Slides developed by Les Wiletzky Wiletzky and Associates Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. PowerPoint Slides to Accompany CONTEMPORARY BUSINESS AND ONLINE COMMERCE LAW 5 th Edition by Henry R. Cheeseman Chapter 22 Credit, Secured Transactions, and Surety Agreements

22 - 2Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Introduction The American economy is a credit economy Businesses and individuals use credit to purchase many goods and services Debtorborrower Debtor – The borrower in a credit transaction Creditorlender Creditor – The lender in a credit transaction

22 - 3Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Unsecured Credit Credit that does not require any security (collateral) to protect the payment of the debt The creditor relies on the debtor’s promise to repay the principal (plus an interest) when it is due The creditor may bring legal action if the debtor fails to make the payments

22 - 4Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Secured Credit Credit that requires security (collateral) that secures payment of the loan Security interests may be taken in real, personal, intangible, and other property The collateral may be repossessed to recover the outstanding amount if the debtor fails to make payment

22 - 5Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Mortgage A collateral arrangement where a property owner borrows money from a creditor who uses a deed as collateral for repayment of the loan Mortgagor Mortgagor – The owner-debtor in a mortgage transaction Mortgagee Mortgagee – The creditor in a mortgage transaction

22 - 6Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Parties to a Mortgage Loan of Funds Security Interest in Real Property Owner-Debtor Mortgagor (Borrower) Creditor Mortgagee (Lender) MORTGAGE

22 - 7Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Notes and Deeds of Trust Note Note – An instrument that evidences the borrower’s debt to the lender Deed of Trust Deed of Trust – An instrument that gives the creditor a security interest in the debtor’s property that is pledged as collateral

22 - 8Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Parties to a Note and Deed of Trust Loan of Funds Security Interest in Real Property Owner-Debtor Trustor (Borrower) Creditor Beneficiary (Lender) Trustee Legal Title If default, can perfect rights

22 - 9Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Recording Statute A statute that requires the mortgage or deed of trust to be recorded in the county recorder’s office of the county in which the real property is located This record gives potential lenders or purchasers of real property the ability to determine whether there are any existing liens (mortgages) on the property

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Foreclosure Legal procedure by which a secured creditor causes the judicial sale of the secured real estate to pay a defaulted loan foreclosure sales All states permit foreclosure sales power of sale Most states permit foreclosure by power of sale

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 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, deficiency judgment the court will award a deficiency judgment entitles the mortgagee to recover the amount of the judgment from the mortgagor’s property

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Right of Redemption A right that says the mortgagor has the right to redeem real property after default and before foreclosure Requires the mortgagor to pay the full amount of the debt incurred by the mortgagee because of the mortgagor’s default

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Material Person’s Lien A contractor’s and laborer’s lien that makes the real property to which improvements are being made become security for the payment of the services and materials for those improvements

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Secured Transaction A transaction that is created when a creditor makes a loan to a debtor in exchange for the debtor’s pledge of personal property as security.

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Article 9 of the UCC – Security Interests in Personal Property An article of the Uniform Commercial Code (UCC) that governs secured transactions in personal property Article 9 Article 9 has been adopted by all states except Louisiana Article 9 Although there may be some variance among states, most of the basics of Article 9 are the same

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Two-Party Secured Transaction Sale of Goods on Credit Secured Interest in the Goods Buyer-Debtor Seller-Lender Secured Creditor

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Three-Party Secured Transaction Sale of Goods Buyer-DebtorSeller Lender-Secured Creditor Security Interest in the Goods Loan of Funds

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Personal Property Subject to a Security Agreement A security interest may be given in various types of personal property, including: 1. goods 2. instruments 3. chattel paper 4. documents of title 5. accounts 6. general intangibles

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Creating a Security Interest in Personal Property Security Agreement: Security Agreement: the agreement between the debtor and the secured party that creates or provides a security interest Unless the creditor has possession of the collateral, the security agreement must be in writing Attachment: Attachment: the creditor has an enforceable security interest against the debtor and can satisfy the debt out of the designated collateral Security Agreement: Security Agreement: the agreement between the debtor and the secured party that creates or provides a security interest Unless the creditor has possession of the collateral, the security agreement must be in writing Attachment: Attachment: the creditor has an enforceable security interest against the debtor and can satisfy the debt out of the designated collateral

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. The Floating-Lien Concept A security interest in property that was not in possession of the debtor when the security agreement was executed A floating lien can attach to: After-acquired property Sale proceeds Future advances

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Perfection of a Security Interest Establishes the right of a secured creditor against other creditors who claim an interest in the collateral Perfection is a legal process The three main methods of perfecting a security interest under the UCC are: 1.Perfection by filing a financing statement 2.Perfection by possession of collateral 3.Perfection by a purchase monetary security interest in consumer goods

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Summary: Methods for Perfecting a Security Interest Perfection MethodHow Created Financing statementCreditor files a financing statement with the appropriate government office. Possession of collateral Creditor obtains physical possession of the collateral. Purchase money security interest Creditor extends credit to a debtor to purchase consumer goods and obtains a security interest in the goods.

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Termination Statement A document filed by a secured party that ends a secured interest because the debt has been paid Must be filed within one month after the debt is paid or 10 days after receipt of the debtor’s written demand (whichever occurs first)

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Priority of Claims Priority Priority – The order in which conflicting claims of creditors in the same collateral are solved The priority of claims is determined according to: 1.Whether the claim is unsecured or secured 2.The time at which secured claims were attached or perfected

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Exceptions to the Perfection-Priority Rule Purchase money security interest: inventory as collateral Purchase money security interest: non- inventory as collateral Buyers in the ordinary course of business Secondhand consumer goods

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Artisan’s and Mechanic’s Liens artisan’smechanic’s lien statutory lien If a worker in the ordinary course of business furnishes services or materials to someone with respect to goods and receives a lien on the goods by statute or rule of law, this artisan’s or mechanic’s lien prevails over all other security interests in the goods unless a statutory lien provides otherwise [UCC 9-310]

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Default Failure to make scheduled payments when due, bankruptcy of the debtor, breach of the warranty of ownership as to collateral, and other events defined by the parties to constitute default [UCC 9-501(1)].

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. UCC Remedies for Default Upon default by the debtor, the secured party may reduce his or her claim to judgment, foreclosure, or otherwise enforce his or her security interest by any available judicial procedure: Repossession Retention of collateral Disposition of collateral Proceeds from disposition Deficiency judgment Redemption rights Upon default by the debtor, the secured party may reduce his or her claim to judgment, foreclosure, or otherwise enforce his or her security interest by any available judicial procedure: Repossession Retention of collateral Disposition of collateral Proceeds from disposition Deficiency judgment Redemption rights

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Surety Arrangement primarily An arrangement where a third party promises to be primarily liable with the borrower for the payment of the borrower’s debt Surety Surety – The third person who agrees to be liable in a surety arrangement

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Guaranty Arrangement secondarily liable An arrangement where a third party promises to be secondarily liable for the payment of another’s debt Guarantor Guarantor – The third person who agrees to be liable in a guaranty arrangement

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Summary: Liability of Sureties and Guarantors Compared Type of Arrangement PartyLiability Surety ContractSuretyPrimarily liable. The surety is a co-debtor who is liable to pay the debt when it is due. Guaranty ContractGuarantorSecondarily liable. The guarantor is liable to pay the debt if the debtor defaults and does not pay the debt when it is due.

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Collection Remedies (1 of 2) When a debt is past due, the creditor may bring a legal action against the debtor If the creditor is successful, the court will award a judgment against the debtor The judgment will state that the debtor owes the creditor a specific sum of money: Principal and interest past due on the debt, Other costs resulting from the debtor’s default, and Court costs

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Collection Remedies (2 of 2) The most common collection remedies are: 1.Attachment 2.Execution 3.Garnishment