3. Learning Objectives
The meaning of a secured transaction
Suretyship and guaranty
Liens on personal property
Security interests in real property
Mechanics and materialman’s liens
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4. Overview
The term credit has many meanings, but for
purposes of this course, credit refers to
transactions in which goods are sold,
services are rendered, or money is loaned in
exchange for a promise to repay the debt at
some future date
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5. Secured vs. Unsecured Credit
Most transactions are unsecured: a service
was rendered or good sold and the
consumer-debtor promises to pay for the
service or good upon receiving a bill
Maximum risk of loss to the creditor
To minimize risk, a creditor may require the
debtor to convey to the creditor a lien
(security interest) on the debtor’s property
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6. If Consumer Fails to Pay
In unsecured credit transactions, a creditor
has recourse against the debtor’s default by
sending notices to pay and eventually filing
suit against the debtor for payment
Result: collection effort begins
In a secured credit transaction, creditor can
go against the security (repossess) to collect
the debtor’s outstanding obligation
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7. Security Devices
A creditor’s or debtor’s rights and liabilities in
a secured transaction depends on the
particular security device used: surety,
guaranty, lien, or mortgage
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8. Surety
A surety is a person who is liable for the
payment of another person’s debt or for the
performance of another person’s duty
The surety joins with the person primarily
liable in promising to make the payment or to
perform the duty
The classic “co-sign” situation
Generally on the same signature page
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9. Surety
A surety is primarily liable
for the debtor’s
obligation, and creditor
can demand performance
from the surety at the
time the debt is due
rather than sue debtor for
payment or performance
on the duty
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10. Guaranty
A guaranty contract is like a suretyship, but
the guarantor does not join the principal
debtor in making a promise, but makes a
separate promise to be liable only after the
principle debtor defaults and cannot pay
A surety is primarily liable on the debt, but the
guarantor is secondarily liable
Typically, a separate guaranty document that
must be in writing to satisfy the statute of frauds
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11. Defenses of a Surety
A surety may use defenses to a creditor’s
demand for payment that principle debtor
would have under the primary contract:
Breach of warranty, lack or failure of
consideration, fraudulent inducement, and
breach of contract by the creditor party
Courts protect accommodation sureties (e.g.,
friend, parent) more than compensated
sureties (e.g., bonding company)
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12. Creditor’s Duties to Surety
Creditor must disclose any material facts
about the risk involved to the surety
Failure to do so relieves the surety of liability
See New Jersey Economic Development
Authority v. Pavonia Restaurant, Inc.
Court rejected claim by sureties that creditors
violated their duty to the sureties because
creditors did not have any superior
knowledge of material facts about risk
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13. Surety’s Rights
If the surety performs or pays principal’s
obligation, then the surety acquires all rights
creditor had against the principal
Surety’s right of subrogation: right to collateral in
creditor’s possession, judgment rights creditor
had against principal, and creditor rights in
bankruptcy proceedings
Surety may recover costs from the principal
Surety’s right to reimbursement
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14. Surety’s Rights
If one of two or more co-sureties performs or
pays principal’s obligation, the surety who
satisfied the obligation has a right to
contribution from the co-sureties
A surety or guarantor has a right to
exoneration: principal debtor must make
good on the commitment to creditor when s/
he (1) is able to do so and (2) does not have
a valid defense against payment
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15. Liens on Personal Property
A lien – a security interest in personal
property – is available to businesses and
individuals by common law and statute
Statutes often provide a procedure for
foreclosing the lien (foreclosure)
Property owner’s rights are cut off so the
lienholder can realize the security interest
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16. Liens on Personal Property
Two essential elements of the possessory
lien (e.g., artisan, innkeeper, common
carrier):
(1) possession by improver/provider of services
(2) a debt created by the improvement to goods
or provision of services concerning the goods
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17. In re Borden
Facts:
The Bordens granted the Genoa National Bank
(Bank) a security interest on all personal property
and Bank perfected security interest
Perfected by filing UCC financing statement
Farm machinery required and received repairs by
Bellamy’s, which sent bills to Bordens
Bordens couldn’t pay, so Bellamy’s refused to
release property to Bordens
Bordens filed for bankruptcy, then took and used
machinery without permission from Bellamy’s
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18. In re Borden
Procedural History and Legal Reasoning:
Bank filed motion to determine priority of liens
Court found conflicting authority, deciding that
Bank had priority over Bellamy’s (artisan) since
continuous possession is required to maintain an
artisan’s lien; Bellamy’s appealed
Appellate court reasoned that an artisan’s lien is a
possessory lien and possessory liens have priority
over a creditor’s lien unless artisan voluntarily
loses possession
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19. In re Borden
Eighth Circuit Bankruptcy Appellate Panel:
“Artisan did not lose its artisan’s lien…when
Debtor took the Equipment without the Artisan’s
knowledge or consent…Reverse the bankruptcy
court’s order” determining priority.
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20. Security for Real Property
Three basic contract devices for using real
estate as security for an obligation: (1) the
real estate mortgage, (2) the deed of trust,
and (3) the land contract.
Also, state statutes give mechanics and
materialmen a right to a lien on real property
into which their labor or materials have been
incorporated
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21. The Mortgage
A mortgage is a security
interest in (or deed to) real
property given by the owner
(mortgagor) as security for a
debt owed to the creditor
(mortgagee)
A lien on land rather than
conveyance of title
Must be executed with the
formality of a deed
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22. The Mortgage & Sale of Interest
A mortgagor (owner) can sell the property
interest without consent of the mortgagee,
but the sale does not affect the mortgagee’s
property interest or claim against mortgagor
A purchaser of mortgaged property may buy it
and assume (take over) the mortgage
If a mortgage contains a due on sale clause,
when the property is sold, any remaining
balance becomes immediately due and payable
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23. Foreclosing The Mortgage
Foreclosure: rights of the mortgagor or
current property owner are cut off
Foreclosure proceedings are regulated by
state statutes using three methods:
strict foreclosure
action and sale
power of sale
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24. Mortgage Redemption
A mortgagor or an assignee of mortgagor
has an equity of redemption in the real
estate within a specified redemption period
and by full discharge of the mortgage debt
Title to property restored free and clear
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25. In re Foreclosure Cases
Pooling of home loans into securities has
been long-standing practice
Practice makes working out troubled loans
difficult for homeowners
2007: Federal Court judge dismissed 14
foreclosures filed by Deutsche-Bank
Bank was trustee for investment pool
Bank did not own or hold the mortgage loan
at the time the lawsuits were filed
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26. Deed of Trust
A deed of trust is another mechanism for a
security interest in real property
Generally, treated like a mortgage
Three parties to a deed of trust: (1) property
owner who borrows money (debtor), (2) trustee who
holds legal title to property put up as security, and
(3) lender and the beneficiary of the trust
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27. Land Contract
Land contract secures the balance due
seller for the purchase of real estate
An installment contract for a land purchase
Seller agrees to convey property title to
buyer when full price paid, but buyer takes
possession of, pays taxes on, insures, and
assumes other obligations for the property
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28. Mechanic’s &
Materialman’s Liens
Two statutory systems permit one who
furnishes labor or materials to improve real
estate to claim a lien until they are paid
Simple sale of goods does not entitle seller to a
lien on real property
A general contractor contracts with owner to
build, remodel, or improve real property
A subcontractor contracts with general
contractor to perform a particular job
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29. Mechanic’s &
Materialman’s Liens
New York system: subcontractors or
materialmen cannot recover more than is
owed to the contractor at the time they file a
lien or give notice of lien to owner
Pennsylvania system: subcontractors or
materialmen have direct liens and are entitled
to liens for the value of labor and materials
furnished, irrespective of amount due from
owner to contractor
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30. Mechanic’s &
Materialman’s Liens
Statutes generally require
filing of a notice of lien with a
county official
Most statutes grant priority
to mechanic’s lien over all
liens attaching after first
work performed or first
materials are furnished
Priority: order of payment
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31. Test Your Knowledge
True=A, False = B
A guarantor is primarily liable for debtor’s
obligation, and the creditor can demand
performance from the guarantor at the
time the debt is due.
Since a surety is not the principle debtor, it
has no defenses available in response to
a creditor’s demand for payment.
A bond company is a compensated surety.
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32. Test Your Knowledge
True=A, False = B
A creditor must disclose to a surety all
information about the risk involved in a
particular debtor, including whether the
debtor business is likely to be successful
Foreclosure means that the mortgagor’s
rights to the property are terminated.
A mortgage is a security interest in (or
deed to) personal property.
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33. Test Your Knowledge
Multiple Choice
Bob Builder contracted with Joe Homes to
build a house. Bob hired Ken Carpenter,
who built the kitchen cabinets, but Bob
refused to pay Ken. What should Ken
do?
(a) Ken may file a lien on Joe’s real property
(b) Ken may file a mortgage on Joe’s property
(c) Ken may sue Bob and Joe for redemption
(d) Ken may foreclose on Bob for payment
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34. Test Your Knowledge
Multiple Choice
Which two statutory systems permit one who
furnishes labor or materials to improve real
estate to claim a lien until they are paid?
(a) The Torrens and Priority systems
(b) The Pennsylvania and New York systems
(c) The New York and New Jersey systems
(d) None of the above
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35. Thought Questions
What are the
advantages and
disadvantages
of credit?
How does credit
affect your life?
Do you have
any secured
credit?
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Editor's Notes
Examples of unsecured credit: store charge accounts, medical services to be billed, repair services later billed, inventory shipped and invoiced for later billing, etc. Examples of secured credit: appliances sold on an installment plan, a mortgage for real property, a lien on restaurant equipment, a lien on agricultural products or machinery, etc.
The collection effort includes having a sheriff “execute” a judgment and/or (depending on state law) garnishing debtor’s wages – a very long process in and of itself.
Students probably had their parents co-sign for their first car or for students loans.
Note that the New Jersey Economic Development Authority v. Pavonia Restaurant, Inc. case may confuse students!!! Note that the investors who secured the transaction signed under a separate agreement: “ The guarantors executed a Personal Guaranty Agreement under which they each agreed individually to guarantee repayment of the loan to EDA and the Bank.” The court referred to the investors as guarantors. However, the discussion about how the NJEDA and bank pursued repayment equally from the restaurant company and the guarantor investors (and granted a forbearance), and later sued both the principle debtor and the guarantors jointly, indicates the investors actually were sureties, primarily liable in conjunction with the principle debtor restaurant rather than secondarily liable. Oddly, the court even quotes a statement from Section 124 from the Restatement of Security – Suretyship that discusses the duty to a surety. Just warn them that the distinction between a surety and a guaranty is a fine line and that a guaranty is almost more of a subset of the broader “surety” classification than a separate classification.
Pronunciation of “lien” varies in the U.S. from “lēn” (like lean ) to “lē-ən” (like Lee-en )
The hyperlink is to the Eighth Circuit Bankruptcy Appellate Panel’s decision On June 25, 2002, Michael Borden and his wife granted the Genoa National Bank a blanket security interest on all of their personal property, including machinery and equipment then owned and thereafter acquired. The lender perfected its security interest by filing a UCC financing statement with the Nebraska Secretary of State on June 26, 2002. [These concepts are covered in the next chapter, Chapter 29, Security Interests in Personal Property.] On separate occasions in late 2004, Borden took a cornhead and a tractor to Bellamy’s, Inc., for repairs. Bellamy’s performed the repairs and in February 2005 sent the Bordens a bill in the amount of $3,811.46 for the work performed on the cornhead and in March 2005 sent a bill in the amount of $1,281.34 for the work performed on the tractor. Borden did not have the money to pay for the repairs and Bellamy’s refused to release the tractor and cornhead to Borden without payment, so they remained in Bellamy’s possession. On April 1, Borden and his wife filed a voluntary petition for relief under Chapter 12 of the Bankruptcy Code. [Bankruptcy is discussed in Chapter 30 of this textbook]. On this date the tractor and cornhead were in Bellamy’s possession. In June 2005, Borden took the tractor from Bellamy’s lot without permission and used it in connection with his farming operation. Bellamy’s discovered the tractor was missing and contacted Borden to inquire if he had it in his possession. Borden admitted he had taken the tractor, explained that he needed it for his farming operation, and agreed to return it to Bellamy’s as soon as he was finished using it. The tractor broke down while he was using it, and he returned it to Bellamy’s in the fall of 2005. Borden later took the cornhead without permission, used it, and returned it.
In 2006, Genoa National Bank filed a motion with the bankruptcy court to determine the priority of the respective liens claimed by it and by Bellamy’s. The bankruptcy court determined that no controlling authority existed in Nebraska concerning the situation of competing liens where an artisan loses possession of the personal property through action of the property owner. The bankruptcy court looked to other jurisdictions for guidance and found that other courts faced with the issue had reached conflicting results. The bankruptcy court decided that Genoa National Bank’s lien had priority over the lien asserted by the artisan, Bellamy’s. In reaching its decision, the bankruptcy court concluded that continuous possession is required to maintain an artisan’s lien. Bellamy’s appealed. Court: “An artisan’s lien falls within this definition of possessory lien under Nebraska law. A possessory lien on goods, such as an artisan’s lien, has priority over a security interest in the goods unless the possessory lien is treated by a statute that expressly provides otherwise. The artisan’s lien statute does not provide otherwise; accordingly, an artisan’s lien has priority over a previously perfected security interest in the same goods…. Possession is generally required for a possessory lien. If an artisan surrenders possession, the artisan no longer has a possessory lien with priority over pre-existing security interests…. Where the artisan loses possession involuntarily, the artisan does not necessarily lose the artisan’s lien.”
The photo is of a combine with corn header on the front of the machine and tractor with trailer. A corn header is used to remove kernels from the cobs. Corn stover – the stalks, cobs, and leaves – is left. Eighth Circuit Bankruptcy Appellate Panel: “We conclude that the Artisan did not lose its artisan’s lien in the Equipment when the Debtor took the Equipment without the Artisan’s knowledge or consent. Such involuntary loss of possession does not defeat the Artisan’s lien. Furthermore, even if the Artisan’s failure to take action to regain possession of the Equipment can be deemed consent to the Debtor’s prior wrongful taking of the Equipment, such after-the-fact consent could not have been more than a conditional consent to the Debtor’s temporary use of the Equipment with an agreement to return it to the Artisan. A conditional consent to a prior wrongful taking likewise does not defeat the Artisan’s lien…. An artisan’s lien does not require registration with any entity…Courts and legislatures generally recognize that a party who provides labor and materials to property enhances the value of the property. Therefore, the principles of natural justice and commercial necessity dictate that the entity who enhances the value of property should be entitled to payment for such services and may retain the property until receipt of payment therefore.” Conclusion: “The Artisan had an artisan’s lien in the Equipment on the date the Debtor filed bankruptcy which had priority over the Lender’s security interest under Nebraska law. The Artisan did not lose its artisan’s lien nor its priority over the Lender’s security interest when the Debtor took the Equipment from the Artisan’s possession postpetition without authority. Accordingly, under these circumstances we REVERSE the bankruptcy court’s order determining that the Lender’s security interest in the Equipment takes priority over the Artisan’s lien therein.” … . Judgment awarding damages to ARS reversed and remanded.”
Strict foreclosure. Creditor keeps property in satisfaction of debt, and owner’s rights cut off. Creditor has no right to a deficiency and debtor has no right to any surplus. Foreclosure by action and sale , is permitted in all states and the only method of foreclosure permitted in some states. Although state statutes not uniform, they are alike in their basic requirements: suit is brought in a court having jurisdiction, any party with a property interest that would be cut off by the foreclosure must be made a defendant, if any such party has a defense s/he must enter his appearance and set up the defense, after trial a judgment is entered and the property is sold, proceeds of sale are applied to payment of the mortgage debt, any surplus is paid to mortgagor and any deficiency is entered as a judgment against mortgagor and such other persons as are liable on the debt. Right to foreclose under a power of sale must be expressly conferred on the mortgagee by the terms of the mortgage. If the procedure for the exercise of the power is set out in the mortgage, that procedure must be followed. Several states have enacted statutes that set out the procedure to be followed in the exercise of a power of sale. No court action is required.
The opinion by Judge Boyko, Eastern Ohio United States District Court, in In re Foreclosure Cases (pg. 730 of text) generated a lot of attention in the media and in the financial and legal communities when it was issued in October 2007. Judge Boyko dismissed 14 Deutsche Bank-filed foreclosures, basing the decision on lack of standing for not owning and/or holding the mortgage loan at the time the lawsuits were filed. The opinion served as a warning to would-be foreclosers that they needed to have their paperwork in order before they sought to put a homeowner out of his house.
Depending on state statute, seller may have right to declare forfeiture and take possession if buyer defaults
Mutual Savings Association v. Res/Com Properties, L.L.C., on page 734 of the text, illustrates a situation where subcontractors were able to obtain a preferred position through compliance with a state lien statute.
False. A surety is primarily liable for the debtor’s obligation, and creditor can demand performance from the surety at the time the debt is due . A guarantor is secondarily liable for the debt. However, note that even courts frequently treat these two security devices equally. False. A surety may use defenses to a creditor’s demand for payment. True.
False. A creditor only has the duty to disclose material information, but information equally available to a surety (such as an opinion of success) need not be disclosed. This is the lesson of the New Jersey Economic Development Authority v. Pavonia Restaurant, Inc case. True. False. A mortgage is a security interest in real property.
The correct answer is (a).
The correct answer is (b). Stan has choices: waive his right to performance under the contract and hire somebody else, w ithhold his/her own performance (payment) and sue Robert for damages for total breach of contract immediately, wait until the time for performance to file suit in case Robert changes his mind and decides to perform.
Opportunity to discuss the impact of credit on society as well as individuals.