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Secured Transactions ? the Basics

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Silicon Valley is the home to a number of overnight millionaires and billionaires overflowing in wealth and good fortune. From luxury automobiles to personal planes, these high-tech luminaries radiate an aura of confidence, wealth and success. Accordingly, it may be surprising to discover that the region's other big business during this high-flying era is bankruptcies.

From 1988 to 1998, the Northern District of California witnessed a boom in bankruptcy filings.

Year Total Business Consumer
1988 19,329 2,402 16,927
1998 34,082 1,567 32,665

Obviously, not all or even most of these bankruptcy filings are attributable to failed high-tech ventures or other businesses. However, some lessons can still be drawn from these numbers.

First, just because everyone else appears to be succeeding, it is still possible for your company to fail even if it is the best planned enterprise. For example, a number of unpredictable events can deal your company a fatal blow. An earthquake could disrupt your contractor's manufacturing plant in Asia, delaying the launch of your sole product for weeks or even months. Alternatively, a customer or retailer clutching on to a large portion of your inventory could suddenly file for bankruptcy, tying up your precious goods in lengthy court proceedings.

If your company is well capitalized, these problems may be mere hiccups. However, if your company is starved for revenue and its livelihood is tied to an immediate product launch, the phones ringing off the hook may be the sounding of the modern death knell. What can you do if your company cannot pay its bills on time? What are the pitfalls of negotiating with creditors, borrowing additional money or filing for bankruptcy protection?

Loans

Generally, a company has two methods for raising working capital. It can sell equity in the company to angel or venture capital investors. Alternatively, it can borrow needed funds from a bank, savings and loan, or even friends and family members.

If a company decides to borrow money, it faces several loan options:

Term or Revolving Loan

The nature of a company's expenses will dictate whether a term or revolving loan is more appropriate. A car loan is an example of a term loan. There, the loan amount and duration are fixed. The borrower must repay the loan amount and interest according to a preset payment schedule.

In contrast, a revolving loan has no set amount, duration, or fixed payment schedule. A credit card is an example of a revolving loan. Such a loan offers the borrower an open amount up to a preset credit limit. Furthermore, so long as the credit line remains open, the borrower can withdraw additional funds or repay the loan at his discretion within the terms of the loan agreement.

Secured or Unsecured Loan

A loan may be unsecured or secured by collateral. This factor will largely dictate the remedies open to the lender if the borrower defaults. If the loan is unsecured, the lender's sole remedy is to sue the borrower for the amount owed. Like other general creditors, the lender can assert no special claim to the borrower's particular assets. A credit card is an example of an unsecured loan.

In contrast, a secured loan is backed by a particular piece of the borrower's property. If the borrower defaults on a secured loan, the lender holds the additional option of foreclosing on the collateral. The lender may then sell the foreclosed property to repay the debt or keep it in satisfaction of the debt. If the value of the collateral is less than the outstanding debt, some states allow the lender to sue for the outstanding amount. A home loan is an example of a secured loan.

An unsecured loan will carry a higher interest rate than a secured loan because the unsecured loan places the lender at a greater risk in the event of a default. A company seeking an unsecured loan may also have to possess a credit history that indicates that the company has the means to repay the loan.

Uniform Commercial Code (UCC) - Secured Transactions

Article 9 of the Uniform Commercial Code governs secured transactions; i.e., those transactions which create a security interest in personal property or fixtures including goods, documents, instruments, general intangibles, chattel paper or accounts. Because some states have enacted modified versions of the Uniform Commercial Code, a prudent individual should refer to their state statute instead of the general text. In California, the Article 9 provisions are found at California Commercial Code § 9101 et seq.

General Provisions

A Security Agreement is an agreement between a debtor and a secured party which creates or provides for a security interest. UCC § 9-105(1)(l). The Debtor is the person who owes payment or other performance of the obligation secured, whether or not he owns or has rights in the collateral. UCC § 9-105(1)(d). The Secured Party is the lender, seller or other person in whose favor there is a security interest. UCC § 9-105(1)(m).

Example 1 - Security Agreement
Security Agreement

This Security Agreement ("Agreement") is made as of June 11, 1998, by XOOM,Inc. ("Debtor") in favor of Revolutionary Software, Inc., a California corporation ("Secured Party").

Recitals:

(1) Secured Party and Debtor have entered into that certain Asset PurchaseAgreement as of this date (the "Asset Purchase Agreement"), pursuant to whichSecured Party transferred to Debtor Sitemail Application Software and allrelated intellectual property.

(2) Debtor has executed that certain promissory note as of this datepayable to Secured Party (the "Note"), which evidences Debtor's obligation topay Secured Party the balance of the purchase price of the Collateral (asdefined in Section 1) and interest thereon. To secure such payment, SecuredParty has required Debtor to grant a security interest in the Collateralpursuant to the terms and conditions of this Security Agreement.

Grant of Security Interest

For a security interest to be enforceable against the debtor or third party with respect to the collateral, (a) the collateral must be in the possession of the secured party pursuant to agreement, or the debtor must sign a security agreement which covers the description of the collateral, (b) value must have been given, and (c) the debtor must have rights in the collateral. UCC § 9-203(1)(a)-(c).

Example 2 - Granting Clause
2. Grant. Debtor hereby grants to Secured Party a security interest in the Collateral to secure the timely payment and performance of the Obligations.




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