WHEN YOU CAN TAKE BACK WHAT YOU SELL IF YOU DO NOT GET PAID
(What a Security Agreement Is, and Why It Might Help You)
By Andrew J. Steil

February 2009

Friday the 13th is regarded as a day of bad luck, or if you are a movie fan, the day another mediocre horror movie with the same name is released in theaters.  Since I am writing this article on Friday the 13th, it is a great time to discuss something that is scary to construction suppliers-customers who fail to pay. 

While not having the cinematic drama that Jason Voorhees inflicts in his Friday the 13th movies, receivables are lurking just waiting to hurt our businesses.  The purpose of this article is to introduce security agreements, and provide a general overview of how they may help protect suppliers to ensure payment.

Security Agreements 

A “security agreement” is the formal name for the agreement between a buyer and seller (the person lending the money or extending credit) which creates a lien on the personal property, such as appliances, inventory, and goods, in favor of the seller.  For instance, if you are selling a refrigerator to a customer, you can have the customer agree to give you a lien in the refrigerator.  The lien a seller has on products sold through a security agreement is formally referred to as a “security interest” in the item. 

Some initially balk when I suggest a security agreement because they feel if selling on credit, they automatically retain lien rights in the items they sell.  This is wrong.  Generally, once you sell something to a customer, regardless of whether the customer pays in full at the time of sale or is paying you monthly over a period of time, your rights in the product sold are eliminated at the time of sale.  If you sell a refrigerator on credit, and fail to have a security agreement, you cannot repossess it. 

Obtaining a Security Interest 

A security agreement does not need to be long or complicated, and can be as short as one sentence.  A security agreement can usually be incorporated into your purchase agreement.  The security agreement identifies the item or items that the seller will have a lien on.  However, it is essential that the buyer sign the document which includes the agreement. 

To ensure your lien is protected against other lien claimants or a bankruptcy filing, you should file a UCC-1 Financing Statement to “perfect” your lien.  While sounding difficult, a financing statement is nothing more than a form provided by the state identifying the seller, buyer, and item that has a security interest on it.  It is critical that you have the correct name of your customer because minor mistakes may cause your financing statement to be invalid.  Your customer does not have to sign a financing statement.  A financing statement is good for five years but may be continued longer prior to its expiration.  Determining the location to file your financing statement is beyond the scope of this article. 

Often, a debtor will have more than one creditor claiming a lien on the same property.  A seller who properly perfects its lien will have priority over everyone else as a “purchase money security interest”.  To have this protection, a financing statement must be filed within 20 days of your customer receiving the item.  If you are selling wholesale and your customer is placing your item into its inventory for resale, there are additional steps to obtain priority beyond the scope of this article. 

Repossession/Replevin

The techniques used to remove the items that you have a lien on are a replevin or repossession.  Repossession is the self-help technique of taking of an item back without court assistance.  A repossession must be conducted without breaching the peace.  The standard for breaching the peace is low and a breach may occur if the customer asks you to leave his/her property and you fail to do so.  Additionally, repossession generally allows you to retake items that are on public land.  If an item is stored in a private structure you are not allowed to break in to take it.  A breach of the peace while repossessing an item can result in damages being awarded against you.  

While repossession does not allow you to enter a structure or breach the peace, a court procedure is available to better assist you; replevin.  Replevin is a lawsuit asking the court to order the sheriff to seize the property for you. 

The law allows a party with a lien to remove the item from a structure but the secured party shall reimburse the owner for the cost of repair of any physical damage caused by the removal.  This does not mean you must reimburse the owner for the diminution in value to the property.  Thus, while lumber might be impossible to take out because of the damage to the property in doing so, other fixtures, such as lights and carpet are not.  Items that are not fixtures, such as appliances, furniture, air-conditioners, etc. are much easier to remove. 

Bankruptcy

If you do not have a perfected security interest and your delinquent customer files bankruptcy you have given away your product.  Bankruptcy generally wipes out “unsecured debts”.  A lien, or “secured debt” in bankruptcy, will either help ensure payment or the item will be returned to you.  A security agreement is a powerful tool that survives other lenders’ liens, allows you to get your items back, and even survives bankruptcy.  While this article is intended as an introduction and if you are considering using a security agreement you should consult an attorney, my hope is it provides you with an understanding to help protect your business now so you ensure you are paid later. 

Andrew Steil practices in the areas creditor/debtor commercial collections, construction and litigation.

© 2009 Rinke-Noonan.

This article is a general discussion of legal issues and is not intended to be legal advice. We would be pleased to review the specific facts and law regarding any given legal matter.