Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Slides developed by Les Wiletzky PowerPoint Slides to Accompany ESSENTIALS OF BUSINESS AND ONLINE COMMERCE LAW 1 st Edition by Henry R. Cheeseman Chapter 15 Credit, Secured Transactions, and Bankruptcy Chapter 15 Credit, Secured Transactions, and Bankruptcy

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Introduction  The U.S. 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

Copyright © 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

Copyright © 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

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Example of a Credit Transaction Extension of Credit Promise to Repay Credit Debtor(Borrower) Creditor (Lender) (Lender)

Copyright © 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

Copyright © 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

Copyright © 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

Copyright © 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 Material Person’s Lien  Owners of real property often hire contractors and laborers to make improvements to that property  The contractors and laborers expend the time to provide their services as well as money to provide the materials for the improvements material person’s lien  Their investments are protected by state statutes that permit them to file a material person’s lien against the improved real property

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 Revised 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. accounts 4. general intangibles 5. other personal property

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 collateralCreditor 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 Exceptions to the Perfection Rule  Inventory as collateral  Buyer 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 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 Bankruptcy and Reorganization (1 of 2)  Article I, section 8, clause 4 of the U.S. Constitution  Article I, section 8, clause 4 of the U.S. Constitution provides that “The congress shall have the power...to establish... uniform laws on the subject of bankruptcies throughout the United States” federal law  Bankruptcy law is exclusively federal law  There are no state bankruptcy laws

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Federal Bankruptcy Code  Bankruptcy Reform Act  Bankruptcy Reform Act (1978) Bankruptcy Code This is the Bankruptcy Code  The Bankruptcy Code establishes rules and procedures for filing and completing bankruptcy

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved The “Fresh Start”  The primary purpose of federal bankruptcy law is to discharge the debtor from burdensome debts  The law gives debtors a fresh start by freeing them from legal responsibility for past debts

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 7 Liquidation Bankruptcy  The most familiar form of Bankruptcy The debtor’s nonexempt property is sold for cash, The cash is distributed to the creditors, and Any unpaid debts are discharged  Any person (including individuals, partnerships, and corporations) may be debtors in a Chapter 7 proceeding

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 7: Bankruptcy Procedure 1. Filing a petition Voluntary petition Involuntary petition 2. Order for relief 3. Meeting of the creditors 4. Appointment of a trustee 5. Proof of claims

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 7: The Bankruptcy Estate  An estate created upon the commencement of a Chapter 7 proceeding exempt property  It includes all the debtor’s legal and equitable interests in real, personal, tangible, and intangible property, wherever located, that exist when the petition is filed, minus exempt property

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 7: Exempt Property  Property that may be retained by the debtor pursuant to federal or state law  Debtor’s property that does not become part of the bankruptcy estate  The Bankruptcy Code also permits states to enact their own exemptions Declaration of Homestead  Many states require the debtor to file a Declaration of Homestead prior to bankruptcy

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 7: Voidable Transfers paymentstransfers  The Bankruptcy Code prevents debtors from making unusual payments or transfers of property on the eve of bankruptcy that would unfairly benefit the debtor or some creditors at the expense of others Preferential transfers to insiders Fraudulent transfers

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 7: Statutory Distributions to Unsecured Creditors statutory priority  The Bankruptcy Code stipulates that unsecured claims are to be satisfied out of the bankruptcy estate in the order of their statutory priority as established by the code  Generally, unsecured creditors receive little if anything in a Chapter 7 bankruptcy

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 7: Discharge  The termination of the legal duty of a debtor to pay debts that remain unpaid upon the completion of a bankruptcy proceeding  Only individuals may be granted a discharge Not all debts are dischargeable in bankruptcy  Discharge is not available to partnerships and corporations  Discharge of student loans

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 11 Reorganization Bankruptcy (1 of 2)  A bankruptcy method that allows reorganization of the debtor’s financial affairs under the supervision of the Bankruptcy Court  Chapter 11 is used primarily by businesses to reorganize their finances under the protection of the Bankruptcy Court  The debtor usually emerges from bankruptcy a “leaner” business, having restructured and discharged some of its debts  A bankruptcy method that allows reorganization of the debtor’s financial affairs under the supervision of the Bankruptcy Court  Chapter 11 is used primarily by businesses to reorganize their finances under the protection of the Bankruptcy Court  The debtor usually emerges from bankruptcy a “leaner” business, having restructured and discharged some of its debts

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 11: Reorganization Bankruptcy (2 of 2) available  Chapter 11 is available to individuals, partnerships, corporations, and other businesses  Debtor-in-Possession A debtor who is left in place to operate the business during the reorganization proceeding  Creditor’s Committee creditors’ committee The creditors holding the seven largest unsecured claims are usually appointed to the creditors’ committee

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 11: Automatic Stay  The result of the filing of a voluntary or involuntary petition  The suspension of certain actions by creditors against the debtor or the debtor’s property  Relief from stay – may be granted in situations involving depreciating assets where the secured property is not adequately protected during the bankruptcy proceedings

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 11: Plan of Reorganization  A plan that sets forth a proposed new capital structure for the debtor to have when it emerges from reorganization bankruptcy  The debtor has the exclusive right to file the first plan of reorganization  Any party of interest may file a plan thereafter

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 13 Consumer Debt Adjustment  A rehabilitation form of bankruptcy that permits the courts to supervise the debtor’s plan for the payment of unpaid debts by installments  Debtor avoids the stigma of Chapter 7 liquidation  Creditors may recover a greater percentage of the debts owed them than they would under a Chapter 7 proceeding

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 13: Filing the Petition  A Chapter 13 proceeding can be initiated only by the voluntary filing of a petition by the debtor  Creditors cannot file an involuntary petition to place a debtor in Chapter 13 bankruptcy  A Chapter 13 is a form of reorganization bankruptcy plan of payment  The debtor must file a proposed plan of payment on how the debts are to be rescheduled  A Chapter 13 proceeding can be initiated only by the voluntary filing of a petition by the debtor  Creditors cannot file an involuntary petition to place a debtor in Chapter 13 bankruptcy  A Chapter 13 is a form of reorganization bankruptcy plan of payment  The debtor must file a proposed plan of payment on how the debts are to be rescheduled

Copyright © 2006 by Pearson Prentice-Hall. All rights reserved Chapter 13: Plan of Payment plan of payment  The debtor’s plan of payment must be filed within 15 days of filing the petition  The debtor must file information about his or her finances  The plan period cannot exceed three years unless the court approves a longer period  Installment payments to the trustee must begin within 30 days after the plan is filed