You are the chief executive officer of Money Games Inc. (MGI), which has begun to market Borrow & Spend, a video game set in the world of finance. To buy ads, MGI borrows $50,000 from First...

You are the chief executive officer of Money Games Inc. (MGI), which has begun to market Borrow & Spend, a video game set in the world of finance. To buy ads, MGI borrows $50,000 from First Savings Bank. On MGIs behalf, you sign a note for the loan and offer it's accounts receivable as collateral. You sign a security agreement that describes the collateral. The bank does not file a financing statement. Has the banks security interest attached? If so, when?

Asked on by berty63

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docholl1's profile pic

Stephen Holliday | College Teacher | (Level 1) Distinguished Educator

Posted on

In your scenario, First Savings Bank's security interest has attached when the security agreement is properly executed, but under Article 9 of the Uniform Commercial Code, its interest is not perfected unless it also executes and files with the secretary of state (the state of jurisdiction) a UCC-1 Financing Statement.  There is an important difference between obtaining a security interest and perfecting that interest.

A valid security instrument must be based on three elements. First, there must be an exchange in value--in this case, MGI provides its accounts receivable as collateral, and the bank provides $50,000.  Second, MGI must prove that it owns the collateral and that it has not pledged the collateral for any other use. Third, the security agreement must be executed with authorized signatories of each entity.

The last step is for the secured party--First Savings Bank--to file a UCC-1 Financing Statement (the "UCC-1").  The purpose of filing the UCC-1 is to "perfect" the bank's interest by putting all other potential creditors on public notice that it has a security interest in the collateral.  If other lenders become involved with MGI, they know, by doing a UCC search, that certain collateral has already been pledged for a debt and its security has been perfected, and they will not lend money secured by that collateral.  If, for example, MGI were to file bankruptcy, the UCC-1 in favor of First Savings Bank puts other secured creditors and the Bankruptcy Trustee on notice that certain collateral of the bankrupt entity is already encumbered and must be liquidated in favor of the creditor with the UCC-1 interest.

In most jurisdictions, the UCC-1 expires after six years and must be renewed by secured creditor within a six-month "window" prior to the expiration date.  If the creditor were to renew the UCC-1 six months and two days before the expiration, the renewal would not be valid.  The UCC-1 must be renewed only during the six-month window, not six-months and a couple of days before the expiration date.  The unintentional lapse of a UCC-1 interest can be disastrous for a secured lender.

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boomer-sooner's profile pic

boomer-sooner | College Teacher | (Level 1) Associate Educator

Posted on

Security interest is simply the collateral a bank will accept to offset a loan if the borrower cannot fulfill the terms of the agreement.  The Uniform Commercial Code (UCC) requires three specifications to be met for a legal security interest exchange.

First, the security interest must be given a value.  The value can be a static or fluctuating value, meaning it might be $1.00 or range from $1.00 - $1.25.  The fluctuating value is fine as long as the minimum covers the loan or the bank agrees to forgive the difference.  The value protects both bank and borrower from claims the collateral is not sufficient to cover the loan if it turns into a bad loan.

Second, the borrower must own the collateral.  Simple enough.  In this case the company "owns" the accounts receivable which are monies legally owed the business from other individuals or companies.  In theory, if the bank accepts this as collateral and the company defaults on the loan, the bank will attempt to collect the accounts.  This is a common collateral in business.

Lastly, the borrower must sign the security interest.  The security interest must also meet legal criteria.  The interest must be particularly described and not encumbered by other debts.  In our example the accounts receivable must be described to list the accounts.  For example, "AAA Account $112.00; BBB Account $54.00, etc.  In addition the accounts cannot be owed to any other party. 

Once the bank and borrower have agreed to a value, it is owned by the borrower AND the security agreement is signed then the banks security interest is attached.

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