Any transaction or agreement in which a security interest in created in personal property or fixtures is a secured transaction. Personal property is any property that is not real estate. "Fixtures" means personal property that is attached to real estate. A security interest is a right to take the personal property and sell it to satisfy a debt due the owner of the security interest. In essence a secured transaction is like the creation of a mortgage on personal property and security interests were at one time called chattel mortgages. The object of these transactions is to enable a lender or creditor to have security for payment of amounts owed to them.

The creditor could do this by taking possession of the property but then the debtors could not use the property (inventory, equipment etc.) to make money to pay the debt. To enable the debtors to use the property and the creditors to still have an interest which is good against third parties a system of giving notice of the security interests is provided for by legislation. This system provides that security interests must be reported to the relevant state in financing statements. Third parties dealing with the debtor can then check with the state to see what property of the debtor is encumbered with security interests. Any third party dealing with the debtor will take the debtor's property subject to security interests evidenced by properly filed financing statements. On the other hand, if a creditor does not make a proper financing statement filing its security interest will not be effective against third parties who do not actually know of it.

The personal property or fixtures which secure the debt is called collateral. A financing statement must state the names and addresses of the debtor and secured party (creditor) and describe the collateral. Proper filing of the financing statement perfects the security interest makes it effective against third parties.

In order for there to be an effective security interest to begin with there must be an agreement by the debtor to give one. This agreement must describe the collateral. This is referred to as the security agreement.

An exception to the requirement of a security agreement is the pledge - where the secured party takes possession of the collateral.

Security agreements and security interests may include as collateral property acquired after the security agreement is signed if this is called for in the agreement. The language calling for this is usually called an after acquired property clause. There are some exceptions to this. Security agreements and security interests can also secure advances made after the security agreement is signed.

If the security agreement secures payment of a negotiable instrument (a promissory note payable to someone's order) or if the grantor of a security interest agrees to it the debtor (grantor) cannot assert against any assignee of the security interest any defense or claim the debtor has against the original secured party (for example, someone from whom the debtor bought goods on credit). This holds true only if the assignee pays full value for the debt and does not actually know of the defenses or claims. (In some particular types of transactions statutes change the rule). This rule is intended to make it easier for secured parties to sell the security interests and promissory notes. (For example, the seller of goods on credit assigns the notes and security interests to a bank so the seller can get paid.) In order for the assignee to have the right to payments from the debtor the debtor must be notified of the assignment. Otherwise payments to the original creditor/assignor reduce the debt.

The financing statement is the key to protecting the secured party's interest. It must give the names and addresses of the debtor and secured party. The exact name of the debtor must be used. This statement must be signed by the debtor, except in a few instances. It must describe the types or describe the items of collateral. If crops are the collateral the real estate must also be described. The same applies when the collateral is timber to be cut or minerals or oil and gas to be extracted. Where a description of real estate is required the financing statement must also be recorded with the recorder of deeds for the county where the real estate is located.

The place where a security interest must be filed depends on the collateral. Generally the place for filing is the Secretary of State. However, for consumer goods the place for filing is recorder of deeds for the county where the debtor resides or the county where the goods are kept if the debtor lives out of state. For timber to be cut, and minerals and oil to be extracted and fixtures the place for filing is the recorder of deeds for the county where the real estate is located. Financing statements relating to crops and farming at one time had to be filed with the local recorder of deeds, but are not filed with the Secretary of State.

All financing statements are effective for 5 years from the date of filing unless a continuation statement is filed within 6 months before the end of the 5 year period. There is an exception for debtors who file bankruptcy proceedings. Perfection continues throughout the bankruptcy proceedings and thereafter for 60 days, even if the 5 years has expired. There are several other exceptions for certain kinds of debtors which are utility companies and real estate mortgages used as fixture filings.

A continuation statement must be filed within 6 months prior to expiration of the 5 year period. It must be signed by the secured party or, if signed by the assignee, it must be accompanied by the assignment signed by the original secured party. The continuation statement continues perfection of the security interest for another 5 years. The same procedure may be used to continue effectiveness of the financing statement for successive 5 year periods.

Notice of an assignment need not be made, but one may be filed.

If the financing statement covers consumer goods the secured party must file a termination statement when there is no longer any outstanding debt or commitment to make advances. When other goods are the collateral and payment has been made in full the secured party must give the debtor a termination statement on demand.

There are often conflicts between secured parties and other creditors dealing with the debtor. There are rules for dealing with most of these situations in the statute. Usually a perfected security interest prevails over third parties or later perfected security interests. However, a purchase money security interest in inventory (for funds used to acquire the inventory) prevails over a prior security interest covering the same collateral if it is properly perfected and the second lender gives the first lender notice according to a prescribed set of rules. Purchase money security interests in other types of collateral take priority over other earlier perfected security interests without notice to the prior lender.

Generally, a perfected security interest can give the secured party priority for future advances. This means a second lender seeing that a prior lender's financing statement covers future advances knows that the first lender will have a prior interest in the collateral not only for the first lender's original loan, but also for loans made after the second lender perfects its security interest.

On default the rights and remedies of a secured party are set forth in the statute and amount to using legal process to get a judgment and foreclose on the collateral. The secured party also has a right to take possession of the goods and sell them - if this can be done without a breach of the peace. The proceeds are first applied to the costs of sale and attorneys fees. Sale may be at public or private sale. Every aspect of the process must be commercially reasonable. Notice must be given to the debtor. The secured party can be the buyer, but only at a public sale.

Donald M. Thompson * Business Lawyers Chicago - 55 W. Monroe #3950; Chicago, IL 60603
Ph: 312-782-0844 * Fax: 312-201-1436 * Email: donthompsonlaw@sbcglobal.net