• Chattel paper is a legal instrument that simultaneously represents a monetary obligation and establishes a security interest or lease agreement over personal property, called “chattel.”
• The Uniform Commercial Code (UCC) defines chattel paper as “a record or records that evidence both a monetary obligation and a security interest in or a lease of specific goods.”
• Chattel paper provides lenders with a tangible form of collateral to secure their loans.
• Chattel paper is also relevant for the financing of mobile homes and manufactured housing, the procurement of specialized equipment, and the management of leasing arrangements.
• In the case of multiple security interests on the same asset, the first party to perfect theirs in the chattel paper will have priority over the others.

Chattel paper is a legal instrument that serves a dual purpose. It simultaneously represents a monetary obligation, such as a loan or a lease, and establishes a security interest or lease agreement over specific movable personal property, or “chattel.”

In this context, chattel can include equipment, vehicles, machinery, or other tangible assets not considered real estate.

The significance of chattel paper lies in its ability to provide lenders with a tangible form of collateral to secure their loans. By documenting the debtor’s obligation and the lender’s security interest in the underlying asset, chattel paper offers a clear and enforceable framework for the transaction. This, in turn, helps mitigate the risks associated with lending and can facilitate borrowers’ access to financing.

The Uniform Commercial Code (UCC) Definition of Chattel Paper

The Uniform Commercial Code (UCC), a comprehensive set of laws that all 50 U.S. states and the District of Columbia have ratified, largely establishes the legal framework governing chattel paper. The UCC standardizes the treatment of commercial transactions, including the handling of chattel paper, particularly Article 9.

Specifically, the UCC defines chattel paper as “a record or records that evidence both a monetary obligation and a security interest in or a lease of specific goods.” This definition establishes the key elements that must be present for a document to be considered chattel paper, ensuring consistency and clarity across different states and transactions.

The UCC also outlines the specific requirements for the proper perfection and priority of security interests in chattel paper, as well as the rules governing the transfer and negotiation of these documents.

Chattel paper typically consists of two key components:

• The Monetary Obligation: This section of the chattel paper document outlines the details of the loan, lease, or other financial arrangement, including the principal amount, interest rate, repayment schedule, and other relevant terms.
• The Security Interest or Lease: The second component of chattel paper establishes the lender’s or lessor’s security interest in the underlying personal property asset. This section describes the chattel, the terms of the security agreement or lease, and the rights and obligations of the parties involved.

The combination of these two elements—the monetary obligation and the security interest or lease—streamlines the process of securing and enforcing loans or leases, providing benefits to both the borrower and the lender.

One of the primary functions of chattel paper is to serve as collateral for commercial loans. When a borrower seeks financing, the lender may require the borrower to provide some form of security or collateral to mitigate the risk of default. Chattel paper allows the lender to hold a lien or security interest in the specific personal property assets being financed, such as equipment, vehicles, or machinery.

In the event of a default, the lender can seize the collateral outlined in the chattel paper and sell it to recoup the outstanding debt.

Transferring and Perfecting Chattel Paper

Chattel paper can also be transferred to other parties through a process known as “assignment.” This is particularly relevant in secondary markets, where debts are bought and sold. When chattel paper is transferred, the new holder of the document acquires the rights to enforce the underlying obligation, including the ability to seize the collateral in case of default.

To ensure the enforceability and priority of their security interest, lenders and holders of chattel paper must “perfect” their interest. Perfection refers to making a security interest in the collateral enforceable against third parties, such as other creditors or subsequent purchasers. This is typically achieved by filing a financing statement with the appropriate state or local government agency, such as the Secretary of State’s office.

The perfection of chattel paper is paramount when dealing with multiple security interests in the same asset. By properly perfecting their interest, lenders can establish their priority over other claimants, ensuring that their rights to the collateral are recognized and protected in the event of a dispute or bankruptcy.

While chattel paper is primarily associated with personal property transactions, it can also be relevant to real estate investors in several ways:

Mobile Homes and Manufactured Housing

Chattel paper is important in the financing of mobile homes and manufactured housing. These types of properties are often considered personal property rather than real property, and the use of chattel paper allows lenders to secure their interests in the underlying assets.

Equipment Financing

Many real estate investors require specialized equipment, such as construction machinery, landscaping tools, or office furnishings, to support their operations. Properly structuring chattel paper can help protect the investor’s interests and ensure credit availability when financing these personal property assets.

Leasing Arrangements

Real estate investors may also encounter chattel paper in leasing arrangements, where the lease agreement is combined with a security interest in the leased equipment or personal property. This can be particularly relevant for investors who engage in commercial or industrial property management, where leasing specialized equipment or machinery is common.

In the context of real estate and finance, chattel paper may share a description similar to the following:

Deed of Trust vs. Chattel Paper

A deed of trust is a legal instrument used in real estate transactions that conveys an interest in a property to a trustee as security for a loan. Unlike chattel paper, a deed of trust is specifically associated with real estate assets.

Mortgage vs. Chattel Paper

Like a deed of trust, a mortgage is a security instrument that pledges a property as collateral for a loan. Mortgages are also distinct from chattel paper, as they deal exclusively with real estate rather than personal property.

RELATED: Mortgage vs. Land Contract vs. Deed of Trust: What’s Right for You?

Security Interest vs. Chattel Paper

This can be defined as a legal claim or lien on an asset that secures a debt or obligation. Chattel paper establishes a security interest in the underlying personal property, while mortgages and deeds of trust create security interests in real estate.

Security Agreement vs. Chattel Paper

A security agreement is a standalone document that outlines the terms and conditions under which a borrower grants a lender a security interest in specific collateral, such as equipment, inventory, or other assets. In contrast, chattel paper combines the security agreement with evidence of a monetary obligation, such as a loan or a lease.

Bill of Sale vs. Chattel Paper

A bill of sale is a simple document that records the sale of an asset, such as a vehicle or equipment, from one party to another. It establishes the ownership and transfer of the asset but does not include any information about financing or security interests.

Promissory Note vs. Chattel Paper

While both chattel paper and a promissory note involve a monetary obligation, they serve different functions and have distinct legal characteristics. A promissory note is a standalone document that simply evidences a debt, such as a loan or a personal IOU, without any associated security interest or collateral.

What happens if there are multiple security interests on the same chattel paper?

In situations where there are multiple parties claiming a security interest in the same chattel paper, the priority of those interests is determined by the order in which they were perfected. Perfection is the process of making a security interest enforceable against third parties, typically through the filing of a financing statement.

The party that first perfects their security interest in the chattel paper will generally have priority over any subsequent claimants. This is known as the “first-to-file” rule, and it helps to establish clear ownership rights and enforce the lender’s or lessor’s claim on the collateral.

In the event of a dispute or bankruptcy, the party with the first-perfected security interest will have the strongest legal standing to claim the underlying assets described in the chattel paper.

Can chattel paper be used to finance consumer purchases?

Yes, chattel paper can be used to finance consumer purchases of personal property, such as vehicles or household appliances. In these situations, the chattel paper would document the consumer’s obligation to repay the loan or lease, as well as the lender’s security interest in the purchased item.

Using chattel paper in consumer transactions is subject to additional regulations and consumer protection laws, such as the Truth in Lending Act and the Uniform Consumer Credit Code. Lenders must ensure that their chattel paper documentation and practices comply with these requirements to avoid potential legal issues or disputes.

How does the transfer of chattel paper affect the rights and obligations of the parties involved?

When chattel paper is transferred or assigned to a new holder, the new holder of the chattel paper acquires the same rights and remedies as the original lender or lessor. This includes enforcing the security interest and seizing the collateral in the event of a default.

However, the transfer of chattel paper also triggers certain responsibilities for the new holder. They must ensure that the security interest is properly perfected, and they may need to take additional steps to notify the debtor or any other parties with an interest in the collateral. Failure to properly manage the transfer of chattel paper can lead to legal complications and the potential loss of the secured party’s priority or enforcement rights.