R8.1 – Suretyship and Creditor's Rights

Question 1

Suretyship

Answer 1

Surety = one who is liable for the debt or obligation of another.

Suretyship involves three parties:

1. Creditor (the obligee)
2. Principal (debtor or obligor)
3. Surety

Question 2

Surety vs. Guarantor

Answer 2

Surety directly liable on his contract

Guarantor – liable to creditor only if the debtor does not perform his duty to the creditor

Guarantor of collectibility – liable only if creditor unable to collect from debtor after exhausting all legal remedies including demand, suit judgement, and exhaustion of all supplementary proceedings.

Question 3

The Statute of Frauds requires written evidence of suretyship

Answer 3

A suretyship undertaking not evidenced by a written memorandum is unenforceable

Question 4

Gratuitous Surety

Answer 4

Not compensated for his promise to the creditor

If the creditor does anything that varies the gratuitous surety’s risk IN ANY WAY, the surety’s obligation is discharged

To be binding, surety’s promise must be a condition of the creditor making the loan

Generally, suretyship promise made after the loan contract has been made will not bind the contract

Question 5

Compensated surety

Answer 5

Paid for his promise to the creditor.

Only changes by the creditor that MATERIALLY INCREASE the surety’s risk will release a compensated surety

Question 6

Surety’s Rights – Against Creditor

Answer 6

When a debtor defaults in a suretyship situation, the creditor may do any of the following in any order:
– Immediately demand payment from the surety
– Immediately demand payment from the debtor
– Immediately go after collateral if there is any

Creditor not required to go after debtor or collateral, or apply security held to reduce debt, before going after surety
– Exception: Guarantor of collectibility - creditor must go after debtor and collateral before coming to guarantor of collectibility.

Creditor does not have to notify the surety if principal default

Question 7

Surety’s Rights – Against Principal Debtor

Answer 7

1. Exoneration
   = suit to compel debtor to pay
   – Surety can do this prior to paying creditor
   – Exoneration does not affect creditor’s right to proceed against a surety
2. Subrogation
   = enforcement of creditor’s right against debtor
   – Once the surety pays the creditor, the surety may enforce any right that the creditor had against the debtor
3. Reimbursement/Right to indemnification = suit against principal after payment
   – The surety is entitled to reimbursement from the debtor for any amounts that the surety paid

Question 8

Surety’s Rights – Against Co-Sureties: Exoneration

Answer 8

Creditor has moved against only one surety
BUT
Surety has not yet paid more than his share of debt

Surety compels co-sureties by a suit in equity for exoneration to pay their pro-rata shares of the debt

Question 9

Surety’s Rights – Against Co-Sureties: Consideration

Answer 9

Creditor has moved against one surety
AND
Surety has paid more than his sure of debt

Surety compels co-sureties to pay their shares of the debt

If contract does not specify liability of each surety, pro-rata share determined by number solvent sureties

If principal has paid back part of debt, debt is reduced by part payment but each co-surety still liable for original amount stated in agreement.
– Payment of more than his pro-rata share of reduced debt entitles surety to contribution from co-sureties

If co-surety’s obligation discharged in bankruptcy, his agreed share is ignored in determining the pro-rata share of remaining co-sureties.

Question 10

Co-Sureties

Answer 10

Co-sureties = two or more sureties of the same obligation.

Co-sureties are jointly and severally liable

Question 11

Surety’s Rights – Against Co-Sureties: Consideration, Co-Surety’s Obligation Discharged in Bankruptcy Example

Answer 11

C loans D $9,000, and X, Y, and Z agree to be co-sureties. The maximum liability for each is X: $6,000, Y = $3,000, Z = $9,000. D makes loan payments of $3,000, and then defaults. Z pays the entire balance of $6,000. X’s debts, including his surety obligations, are discharged in bankruptcy

Pro-rata share before X’s debts was discharged
X = 6,000 ÷ (6,000 + 3,000 + 9,000) = 0.33
Y = 3,000 ÷ (6,000 + 3,000 + 9,000) = 0.17
Z = 9,000 ÷ (6,000 + 3,000 + 9,000) = 0.33

Pro-rata share now that X’s debts are discharge
X = 0
Y = 3,000 ÷ (3,000 + 9,000) = 0.25
Z = 9,000 ÷ (3,000 + 9,000) = 0.75
– Z can not collect anything from X
– Z can collect 0.25 x $6,000 = $1,500 from Y

Question 12

Defenses of Surety

Answer 12

1. Fraud
2. Duress and Illegality
3. Discharge of Debtor’s obligations
4. Surety’s contract incapacity or bankruptcy
5. Variation of Surety’s Risk

Question 13

Defenses of Surety – Fraud

Answer 13

Fraud by creditor is defense against creditor
– Debtor was induced into the debt agreement by the creditor’s fraud

Fraud by debtor not a defense against creditor unless creditor knew of fraud

Question 14

Defenses of Surety – Duress and Illegality

Answer 14

The surety is not liable if the debtor’s promise was obtained by duress or if the debtor’s obligation was illegal

Question 15

Defenses of Surety – Discharge of debtor’s obligations

Answer 15

Payment or tender of payment by debtor or a third party

Question 16

Defenses of Surety – Surety’s contract incapacity or bankruptcy

Answer 16

Contract incapacity = minority or adjudicated insantiy

Question 17

Defenses of Surety – Variation of Surety’s Risk: Alteration of Contract

Answer 17

Alteration that leads to ANY CHANGE in surety’s risk (even if decrease) releases GRATUITOUS surety

Alteration that leads to MATERIAL INCREASE in surety’s risk releases COMPENSATED surety

Question 18

Defenses of Surety – Variation of Surety’s Risk: Extension of time of debtor’s payment

Answer 18

If creditor agreed to extension
–ANY EXTENSION of time releases GRATUITOUS surety
–Compensated surety is released only if the extension of time MATERIALLY INCREASES the surety’s risk

Surety is not released if creditor did not agree to extend time

Question 19

Defenses of Surety – Variation of Surety’s Risk: Loss of Security

Answer 19

Released security –Surety discharged in the amount of the value of the security released

Security lost due to creditor’s inaction – Surety discharged in amount of value of security unless substantial and burdensome acts required to protect security

Question 20

Defenses of Surety – Variation of Surety’s Risk: Release of co-surety without other co-surety’s consent

Answer 20

Remaining surety discharged in the amount he could have recovered from released surety

Question 21

Defenses not Available to Surety

Answer 21

Debtor’s fraud or duress upon the surety
- Can be used if creditor aware of fraud
– Can be used if fraud makes surety’s undertaking absolutely void

Debtor’s contractual capacity
– Surety’s own contractual capacity not debtor’s contractual capacity is a defense

Bankruptcy of debtor
–Bankruptcy of debtor discharges creditor and surety’s rights with respect to debtor; it does not discharge creditor’s rights with respect to surety
–Surety’s own bankruptcy is a defense

Question 22

Creditor’s Rights Outside of Suretyship –Debtor Remedies

Answer 22

Debtor’s bankruptcy

Creditor’s composition
– Entered into by debtor and at least 2 creditors that debtor has defaulted on
–Each creditor agrees to take less that his full claim
– Debtor discharged in full for debts of participating creditors after debtor pays agreed amount

Assignment for the benefit of creditors
– Debtor transfers some or all his property to a trustee
–Trustee disposes of property and uses proceeds to satisfy debtor’s debt
– Debtor not discharged from unpaid debt

Question 23

Judicial Liens and Garnishment

Answer 23

Creditors without security interest or mortgages in debtor’s property can gain rights in the property through
– Imposition of a judicial lien on property in debtor’s hands
–Garnishment of property in hands of 3rd party

Question 24

Judicial Lien

Answer 24

Creditor asks court to impose lien on specific property owned and possessed by creditor

Court imposes lien and issues writ directing authorizes to seize property, sell it, and turn proceeds over to creditor

Personal property lien – lien attaches upon seizure by sheriff

Real property lien – lien attaches on date judgment docketed by court

Generally, Creditor can ask only if debtor adjudged to owe creditor and judgement has gone unsatisfied

Creditor can ask for lien even before judgment has been rendered if he believes debtor will not pay
– There will be adhering before writ issued
– Courts will ask creditor to post bond for damages that result if creditor does not prevail in suit.

Question 25

Garnishment

Answer 25

Writ of garnishment orders 3rd party to turn over property to creditor or to beheld personally liable for value of property not turned over.

Social Security payments are not subject to garnishment, execution, levy, or attachment.

Question 26

Judicial Liens and Garnishment – Exceptions

Answer 26

Certain items of a person’s household up to a certain amount are excluded from liens of most creditors
– Does not apply to persons with PMSI in personal property or purchase money mortgages against real property

Personal injury awards exempted from liens
– Not protected vs. liens of creditors who rendered medical assistance

The amount of an employee’s wages that can be garnished is limited.

No protection from IRS

Question 27

Mechanic’s and Artisan’s Liens

Answer 27

Mechanic or artisan who works on property and improves and repairs it automatically has lien on property for the price of repairs

Must be in lienor’s possession

Lien dissolves as soon as lienor lets owner have property back

Lienor can sell retained property or foreclose on property by filing suit
–Must give owner notice

Question 28

Materialsman’s Lien

Answer 28

For contractors who work on, or provide supplies for, real property improvements

Must file notice with local recorder of deeds.

Question 29

Fraudulent Conveyances

Answer 29

Fraudulent conveyances = debtor transfers property with intent to hinder, delay, or degrade creditors

Indications of fraudulent conveyances
– Transfer to an insider
– Debtor retained possession or control of property
– Transfer not disclosed, or was concealed
– Transfer of substantially all of debtor’s assets
– Value received by debtor for asset not reasonable
– Debtor insolvent shortly after transfer

Question 30

Fraudulent Conveyances – Remedies

Answer 30

Creditor can not repossess fraudulently transferred property without legal process

Creditor may
– Avoid transfer to extent necessary to satisfy his claim
– Obtain attachment vs. transferred or other property
– Obtain injunction vs. further transfer by debtor or transferee, of asset transferred.

Question 31

Fair Debt Collection Practices Act (FDCPA)

Answer 31

FDCPA curb abuses by collection agencies and collecting consumer debts

Does not apply to a creditor attempting to collect its own debts; just the services to collect consumer debts for others.

Restrict collection agencies’ ability to call third parties, such as relatives of the debtor, to indirectly pressure the debtor.

Can contact third party to disclose debtor’s whereabouts but can not disclose that it is a collection agency or that debtor owes a debt

Question 32

Fair Debt Collection Practices Act (FDCPA) – Prohibited behavior

Answer 32

Contacting the debtor at inconvenient all unusual times; in most cases, “convenient” times are between 8 pm and 9 pm.

Contacting the debtor directly if the debtor is represented by an attorney

Using harassing or abusive language in talking to debtor.

Making false or misleading claims

Contacting debtor at place of employment if employer objects

Question 33

Fair Debt Collection Practices Act (FDCPA) – Remedies

Answer 33

Debtor’s power to terminate contacts
– Notifies agency in writing the debtor will not pay and to stop further communication
– Agency must stop communication except to inform debtor it is bringing lawsuit or seeking other remedies

Damages
– Debtors have right to sue for actual damages cause by collection agency’s misconduct
–Statutory $1,2000 damage award

Federal Trade Commission
– FTC can bring administrative enforcement actions under the act to force a collection agency to comply with the act’s provisions