Collateral Account Agreement

What Is a Collateral Account Agreement?

A Collateral Account Agreement or Cash Collateral Account Agreement is executed by the borrower as security against the loan undertaken by him. This is a legal arrangement where in the debtor is required to provide collateral so that the lender is assured that he can recover the sums due to him/her in a loan transaction if the borrower defaults any payments.

When Do You Need a Collateral Account Agreement?

This greement is required to secure a loan transaction. The agreement acts as a safeguard against the borrower’s default and aids the lender to recover his dues by using the cash deposited in the collateral account in case the borrower is unable to pay the debts.

The collateral account control agreement generally has three parties to it, i.e. the Secured Party or the Lender, the Pledgor or the Borrower and the Security Intermediary with whom the collateral is deposited.

What Should Be Included in a Collateral Account Agreement?

The agreement should be drafted clearly and concisely. While the contents of the agreement may vary, a standard collateral account agreement template should typically include the following:

Name/Registered Name of the Pledgor, Secured Party and Security Intermediary
Details of Collateral Account
Clause stating that the intermediary does not have any lien on the collateral
Establishment and Maintenance of Collateral Accounts
Terms of use of Collateral Account by Pledgor and Secured Party
Investment of Collateral
Representations and Warranties of Pledgor
Covenants of Pledgor including his rights and responsibilities
Duties of Security Intermediary
Governing Law, and jurisdiction for disputes
Termination of the agreement including penalties and rules for arbitration
Miscellaneous Provisions, if any

How to Draft a Collateral Account Agreement?

It is important to draft the agreement clearly. The agreement should include simple language and state the responsibilities/rights of the Pledgor, Secured Party and the Security Intermediary without the use of unnecessary jargon. It should precisely indicate the purpose of the agreement, and when the remedies under it can be evoked.

It is important to note that the agreement is only a security mechanism in a loan transaction and does not automatically allow the lender to claim rights on the collateral account.

It is advisable to hire the services of a seasoned attorney while drafting and negotiating an agreement if required. So, some things to keep in mind when drafting this agreement are

The nature of the liability that the buyer has towards the lender
The circumstances in which the lender has the right over the collateral
The circumstances in which the lender forfeits his right to receivables over the collateral
The rights of the security intermediary towards any maintenance cost, and how he shall be reimbursed
Investment portfolios for the collateral cash, and the intermediary who will oversee such investment
Circumstances that constitute performance of the contract and circumstances that constitute non-performance of the contract.

Benefits of a Collateral Account Agreement – Pros and Cons

Some of the advantages of this agreement are:

The lender’s sums and dues are assured in case the buyer defaults
The agreement is legal protection so that both parties do not renege on their performance obligations
It identifies the exact security required for the loan and marks that so that disputes don’t arise later about the actual value of the cash after investment or some use
It provides a guarantee to the debtor that his funds won’t be blocked even after paying his dues
The debtor doesn’t lose control of his funds unless he doesn’t pay the debts
This agreement helps in expediting the loans or money lending transactions.

Key Terms/ Clauses of a Collateral Account Agreement

While the terms of an agreement may vary, it should contain the following information:

The type of collateral account and conditions for its establishment and use
The duties of the security intermediary
Representation and warranties by the debtor
Indemnification
Termination
Obligations of the parties
Miscellaneous provisions such as the appointment of administrative agent, release provisions, etc.

This agreement is a legal agreement wherein the debtor establishes a cash collateral account as security in a loan transaction. A well-drafted agreement enables a debtor to secure faster loans and facilitates faster recovery of dues for the lender borrower’s defaults in repaying the sum borrowed.

[ Also Read: Collateral Security Agreement]