Sale of collateral: Overview, definition, and example
What is the sale of collateral?
The sale of collateral occurs when a lender or secured party sells assets that a borrower pledged as security for a loan. This usually happens when the borrower defaults on their loan, allowing the lender to recover the outstanding debt by selling the collateral. The sale can be conducted through auctions, private sales, or other legally permitted methods.
For example, if a borrower takes out a business loan secured by equipment but fails to repay it, the lender may seize and sell the equipment to recover the loan balance.
Why is the sale of collateral important?
The sale of collateral is important because it allows lenders to minimize financial losses when a borrower defaults. By securing a loan with assets, lenders reduce their risk and increase their chances of recovering funds. For borrowers, pledging collateral can make it easier to qualify for loans, but it also means they risk losing valuable assets if they fail to meet repayment terms.
Laws typically regulate how collateral sales must be conducted to ensure fairness and prevent lenders from selling assets at an unfairly low price. Some agreements also allow borrowers to reclaim collateral by paying off the debt before the sale occurs.
Understanding the sale of collateral through an example
Imagine a business takes out a $50,000 loan using company vehicles as collateral. When the business fails to make payments, the lender repossesses the vehicles and sells them at an auction for $40,000. The lender applies the proceeds to the outstanding debt, and depending on the loan terms, the business may still owe the remaining $10,000.
In another example, a homeowner takes out a secured personal loan using jewelry as collateral. If they default, the lender follows legal procedures to sell the jewelry. If the sale price exceeds the remaining loan balance, the borrower may be entitled to the excess funds after costs are deducted.
Example of a sale of collateral clause
Here’s how a sale of collateral clause might appear in a contract:
"In the event of default by the Borrower, the Lender shall have the right to take possession of and sell the Collateral in a commercially reasonable manner. Proceeds from such sale shall be applied to the outstanding debt, with any remaining balance payable by the Borrower or surplus returned to the Borrower, as applicable."
Conclusion
The sale of collateral allows lenders to recover losses when borrowers fail to meet their obligations. While this process helps mitigate risk for lenders, borrowers should carefully assess the risks of pledging assets and ensure they can meet their repayment terms.
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.