Westbrook_Secured Credit_Fall_2009
Enforcement of Debt Obligations
1. Under State Law
a. Unsecured Creditors on a Treasure Hunt: Enforcement of Judgments against the Debtor’s Property
i. “Execution” and Priorities Among “Executing” Creditors
1. Collection Process of a Unsecured Creditor:
a. Judgment for the creditor: The claim becomes indisputable by the debtor, but does not give the creditor any interest or priority. At this point, the creditor is a “judgment creditor.”
b. Granting of a writ: A court order that orders the sheriff or marshal to go look for non-exempt property of the judgment debtor and execute the collections process
c. Executing on the writ: The sheriff goes looking for debtor property and levies upon the property
i. To levy the property:
1. Ordinarily, the sheriff will take physical possession, transport it, and lock it in the courthouse
2. If the property cannot be immediately seized, the sheriff may tag it with a notice of seizure
ii. Upon the levy, the creditor becomes a “judgment lien creditor” (often “lien creditor” for short)
iii. Sheriff then files a “return” which describes process to the court
d. Public sale: Sheriff advertises the property for a public sale and sells to the highest bidder.
i. Proceeds are paid to the creditor until paid in full. Any leftover will be paid back to the debtor.
ii. If funds are insufficient, the sheriff will be commanded to look for more debtor property to seize
2. Priority between unsecured creditors
a. General Rule: “First in time, first in right” –first creditor to levy on a particular piece of property will have the right to be paid in full from the proceeds of the sale of that property before any other creditor gets any of the proceeds
b. In the majority of states, the issuance of the writ to the sheriff determines the priority date, but some states base it on the levy date
c. Most states require that the creditor take the property in order to become a judgment lien creditor
3. In the Matter of the General Assignment for the Benefit of Creditors of Hiawatha Do It Yourself, Inc. (M69)
a. Facts: Two judgment lien creditors choose not to sell the assets, but allowed Hiawatha to continue to operate. After they had both levied the assets, the US filed a tax notice.
i. Judgment doesn’t give interest in the debtor’s property, but the levy does
ii. Filed tax claim is the equivalent of judgment execution of all the debtor’s property
b. Holding: Whitlock gets first priority, Anchor gets second, and US has third; but the US get the inventory because the law gives the US a continuing levy on the inventory
i. Lien must become choate, or perfected, in order to have interest in the property (in minority state that doesn’t require the creditor to take the property in order to be a judgment lien creditor)
ii. Exception for inventory because it is not specific or constant so the property subject to lien is not established
1. Common law couldn’t deal with after acquired property
2. Therefore, in order to seize, the creditor must immediately take
4. Credit Bureau of Broken Bow v. John V. Moninger (M72)
a. Facts: Bureau gets default judgment against debtor. The debtor subsequently renewed a prior note with Bank with the intention to secure the note. Bureau gets a writ of execution and the debtor’s truck is levied, but the Sheriff does not take possession and is told of the Bank’s interest. After the levying, Bank and debtor execute and file a security agreement.
b. Holding: Bureau has prior rights to the proceeds over the Bank.
i. Bureau became lien creditor with levy because Nebraska doesn’t require possession to have a valid levy
ii. Sheriff’s knowledge of the Bank’s interest is not imputed on Bureau so Bureau has priority under 9-317 because it is w/o knowledge
5. Problem Set I (M78)
a. Question 1: RHA is financial trouble and owes 3 judgment creditors $10k each. AM obtained judgment on 11/1. BC got judgment on 11/10 and delivered writ to sheriff on 11/15. CP got judgment on 11/20, delivered writ on 11/22, got execution on 11/25. Sale gets $15k.
i. Some states allow a pro forma levy at the courthouse later for this writ which is required in the relation back system. If possible, BC should execute a pro forma levy on the goods that CP had already gotten execution on.
ii. If BC can get a pro forma levy, then the distribution will depend on the state
1. Most states base on the date of delivery of writ to sheriff (relation back), if this is the case, BC will get $10k and CP will get $5k.
2. Some states base the “first in time” on date of levy. In this case, BC will get $5k and CP will get $10k
iii. If BC doesn’t get a levy, CP will get $10,000 and the excess money goes back to RHA.
b. Question 2: SBC has 5 judgment creditors, but only one was executed. Each judgment is for $5k. The sheriff executed on HK’s fi fa by going to SBC and announcing that he was seizing the entire inventory. SBC convinces HK to forebear on seizing the inventory. Afterwards SBC granted SSB a SI in all inventory for a $10k loan which was properly perfected. SBC then fails. The sale of inventory will net $12k.
i. If in a levy as date state, 10k to SSB, 2K to SBC
1. No other creditor has perfected their claim
2. HK can try to levy the shoes after SSB has seized it
ii. Common law will likely not allow interest in inventory, so the bank would have the only valid interest (bank has right under Article 9)
ii. Garnishment
1. Used to attach debts owed to the debtor for the benefit of the debtor’s judgment creditor. The property being seized here is the debt. Common form of garnishment is to the debtor’s wages, bank account, and third party possession of debtor goods.
2. Garnishment process
a. Writ of garnishment:
i. Set of questions to determine if the garnishee owes money to or has any property of the debtor
ii. Command to the third-party garnishee to withhold payment or return of the debtor’s property
b. Garnishment: Either the seizure of the property from the garnishee or the transfer of debts. Treated as an ancillary lawsuit, so if the third party contests the garnishment a trial can be held.
i. Judgment debtor receives notice of the garnishment and may also participate
ii. Garnishee may assert defenses to garnishment such as claiming that he owns the property or that the debt had been released or satisfied. Most often it will be that the garnishee has superior rights to the property.
3. Some states allow for the entire judgment to be rendered against a garnishee who fails to answer the writ within the time specified (Webb v. Erickson [M83])
4. Webb v. Erickson (M83)
a. Facts: Judgment creditor got a judgment against Bates for the amount owed by Erickson. Another lawsuit for enforce garnishment against Bates from his employer.
b. Holding: Set aside the judgment against Bates
i. More liberality should be shown in setting aside a judgment against a defaulting garnishee
ii. Bates acted with excusable neglect due to his personal circumstances
iii. Lack of notice of the default judgment
5. Problem Set II (M98; uses Texas Rules on M96-97)
a. Question A: FC gets $3,000 judgment on 2/1 and delivered writ of garnishment to sheriff on the same date. Bank has an offset of $10. On 2/5 debtor deposits $2,500, and on 2/9 bank is served the writ.
i. Bank gets $10, and FC gets $2,490
ii. Bank usually gets offset no matter what time the offset is executed
iii. According the TX law, the bank needs to answer based on the amount it holds on the day that it is served
b. Question B: Same as question A, but debtor wrote a $500 check on 2/9 and bank accidently paid the check on 2/10. Still unknowing, debtor deposited $200 on 2/11. Bank answered on 2/15. On 2/16 the debtor’s employee made an ETF deposit into the account of $200.
i. Usually a period of time that the debtor doesn’t know that their account has been garnished
ii. Bank can later bring suit for the debtor for anything that it had to pay to the creditor
b. Secured Creditors: Persons of Property
i. What is Default?
1. General Rule: The only judicially recognized form of default is failure to pay the debt on time
a. Job of lawyers to fill in possible exigencies with appropriate clauses triggering default and ability for foreclose
b. Ex. Default can be defined to include failure to perform any of the terms of the agreement, cover specific problems such as the death of the debtor, impairment, etc.
c. 1-208 allows parties to use acceleration clauses/insecurity clauses
i. Acceleration Clause: contractual clause allowing creditor to accelerate the payment structure of a loan
ii. Insecurity Clause: contractual clause allowing creditor to declare the entire obligation due “at will”
iii. Good Faith
1. 1-304 requires every contract or duty within the UCC imposes an obligation of good faith in its performance and enforcement
2. 1-201(b)(20): Good faith means honesty in fact & observance of reasonable commercial stds. of fair dealing
a. Includes subjective (“honesty in fact”) and objective (“reasonable commercial standards”) beliefs
b. Some states only require the subjective element
2. Problem 115 (B275): If there is an acceleration clause that requires “good faith that the creditor believes the prospect of payment or performance is impaired”, what situations qualify?
a. Courts tend to stretch to protect debtors whenever the secured party’s insecurity is unwarranted
b. Economic conditions of the creditor would not qualify
c. But what about the balance between creditor’s rights vs. debtor’s rights?
i. Don’t want to imposed too much cost for creditors so that it will run up costs of granting credit
ii. However, we don’t want debtors to constantly be under the threat of acceleration
3. Klingbiel v. Commercial Credit Corp (B276): Δ repossessed π’s car in the middle of the night even before the due date of the first payment without giving π any notice. π brings action for the tort of conversion.
a. Δ argues that the contract doesn’t require Δ to give notice
b. Holding: K requires that Δ make a demand to require vehicle or the acceleration. To repossess without notice, there must be a default.
ii. Repossession and Sale
1. Process
a. After a default, a secured party can take possession of the collateral and without removal, may render equipment unusable and dispose of collateral on a debtor’s premise in two manners: (1) pursuant to the judicial process or (2) without judicial process, if it proceeds without breach of the peace. [9-609(a)-(b)]
i. Parties can only take possession if there is a default.
ii. If the creditor repossesses with there is not right to do so, the creditor is guilty of conversion and breach of contract and will have to pay the appropriate damages
iii. A certain amount of trickery seems to be accepted
iv. What is breach of the peace? Depends on the weight given to breach of peace.
1. Doesn’t matter if the creditor acts peacefully, what matters is the general breach of peace
2. Can’t use police officers in non-judicial process because it is “constructive force”
3. Trespass is usually breach of the peace
4. MBank v. Sanchez (M110): Breach of the peace in repo by an independent contractor imputes the creditor
b. After repossession, the secured party can either resale the collateral or keep the collateral
i. The secured party can dispose of the collateral in a commercially reasonable fashion in private or public proceedings. [9-610(b)]
1. Commercially reasonable requires that the disposition is made (1) in the usual manner on any recognized market, (2) at the price current in any recognized market at the time of the disposition, or (3) otherwise in conformity with reasonable commercial practices among dealers in the type of property that was the subject of the disposition. [9-627(b)]
2. “Public sale”: a sale at which the price is determined after the public has had a meaningful opportunity for competitive bidding [9-610 cmt. 7]; essentially an auction
a. Meaningful opportunity implies that some form of advertisement of public notice must precede the sale and the public must have access to the sale [9-610 cmt. 7]
b. In a public sale, the secured credit
sumption rule which creates a presumption that the sale would have covered the whole debt, but the secured party has an opportunity to prove otherwise.
1. Absolute bar rule is still majority (especially in consumer cases), but it is close
2. This is the remedy that matters
3. The damage remedy under 9-625 is not very prophylactic
g. If CCA had not publicized the public sale, the sale was not commercially reasonable. [9-610 cmt. 7]
h. Foreclosure sales give rise to the same warranties as an Art. 2 transaction [9-610(d)] but the secured party is allowed to disclaim or modify warranties under certain circumstances [9-610(e)].
6. Bezanson v. Fleet Bank (M100): Secured creditor selected a lower offer in disposition which gave them more potential earnings in the long term in a joint venture deal with participation by the bank.
a. Issue: Was the sale of the collateral commercially reasonable?
b. Holding: Reasonable jury could have found that it was more than likely that the first offer would have been accepted but for the bank’s bad faith rejection of that offer so Bezanson gets the difference between the first offer and what the bank was ultimately paid.
c. General Rule: Secured party can’t act as owner, but must sell to get as much as you can.
iii. Other Sanctions Protecting Secured Creditors
1. Could be criminal charge if the debtor does something outside of the allowances of the security agreement. Ex. the Texas Penal Code has statutes that prevent the hindering of secured creditors.
2. Commercial lawyers must be careful because it can be unlawful as extortion to use threats of criminal prosecution for things that only amount to civil litigation
3. In re Barnes (M109): Alleged that the debtor had willfully breached the terms of a security agreement. He had sold inventory and accounts and used the money for his own purposes. May lose bankruptcy discharge because such an action is an intentional tort.
iv. Protective Covenants
1. Can be a substitute for secured credit or are given strength by the fact there is security underlying those covenants
2. Problem Set III (2) (M113):
a. Continental had a bond issue that had three tranches against a pool of collateral, a pool of planes. The most senior tranche was $100M, the second and third were each $150M. The planes were allegedly worth $500M. The most senior tranche had priority to paid in full before the next level.
i. From the perspective of the senior party, it was secured 5 to 1 (collateral ratio), and the second level had 2 to 1 collateral
ii. Interest rates were determined by the level of the party
b. What then happened:
i. Value of the airplanes sank to $300M
ii. Continental had a right to sell collateral as long as it used proceeds to buy bonds at market and it did so with $100M of the collateral but were able to buy the majority of the 2nd and 3rd tier of bonds for cheap
c. The top tier is reduced to 2 to 1 coverage, so the value of those bonds dropped
d. The underwriters failed the investors by allowing continental to go out into the market place and buy them from the bottom up
e. Example of covenant-lite debt in a hot market
3. Problem Set III (3) (M114)
a. Unsecured bonds so Marriott was able to divide the assets of the company and the management. This leaves the unsecured lenders with the company that is not strong.
b. Had the bondholders been secured, the debt would follow the collateral
c. Could also have used covenants that restrict these things from happening
d. Example of covenant-lite debt in a hot market
v. Section 620 “Deal”
1. 9-622 allows for the acceptance of collateral in full or partial satisfaction of obligation and 9-620 has the rules governing the deal
a. May make time and money
b. But subject to abuse so 9-620 regulates this deal
2. How to make Section 620 Deal
a. Consumer
i. Can’t have partial satisfaction [9-620(g)]
ii. Requirements:
1. There is a signature or if the debtor doesn’t object [9-620(a)(1), (c)(2)]
2. No other objection [9-620(a)(2),(d)]
3. Collateral not debtor’s possession [9-620(a)(3)]
iii. Exception: the consumer has paid for 60% of the collateral, then there must be a sale [9-620(f)] unless there is a waiver signed after default [9-620(a)(4)]
b. Non-consumer
i. Full satisfaction
1. Must have a signature or if the debtor doesn’t object [9-620(a)(1), (c)(2)]
2. No other objection [9-620(a)(2),(d)]
ii. Partial satisfaction
1. Must have a signature [9-620(a), (c)(1)]
2. No other objection [9-620(a)(2),(d)]
3. Once there is partial satisfaction, there is valuation.
a. Drafters were not confident in allowing consumers to value collateral
b. Some courts have found that secured parties that have sat on their collateral to have accepted this kind of deal, but the drafters didn’t like that at all, so 9-620(b) now prevents this assumption
2. Under Federal Bankruptcy Law
a. The Automatic Stay
i. As soon as a bankruptcy petition is filed, an automatic stay goes into effect like an injunction and forbids any act whatsoever to collect any debt form the debtor or the debtor’s property. [11 U.S.C. §362(a)]
