Proceeds of collateral: Overview, definition, and example
What are proceeds of collateral?
Proceeds of collateral refer to the money or assets that are generated or derived from the sale, liquidation, or use of collateral pledged in a loan agreement or security interest. Collateral is an asset or property that a borrower offers to a lender to secure a loan or credit. If the borrower fails to repay the loan, the lender can seize the collateral and sell it to recover the debt. The proceeds of collateral are the funds or assets the lender receives from such a sale or liquidation.
For example, if a borrower uses a car as collateral for a loan and defaults on the loan, the lender might sell the car and the proceeds from the sale would be used to pay off the loan balance.
Why are proceeds of collateral important?
Proceeds of collateral are important because they help secure the lender’s interest in the loan agreement. If the borrower defaults, the lender can rely on the proceeds from the collateral to recover the outstanding debt. By including provisions related to the proceeds of collateral in a loan agreement, both parties understand how any sale or liquidation of collateral will be handled and how the proceeds will be applied.
For borrowers, it’s important to understand that the proceeds from collateral may not always fully cover the loan amount, especially if the asset doesn’t sell for its full value. For lenders, it ensures that they have a pathway to recover at least part of their loan in case of default.
Understanding proceeds of collateral through an example
Imagine a small business owner takes out a loan to purchase equipment and offers the equipment as collateral. If the business owner defaults on the loan, the lender can seize the equipment and sell it. The proceeds from the sale of the equipment are then used to pay off the loan. If the equipment is sold for $50,000, and the outstanding loan balance is $45,000, the lender uses the proceeds to satisfy the debt, with the remaining $5,000 potentially returned to the borrower.
In another example, a person uses their home as collateral for a mortgage. If the borrower defaults, the bank may foreclose on the house and sell it. The proceeds from the sale of the house will be used to pay off the mortgage, and any excess proceeds (after the loan is satisfied) will be returned to the homeowner.
An example of a proceeds of collateral clause
Here’s how a clause related to the proceeds of collateral might appear in a loan agreement:
“In the event of default, the Lender shall have the right to sell or liquidate the collateral described in Exhibit A. The proceeds from such sale or liquidation shall first be applied to satisfy the outstanding loan balance, with any remaining proceeds to be returned to the Borrower, subject to the terms outlined in Section 4 of this Agreement.”
Conclusion
Proceeds of collateral are the funds or assets obtained from the sale or liquidation of collateral used to secure a loan. These proceeds are crucial for lenders to recover their losses in case of borrower default. By including clear terms about how the proceeds will be handled, both borrowers and lenders can ensure that they understand their rights and obligations. For lenders, proceeds of collateral represent a safety net for the loan, while for borrowers, it emphasizes the importance of protecting the value of their pledged assets.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.