A Lender’s Guide to Fraud: Safeguarding Collateral
In asset-backed lending, the strength of the secured lender's position is only as reliable as the collateral securing it and the lender's ability to realize upon that collateral in the event of borrower distress.
Safeguarding the lender's collateral is therefore a critical component of prudent risk management, achieved principally through a variety of carefully negotiated provisions and protections in underlying credit agreement and security documents, and through periodic on-site collateral audits, sometimes called collateral field exams, of the borrower's pledged assets.
The stakes of developing processes for safeguarding collateral can be seen in the bankruptcy courts and recent headlines. Just recently, on Aug. 18, the U.S. Securities and Exchange Commission filed securities fraud claims against the former CEO, chief financial officer and senior director of finance of subprime auto lender Tricolor Holdings LLC.
According to the SEC complaint, Tricolor's fraud included the deliberate double-pledging of auto loan receivables that served as collateral for the funding Tricolor obtained to run its operations, and Tricolor had overstated its collateral by approximately $800 million.
This article, the second in a series examining fraud risks in lending and how to mitigate them, focuses on the protection of lender collateral.
As fraud schemes become more sophisticated, including the altering of documentation and the use of artificial intelligence, lenders' methods and systems for detecting fraud should continually evolve and become increasingly robust in order to safeguard their collateral.
Protections in Credit Documents
Credit- and security-agreement-based protections can vary based on the particular lender-borrower relationship and the specifics of a given situation, including, importantly, the negotiation dynamics between the lender and borrower during negotiations. Credit agreement structure and terms could, no doubt, be the subject of its own article series.
But at a high level, it is fair to note that certain types of provisions should be regularly required by lenders for the purpose of protecting lenders' collateral during the anticipated term of the credit relationship.
For example, regardless of transaction size, lenders should consider requiring credit and security documents:
- To impose upon the borrower regular reporting obligations as to collateral status and for that reporting to be certified as to accuracy by an officer of the borrower;
- To require annual audited financial statements;
- To grant the lender reasonable access to inspect the collateral;
- To maintain insurance and provide proof of insurance to the lender; and
- To prohibit the borrower from engaging in transactions involving the lender's collateral other than as expressly permitted or consented to in writing, in advance, by the lender.
Put differently, credit and security agreements should, and typically do, impose meaningful affirmative and negative covenants upon the borrower with respect to maintaining the lender's collateral — the breach of which generally constitutes a default giving rise to the lender's right (subject to credit agreement terms) to enforce remedies.
That said, while credit- and security-agreement-based protections provide means to influence a borrower's behavior with respect to the lender's collateral during the term of the credit relationship — and by doing so help manage the risk associated with the extension of credit to the borrower — traditional risk assessments and associated underwriting performed at origination cannot substitute for ongoing diligence and audits.
Assessments and underwriting, though obviously critical, cannot substitute for actually laying eyes on the collateral and physically confirming its integrity and safety when dealing with physical collateral.
Underwriting review may be insufficient to detect many forms of fraud involving collateral integrity, particularly fraud involving collateral that does not exist or that has been pledged to multiple creditors.
Collateral Audits
An important, but often underutilized, tool for lenders to safeguard collateral is the collateral audit. While most lenders in asset-backed credits have the right to conduct collateral audits, many choose not to conduct them regularly.
Lenders may choose not to perform collateral audits to avoid the time and expense, because they believe review of audited financials and related documentation is sufficient, or because they do not have the internal resources or expertise to perform them.
That can be a justifiable decision depending on the circumstances of a particular credit, but lenders should be cognizant that not conducting a collateral audit foregoes a valuable tool in discouraging and detecting fraud.
A well-designed collateral audit may prevent or uncover several categories of fraud, including:
- Collateral that does not exist or does not exist in the stated form;
- Collateral given appraised values far in excess of its actual value; and
- Collateral pledged to multiple creditors.
The last category — collateral pledged to multiple creditors — is particularly difficult to detect and typically requires reconciling pledged assets across creditors or credit facilities.
Generally, the difficulty of that task depends on factors such as the nature of the collateral (i.e., tangible or intangible), the extent to which the collateral is specifically and readily identifiable, and the complexity of untangling what may be a sophisticated effort by the borrower to conceal the fraudulent activity giving rise to the pledge of the same item of collateral multiple times to unsuspecting lenders.
A well-designed collateral audit may be necessary to uncover this type of fraud, which often can go undetected if lenders or auditors rely strictly on borrower-supplied documentation.
Lenders should consider oversampling high-risk collateral categories to improve the odds of detection. Collateral categories that may warrant oversampling include goods stored in third-party warehouses; assets evidenced solely by documentation, such as accounts receivable; and assets subject to rapid depreciation, such as specialized machinery.
If a lender lacks the internal resources to conduct collateral audits, or conduct them thoroughly, it should consider engaging a third-party verification agent or valuation agent with expertise in field exams. Third-party verification of collateral is becoming more common and will continue to be an important option for lenders to ensure the integrity of collateral.
Relying on audited financials is not a substitute for collateral field exams, as a borrower's auditors may not perform collateral field exams as part of their audit procedures or may perform very limited review of collateral in their audits.
Conducting collateral audits is not merely a best practice — it can also affect a lender's ability to pursue claims against other parties, including auditors, for negligence or create legal exposure.
For example, if a lender pursues a negligent misrepresentation claim against a borrower's auditor for issuing misstated audited financial statements, the auditor may assert a contributory or comparative negligence defense based on the lender's failure to conduct a collateral audit.
Recent Examples Involving Collateral
Recent events illustrate the stakes and underscore how gaps in collateral verification can expose lenders to substantial, and sometimes unrecoverable, losses.
The 2025 collapse of subprime auto lender Tricolor, mentioned above, followed an extensive fraud that, according to court filings, involved the same collateral being pledged to multiple lenders and fabricated or inflated equipment collateral.
Tricolor is alleged to have overstated collateral by approximately $800 million. The inability of the diligence and audits that were conducted to obtain the full picture of Tricolor's collateral and to verify the uniqueness of collateral across multiple credit facilities appears to have prevented earlier detection.
The Broadband Telecom and Bridgevoice bankruptcy, filed in 2025, also followed the alleged fabrication of collateral — this time accounts receivable.
According to court filings, the fraud perpetrated by Broadband Telecom and Bridgevoice's owner persisted for five years, until one of the lender's analysts flagged a fake email domain connected to a receivable purportedly serving as collateral.
Although regular audits and customer checks had been conducted, it appears that the audits relied heavily on the review of borrower-supplied documentation, which had been fabricated or manipulated.
The double-pledging of collateral also contributed to the collapse, as illustrated in 2024 bankruptcy filings, of Pride Group, a Canadian-American trucking and logistics company.
According to court filings, Pride Group's management pledged the same vehicles as collateral to multiple lenders. The double-pledging of collateral was discovered during a collateral audit performed by one of Pride Group's lenders.
Conclusion
As fraud schemes become more sophisticated, lenders will need to ensure that the safeguards for their collateral also evolve. Robust credit agreement protections and regular collateral audits, tailored to the specific collateral, are tools lenders should consider to safeguard their collateral.
The next article in this series will discuss the detection of fraud, including the indicators of particular types of fraud and the processes, procedures and controls that can assist in detection.
This article was originally published on September 15, 2026, by Law360 and is republished with permission.