Chp. 29 - West Business Law - 6th edition version Other
Creditor Remedies
Introduction
The law governing debtor-creditor relations has undergone various
changes over the years. Historically, debtors and their families
have been subjected to punishment, including involuntary servitude
and imprisonment, for their inability to pay debts. The modern
legal system has moved away from a punishment philosophy in dealing
with debtors. In fact, many observers say that it has moved too
far in the other direction, to the detriment of creditors. Today,
consumer protection is emphasized, and the legal system is designed
to aid and protect the debtor and the debtor’s family. Nonetheless,
creditors continue to have numerous remedies available to them.
Laws Assisting Creditors
As pointed out in Chapter 28, if a debtor defaults, a secured
creditor’s priority can determine whether the creditor recoups
complete, partial, or no payment of amounts he or she is owed.
Creditors with no priority are paid last, of course—if at
all.
A perfected security interest, in the case of personal property,
or a mortgage, in the case of real estate, may be referred to
as a consensual lien. A lien is a claim or charge on a debtor’s
property that must be satisfied before the property (or its proceeds)
is available to satisfy the claims of other creditors. Referring
to the lien as consensual indicates that its basis is the parties’
agreement. Consensual liens on personal property are the subject
of Article 9 of the UCC and were discussed in Chapter 31. Enforcing
payment under a consensual lien on real estate is discussed later
in this chapter.
A lien may also arise under a statute or the common law or through
a judicial proceeding. Statutory liens include mechanic’s
liens. Liens created at common law include artisan’s liens
and innkeeper’s liens. Judicial liens include those that
represent a creditor’s efforts to collect on a debt before
a judgment (for example, through prejudgment
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attachment) or after it (for example, through a writ of execution).
These terms are defined in the discussion of remedies that follows.
It is important to remember that a lien creditor has priority
only to the extent of the value of his or her collateral. To illustrate,
imagine that McInerney owns property worth $100,000, including
a cache of furs worth $40,000. McInerney owes Bret $40,000, Easton
$50,000, and Ellis $60,000. Bret has a lien on the furs. On McInerney’s
default, Bret has the first right to the furs or the proceeds
from their sale. If the furs turned out to be worth only $20,000,
Bret’s claim for the other $20,000 would have no greater
priority than the claims of Easton and Ellis.
Generally, a lien creditor has priority over an unperfected security
interest but not over a perfected security interest. Thus, a person
who becomes a lien creditor before another security interest in
the same property is perfected has priority, but one who acquires
the lien after perfection does not have priority. Mechanic’s
and artisan’s liens, however, have priority over perfected
security interests unless a statute provides otherwise. These
types of liens are discussed below.
MECHANIC’S LIEN
When a person contracts for labor, services, or material to be
furnished for the purpose of making improvements on real property
but does not immediately pay for the improvements, the creditor
can place a mechanic’s lien on the property. This creates
a special type of debtor-creditor relationship in which the real
estate itself becomes security for the debt.
For example, a painter agrees to paint a house for a homeowner
for an agreed-upon price to cover labor and materials. If the
homeowner cannot pay or pays only a portion of the charges, a
mechanic’s lien against the property can be created. The
painter is the lienholder, and the real property is encumbered
with a mechanic’s lien for the amount owed. If the homeowner
does not pay the lien, the property can be sold to satisfy the
debt. Notice of the foreclosure and sale must be given to the
debtor in advance, however.
The procedures by which a mechanic’s lien is created are
controlled by state law. Generally, the lienholder must file a
written notice of lien against the particular property involved.
The notice of lien must be filed within a specific time period,
measured from the last date on which materials or labor were provided
(usually within 60 to 120 days). Failure to pay the debt entitles
the lienholder to foreclose on the real estate on which the improvements
were made and to sell it to satisfy the amount of the debt. Of
course, the lienholder is required by statute to give notice to
the owner of the property prior to foreclosure and sale. The sale
proceeds are used to pay the debt and the costs of the legal proceedings;
the surplus, if any, is paid to the former owner.
At issue in the following case was whether a party who performed
engineering work, but who was not licensed as an engineer, could
enforce a mechanic’s lien.
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Case 32.1
MIDWEST ENVIRONMENTAL CONSULTING & REMEDIATION SERVICES,
INC. v. PEOPLES BANK OF BLOOMINGTON
Appellate Court of Illinois, Fourth District, 1993.
251 Ill.App.3d 256, 620 N.E.2d 469, 189 Ill.Dec. 501.
COMPANY PROFILE During the Great Depression, many banks suffered
huge losses on their investments and, with depositors lining up
to withdraw all of their funds, were forced to close. To take
over some of the assets of two closed Detroit banks, the National
Bank of Detroit was organized with help from General Motors Corporation
in 1933. Forty years later, the National Bank of Detroit merged
with Detroit National Bank. The new company called itself National
Bank of Detroit until 1990, when it changed to NBD Bank, N.A.
NBD is the largest bank in Michigan and the leader in a five-state
system of eighteen bank subsidiaries owned by NBD Bancorp, Inc.,
which has offices in London, Frankfurt, Tokyo, Australia, Canada,
and Hong Kong, and an offshore banking facility in Nassau, Bahamas.
NBD Bancorp became the sixteenth largest U.S. banking company
in 1992, when it merged NBD Indiana, Inc., one of its subsidiaries,
with INB Financial Corporation, Indiana’s leading banking
company.
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Headquartered in Indianapolis, INB operated 130 offices through
six banks, the oldest of which was founded in 1834. Originally
named Commerce America Banking Company, which was formed in a
merger between Citizens Bank and Trust Company of Jeffersonville,
Indiana, and Clark County State Bank in 1984, INB had expanded
into Illinois in 1990 by acquiring Peoples Mid-Illinois Corporation.
Organized in 1972, the principal asset of Peoples had been Peoples
Bank of Bloomington.
BACKGROUND AND FACTS Allan Green worked for an Illinois engineering
firm, Lewis, Yockey, and Brown (LYB), as an environmental engineer
and project manager. Green was not, however, licensed as an engineer
in Illinois. In October 1991, Green performed engineering work
on a subsurface investigation for Snyder Development, Inc., concerning
property on which a gas station had been located in Bloomington,
Illinois. Snyder wanted to sell the property. Green discovered
that the soil was contaminated and told Snyder that according
to the regulations of the Illinois Environmental Protection Agency
(IEPA), the contamination would have to be removed. Green left
LYB in November to form his own company—Midwest Environmental
Consulting & Remediation Services, Inc. At the end of November,
Snyder asked Green if he would provide engineering services with
regard to the clean-up. Green agreed. Midwest removed the contaminated
soil according to IEPA specifications, but Snyder failed to pay
for the removal. Midwest (Green) brought an action against Snyder
and its bank, the Peoples Bank of Bloomington, to foreclose on
the property on the basis of its filed mechanic’s lien. The
trial court issued a judgment that included an award of more than
$40,000 in Midwest’s favor, and the defendants appealed.
Among the issues on appeal was whether Midwest could assert a
mechanic’s lien given the fact that Green was not licensed
as an engineer in Illinois.
Justice McCULLOUGH delivered the opinion of the court:
* * * *
* * * The persons entitled to a mechanic’s lien are defined
in section 1 of the [Illinois Mechanics Lien] Act. That statute
states in part: “Any person who shall by any contract or
contracts, express or implied, or partly expressed or implied,
with the owner of a lot or tract of land, or with one whom the
owner has authorized or knowingly permitted to contract, to improve
the lot or tract of land or to manage a structure thereon * *
* or perform any services or incur any expense as an architect,
structural engineer, professional engineer, land surveyor or property
manager in, for or on a lot or tract of land for any such purpose;
* * * is known under this Act as a contractor, and has a lien
upon the whole of such lot or tract of land and upon adjoining
or adjacent lots or tracts of land of such owner constituting
the same premises and occupied or used in connection with such
lot or tract of land as a place of residence or business * * *
. This lien attaches as of the date of the contract.”
Contrary to defendant’s position, plaintiff need not be an
architect, structural engineer, professional engineer, land surveyor,
or property manager to assert a mechanic’s lien. Any person
who does improvement work on the land under a contract with the
owner can assert a mechanic’s lien.
* * * *
* * * [T]he contract was not illegal. Nor has defendant proved
that, in order to do the job, Green must have been a licensed
professional engineer. When defendant began dealing with Green,
he was an employee of another engineering firm, Lewis, Yockey,
and Brown (LYB).
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It was at this time that Green made the original estimates. Defendant
does not complain that LYB was not licensed in Illinois. Nor has
defendant presented any evidence suggesting that only an engineer
can enter into a contract to remove contaminated soil from the
site of a former gasoline service station.
DECISION AND REMEDY The appellate court affirmed the judgment
of the trial court but reduced the award by 15 percent to reflect
a markup to which Snyder had not agreed in the contract.
Full text of case
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ARTISAN’S LIEN
An artisan’s lien is a security device created at common
law through which a creditor can recover payment from a debtor
for labor and materials furnished in the repair of personal property.
For example, Whitney leaves her diamond ring at the jewelry shop
to be repaired and to have her initials engraved on the band.
In the absence of an agreement, the jeweler can keep the ring
until Whitney pays for the services that the jeweler provides.
Should Whitney fail to pay, the jeweler has a lien on Whitney’s
ring for the amount of the bill and can sell the ring in satisfaction
of the lien.
In contrast to a mechanic’s lien, an artisan’s lien
is possessory. The lienholder ordinarily must have retained possession
of the property and have expressly or impliedly agreed to provide
the services on a cash, not a credit, basis. Usually, the lienholder
retains possession of the property. When this occurs, the lien
remains in existence as long as the lienholder maintains possession,
and the lien is terminated once possession is voluntarily surrendered—unless
the surrender is only temporary. If it is a temporary surrender,
there must be an agreement that the property will be returned
to the lienholder. Even with such an agreement, if a third party
obtains rights in that property while it is out of the possession
of the lienholder, the lien is lost. The only way that a lienholder
can protect a lien and surrender possession at the same time is
to record notice of the lien in accordance with state lien and
recording statutes.
The artisan’s lien has priority over a filed statutory lien,
such as a title lien on an automobile or a lien filed under Article
9 of the UCC. This may not be true for a bailee’s lien (such
as a storage lien), however.
Modern statutes permit the holder of an artisan’s lien to
foreclose and sell the property subject to the lien to satisfy
payment of the debt. As with the mechanic’s lien, the lienholder
is required to give notice to the owner of the property prior
to foreclosure and sale. In some states, holders of artisan’s
liens must give notice to title lienholders of automobiles prior
to foreclosure. The sale proceeds are used to pay the debt and
the costs of the legal proceedings, and the surplus, if any, is
paid to the former owner.
Can towing and storage services give rise to an artisan’s
lien? The court deals with this issue in the following case.
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Case 32.2
CHRYSLER CREDIT CORP. v. KEELING
Missouri Court of Appeals, 1990.
793 S.W.2d 222.
BACKGROUND AND FACTS Chrysler Credit Corporation had a perfected
security interest in a 1988 Dodge pickup that had been purchased
by Robert Keeling. When Keeling defaulted on his payments, Chrysler
attempted to repossess the vehicle but could not locate it for
some time. Finally, the pickup was found in a lot operated by
Joe Booth, doing business as Highway Tow Service. Booth had towed
the pickup from an apartment complex parking lot to Booth’s
lot at the request of the apartment manager and had stored the
pickup on his auto lot for over two months. Chrysler requested
Booth to deliver possession of the car to Chrysler, but Booth
refused to do so until he was paid for the towing ($50) and storage
($1,235) services. Chrysler then sued Booth to gain possession
of the pickup. Booth contended that he had an artisan’s lien
on the truck and that under Missouri law, the common law artisan’s
lien took priority over Chrysler’s
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perfected security interest. The trial court held for Chrysler,
and Booth appealed.
TURNAGE, Presiding Judge.
* * * *
Booth is correct that the common law artisan’s lien has not
been abrogated by statute as held by this court in [a previous
case]. The difficulty with Booth’s contention is that the
artisan’s lien is only for one who furnishes labor or materials
in the repair of a vehicle. Here, Booth makes no claim that he
furnished labor or materials for the repair of the pickup. He
makes some claim that towing the vehicle constituted a basis for
an artisan’s lien, but it is apparent that towing a vehicle
does not constitute the furnishing of labor or materials for the
repair of a vehicle. [Emphasis added.] Under the facts here Booth
did not have a common law artisan’s lien.
Booth’s claim is for towing and storage. At common law there
was no lien for storage. Thus, Booth did not have a common law
lien for storage.
What Booth did have was a statutory lien for storage under [Section]
430.020 [a Missouri statute] which provides that every person
who stores any vehicle shall have a lien for the amount due. Section
430.040.1 provides that no person shall have the right to take
any vehicle out of the possession of any person who has a storage
lien without paying the amount lawfully due.
Booth conveniently overlooks [Section] 430.040.2 which provides
that a storage lien shall not take precedence over or be superior
to any prior lien duly perfected in accordance with the laws of
this state without the written consent of the holder of such prior
lien.
DECISION AND REMEDY The appellate court affirmed the trial
court’s holding that Chrysler was entitled to possession
of the pickup. Although under Missouri law, an artisan’s
lien would be superior to a duly perfected security interest,
such as Chrysler’s, Booth did not have an artisan’s
lien, because he had furnished no labor or materials for the repair
of the vehicle.
Full text of case
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INNKEEPER’S LIEN
An innkeeper’s lien is another security device created at
common law. An innkeeper’s lien is placed on the baggage
of guests for the agreed-upon hotel charges that remain unpaid.
If no express agreement has been made on the amount of those charges,
then the lien will be for the reasonable value of the accommodations
furnished. The innkeeper’s lien is terminated either by the
guest’s payment of the hotel charges or by the innkeeper’s
surrender of the baggage to the guest, unless the surrender is
temporary. Most state statutes permit the innkeeper to satisfy
the debt by means of a public sale of the guest’s baggage.
There is a trend toward requiring that the guest first be given
an impartial judicial hearing.(1)
Next page of section
JUDICIAL LIENS
A debt must be past due before a creditor can commence legal action
against a debtor. Once legal action is brought, the debtor’s
property may be seized to satisfy the debt. If the property is
seized prior to trial proceedings, the seizure is referred to
as an attachment of the property. The seizure may also occur following
a court judgment in the creditor’s favor. In that case, the
court’s order to seize the property is referred to as a writ
of execution.
ATTACHMENT Attachment under Article 9 of the UCC, as discussed
in Chapter 31, refers to the process through which a security
interest becomes enforceable against a debtor with respect to
the debtor’s collateral [UCC 9–203]. In the present
context, attachment refers to a court-ordered seizure and taking
into custody of property prior to the securing of a judgment for
a past-due debt.
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Attachment rights are created by state statutes. Normally a prejudgment
remedy, attachment occurs either at the time of or immediately
after the commencement of a lawsuit and before the entry of a
final judgment. By statute, the restrictions and requirements
for a creditor to attach before judgment are specific and limited.
The due process clause of the Fourteenth Amendment to the Constitution
limits the courts’ power to authorize seizure of a debtor’s
property without notice to the debtor or a hearing on the facts.
In recent years, a number of state attachment laws have been held
to be unconstitutional.
Profile: Due Process Clause of the Fourteenth Amendment
To use attachment as a remedy, the creditor must have an enforceable
right to payment of the debt under law, and the creditor must
follow certain procedures. Otherwise, the creditor can be liable
for damages for wrongful attachment. He or she must file with
the court an affidavit (a written or printed statement, made under
oath or sworn to) stating that the debtor is in default and stating
the statutory grounds under which attachment is sought. A bond
must be posted by the creditor to cover at least court costs,
the value of the loss of use of the good suffered by the debtor,
and the value of the property attached. When the court is satisfied
that all the requirements have been met, it issues a writ of attachment,
which is similar to a writ of execution (to be discussed shortly)
in that it directs the sheriff or other officer to seize nonexempt
property. If the creditor prevails at trial, the seized property
can be sold to satisfy the judgment.
As the following case illustrates, strict compliance with every
specific procedure established by the state’s attachment
statute is required for the property to be subject to an enforceable
writ of attachment. Exact compliance with state law is required
because a writ of attachment operates against a debtor’s
property simply on the strength of the creditor’s sworn statement
that a debt is owed.
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Case 32.3
TOPJIAN PLUMBING AND HEATING, INC. v. BRUCE TOPJIAN, INC.
Supreme Court of New Hampshire, 1987.
129 N.H. 481, 529 A.2d 391.
BACKGROUND AND FACTS Topjian Plumbing and Heating, Inc.,
the plaintiff, sought prejudgment writs of attachment to satisfy
an anticipated judgment in a contract action against Bruce Topjian,
Inc., the defendant. Topjian Plumbing did not petition the court
for permission to effect the attachments but merely completed
the forms, served them on the defendant and on the Fencers (the
owners of a parcel of land that had previously belonged to the
defendant), and recorded them at the registry of deeds. The Fencers
objected to the attachment of their property, and in the course
of the hearing on their objection, the superior court invalidated
all of the attachments, holding that they were not in compliance
with the New Hampshire prejudgment attachment statute as stated
in Revised Statutes Annotated (RSA) Section 511-A:8. This statute
requires application to the court for an order to attach property.
Topjian Plumbing appealed.
THAYER, Justice.
* * * *
The superior court invalidated the plaintiff’s attachments
because of the plaintiff’s failure to petition the court
for permission to attach the property prior to serving the attachments
on the defendants and recording them at the registry of deeds.
RSA 511-A:8 clearly requires that application must be made to
the court for an order authorizing an ex parte [a hearing at which
the defendant is not required to be present] pre-judgment attachment,
“[t]he purpose of [which] is to obtain security for the payment
of a plaintiff’s judgment should [plaintiff] prevail.”
* * * *
In 1984, this court, interpreting RSA chapter 511-A, determined
that the standard requirements of due process, such as notice
and hearing, must be adhered to before property interests can
be encumbered by a pre-judgment attachment. [T]he proper procedure
for obtaining an ex parte attachment is for the plaintiff to petition
the court for
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permission to obtain an ex parte attachment order before serving
the attachment on the defendant and recording it at the registry
of deeds.
Furthermore, the Superior Court Rules pertaining to ex parte
pre-judgment attachments require plaintiffs to petition the court
for permission to attach the property prior to service or entry
of any writ of summons or other pleading.
DECISION AND REMEDY The Supreme Court of New Hampshire affirmed
the decision of the lower court, holding that the attachments
were invalid because the plaintiff had failed to comply with the
attachment statute.
INTERNATIONAL CONSIDERATIONS Fair Procedures and International
Enforcement of Attachments In general, a U.S. court will give
full effect to a foreign judgment and enforce the judgment in
an action to attach assets in the United States. The judgment
will not be enforced, however, if the procedures underlying the
foreign judgment seem too unfair. For example, in one case, a
U.S. court refused to enforce a pretrial judgment of a Spanish
court. The U.S. court refused to “tie up all the assets of
an enterprise in Illinois” because the Spanish defendant
had no opportunity to appear before the Spanish court to contest
the order.(a)
Full text of case
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WRIT OF EXECUTION If a creditor is successful in a legal
action against a debtor, the court awards the creditor a judgment
against the debtor (usually for the amount of the debt plus any
interest and legal costs incurred in obtaining the judgment).
Frequently, the creditor finds it easy to secure a judgment against
the debtor but nevertheless fails to collect the awarded amount.
If the debtor will not or cannot pay the judgment, the creditor
is entitled to go back to the court and obtain a writ of execution,
which is an order, usually issued by the clerk of the court, directing
the sheriff to seize (levy) and sell any of the debtor’s
nonexempt real or personal property that is within the court’s
geographical jurisdiction (usually the county in which the courthouse
is located). The proceeds of the sale are used to pay off the
judgment and the costs of the sale. Any excess is paid to the
debtor. The debtor can pay the judgment and redeem the nonexempt
property any time before the sale takes place. Because of exemption
laws (which cover the debtor’s homestead and designated items
of personal property) and bankruptcy laws, however, many judgments
are virtually uncollectible.
GARNISHMENT
An order for garnishment permits a creditor to collect a debt
by seizing property of the debtor (such as wages or money in a
bank account) that is being held by a third party (such as an
employer or a bank). Typically, a garnishment judgment is served
on a debtor’s employer so that part of the debtor’s
usual paycheck will be paid to the creditor.
The legal proceeding for a garnishment action is governed by
state law. As a result of a garnishment proceeding, a third party
(such as the debtor’s employer) is ordered by the court to
turn over property owned by the debtor (such as wages) to pay
the debt. Garnishment operates differently from state to state,
however. According to the laws in some states, the judgment creditor
needs to obtain only one order of garnishment, which will then
continuously apply to the judgment debtor’s weekly wages
until the entire debt is paid. In other states, the judgment creditor
must go back to court for a separate order of garnishment for
each pay period.
Both federal laws and state laws limit the amount of money that
can be garnisheed from a debtor’s weekly take-home pay.(2)
Federal law provides a minimal framework to protect debtors from
losing all their income in order to pay judgment debts.(3)
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State laws also provide dollar exemptions, and these amounts are
often larger than those provided by federal law. State and federal
statutes can be applied together to help create a pool of funds
sufficient to enable a debtor to continue to provide for family
needs while also reducing the amount of the judgment debt in a
reasonable way.
Under federal law, garnishment of an employee’s wages for
any one indebtedness cannot be grounds for dismissal of an employee.
But what if the employee is dismissed after the employer learns
of the garnishment proceeding but before any wages are actually
garnished? Does the law prohibiting dismissal for any one garnishment
proceeding apply in such a situation? The court addresses this
issue in the following case.
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Case 32.4
JOHNSON v. TOWN OF TRAIL CREEK
United States District Court, Northern District of Indiana, 1991.
771 F.Supp. 271.
BACKGROUND AND FACTS John Johnson worked for the street department
of the Town of Trail Creek. In August 1989, Trail Creek received
notice from a court that one of Johnson’s creditors had received
a court judgment against Johnson for an unpaid debt. The notice
also stated that Johnson’s wages would be subject to garnishment,
pending a determination of whether Trail Creek owed any obligations
or credits (for example, wages) to Johnson that could be garnished.
Johnson was fired two days after this notice was received. Johnson
brought an action against the town, the president of the town
council, and the superintendent of the town’s street department
(the defendants), alleging, among other things, that the defendants
had violated federal law because he was dismissed as a result
of the notice of possible garnishment. The defendants moved to
dismiss Johnson’s complaint on the ground that they could
not have violated the law, because Johnson’s wages were not
actually being withheld at the time of his discharge—in other
words, no garnishment proceeding had yet occurred.
MILLER, District Judge.
* * * *
15 U.S.C. [Section] 1674(a) provides, “No employer may discharge
any employee by reason of the fact that his earnings have been
subjected to garnishment for any one indebtedness.” 15 U.S.C.
[Section] 1672(c) defines “garnishment” as meaning “any
legal or equitable procedure through which the earnings of any
individual are required to be withheld for payment of any debt.”
Indiana’s procedure for garnishment of wages consists of
two steps. First, upon the filing of a verified motion by the
judgment creditor, the employer is required to answer interrogatories
or appear at a hearing to disclose whether it has an obligation
owing to the judgment debtor * * * . If the employer is found
to have an obligation owing to the judgment debtor-employee, the
court may order the payment of [the] obligation to the judgment-creditor.
Thus, the judgment creditor’s filing of the verified motion
and the state court’s order to Trail Creek were part of a
garnishment: legal procedure through which Mr. Johnson’s
earnings were required to be withheld for a debt.
* * * *
If the defendants discharged Mr. Johnson by reason of the garnishment
proceedings embodied by the [court’s] order, they may be
found to have deprived Mr. Johnson of his rights under 15 U.S.C.
[Section] 1674(a).
DECISION AND REMEDY The court denied Trail Creek’s motion
to dismiss the complaint.
— Page 623 —
ETHICAL CONSIDERATIONS Clearly, the defense against Johnson’s
claim was a technical defense that violated the “spirit”
(as well as the “letter”) of 15 U.S.C. Section 1674(a).
But before judging too harshly the defendants’ attempts to
evade the law, consider the effect of garnishment proceedings
on employers. Compliance by employers with garnishment procedures
(appearing at a court hearing, filing the appropriate documents,
establishing and maintaining records relating to the garnishment,
and so on) requires time. For employers, time is a costly resource,
and garnishment proceedings are burdensome for employers because
they are not compensated for these time costs. When considering
these costs and the fact that an employer is an innocent third
party caught in the middle of a creditor-debtor dispute, it should
come as no surprise that the employer would want to avoid the
hassle of garnishment if at all possible.
Full text of case
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CREDITORS’ COMPOSITION AGREEMENTS
Creditors may contract with the debtor for discharge of the debtor’s
liquidated debts (debts that are definite, or fixed, in amount)
upon payment of a sum less than that owed. These agreements are
called composition agreements or creditors’ composition agreements
and, unless they are formed under duress, are usually held to
be enforceable.
MORTGAGE FORECLOSURE
Mortgage holders have the right to foreclose on mortgaged property
in the event of a debtor’s default. The usual method of foreclosure
is by judicial sale of the property, although the statutory methods
of foreclosure vary from state to state. If the proceeds of the
foreclosure sale are sufficient to cover both the costs of the
foreclosure and the mortgaged debt, any surplus is received by
the debtor. If the sale proceeds are insufficient to cover the
foreclosure costs and the mortgaged debt, however, the mortgagee
(the creditor-lender) can seek to recover the difference from
the mortgagor (the debtor) by obtaining a deficiency judgment
representing the difference between the mortgaged debt plus foreclosure
costs and the amount actually received from the proceeds of the
foreclosure sale. A deficiency judgment is obtained in a separate
legal action that is pursued subsequent to the foreclosure action.
It entitles the creditor to recover from other property owned
by the debtor. Some states do not permit deficiency judgments
for some types of real estate interests.
Before the foreclosure sale, a defaulting mortgagor can redeem
the property by paying the full amount of the debt, plus any interest
and costs that have accrued. This right is known as the equity
of redemption. In some states, a mortgagor may even redeem the
property within a certain period of time—called a statutory
period of redemption—after the sale. In these states, the
deed to the property is not usually delivered to the purchaser
until the statutory period has expired.
ASSIGNMENT FOR BENEFIT OF CREDITORS
Both common law and statutes may provide for a debtor’s assignment
of assets to a trustee or assignee for the benefit of the debtor’s
creditors. In these situations, that debtor voluntarily transfers
title to assets owned to a trustee or assignee, who in turn sells
or liquidates these assets, tendering payment to the debtor’s
creditors on a pro rata (proportionate) basis. Each creditor may
accept the tender (and discharge the debt owed to him or her)
or reject it (and attempt to collect the debt in another way).
The flexibility and informality of an assignment for the benefit
of creditors may save creditors time and expense and result in
better prices when a debtor’s property is liquidated. Nevertheless,
creditors may decide that this option does not adequately protect
their rights. Under the bankruptcy laws, creditors of a certain
number with a certain amount of
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claims may have administration of the debtor’s property transferred
to the bankruptcy court—in other words, force the debtor
into involuntary bankruptcy (see Chapter 33). Thus, a debtor’s
bankruptcy may supersede assignment for the benefit of creditors—even
if the bankruptcy is initiated by creditors.
Concept Summary 32-1
Suretyship and Guaranty
When a third person promises to pay a debt owed by another in
the event the debtor does not pay, either a suretyship or a guaranty
relationship is created. Exhibit 32–1 illustrates these relationships.
The third person’s credit becomes the security for the debt
owed.
SURETYSHIP
A contract of strict suretyship is a promise made by a third person
to be responsible for the debtor’s obligation. It is an express
contract between the surety and the creditor. The surety in the
strictest sense is primarily liable for the debt of the principal.
The creditor can demand payment from the surety from the moment
that the debt is due. A suretyship contract is not a form of indemnity;
that is, it is not merely a promise to make good any loss that
a creditor may incur as a result of the debtor’s failure
to pay. The creditor need not exhaust all legal remedies against
the principal debtor before holding the surety responsible for
payment. Moreover, a surety agreement does not have to be in writing
to be enforceable, although usually such agreements are in writing.
For example, Jason Ogger wants to borrow money from the bank
to buy a used car. Because Jason is still in college, the bank
will not lend him the money unless his father, Stacey Ogger, who
has dealt with the bank before, will
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cosign the note (add his signature to the note, thereby becoming
jointly liable for payment of the debt). When Mr. Ogger cosigns
the note, he becomes primarily liable to the bank. On the note’s
due date, the bank has the option of seeking payment from either
Jason or Stacey Ogger, or both jointly.
GUARANTY
A guaranty contract is similar to a suretyship contract in that
it includes a promise to answer for the debt or default of another.
With a suretyship arrangement, however, the surety is primarily
liable for the debtor’s obligation. With a guaranty arrangement,
the guarantor—the third person making the guaranty—is
secondarily liable. The guarantor can be required to pay the obligation
only after the principal debtor defaults, and usually only after
the creditor has made an attempt to collect from the debtor.
For example, a closely held corporation, BX Enterprises, needs
to borrow money to meet its payroll. The bank is skeptical about
the creditworthiness of BX and requires Dawson, its president,
who is a wealthy businessperson and owner of 70 percent of BX
Enterprises, to sign an agreement making himself personally liable
for payment if BX does not pay off the loan. As a guarantor of
the loan, Dawson cannot be held liable until BX Enterprises is
in default.
The Statute of Frauds requires that a guaranty contract between
the guarantor and the creditor must be in writing to be enforceable
unless the main-purpose exception applies. Briefly, this exception
provides that if the main purpose of the guaranty agreement is
to benefit the guarantor, then the contract need not be in writing
to be enforceable. (See Chapter 16 for a more detailed discussion
of this exception.)
Landmark in the Law: Statute of Frauds
The guaranty contract terms determine the extent and time of
the guarantor’s liability. For example, the guaranty can
be continuing, designed to cover a series of transactions by the
debtor. Also, the guaranty can be unlimited or limited as to time
and amount. In addition, the guaranty can be absolute, in which
case the guarantor
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becomes liable immediately upon the debtor’s default, or
conditional, in which case the guarantor becomes liable only upon
the happening of a certain event.
In the following case, the defendant claimed that he was a guarantor,
not a surety, on a contract for the purchase of an automobile.
¾¾¨¾¾
Case 32.5
GENERAL MOTORS ACCEPTANCE CORP. v. DANIELS
Court of Appeals of Maryland, 1985.
303 Md. 254, 492 A.2d 1306.
BACKGROUND AND FACTS In June 1981, John Daniels agreed to
purchase a used car from Lindsay Cadillac Company. Because John
had a poor credit rating, his brother, Seymoure, agreed to cosign
the installment sales contract. Seymoure signed the contract on
the line designated “Buyer,” and John signed on the
line designated “Co-Buyer.” Lindsay then assigned the
contract to General Motors Acceptance Corporation (GMAC). In May
1982, GMAC declared the contract in default. After attempting
to locate the car for several months, GMAC finally found it in
a condition of total loss. GMAC brought an action for damages,
but because service of process was never effected on John, the
action proceeded only against Seymoure. The trial court found
that Seymoure was a guarantor of the contract between John and
GMAC and held that GMAC would have to attempt to bring suit first
against John before it could proceed against Seymoure. GMAC appealed
the ruling.
COLE, Judge.
* * * *
A suretyship and guaranty are contractual agreements. * *
* It is well settled that Maryland follows the objective law
of contracts. A court construing an agreement under this test
must first determine from the language of the agreement itself
what a reasonable person in the position of the parties would
have meant at the time it was effectuated. In addition, when the
language of the contract is plain and unambiguous there is no
room for construction, and a court must presume that the parties
meant what they expressed. In these circumstances, the true test
of what is meant is not what the parties to the contract intended
it to mean, but what a reasonable person in the position of the
parties would have thought it meant. * * *
* * * *
Our review of the evidence in this case convinces us that the
District Court erred in finding that Seymoure was a guarantor
rather than a surety with respect to the installment contract.
* * *
* * * Seymoure agreed to purchase the subject automobile
by affixing the signature to the installment sales contract on
the line designated “Buyer.” The contract clearly stated
that all buyers agreed to be jointly and severally [individually]
liable for the purchase of that vehicle. Therefore, under the
objective law of contracts, a reasonable person knew or should
have known that he was subjecting himself to primary liability
for the purchase of the automobile. In short, although uncompensated
sureties are favorites of the law, Seymoure’s careless indifference
does not insulate him from primary liability on that agreement.
Seymoure executed the same contract as his brother, thereby making
himself a party to the original contract. There is no evidence
that Seymoure executed an agreement collateral to and independent
of this contract. This fact, standing alone, ordinarily negates
the existence of a guaranty. * * *
Both Seymoure and John signed the contract at the same time.
* * * [T]his fact tends to establish the existence of a contract
of suretyship rather than a contract
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of guaranty. Furthermore, there are no competent facts indicating
that Seymoure expressly agreed to pay for the automobile only
upon the default of John.
DECISION AND REMEDY The appellate court reversed the lower
court’s ruling.
Full text of case
¾¾¨¾¾
DEFENSES OF THE SURETY AND THE GUARANTOR
The defenses of the surety and the guarantor are basically the
same. Therefore, the following discussion applies to both, although
it refers only to the surety.
Certain actions will release the surety from the obligation.
For example, making any material modification in the terms of
the original contract between the principal debtor and the creditor,
including the awarding of a binding extension of time for making
payment, without first obtaining the consent of the surety will
discharge a gratuitous surety completely and a surety who is compensated
to the extent that the surety suffers a loss.
Naturally, if the principal obligation is paid by the debtor
or by another person on behalf of the debtor, the surety is discharged
from the obligation. Similarly, if valid tender of payment is
made, and the creditor for some reason rejects it with knowledge
of the surety’s existence, then the surety is released from
any obligation on the debt.
Generally, any defenses available to a principal debtor can be
used by the surety to avoid liability on the obligation to the
creditor. Defenses available to the principal debtor that the
surety cannot use include the principal debtor’s incapacity,
bankruptcy, and the statute of limitations. The ability of the
surety to assert any defenses the debtor may have against the
creditor is the most important concept in suretyship, because
most of the defenses available to the surety are also those of
the debtor.
Obviously, a surety may also have his or her own defenses—for
example, incapacity or bankruptcy. If the creditor fraudulently
induced the surety to guarantee the debt of the debtor, the surety
can assert fraud as a defense. In most states, the creditor has
a legal duty to inform the surety, prior to the formation of the
suretyship contract, of material facts known by the creditor that
would substantially increase the surety’s risk. Failure to
so inform is fraud and makes the suretyship obligation voidable.In
addition, if a creditor surrenders or impairs the debtor’s
collateral while knowing of the surety and without the surety’s
consent, the surety is released to the extent of any loss suffered
from the creditor’s actions. The primary reason for this
is to protect the surety who agreed to become obligated only because
the debtor’s collateral was in the possession of the creditor.
RIGHTS OF THE SURETY AND THE GUARANTOR
The rights of the surety and the guarantor are basically the same.
Therefore, again, the following discussion applies to both.
When the surety pays the debt owed to the creditor, the surety
is entitled to certain rights. First, the surety has the legal
right of subrogation. Simply stated, this means that any right
the creditor had against the debtor now becomes the right of the
surety. Included are creditor rights in bankruptcy, rights to
collateral possessed by the creditor, and rights to judgments
secured by the creditor. In short, the surety now stands in the
shoes of the creditor and may pursue any remedies that were available
to the creditor against the debtor.
Second, the surety has a right to be reimbursed by the debtor.
This right of reimbursement may stem either from the suretyship
contract or from equity. Basically, the surety is entitled to
receive from the debtor all outlays made on behalf of the suretyship
arrangement. Such outlays can include expenses incurred, as well
as the actual amount of the debt paid to the creditor.
Third, in the case of co-sureties (two or more sureties on the
same obligation owed by the debtor), a surety who pays more than
his or her proportionate share upon a debtor’s default is
entitled to recover from the co-sureties the amount paid above
the surety’s obligation. This is the right of contribution.
Generally, a co-surety’s liability either is determined by
agreement or, in the absence of agreement, is set at the maximum
liability under the suretyship contract.
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For example, assume that two co-sureties are obligated under a
suretyship contract to guarantee the debt of a debtor. Together,
the sureties’ maximum liability is $25,000. Surety A’s
maximum liability is $15,000, and surety B’s is $10,000.
The debtor owes $10,000 and is in default. Surety A pays the creditor
the entire $10,000. In the absence of agreement, surety A can
recover $4,000 from surety B ($10,000 ÷ $25,000 x $10,000
= $4,000, surety B’s obligation).
Protection for Debtors
The law protects debtors, as well as creditors. Certain property
of the debtor, for example, is exempt from creditors’ actions.
Consumer protection statutes also protect debtors’ rights.
Of course, bankruptcy laws, which will be discussed in the next
chapter, are designed specifically to assist debtors in need of
help.
EXEMPTIONS
In most states, certain types of real and personal property are
exempt from levy of execution or attachment. Probably the most
familiar of these exemptions is the homestead exemption. Each
state permits the debtor to retain the family home, either in
its entirety or up to a specified dollar amount, free from the
claims of unsecured creditors or trustees in bankruptcy. The purpose
is to ensure that the debtor will retain some form of shelter.
Suppose that Beere owes Veltman $40,000. The debt is the subject
of a lawsuit, and the court awards Veltman a judgment of $40,000
against Beere. Beere’s homestead is valued at $50,000. There
are no outstanding mortgages or other liens on his homestead.
To satisfy the judgment debt, Beere’s family home is sold
at public auction for $45,000. Assuming that the homestead exemption
is $25,000, the proceeds of the sale are distributed as follows:
1. Beere is given $25,000 as his homestead exemption.
2. Veltman is paid $20,000 toward the judgment debt,
leaving a $20,000 deficiency judgment (that is, “leftover
debt” ) that can be satisfied from any other nonexempt
property (personal or real) that Beere may have, if
allowed by state law.
In a few states, statutes permit the homestead exemption only
if the judgment debtor has a family. The policy behind this type
of statute is to protect the family. If a judgment debtor does
not have a family, a creditor may be entitled to collect the full
amount realized from the sale of the debtor’s home.
State exemption statutes usually include both real and personal
property. Personal property that is most often exempt from satisfaction
of judgment debts includes the following:
1. Household furniture up to a specified dollar amount.
2. Clothing and certain personal possessions, such as
family pictures or a Bible.
3. A vehicle (or vehicles) for transportation (at least up to
a specified dollar amount).
4. Certain classified animals, usually livestock but
including pets.
5. Equipment that the debtor uses in a business or trade,
such as tools or professional instruments, up to a
specified dollar amount.
SPECIAL PROTECTION FOR CONSUMER DEBTORS
Numerous consumer protection statutes and rules apply to the debtor-creditor
relationship. We have already discussed the Federal Trade Commission’s
rule limiting the rights of a holder in due course (HDC) who holds
a negotiable promissory note executed by a debtor-buyer as part
of a consumer transaction. This rule, discussed in Chapter 27,
provides basically that any personal defenses that the buyer can
assert against the seller can also be asserted against an HDC.
The seller must disclose this information clearly on the sales
agreement.
Profile: Federal Trade Commission
Other laws regulating debtor-creditor relationships include the
Truth-in-Lending Act, which protects consumers by requiring creditors
to disclose specific types of information when making loans to
consumers. This act, along with other consumer protection statutes,
will be discussed in Chapter 46.
Profile: Truth-in-Lending Act
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Terms and Concepts to Review
( To review the Glossary definition of a term, select that term.
To go to the text coverage of a term, select the page number that
follows it.)
affidavit 620
artisan’s lien 618
attachment 619
cosign 625
co-surety 627
creditors’ composition agreement 623
equity of redemption 623
garnishment 621
guarantor 625
homestead exemption 628
innkeeper’s lien 619
lien 615
mechanic’s lien 616
mortgagee 623
mortgagor 623
right of contribution 627
right of reimbursement 627
right of subrogation 627
statutory period of redemption 623
surety 624
suretyship 624
writ of attachment 620
writ of execution 621