BUSINESS LAW TODAY
Essentials 9th Ed.
Roger LeRoy Miller - Institute for University Studies, Arlington, Texas
Gaylord A. Jentz - University of Texas at Austin, Emeritus
Chapter
16
Security Interests,
Creditors’ Rights, and
Bankruptcy
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1
Learning Objectives


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What is a security interest? What is the most
common method of perfecting security interest
under Article 9?
What is garnishment? When might a creditor
undertake a garnishment proceeding?
In a bankruptcy proceeding, what constitutes the
debtor’s estate in property? What property is
exempt under federal bankruptcy law?
What is the difference between an exception to
discharge and objection to discharge?
In a Chapter 11 reorganization, what is the role
of the debtor in possession?
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2
Security Interests: Terminology
 Secured Party: creditor who has a security





interest in debtor’s collateral.
Debtor: person who owes payment of a
secured obligation.
Security Interest: interest in the collateral that
secures the performance.
Security Agreement: agreement that creates
or provides for a security interest.
Collateral: subject of the security interest.
Financing Statement: normally filed with
public notice to third parties.
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3
Creating a Security Interest
 Creating a Security Interest.
 Collateral in Possession of Creditor, or there must be a
written agreement describing the collateral signed by
Debtor.
 Creditor must give something of value to Debtor.
 Debtor must have “rights” in collateral.
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4
Creating a Security Interest
 Once these requirements are met, the

creditor’s rights “ATTACH” to the collateral,
giving the creditor an enforceable security
interest.
Written or Authenticated Security Agreement.
 When collateral is NOT in possession of secured
party. Document must contain description of property.
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5
Perfecting a Security Interest
 Perfection is the legal process by
which the secured party protects
herself from third party claims against
the same collateral, which is divided
into two categories:
Tangible: Consumer goods, equipment, farm
products, inventory, accessions.
Intangible: Chattel Paper, Instruments, Accounts,
Deposit Accounts, General Intangibles.
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6
Perfecting by Filing
 File financing statement with
proper state authority. Gives 3rd
parties notice. Lasts 5 years.
Financing statement must provide:
Proper Legal Name of Debtor, Secured
Party, and description of Collateral.
Improper filing reduces secured party’s
claim in bankruptcy to an unsecured
creditor.
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7
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8
Perfection Without Filing
 Perfection by Possession: collateral is in
the possession of the secured party.
 Perfection by Attachment:
Purchase Money Security Interest (PMSI) in
consumer goods and seller/manufacturer
provides financing.
Automatic Perfection: at the time of credit sale,
unless certificate of title is required (automobile,
mobile homes, tractors, etc).
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9
Effective Time Duration of Perfection
 Financing Statement is effective FIVE (5)
years from date of filing.
If continuation statement is filed six months prior
to expiration, continues for another five years.
Can continue indefinitely.
 If Financing Statement lapses, becomes
unperfected.
Purchaser for value can acquire the collateral
as if the security interest had never been
perfected.
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10
The Scope of a Security Interest
 Proceeds: whatever received when collateral

sold or disposed of.
After-Acquired Property.
 Security Agreement may provide for a security interest
in property acquired after execution of security
agreement.
 Future Advances.
 Continuing line of credit.
 Subject to security interest.
 Floating Liens
 Security interest in proceeds in after-acquired
property, or
 Collateral subject to future advances.
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11
Priorities
 General Rule is that a first-in-time
perfected security interest has priority
over:
Unsecured creditors and unperfected security
interests.
Conflicting perfected security interests.
Conflicting unperfected security interests.
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12
Priorities
 Buyers in the Ordinary Course of Business:
take goods free from any security interest, even if
perfected and the buyer knows of its existence.
 Good faith, without notice.
 Exception to the First-in-Time Rule: PMSI in


equipment that is not inventory.
Exception to First-in-Time Rule: security interests
in inventory.
Buyers of the Collateral: may conflict with
perfected interests on debtor’s default. 
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13
Priorities
 Buyers of the Collateral.
Conflicts with Perfected Secured Party.
Buyers in the Ordinary Course of Business.
Buyers not in the Ordinary Course of Business
of Consumer Goods.
Buyers of Chattel Paper.
Buyers of Instruments, documents or securities.
Buyers of Farm Products.
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14
Default and Remedies
 Not expressly defined by Article 9 but
rather in the security agreement. Any
breach can constitute default.
 Basic Remedies are cumulative:
Repossession of the Collateral (Self-Help).
Judicial Remedies: execution and levy.
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15
Disposition of Collateral
 Disposition of Collateral: Retention of
Collateral by Secured Party (unless PMSI
and debtor paid 60% or more).
Notice Required. If objection, then Secured
Party must sell property.
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16
Disposition of Collateral
 Disposition Procedures:
Flexible but commercially reasonable manner.
Public or private sale with notice (unless
perishable).
Secured party may purchase collateral at a
public (but not private) sale.
• “Satisfactory” price is only one factor: CASE
16.1 Hicklin v. Onyx Acceptance Co. (2009).
Seller did not sell car in commercially
reasonable manner.
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17
Disposition of the Collateral
 Distribution of Proceeds
Expenses balance of debt junior liens
then balance to secured party.
 Noncash Proceeds.
 Deficiency Judgment.
Debtor is liable for deficiency owing to the
creditor.
 Redemption Rights.
Debtor can ‘redeem’ property by tendering
performance of all obligations prior to sale or
discharge.
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18
Additional Laws Assisting Creditors
 Liens:
Mechanic’s Lien (real property).
Artisan’ Lien (personal property).
Innkeeper’s Lien (baggage of guests).
Judicial Lien:
• Attachment: court-ordered seizure of
property.
• Writ of Execution: court-ordered sale.
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19
Garnishment
 Garnishment.
Creditor permitted to collect a debt by
seizing property held by third party
(usually wages held by debtor’s
employer).
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20
Mortgage Foreclosure
 Creditor (mortgagee) has the right to
foreclose on property upon debtor’s
(mortgagor) default.
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21
Suretyship and Guaranty
 Third person promises to pay debt owed
by another.
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22
Suretyship and Guaranty
 Third person promises to pay debt owed
by another.
Surety (3rd person is primarily liable).
Guaranty (3rd person is secondarily liable).
• Must be in writing unless the “main purpose” of the
guaranty is to personally benefit the guarantor.
CASE 16.2 Capital Color Printing, Inc. v.
Ahern. (2008). Document satisfied Statute of
Frauds, identified Quality Printing as the
customer with a signed personal guaranty.
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23
Suretyship and Guaranty
 Actions that Release the Surety and
Guarantor.
 Defenses of Surety and Guarantor:
Can assert any defense of principal debtor
except debtor’s incapacity or bankruptcy (which
are personal to debtor).
 Rights of Surety and Guarantor:
Subrogation.
Reimbursement (from debtor).
Contribution.
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24
Laws Assisting Debtors
 Homestead Exemption.
Family home free from claims of unsecured
creditors or trustees in bankruptcy.
 Other Exemptions:
Household furniture.
Clothing and personal possessions.
Vehicle.
Tools of the trade.
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25
Bankruptcy Proceedings
 Article I, Section 8 of the U.S.
Constitution. Federal jurisdiction.
 Bankruptcy Reform Act of 2005
significant modified bankruptcy laws.
 Federal Bankruptcy Courts under U.S.
district courts, can appeal to district
courts.
 Federally appointed judges.
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26
Types of Bankruptcy Relief
 Bankruptcy provides different relief:
Chapter 7: Liquidation.
Chapter 11: Corporate Reorganizations.
Chapter 12: Family Farmers.
Chapter 13: Adjustment of Individuals’
Debts with a payment plan.
 Special Treatment of ConsumerDebtors: debts from consumer purchases.
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27
Chapter 7 - Liquidation
 Any person (including corporation) can
file.
 All debts are liquidated (discharged).
 Begins with a voluntary or involuntary
Filing of a Petition (Automatic Stay).
Voluntary: filed by debtor.
Involuntary: creditors force debtor to file.
2005 Act: Debtors must go through
counseling with approved nonprofit agency
during the 180 days prior to filing.
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28
Chapter 7
 2005 Act: Attorney must file affidavit

explaining other chapters available to
debtor.
2005 Act: Attorney must make reasonable
attempt to verify accuracy of petition and
schedules. Failure to do so could be
perjury.
 List secured and unsecured creditors and addresses
and amount of money owed on schedules. List of all
property owned including property claimed; current
income and expenses.
 Swear to these and sign. Federal crime to misrepresent.
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29
‘Substantial Abuse’
 Under 2005 Act, Substantial Abuse WILL
be Presumed If:
Based on “Means Testing” debtor’s family
income is greater than state median income.
Creditors have standing to dismiss petition.
 Substantial will NOT be Presumed If:
Based on “Means Testing” debtor’s family
income is less than state median income.
But creditors have no standing to dismiss.
 Order for Relief.
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30
Involuntary Chapter 7
 Occurs when debtor’s creditors force
debtor into bankruptcy proceedings.
 Can occur if:
If debtor has twelve or more creditors, three or
more with claims totaling $13,475, or
If debtor has twelve or more creditors, one has
a claim totaling $13,475.
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31
Automatic Stay
 Automatic Stay upon Filing either
Voluntary or Involuntary Petition.
 Creditors cannot commence or
continue most legal actions.
 Damages for violation of stay.
 CASE 16.3 In re Kuehn (2009). Kuehn
owed $6,000 in tuition and filed bankruptcy.
University’s refusal to provide transcript, unless
she paid the tuition, violates automatic stay.
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32
Automatic Stay
 Exceptions to Automatic Stay:
 Collection can continue for domestic-support
obligations.
 Proceedings against debtor in divorce, domestic
violence can continue.
 Investigations by securities enforcement are not
stayed.
 Limitations on Automatic Stay:
 Creditors can get “adequate protection.”
 Periodic or one time cash payments or equivalent.
 Reaffirmation.
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33
Property of the Estate
 Debtor’s Estate includes:
All Debtor’s legal and equitable interests in
property presently held, including community
property,
Property transferred in a “voidable” transaction,
and
Property which Debtor becomes entitled within
180 days after filing.
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34
Property of the Estate
 Estate includes (cont’d):
Proceeds and profits from the property of the
estate.
After-acquired property such as inheritances,
property settlements, and life insurance death
proceeds.
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35
Exemptions
 Up to $20,200 in home equity.
 Up to $3,225 in car.
 Up to $10,775 in personal possessions (up to





$525 per item).
Up to $1,350 in jewelry.
Up to $2,025 in tools.
Social security, alimony and support
payments.
Up to $20,200 in personal injury awards.
2005 Act: Homestead Exemption.
 Debtor must have lived in state two years.
 Up to $136,875 of equity.
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36
Trustee’s Powers
 Court-appointed until first meeting of
creditors.
 Creditors elect permanent trustee
 Administers estate.
 Collects proceeds, liquidates assets and
pay Creditors in order of priority.
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37
Trustee Rights and Duties
 New Duties under the 2005 Bankruptcy
Reform Act:
Promptly review all materials filed by debtor.
Not later than 40 days after filing, Trustee must
file: a motion to dismiss the case, change to
Chapter 13, or why motion would not be
appropriate.
New duties to protect domestic-support
obligations.
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38
Trustee Rights and Duties
 Right to Possession of Debtor’s Property.
Constructive Possession (change lock on door).
 Avoidance Powers.
Trustee can set aside a sale or transfer of
debtor’s property (2005 Act: cannot avoid bona
fide domestic support debt).
 Voidable Rights.
Trustee can stand in shoes of debtor and assert
any lack of capacity or lack of assent.
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39
Preferences
 A Debtor is not permitted to transfer


property or make a payment that favors—or
gives a preference to—one creditor over
another.
For a Trustee to recover preferential
payment, Debtor must be insolvent and
transferred property for pre-existing debt
within previous 90 days.
2005 Act: permits consumer-debtor to
transfer any property to creditor up to
$5,475.
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40
Preferences
 Trustee can use preferential payment to pay



a real preexisting debt, not for current
consideration.
Creditor gets more than he would in a
Chapter 7.
Consumer can transfer up to $5,000 without
constituting a preference.
Domestic-support debts are not
preferences.
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41
Distribution of Property
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42
Distribution of Property
 If Secured Creditors:
Consumer debtors.
• Have 30 days from filing petition or before first
meeting of creditors.
• Debtor must tell what she intends to do with
collateral-- keep or surrender.
• Trustee must enforce within 45 days.
If surrenders: creditor can keep or sell.
• If creditor keeps = full satisfaction of debt.
• If creditor sells = can use extra for costs, or can
become unsecured creditor for deficiency.
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43
Distribution to Unsecured Creditors
 Unsecured property:
Paid according to bankruptcy law.
All of one class must be paid before moving to
next.
Creditor within last class receive proportionately
if not enough.
See Priority List in text.
All creditors paid, trustee gives extra back to
debtor.
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44
Chapter 7—Discharge
 Exceptions.
 Objections to Discharge. 
 Effect of Discharge.
 Revocation of Discharge.
 Reaffirmation of a Debt.
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45
Chapter 7—Exceptions to Discharge
 Claims for back taxes.
 Claims for amounts borrowed by Debtor to



pay federal taxes.
Claims against property/money obtained by
Debtor under false pretenses.
Claims by Creditors who did not know about
bankruptcy.
Student Loans.
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46
Objections to Discharge
 Bankruptcy may also deny the discharge
of the debtor (not the debt):
If debtor intentional concealment or destruction
of property or financial records.
 Granting of discharge within 8 years of
previous bankruptcy discharge.
Debtor’s failure to complete credit counseling
courses.
Debtor found guilty of felony.
 Revocation of Discharge.
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47
Reaffirmation of Debt
 Debtor may wish to pay a debt
notwithstanding the debt could be
discharged in bankruptcy.
 Agreement is filed with court.
 Debtor can rescind agreement at any
time before discharge.
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48
Chapter 11-Reorganization
 Debtor and Creditors formulate a plan
under which the Debtor pays a portion of
its debts and is discharged of the rest.
 Same debtors as are eligible under
Chapter 7.
 Focus is on “Best Interests” of the
Creditors.
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49
Chapter 11-Reorganization
 “Fast track” Chapter 11 for small
business debtors whose liabilities do no
exceed $2 million and who do not own or
manage real estate.
 “Workouts” (private negotiated
settlements).
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50
Chapter 11-Reorganization
 Debtor in Possession
(DIP).
Trustee may be appointed.
DIP has same powers as trustee in Chapter 7.
• Strong-arm clause.
 Creditors’ Committees.
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51
Chapter 11-Reorganization Plan
 Acceptance and Confirmation of the Plan.
(2005 Act: Confirmation does not discharge a
debtor.)
Rehabilitates debtor and conserves estate.
Court may “cram down” plan on all creditors.
 Plan must be equitable and:
Designate classes of claims and interests.
Specify treatment to be afforded the classes.
Provide adequate means for execution.
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52
Chapter 13-Individuals’
Repayment Plan
 Chapter 13: Individuals’ Repayment
Plans.
 For individuals with regular income
who owe fixed unsecured debts of
<$336,900 or fixed secured debts of
<$1,010,650.
 Not for partnerships or corporations.
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in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Chapter 13-Individuals’
Repayment Plan
 The Repayment Plan.
For all or a portion of debts to be paid during
a period not to exceed 3 years.
Confirmation Hearing for the Plan.
• Hearing for interested parties to object to plan.
• Court will confirm (order) the plan after creditors
approve.
Objections to the Plan.
 Discharge balance of debt (after
completion of all payments in the plan).
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in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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Chapter 12-Family Farmers
and Fishermen
 Chapter 12: Family Farmer and
(Fisherman, 2005) Plans.
“Family Farmer” (Or Fisherman): 50% of
gross income comes from farming (or fishing)
and whose debts are 80% farm (commercial
fishing) related.
Procedure for filing.
Content of plan.
Court confirmation.
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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