Legal Definitions - Secured transaction

A secured transaction is a financial arrangement where one party, known as the debtor (typically a borrower or buyer), promises to pay money or fulfill an obligation to another party, called the secured party (usually a lender or seller). To guarantee this payment, the debtor grants the secured party a legal right, known as a security interest, over specific property. This property is referred to as collateral.

The purpose of a secured transaction is to reduce the risk for the secured party. If the debtor fails to meet their payment obligations as agreed, the secured party has the legal right to take possession of or sell the collateral to recover the money owed. This gives the secured party a specific asset to turn to if the debtor defaults, making the loan or credit more secure.

• Example 1: Purchasing a Car with a Loan

  When an individual takes out a loan from a bank to purchase a new car, this is a common secured transaction. The individual is the debtor, and the bank is the secured party. The loan agreement specifies that the car itself serves as collateral. The bank holds a security interest in the car. If the individual stops making car payments, the bank has the legal right to repossess the car and sell it to recover the outstanding loan amount.

• Example 2: Small Business Equipment Financing

  A small manufacturing company needs to buy new machinery but lacks the upfront capital. It obtains a loan from a commercial lender. The manufacturing company is the debtor, and the lender is the secured party. The new machinery purchased with the loan acts as collateral, and the lender holds a security interest in it. Should the company face financial difficulties and default on its loan payments, the lender can seize and sell the machinery to recoup its investment.

• Example 3: Inventory Financing for a Retail Store

  A clothing boutique needs to stock up on seasonal merchandise but doesn't have enough cash to pay its suppliers immediately. It enters into an agreement with a specialized finance company for inventory financing. The boutique is the debtor, and the finance company is the secured party. The boutique's current and future inventory of clothing serves as collateral, and the finance company holds a security interest in it. If the boutique fails to pay its invoices to the finance company, the company can claim the inventory to satisfy the debt.