Security is a relationship between collateral and monetary obligations. The essence of the relationship is that if the obligations are not paid, the collateral may be sold and the sale proceeds applied to pay the obligations. The security concept is embodied in mortgages, security interests, and liens.
Security enjoys a highly privileged position in American law. A simple-sentence grant of a security interest, (1) combined with the filing of notice in an obscure set of public records, will give the secured creditor's claim priority over employees' wage claims, (2) child support obligations, (3) tax claims, (4) civil damage judgments, (5) criminal fines and forfeitures, (6) claims for unjust enrichment, (7) and just about any other kind of debt imaginable. (8)
Scholars have attempted to justify security on both contract and property theories. On the American side, Dean David Leebron best articulated the contract argument:
The priority claim of a secured creditor rests almost entirely on
principles of contract and notice. A persuasive theory of secured
credit financing has been elusive, but the priority of a secured
creditor over other financial creditors can be justified on the
grounds that non-secured creditors grant a loan knowing that some
assets are subject to security interests or could be subjected to
security interests without their permission. If particular
creditors will not tolerate other creditors having security
interests in the borrower's assets, they can refuse to make a loan
or make it only if the borrower agrees not to subject its assets to
any security interests. (9)
Contract cannot, however, justify security because security agreements "[are] effective according to [their] terms ... against purchasers of the collateral, and against creditors." (10) That includes purchasers and creditors who did not consent to the security agreement, had no way of knowing of its existence, or never chose to become creditors at all. (11) Agreement is the essence of contract, but the affected purchasers and creditors have not agreed. As Professors Lynn LoPucki and Elizabeth Warren put it, "[s]ecurity is an agreement between A and B that C take nothing." (12)
Other scholars attempt to justify security on property theories. For example, Professors Stephen Harris and Charles Mooney argued:
It seems clear enough that security interests, under Article 9 and
real estate law alike, are interests in property. The legal regime
for security interests reflects property law functionally as well
as doctrinally. We believe it follows that the law should honor the
transfer or retention of security interests on the same normative
grounds on which it respects the alienation of property generally.
The property theory begins from the generally accepted premise that a building owner can, by conveying the building in an otherwise unobjectionable transaction, cut off the rights of the debtor's creditors to the building. By analogy, the property theory holds that by conveying the first $100,000 of the value of the building in return for a $100,000 loan, the owner should be able to cut off the rights of the debtor's other creditors to the first $100,000 of the value of the building. Frequent American literature references to security interests as "property" (14) and English literature references to charges as "proprietary" (15) are invocations of this theory.
A necessary implication of the property conveyance theory is that encumbered property has multiple owners. The secured creditor owns the value of the collateral up to the full amount of the debt. The debtor owns the value of the collateral in excess of the amount of the debt, the right to redeem the property by paying the debt, (16) and the right to use the property in the interim.
The principal policy objections to security are that it is deceptive (17) (the "Deception Problem") and that it distorts incentives for the management of property (the "Incentives Problem"). …