For some inexplicable reason, we have seen several clients and potential
clients lately that need assistance collecting substantial loans they
have made and the borrower has stopped paying and by "substantial",
we mean huge amounts, from $100,000 to as much as a quarter of a million
dollars. Unfortunately for some of these clients, they failed to properly
secure the loan with some form of collateral before giving it, leaving
them unprotected and at the mercy of the defaulting borrower.
The purpose of securing a loan with collateral is to provide protection
to the lender in the event the borrower stops paying. The collateral can
be anything real or personal property, business inventory or equipment,
intellectual property rights, etc.
Without collateral, the lender's only recourse is to file a lawsuit
and hope to acquire a judgment against the borrower personally. The lender
is then left to frantically search the borrower's assets that have
value or equity (if any exist, and that aren't already securing some
other debt the borrower owes). Essentially, the lender is left looking
for "collateral" after the borrower has already defaulted which
is usually an unsuccessful search.
When the loan is secured (i.e., the collateral is pre-designated), the
lender may still have to file a lawsuit, but it will be to foreclose on
the collateral, which the lender already knows to exist and knows has
sufficient value or equity to cover the loan (because the diligent lender
confirmed this information prior to giving the loan).
Further, if the debtor files for bankruptcy protection at any time, the
unsecured creditor becomes a mere "general creditor" of the
bankrupt individual and will typically receive nothing (or pennies on
the dollar). While a bankruptcy will absolve the debtor of any obligation
to pay the loan, it will not affect a secured creditor's right to
foreclose against the collateral.
So, unless you're in a highly charitable mood, don't give any loan
especially a significant one without finding sufficient collateral and
then properly securing it. (Note: This article applies to straight loans.
If the "borrower" is offering you an ownership interest in a
company or some other business venture in return for your money, then
there are other legal considerations that must be addressed before such
money is given, such as the viability of the venture and compliance with
complicated investment and securities laws.)