First Principles of Business Law

5. Using property as a security

5.1. Enforcing performance of an obligation

If two persons enter into a contract, and one of them fails to carry out their promises, the non-defaulting party can bring an action in contract to enforce the legal obligations owed. For example, if a debtor owes money to a creditor and fails to pay, the creditor can sue the debtor for payment or damages. However, bringing a legal action to enforce a contractual right is a slow, expensive, and sometimes uncertain process. And it may happen that, by the time a judgment is obtained, the defendant no longer has sufficient assets to pay what they owe. These are major problems.

One way for a creditor to minimise these difficulties is to obtain property rights in the debtor's assets at the time of giving credit. If the debtor fails to perform their contractual obligations, the creditor can then rely on the property rights to guarantee what is due. The creditor can enforce their security right in the debtor's property rather than having to bring an action based on the contract.

How this is done depends on what type of property is available to a debtor to use as security, and what property rights it is agreed that the creditor should have.