BUS607 Week 4 Discussion 2 Bankruptcy

Security interest

A security interest is a claim on another person’s property that secures payment or performance of an obligation (such as a mortgage). The security interest holder has the right to take possession of any collateral if: The secured debt becomes due and the debtor does not pay it or perform its other obligations.

A security interest is created by a debtor and a creditor agreeing to the terms of the security interest (Harris,2020). The creation of security interest involves two elements: The debtor must pay money to the creditor, such as by a loan or credit card purchase. The collateral is then given to the creditor as security for the obligation. Laws in the countries can also create a security interest. For example, in the US, home mortgage interests can be made by a mortgage that is signed by both parties, or it can be created where the property is used as collateral for a debt (like consumer credit).

The way that security interests can be terminated/released depends on each country’s regulations. Security interests are normally perfected when filed with a government registry so that third parties notice the security interests (Harris,2020). A security interest can also be perfected by securing the party recording a financing statement in the proper land records. Still, they are often released when they become due, and only secured debt has been paid off.

A perfected security interest is an interest in personal property that a filing with the state has perfected. An unperfected interest is not filed or recorded and could or should be further perfected. For example, if you have a security interest on a home, it’s not perfected until you file the lien with the county recorder and they record it.

To a creditor, the difference between having a perfected security interest and an unperfected interest is that an unperfected security interest could be vulnerable to a legal challenge by the debtor. If a creditor has a perfected interest and the debtor challenges it in court, the lien is sustained and may be enforced by judgment. However, if a court reviews an unperfected interest, the creditor may have no security interest.

An unperfected interest could be challenged because an unperfected security interest is not filed and recorded. With no record of the lien against the property, it is hard for creditors to show that they have any right to collect on a debt.

Reorganization and ordinary bankruptcy

A reorganization bankruptcy is a type of personal bankruptcy filing in which an individual seeks to restructure their financial obligations and repay the debts over a more extended period (Bulow,2018). As with all other forms of personal bankruptcy, reorganization bankruptcy allows the debtor to continue living their day-to-day life and protect their property during the process. What differentiates it from other types of bankruptcies is that before the person is granted protection, they must prove that they have made arrangements with creditors to repay debts over a lengthy period.

Ordinary bankruptcy, on the other hand, is when an individual declares bankruptcy but does not have any viable repayment plan at the time of filing (Bulow,2018). When somebody declares ordinary bankruptcy, there can be severe negative consequences, such as foreclosure on their home or repossession of their vehicle.

An example of reorganization bankruptcy is a person with $50,000 in credit card debt. They cannot make any of the regular monthly payments and wants to repay them over a more extended period. They could then file for reorganization bankruptcy, in which 100% of the debt is erased. The individual would then need to develop a repayment plan covering 100% of the debt over a set period- usually about five years. The individual would have to sign an agreement with creditors, under oath, agreeing to pay back their debts according to this new repayment plan.

An example of ordinary bankruptcy is a person with $50,000 in credit card debt. They want to pay off this debt and cannot do so. They could then file for ordinary bankruptcy, in which the individual’s debts are reduced to about $25,000. The individual would then have to pay back the remaining $25,000 over a few years under an installment plan. The individual would have to sign an agreement with creditors, under oath, agreeing that they will pay back their debts according to this new repayment plan.

Rights of secured creditors over unsecured creditors

In bankruptcy, the rights secured creditors have over unsecured creditors include the right not to be paid back, the obligation to return a debtor’s property used for collecting a debt, and the ability to convert an unsecured claim into a secured claim.

Secured creditors know that since they have assets on hand, their chances of being allowed to be repaid are much higher in comparison with unsecured creditors. Unsecured creditors like credit card companies and other lenders are typically not protected by assets because securing their debt is too tricky. As such, they lose out on the right to be repaid if secured creditors succeed in bankruptcy.           

Secured creditors also can convert an unsecured claim into a secured claim. If a property used as collateral has a higher market value than what is owed, the creditor can petition the court to have the debt secured, meaning they would get the excess profit after repaying the debt (Warren,2017). For example, if a creditor owns a car and there is $18,000 owed on it, but it’s worth $20,000 at auction, he or she can change what was originally an unsecured obligation into a secured claim by having that sum of money put against the liability. In most cases, this is done when the creditor believes that there are better chances of repayment with that extra cushion. In contrast, unsecured creditors do not have any means of converting the debt into a secured claim.

Secured creditors also have the obligation to return a debtor’s property that was used for the purpose of collecting a debt (Warren,2017). For example, if a vehicle was given as collateral in order to secure a loan, the creditor must return it to the debtor prior to bankruptcy or else they face criminal charges. This obligation is also true in terms of repaying the debt as well, so secured creditors must bring back all collateral that was taken within one year prior to filing bankruptcy. Unsecured creditors do not have any rights over secured creditors; thus, they have no right to be paid back or have their property returned. However, since they are entitled to equal footing in bankruptcy proceedings under federal law, they are considered joint claimants with secured creditors if no plan is accepted by either party.

References

Warren, E. (2017). Bankruptcy policy. The University of Chicago Law Review, 54(3), 775-814.

Bulow, J. I., & Shoven, J. B. (2018). The bankruptcy decision. The Bell Journal of Economics, 437-456.

Harris, S. L., & Mooney Jr, C. W. (2020). A property-based theory of security interests: Taking debtors' choices seriously. Virginia law Review, 2021-2072.