Perfection:Legal Definition and Implications
Beyond securing a loan with an agreement and collateral, the secured party can further more protect themselves in the event of the debtor’s default, by perfecting the collateral. Perfection is a legal process that a secured party can protect themselves from future claims on the same collateral, made by a third party. Perfection is accomplished by filing a financial statement with local or state officials. For the financial statement to be effective it must contain several features. The signature of the debtor, as well as the address of the creditor and the debtor. Furthermore, the financial statement must also have a complete description of the collateral by item or type.
Once the financial statement is filed with the proper authorities, the statement will be effective for five years. If the loan should surpass this time period, a continuation statement can be filed six months before the time is up, to prolong the collateral’s perfection for another five years.
If a debtor uses collateral for one loan and then later uses the same collateral again for another loan, unless perfection is established, both parties may have a claim to the same collateral, as long as the second or third party did not know about the collateral attachment to the first. However, is perfection is established and not expired, the second and third party will have only secondary rights to the collateral. Meaning, only when the first parties is satisfied, will any proceeds from the collateral be made available to any secondary parties.