What Is a Security Agreement?

A security agreement refers to a document that provides a lender a security interest in a specified asset or property that is pledged as collateral. Terms and conditions are determined at the time the security agreement is drafted. Security agreements are a necessary part of the business world, as lenders would never extend credit to certain companies without them. In the event that the borrower defaults, the pledged collateral can be seized by the lender and sold.

Key Takeaways

  • A security agreement is a document that provides a lender a security interest in a specified asset or property that is pledged as collateral.
  • Security agreements often contain covenants that outline provisions for the advancement of funds, a repayment schedule, or insurance requirements.
  • These agreements may also pertain to intangible property such as patents or receivables.

Understanding Security Agreements

Businesses and people need money to run and fund their operations. There are rarely cases where entities can fund themselves, which is why they turn to banks and other investment sources for capital. Some lenders require more than just good word and interest payments. That's where security agreements come into play. These are important documents drafted between both parties at the time the loan is advanced.

Security agreements often contain covenants that outline provisions for the advancement of funds, a repayment schedule, or insurance requirements. The borrower may also allow the lender to hold the collateral for the loan until repayment. Security agreements may also pertain to intangible property such as patents or receivables.

A secured promissory note may include a security agreement as part of its terms. If a security agreement lists a business property as collateral, the lender might file a UCC-1 statement to serve as a lien on the property.

A security agreement mitigates the default risk faced by the lender.

The existence of a security agreement and a possible lien on that collateral could affect the borrower’s ability to obtain more financing from other lenders. The property used to serve as collateral will be tied up with the terms of the first lender, which would mean that securing another loan against the same piece of property would lead to cross-collateralization.

Special Considerations

Many lenders are reluctant to engage in arrangements that would put into question their ability to receive appropriate compensation if the borrower lapses into default. Business owners who seek financing from multiple sources can find themselves in challenging positions if borrowers require security agreements on their assets. Small businesses, in particular, may have few pieces of property or assets that can be used as collateral to secure loans.

The borrower may have limited options to provide collateral that would satisfy lenders. Even if a security agreement only grants a partial security interest in the property, lenders may be reluctant to offer financing against that property. The possibility would remain for cross-collateralization, which would force the property to be liquidated in order to attempt to unlock its value and provide compensation to the lenders.

Property that may be listed as collateral under a security agreement includes product inventory, furnishings, equipment used by a business, fixtures, and real estate owned by the business. The borrower is responsible for maintaining the collateral in good working condition in the event that there is a default. The property that is listed as collateral must not be removed from the premises unless the property is needed in the regular course of doing business.