II. Business Law-Debtor-Creditor Relationships Flashcards
II. Business Law-Debtor-Creditor Relationships
- Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
- Article 9 UCC Secured Transactions
- Bankruptcy and Insolvency
II. Business Law-Debtor-Creditor Relationships
- Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
- Suretyship: Introduction, Creation, and Types
Introduction: The parties(Creditor/ Principal debtor/ Surety or guarantor)
Creation: 1) must be in writing and signed by the surety (guarantor)
2) consideration is Not Required
II. Business Law-Debtor-Creditor Relationships
- Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
- Suretyship: Introduction, Creation, and Types
Edwards Corp. lent Lark $200,000. At Edwards’s request, Lark entered into an agreement with Owen and Ward for them to act as compensated co-sureties on the loan in the amount of $200,000 each.
If Edwards releases Ward without Owen’s or Lark’s consent, and Lark later defaults, which of the following statements is correct?
- Lark will be released for 50% of the loan balance.
- Owen will be liable for the entire loan balance.
- Owen will be liable for 50% of the loan balance.
- Edwards’s release of Ward will have no effect on Lark’s and Owen’s liability to Edwards.
Since Edwards released one of the two sureties, the remaining surety is liable for only half of the entire debt. Until the release, Edwards could have collected the entire debt from either surety, and then that surety could have sued the other surety for half of that amount under the right of contribution. However, now Edwards can only collect 50% of the debt from Owen, because he has eliminated Owen’s ability to collect anything from Ward. Lark is still liable for the entire amount.
C
II. Business Law-Debtor-Creditor Relationships
- Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
- Suretyship: Introduction, Creation, and Types
AICPA.921126REG-BL
Ivor borrowed $420,000 from Lear Bank. At Lear’s request, Ivor entered into an agreement with Ash, Kane, and Queen for them to act as co-sureties on the loan. The agreement between Ivor and the co-sureties provided that the maximum liability of each co-surety was: Ash, $84,000; Kane, $126,000; and Queen, $210,000. After making several payments, Ivor defaulted on the loan. The balance was $280,000.
If Queen pays $210,000 and Ivor subsequently pays $70,000, what amounts may Queen recover from Ash and Kane?
- $0 from Ash and $0 from Kane.
- $42,000 from Ash and $63,000 from Kane.
- $70,000 from Ash and $70,000 from Kane.
- $56,000 from Ash and $84,000 from Kane.
2.
The total maximum amount that the sureties stand to lose is $84,000 + $126,000 + $210,000 = $420,000. If the loss is below the maximums, each co-surety is ultimately liable for a proportionate share of the total debt based on their maximum liability. For example, Queen will bear 50% of any loss because Queen is liable for $210,000 of the $420,000 total maximum, or 50%.
Here, after Ivor has paid in $70,000 toward his loan balance of $280,000, the loan balance stands at $210,000. The exact order of payments is not important; what is important is that at the end of the day all co-sureties pay their fair share. Since the debt balance is $210,000, and the maximum total the sureties stand to lose is $420,000, each surety will pay exactly 1/2 of their personal maximum liability. Since Queen paid the entire debt to begin with, Queen is able to recover half of Ash’s maximum, or $42,000, and half of Kane’s maximum, or $63,000.
II. Business Law-Debtor-Creditor Relationships
- Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
- Suretyship: Rights of Parties
II. Rights of the Surety or Guarantor
- Exoneration—This equitable right permits a surety to petition the court to order the creditor by court decree to exhaust recovery against the principal debtor before holding the surety liable.
- Reimbursement and Indemnity
- Subrogation—Upon payment, the surety succeeds to any rights the creditor has (stands in the shoes of the creditor). These include the following.
- Right of Contribution—Applies when two or more sureties are liable on the same obligation to the same creditor and, upon debtor’s default, one cosurety pays more than his or her proportionate share of the obligation. The right of contribution entitles this cosurety to recover the amount paid above his or her share owed from the other cosurety.
II. Business Law-Debtor-Creditor Relationships
- Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
- Suretyship: Rights of Parties
III. Defenses of the Parties—Events that Do Not Release or Discharge the Surety from Liability
- Insolvency of the Principal Debtor
- Bankruptcy of the Principal Debtor
- Fraud or Misrepresentation by the Debtor
- Principal Debtor’s Incapacity
- Death of the Principal Debtor
- Release—Release by the creditor of the principal debtor, without the surety’s consent and with the creditor reserving rights against the surety, does not result in a release of the surety.
- Changes or Modification
II. Business Law-Debtor-Creditor Relationships
- Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
- Suretyship: Rights of Parties
IV. Defenses of the Parties—Events that Do Result in the Release of the Surety
- Principal Debt Paid
- Surety’s Incapacity
- Guarantor’s Discharge Decree in Bankruptcy
- Statute of Limitations Expires
- Fraud or Misrepresentation by the Creditor
- Release—Release of the principal debtor without the surety’s consent is also a release from liability of the surety. Collateral of the principal debtor held by either the creditor or the guarantor can still be used by the creditor to satisfy the debt.
- Refusal of Principal Debtor’s Tender—If the principal debtor tenders payment to the creditor under a surety contract, and the creditor refuses the proper tender, the surety is completely discharged from liability.
- Material Alteration by Creditor
- Creditor’s Failure to Disclose
- Changes and Modifications where There Is an Uncompensated Surety
- Surrender or Impairment of Debtor’s Collateral
- Special Release for Guaranty of Collections
- Statute of Frauds—Surety contracts must be in writing. A surety is always released from liability under an oral suretyship agreement.
II. Business Law-Debtor-Creditor Relationships
- Rights, Duties and Liabilities of Debtors, Creditors, Sureties, and Guarantors
- Suretyship: Rights of Parties
Modifications
- Evans is a gratuitous guarantor on a loan made to her daughter by West Bank. The loan is due in one month. Without Evans’ consent, her daughter and West Bank agree to extend the loan period for one month without interest or other fees charged. After the one month, the daughter goes into default. Can Evans be held liable on her surety contract? TRUE
- Gail is a gratuitous guarantor on a loan West Bank made to her son. It is an absolute guaranty. One month before the loan is due, Gail’s son and West Bank enter into a written agreement, without Gail’s consent, to extend the loan with a 2% increase in the interest rate for two years. This modification completely discharges Gail’s surety liability. TRUE
II. Business Law-Debtor-Creditor Relationships
- Article 9 UCC secured Transactions
- Introduction and Creation of Security Interests
C. Article 9 security interests apply to personal property or fixtures including goods, documents, instruments, general intangibles, chattel paper, and accounts, agricultural liens, sales of accounts, and promissory notes, and commercial consignments of $1,000 or more—UCC 9-109.
- Transactions excluded from secured transactions law (other laws apply):
- Landlord’s liens
- Mechanic’s liens
- Artisan’s liens
- Assignment of wage
- Tort claims (see discussion of commercial tort claims below)
- Insurance (except proceeds from policies covering covered collateral)
- Judgments
- Leases
- Real estate mortgages
II. Business Law-Debtor-Creditor Relationships
- Article 9 UCC secured Transactions
- Introduction and Creation of Security Interests
To create a security interest
- the creditor must give value,
- the debtor must have rights in the collateral,
- the creditor must take possession of the collateral or obtain the agreement in a signed or authenticated writing by the debtor.
Filing is not necessary to create an interest, it is only necessary to perfect an interest that has already been created.
II. Business Law-Debtor-Creditor Relationships
- Article 9 UCC secured Transactions
- Perfection of Security Interests
A filing is effective even if filing officer refuses it unless, generally—UCC 9–516(d):
- The proper filing fee is not tendered.
- The name of the debtor is not provided (which would prevent indexing).
- The record filing is communicated in an unauthorized (as set by the filing offices) medium.
- Where required, there is not a sufficient description of the realty—UCC 9–516(b).
II. Business Law-Debtor-Creditor Relationships
- Article 9 UCC secured Transactions
- Perfection of Security Interests
V. Automatic Perfection
PMSI
- A purchase money security interest (PMSI) in consumer goods
Ex1)
Beyer wants to purchase a large-screen TV from Sallor TV Inc. for $1,500. Beyer pays $200 down and signs a security agreement giving Sallor TV a security interest in the set being purchased until the balance of $1,300 is paid. Sallor has a PMSI.
Ex2)
Beyer wants to buy a large-screen TV from Sallor TV Inc. Beyer goes to West Bank seeking a loan to buy the set. West Bank loans Beyer the money and Beyer signs a security agreement giving West Bank a security interest in the to-be-purchased TV set. If Beyer does purchase the set, West Bank has a PMSI in the set. (Note: If Beyer purchases a large refrigeratorfreezer instead of the TV, West Bank would be an unsecured creditor.) - A sale of payment intangibles;
- A sale of promissory notes
II. Business Law-Debtor-Creditor Relationships
- Article 9 UCC secured Transactions
- Perfection of Security Interests
V. Automatic Perfection
Temporary Perfection
- There is temporary perfection without filing or possession for certificated securities, negotiable documents, and instruments if new value is given
- For 20 days from creation of the security interest by authenticated security agreement;
- Applicable only to certificated securities, negotiable documents, and instruments if new value is given.
- If perfected by possession—Remains perfected for 20 days without a filing:
- For goods in possession of a bailee or a negotiable document where the secured party makes the goods or documents available to the debtor for sale, exchange, loading, shipping, etc.
- For a certificated security or an instrument where the secured party delivers the security certificate or instrument to the debtor for sale, exchange, collection, presentation, etc.
- Need to take action for post-20-day period in order to retain perfection.
- When a debtor moves out of state—(debtor moved to a new jurisdiction)—UCC 9-316.
- If collateral is perfected in one jurisdiction (e.g., in state A) and the debtor moves into another jurisdiction (state B), the perfected secured party (state A) has priority over a subsequent perfected secured party in the new jurisdiction (state B) for a period of four months (or for the period of time remaining under the original perfection, whichever is earlier) from the date the debtor changes his/her location into the new jurisdiction (state B).
II. Business Law-Debtor-Creditor Relationships
- Article 9 UCC secured Transactions
- Priorities in Security Interests
When a perfected secured party’s interest has priority over:
- Unsecured creditors—Perfected secured creditor vs. unsecured creditor: Perfected secured creditor has priority.
- Unperfected secured parties—Perfected secured party vs. unperfected secured party: Perfected secured creditor has priority.
- Lien creditors—Perfected secured creditor vs. lien creditor —First to attach has priority. If the perfected secured party perfected before the lien attached, the perfected secured party has priority. If the lien attached prior to perfection, the lien creditor has priority.
- Judgment creditors—Perfected secured creditor vs. judgment creditor —First to attach has priority. If the perfected secured party perfected before the judgment lien attached, the perfected secured party has priority. If the judgment lien attached prior to perfection, the lien creditor has priority.
- Trustees in bankruptcy.
II. Business Law-Debtor-Creditor Relationships
- Article 9 UCC secured Transactions
- Priorities in Security Interests
II. Priority of Perfected Secured Parties over Buyers
- Buyers in the Ordinary Course of Business—Perfected secured creditor vs. buyer in the ordinary course of business:Buyer in the ordinary course of business wins and gets the goods/collateral.
- Buyer Not in the Ordinary Course of Business (perfected secured creditor)—Perfected secured party vs. buyer not in the ordinary course of business: Perfected secured party takes priority because buyers not in the ordinary course of business need to check for creditors’ interests before buying in less-than-ordinary transactions.
- Buyer Not in the Ordinary Course of (secured creditor only)—Secured creditor vs. buyer not in the ordinary course of business: Buyer will have priority unless the buyer is aware of the creditor’s secured interest.
- Buyer Not in the Ordinary Course of Business of Consumer Goods—A buyer not in the ordinary course of business of consumer goods will prevail over a previously perfected secured party by attachment (automatically)
If the buyer cannot establish all four of these requirements, the perfected secured party has priority.
- Buyer must give value to the seller-debtor;
- Buyer must not know of secured party’s security interest;
- Buyer must buy for personal use (as consumer goods); and
- Buyer must buy before the secured party perfects by filing a financing statement.
II. Business Law-Debtor-Creditor Relationships
- Article 9 UCC secured Transactions
- Rights of Secured Parties and Debtors
I. Creditor’s Options upon Debtor Default
F. Creditor’s Rights on Disposal of the Repossessed Collateral
- When the creditor must sell the collateral—If the collateral is consumer goods and 60% or more of the purchase price (or debt if the collateral was not fully financed by the creditor) has been paid, the creditor must sell it
- Time requirement for sale—If objection is received or the secured party must sell, the secured party must dispose of the collateral within 90 days after taking possession.
II. Business Law-Debtor-Creditor Relationships
- Bankruptcy and Insolvency
- Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy
I. When the Debtor Does Not Pay—Options for Creditors
- Creditors may execute rights under common law or statutory lien rights,
- under Article 9 secured transactions and/or suretyship agreements, or
- Repossess the collateral from the debtor, or
- Bring suit for collection of the amount due.
- under the Fair Debt Collections Practice Act (FDCPA) to try to collect the debt.
the creditor may:- Not talk to the debtor once the debtor has a lawyer.
- Contact third parties to obtain information about the debtor.
- File suit for collection.
- Not harass the debtor or call during certain time periods.
II. Business Law-Debtor-Creditor Relationships
- Bankruptcy and Insolvency
- Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy
III. Types of Bankruptcy
- Chapter 7—Referred to as “straight bankruptcy” or liquidation
- Permits voluntary and involuntary petitions
- Permits individuals and businesses to file
- Consumers generally cannot go directly to a Chapter 7 liquidation bankruptcy.
- >> means test
- examines the debtor’s monthly income
- not include income tax refunds SS retirement benefits
- If the debtor’s income is at or below the state median income, the bankruptcy can proceed
- If above >> examines expenses >> If there is sufficient income after the coverage for reasonable expenses to pay off debts, then the debtor is required to go through Chapter 13 bankruptcy.
- Trustee is appointed.
- Not eligible for Chapter 7:
- Railroads
- Domestic insurance companies
- Credit unions
- Savings and loans
- Banks and cooperative banks
- Certain SBA entities
II. Business Law-Debtor-Creditor Relationships
- Bankruptcy and Insolvency
- Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy
III. Types of Bankruptcy
- Chapter 9—Allows for the adjustment of debts of an insolvent municipality
- Permits voluntary petitions only by the municipality.
- This chapter is rarely addressed on the exam.
- Liquidation of the municipality’s assets is not permitted.
- Automatic stay, but there are limitations on the stay.
II. Business Law-Debtor-Creditor Relationships
- Bankruptcy and Insolvency
- Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy
III. Types of Bankruptcy
- Chapter 11—Allows for the reorganization of a business debtor to pay debts—a rehabilitation of a debtor.
- Permits voluntary and involuntary petitions.
- Allows companies to restructure and be discharged from certain debts.
- Generally, no trustee.
- Reorganization plan approved by half of the creditors with two-thirds of the total claims (includes shareholders).
- Court must approve.
- Savings and loans, banks, insurance companies are not eligible for Chapter 11.
II. Business Law-Debtor-Creditor Relationships
- Bankruptcy and Insolvency
- Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy
III. Types of Bankruptcy
- Chapter 12—Allows for the adjustment of debts of a family farmer and family fisherman—a rehabilitation of a person (including a corporation or a partnership) who meets the definition of a family farmer or fisherman (rarely tested on the exam).
- Permits only voluntary petitions by the family farmer or family fisherman.
- Chapter 12 is a more streamlined process than Chapter 11, which is used for other types of businesses.
- Automatic stay upon filing.
- Court appoints an interim trustee.
- Debt adjustment plan is established at a meeting of the creditors.
II. Business Law-Debtor-Creditor Relationships
- Bankruptcy and Insolvency
- Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy
III. Types of Bankruptcy
- Chapter 13 (also called a wage earner’s plan)—Allows for the adjustment of debts of an individual with regular income—a rehabilitation of only individuals (not partnerships or corporations) with limited total secured and unsecured debt amounts.
- Permits only voluntary petitions
- Less than $394,725/$419,275 in unsecured and less than $1,184,200/$1,257,850 in secured debt
- Always has a trustee
- Applies only to individuals (debt limits)
- Debtor’s plan
- Court confirmation
- Three to five years for plan—discharged if payment is made
- The debtor(s) must have undergone credit/debt counseling within the 180 days preceding the filing of Chapter 13 petition.
- The credit counseling must be from an agency approved by the U.S Trustee’s office.
- The agency gives debtors a certificate of completion that must be filed no later than 15 days after the bankruptcy is filed. date. The counseling service also provides a repayment plan that must then be approved by the court.
II. Business Law-Debtor-Creditor Relationships
- Bankruptcy and Insolvency
- Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy
IV. Commencement of Bankruptcy
- Chapter 7—Involuntarily petition into a Chapter 7 bankruptcy
- Same persons eligible as under voluntary Chapter 7 declaration except:
- All of the above exclusions from a voluntary Chapter 7 petition
- Nonprofit (not for profit) corporations
- Farmers (those that receive 80% or more of gross income from a farming operation and family farmers who meet that definition under a Chapter 12 bankruptcy—see detailed discussion below of Chapter 12 bankruptcies).
- Requirements for creditors’ involuntary petitions of a debtor into bankruptcy
- If the debtor has 12 or more unsecured creditors with noncontingent claims, the petition must be signed by three or more of these creditors whose aggregate claims are $15,775/$16,750 or more;
- If the debtor has less than 12 unsecured creditors with noncontingent claims, the petition requires only one (more can sign) of these creditors with an aggregate debt of $15,775/$16,750 or more to sign the involuntary petition.
- Same persons eligible as under voluntary Chapter 7 declaration except:
- Chapter 11 Bankruptcy
- Debt adjustment plan for businesses.
- If the business bankruptcy is filed by an individual (sole proprietorship), the same requirements for debt counseling within 180 days of the declaration of bankruptcy apply.
- same amounts and number of creditor requirements for Chapter 7 apply under Chapter 11. The same debt requirements apply for voluntary petitions.
- No trustee is appointed
- Chapter 13 Bankruptcy Consumer Debt Adjustment Plan
- Individuals and married couples with regular income who have been through credit counseling and have a proposed plan qualify if they have less than $394,725/$419,275 in unsecured debts and less than $1,184,200/$1,257,850 in secured debts. The court also applies the means test, which is an evaluation of whether the debtors have sufficient means to pay their debts.
- Corporations and partnerships do not qualify for Chapter 13 bankruptcy.
II. Business Law-Debtor-Creditor Relationships
- Bankruptcy and Insolvency
- Prebankruptcy Options, and Introduction to and Declaration of Bankruptcy
F. Effect of Bankruptcy Petition
- Upon the filing of a voluntary petition or the filing or granting of an involuntary petition, the court will grant an order for relief or a stay.
- Order for relief or stay means that creditors must stop collection and all pending credit proceedings (lien foreclosure; judicial liens, etc., as discussed in the earlier sections of this lesson) are stayed (stopped), and the debts and payments will be handled through the bankruptcy court.
- This stay sets in motion proceedings that lead to the discharge of the debtor’s debts.
- Some proceedings are not affected by the order for relief or stay including:
- Criminal prosecution of the debtor
- Collection of child support and/or alimony
- Tax audits
- Department of Housing and Urban Development (HUD) foreclosures
- Investigations by a securities regulatory agency (Securities Exchange Commission)
- Driver’s license suspensions
EX) If bridal store files for Chapter 7 bankruptcy, once the petition is filed, the owner of the bridal store no longer has access to the inventory (the dresses) and the trustee is in possession of those dresses.
NOTE: Under Chapter 11, there is no trustee, and the owner of the bridal store would continue to be in possession of the inventory (the dresses) and could continue to operate, including selling the dresses.