Editor’s note: this blog post was recently published in Law360.
The Advantages of Security
Security has many advantages for creditors. Four important advantages are listed below, followed by a discussion of the results of a recent empirical study showing that creditors recognize the benefits of obtaining security from their borrowers.
Advantage 1: A Secured Creditor Will Rarely Walk Away Empty-Handed
When a debtor files a bankruptcy petition, there is often not enough money to go around. Equity holders may be completely wiped out, receiving zero cents on the dollar. Unsecured creditors are slightly better-positioned, occasionally receiving a dividend, but this dividend is often less—sometimes much less—than 100 cents on the dollar.
However, secured creditors, while never thrilled to learn about a borrower’s bankruptcy, can at least take solace in the fact that they will retain their interest in their collateral. This interest may be subject to a trustee’s surcharge, discussed below, but even after this surcharge, the security interest will often have value.
Further, secured creditors are protected against a decline in value of their collateral. This protection, known as “adequate protection” under the Bankruptcy Code, most frequently comes in the form of cash payments or in the form of additional or replacement liens. 11 U.S.C. § 361.