Chapter 33 Creditors, Debtors and Bankruptcy Unit 3: Operational Law For Business Legal Environments of Business

ESSENTIAL QUESTIONS: WHAT IS BANKRUPTCY? WHAT ARE SOME TYPES OF DEBTOR PROTECTION AVAILABLE UNDER LAW? WHAT IS THE DIFFERENCE BETWEEN CHAPTER 7 AND CHAPTER 13 BANKRUPTCY? WHAT ARE THE LONG-TERM EFFECTS OF BANKRUPTCY? Standards: BMA-LEB-7: Categorize, evaluate, and assess specific statutory/regulatory schemes impact on a business. BMA-LEB-10: Explore how student organizations are an integral part of career and technology.

33-1 Legal Protection of Creditors It is in the interest of all society that fair and honest loans be collected with minimum difficulty and expense. Taking security interest in personal property and fixtures or a mortgage on real property are common ways the law allows creditors to protect themselves.

Some secured debt management arrangements protect the creditor by allowing the creditor possession of the collateral unit until the debt is paid. There are other means of protection are available to creditors which includes mechanics’ and artisans liens as well as means that involve third parties are known as suretyship and guaranty.

Law Allowing Secured Debts The most important secured creditors in our society are those lenders who extend large amounts of credit to purchasers or developers of real estate. Real estate such as land, homes, businesses, and factories that may be considered collateral for loans.

In order to obtain a secured position in real estate, most lenders require the individual take out a mortgage, signed written transfer of interest in the subject property to be used as collateral. Two types of mortgage: fixed-rate and adjustable rate. ◦ Fixed rate (interest rate does not change over term of the loan) ◦ Adjustable rate (interest percentage changes with the changing market conditions) Deed of Trust – used in some states; title of subject property is transferred by the debtor/owner to trustee; title will only be reclaimed by the owner when loan is repaid.

Pledge is the transfer of possession of personal property to a creditor as security for the payment of debt or performance of an obligation. Pawn is a legally regulated pledge of tangible personal property, usually a small size ad comparatively high value, e.g., watches, musical instruments, and jewelry.

Involuntary Liens Lien – claim, encumbrance, or charge against property that give the creditor the right, in case of default on a payment that is due, to sell the property and use the proceeds from the sale to pay the debt. Almost all liens are created with the consent of the debtor/owner.

Involuntary liens continue…. Mechanic’s lien- allow a person who has not been paid for labor or materials furnished to build a home, building, or other real property improvement to file a legal claim against the property. If debt is not paid, the realty may be sold and the lien holder takes the proceeds of the sale

Artisan’s lien – allows persons who haven’t been paid for services, e.g., car repair, to retain possession of the serviced item until service charges are paid. Length of time is usually two months to a year. Hotelkeeper’s lien – usually luggage or other items that guest leave at hotels for temporary quarters.

Laws Involving Third Parties Other means of protection available to creditors involve third parties known as suretyship and guaranty. Suretyship – contractual relationship in which a third party agrees to be primarily liable for the debt or obligation if payment or performance by the principal obligator become overdue. Guaranty – the third party, guarantor agrees to pay if the principal debtor fails to do so.

Laws Concerning Unsecured Debt Unsecured debt – usually exists when the debt is small or the credit standing of the borrower is very good; this type of debt is based only on the oral or written promise of the debtor; collateral is not needed. If there is a loan default, the unsecured creditor is at a disadvantage than a secured debt. Creditor may take judgment against debtor Debtors may discharge their obligations by going through bankruptcy.

Laws Allowing Garnishment of Wages Garnishment of wages –when a debtor has defaulted in the payment, creditors may legally file a claim in court in order to receive a portion of the debtor’s wages directly from the debtor’s employer. The total amount that could be garnished by all creditors, is generally limited by the Consumer Credit Protection Act to 25% of the debtor’s disposable earnings. Note: Up to 60% of disposable earnings can be garnished for child support, bankruptcy payments, and back taxes. Disposable earnings means the amount left after legally required amount of taxes, social security, and unemployment insurance, etc., have been deducted.

33-2 LEGAL PROTECTION OF DEBTORS AND CREDIT CARD USERS

The law tries to protect debtors from unfair practices and situations by: setting maximum interest rates requiring disclosure of loan terms changing the terms of unconscionable contracts correcting specific abuses of the credit system requiring the creditor to record a public notice when certain debts have been paid and providing a procedure allowing canceling most debts so as to give the debtor’s financial life a fresh start.

Laws Setting Maximum Interest Rates Usury Laws– most state4s provide that lenders of money may not charge more than a specified maximum rate of interest. (pg. 176) The maximum rate varies among states and 18 percent is a common maximum. Lending money at a rate higher than the state’s maximum allowable rate is usury.

Laws Requiring Disclosure of Terms The Federal Truth in Lending Act (FTLA – part of Consumer Credit Protection Act) was designed to protect consumers when they become debtors. Law requires complete and clear disclosure by creditors of loan terms such as interest rates and finance charges. The law does not limit the percentage amounts that may be charged except fro certain specialize types of mortgage loans. Finance charge – total added to cost when one pays in installments for goods and services.

Laws Challenging Unconscionable Contracts UCC provides that court may find a contract or clause unconscionable, glossily unfair and oppressive and unethical. If contract is challenged in court, a judge decides that he clause is unconscionable and may: ◦ Refuse to enforce the contract ◦ Enforce without the unconscionable clause ◦ Limit the clauses’ application so that the contract is no longer fair.

Laws Prohibiting Abuses in the Credit System Federal Credit Opportunity Act – makes unlawful for any creditor to discriminate against an applicant based on race, marital status, age, origin, recipient of public assistance, etc. Federal Debt Collection Practices – Makes abusive and deceptive debt collection practices illegal. Applies to professional bill collectors or agencies that regularly try to collect consumer debts from clients. (e.g., harassment, abusive language, threats)

Federal Fair Credit Billing Act – provides protections to credit card holder (e.g., bills must be mailed at least 14 days before due date, creditors may not send repeat, persistent letters demanding payment). Federal Fair Credit Reporting Act – regulates credit- rating service companies that review personal financial records of credit applicants. Credit rating reflects the evaluation of one’s ability to pay debtis.

Federal Credit Repair Organizations – the Credit Repair Organizations Act (CROA) prohibits the issuing of false and misleading statements as well as the commission of outright fraud by credit repair organizations.

Laws Requiring Notice of Debt Payment to be Recorded Debtors should always request receipts, especially when paying cash. In some states a debtor is not required to pay a debt unless a receipt is given When a secured debt is paid in full, the law generally permits the debtor to require the creditor to record that fact in the public record.

Laws Allowing Debtors to Cancel Debts and Start Over Bankruptcy laws have been enacted to help debtors who have become overburdened with debts. As a statue of limitation laws will after a suitable period, required that all efforts to enforce debts through the court system cease. Generally, unsecured debts have a statue of limitation of three to six years, written obligations six years, and court judgments up to 20 years. Note: Child support payments typically do not have a statue of limitation.

Protections for Credit Card Users Millions of consumers buy goods and services using credit cards which identify the holder as the person entitled to goods and services. Protection include the persons picture on the card, security information, number or key on the back, signature requirements, etc. The los of theft of a credit card should be reported immediately.

33-3 BANKRUPTCY

The ability to avoid harsh treatment for unpaid debts through a process of bankruptcy was considered important enough to be included in the U.S. Constitution.

The Bankruptcy Act Bankruptcy protects creditors by setting up a framework to provide fair treatment in their competition for the bankrupt person’s assets. It protects debtors by giving them an opportunity for a new economic start, free from most creditor’s claims. To accomplish these purposes, the federal Bankruptcy Code in Chapters 7, 11, 12, and 13 provides a variety of possible ways for debtors to seek relief.

The federal Bankruptcy Code in its Chapters provides a variety of possible ways for debtors to obtain relief from an oppressive load of debt. ◦ Chapter 7 for liquidation ◦ Chapter 11 for reorganization ◦ Chapter 12 for family farms ◦ Chapter 13 for an extended payment plan

Chapter 7 Liquidation, or “Straight Bankruptcy” Involves the sale for cash of the debtor’s nonexempt property and the destruction of the proceeds to the creditors. (bank assets, stocks, bonds, etc.) Utilizing Chapter 7 results in the discharge of most debtor’s financial obligations. However, relief under Chapter 7 will be denied if debtors have income above the median income for similarity size families in the sate.

Chapter 11 Reorganization Designed to keep a business organization (corporation, partnership, or sole proprietorship) in operation with no liquidation. Claims of both secured and unsecured creditors and the interest of the owners of the business may be “impaired” or reduced.

Chapter 12 Debt Relief for Family Farms Added to Bankruptcy Code in 1986 for family farm owners. Individual, couple, corporation can be eligible to file a petition for relief. This petition entitles them to a court order protecting the from their creditors. Similar in operation to the Chapter 13 proceedings for other debtors.

Chapter 13 Extended Time Payment Plan Available only to individuals who have regular incomes. Avoids liquidation of assets. Debtor must have regular income, unsecured debts of less than $360,470 and or secured debts of less than $1,081,500. Debtor must submit a plan for the installment payments of debts within three years with a possible extension to five years.

During this time, creditors may not file suit for payment of any debt. Both secured and unsecured claim may be reduced in amount or extended in time for payment. The plan must be in the best interest of the creditors, who might otherwise receive even less in a Chapter 7 liquidation. A major advantage of Chapter 13 proceeding is that upon completion of payments under the plan, the court grants a discharge for almost all debts. Exceptions include house and payments of alimony and child support.

The Bankruptcy Petition Chapter 7 may be voluntary or involuntary. Voluntary Bankruptcy – person does not have to be insolvent (unable to pay debts when they are due) to file the petitions. Involuntary Bankruptcy – person owing at least $12,450 to their petition and unsecured creditors and unable to pay debts when they are due.

Required Information for Filing List of all creditors and amounts owed List of all property owned including property claimed to be exempt from seizure Statement explaining the debtors’ financial affairs List of current income and expenses

Selection of Trustee in Bankruptcy After petition is filed, a trustee is selected to find and protect the assets of the debtor, liquidate them, and pay the claim against the debtor’s estate with proceeds.

Non-Dischargeable Debts Certain types of claims that cannot be discharged by bankruptcy. ◦ Certain taxes ◦ Alimony and child support ◦ Claims against the debtor for property obtained by fraud, embezzlement, or larceny ◦ Judgments against debtor for willful and malicious injury to person or property of another ◦ Student loans (federal loans cannot but private student loans can be discharged)

Liquidation and Distribution of Proceeds Proceeds are used to pay the creditors after secured collateral, the law provides and order of priority for payment of claims against the bankruptcy estate. ◦ Unsecured claims for domestic support orders ◦ Expense of administration of the bankruptcy, including trustee fees, ◦ Claims for wages, salaries, commission, maximum $10,950

Exempt Property Examples include: ◦ Real property (mobile home ◦ Life insurance payments for the debtor depended on for support ◦ Life insurance policy with loan values to $10,775 ◦ Alimony and child support ◦ Pensions and retirement benefits ◦ Health aids ◦ Jewelry up to $1350 ◦ Motor vehicles to $3,225,

Bankruptcy laws in the United States are more lenient and the costs thereof to society greater than those in other countries.