Never, Ever, Give a Loan Without Properly Securing It

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.)