Security Interests, Creditors’ Rights, and Bankruptcy

1. BUSINESS LAW TODAYEssentials 9th Ed.Roger LeRoy Miller - Institute for University Studies, Arlington, TexasGaylord A. Jentz - University of Texas at Austin, Emeritus Security Interests, Creditors’ Rights, and Bankruptcy Chapter 16

2. Learning Objectives • What is a security interest? What is the most common method of perfecting security interest under Article 9? • What is garnishment? When might a creditor undertake a garnishment proceeding? • In a bankruptcy proceeding, what constitutes the debtor’s estate in property? What property is exempt under federal bankruptcy law? • What is the difference between an exception to discharge and objection to discharge? • In a Chapter 11 reorganization, what is the role of the debtor in possession?

3. Security Interests: 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.

4. Creating a Security Interest • Creating a Security Interest. • Collateral 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.

5. Creating a Security Interest • Once these requirements are met, the creditor’s rights “ATTACH” to the collateral, giving the creditor an enforceable security interest. • Written or Authenticated Security Agreement. • When collateral is NOT in possession of secured party. Document must contain description of property.

6. Perfecting a Security Interest • Perfection is the legal process by which the secured party protects herself from third party claims against the same collateral, which is divided into two categories: • Tangible: Consumer goods, equipment, farm products, inventory, accessions. • Intangible: Chattel Paper, Instruments, Accounts, Deposit Accounts, General Intangibles.

7. Perfecting by Filing • File financing statement with proper state authority. Gives 3rd parties notice. Lasts 5 years. Financing statement must provide: • Proper Legal Name of Debtor, Secured Party, and description of Collateral. • Improper filing reduces secured party’s claim in bankruptcy to an unsecured creditor.

9. Perfection Without Filing • Perfection by Possession: collateral is in the possession of the secured party. • Perfection by Attachment: • Purchase Money Security Interest (PMSI) in consumer goods and seller/manufacturer provides financing. • Automatic Perfection: at the time of credit sale, unless certificate of title is required (automobile, mobile homes, tractors, etc).

10. Effective Time Duration of Perfection • Financing Statement is effective FIVE (5) years from date of filing. • If continuation statement is filed six months prior to expiration, continues for another five years. • Can continue indefinitely. • If Financing Statement lapses, becomes unperfected. • Purchaser for value can acquire the collateral as if the security interest had never been perfected.

11. The Scope of a Security Interest • Proceeds: whatever received when collateral sold or disposed of. • After-Acquired Property. • Security Agreement may provide for a security interest in property acquired after execution of security agreement. • Future Advances. • Continuing line of credit. • Subject to security interest. • Floating Liens • Security interest in proceeds in after-acquired property, or • Collateral subject to future advances.

12. Priorities • General Rule is that a first-in-time perfected security interest has priority over: • Unsecured creditors and unperfected security interests. • Conflicting perfected security interests. • Conflicting unperfected security interests.

13. Priorities • Buyers in the Ordinary Course of Business: take goods free from any security interest, even if perfected and the buyer knows of its existence. • Good faith, without notice. • Exception to the First-in-Time Rule: PMSI in equipment that is not inventory. • Exception to First-in-Time Rule: security interests in inventory. • Buyers of the Collateral: may conflict with perfected interests on debtor’s default. 

14. Priorities • Buyers of the Collateral. • Conflicts with Perfected Secured Party. • Buyers in the Ordinary Course of Business. • Buyers not in the Ordinary Course of Business of Consumer Goods. • Buyers of Chattel Paper. • Buyers of Instruments, documents or securities. • Buyers of Farm Products.

15. Default and Remedies • Not expressly defined by Article 9 but rather in the security agreement. Any breach can constitute default. • Basic Remedies are cumulative: • Repossession of the Collateral (Self-Help). • Judicial Remedies: execution and levy.

16. Disposition of Collateral • 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.

17. Disposition of Collateral • Disposition Procedures: • Flexible but commercially reasonable manner. • Public or private sale with notice (unless perishable). • Secured party may purchase collateral at a public (but not private) sale. • “Satisfactory” price is only one factor: CASE 16.1Hicklin v. Onyx Acceptance Co. (2009). Seller did not sell car in commercially reasonable manner.

18. Disposition of the Collateral • Distribution of Proceeds • Expenses balance of debt junior liens then balance to secured party. • Noncash Proceeds. • Deficiency Judgment. • Debtor is liable for deficiency owing to the creditor. • Redemption Rights. • Debtor can ‘redeem’ property by tendering performance of all obligations prior to sale or discharge.

19. Additional 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.

20. Garnishment • Garnishment. • Creditor permitted to collect a debt by seizing property held by third party (usually wages held by debtor’s employer).

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

22. Suretyship and Guaranty • Third person promises to pay debt owed by another.

23. Suretyship and Guaranty • Third person promises to pay debt owed by another. • Surety (3rd person is primarily liable). • Guaranty (3rd person is secondarily liable). • Must be in writing unless the “main purpose” of the guaranty is to personally benefit the guarantor. • CASE 16.2Capital Color Printing, Inc. v. Ahern. (2008). Document satisfied Statute of Frauds, identified Quality Printing as the customer with a signed personal guaranty.

24. Suretyship and Guaranty • Actions that Release the Surety and Guarantor. • Defenses of Surety and Guarantor: • Can assert any defense of principal debtor except debtor’s incapacity or bankruptcy (which are personal to debtor). • Rights of Surety and Guarantor: • Subrogation. • Reimbursement (from debtor). • Contribution.

25. Laws Assisting Debtors • Homestead Exemption. • Family home free from claims of unsecured creditors or trustees in bankruptcy. • Other Exemptions: • Household furniture. • Clothing and personal possessions. • Vehicle. • Tools of the trade.

26. Bankruptcy Proceedings • Article I, Section 8 of the U.S. Constitution. Federal jurisdiction. • Bankruptcy Reform Act of 2005 significant modified bankruptcy laws. • Federal Bankruptcy Courts under U.S. district courts, can appeal to district courts. • Federally appointed judges.

27. Types of Bankruptcy Relief • Bankruptcy provides different relief: • Chapter 7: Liquidation. • Chapter 11: Corporate Reorganizations. • Chapter 12: Family Farmers. • Chapter 13: Adjustment of Individuals’ Debts with a payment plan. • Special Treatment of Consumer-Debtors: debts from consumer purchases.

28. Chapter 7 - Liquidation • Any person (including corporation) can file. • All debts are liquidated (discharged). • Begins with a voluntary or involuntary Filing of a Petition (Automatic Stay). • Voluntary: filed by debtor. • Involuntary: creditors force debtor to file. • 2005 Act: Debtors must go through counseling with approved nonprofit agency during the 180 days prior to filing.

29. Chapter 7 • 2005 Act: Attorney must file affidavit explaining other chapters available to debtor. • 2005 Act: Attorney must make reasonable attempt to verify accuracy of petition and schedules. Failure to do so could be perjury. • List secured and unsecured creditors and addresses and amount of money owed on schedules. List of all property owned including property claimed; current income and expenses. • Swear to these and sign. Federal crime to misrepresent.

30. ‘Substantial Abuse’ • Under 2005 Act, Substantial Abuse WILL be Presumed If: • Based on “Means Testing” debtor’s family income is greater than state median income. • Creditors have standing to dismiss petition. • Substantial will NOT be Presumed If: • Based on “Means Testing” debtor’s family income is less than state median income. • But creditors have no standing to dismiss. • Order for Relief.

31. Involuntary Chapter 7 • Occurs when debtor’s creditors force debtor into bankruptcy proceedings. • Can occur if: • If debtor has twelve or more creditors, three or more with claims totaling $13,475, or • If debtor has twelve or more creditors, one has a claim totaling $13,475.

32. Automatic Stay • Automatic Stay upon Filing either Voluntary or Involuntary Petition. • Creditors cannot commence or continue most legal actions. • Damages for violation of stay. • CASE 16.3In re Kuehn (2009). Kuehn owed $6,000 in tuition and filed bankruptcy. University’s refusal to provide transcript, unless she paid the tuition, violates automatic stay.

33. Automatic Stay • Exceptions to Automatic Stay: • Collection can continue for domestic-support obligations. • Proceedings against debtor in divorce, domestic violence can continue. • Investigations by securities enforcement are not stayed. • Limitations on Automatic Stay: • Creditors can get “adequate protection.” • Periodic or one time cash payments or equivalent. • Reaffirmation.

34. Property of the Estate • Debtor’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.

35. Property of the Estate • Estate 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.

36. Exemptions • Up to $20,200 in home equity. • Up to $3,225 in car. • Up to $10,775 in personal possessions (up to $525 per item). • Up to $1,350 in jewelry. • Up to $2,025 in tools. • Social security, alimony and support payments. • Up to $20,200 in personal injury awards. • 2005 Act: Homestead Exemption. • Debtor must have lived in state two years. • Up to $136,875 of equity.

37. Trustee’s Powers • Court-appointed until first meeting of creditors. • Creditors elect permanent trustee • Administers estate. • Collects proceeds, liquidates assets and pay Creditors in order of priority.

38. Trustee Rights and Duties • New Duties under the 2005 Bankruptcy Reform Act: • Promptly review all materials filed by debtor. • Not later than 40 days after filing, Trustee must file: a motion to dismiss the case, change to Chapter 13, or why motion would not be appropriate. • New duties to protect domestic-support obligations.

39. Trustee Rights and Duties • Right to Possession of Debtor’s Property. • Constructive Possession (change lock on door). • Avoidance Powers. • Trustee can set aside a sale or transfer of debtor’s property (2005 Act: cannot avoid bona fide domestic support debt). • Voidable Rights. • Trustee can stand in shoes of debtor and assert any lack of capacity or lack of assent.

40. Preferences • A Debtor is not permitted to transfer property or make a payment that favors—or gives a preference to—one creditor over another. • For a Trustee to recover preferential payment, Debtor must be insolvent and transferred property for pre-existing debt within previous 90 days. • 2005 Act: permits consumer-debtor to transfer any property to creditor up to $5,475.

41. Preferences • Trustee can use preferential payment to pay a real preexisting debt, not for current consideration. • Creditor gets more than he would in a Chapter 7. • Consumer can transfer up to $5,000 without constituting a preference. • Domestic-support debts are not preferences.

42. Distribution of Property

43. Distribution of Property • If Secured Creditors: • 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.

44. Distribution to Unsecured Creditors • Unsecured property: • Paid 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.

45. Chapter 7—Discharge • Exceptions. • Objections to Discharge.  • Effect of Discharge. • Revocation of Discharge. • Reaffirmation of a Debt.

46. Chapter 7—Exceptions to Discharge • Claims 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. • Student Loans.

47. Objections to Discharge • Bankruptcy may also deny the discharge of the debtor (not the debt): • If debtor intentional concealment or destruction of property or financial records. • Granting of discharge within 8 years of previous bankruptcy discharge. • Debtor’s failure to complete credit counseling courses. • Debtor found guilty of felony. • Revocation of Discharge.

48. Reaffirmation of Debt • 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 before discharge.

49. Chapter 11-Reorganization • 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. • Focus is on “Best Interests” of the Creditors.

50. Chapter 11-Reorganization • “Fast track” 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).