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Security Agreement

This Agreement is entered by and between Jonas Adam, individually or collectively as the "Signee" and Jane Smith, as the "Signer", together referred to as the "Parties".
The Contract is dated [the date both parties sign].

1. Agreement terms

The Parties agree that the following agreement is dependent on the terms presented as follow:

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Security Agreement

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Are you thinking of starting a business? If so, you likely need to secure a line of credit. In order to obtain reasonable interest rates or participation from major financial institutions, you will be asked to put forward collateral. The security interest that your lender has in your collateral property is outlined in a legal form known as a security agreement. In this article, we will outline some of the key terms of the most common security agreements.


What is a security agreement?

Security agreements are foundational in the world of business, as they enable transactions between lenders and borrowers that may not otherwise be possible. A security agreement is a basic contract between a lender and a debtor. It describes the rights of both parties regarding the collateral put forward by the debtor.

If the debtor ends up defaulting on the loan, the lender can take ownership of the collateral. This possibility is the lender’s security interest in the specified property. A security interest is a legal claim and part of many security agreements. It helps to reduce the risk for the lender, which makes them more likely to provide favorable terms to the borrower.

Secured loans, such as those to purchase cars and homes, often make use of security interests. An unsecured loan is one where the lender does not assert a claim over your personal property because it was not offered as collateral.

For a security interest to be authorized, the lender needs to accept the property provided as capital. Some examples of appropriate collateral are business inventory, farming products like livestock, equipment, real estate, fixtures, and insurance policy accounts.


A security agreement can be a relatively simple document. (Source)

Why use security agreements?

The main reason to develop a security agreement is to help businesses and individuals obtain loans, and to protect lenders from losing their investments. Unless you are able to self-fund your own enterprise, you will need to turn to a bank for credit. And in today’s financial world, banks and other high-level lenders need more than a verbal agreement to provide large sums of money.

Security agreements can be a good way to outline and describe details of the loan as well, such as a repayment schedule and where the collateral resides until completion of the loan. During the loan period, the collateral will not be available for use with another lender, thus potentially limiting a borrower’s ability to source additional financing.


How to write a security agreement

A security agreement does not have to be complex or complicated to be effective. However, it does need to contain a few key elements to be valid. A security agreement should contain a detailed description of the collateral, signatures from all parties (including the borrower and the lender), and information about the security interest intention. Compared to those content sections, the other aspects of a security agreement are more relaxed.

These are the required components of an enforceable security agreement. If these elements are not accurately provided, it could impact the lender’s ability to take ownership of the collateral in case of default. Importantly, there may be additional elements that should be included in the security agreement, even if they aren’t required for the document to be legal. Such information should be balanced in such a way that it is not too restrictive for either party.

Additional information that a creditor may wish to include in a security agreement is any rule that pertains to the collateral and how it may or may not be used during the loan period. The creditor can require that the property be kept in a certain place, be insured, and so on.

Once drafted, the security agreement should be ‘attached’. To do this, it needs to be ‘perfected.’ In terms of a security agreement, perfect means that a lender can obtain the borrower’s collateral even if the borrower ends up declaring bankruptcy. Perfecting a security interest is the best way to ensure that the creditors feel as comfortable as possible with their transactions. The security agreement should also be authorized by a notary public.

There are a few standard ways to perfect a security interest/agreement. They include:


Filing Financing Statements

A financing statement is different than a security agreement. It is used to give notice that the lender has a security interest in the borrower. It can be used for communication purposes but does not take the place of the full security agreement. States have different requirements for filing financing statements. But generally speaking, a financing statement needs to clearly define the collateral and be signed by all parties. You can file a financing statement before you file the security interest as a way to increase the speed at which the security agreement is perfected.

Control or Possession

Another way to ensure that a lender has access to the collateral in the event of a borrower bankruptcy is ‘control.’ Control helps a security agreement achieve perfection by allowing the lender to actually take over the collateral. If it is a piece of property, the borrower gives the property to the lender through any required legal channels. Possession is a similar approach, wherein the lender takes possession of the collateral. This can only apply to tangible items and is not a common approach.


Challenges

For new or small businesses, it may be difficult to provide enough collateral to satisfy a lender. Many start-ups seek financing from multiple sources, whether it's through debt, equity, or some other unique situation like a joint venture. If all sources require full security interest on collateral as part of a security agreement, there is a serious risk of cross-collateralization. In the event that a borrower defaults and there are multiple claims on a property, it will likely need to be liquidated in order to satisfy loan terms.

Lenders may also run into difficulty when trying to establish ‘priority’ on a security interest. If a borrower is using the same collateral for multiple funding sources, a creditor will wish to establish a priority interest. That way, they are assured compensation in the event of bankruptcy by the borrower. If they are not granted proper perfection and another creditor has, the unperfected creditor may be considered ‘unsecured.’ This is typically a first-come-first-served process, with priority status being granted to the first secured party to file.


Loans in default

Loans are usually considered in default when the borrower fails to make all loan payments on the agreed-upon schedule. Of course, the creditor may add more conditions to the agreement based on their specific needs or concerns. Some of those conditions that could put the loan in default include:

  • the collateral is no longer available
  • the borrower does not abide by other clauses of the agreement
  • the borrower misrepresented the collateral


Lenders should protect themselves against borrower bankruptcy. (Source)


When a loan is in default, a creditor has a few options for recovering losses.

The most common solution is called ‘collection.’ When a collection is taking place, the creditor offers the borrow notice of the impending collection. They are then able to collect the assets per the terms of their security interest and security agreement. This is simplest with liquid assets.

Repossession is a similar approach, but it may only be a temporary solution. With repossession, the borrower who has defaulted does have to option to regain control of their asset if they repay the loan amount. It can provide creditors with a powerful tool of persuasion, but it may also result in costly or cumbersome maintenance duties depending on the condition of the property.

The final option for recovering losses is ‘disposition.’ Disposition is simply the sale of the collateral property. If the collateral is a car, for example, the creditor may take possession and sell the car at auction to recoup their losses.

Defaulting on a loan is a serious risk. Both lenders and borrowers should put a great deal of thought and consideration into the terms of their agreements to ensure that they are willing and able to take on the responsibilities involvement. Parties can also an agreement to a settlement and release, where some portion is paid back and both parties agree to forgo any further challenges to one another.