Legal Environment for a New CenturyPresentation Transcript
Secured Transactions and Bankruptcy CHAPTER 12
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Quotes of the Day
“ All progress is based on a universal innate desire on the part of every organism to live beyond its means.”
“ Be not made a beggar by banqueting on borrowing.” Ecclesiasticus 18:33
Revised Article 9
Article 9 of the Uniform Commercial Code (UCC) governs secured transactions in personal property.
Article 9, which was recently revised, applies to any transaction intended to create a security interest in personal property or fixtures.
Fixtures: goods that have become firmly attached to real estate.
Security interest: interest in personal property or fixtures that secures the performance of an obligation.
Secured party: party who holds the security interest.
Collateral: property subject to the security interest.
Debtor: person who has some original ownership in the collateral.
Obligor: person who must repay money.
Security agreement: contract which gives a security interest to the secured party.
Default: when the debtor fails to pay
Repossession: when the secured party takes back the collateral because the debtor has defaulted.
And More Definitions
Perfection: steps the secured party must take to protect rights in the collateral against people other than the debtor.
Financing statement: document filed by secured party to give notice of security interest in the collateral.
Record: information on paper or other medium.
Authenticate: to sign a document (includes use of symbols or electronic encryption.)
Article 9 Revisions
Throughout the past 10-15 years, revisions to Article 9 were recommended and adopted.
Revised Article 9 is now law in all states.
Expansion of transactions covered
Clarification of rules for creating, perfecting, and enforcing security interests
Adoption of a medium-neutral provision– meaning that security interests may be filed electronically, on paper, and in other forms.
Scope of Revised Article 9
Collateral for transactions may include, among other things:
Goods (includes goods in inventory)
Documents of Title
Chattel Paper (includes electronic chattel paper)
Attachment of Security Interest
Attachment is a vital step in a secured transaction.
The two parties made a security agreement and either, (1) the debtor has authenticated the agreement, or (2) the secured party has possession of the collateral.
The secured party gave value in order to get the security agreement.
The debtor has rights in the collateral.
After-acquired property refers to items that the debtor obtains after the parties have made their security agreement.
The parties may agree that the security interest attaches to after-acquired property.
Proceeds: what is obtained when collateral is sold or disposed of.
The secured party automatically obtains a security interest in the proceeds, unless the security agreement states otherwise.
Perfection guarantees the collateral’s availability in case of default. It keeps the collateral from being used for more than one security agreement at a time.
Methods of Perfecting
Filing a financing statement
Possession of the collateral
Purchase money security interest in consumer goods (PMSI)
(More detail about these on the next several slides.)
Perfecting by Filing
Contents of the Financing Statement
A financing statement is sufficient if it provides the name of the debtor, the name of the secured party and a description of the collateral.
Names must be the registered name of an organization or legal name of a person.
Under Revised Article 9, if a computer search under the debtor’s correct name would reveal the financing statement, the record is valid.
Perfecting by Filing (cont’d)
Place of Filing
In general, state statutes require filing with the central filing office in the state where the debtor lives, but this varies from state to state.
Duration of Filing
Generally, a filed financing statement is good for five years unless the secured party files a continuation statement within six months prior to expiration. This extends the protection for another five years.
Perfection by Possession or Control
The advantages to the creditor of holding the collateral are obvious – the collateral is safe, its location is known, it cannot be used to secure another loan, and “repossession” is simple.
A secured party must use reasonable care in the custody and preservation of collateral in her possession.
Perfection: Consumer Goods
The Code gives special treatment to security interests in consumer goods.
The purchase money security interest (PMSI) is one taken by the person who sells the collateral or by the person who advances money so the debtor can buy the collateral.
A PMSI in consumer goods perfects automatically, without filing.
A PMSI may be created only in goods, fixtures, or software.
Protection of Buyers
Generally, once a security interest is perfected, it remains effective regardless of whether the collateral is sold, exchanged, or transferred.
Buyers in Ordinary Course of Business
One who buys goods in good faith from a seller who routinely deals in such goods.
A BIOC takes the goods free of a security interest created by his seller even though the security interest is perfected.
Protection of Buyers (cont'd)
Buyers of Chattel Paper, Instruments, and Documents
If bought in the ordinary course of her business, and she takes possession, she generally takes free of any security interest.
Priorities Among Creditors
A a perfected security interest takes priority over one with an unperfected interest.
If neither secured party has perfected, the first interest to attach gets priority.
Between perfected security interests, the first to file or perfect wins.
A secured party controlling or possessing an instrument, deposit account, investment property and letter-of-credit rights wins over a party that merely filed.
A PMSI in collateral other than inventory takes priority over a conflicting security interest if the PMSI is perfected at the time the debtor receives the collateral or within 10 days after he receives it.
Default and Termination
Default: when debtor fails to make payments due or enters bankruptcy.
Taking Possession of the Collateral
When the debtor defaults, the secured party may take possession of the collateral.
The secured party can take the collateral without a court order if it can be done without disturbing the peace.
Upon default, a secured party may sue the debtor for the full debt instead of seizing the collateral.
Disposition of Collateral
A secured party may sell, lease, or otherwise dispose of the collateral in any commercially reasonable manner.
A debtor is liable for any deficiency (insufficient funds to pay off the debt).
Any surplus is to be returned to the debtor.
Right of Redemption
The debtor may redeem the collateral by paying the full value of the debt at any point before the secured party disposes of it.
Acceptance of Collateral
If the secured party has possession, he may notify the debtor that he intends to retain the collateral as full or partial satisfaction of the debt.
If the debtor does not object within 20 days, the secured party may keep the collateral as full payment, but not as partial.
If the debtor objects to acceptance, the secured party must sell or otherwise dispose of the collateral.
A termination statement is a document indicating that there is no longer a security interest in the collateral.
This happens when the debtor has fully paid off the debt.
The termination statement must be filed, generally within one month of the satisfaction of the debt.
Overview of the Bankruptcy Code
The objective of Chapters 11 and 13 of the Bankruptcy Code is rehabilitation of the debtor.
When debtors are unable to develop a feasible plan for rehabilitation, Chapter 7 allows for liquidation (also known as straight bankruptcy).
Click here to see the text of the Bankruptcy Code online.
The Bankruptcy Code has three primary goals:
To preserve as much of the debtor’s property as possible.
To divide the debtor’s assets fairly between the debtor and the creditors.
To divide the debtor’s assets fairly among the creditors.
Chapter 7 -- Liquidation
Filing a Petition
Any individual, partnership, corporation, or other business organization that lives, conducts business, or owns property in the United States can file under the Code.
Petitions may be voluntary or involuntary.
Ch. 7 -- Voluntary Petition
May be filed by any debtor; not necessary to be insolvent or for liabilities to exceed assets.
Filed by providing a petition, list of creditors, schedule of assets and liabilities, claim of exemptions, schedule of income and expenditures, and a statement of financial affairs.
Ch. 7 -- Involuntary Petition
An involuntary petition must meet all the following requirements:
The debtor must owe at least $10,000 in unsecured claims to the creditors who file.
If the debtor has at least 12 creditors, three or more must sign the petition. If fewer than 12 creditors, any one can file.
The creditors must allege either that a custodian for the debtor’s property has been appointed in the prior 120 days or that the debtor has generally not been paying debts.
The trustee is responsible for gathering the bankrupt’s assets and dividing them among creditors.
Creditors may elect the trustee or the trustee may be appointed by the U.S. Trustee for that region of the country.
The U.S. Trustee calls a meeting of creditors sometime within 20 to 40 days after the order of relief.
Unsecured creditors must submit a proof of claim within 90 days after the meeting of creditors.
Secured creditors do not file proofs of claim unless the claim exceeds the value of their collateral.
An automatic stay prohibits creditors from collecting debts that the bankrupt incurred before the petition was filed.
The purpose of the automatic stay is to give the debtor time and space to make a rational plan for paying debts without pressure from creditors.
The Code permits individual debtors (not organizations) to keep some property for themselves.
States have the option of determining what property is exempt or adopting federal Code.
For example, federal Code allows only $15,000 of the value of a home; some states allow exemption of a home of any value.
Usually, debtors cannot keep property that is the collateral for a secured loan. If the loan amount is for more than the debt, the property can be sold and the debtor may be able to keep the difference.
A preference is a transfer of money or property just before filing bankruptcy.
The trustee can void a transfer that meets all of the following requirements:
The transfer was to a creditor of the bankrupt.
It was to pay an existing debt.
The creditor received more than she would have received during the bankruptcy process.
The debtor’s liabilities exceeded assets at the time of the transfer.
The transfer took place in the 90-day period before the filing of the petition.
A transfer is fraudulent if it is made within a year before a petition is filed and its purpose is to hinder, delay, or defraud creditors.
A trustee cannot void pre-petition payments made in the ordinary course of business.
Payment of Claims
The trustee pays the bankruptcy estate to the various classes of claims in the following order of rank:
Priority Claims (seven subcategories)
Unsecured Claims (three subcategories)
All creditors with Secured Claims are paid before any in the Priority Claims category, etc.
Once a bankruptcy estate is distributed, the creditors cannot make claims on the debtor for money owed before filing.
There are some circumstances that prevent debts from being discharged, such as repeated bankruptcy filings, dishonesty, and conduct of some kinds of business.
Debts that cannot be discharged include (among others):
Income taxes and property taxes
Money obtained fraudulently or illegally
Recent cash advances on credit cards
Debts omitted from the Schedule of Assets and Liabilities if the creditor did not know about the bankruptcy
Alimony and child support debt
Liability for intentional and malicious injury
Some student loans
Circumstances that Prevent Discharge
Under Ch. 7, debts of partnerships and corporations cannot be discharged.
Repeated filings for bankruptcy (within 6 years)
Revocation of previous discharge if evidence of fraud is discovered.
Debtor who has acted in bad faith – made fraudulent transfers, hidden assets, falsified records, etc.
To reaffirm a debt means the debtor promises to pay even after discharge.
In order to be valid, the reaffirmation must:
Not violate laws for fraud or duress.
Be filed in court.
Not impose undue hardship on the debtor.
Clearly state that reaffirmation is not required by law.
Chapter 11-- Reorganization
Chapter 11 does not require a trustee; the petitioner (called debtor in possession) serves as the trustee. He:
Operates the business, and
Develops a plan of reorganization.
A creditors’ committee watches over the interests of the creditors.
A committee of equity security holders may be appointed to watch out for the interests of the shareholders.
Plan of Reorganization
The debtor has 120 days to come up with a plan that is acceptable to the creditors.
The creditors will usually only accept a reorganization plan that they believe will be better for them than liquidation.
If they reject the debtor’s proposal, the creditors or shareholders may submit alternative plans.
Confirmation of the Plan
A confirmation hearing is held to determine whether it should accept the plan.
The court will approve a plan if a majority of each class votes in favor of it.
Sometimes the court will confirm a plan even if some classes of creditors have voted against it. This is called a cramdown.
A confirmed plan is binding on the debtor, creditor and shareholders.
A typical plan of reorganization gives some current assets to the creditors and promises to pay them a portion of future earnings.
The debtor now owns the assets in the bankrupt estate, free of all obligations except those listed in the plan.
Chapter 13 -- Consumer Reorganization
The purpose of Chapter 13 is to rehabilitate an individual debtor.
Creditors cannot use an involuntary petition to force a debtor into Ch. 13.
A trustee is appointed to supervise the debtor, who remains in possession of all assets.
Ch. 13 -- Plan of Payment
Plan of payment must be submitted by the debtor within 15 days after filing the petition. The plan must:
Commit some future earnings to pay off debts,
Promise to pay all secured and priority claims in full, and
Treat all remaining classes equally.
Confirmation of Plan
To confirm a plan, the court must ensure:
All unsecured creditors receive at least as much as they would have under Chapter 7
The plan is feasible and the debtor will be able to make the promised payments
The plan does not extend beyond three years without good reason, and in no even more than five years
The debtor is acting in good faith, making reasonable effort to pay obligations.
Once confirmed, the plan is binding on all creditors.
The debtor is washed clean of all pre-petition debts except those provided for in the plan, but (unlike under Chapter 7), the debts are not permanently discharged and may be revived if the debtor does not comply with the plan.
“ Secured transactions are essential to modern commerce but create pitfalls for the unknowing. A person doing business in ignorance of Article 9 takes risks of loss. When that loss (or other) leads to bankruptcy, the law must balance between competing interests. When an individual or business files for bankruptcy protection, generally neither debtor or creditor comes out whole.”
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