McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 20 Creditors’ Rights and Bankruptcy

20-2 CREDITORS’ RIGHTS Credit that is not collateralized is known as unsecured. When the borrower has pledged collateral in order to obtain credit, the creditor is known as a secured creditor.

20-3 Secured Transactions under Article 9 of the UCC Article 9 provides a framework for secured transactions by recognizing the rights of the creditor, known as the secured party, against other creditors of the borrower and against the borrower himself in the event of a default in payment. In the UCC, a borrower is known as the debtor.

20-4 Security Agreement The parties will enter into a security agreement that:  specifies the parties,  describes the collateral,  articulates the obligations of the debtor,  states remedies available to the secured party in the event of default.

20-5 Perfection Perfection of security interest is the act of establishing the secured party’s rights ahead of the rights of other creditors.

20-6 Methods of perfection Perfection occurs at the moment of: (1) physical possession of the collateral, or (2) official filing of a statement of notice with a state and/or local government office, or (3) taking legal control of the collateral (such as establishing joint authority over a brokerage account where the account funds are being used to collateralize a loan).

20-7 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).

20-8 Exempt property Up to $18,450 in equity in the debtor’s primary residence (homestead exemption). Interest in a motor vehicle up to $2,950. Interest up to $9850 for household goods/furnishings. Interest in jewelry up to $1,225. 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 $18,450.

20-9 Distribution 1. Administration expenses—court costs, trustee and attorney fees. 2. Involuntary bankruptcy expenses incurred from date of filing. 3. Unpaid wages earned within 90 days, $4,300 per claimant. 4. Unsecured claims for contributions for employee benefits, 180 days prior to filing and $4,300 per employee. 5. Claims by farmers or fisherman up to $4, Consumer deposits up to $1, Paternity, alimony, maintenance, and support debts. 8. Certain taxes and penalties due to government. 9. Claims of general creditors.

20-10 Non-dischargeable Claims for federal, state, and local taxes (including fines and penalties related to the taxes) within two years of the petition filing. 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. Alimony, maintained and child support. Debts related to willful or malicious injury to a person or property. Debts related to court-ordered punitive damages against the debtor. Student loan debts, unless the debtor can prove “undue hardship.”

20-11 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).

20-12 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.

20-13 learning outcomes checklist Distinguish between unsecured creditors and secured creditors and determine the rights of each set of creditors Apply the framework for a secured transaction for personal property under UCC Article 9 in a business context.

20-14 learning outcomes checklist Articulate the process of obtaining a secured interest in real estate Explain the various nonstatutory options and legal ramifications for a business facing financial distress.

20-15 learning outcomes checklist Determine the rights, protections, and obligations of both creditors and debtors under federal bankruptcy laws Distinguish the various bankruptcy options under Chapter 7, Chapter 11, and Chapter 13 and understand when a debtor qualifies for each.