Topics:Business Loans 101
More often than not, when someone borrowers money from a lender, the lender needs some kind of insurance that the money will be paid back. A general lien is insurance for a creditor, or lender, in the form of collateral. This lien is a signed agreement between the lender and borrower that gives the lender the legal right to seize the borrower's collateral if a loan is not paid back in full. The collateral is either a physical or financial asset that the borrower pledges to the loaner in case the loan defaults.
Besides promising assets to the lender, a lien also prevents the borrower from selling or transferring pledged assets without first paying off his or her loan. For example, if one pledges their house as collateral, they cannot sell their house without first paying off their loan.
Some assets that small business owners often pledge are:
A general lien also legally allows for the lienholder (lender) to seize assets if the terms of the loan are not met. For example, if a person does not fulfill their payments on their loan on time, the lender legally has the right to seize all promised collateral. Or, another example of default would be borrowing more than agreed upon in the contract.
If a business owner offers specific assets as collateral in a loan agreement, those are the assets that the lien applies to. For example, if I pledge my home equity, that is what the creditor takes if I default. However, if a "blanket" lien is agreed upon, this means that the creditor can take possession of business assets in general. Blanket liens can cause quite a headache if a business owner defaults because of the court process that they will be involved in to determine what business assets the creditor can and cannot seize.
The contract that legalizes a lien is called a "lien letter" or a "letter of set-off". This letter, often given to banks, means that the borrower gives up their rights to their assets if needed. Generally, in the U.S. a lien (and lien letter) only applies to the personal property of a borrower.
In the case of a borrower pledging the same assets to different lenders, a lien insures that the lender stipulating the lien gets first rights to the assets. Once seized by the lender, the assets can be sold or kept according to the preferences of the lender. However, for all of this to take place, the collateral promised by the borrower has to be registered with the public records office.
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