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Security Agreement
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UCC Rules - The Three Steps

The relationship between the borrower and the lender, if there is a security interest, is governed almost exclusively by Article 9 of the Uniform Commercial Code (UCC).  This has several ramifications. 

The Security Agreement should be used only with tangible personal property.  In other words, the agreement should not be used with real estate, or with intangible items, such as shares of stock.  While intangible items may be used to secure a loan, the agreements are more complex, and "perfecting the security interest" (discussed below) under Article 9 may be more complicated. 

Once there is agreement on the loan, under the rules of the UCC, there are three basic steps to make sure that a loan is properly secured: 
1.  Confirm that the property does not already secure another obligation. 
2.  Get a Security Agreement. 
3.  "Perfect" your security interest. 

Check The Public Records

You do not want to take some property as collateral if it already serves as collateral for another loan.  Your security interest will be worth little, because the other creditor could take the property from you if that creditor is not paid. 
 
Ask the borrower if the property is collateral for another loan.  If the answer is "yes," you will need to look for other property.  If the answer is "no," you still need to check the public records to see whether someone claims an interest. Contact the county records office in the county where the borrower and/or property are located.  Tell them you want to conduct a "UCC search".  For a modest fee (usually $5 to $10), they will search the records by the borrower's name.  You will have to conduct the same kind of search at the state capitol, usually at the secretary of state's office.   

If you discover that the borrower has already used the property as collateral, do not accept this property.  If the searches show no one else claims an interest in the item, you can go to steps 2 and 3. 

Perfect The Security Interest

After you have your signed Security Agreement, you need to put your interest on the public record to prevent other creditors from claiming it.  "Perfecting the security interest" is the process of establishing that the lender has priority over other parties that may claim an interest in the property.  In other words, if you are the lender, and if the borrower is unable to repay the loan, you have the first priority for taking possession of the property. Other lenders can take it only if you decide not to.  Even if you have a security agreement, if your security interest is not properly perfected then the collateral may be lost to another creditor. 

In most cases, perfecting a security interest in tangible personal property requires that the borrower sign a UCC Form 1 financing statement, and that the statement be filed in the appropriate place.  The location for filing depends on the kind of property given as security and the state law.  Usually, the financing statement must be filed with the appropriate recording office, either at the state capitol ("filing centrally"), or in the county where the property is located ("filing locally"), or both.  These will likely be the same offices where you conducted your UCC search. 

It is very important to file based on where the collateral is located.  In other words, follow the state laws of the state where the collateral is located.  If that state's laws require you to file centrally, file with centrally in that state.  If that state's laws require you to file locally, file in the county in that state where the collateral is located. To find out which state and local offices to file in, consult with a local attorney, the state government, or a friendly local bank. 

To avoid an argument that you did not file the financing agreement in the right place, many lawyers recommend you file both locally and centrally with each item of collateral.