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Security Interest

A security interest in simple terms means the rights conferred upon a creditor to take all or part of a property offered as security for loan. A security interest is an interest created by law or by legal binding agreement over assets to act as collateral for the performance of a legal obligation, normally the payment of a debt. The beneficiary in favor of the security interest gets certain preferential rights when it comes to the disposition of the assets set as security. The preferential rights will vary from one type of security interest to another but normally the holder of the interest has the right to repossess and sell the property in order to cover for the debt that the security interest guarantees.

Types of Security Interest

There are eight types of security interests:
1. ‘True’ legal mortgage
2. Statutory mortgage
3. Pledge (pawn)
4. Equitable lien
5. Legal lien
6. Hypothecation or trust receipt
7. Equitable mortgage
8. Floating equitable charge

In most cases, security interests can either be non-possessory or possessory, which is determined by whether the party that is secured is in actual need of taking full or partial possession of the security/collateral. Security interests can be taken on any kind of property and the law defines property by dividing it into two major categories i.e. personal and real property. Real property is defined as land, all the structures on the land and the full rights that accompany the land. Personal property on the other hand is defined as any other form of property that is not real property.

Underlying principles of security interests

A creditor takes security interest to put into effect the rights of the interest against the collateral in cases where the debtor fails to service the loan by way of default or otherwise stated. If a borrower goes bankrupt, the secured creditor is given priority over an unsecured creditor when it comes to property distribution. The other reason why someone may take security interests over assets is in the case of a joint venture involving two parties in shareholder’s agreements. In such a case, the concerned parties will each charge its shares favoring the other party as security to oversee the performance of their obligations as stipulated in the agreement in order to discourage the other shareholder from selling their shares.

Controversies over Security Interest

Some economists question the value of security interests and the general process of secured lending where supporters argue that these interests reduce the risks for the lender, hence allowing the lender to charge a low rate of interest and in turn reducing the capital cost for the borrower. Opponents however argue that creditors who have security interests are able to bring down companies that are going through financial difficulties but which have the potential of recovering and becoming profitable. This, they argue that the creditors can get nervous prematurely and put into effect their security early, reclaiming key assets and forcing the company in question into bankruptcy.

Tags: bank, collateral, credit, law, Legal, loan, mortgage, risk

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