Few buyers have sufficient resources to pay cash for a business. Rarely does a seller feel completely comfortable with only the buyer’s bare promise to pay for a business after the closing. The seller usually wants something else, some additional assurances, from the buyer. The seller of the business wants to be in a secured position if the buyer does not fully pay for the business at closing. A secured transaction is as basic to business transactions as the seller’s extending credit to the buyer.
To lessen the seller’s risk of loss if the buyer does not make payments under the promissory note, the seller should require that the buyer provide some additional security or collateral for payments, that is to afford the seller with the opportunity to take possession of certain assets and sell or otherwise dispose of them as a means of paying the seller when the buyer cannot. The seller must negotiate a favored position if the buyer cannot make payments or becomes bankrupt.
The buyer can usually offer collateral assurances in addition to the buyer’s promise to pay. The buyer should almost always offer the business assets as collateral but may additionally need to offer real estate or other property, such as stocks, bonds, certificates of deposit, insurance proceeds and the like, as sources to pay the seller if the business assets are not likely to have a worth equal to the obligations due under the promissory note. Some buyers may need friends or others to offer some of their property as security collateral for the buyer’s payment.
When the buyer or someone else offers personal property as security for note payments, the secured transaction is governed by Article 9 of the UCC. When the buyer or someone else offers real estate as security for note payments, the transaction customarily includes a mortgage. In either event, the seller must have an enforceable interest, a security interest, in the property given as collateral and should have priority over other creditors’ claims against that property.
Under the UCC, the seller can only become a secured party if the seller’s security interest attaches to the collateral pledged by the buyer, that is that the seller has an enforceable security interest in the collateral, that the parties’ agreement is written, that the seller gave something of value (the business) to the buyer and that the buyer must have rights in the collateral (the right to own the business and its assets). G.L. c. 106 §9-203.
The agreement which creates and provides for the seller’s security interest in the collateral is called a security agreement under the UCC. G.L. c. 106 §9-203. Documentation for an installment sale of a business should include a security agreement which fully describes the collateral already in the buyer’s possession, in which the buyer specifically grants a security interest to the seller, and any other collateral (“proceeds” G.L. c. 106 §9-315; “accessions” G.L. c. 106 §9-335; after-acquired property and inventory) which may later come into the buyer’s possession and in which the seller will also have a security interest. The security agreement should also contain provisions about what happens when the buyer cannot make note payments or when the buyer breaches some other covenant in the transaction, what kind of notices are required from the seller to the buyer, whether the buyer has an opportunity to cure or correct the default and what the seller may elect to do in such events and to the collateral.