Chapter 14Secured Transactions, Creditors’ Rights, and

Bankruptcy

What is a security interest? Why and how are security interests perfected?

How are priority disputes among creditors decided?

What are the various remedies available to creditors, and how and when do creditors use these remedies?

What are the typical steps in a bankruptcy proceeding?

Learning ObjectivesLearning Objectives

Secured Transactions: Terminology

Secured Party: creditor who has a security interest in debtor’s collateral.

Debtor: person who owes payment of a secured obligation. Security Interest: interest in the collateral that secures the

performance. Security Agreement: agreement that creates or provides

for a security interest. Collateral: subject of the security interest. Financing Statement: normally filed with public notice to

third parties.

Creating and Perfecting A Security Interest

Creating a Security InterestCollateral in possession of Creditor or there must be

a written agreement describing the collateral signed by Debtor.

Creditor must give something of value to Debtor.Debtor must have “rights” in collateral.

Once these requirements are met Creditor’s rights “ATTACH” to the collateral, giving Creditor enforceable security interest.

CollateralCollateral is generally divided into two

categories: tangible and intangible.Tangible: Consumer goods, equipment,

farm products, inventory, accessions.Intangible:Chattel Paper, Instruments,

Accounts, Deposit Accounts, General Intangibles.

Perfecting a Security Interest

Perfection is the legal process by which the secured party protects herself from third party claims against the same collateral.

Perfection by Filing a Financing StatementPerfection Without Filing

Possession--Collateral with the Secured PartyPurchase Money Security Interest (financing)

Scope of Security Interest

Security Interest in Proceeds: whatever received when collateral sold or disposed of.

After-Acquired PropertySecurity Agreement may provide for a

security interest in property acquired after execution of security agreement.

Scope of Security Interest Future Advances

Continuing line of creditSubject to security interest

Floating LiensSecurity interest in proceeds in after-acquired

property, orCollateral subject to future advances.

PrioritiesGeneral Rule is that a secured party’s

interest has priority over the following:Unsecured creditorUnperfected secured partySubsequent lien creditorTrustee in bankruptcyBuyers who do not purchase collateral in the

course of Seller’s business.

Priorities Buyers of the Collateral

Conflicts with Perfected Secured PartyBuyers in the Ordinary Course of BusinessBuyers not in the Ordinary Course of Business of

Consumer GoodsBuyers of Chattel PaperBuyers of Instruments, documents or securitiesBuyers of Farm Products

Generally, Buyers in the ordinary course of business take goods free from security interest.

PrioritiesCreditors or Secured Parties

Conflicting Perfected Security Interests• First to Perfect has Priority.

Conflicting Unperfected Security Interests• First to Attach has Priority.

Conflicting Perfected Security Interests in Commingled or Processed Goods

Rights and Duties Information Requests Release, Assignment and Amendment

Secured party can release all or part of the interest.Secured party can assign all or part of the interest.Parties can agree to amend the financing statement.

TerminationWhen Debtor has fully paid the debt, secured party

must release security interest and file a termination statement.

DefaultNot defined by Article 9. Defined in the

security agreement.If Debtor in default, Secured Party can:

Relinquish a security interest and use any judicial proceeding on the underlying debt (execution and levy).

Take peaceful or judicial possession of the collateral.

Default Disposition of Collateral

Retention of Collateral by Secured Party (unless PMSI and debtor paid 60% or more)• Notice Required• If objection, then Secured Party must sell property.

Disposition Procedures• Commercially reasonable manner• Public sale with notice

Distribution of Proceeds• Expenses balance of debt junior liens then

balance to secured party.

Laws Assisting Creditors Liens

Mechanic’s Lien (real property)Artisan’ Lien (personal property) Innkeeper’s Lien (baggage of guests) Judicial Lien

• Attachment: court-ordered seizure of property• Writ of Execution: court-ordered sale

GarnishmentCreditor permitted to collect a debt by seizing

property held by third party (usually wages held by debtor’s employer)

Laws Assisting Creditors Mortgage Foreclosure

Creditor (mortgagee) has the right to foreclose on property upon debtor’s (mortgagor) default.

Suretyship and GuarantyThird person promises to pay debt owed by

another• Surety (3rd person is primarily liable)• Guaranty (3rd person is secondarily liable)

Laws Assisting Debtors Homestead Exemption

Family home free from claims of unsecured creditors or trustees in bankruptcy.

Other Exemptions:Household furnitureClothing and personal possessionsVehicleTools of the trade

Bankruptcy and Reorganization

Bankruptcy provides different relief:Chapter 7: Liquidation (wipe out all debt)Chapter 11: Corporate ReorganizationsChapter 12: Family FarmersChapter 13: Adjustment of Individuals’

Debts with a payment plan.

Chapter 7-Liquidation Most familiar. Any person (including corporation) All debts are discharged. Begins with a voluntary or involuntary

Filing of a Petition (Automatic Stay)Voluntary: filed by debtor Involuntary: creditors force debtor to file

Order for Relief

Chapter 7 Debtor must understand there are other

chapters available. Debtor does not have to be insolvent. List secured and unsecured creditors and

addresses and amount of money owed. List of all property owned including property claimed; current income and expenses.

Swear to these and sign. Federal crime to misrepresent.

Chapter 7 Automatic Stay upon Filing of Petition:

Either voluntary or involuntary. Creditors cannot commence or continue

most legal actions. Damages for violation of stay. Creditors can get “adequate protection.”

Periodic or one time cash payments or equivalent.

Chapter 7 – Creditors Ten-thirty days after filing, Court calls

meeting of creditors. Debtor is examined under oath about his debts and assets.

Within 90 days, Creditors must file “proof of claim” with court clerk.

Leases cannot be for more than one year.

Chapter 7 – CreditorsAllowed unless disputed.If claim is disputed or unliquidated,

court will decide value.It is a crime to file false claim.Employment contracts and real

estate.

Chapter 7 – PropertyDebtor’s Estate includes:

All Debtor’s legal and equitable interests in property presently held, including community property;

Property transferred in a “voidable” transaction; and

Property which Debtor becomes entitled within 180 days after filing.

Chapter 7 – PropertyEstate includes (cont’d):

Proceeds and profits from the property of the estate.

After-acquired property such as inheritances, property settlements, and life insurance death proceeds.

Chapter 7 – Property Exempted Property (Federal)

Up to $17,425 in home equityUp to $2,775 in carUp to $9,300 in personal possessions (up to $450

per item)Up to $1,150 in jewelryUp to $1,750 in toolsSocial security, alimony and support payments.

Chapter 7 – Trustee Court-appointed until first meeting

of creditors.Creditors elect permanent trusteeAdministers estate.Collects proceeds, liquidates assets

and pay Creditors in order of priority.

Chapter 7 – Trustee’s Powers

Trustee has rights to get Debtor’s property back from those Creditors that he can defeat by asserting the rights of:Debtor against the creditors.Lien creditors against the creditors.Bona fide purchaser against the creditors.Trustee still loses to the PMSI creditor who perfects

within his “magic” 10-day period. Trustee can stand in shoes of debtor and

assert any lack of capacity or lack of assent.

Trustee -- LiensTrustee can avoid statutory liens

that became effective when bankruptcy petition filed, or when debtor became insolvent.

Can avoid liens which were unperfected on date of bankruptcy.

Fraudulent TransfersTrustee may avoid fraudulent

transfers made within one year of filing of petition.

Trustee may proceed under state law for fraud with a 3 year statute of limitations.

Chapter 7 -- Property Distribution If Secured property:

Consumer debtors. • Have 30 days from filing petition or before first

meeting of creditors.• Debtor must tell what she intends to do with

collateral-- keep or surrender.• Trustee must enforce within 45 days.

If surrenders: creditor can keep or sell.• If creditor keeps = full satisfaction of debt.• If creditor sells = can use extra for costs, or can

become unsecured creditor for deficiency.

Unsecured propertyPaid according to bankruptcy law.All of one class must be paid before moving to

next.Creditor within last class receive

proportionately if not enough.See Priority List in text.All creditors paid, trustee gives extra back to

debtor.

Chapter 7 -- Property Distribution

Chapter 7 -- DischargeExemptions.Objections to Discharge.Effect of Discharge.Revocation of Discharge.Reaffirmation of a Debt.

Exceptions to DischargeClaims for back taxes.Claims for amounts borrowed by Debtor

to pay federal taxes.Claims against property/money obtained

by Debtor under false pretenses.Claims by Creditors who did not know

about bankruptcy.

Chapter 7 -- Reaffirmation

Debtor may wish to pay a debt notwithstanding the debt could be discharged in bankruptcy.

Agreement is filed with court.Debtor can rescind agreement at

any time.

Chapter 11 -- Reorganizations

Chapter 11—Corporations. Debtor and Creditors formulate a plan under which the Debtor pays a portion of its debts and is discharged of the rest.

Same debtors as are eligible under Chapter 7.

Chapter 11“Fast tract” Chapter 11 for small

business debtors whose liabilities do no exceed $2 million and who do not own or manage real estate.

“Workouts” (private negotiated settlements).

Chapter 11Debtor in Possession (DIP).

Trustee may be appointed.DIP has same powers as trustee in

Chapter 7.• Strong-arm clause.

Collective Bargaining Agreements.Creditors Committees.

Chapter 11Reorganization Plan

Rehabilitates debtor and conserves estatePlan must be equitable and:

• Designate classes of claims and interests.

• Specify treatment to be afforded the classes.

• Provide adequate means for execution.

Chapter 13 – Repayment

Chapter 13: Individuals’ Repayment Plans. For individuals with regular income who owe fixed unsecured debts of <$290,525 or fixed secured debts of <$871,550.

Not for partnerships, corporations.

Chapter 13 – Repayment Repayment Plan

For all or a portion of debts to be paid during a period not to exceed 3 years.

Confirmation of the Plan• Hearing for interested parties to object to plan.• Court will confirm (order) the plan after creditors

approve.Objections to the Plan

Discharge balance of debt (after completion of all payments in the plan)

Chapter 12 – Family Farmer

Chapter 12: Family Farmer Plans “Family Farmer”: 50% of gross income

comes from farming and whose debts are 80% farm related.

Procedure for filing.Content of plan.Court confirmation.