© Cavico & Mujtaba, 2008 Business Law for the Entrepreneur and Manager Frank Cavico and Bahaudin G. Mujtaba Chapter 9 – Creditors and debtors – Rights and Responsibilities

© Cavico & Mujtaba, 2008 Business Law for the Entrepreneur and Manager (Frank Cavico & Bahaudin g. Mujtaba, 2008; ILEAD Academy, LLC) Table of Contents – Chapter Titles Chapter 1 – Introduction to Law and the Legal System Chapter 2 – Torts and Business Chapter 3 – Products Liability Chapter 4 – Contract Law Chapter 5 – Sales Law and the Uniform Commercial Code Chapter 6 – Agency and Employment Law Chapter 7 – Business Organizations Chapter 8 – Commercial Paper and Banking Transactions Chapter 9 – Creditors and debtors – Rights and Responsibilities Chapter 10 – Internet Law Chapter 11 – Intellectual Property Law Chapter 12 – Real Property Law Chapter 13 – International Business Law Chapter 14 – Liability of Accountants and Other Professionals Chapter 15 – Wills and Trusts Chapter 16 – Personal Property, Gifts, and Bailment Chapter 17 – Conclusion and Case Problems

© Cavico & Mujtaba, 2008 Chapter Topics Creditors – Suretyship –Secured Transactions –Other Laws assisting creditors Debtors –Bankruptcy –Other Laws assisting debtors –Summary

© Cavico & Mujtaba, 2008 CREDITORS AND DEBTORS – RIGHTS AND RESPONSIBILITIES This chapter examines creditor and debtor relationships and will analyze the rights and responsibilities of creditors and debtors. The primary creditor rights to be examined are the legal doctrines of suretyship and secured transactions, and the primary debtor right to be examined are bankruptcy.

© Cavico & Mujtaba, 2008 Suretyship Suretyship is the relationship by which one person becomes responsible for the debts of another person. The relationship arises when one has money to lend or goods to sell, or perhaps services to render, but this person may have doubts about a perspective debtor’s ability to pay the obligation, and therefore may want more assurances than the debtor’s mere promise to pay, regardless if embodied in a contract or even a negotiable instrument. One legal solution is for the creditor or seller or performing party to reduce his or her risk by requiring some form of security. Suretyship entails a third person joining the debtor’s obligation as a “surety.”

© Cavico & Mujtaba, 2008 “Surety”: “favorite of the law.” Under the old common law, a “surety” was (and still is) regarded as a “favorite of the law.” Accordingly, the surety possesses certain rights under the common law to protect him or her from sustaining a loss. There are four main surety common law rights: 1) exoneration, 2) subrogation, 3) reimbursement, and 4) contribution.

© Cavico & Mujtaba, 2008 Exoneration Exoneration is a right that the surety can exercise against the principal debtor as well as the creditor. –Regarding the debtor, at the maturity of the obligation, the surety may bring an equitable action against the debtor to compel the debtor to pay the debt or perform the obligation, and thereby to exonerate the surety. –Regarding the creditor, if the surety finds that his or her position may be impaired (for example, the debtor is about to flee the jurisdiction), the surety may call upon the creditor to take action against the debtor; and if the creditor could proceed, but fails to do so, the surety is exonerated from liability to the extent harmed.

© Cavico & Mujtaba, 2008 Subrogation Subrogation arises when the surety is forced to pay the principal debtor’s debt; and then the surety is subrogated to (that is, acquires) any rights the creditor had (for example, rights to the collateral or a preferred position in bankruptcy).

© Cavico & Mujtaba, 2008 Reimbursement Reimbursement arises when the surety pays the debt of the principal debtor; and then the surety may sue the principal debtor for reimbursement.

© Cavico & Mujtaba, 2008 Contribution Contribution occurs when two or more sureties are bound on the same obligation. In such a case, each is liable for the full amount. However, between themselves, each is liable for only a proportionate share of the debt; and thus if one surety pays more than his or her fair share, that surety is entitled to demand, and to sue for, contribution from the co- surety. Of course, the sureties can decide expressly as to the proportion of their obligation.

© Cavico & Mujtaba, 2008 Secured Transactions A large part of business is conducted today “on credit”; and the credit given is typically unsecured credit. For example, the most common types of transactions where unsecured credit is extended by one person or business to another are: –1) sale of goods “on credit,” where the buyer promises to pay the purchase in installments; and –2) the loan of money.

© Cavico & Mujtaba, 2008 How is a security interest created? The first step is the presence of a security agreement between the parties. The formal requirements for a security agreement are as follows: 1) A written agreement is required. (However, if the collateral is a good and it is placed in possession of the secured party, which is called a “pledge,” no writing is required.) 2) The writing must be signed by the debtor. 3) The writing must contain a description of the collateral sufficient to reasonably identify it. 4) The writing usually contains other provisions, such as a statement of the amount of the obligation, the terms of payment, the debtor’s duties with respect to the collateral (e.g., insuring the property), and the rights of the insured party on default.

© Cavico & Mujtaba, 2008 Other Laws Assisting Creditors There are several other important laws that protect and assist creditors. The first is called the artisan’s lien (or laborer’s lien). A “lien” means there is a legal charge against property. The artisan’s lien was originally a common law lien (though in many states it is now in statutory form) given to creditors who perform labor or services on personal property. If the debtor does not pay for the services, the creditor is permitted to obtain a judgment and/or foreclose and sell the property in satisfaction of the debt. However, in most states, the creditor must retain possession of the property in order to exercise the lien.

© Cavico & Mujtaba, 2008 Garnishment Garnishment is an important creditor protection device. It is a court order requiring persons who owe debtor money or who possess the debtor’s personal property to turn over the property or money to the court. The most common types of property garnished are wages and bank accounts. There are federal and state statutory limits as to the types and amounts of property and money that can be garnished, however. Attachment is the seizing of a debtor’s property without a court order. This remedy, moreover, is available to the creditor even before a judgment is rendered.

© Cavico & Mujtaba, 2008 Bankruptcy Bankruptcy protection is the most important law protecting debtors. Bankruptcy law, of course, deals with the problems which arise when a person, including a business or corporation, is unable to satisfy his, her, or its obligations due to creditors. Bankruptcy is based on federal law, stemming from Article I of the Constitution, Section 8, which grants Congress the power to establish bankruptcy laws. The most important modern statute is the Bankruptcy Act of 1978, as amended by the Bankruptcy Act of 1984, and the Bankruptcy Reform Act of 2005.

© Cavico & Mujtaba, 2008 Objectives of Bankruptcy The objectives of bankruptcy law are to: 1) provide a method of applying the debtor’s assets in an equitable distribution among the debtor’s creditors; 2) prevent the debtor from preferring one creditor over another; 3) minimize losses of all the creditors to the extent possible; 4) to relieve “honest” debtors of the weight of oppressive indebtedness; 5) and to allow the debtor a “fresh start” free of his or her former obligations.

© Cavico & Mujtaba, 2008 Other Laws Assisting Debtors There are a variety of federal and state laws protecting debtors, particularly by exempting certain property from seizure by creditors. A very important debtor protection law is the Homestead Exemption, which is a law found in either state statutes or in state constitutions. Generally, a “homestead” is an acreage amount (for example, ½ to 1 and 1/2 acres in most states) of contiguous land within a municipality, including a residence, which is owned by a “natural person” (as opposed to a business entity) or an acreage amount of contiguous land outside a municipality (for example, 100 to 200 acres in most states) including all improvements thereon.

© Cavico & Mujtaba, 2008 Summary The intricate and symbiotic relationships between creditors and debtors are often balanced through supply and demand forces. This chapter has thoroughly and comprehensively examined the relationship between creditors and debtors. It further analyzed and discussed many of the rights and responsibilities associated with creditors and debtors in the United States. The primary creditor rights examined were the legal doctrines of suretyship and secured transactions, and the primary debtor right examined was that of bankruptcy in the United States.

© Cavico & Mujtaba, 2008 Reference 1.Cavico, F. & Mujtaba, B. G., (2008). Business Law for the Entrepreneur and Manager. ILEAD Academy Publications; Davie, Florida, USA. ISBN: Cavico, F. and Mujtaba, B. G. (2008). Legal Challenges for the Global Manager and Entrepreneur. Kendal Hunt Publishing; United States.