SECURED TRANSACTIONS OUTLINE
SPRING 2018
PROFESSOR FROST
Creditor-Debtor Relationship
Remedies of Unsecured Creditor Under State Law
Definition of Unsecured Creditors:
Anyone who is owed a legal obligation that can be reduced to a money judgment is a creditor of the party owing the obligation
Unless a creditor contracts with the debtor for secured status or is granted it by statute, the creditor will be unsecured
How do unsecured creditors compel payment?
Prohibited Remedy—Self-Help Seizure
A prohibited seizure of a debtor’s property is the tort of conversion
Creditor could even be charged with larceny even if the property isn’t worth as much as the amount owed
Creditor, despite the right to demand payment from the debtor, may not do so unreasonably, which could cause liability for wrongful collection practices
Approved Remedy—Unsecured Creditors can:
Go to court and obtain a judgment against the debtor
Judgment gives the creditor the right to invoke the power of the state to levy against property
Creditor then takes the judgment to the clerk and gets a writ of execution
Creditor then takes the writ of execution to the sheriff with clear instructions about what assets to get and where to get the assets
If the sheriff doesn’t execute the writ, then the unsecured creditor can bring an amercement action, which if successful would hold the sheriff liable in monetary damages for not executing the writ
Sheriff seizes the debtor’s assets and ultimately sells the assets
Sheriff can use force when seizing the debtor’s assets
Sheriffs’ sales of property don’t maximize its value
The proceeds from the sale are used to satisfy the debt, without any surplus going back to the debtor
Limitation on Compelling Payment—Exemptions
Exemption Statutes function to prevent the sheriff from seizing certain property under a writ of execution. The property is considered exempt from the remedies available to unsecured creditors:
Impediment to the collection of judgment debt
Rationale is to prevent debt collection from leaving a debtor destitute and/or on the streets
Security interests defeat a claim of exemption
Security interest à right in property contingent on the nonpayment of debt
Downsides of being an Unsecured Creditor
There are two main problems with being an unsecured creditor:
There are obstacles to enforcement of the debt
Debt collection can be more trouble than it is worth
An unsecured creditor may be one of many such creditors trying to get the debtor’s assets
Getting an Article 9 Security Interest is a Solution
Becoming a secured creditor (implicates debtor/creditor relationship)
Article 9 transactions are consensual because creditors get a security interest under Article 9 by contracting with the debtor through attachment
Requires a signed, written agreement between the debtor and creditor granting the creditor a security interest
Once a valid security interest has been created, after default, the secured creditor has an immediate right to possess the collateral, sell it, and apply the proceeds to the debt
If there is a surplus, it goes back to the debtor
If there is a deficiency, the secured creditor can get a deficiency judgment
Perfecting the security interest (implicates creditor vs creditor rights)
Security interest must be attached
Secured party must do some other act such as filing a financing statement, taking possession of the collateral, or a couple other possible acts
Priority à Secured creditors have first claim to collection rights over unsecured creditors
Security and Foreclosure
Modern definition of security interest à “I’ll grant you an ownership interest in my property contingent upon my default on my debt that is limited to the value of the debt.”
Definitions:
Lien à a charge against an interest in property to secure payment of a debt or performance of an obligation
A relationship between particular property (the collateral) and a particular debt or obligation
Security interest is a type of lien
Foreclosure à Process by which the creditor compels application
Redemption à Right to redeem is the debtor’s right to pay the secured debt even after default and retain ownership of the collateral
Restatement of Property à “From the time the full obligation secured by a mortgage becomes due and payable until the mortgage is foreclosed, a mortgagor has the right to redeem the real estate from the mortgage.”
What is a Security Interest? Look at the Substance over the Form
In determining which transactions are in the nature and must be foreclosed, one cannot rely on documents à A transaction is in the nature of security if the intent is to provide one party with an interest in the property of another, which interest is contingent upon the nonpayment of a debt.
UCC § 9-109(a)(1) says that Article 9 applies to “any transaction regardless of its form, that creates a security interest in personal property.
The subjective intention of the parties with respect to the legal characterization of their transaction is irrelevant to whether Article 9 applies.
Transactions Intended as Security
Conditional Sales à UCC § 2-401(1):
“Any retention or reservation by the seller of the title in goods shipped or delivered to the buyer is limited in effect to a reservation of a security interest.”
Buyer becomes the owner of the goods and the seller becomes a secured creditor for the price of goods
Basically is an agreement to buy in increments where the seller “retains ownership” and has a right to retain possession in event of default à court will interpret this as a security.
Leases Intended as Security Interests
If the term of the lease extends for the entire remaining life of the collateral, the economic effect of the lease on the parties may be identical to the economic effect of a sale with a security interest back for the purchase price and will be treated as such.
A sale, combined with a security interest securing payment of the purchase price, has precisely the same economic impact on the parties as a lease for the entire economic life of the property. Touchstone is entire economic life.
Sales of Accounts
This is when a business has debts owed to them (Accounts) and they need cash now, so they sale the accounts to “factors” at a discount. Example: factor gives $950,000 for $1,000,000 in accounts, the business gets the cash it needs now and factor gets a profit of $50,000 when the accounts are fully paid by debtors.
Business could achieve the same result by using the accounts as collateral to borrow $950,000 from a bank
Asset Securitization
Usually done with mortgages and accounts
This is when a business takes these assets and the owner sells the accounts to a separate entity, a special purpose vehicle (SPV), which is usually a trust, which issues certificates in tranches. Tranches are priority level, and if the account debtors’ payments are insufficient to pay all of the certificates, the SPV pays them to the first tranche, in proportion to their shares, until the first tranch certificates are paid in full, the SPV then repeats the process down the hierarchy of tranches until the money is exhausted
Can be done with or without recourse
If with recourse, the originator has agreed to buy back uncollected accounts, or more commonly, substitute new accounts for the uncollected ones
Foreclosure Procedures
Judicial Foreclosure
A foreclosure process is judicial if it is accomplished by the entry of a court order
If the debtor won’t surrender the premises, the purchaser is entitled to a writ of assistance/writ of possession which directs the sheriff to put the purchaser in possession
Statutes in some states mandate delays or waiting periods in addition to those the debtor gain by defending the foreclosure action
With the cooperation of the debtor after default, a secured creditor may be able to avoid the necessity to foreclose
If there are no other liens or interests in the collateral, then the debtor can simply transfer the property to the creditor by a Deed in Lieu of Foreclosure, which is a way of destroying the equity of redemption
Real Property Power of Sale Foreclosure
A quicker, simpler method of foreclosure against real property
Foreclosure is still necessary, but it can be accomplished through a procedure that doesn’t include filing a lawsuit, which avoids the expense and delay of litigat
creditor/assignee)
Additionally, if after receiving notification, the account debtor still pays the debtor instead of secured party, then the secured party can sue the account debtor with the account debtor possibly having to pay twice.
The account debtor would, of course, have a valid restitution claim against the debtor, but that might not be very helpful because the debtor is probably broker than shit
The notice requirement is found in 9-406(b)(1) and it says that notification is ineffective if it doesn’t reasonably identify the debt assigned
Furthermore, under 1-102(d) and (e)(1) à A person gives notice to another person by taking such steps as may be reasonably required to inform the other person in ordinary course, whether or not the person actually comes to know if it. A person received notification when it comes to that person’s attention.
In most states, it is a felony for a debtor to conceal personal property that he knows another person has a security interest in. Accordingly, DON’T ADVISE A CLIENT TO CONCEAL SUCH PROPERTY.
In the repossession context, who wins between a bank and debtor if both are well advised?
Debtor wins in the short-term, while the bank wins out in the long-term.
Real Property: Right to Possession Pending Foreclosure isn’t governed by Article 9
Debtor’s right to possession during foreclosure:
Debtor remains the owner of the property and is entitled to possession of it until the court forecloses the debtor’s equity of redemption and the sheriff sells the property
Only the purchaser at the foreclosure sale may dispossess the debtor
Appointment of a receiver:
While a foreclosure action is pending, an interested party may apply for the appointment of a receiver to preserve the value of the collateral
Example à rental property
The receiver can collect the rents and use the money to maintain the building
Would also have the authority to rent the apartments
Deed in lieu of foreclosure is a deed by which a borrower conveys title to a lender in satisfaction of a mortgage debt and as a substitute for foreclosure
Equity of redemption is the right of a mortgagee in default to recover property before a foreclosure sale by paying the principal, interest, and other costs due. This cures the default
Article 9 Sale and Deficiency
Once the security interest has attached, which implies a security interest has been created, and there has been a default the secured creditor has an immediate right to possess the collateral, sell it, and apply the proceeds to the debt. If there is a surplus, then it goes back to the debtor. If there’s a deficiency, the debtor owes the creditor a deficiency judgment.
Roadmap:
9-609 à Possession
9-610 à Disposition of Collateral
9-611 through 9-614 à Notification of debtor and other parties
9-615 through 9-619 à Effect of Sale
9-615 à What do you do with the money from a sale?
9-620 à Strict Foreclosure
9-623 624 à Redemption Provisions
9-625 à Remedies
Disposition of the Collateral by Sale
9-610(a) (Basic Sale Provision) à After default, the secured party may sell, lease, license, or otherwise dispose of the collateral. Disposition by sale is the most common method of realizing on the collateral. The Code permits either public or private sale.
Is there a duty to fix up the collateral or can you throw it away and sue for a deficiency?
