Chapter 26: Credit and Guarantees
Secured and Unsecured loans
Unsecured
Creditor relies on the character and capacity of the debtor
Secured: Creditor also has Collateral
A contingent interest in some property of the debtor. The right, in event of default, to take possession of the property, sell it, and apply the proceeds to the debt
"Purchase Money"
Secured debt where the seller is also the creditor, financing the sale
"Recourse" or "non-recourse"
Non-recourse: the creditor is limited to the proceeds from selling the collateral.
Recourse: the creditor can get a court "deficiency judgment" for any remaining shortfall in paying off the debt.
Security interests in personal property
"Moveables", as opposed to land
"lien"
Means to "tie up" property, before taking it away from debtor. Is first step followed by a legal taking ("levy") by a sheriff (officer of the court) and a sale w/ proceeds applied towards debt
Judgment lien
Filed by person with a lawsuit judgment as an aid to collection. Public filing puts the world on notice there is a claim against the asset. Debtor can't sell clear title.
Statutory liens
Hotels, common carriers, warehouse operators have liens against personalty in their custody. Also mechanics' liens against personal or real property
Purpose is to make sure providers of goods and services will be paid
Other security interests in personal property: UCC Art 9 financing statements
California practice (many differences among states)
Note Secured by Deed of Trust
Borrower/buyer gives a promissory note secured by deed of trust. (A legal fiction that trustee holds property for "true" owner). Deed of trust is recorded in public land records. Usually the note gets paid off, and the borrower should get the deed of trust "reconveyed", so as to release the property .
If Borrower defaults on the note
Note usually will give creditor right to accelerate, that is, demand full payment if buyer defaults on an installment and does not cure within a limited time. If borrower does not pay, creditor usually will instruct the trustee (usually a company that specializes in foreclosures) to sell the real estate at a public auction. (Often, creditor is the only bidder.) Trustees' sales are heavily regulated (See Civil Code Secs. 2924 ff.) The proceeds go towards expenses of sale, payment to creditor, payment to any lower priority ("junior") secured creditors, and in the rare case something remains, it goes to the borrower.
Alternatively, creditor can bring a lawsuit ("judicial foreclosure") and have the property sold under court supervision. (CCP 726) Rarely done, because it's slow, expensive, and gives the borrower a right of redemption for some time after the sale.
Is Borrower liable for any shortfall?
Not if creditor uses a trustee's sale instead of judicial foreclosure. CCP 580d.
Not if the debt is purchase money (creditor was also the seller), and not if the loan was in fact used to buy a 1 to 4 unit owner occupied building. CCP 580b.
These technical rules have become very significant now, because of the collapse of the real estate home price bubble. Links to More Info Here
Guarantees
No "Suretyship" in California
One person stands behind the debt of another
Secondary liability normally must be in writing
Creditor must disclose known risks to guarantor
Insurance often in the form of a guaranty: eg. a Fidelity bond
Effect of guarantee
Guarantor is only secondarily liable, so creditor must go against primary debtor first, unless this is waived
Guarantor has generally same defenses as primary debtor. Payment, tender of payment or release as to primary debtor frees up guarantor
Guarantor's rights
Subrogation: pay creditor and take over creditor's rights to payment/reimbursement from primary debtor
Right of contribution among multiple guarantors
Note income tax effect of paying on a guarantee
Creditors' collection remedies
prejudgment attachment
Tie up debtor's property to prevent it from disappearing during lawsuit
Must have notice and hearing to get court order for sheriff to attach and hold debtor's property
Collecting on judgments:
The judgment lien (CA is 10 yrs., can extend). See CA Small Claims Guide to Collecting Your Judgment
Debtors sometimes go to great lengths to hide assets and frustrate creditors
Chapter 27: UCC Art. 9: Secured Transactions
UCC Article 9 applies to "personal property" = moveables. Very structured, many defined terms
Special terms
"Security interest"
"... an interest in personal property or fixtures that secures payment or performance of an obligation" UCC 1-201(36)
Security agreement: the written contract which describes the collateral and creates a security interest
Collateral
May be goods, including consumer equipment, farm, inventory, fixtures, or may be paper rights, like receiveables, or other intangibles
Collateral may secure future loans as well as present ones, and proceeds from sale of collateral may themselves be collateral
"Floating lien": a security interest that attaches to after-acquired property
Example inventory financing: as old is sold, new inventory becomes collateral
Note: Special rules for automobiles and other certificate of title property
Creating security interests
- Need written security agreement, unless creditor is to hold the collateral (e.g. pawnshop)
- Secured party must give value (consideration) to debtor
- Debtor must have current or future rights to own or possess the collateral
If these requirements met, the security interest "attaches" to the collateral
"Perfecting" security interests
Attachment creates rights against the debtor. Perfection creates rights against the world
Commonly perfected with a "financing statement"
Filed in state secretary of state's office UCC-1 form effective five years.
California Sec of State is trying to implement major revision/ electronic filing and searching under Revised UCC-9. Download UCC forms here
Must have name and address of debtor, secured party, and description of collateral. "Everything" isn't sufficient description.
Secured party can *transfer* financing statement rights by filing a statement of assignment
Alternately, creditor may perfect by physical possession -- a "pawn" or pledge
For consumer goods, purchase money credit creates & perfects a security interest when it attaches.
Secured priorities: why "attach" and "perfect" matter
In general, perfected trumps attached beats none
If equal priorities, earliest wins
Exceptions to the priority of perfection
Again, this is UCC emphasis on practicality over theoretical consistency
After acquired property
Purchase money security interest may prevail over prior perfected non-purchase money security interest. Meaning: Seller/creditor for a particular item has priority over general secured creditor. (Policy reason is to encourage sales on credit)
After Acquired Inventory
Seller of item that will be in buyer's inventory has priority iff Seller notifies other creditor before buyer/debtor receives inventory
Practical signifcance: Know your customers in distribution chain, and who their UCC creditors are -- public record
After Acquired non-inventory
seller has ten days to perfect lien over prior creditors by filing
Buyer in ordinary course of business
Takes goods free of security interests in inventory
Buyers of secondhand consumer goods
Take free of security interests if they do not have actual/constructive knowledge of security interest
Note relation of this rule to the "perfection w/o filing" rule for consumer goods -- filing gives constructive notice
Mechanic's liens prevail over other security interests, even earlier ones
Significance of security interests: rights on default
"Default" = typically, failure to pay when due
Agreement may give creditor the right to repossess the collateral upon default -- if done w/o breach of the peace
Example: automobile repossession
Secured party may sell the collateral or retain it
Retaining satisfies the entire debt
Sale must be commercially reasonable with notice to debtor. Proceeds applied to (1) sale expenses, (2) the debt, (3) junior debts secured by this collateral, with (4) any surplus to debtor
After sale creditor may, by contract, still have right to seek a deficiency judgment against debtor
