Security agreement: Overview, definition, and example
What is a security agreement?
A security agreement is a legal document that outlines the terms under which a borrower grants a lender a security interest in specific assets or property to secure the repayment of a loan or other financial obligation. It is typically used in secured lending transactions, where the borrower offers collateral as a guarantee to the lender in case they default on the loan.
The security agreement establishes the lender’s right to seize the collateral if the borrower fails to meet their repayment obligations. It specifies the collateral, the obligations being secured, and the procedures for enforcement in the event of default. Security agreements are commonly used in financing arrangements involving businesses, such as loans, leases, and credit facilities, where tangible or intangible assets like equipment, inventory, or intellectual property are pledged as collateral.
Why is a security agreement important?
A security agreement is important because it protects the lender’s interests by providing a legal framework for claiming collateral if the borrower defaults on the loan or obligation. By specifying the collateral and the terms of its seizure, the security agreement ensures that the lender has recourse to assets to recover the debt.
For borrowers, signing a security agreement can allow them to access financing they might not otherwise qualify for by using their assets as collateral. It also helps clarify the terms and conditions under which the lender can claim the collateral, ensuring that both parties understand their rights and obligations.
Understanding security agreement through an example
Imagine a small business takes out a loan from a bank to purchase new equipment. The bank requires a security agreement as part of the loan arrangement, stipulating that the equipment purchased with the loan will serve as collateral. If the business defaults on the loan, the bank has the right to seize the equipment to recover the outstanding balance.
In another example, a business enters into a line of credit agreement with a lender and pledges its inventory as collateral. The security agreement outlines the specific inventory that is pledged, the terms under which the lender can take possession of the inventory in case of default, and the procedure for liquidating the collateral to satisfy the debt.
An example of a security agreement clause
Here’s how a security agreement clause might look in a loan or credit agreement:
“The Borrower hereby grants the Lender a continuing security interest in the following collateral: [list of specific assets, such as equipment, inventory, receivables]. This security interest secures the Borrower’s obligations under the Loan Agreement, including the repayment of the principal, interest, and any associated fees. In the event of default by the Borrower, the Lender shall have the right to take possession of and liquidate the collateral to satisfy the outstanding debt.”
Conclusion
A security agreement is a critical component in secured lending, providing both the borrower and the lender with a clear understanding of the terms under which collateral is pledged and can be seized in case of default. It helps protect the lender’s investment by outlining the process for claiming the collateral and ensures the borrower has a clear understanding of their obligations and the potential consequences of non-payment. By clearly defining the collateral and terms of enforcement, a security agreement serves as an essential safeguard for both parties in financing arrangements.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.