Bankruptcy and the Secured Creditor Advantage

Bankruptcies rose 32% nationwide in 2009, leaving no doubt that the embers of the recession are still burning and small businesses are at risk from unpaid bills. In fact, it can be argued that the collective financial health of its customers forms the basis by which a small business is protected or made vulnerable to financial disaster.

Generally, assets sold on a line of credit become collateral for the creditor. In other words, if a mechanic goes bankrupt, the tire supplier is entitled to unpaid tire setup on the shelves. However, what happens if the goods in question are lost in a manufacturing process or otherwise become unrecoverable? When a mom-and-pop operation goes bankrupt, how do their suppliers, often small businesses, also avoid getting lost in the landslide?

Being a secured party creditor of high-risk clients offers peace of mind. A secured party creditor offers credit in exchange for a lien on personal property. Personal property, in this sense, means any property other than real estate, generally property belonging to the business. The bond does not have to be on the goods that the creditor sold to the debtor, which makes this arrangement particularly advantageous for the supplier of raw materials.

In bankruptcy, secured party creditors have certain advantages over providers whose loans are unsecured. In any bankruptcy proceeding, beneficiaries have a period of time to file a proof of claim. This proof of claim sets out the details of the debt in writing. If this claim is executed incorrectly, it could make you vulnerable to termination. Worse yet, if this proof of claim is not filed within the time frame set by the bankruptcy court, the creditor is likely to lose any chance of recovering the funds from the bankruptcy. Secured creditors who have properly filed the UCC-1 form of the Uniform Commercial Code do not have to file a proof of claim. The pre-bankruptcy lien is enough to have a claim in the short proceeding.

Protecting the proof of claim process isn’t the only reason being a secured creditor is a good idea. In bankruptcy proceedings, there is only a finite amount of funds available for distribution. Secured creditors take precedence over unsecured loans. The Uniform Commercial Code UCC-1 form, once filed, will give the creditor “priority status” over unsecured loans. In fact, being the first secured creditor on file for a personal property will offer protection against subsequent bond filings.

Bankruptcy makes creditors vulnerable to the same fate. However, entrepreneurs who wisely take advantage of the UCC-1 form of the Uniform Commercial Code proactively protect themselves from losses that backfire on delinquent borrowers.