Startegy and Force in the Liquidation of Secured Debt

The question of why parties use secured debt is one of the most fundamental questions in commercial finance. The commonplace answer focuses on force: A grant of collateral to a lender enhances the lender’s ability to collect its debt by enhancing the lender’s ability to take possession of the collateral by force and sell it to satisfy the debt. That perspective draws considerable support from the design of the major legal institutions that support secured debt: Article 9 of the Uniform Commercial Code and the less uniform state laws regarding real estate mortgages. Both of those institutions are designed solely to support the liquidation process. Each has four major elements: statutory rules describing the actions a borrower and lender must take to create a lien or security interest in a particular asset, statutory and contractual rules describing the occurrences that entitle the lender to take possession of the collateral, statutory and contractual regulations of the mechanics by which the lender can sell the collateral, and statutory rules allocating priority among various claimants to the asset or its proceeds.1 All of those rules reflect an implicit assumption that the central focus of the transaction is the ability of the lender to liquidate the collateral. Legal and contractual institutions foster that ability both by enhancing the practicability of reliable and cost-effective liquidation and by tempering the potential for inequities in the process of liquidation.