In our earlier post we had discussed the creation and perfection of security interest in collateral. In this post we look at enforcement of security interest. Particularly we look at the methods for enforcing security interest when a default event or breach of security agreement occurs. We also address how to apply the recovered proceeds.
Methods for enforcing security interest
After a default event occurs, such as a breach in the terms and conditions of a security agreement by the borrower or the borrower not making loan repayments within the grace period, the secured party may notify the borrower to make the payment or perform according the agreed terms. The secured party can then take a reasonable commercial collection action (e.g. filing a money suit, repossession, foreclosure) to collect the collateral and sell it. The expenses for collecting/ recovery including any attorney fees may be recovered from the collection amount.
The lender can either sell, lease or dispose of the collateral in either a public or private sale. However, the sale must be commercially reasonable, i.e. encourage a private sale if the realized proceeds are higher than from a public sale.
Application of sale proceeds
After the collateral sale, the lender may apply the proceeds to:
- The cost of collecting the collateral and disposing of it and may include attorney fees and legal expenses. Which may vary depending on the jurisdiction/ country and/ or terms and conditions of the security agreement.
- The outstanding obligation of the borrower against the senior secured party. Including principal, interest, financial charges and other unpaid charges provided for within the security agreement.
- The claims of those subordinated to the senior secured party. This is contingent on the provision from these parties of an authenticated notice and proof to the senior party to complete the distribution of proceeds.
- Residual rights, if any
The lender pays the borrower back any surplus proceeds. In the event that the proceeds do not cover the outstanding debt of the lender, the debtor is usually has to cover the deficiency. Except where the security agreement explicitly releases or waives the borrower from this condition.
We have reviewed what enforcement of security interest in collateral means. In the next post we will look at how to terminate or extinguish security interest.