Risk of Loss and its Application to Secured Transactions

Many of us have heard the expression “possession is nine-tenths of the law.” It is not a myth and does form the basis for many areas of the law. Both consumers and businesses should understand a bit about the term “risk of loss.” Those in the business world that ship products regularly deal with the issue of risk of loss on a daily basis.

With products moving from manufacturer to shipper to seller to consumer, a possibility for the loss of those items is always on the horizon. Businesses that regularly finance transactions for the purchase of equipment and inventory also should understand “risk of loss.” For consumers, “risk of loss” arises with the purchase of a new car, among other examples.

The focus today is on secured transactions. Secured transactions, in their simplest terms, are those in which one party provides the funds for the purchase of an item and retains an interest in that item until the purchaser has paid in full. For instance, a contractor purchases an excavator for which the equipment seller provides the financing.

The equipment seller retains a security interest, or lien, on the equipment while the seller makes payments.

The first question in determining who bears the risk of loss should something happen to that equipment is who has possession? Generally speaking, whomever has possession bears the risk of loss if a tragedy should befall the equipment. “Risk of loss” in its general form is the party that pays for or covers the value of the loss. Simple, right?

Like many general propositions in the law, there are always exceptions. The parties are free to override those generalities with written contracts. If the parties state in a written contract that risk of loss passes from one party to another at a certain time or upon a certain condition, despite possession, the written terms of the contract will govern.

However, let’s return to possession as the basis for risk of loss and provide an example that may not, at first blush, seem so obvious. In our example, an equipment seller sells equipment to a subcontractor on an installment contract. The equipment seller retains a security interest in the equipment and confirms that by filing a UCC-1 financing statement with the North Carolina Secretary of State.

At some point later in time, our subcontractor defaults on payments and demands that the seller repossess the equipment. It would seem that subcontractor, due to the circumstances has given up ownership of the equipment, yet the subcontractor still remains in possession as the seller has not yet repossessed the equipment. The equipment is later stolen from the subcontractor.

Whose insurance covers the loss? The answer is the subcontractor. Despite the subcontractor’s default and demand for the seller to repossess, the equipment was still in possession of the subcontractor at the time of the theft. The seller is not required to pick up the equipment on demand of the subcontractor. Thus, simply walking away from the equipment because of a default is not a good option for the subcontractor. The equipment should be safeguarded until it is repossessed by the seller.

As most commercial transactions are governed by written contracts, it is best to review those terms for an understanding of the risk of loss in the transaction. Absent coverage in the contract, the Uniform Commercial Code steps in to fill the gap with possession.

The foregoing is written for educational purposes only and should not be relied upon as legal advice. It should not be utilized as a substitute for the professional services of an attorney.  If legal advice is required, the services of a professional should be sought.  Please contact Kurtz Law, PLLC for assistance with legal matters.