Which clause ensures the promissory note is secured by collateral rather than becoming a personal loan?

• A. Lock-in clause
• B. Prepayment clause
• C. Defeasance clause
• D. Usury

Answer: (C)

Defeasance is a provision that converts a loan from a personal obligation into a secured obligation by substituting collateral. In practice, the borrower sets aside replacement collateral—often cash or government securities—whose cash flows are structured to cover the remaining debt. Once those funds or securities are in place and the appropriate documents are executed, the borrower is released from personal liability, and the lender’s recourse shifts to the new collateral. This means the promissory note is effectively secured by collateral rather than being a simple personal loan.

Other clauses don’t accomplish this. A lock-in clause keeps terms fixed rather than changing the security structure. A prepayment clause governs how and when the loan can be paid off early. A usury clause addresses illegal interest rates.