Debtor and Creditor

Creditors' Legal Rights

By William Fisher, Attorney

Collecting business debts can be difficult enough without worrying about whether you've stepped over the line in going about the collection. A little legal knowledge in this area goes a long way.

Secured debt means that there is some property ("collateral") that the debtor has pledged to secure payment of the loan - business property with a mortgage, for instance, or equipment with an equipment loan.

Unsecured debt means there is no property pledged to secure payment, as with most credit card debt, for example.

Secured loans are easier to collect as long as the collateral is worth enough to cover the debt. In either case, the loan should be in writing, but unsecured debt is often not documented in a formal agreement.

If a loan is in default (not paid on time or as otherwise agreed), you'll want to collect. Normally, you should begin that process by sending some type of default notice to the debtor. Often, the parties agree at that point to modify the loan terms and avoid conflict. Otherwise, secured creditors will look to the collateral.

In most states, it takes a long time to foreclose on a mortgage and gain control of a piece of property. On the other hand, it is usually simple to repossess equipment if the "peace is not breached" - a term that in most courts means if confrontation is avoided. If the peace is breached, the debtor can sue the lender or its agents. A lender can always go to court and get the sheriff to repossess to avoid this risk, but this is more costly.

An unsecured loan is more difficult to collect, and often collection agencies will take over. When collecting a consumer debt (a loan for home or personal use), the collection agency or attorney must follow rules that include disclosure requirements and harassment prohibitions. If violated, the collector must pay the debtor damages.

If you're collecting a secured debt, you probably need legal help. You shouldn't try to repossess equipment, for instance, unless you fully understand the law in this area. Hiring a reputable and bonded repo company is one option. Another is to hire an attorney and use the courts. Likewise, if you're trying to foreclose on a mortgage, you'll need the expert assistance of an attorney.

You can turn over an unsecured debt to a collection agency, which normally asks for 30 to 50 percent of the collected debt and expenses. But, if you are owed a lot and you believe the debt is collectible, hire an attorney who charges by the hour - it will be cheaper. (Make sure to get an estimate of the costs first.)

With unsecured debt, or when the collateral is not enough to pay the debt and out-of-court attempts don't work (payment plans or compromise), you'll have to bring suit. Otherwise, an unsecured creditor generally can't take action to collect without the debtor's consent.

Even after the lawsuit is filed, the creditor usually can't begin collecting until a judgment is entered against the debtor. A secured creditor can seek quick court permission to get its collateral prior to judgment (in a procedure called ("replevin") as long as that collateral isn't real estate. Otherwise, the debtor has the opportunity to respond (usually within 20 days) to the creditor's lawsuit and is entitled to a trial if a legitimate defense is raised.

If a debtor doesn't respond, he or she is in default and judgment can be entered. In some states, if there's no timely response to the lawsuit, creditors can even take some actions to collect before the judgment is finalized.

Once there's a judgment, an unsecured creditor can seize (execute upon) the debtor's assets. However, many of the debtor's assets are exempt from execution. In most states, exemptions include:

  • Some equity in the home (the amount varies widely from state to state)
  • Some equity in a car
  • Most clothes
  • Non-valuable home furnishings
  • ERISA-governed pension plans are also exempt under federal law

If the debtor is owed money by a third party, such as an employer or bank, the third party can be forced to pay the creditor instead of the debtor through a process called garnishment and levy. Most states only allow creditors to seize one quarter of wages, though. Texas, for example, allows no wages to be seized.

The bottom line on collecting unsecured debts is this: If you are a creditor and you are convinced the debtor has few non-exempt assets, it may make sense to pursue some kind of settlement and to try to get collateral to secure the new deal.

William Fisher practices commercial law and chairs the reorganization and bankruptcy practice team at the Minneapolis law firm of Gray, Plant, Mooty, Mooty & Bennett.

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