Secured Transactions and
Bankruptcy
In the real world, few goods are paid for in
cash. Most are financed. How does a seller
ensure that the buyer will pay? What can
the seller do to protect herself if the buyer
does not pay?
OBE 118, Section 10, Fall 2004
Professor McKinsey
Notes and Instruments
• Notes and instruments explained how we
allow debts and obligations to be easily
transferred to parties
• Obligations to pay someone money or
perform services can be a promise in a
contract.
• Sometimes the when an obligation is solely
about paying money, it is unconditioned, and
it meets certain other requirements, we call it
a note.
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Negotiable Instruments
• A Note and other instruments such as checks,
Certificates of Deposit can often be
negotiable meaning they are easily
transferred or sold for value.
This week we study the world of notes, loans,
collateralized loans, purchase agreements,
security interests and the like. This is the real
world of most personal property acquisition.
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Security Interest
• A right another party has in property that
allows them take the property and sell it to
recover the amount of a debt or obligation
• Can be in Personal Property or in Fixtures:
(We use a different system for Land)
• A security interest is acquired through a
document called a “security agreement”
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Security Agreements
Security Agreement, $$
Buyer
Seller
Goods
This exchange of a security agreement for goods creates a
valid security interest in the goods.
The goods are “secured property”
The Seller is a “secured party”
The buyer has less than full rights in the goods
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Security Interest
• To have a security interest, the seller must
– Obtain a security agreement
– Give up value
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Security Agreement
•
•
•
•
Identification of the property
Written*
Signed by debtor (authenticated if electronic)
Explanation of what the security interest is
(description of the financial obligations)
• Usually the security agreement is a contract
that will have a lot more information, promises,
terms etc.
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Oral Security Agreement?
• Security Agreements should be in writing
• A secured party can satisfy that requirement if
they gain control or possession of the secured
property
– Control: for intangible things such as accounts.
– Possession: for tangible things
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Security Agreement for Future
Property?
• Sure
• Can be for after-acquired property (Secured party
loans money to debtor).
• Security interests automatically attach to the
proceeds of a sale or disposition of the
property.
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Chattel Paper
• A special form of a security interest for
personal property (chattel)
• Chattel Paper is the equivalent of a security
agreement for a specific piece (or set) of
property.
• Chattel Paper is fairly negotiable: it is often
used for other transactions
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Security Agreements
Security Agreement, $$
Buyer
Seller
Goods
This is a security interest in the goods because the
seller gave up value
Thursday, we examine how this security interest
works with third parties
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Security Interests
Security Agreement, $$
Buyer
Seller
Goods
Review:
When the above occurs, the seller is said
to have a security interest in the goods
which are now called secured property.
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Perfection
• To protect against claims by other parties,
the seller must “perfect” its security
interest.
• “First in time, first in right” is an old
adage that often is accurate in the world of
property rights. Keep this in mind.
• Usually, to perfect a claim, the secured
party must file a financing statement.
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Security Agreements
Security Agreement, $$
Buyer
Seller
Goods
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Perfection by Filing
• Financing Statement:
– Name of debtor
– Name of secured party
– Identifies the collateral
• Filed with correct governmental office:
– Often county office for most goods
– Sometimes state office for special goods
– Must look at specific state laws where resident
lives or organization has executive office
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Perfection by Possession
• It works.
• Morale? Always physically inspect
property you are about use as collateral to
loan you are going to make.
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Security Agreements
Security Agreement, $$
Buyer
Seller
Goods
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Perfection: Consumer Goods
• Purchase Money Security Interests (PMSI’s)
automatically perfect in consumer goods (no
filing required)
• What does this mean?
• Morale? Never let consumer goods already
held by the consumer be used for collateral
when loaning money unless they can show
they paid cash for it.
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Perfected Security Interests
• Good against all the world (from that point on)
except against a buyer who buys the goods from a
seller who routinely deals in such goods and who
created the security interest.
• Buyer in Ordinary Course of Business (BIOC)normally means buying in good faith from a seller
who routinely deals in such goods, but good faith
drops out for this exception, the buyer can even
know of the security interest.
• Morale? Don’t loan money on inventory either.
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Perfected Security Interests
• A security interest allows you to take
possession of the collateral from the buyer and
dispose of it (except for the inventory
exception).
• A perfected security interest allows you to
ignore later claims by other parties and first
pay your claims.
• A perfected security interest allows you to
take possession from another, later “owner” of
the goods.
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Priority
• Book spells it out real well.
• Perfection trumps over non-perfection
• First in time….
Review: what causes a security interest to
attach?
Main answer: when the security agreement is
signed and the secured party has given
value
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Bankruptcy
• Can terminate an otherwise legitimate collectible
debt or owed obligation under a contract.
• Courts do this to allow individuals (people or
artificial entities) to start over again by paying a
limited price (but painful) to creditors according to
a priority list.
• Different types bankruptcy have different effects
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Types of Bankruptcy
• Liquidation (7) versus Reorganization (11 or
13)
• Voluntary versus Involuntary
• Individuals versus Business Entities
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Special Rules
• Payments to creditors in last 90 days before BK
are limited to what creditor would have gotten in
BK.
• Fraudulent transfers in previous year are invalid.
• Six years required after Chapter 7 or 11 before
Chapter 7 allowed.
• Debtor can reaffirm a debt that would have
otherwise have been discharged.
• Creditors can seek reaffirmation (and should
whenever possible)
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Special Rules –
Priority
• Secured Creditors have highest priority to
extend of value of secured property
• Priority Creditors are paid next
• Unsecured Creditors get last feeding at the
BK trough.
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Special Rules –
Debts not Discharged
•
•
•
•
Student loans
Alimony and child support debt
Credit Card Cash Advances in last 60 days
Fraudulent money acquisitions
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Three BK Provisions
Chapter 7
Chapter 11
Chapter 13
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Chapter 7- Liquidation
• Petition
– Involuntary - >$10k in unsecured claims, 3 of 12 or 1 of 11
creditors, and not paying debts that are due
– Creditors stopped from collecting
• Debtor- Creditor Meeting
• Proofs of Claims by Creditors
• BK Estate Figured Out and Divided Up
– Exempt property stays with debtor
– The rest is paid out to creditors
• Secured property first to secured creditors
• Priority claims paid next
• Unsecured claims paid last.
• Debtor is Discharged
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Chapter 11- Reorganization
• No Trustee because debtor keeps operating
• Creditors’ Committee (7 largest creditors)
• Reorganization plan
– How debts will be paid and when, how business will
operate
– Majority of creditors in each class must vote for it or it
must be a “cramdown” by court
• Discharge
– Only some of the debt is discharged.
– Some is paid by some of the existing assets
– Most debts have new right to a stream of income that will
cover remainder
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Chapter 13- Consumer
Reorganization
• Only consumers with certain debts
maximums
• Only voluntary
• Consumer’s Payment Plan
– Secured and Priority paid in full
– Unsecured must do at least as well as under Chapter 7
• Discharge
– Debts are discharged per plan (only temporarily if debtor
violates the plan)
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