THE CREDITOR-DEBTOR RELATIONSHIP I. CREDITORS REMEDIES UNDER STATE LAW A.

UNSECURED CREDITOR REMEDIES i. The Debtor-Creditor Relationship - The law imposes legal duties and establishes who owes what legal duty to whom. Debtor/Creditor law covers how P actually enforces a judgment. Every contract where one party performs first creates a debtor/creditor relationship. 1. 2. Debtor - Person owing the legal obligation that can be reduced to a money judgment. Creditor - Anyone owed a legal obligation that can be reduced to a money judgment is a creditor of the party owing the obligation. Judgment Creditor/Debtor If a creditor has obtained a court judgment to establish liability against the debtor, the creditor is a judgment creditor.

3.

ii.

Who is an Unsecured Creditor Anyone who is owed a legal obligation that can be reduced to a money judgment is an unsecured creditor. Once they obtain a court judgment to establish liability, they become a judgment creditor. This creditor has not contracted with the debtor for secured status (not consensual). Available Remedies to Compel Payment 1. 2. Peaceful Negotiation The law encourages debtors and creditors to resolve issues peacefully. File a Lawsuit to Compel Payment - Only judicial remedies are available to unsecured creditors. a. File Complaint / Win Judgment The complaint will typically allege a breach of contract claim. The court will issue a judgment if the plaintiff is successful. Supplementary Proceedings - The creditor will want to know if the debtor has any property. This allows creditors to put the debtor under oath to ask about his assets. Obtain Writ of Execution Creates an execution lien on debtors property and allows the Sheriff to sell such property to satisfy the judgment. This type of lien can reach both personal and real property.

iii.

b.

c.

3.

Levy on Property (tangible) - The writ is an order to the sheriff to seize the property (levy), sell it, and apply the proceeds in satisfaction of the judgment. Vitale v. Hotel California illustrates the practical problems with compelling payment by levy. a. Exemptions Some property of the debtor will be exempt from levy by the Sherriff. If property is not exempt, have Sheriff seize it and sell it. These provisions apply against unsecured creditors only. (See p. 14).

4.

Garnishment (intangible) If a 3rd party is in possession of the debtors property or owes money to the debtor, the creditor can cause the sheriff to serve a writ of garnishment on the 3rd party. The effect of the writ is to require the third party to pay the judgment creditor rather than the debtor. a. Bank Account - Banks are debtors to their customers. So, instead of paying the customer, a judgment creditor can enforce garnishment against its debtors debtor.

b.

Garnish Wages - The employer is a debtor of its employee during the time where the employee has performed and the employer has not paid. This can be used to make the employer give a portion of its employees paycheck to the judgment creditor. There are caps on the amount available to garnishment.

iv.

Self-Help Unavailable This is not a proper remedy for unsecured creditors because they have no property interest in the debtors property. Initiation of self-help will result in liability for conversion / larceny. Pre-Judgment Protection When a debtor has not yet defaulted for late payment, but is in financial trouble, there is little an unsecured creditor can do. A competent unsecured creditor will include the following events of default provisions into a contact: a. Acceleration Clause One late payment counts as a default for the entire loan. Payments are usually divisible. Payable on Demand When the ratio of debt to assets/income reaches a certain level

v.

b. c. vi.

Types of Liens - A lien is an interest in property that may only be used for the purpose of satisfying the debt it secures. It is the property that secures the debt. 1. Judicial Lien - Creditor who wins lawsuit can get judicial lien against the judgment debtor. Laws differ from state to state, but there are three types of judicial liens: a. Execution Applies only to tangible property. Issued as a ministerial act by the clerk of the court where the judgment was rendered. It orders Sheriff to seize (levy) property of the debtor, sell it, and apply the proceeds in satisfaction of the judgment. Garnishment Applies to intangible property held by third party. The garnishor (judgment creditor) files an affidavit stating that there exists an unsatisfied judgment and that the garnishee (3rd party) holds property of the judgment debtor. The court issues a writ of garnishment to be served upon the garnishee and the principal debtor. The service of the summons creates a lien. Judgment Applies to real property. Some states statutorily provide that the judgment itself creates a lien. Other states provide that a judgment lien arises only after the docketing of the judgment in the county where the debtors property is located. Docketing is accomplished through the county clerks office. In such states, a judgment rendered by a state court in County X, cannot create a lien on property in County Y until the judgment is docketed in County Y.

b.

c.

2.

Statutory Lien If you are a party that is provided for in the statute, then you have a statutory lien even if you didnt sue. a. b. Tax Lien - A lien on a tax debtors property to satisfy his debt. Mechanics Lien - Contractor or subcontractor can get these liens on the land/real estate to satisfy debt paid on the work/materials provided.

3.

Consensual Lien These liens are voluntarily created through mutual agreement (contract) between the creditor and debtor. Any property of the debtor may be used as collateral. a. Security Interest If the lien is in personal property, it is called a security interest. Here, document used to convey the lien is called a security agreement. i. Security Interest means an interest in personal property or fixtures which secures payment or performance of an obligation, 1-201(35). Security Agreement means an agreement that creates or provides for a security interest, 9-102(73).

ii.

b.

Mortgage A lien created in debtors real property. A mortgage is used to describe the document that creates the property interest, and the interest itself. i. A consensual interest in real property, including fixtures, which secures payment or performance of an obligation, 9-102(55).

B.

SECURED CREDITORS: REPOSSESSION & FORECLOSURE i. Intended as Security Doctrine Applicable to mortgages and personal property transactions, the doctrine looks to whether the transaction was intended as a security. Even if the only relevant document lists the transaction as a sale, the relationship created may be a security interest. a. Article 9 - Applies to any transaction, regardless of its form, that creates a security interest in personal property, 9-109(a)(1).

1.

Purchase Money Security Interests Owners who intend to sell goods on credit sometimes seek to retain title to the goods until the buyer has paid for the goods. Buyer becomes the owner of the goods and seller becomes the secured creditor for the price of the goods, 2-401(1). Leases Intended as Security Interests If the term of the lease extends for the entire remaining economic life of the collateral, the economic effect of the lease on the parties may be identical to the economic effect of a sale with a security interest back for the purchase price. .

2.

ii.

Conveyance of Security Interest The creation of a security agreement gives the secured creditor a security interest in the collateral of the debtor. The debtor conveys the security interest to the creditor. 1. Possession Pending Foreclosure A creditor can use possession as leverage to force changes in the debtor-creditor relationship to raise the interest rate, demand additional collateral, etc.:

Real Property Repossession

iii.

Creditor Options Upon Default - A party secured by personal property as collateral, may: 1. Self-Help A creditor with a security interest in personal property can bypass the courts and sheriff by taking possession itself or through an agent. After taking possession, the secured party will hold a private, commercially reasonable foreclosure sale, 9-609(b)(2). a. Breach of the Peace Self-help repossession is permitted only if the secured party repossesses without a breach of the peace, 9-609(b)(2).

Mortgagees (lenders) never become entitled to possession of mortgaged real property. The debtor remains owner of the property and is entitled to possession until the court forecloses the debtors equity of redemption and the sheriff sells the property. Typically, creditor will bring a foreclosure action, the Mortgagee will be the only bidder, and it will sell the property privately

i.

BREACH - If breach occurs, debtor may sue for damages if property was sold (lost revenue), or replevin to get the property back, 9-625(a)(b). 1. 2. 3. 4. 5. Presence of police officer during self-help repossession Disregard of debtor request for creditor to leave the premises Loud argument between debtor and creditor Lying is not a breach, but trespass likely is Cutting chain to a locked fence or physical violence

b.

No Property Exemptions Exemptions protect debtors from unsecured creditors and judicial liens, thus do not apply to consensual liens. Repossession Agencies Secured parties are liable for the illegal actions of their agents who seize the property of their debtors upon default, Comment 3, 9-609. Accounts Party holding a security interest in accounts has a self-help remedy to force payment by the account debtor (debtors debtor), 9-607(a). i. Account Debtor Obligation -The debtor who receives the notice can discharge its obligation only by paying the secured party, 9-406(a).

c. The UCC does not govern real estate.

d.

2.

Replevin Action Any party entitled to possession of tangible personal property is entitled a writ of replevin. After the plaintiff files the civil action, if will win case gets writ, the writ directs the sheriff to take possession of the property from the debtor and give it to the creditor, 9-609(b)(1). a. Private Foreclosure Sale If secured creditor has obtained possession of collateral, creditor may sell the collateral in a commercially reasonable manner, 9-610. Commercially Reasonable Foreclosing creditor has a duty to choose a proceeding for sale that is commercially reasonable. Every aspect of the disposition of collateral, including the method, manner, time, place, etc. must be reasonable, 9-610(b).

b.

3.

Disable Equipment The creditor has the option to leave equipment temporarily in the possession of the debtor, but render it unusable. Thus, a creditor may remove a key part of the equipment so that it may not be used pending sale, 9-609(a)(2). Retaining the Collateral A secured creditor with repossessed goods due to default can seek consent from the debtor to keep the collateral, 9-620(a). a. Subsequent Sale If consent was granted by debtor, the creditor may sell and keep proceeds. If no consent, sale must be commercially reasonable, 9-610(a)(b).

4.

iv.

Foreclosure A process that transfers ownership from the debtor to the purchaser at the foreclosure sale and cuts off the debtors rights to redeem the collateral. Secured creditor has two means by which to foreclose: 1. Judicial Foreclosure Process A foreclosure process is judicial if it is accomplished by the entry of a court order. This procedure is determined by each state, 9-601(a). a. File a Complaint The creditor details the terms of the loan and the nature of the default, and requests foreclosure. It is served upon the debtor and subordinate lien holders who then have a period of time to raise defenses.

b. c.

Entry of Final Judgment Court sets a date for the foreclosure sale. Foreclosure Sale The Sheriff sells the collateral, collects the proceeds from the sale and applies them towards payment of the debt.

2.

UCC Foreclosure by Sale After default, the secured party may (1) sell, license, or otherwise dispose of any or all collateral, 9-610(a). a. Creditor Generally Must Sell Purpose is to prevent unjust enrichment. Sale ensures everyone is made whole. All excess value of sale proceeds is returned to the debtor. Effect on Security Interest Foreclosure sale extinguishes the creditors security interest in collateral. Purchasers have the debtors rights in the collateral, 9-617(a). Real Property NOT Governed by UCCno need for uniform law because land is immobile. Typically, a public auction will be held by a Govnt employee. When the court confirms the sale, the transfer of title of the property is deemed completed.

b.

c.

v.

Debtor Redemption To redeem collateral, a debtor shall pay all obligations, expenses, and attorneys fees at any time before collection, sale, of acceptance of collateral in satisfaction of obligation, 9-623(a)(b). 1. Sale / Disposition - A sale/disposition forecloses a debtors right to redeem, 9-623(c).

----------------------------------------------------------------------------------------------------------------------------------------------------------------Consensual Lien Security Interest 9-610 sale Creditor Sells; Foreclosure Sale Usually Sold Privately Judicial Lien Execution Lien Execution Sale, 9-601(a) Sheriff Sale per State law Public Auction

Personal Property

Real Property

Mortgage Mortgage Foreclosure Sale This is not governed by the UCC Public Auction Court Confirmation

Judgment Lien Judicial Sale

Sheriff Sale Public Auction

C.

ARTICLE 9 SALES & DEFICIENCY

i.

Creditor Keeping Collateral A secured creditor with repossessed goods due to default can seek consent from the debtor to keep the collateral, 9-620(a). 1. Valid Consent The right to consent is subject to four conditions: a. b. c. d. No objection exists from others holding liens against the collateral, 9-620(a)(2). If a consumer transaction, must be in complete satisfaction, 9-620(g). If consumer goods, debtor can consent in writing or silence to strict foreclosure only after repossession has occurred, 9-620(a) Not permitted if the debtor has paid 60% of the cash price of the consumer goods purchased on credit, 9-620(e). Debtor may waive this in writing, 9-624(b).

Failure to Comply
A person is liable for damages in the amount of any loss caused by failure to comply with Article 9, 9-625.

2.

Implied Consent - Consent is implied if the secured creditor sends the debtor a proposal for retention and does not receive notice of rejection within 20 days, 9-620(c). Subsequent Sales The rules applying to a subsequent sale by the creditor are based on whether consent was granted. If consent is valid, then the creditor may sell and keep proceeds. a. No Consent - The sale must be commercially reasonable, 9-610(a).

3.

ii.

Private Sale Procedure Creditor has broad latitude to determine the method & timing of a foreclosure sale, but the creditor has a duty to choose a sale procedure that is commercially reasonable, 9-610. 1. Commercially Reasonable The fact that a greater amount could have been obtained at a different time / different method from that selected by the secured party is not itself sufficient to preclude the secured party from showing that the sale was commercially reasonable, 9-627(a). a. Commercially Reasonable Dispositions: 9-627(b) i. ii. iii. iv. b. Made in the usual manner on any recognized market Made at the price current in any recognized market at the time of sale, or Otherwise in conformity with reasonable commercial practices among dealers in the type of property involved. Dispositions that have been approved by judicial proceeding

Failure to Sell Collateral

Sale must be commercially reasonable. So, if there is no buyer, it may be commercially reasonable to hold another sale. If there is still no buyer, the FMV must be nothing.

Unreasonable Sales If the only defect in the sale is the reasonableness of the sale, then the debtor is likely to be left with the right to sue for damages.

2.

Notice The creditor must give the debtor prior notice of the sale to enable the debtor to observe the sale, participate in it, and protect its rights, 9-611(c)(1). a. Failure to Gove Notice - Does not invalidate the sale, but is a defect that can have the effect of reducing the amount of the deficiency the secured party can recover, 9-617

iii.

Common Law Redemption While a foreclosure is in progress, the debtor has the right to redeem the collateral by paying the full amount due including interest and attorneys fees, 9-623. 1. Ends at Moment of Sale At the moment the creditor enters into a contract for the disposition of the collateral, it is too late for the debtor to redeem.

iv.

Deficiency Judgments re Non-Consumer Transactions Debtor is liable for any deficiency remaining after application of the sale proceeds, unless state consumer protection statute applies, 9-615(d).

1.

Secured Party Purchases - When the secured party is purchaser, the deficiency is the amount that would have been realized in a complying sale to a 3rd party, 9-615(f). Non-Commercially Reasonable Sales Including failure to give notice, when calculating a deficiency, the amount that would have been realized in a complying sale is treated as the sale price, 9-626(a)(3) a.

2.
Exceptions

d.

Rebuttable Presumption The amount of in a complying sale is treated as equal to the amount of the entire debt, 9-626(a)(4). JUDICIAL SALE & DEFICIENCY IN REAL PROPERTY i. Strict Foreclosure These involve contracts for the sale of real property that provides for the payment of the purchase price in installments over many yearswith the deed deliverable upon full payment. 1. Effect of Default -The debtors interest in the property is forfeited, and the title remains with the seller rather than the property being sold off. Does not require a sale of collateral.

ii.

Foreclosure Sale Procedure These are regulated by state statute and occur at the county courthouse. They are always conducted by a public official. After a sale, the court must confirm the sale to review the circumstances under which the process was held. 1. Advertising This may be fixed by statute. Typically, written notice is to be posted in various public places for a certain amount of time before the sale. No Right to Inspect The debtor is entitled to remain in possession of the property until after the sale. Bidders can observe the property from public places but have no right to inspect or enter. Title / Condition Buyers take subject to any defects in the title that they could have discovered through a search of public records or inspection of the property. Application of Sale Proceeds - Monetary payments go first to pay off expenses of the sale, then to the creditor, then surplus to debtor. a. Credit Bid - The secured party can bid its credit (amount owed by debtor) at the sale without having to pay any money. Deficiency Judgment - When the purchase price is less than the amount owed on the debt, the court may grant a deficiency judgment and the creditor can collect the remaining amount like any other unsecured creditor.

2.

3.

4.

b.

iii.

Anti-Deficiency Statutes - They prohibit a court from granting a deficiency judgment in particular circumstances or give the court discretion to do so. They typically credit the debtor for the FMV of the property even if the sale brings in less. The remainder may be sought out as unsecured creditor status. a. b. c. Creditor loses nothing by bidding the full amount Always bid full amount! Decreased chance sale will be set aside for inadequate price Decreased chance debtor will exercise right to redeem

iv.

Deficiency Permitted Once proceeds from sale are applied to debt, any remaining deficiency may be sought by creditor as an unsecured creditor. Garnish & Levy. Statutory Redemption While a foreclosure is in progress or afterward for a specified period of time (one year), the debtor has the right to redeem the property by: a. b. 2. Paying the price paid at foreclosure sale and Paying Interest and attorneys fees

v.

3rd Party Purchasers They take subject to a debtors right to redemption and are at risk that if they buy debtors home, the debtor may redeem within the redemption period. Buyers should not make any improvements until redemption period expires

vi.

Under-Secured v. Over-Secured 1. Under-secured Creditor whose collateral is worth less than the debt owed. i. ii. iii. 2. Borrow from another lender Have a friend win the bidding and lease it back to the debtor Sell house before foreclosure sale to get the most money out of it.

E.

Over-secured Creditor whose collateral is worth more than the debt owed. Debtor is crazy to let this go to foreclosure because they will lose equity in the home. Debtor should sell the property in the market to capture the equity. INTANGIBLE COLLATERAL: ACCOUNTS i. Account Defined A right to payment of a monetary obligation, for property that has been sold, leased, assigned, or otherwise disposed of . . . (not deposit accounts), 9-102(a)(2). 1. Accounts as Collateral Article 9 applies to a sale of accounts, 9-109(a)(3). a. Sales of Accounts - Businesses who lend on unsecured credit operate on a system of outstanding debt owed to them by their clientsaccounts receivable. Their clients owe this amountaccounts payable. Business may sell the account, 9-102(a).

ii.

Accounts Receivable as Collateral Two options exist, but either way, the creditor has an intangible property interest. The UCC treats both arrangements the same and treats them as an assignment of accounts. 1. Loan / Security Interest In this arrangement, the seller merely gets the buyers promise to pay, but the sellers asset in the arrangement is an account receivablethe right of the seller to collect payments from buyers customers. Sale / Assignment This arrangement allows the buyer to sell his right to the accounts (assign accounts) to the seller so that the seller gets the money from the accounts directly instead of customers paying the buyer directly.

2.

iii.

Assignment Scenario Seller delivers goods on open account and buyer pays within 30 days. The open account is the collateral. The seller may want a loan from the bank to have the bank cover for the buyer, and the seller promises to repay the loan while granting to the bank a security interest in the account. 1. Assignee Rights Upon Default - Bank gets ownership of the accounts and the right to go to the Buyer for payment. The assignee gets the exact rights that the assignor had, 9-404(a)(1).

a.
Parties have the ability to assign their rights to receive money

Provide Notice - To get the money from the buyer, assignee sends notice to the buyer letting them know to pay the assignee (bank) rather than the assignor. Buyer can only discharge debt by paying assignee bank, 9-406(a). i. Buyer will likely be skepticalwont want to pay twice if the Bank is engaged in a fraud.

b.

Right of Recourse If the Bank buys the accounts and Buyer refuses to pay, under a right of recourse, the Seller must buy back the account from the Bank.

iv.

Self-Help Against Accounts - Party holding a security interest in accounts has a self-help remedy. A secured creditor who knows of the debtors identity can send them written notice to pay the creditor, 9-607. 1. Account Debtor - They can only discharge the debt by paying their creditors creditor, 9-406(a).

II.

CREDITORS REMEDIES IN DEBTOR BANKRUPTCY A.

BANKRUPTCY & AUTOMATIC STAY see page 96

i.
ii.

Federal Bankruptcy System -A faster and more efficient resolution that supersedes the state systems once the process has begun. It offers permanent forgiveness of debt (discharge) or rescheduling of repayment. Filing Procedure To file a claim, the creditor or debtor files a proof of claim that describes the debts, assets, income, and interest/attorneys fees owed, B 501. 1. Objection - If there is an objection to the claim, the court will decide what is owed, B 502.

2. Effect of a Proof of Claim - A bankruptcy estate is automatically created and a stay is imposed
against all collection activities of the debtors creditors, B 362(a).

a.

Chapter 7 (Liquidation): Debtor surrenders all of his non-exempt assets to a bankruptcy trustee and receives a discharge of all of the debtors dischargeable debt.

i.

Non-Dischargeable Student loans, domestic support, taxes

b.

Chapter 11 (Corp. Reorganization): Debtor remains in possession of the property during the case. It can continue to operate its business and manage financial affairs. If a reorg plan is confirmed by the court, the debtors obligations under the plan replace the previous obligations and the rest of the debt is discharged. Chapter 13 (Indiv. Reorganization): Available to only individual debtors whose unsecured debts are less than $337,000 and whose secured debts are less than $1 million. Court confirms plan & if debtor makes payments, debtor keeps all property.

c.

iii.

The Stay The stay is an immediate stopping of all of a creditors collection activities. It locks up the estate temporarily so that an accurate count and orderly distribution can be made, B 362(a).

1. Violations Actions that violate the stay are void or voidable. Deliberate violators are held in
contempt, fined and face payment of damages and attorneys fees, B 362(k).

2. Criminal Proceedings The stay does not halt criminal proceedings against debtor, B 362(b)(1). iv.
Lifting the Stay Secured creditor may be able to get the stay lifted and continue with non-bankruptcy collection if the following apply, B 362(d).

1. Secured Creditors They are assured to collect the amount of the debt or the amount of the
Unsecured Creditors

collateral, whichever is less. They can move to lift the stay at any time so long as:

Costs are paid pro rata from the estate. They rarely have cause to lift the stay. They

a. b.

MUST lift the stay if the trustee in bankruptcy or debtor does not provide the creditor with adequate protection, B 362(d)(1) OR MAY lift the stay if: B 362(d)(2)

i. ii.

(1) There is no equity in the collateral (under-secured), and (2) Collateral is not necessary to an effective reorganization

v.

Debtor May Retain its Property To be entitled to retain its property, the debtor or trustee must show the following, otherwise, the court must lift the stay:

1. Bankruptcy Purpose - Its retention of the collateral serves a bankruptcy purpose, and 2. Adequate Protection The debtor must protect the secured creditor against loss as a result of the
delay in foreclosure that is caused by the stay, B 362(d)(1).

a.

Cushion of Equity Excess of collateral value over loan amount:

B.

Nature of factors that might change the value of collateral ii. Volatility of the market in which the creditor would sell iii. Rate at which the secured debt is likely to increase in amount TREATMENT OF SECURED CREDITORS IN BANKRUPTCY i. Collecting From a Bankrupt Debtor A creditors claim in bankruptcy is the amount of the debt owed to the creditor under non-bankruptcy law at the time the bankruptcy case is filed. 1. Discharged Debt A debt that still exists, but creditors are enjoined from collection--nonrecourse. Both secured and unsecured debts can be discharged, B 524(a)(2).

i.

10

a.

Nonrecourse Secured Debt While the debt cannot be enforced against the debtor, failure to pay has consequences. If a lien has not been removed during bankruptcy, it continues to encumber the collateral afterward and the creditor can then foreclose.

2.

Calculating the Amount of a Secured Claim Three steps: a. b. (1) Determine the amount owed under non-bankruptcy law (2) Bifurcate the claim Claim can be secured only to the extent of the value of the collateral. The remainder is an unsecured claim, B 506(a)(1). (3) Determine whether the creditor is entitled to accrue post-petition interest, attorneys fees, or costs, B 506(b).

c.
Unsecured Creditors Generally cannot recover these even if the contract says they can because they recover fractions of the principal owed to them.

i.

Secured Creditors May recover interest, fees, & costs when: 1. 2. 3. The attorneys fees and costs are reasonable Payment of such fees must be provided under the agreement Interest, fees, & costs can accrue to the extent that the value of the collateral exceeds the amount of the secured claim.

ii.

Trustee Sale - Trustee sells property in whatever manner he thinks will maximize net proceeds, B 541(a). 1. Effect of Trustee Sale a. Over-Secured Any purchaser will buy subject to the secured creditors lien, so trustee sells only equity. Sale terminates the stay on the property, B 362(c)(1). b. 2. Under-Secured Estate will abandon it.

Abandoning Property Trustee may abandon property of the estate that is of inconsequential value. The property ceases to be part of estate & ownership reverts back to debtor. a. Lift Stay - SC must still move to lift the stay before foreclosing, B 554(a).

3.

Paying for the Sale A trustee who has incurred reasonable & necessary costs of disposing of property may recover them, but only if such expenses benefited the secured creditor, 506(c). a. Benefit Compares what actually happened with what would have happened if the stay had been lifted and the secured creditor had dealt with the problem on his own. i. Under-Secured Sale Sale of such collateral will ordinarily benefit the creditor and be deducted from its recovery. Over-Secured Sale Sale of such collateral will not benefit the creditor.

ii. iii.

Reorganizations The debtor seeks to keep the collateral to continue using it by creating a plan to reduce the amount of the debt and reschedule payments. Plan discharges the old debt and substitutes the new debt. 1. Cramdown Where the secured creditor has not agreed to the reorganization plan. The minimum repayment that is considered fair and equitable is where the debtor must either:

11

a. b.

Surrender the collateral to the secured creditor in satisfaction of the claim, OR Promise to distribute property to the creditor with a value as of the effective date of the plan that is not less than the amount of the allowed secured claim. 1. Series of Payments, the present value of which is $____

III. CREATION OF SECURITY INTERESTS A.

FORMATION OF SECURITY INTERESTS i. Attachment A security interest attaches to collateral when it becomes enforceable against the debtor with respect to the collateral, unless an agreement expressly postpones the time of attachment, 9-203(a). A security interest is enforceable against the debtor only if: 1. Value has been Given All consideration including past consideration, 9-203(b)(1). a. 2. Sophisticated creditors will make this the last step in forming a security interest.

Debtor has rights in the Collateral When the debtor owns the collateral or has power to transfer rights in the collateral to a secured party, 9-203(b)(2). a. Limited Interests If the debtor owns a limited interest in property, a security interest granted by the debtor will attach only to the limited interest, Comment 6, 9-203. Fraudulently Acquired Rights Those who acquired their rights in property by fraud have the power to transfer ownership rights to bona fide purchasers, 2-403.

b.

3.

Security Agreement or Possession of Collateral a. Authenticated Agreement A signed writing (security agreement): 9-203(b)(3)(A). i. ii. iii. b. A description of the collateral, A description of the obligations secured, Provisions describing default and rights there-under.

Possession When the creditor has possession of the collateral, 9-203(b)(3)(B).

ii.

Financing Statements They are not required to make a security interest enforceable against a debtor. These are effective for the secured creditor to have priority over other creditors. Attachment in Real Property: Mortgage Rules are determined by state statute. Usually must be in writing, signed by debtor, and witnessed by one or more people.

iii.

12

b.

TERMS OF THE SECURITY AGREEMENT i. Debtor-Creditor Contract A security agreement is a contract between debtor and creditor, 9-102(a)(73). Courts will try to determine the intention of the parties as objectively expressed in the security agreement. a. Third Parties - Security agreements bind 3rd parties who are not part of the security agreement. Secured parties take the collateral on default over other creditors.

ii.

Describing Collateral - When parties use Article 9 terms in a security agreement, courts give them their Article 9 meaning rather than their common meaning, 9-108(b)(3). 1. 2. Obligation Secured Stated obligations of the parties under the agreement. Sufficient Description It is sufficient if it reasonably identifies the collateral, 9-108(a). a. Reasonable Identification If the collateral is identified by a specific listing, category, quantity, type of collateral defined in UCC, or any other method if the identity of the collateral is objectively determinable, 9-108(b).

13

i. Insufficient Description All the debtors assets ii. iii.

Accounts A right to payment of a monetary obligation for property that is sold, leased, licensed, or otherwise disposed of, 9-102(a)(2). Equipment Goods other than inventory / consumer goods, 9-102(a)(33) Inventory Goods, which are held by a person for sale/lease, 9-102(a) (48) Consumer Goods Used for personal, family, household purposes, 9102(a)(23).

iv.

iii.

After-Acquired Property - Property that a debtor acquires after the security agreement is created. A security agreement may create or provide for a security interest in after-acquired collateral, 9-204(a). 1. No Attachment When A security interest does not attach under a term constituting an afteracquired property clause when: 9-204(b) i. Collateral is consumer goods that the debtor acquires more than 10 days after the secured party gave value for the transaction, or Commercial tort claim

ii. 2.

Implied Clauses If the collateral is the type of item where the debtor is constantly creating new collateral (inventory), courts will imply an after-acquired property clause, Stoumbous v. Kilimnk. Bankruptcy After-acquired property clauses become ineffective upon bankruptcy, B 552(a).

3. iv.

Future Advances - Any obligation can be secured if the intent is clear. A security interest can also secure a debt that does not exist yet but that the parties contemplate will in the future, 9-204(c). 1. Future Advance Clause - If creditor later lends additional money, a security agreement with a future advance clause will ensure that the subsequent loan is secured from its inception by the collateral securing the initial loan.

v.

Attorneys Fees Security agreements usually provide that in the event of default, the debtor will pay the creditors attorneys fees by adding them to the amount of the secured debt. Real Estate Mortgages: Description in a mortgage must describe the land sufficiently to identify it. It may refer to separate documents such as maps or plats. Permanent buildings / structures are part of the real estate. 1. Doctrine of After Acquired Title Permits an earlier mortgage document to convey a security interest in land later acquired by the mortgagor. Future Advance Clauses Can be included in mortgages, but there are limits: i. ii. iii. Proof that a later advance was contemplated at the time of the mortgage Mortgage must indicate maximum amount of debt secured Mortgage cannot secure something that cannot be liquidated

vi.

2.

14

c.

PROCEEDS & VALUE-TRACING CONCEPTS What is the Collateral? i. Proceeds Whatever is acquired upon the sale of collateral; Rights arising out of collateral; To the extent of the value of collateral, claims arising out of the loss/damage of collateral, including insurance, 9-102(a)(64). 1. General Rule - A security interest follows collateral and attaches to the value of collateral when a debtor transforms the value of an item of collateral to some other type of asset, 9-315(a)(1) a. Automatic Collateral Proceeds are considered to be collateral, 9-102(a)(12). The security agreement automatically covers identifiable proceeds, 9-203(f). Purchasers Buyers of collateral take subject to the security interest, 9-401. Ordinary Course of Business - Sales of collateral in the ordinary course of business often strip liens from the collateral, 9-320(a).

b. c.

2.

Identifiable Proceeds A security interest continues to encumber proceeds only so long as they remain identifiableconsider commingling of funds, 9-315(a)(2). a. Commingling When the property of multiple secured creditors is commingled, their interests are determined pro rata. Lowest Intermediate Balance Rule Debtor is presumed to spend first from his own personal funds and whatever remains is the proceeds, Comment 3 - 9-315(b). (173) Bank Funds Transferee Transferee takes free and clear of a security interest in a deposit account unless the transferee acts in collusion with the debtor, 9-332(b).

b.

c.

ii.

Other Forms of Proceeds - The following are rights arising from collateral, and are proceeds, 9-102(a)(64) 1. 2. 3. 4. Product Something the collateral produces (agriculture) Profit Excess of revenues over expenses, or A right in the soil of another Rents Money paid for the temporary use of collateral Offspring Used with regard to animals.

iii.

Non-Value Tracing Concepts - The value of after-acquired property, replacements, additions, and substitutions do not arise automatically, but can be included in the security agreement.

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d.

LIMITS ON WHAT MAY BE COLLATERAL i. After-Acquired Consumer Goods No attachment occurs relating to consumer goods acquired more than 10 days after the lender makes a loan, 9-204(b). Commercial Tort Claims Debtor cannot grant a security interest in a claim that does not yet exist at the time of the agreement. The purpose is to prevent debtors from pledging valuable lawsuits before they have any idea what the suits might be, 9-204(b). Non-Property Because a security interest is defined as an interest in property or fixtures, the effect is that items must be property or they cannot qualify as collateral, 1-201(b)(35). 1. Property of Personal Nature Low-value personal items cannot serve as collateral. Examples include the debtors false teeth, artificial limbs, or personal clothing. Congress intent was to prevent creditors from taking advantage of debtors to motivate them to pay. a. Unfair Credit Practices It is an unfair act or practice for a lender to take from a consumer, an obligation that constitutes a non-possessory interest in household goods. i. ii. iii. iv. v. 2. Clothing Furniture Appliances / radio / television Linens / china / crockery / kitchenware Personal effects wedding ring

ii.

iii.

FTC Trade Regulations 16 C.F.R. 444.2

Future Income of Individuals Article 9 does not permit an attempt to create a security interest in a debtors ability to earn income in the future, 9-109(d)(3). a. Distinguish Garnishment Debtors being garnished have already lost a judgment and the garnishment is against money they are currently earning. But if it is collateral, then debtors may pledge wages two years from nowtoo prospective and risky. Consumer Deposit Accounts Cannot serve as collateral, 9-109(d)(13).

b. 3.

Pension Rights The requirements that make these plans eligible for tax breaks also make the retirement funds ineligible to serve as collateral for a loan. Licenses / Franchises The federal govnt issues licenses for broadcast, airport landing, sale of liquor, etc. Although these are routinely bought and sold, they are non-property by law and exist for the public convenience.

4.

16

a.

Loophole Debtors may create security interests in the revenues they derive from their use of the licenses and franchises.

iv.

Future Property A debtor can grant a security interest in property the debtor does not yet own. When the property comes into existence or possession of the debtor, the security interest attaches. 1. Future Income of Corporations A business debtor may encumber future earnings of the business by encumbering accounts, chattel paper, money, and bank accounts.

IV. DEFAULT, ACCELERATION, & BREACH a. STATE LAW - Creditor Friendly i. Default (Breach) The debtors failure to pay a debt when due, or otherwise perform the agreement between creditor and debtor. Both parties prefer that default is defined precisely in the security agreement. 1. When is Payment Due? a. Installment Loans Debtor pays in a series of installments usually at ordinary intervals. Most common are real estate mortgages and car loans. Single Payment Loans Secured loans payable on a certain day (accounts receivable). If debtors financial condition remains satisfactory, bank may renew the note for an additional period. On Demand Debtor must pay the loan when creditor demands money good faith. Line of Credit Bank contracts to lend up to a certain amount of money. Debtor borrows the money by writing checks and bank covers overdrafts up to the limit.

b.

c. d.

ii.

Acceleration Call the Loan These clauses state that in the event of default in any obligation, the creditor may, at its option, declare all of the payments immediately due and payable. 1. 2. Common Law No acceleration, creditor can only collects amounts owed and defaulted upon. Insecurity Clause If the grounds for acceleration are merely that the secured creditor deems itself insecure the creditor has the right to accelerate only if it may do so at will and in good faith belief that the prospect of payment or performance is impaired, 1-309.

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a.

Duty of Good Faith Honesty in fact and the observance of reasonable commercial standards and fair dealing, 1-304. There is no independent cause of action for failure to perform or enforce in good faith. The doctrine merely directs a court toward interpreting contracts, Comment 1, 1-304.

3.

Kansas Deficiency Judgments An agreement of the parties to a consumer credit transaction with respect to default on the part of the consumer is enforceable only to the extent that: KS 5-109 i. ii. The consumer fails to make a payment as required by agreement, or The prospect of payment, performance, or realization of collateral is significantly impaired.

iii.

Right to Cure Debtor has the right to cure a default by paying the amount then due. Once acceleration has occurred, a debtor must pay the entire amount of the accelerated debt. 1. Kansas Consumer Credit Protection Act a. Notice of Consumers Right to Cure After consumer has been in default for 10 days for failing to make a payment, creditor may give notice, KSA 16a-5-110 (UCCC) Cure of Default. After a default for failure to make a payment, creditor may neither accelerate nor take possession until 20 days after notice, KSA 16a-5-111 (UCCC)

b.

iv.

Waiver of Default A claim or right arising out of an alleged breach may be discharged in whole or in part without consideration by agreement of the aggrieved party in an authenticated record, 1-306. a. 2. Debtor Argues By creditors prior conduct, debtor thought that his breach was okay.

Anti-Waiver Provisions Creditors include these provisions in security agreements to avoid claims by debtors that the creditor has waived exercise of his rights after default. a.

b.

Example Secured party, in his sole discretion, waive a default. Any such waiver shall not be a waiver of other defaults of the same kind of default at another time. BANKRUPTCY LAW Debtor Friendly i. Reorganization Protections When a debtor files for bankruptcy, the automatic stay imposed halts all collection efforts, unless the stay is lifted. Whether the debtor must make installment payments pending confirmation of the plan depends on the chapter which the case is pending. 1. Chapter 13 (payments) Debtors are required to file plans within 15 days after the filing of the petition and the debtor must commence making payments within a month of the filing, B 1326. Chapter 11 Debtors need not begin making payments until the plan is confirmed. This means the debtor has use of the collateral, but doesnt have to make payments.

2.

ii.

Modification Rewriting the loan is accomplished by confirmation of a plan of scheduled payments. The minimum amount the debtor must pay on a modified secured claim must be at least equal to the amount of the claim plus interest at the market rate from the effective date of the plan until the payments are due. 1. Chapter 13 Payments can extend only over the period of the plan

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2.
Chapter 11

Chapter 11 Payments can extend over any period of time that is fair & equitable, B 1129(b)(1).

iii.

Reinstatement & Cure A return to the repayment terms agreed to by the creditor and debtor, B 1124(2). If the plan is unimpaired, the creditor is presumed to have accepted the plan and is not entitled to vote on it. It can be imposed over the holders objection, B 1126(f). 1. Unimpaired Claims - A class of claims is unimpaired if the debtors proposed treatment of the class under its plan complies with four requirements: B 1124(2). a. Debtor must cure any default occurring before or after the commencement of the bankruptcy case. Plan must reinstate the maturity of that part of the claim that remains outstanding after the curefuture payments remain due at the times specified in the original contract Debtor must compensate the holder of the secured claim for damages incurred through reasonable reliance on the breached repayment contract. The plan must not otherwise alter the rights of the holder.

b.

c.

d. iv.

Chapter 13

Reinstatement & Cure This plan may provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any secured claim on which the last payment due. It imposes the same four requirements, B 1322(b)(5). 1. Practical Effect - Debtors are far more likely to use reinstatement here because Chapter 13 requires full payment of modified claim s within the period of the plan. Modification Cure & Reinstatement Debtor returns to original payment schedule Arrearage is paid separately Interest at the contract rate Debtor pays unsecured portion in full. Unsecured Pro rata share of whats left after secured claims paid Series of payments the present value of which is what creditor would have received if filed under Chapter 7.

Payment Schedule Arrearage Interest Unsecured Portion

Debtor proposes new payment schedule Arrearage is included in payments Interest at a market-based rate set by the court Debtor pays the unsecured portion like other unsecured claims Over-secured Creditor (1) Full claim (2) Post-petition interest to the extent of the over-security Series of payments the present value of which is what creditor would have received if filed under Chapter 7.

Under-secured Creditor (1) Value of collateral (2) Unsecured claim Series of payments the present value of which is what creditor would have received if filed under Chapter 7.

Chapter 7

Reorganization

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