CREDITOR’S AND DEBTOR’S RIGHTS CHAPTER 26 CREDITOR’S AND DEBTOR’S RIGHTS © 2010 Pearson Education, Inc., publishing as Prentice-Hall

Debtor and Creditor Businesses and individuals use credit to purchase goods and services. Debtor – The borrower in a credit transaction. Creditor – The lender in a credit transaction.

Unsecured Credit Credit that does not require any security (collateral) to protect payment of the debt. Creditor relies on debtor’s promise to repay the principal (plus interest) when it is due. Creditor may bring legal action if the debtor fails to make the payments.

Secured Credit Credit that requires collateral to secure payment of the loan. Security interests may be taken in real, personal, intangible, other property. Collateral may be repossessed to recover the outstanding amount if the debtor fails to make payment.

Mortgage Two-party instrument. Real property used as collateral. Owner/debtor is mortgagor. Creditor is mortgagee. Real property used as collateral.

Parties to a Mortgage Loan of Funds Owner-Debtor Mortgagor (Borrower) Creditor Mortgagee (Lender) Security Interest in Real Property

Note and Deed of Trust Used in place of mortgage in some states. Note is instrument evidencing borrower’s debt. Deed of trust gives creditor security interest in property. Three-party instrument. Legal title of property placed with trustee until owner-debtor (trustor) pays creditor (beneficiary).

Parties to Note and Deed of Trust Loan of Funds Owner-Debtor Trustor (Borrower) Creditor Beneficiary (Lender) Security Interest in Real Property Legal Title If default, can perfect rights Trustee

Recording Statute Mortgages, deeds of trust must be recorded at county recorder’s office. Public record. Gives potential lenders, purchasers notice of claims against property. Nonrecordation does not affect legality of instrument or rights of parties. Improperly recorded instrument not effective against subsequent purchasers, other mortgagees, or lienholders.

Foreclosure Legal action for foreclosure, seeking payment of defaulted loan. Judgment ordering judicial foreclosure sale. Many states permit foreclosure by power of sale. No court action necessary. Auction held.

Deficiency Judgment Some states permit the mortgagee to bring a separate legal action to recover a deficiency from the mortgagor. If the mortgagee is successful, court will award a deficiency judgment entitles mortgagee to recover amount of judgment from mortgagor’s property.

Antideficiency Statutes Some states prohibit deficiency judgments for some types of mortgages. Usually only first purchase money mortgages. Second mortgages usually not protected.

Right of Redemption State statutes allowing mortgagor to redeem real property after default and before foreclosure. Require mortgagor to pay full amount of debt incurred by mortgagee because of mortgagor’s default. Statutory period of redemption may allow mortgagor to redeem property even after foreclosure sale.

Land Sales Contract Purchaser agrees to pay purchase price to the owner-seller over an agreed-upon period of time. Often used to sell undeveloped property and farms. If purchaser defaults, seller may declare a forfeiture and retake possession of the property.

Mechanic’s Lien Contractor’s and laborer’s lien on real property to which improvements are being made. Security for payment of services and materials for those improvements. Procedures set by state statute. Lien filed in recorder’s office.

Surety and Guaranty Arrangements Surety – Third party (accommodation party or cosignor) promises to be liable for payment. Surety is primarily liable on the debt. Guaranty – Third party (guarantor) agrees to pay debt if debtor defaults. Guarantor is secondarily liable. Defenses that principal debtor has against creditor may also be made by surety or guarantor.

Debtor Protection Laws Truth-in-Lending Act Fair Credit Billing Act Consumer Leasing Act Fair Credit and Charge Card Disclosure Act Equal Credit Opportunity Act Fair Credit Reporting Act Fair Debt Collection Practices Act

Collection Remedies Attachment – prejudgment court order permitting seizure of debtor’s property during pending lawsuit. Execution – postjudgment court order permitting seizure of property and authorizing judicial sale, with proceeds to creditor. Garnishment – Postjudgment court order permitting seizure of debtor’s property in possession of third party. E.g., wages, bank accounts.