Bank Financing
Sureties and Guarantors
Sureties and guarantors are people who agree to be liable for a debt in the event that the primary debtor refuses to pay, or is unable to pay. In order to convince a bank to lend you some money, you can either gather up some collateral and pledge it as security for your loan, or brining in a surety or guarantor.
| Surety | Primary liability |
| Guarantor | Secondary liability |
Rights of sureties & guarantors:
- Reimbursement: The original primary debtor has obligation to reimburse surety for expenses.
- Subrogation: The surety acquires all of the rights that the lender had with respect to the borrower.
- Contribution: When one of sureties is made to pay their fair share, it has right to collect from co-sureties.
Sureties and guarantors are discharged from liability:
- when the original debt is repaid in full, or
- when the debtor and lender make a change in their relationship without the consent of sureties and guarantors.
Collection of Debts
When there has been no collateral pledged to secure the debt, there are several methods available to lenders / creditors to collect on unsecured debts:
- Civil judgement
- Lien / Judicial Lien (ability to latch on something owned by the debtor, court ordering the debtor to turn over its own property)
- Garnishment (court ordering some 3rd party to turn over debtor’ property)
Debt Financing
Debt Financing is a mechanism that allows businesses to sell debt on open market in order to finance their growth. Instead of being a loan from a bank, a debt security or a bond is a loan from either an individual or institutional investors, usually multiple investors who buy bonds issued by a company.
Debt securities carry with no ownership interest, whereas an equity security (stock) has, but debt securities do have a guaranteed rate of return. Types of debt include;
- Debentures (unsecured bonds, or unsecured form of debt security)
- Secured bonds
- Convertible bonds (convert the bond to common stocks)
- Callable bonds (allow repayment prior to the maturity date)
Secured Transactions
Secured transactions are loans that have some collateral attached to them, in order to satisfy the debtor if borrower fail to do so.
| Unsecured | Credit cards are unsecured loans because there is no collateral. |
| Secured | Contrast that with car loans, bank hold the title to your cars until that loan is paid off. |
Secured transactions are governed by Article 9 of Uniform Commercial Code. You must have a security agreement, which is a document needed in order to take a security interest and personal property. There are some essential elements:
- Describe the collateral
- Debtor must have rights in the collateral
- Secured party must give value
- Must contain the terms of repayment (interest rate, due date, etc)
- Must describe rights upon default
- Must be in writing and signed by the debtor
Remedy upon default:
- Repossess collateral
- Lawsuit is not required
Attachment is what gives you right in collateral, it defines when the security agreement becomes enforceable against the debtor. Perfection is what solidifies your place in line when it comes to who gets that collateral. Priority is the rules that determine how collateral is distributed.
Bankruptcy
The fact that we have a bankruptcy system (enshrined in Constitution) is amazing. It allows people to take risks, and give them a fresh start. It is strictly a federal law – the bankruptcy code is a set of statutes that govern bankruptcy and how it works. Bankruptcy courts are specialized courts that handle matters of bankruptcy only. Bankruptcy estate is the new entity that springs to life the minute you file your bankruptcy case in bankruptcy court. Bankruptcy trustee‘s job is to oversee and administer the estate.
The way a bankruptcy case moves through the court varies depending on which type of bankruptcy chapter you are utilizing. But in general, there are something apply to most of cases:
- Individual debtors are required to complete some counseling to help increase finance literacy
- Real bankruptcy case starts with filing of petition, which creates the estate and automatic stay.
- Automatic stay goes into effect, it stops all collection efforts.
- Meeting of creditors and proof of claims.
- If we are in a liquidation type of bankruptcy, then marshal all the assets of debtor.
- In other types of bankruptcy, the debtor and creditors come up with a plan of repayment or reorganization.
- Debtor is discharged from the debt, there are exceptions, e.g., student loans.
- Reaffirm certain debts.
Exempt property
The bankruptcy code actually include the concept of exempt property, which sets forth a certain amount of property that you can keep for yourself that does not go into the bankruptcy estate. State law come into play. There are federal exemptions, and also state exemptions.
Fraudulent transfer
Any transfer of assets that you give to somebody else within 2 years prior to filing your bankruptcy petition, can be undone. In contrast, a preference payment is actually a payment made to a creditor, giving the creditor an unequal footing with the other creditors by receiving more payments than it would have received in bankruptcy. If a preference payment was made within 90 days prior to the petition, it can be clawed back. For inside creditors, it is 1 year, instead of 90 days.
3 main types of bankruptcy
| Chapter 7 | Straight liquidation / regular bankruptcy All of the debtor’s non-exempt assets are liquidated and proceeds are distributed to the creditors and discharge occurs. Individual has to pass tests. There is statutory order of distribution of proceeds. |
| Chapter 11 | Business reorganization This is a reorganization of debts, the goal is for the business to go through the bankruptcy and still be operating business in a much better position to succeed. Usually debtor-in-possession is applied. Creditors form a committee. The end result is to have a plan, which sets forth all of the changes in the debtor’s financial structure, then approved by court. |
| Chapter 13 | Individual reorganization Similar to chapter 11 but only for individuals with regular income. The debtor gets to keep their stuff, you don’t have to sell everything. |
My Certificate
For more on Debtor-Creditor Relationships, please refer to the wonderful course here https://www.coursera.org/learn/corporate-commercial-law-part2
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