Chapter 21 Creditors’ Rights and Bankruptcy Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

21-2 Creditors’ Rights Credit that is not collateralized is known as unsecured debt. When the borrower has pledged collateral in order to obtain credit, the creditor is known as a secured creditor.

21-3 Perfection Perfection of security interest is the act of establishing the secured party’s rights ahead of the rights of other creditors.

21-4 Real Estate When real estate is used to collateralize a loan, the creditor takes an interest in the collateral through use of a mortgage.

21-5 Sureties and Guarantors 3 rd party also agrees to be responsible. When a party agrees to be primarily liable to pay the loan, she is known as a surety. When a party agrees only to be liable if the debtor actually defaults, she is known as a guarantor.

21-6 Personal Guaranties for Business Loans Business owners and managers often use suretyship and guaranty concepts in the context of a personal guaranty of a business loan, due to insufficient business credit.

21-7 Bankruptcy The most common forms of bankruptcy: –Chapter 7 (liquidation of debtor’s assets and discharge of debts), –Chapter 11(reorganization), and –Chapter 13 (debt adjustment and repayment of consumer debt).

21-8 Automatic Stay An automatic stay halts creditors, including government agencies, from all collection efforts, including litigation.

21-9 Chapter 7: Liquidation and Discharge Chapter 7 bankruptcy is perhaps the most extreme measure a business or individual can take. Debtor agrees to have most of her property liquidated and the the cash distributed to creditors. In exchange, the bankruptcy court gives legal protection to the debtor by discharging any remaining debts.

21-10 Exempt Property Up to $22,975 in equity in the debtor’s primary residence (homestead exemption) Interest in a motor vehicle up to $3,675 Interest up to $12,250 for household goods/furnishings Interest in jewelry up to $1,550 Right to receive Social Security and certain welfare benefits, alimony and child support, education savings accounts, and certain pension benefits Right to receive certain personal injury and other awards up to $22,975

21-11 Distribution 1)Administration expenses—court costs, trustee and attorney fees 2)Involuntary bankruptcy expenses incurred from date of filing to order of relief 3)Unpaid wages and commissions earned within 90 days, limited to $10,950 per claimant 4)Unsecured claims for contributions for employee benefits, 180 days prior to filing and $10,950 per employee 5)Claims by farmers or fisherman up to $5,400 6)Consumer deposits up to $2,425 7)Paternity, alimony, maintenance, and support debts 8)Certain taxes and penalties due to government 9)Claims of general creditors

21-12 Non-dischargeable 1)Claims for federal, state, and local taxes (including fines and penalties related to the taxes) within two years of the petition filing 2)Debts incurred within 60 days of petition for luxury goods of more than $1,000 from a single creditor; or cash advances in excess of $1,000 obtained by a debtor using credit 3)Alimony, maintenance and child support 4)Debts related to willful or malicious injury to a person or property 5)Debts related to court-ordered punitive damages against the debtor 6)Student loan debts, unless the debtor can prove “undue hardship”

21-13 Chapter 11: Reorganization Chapter 11 is best thought of as temporary protection for a corporation from creditors while the corporation goes through a planning process to pay creditors and continue business without the need to terminate the entity completely. Known as debtor in possession (DIP)

21-14 Reorganization Plan So long as the plan is fair, equitable, and feasible from the court’s perspective, the court will require creditors to accept the plan even over their objections. The plan is binding on all parties upon its approval by the court.

21-15 Chapter 13: Repayment Plan Chapter 13 allows debtors with a regular source of income to catch up on mortgage, car, tax, and domestic support payments, to repay an adjusted debt to certain creditors over time (typically five years), and still keep all of their assets.