in security agreements can negotiate the terms of virtually any provision included therein. For example, while many security agreements abide closely by definitions outlined in Article 9 of the UCC, parties involved in agreements may instead prefer to use definitions included in one of the UCC's other sections. Many security agreements, however, stipulate that, when in doubt, the contract will abide by definitions set forth in Article 9. Negotiable provisions may also determine whether the contract will refer to existing obligations (as opposed to future obligations). Caution is critical, as not all courts will enforce negotiable provisions in the event of a dispute.

Do I need to register my security interest with the state?

Registering a security interest with your state—known as "perfecting" the security interest—is normally recommended in order to ensure that there are no prior claims to the collateral and to protect the secured party in the event that the debtor becomes insolvent or declares bankruptcy. While taking the step to perfect a security interest is not required by law, it is often the only way that the secured party can rest assured that its interest in the collateral is safe from other creditors.

You can perfect your interest by simply filing a short document, called a financing statement, in the debtor's state or local jurisdiction. If the debtor is an individual, this is the state where the debtor resides; if the debtor is a business, this is the state where the business was formed. While the rules vary by location, a financing statement normally only requires identifying the parties and providing a description of the collateral. In most states you can easily provide this information by completing Form UCC-1 and filing it with the Secretary of State's office. You can find your state's requirements online or by calling your state office.

Certain types of collateral may be perfected without filing a financing statement and simply by the secured party having possession or control over them. However, filing a financing statement is usually recommended as the more straightforward method of ensuring the secured party's interest is fully protected.

What are the secured party's rights if the debtor defaults?

Section 9-601 and 602 of the UCC's Article 9 explicitly states the rights of a secured party following default:

  • The secured party can enforce the claim via available judicial procedure.
  • The secured party can reduce the claim to judgment.
  • The secured party can take possession of the collateral.
  • If agreed, the debtor may be required to assemble the collateral or otherwise make it available to the secured party at a reasonably convenient and specifically designated location.
  • The secured party can lease, license, or sell collateral.

Can security interest involve future assets?

In most cases, a security interest can involve property to be acquired by the debtor in the future. This approach is actually quite common, particularly if a future possession is actively used as collateral. Some restrictions may be placed on after-acquired consumer goods, however. If collateral consists of commercial torts, then after-acquired clauses may be prohibited. In general, after-acquired items must be explicitly stated in the security agreement.

How do security agreements and financing statements differ?

Security agreements and financing statements are often confused with one another. The primary difference is that the financing statement largely serves as notice that a creditor possesses security interest in the debtor's assets or property.

The financing statement is not a contract. Rather, it is filed to alert third parties to security interest. While the financing statement should include the names of the secured party and the debtor (along with some indication of the collateral), it need not be authenticated or signed. The financing statement lacks several of the requirements attached to a security agreement, so it cannot serve as a valid substitute.

How do I determine which jurisdiction governs perfection for my security agreement?

Because procedures and filing of financing statements can vary somewhat between states, it is important to file the security agreements with the correct jurisdiction. For individuals, this is easy: the person's jurisdiction is dictated by his or her primary residence. With registered organizations, however, the jurisdiction may be determined by the state in which the business is incorporated or organized. Without registry (as in a general partnership), the jurisdiction may be based on the location of the chief executive's office or primary place of business.

Does a notary need to act as a witness to the security agreement?

A notary can serve as a witness for a security agreement, but this is not required for the agreement to be deemed valid. However, use of a notary is recommended to ensure that proof of contract validity is available in the event of a dispute. If a notary is not available, it is important (but still not required) to sign the agreement before a non-notary witness. Ideally, security agreements will be completed before both a notary and a separate, non-notary witness. Some creditors may refuse to complete security agreements if the debtor lacks a notary and/or witness.

What is a UCC-1 form?

Often, secured parties use UCC-1 financing statement forms to achieve perfection of security interest outlined in a security agreement. Prepared and signed by both parties, this form includes the following information:

  • The debtor's name (either the name of an organization or an individual taking on debt). Addendums may be required for additional debtors.
  • The debtor's contact information.
  • The secured party's name and contact information. As with debtors, addendums may be necessary for additional secured parties.
  • A detailed description of property intended for use as collateral.
  • Description of terms to be used if both parties prefer terms other than 'debtor' and 'secured party.' For example, filers may prefer to be called 'sellers' and 'buyers.'

What does attachment mean in regard to security interest?

Three main requirements must be met in order for a security interest to be deemed enforceable:

  • Some sort of exchange of value must occur between the debtor and the creditor.
  • The debtor must either possess rights in the collateral or the power to transfer said rights.
  • The debtor must authenticate the agreement. This could either involve signing in person or electronically.

The security ultimately attaches to the collateral if the aforementioned conditions are met.

What does perfection mean in regard to security agreements?

Perfection essentially involves granting third parties notice of a security interest's role in property. Perfection may vary based on whether property is deemed personal or real.

A variety of methods can be used to obtain perfection in a security agreement. The following are among the most common:

  • Filing a financing statement
  • Possession of the collateral by the secured party or the secured party's agent
  • Control over the collateral by the secured party
  • Automatic perfection upon attachment

How do I attach and perfect a security interest?

Three things must be present in order for the secured party to obtain a protected security interest in the collateral: 1) the secured party must pay for or give something of value in exchange for receiving the security interest, 2) the debtor must own the collateral or have proper authority over the collateral in order to pledge the security interest, and 3) the debtor must sign a security agreement. Once all three items occur, then the secured party will rightfully have a security interest in the collateral. This process is called "attachment" of a security interest. Assuming the first two items are present, the secured party should have an attached security interest when the debtor signs the security agreement.

Next, the secured party needs to "perfect" its security interest. This means that the secured party has taken steps to ensure that no other creditor has a prior claim over the collateral and that the secured party will be able to claim the collateral in the event that the debtor becomes insolvent or declares bankruptcy. While taking the step to perfect a security interest is not required by law, it is often the only way that the secured party can rest assured that its interest in the collateral is safe from other creditors.

You can perfect your interest by simply filing a short document, called a financing statement, in the debtor's state or jurisdiction. If the debtor is an individual, this is the state where the debtor resides; if the debtor is a business, this is the state where the business was formed. While the rules vary by location, a financing statement normally only requires identifying the parties and providing a description of the collateral. In most states you can easily provide this information by completing Form UCC-1 and filing it with the Secretary of State's office. You can find your state's requirements online or by calling your state office.

Certain types of collateral may be perfected without filing a financing statement and simply by the secured party having possession or control over them. However, filing a financing statement is usually recommended as the more straightforward method of ensuring the secured party's interest is fully protected.

Can the terms of a security agreement be amended?

In select cases, secured parties and debtors may need to change specific provisions of a security agreement. Some, however, prefer to draft an amended and restated version of the document—particularly if extensive updates are warranted or if a single change impacts numerous provisions. Terms for future modification may be included in the original security agreement. Often, debtors and creditors prefer to draft an 'amended and restated' agreement rather than attach amendments to the existing agreement.

What is a purchase money security interest?

A purchase money security interest (PMSI) allows a security interest to achieve perfection automatically upon attachment. This approach is most commonly used if financing for property is provided at the point of sale. Use of PMSI is limited to tangible goods and, sometimes, new software. To qualify, the secured party must provide new value, and said value must allow the debtor to purchase (or acquire rights for) the collateral.

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Checklist

Step 1: Gather Information

As you complete your security agreement, you will need to provide certain relevant information. This includes the names and addresses of the parties, the amount and interest rate (if any) owed by the debtor, and collateral details. You may also need to include additional payment details, such as payment frequency, late fees, and prepayment requirements, if they are not already contained in a separate agreement.

Step 2: Answer Key Questions

Use the information you collected to complete the security agreement. We make this easy by guiding you each step of the way and helping you to customize your document to match your specific needs. The questions and information we present to you dynamically change depending on your answers and the state selected.

Step 3: Review and Sign

It is always important to read your document thoroughly to ensure it matches your needs and is free of errors and omissions. After completing the questionnaire, you can make textual changes to your document by downloading it in Microsoft Word. If no changes are needed, you can simply download the PDF version and sign. These downloads are available by navigating to the Documents section of your account dashboard.

The agreement allows the parties to sign and deliver it to one another electronically. This means that it is not necessary for the parties to sign a single printed agreement. Instead, they may choose to both sign the same electronic copy using electronic signatures, or they may sign separate electronic copies and email them to each other.

When signing the document, be sure to follow any additional instructions related to signing and witnessing the document. Any such instructions will either be located next to the signature line or in the instructions attached at the end of the document.

Although using a notary is not required, it is recommended that you do so to ensure that you can prove the authenticity of the document. When using a notary, be sure to wait to sign the document until they are present.

Step 4: Distribute and Store Copies

At a minimum, all parties that sign the document should receive a copy once it is fully executed (everyone has signed). Other interested parties may need or want copies as well. Be sure to store your copy in a safe location. It is a good idea to keep both a physical and electronic copy.

Step 5: Perfect Your Security Interest

Three things must be present in order for the secured party to obtain a protected security interest in the collateral: 1) the secured party must pay for or give something of value in exchange for receiving the security interest, 2) the debtor must own the collateral or have proper authority over the collateral in order to pledge the security interest, and 3) the debtor must sign a security agreement. Once all three items occur, then the secured party will rightfully have a security interest in the collateral. This process is called "attachment" of a security interest. Assuming the first two items are present, the secured party should have an attached security interest when the debtor signs the security agreement.

Next, the secured party needs to "perfect" its security interest. This means that the secured party has taken steps to ensure that no other creditor has a prior claim over the collateral and that the secured party will be able to claim the collateral in the event that the debtor becomes insolvent or declares bankruptcy. While taking the step to perfect a security interest is not required by law, it is often the only way that the secured party can rest assured that its interest in the collateral is safe from other creditors.

You can perfect your interest by simply filing a short document, called a financing statement, in the debtor's state or local jurisdiction. If the debtor is an individual, this is the state where the debtor resides; if the debtor is a business, this is the state where the business was formed. While the rules vary by location, a financing statement normally only requires identifying the parties and providing a description of the collateral. In most states you can easily provide this information by completing Form UCC-1 and filing it with the Secretary of State's office. You can find your state's requirements online or by calling your state office.

Certain types of collateral may be perfected without filing a financing statement and simply by the secured party having possession or control over them. However, filing a financing statement is usually recommended as the more straightforward method of ensuring the secured party's interest is fully protected.

Step 6: Complete Related Documents

Other documents may offer additional legal protection. For example, those who use security agreements often incorporate promissory notes, loan agreements, and sales contracts into their existing business practices.