What Is Purchase Money Security Interest?

What does a purchase money security interest do?

A purchase money security interest lets a lender seize property that their loan financed. It also allows them to demand money if the debtor cannot pay back their loan. A purchase money security interest gives the lender the first right to the payment over other lenders. So, if a debtor has a number of creditors asking for repayment, the purchase money security interest gives that particular lender priority.

When a borrower does not pay back their loan, a lender has a few options to get their money back. A debtor may be sent to collections or have a lien enforced. They may also face legal action. Another option is the purchase money security interest, which gives a lender the right to the property their money purchased. Also acceptable is its value in cash.

A purchase money security interest essentially gives a lender collateral on a large purchase. It can also be used when businesses make transactions between one another. A purchase money security interest is only legitimate when it is put in writing and the lender has filed a financing statement. Most states accept the practice as outlined in UCC Article 9, which controls the creation and enforcement of security interests. These regulations make it easier for companies to do business with one another in different states.

The purchase money security interest has given a boost to point-of-sale financing. This is where a seller offers a buyer direct financing when they make big purchases. If the buyer cannot pay back the money, the seller can take back the sold item. A purchase money security interest, with the help of a business dispute attorney, also get priority over other creditors because of the purchase money security interest.

What are the rules for using a purchase money security interest?

The rules that control a purchase money security interest will depend on the kind of collateral that a loan purchased. The general rule is that a purchase money security interest is given to the creditor who submitted a financing statement for the collateral.

Let’s take a look at some of the specific rules for a purchase money security interest:

Inventory collateral

According to Section 9-324(b), the lender must file a financial statement at the time of sale – or when the borrower obtains the inventory. The lender needs to inform other lenders before they do this. They also need to let other lenders know they plan to get a purchase money security interest in the inventory of that borrower.

The financial statement that needs to be filed is a UCC-1. This is the form that indicates the purchased item is collateral. Essentially, this form lets other lenders know that the lender in question has a claim on that collateral. This notice needs to be given no earlier than five years prior to the borrower getting the inventory.

Collateral that is not inventory

When it comes to collateral that is not inventory, the purchase money security interest rules are not as strict. The lender needs to prove that the money they gave to the borrower was used to buy the collateral in question. The financing statement, or UCC-1, needs to be filed no later than twenty days after the borrower receives the item. If the UCC-1 is filed after the twenty-day limit, the lender does not get priority for the purchase money security interest.

How can a seller establish their security interest?

A lender needs to show that the credit they gave to a borrower was used to buy the collateral. To do this, a company can create a series of payments for items that have yet to be made.

Let’s consider an example. Bob wants to buy a fancy bed from a furniture retailer. However, he does not have the money to buy it in one go, so he purchases the bed on credit. The furniture store orders the bed from the manufacturer and sets up a financing agreement. In this example, the furniture store is the party selling the bed, not the company that makes the bed. The furniture store has a security interest in the bed and can get a purchase money security interest.

Now let’s say Bob pays a security deposit for the bed. The furniture store can demand that Bob pay in full for the bed before he gets his deposit back. This sets the monetary amount the lender has the right to if the loan is not paid back. There have been court decisions regarding purchase money security interest that have backed a lender’s right to be reimbursed for things like shipping charges.

How does a lender obtain a purchase money security interest?

To get a purchase money security interest, a lender has to give money to a borrower who then uses it to buy something. The borrower gives the creditor a security interest in return. There are different rules based on the kind of collateral. However, in all cases, the lender needs to file a UCC-1 and notify other lenders.

What does the UCC say about purchase money security interest?

If a lender gets a purchase money security interest under the UCC, the priority rule can be waived. Normally, creditor priority is determined by whoever files a UCC-1 first. However, if a creditor meets the UCC filing requirements, they may jump ahead in line.

Is a purchase money security interest stronger than a blanket lien?

If a purchase money security interest has been perfected, it has priority status over a blanket lien. However, it must meet certain requirements. For instance, the purchase money security interest needs to be filed within twenty days of the borrower receiving the item.

Let’s consider a car loan as an example of a purchase money security interest. Bank A agrees to give Tom a loan to buy a Tesla. Bank A uses a purchase money security interest to make the car collateral. It can do this because the money it gives Tom is being used specifically to buy the car.