The division of debt between "secured" and "unsecured" guides what bankruptcy reorganization can do for you. "Secured debt" is a creditor's claim that is secured by a lien of some type in your property, either by your agreement or involuntarily such as with a court judgment or taxes.
Some secured debts are familiar: mortgages, equity lines of credit and vehicle and equipment loans. These are all liens created by agreement between you and the creditor in some sort of recognizable legal agreement.
There are several other kinds of debt that are secured by liens on property, sometimes without you even realizing it:
Purchase Money Security Interests
These security interests are lien rights that the seller takes in purchased goods when the seller finances the purchase. The lien can be created by a specific written agreement or may arise when the item is financed on the seller's revolving credit or store credit card. This kind of lien does not have to be recorded through the usual filing of a Uniform Commercial Code (UCC) financing statement.
In theory, even if the buyer steers clear of liability on the debt through bankruptcy, the seller still has the right to reclaim the goods. The usual office supply store credit plans give the seller a security interest in the goods purchased. But if you buy the same goods using a Visa or MasterCard (credit provided by a lender other than the seller), you get clear title to the goods. Even if you avoid your liability on the credit card through bankruptcy, the goods charged to the card are yours, free and clear of any security interest in favor of the seller or the credit card issuer.
Purchase money security interests can be avoided or "stripped down" to the current value of the purchased goods in Chapter 11 and 13 bankruptcies.
Creditors with purchase money security interests in goods with lower value almost never file a lawsuit to enforce their interest in the goods. They are not really interested in the goods. They rely on the debtor's fear of repossession to "encourage" debtors to pay for things with little present market value.
Judgment Liens
Usually a judgment does not, in and of itself, give the judgment creditor a lien. The creditor must usually take the additional step of "perfecting" a lien by filing or recording the judgment with the designated government agency to create a lien on the judgment debtor's property.
Check the laws of your state to determine how judgment liens are perfected. Get a report of liens on file with the Secretary of State to know which liens are perfected, and the seniority of each lien. Liens filed first have priority.
In bankruptcy planning, it's important to know if judgment liens have been perfected, as secured debts are totaled separately from unsecured debts in calculating your eligibility for Chapter 13 bankruptcy. With a Chapter 13 proceeding, these debts can be "stripped down" to the value of the assets on which the lien is filed.
Tax Liens
The recording of a tax lien creates a lien on all of the taxpayer's real estate and personal property. It can be eliminated in Chapter 13 bankruptcy if there is no equity in the property. But tax liens can even reach retirement savings and 401(k) plans that are beyond the grasp of other creditors.
Blanket Security Interests
This is the term in most secured bank or SBA loans by which the borrower gives the lender a security interest in all the borrower's personal property: the lien "blankets" all the borrower's assets. ("Personal" here means everything but real estate, not "personal" as opposed to "business" assets.) Even things like accounts receivable and intellectual property can be covered by a blanket security interest. The agreement may also give the creditor a lien in assets purchased after the security agreement is signed.
Since the borrower agreed to give the lender a security interest in the property described in the security agreement, the lien can't be avoided on the grounds it impairs an exemption (the lien is not a "judicial lien"). In Chapter 11 or Chapter 13, the lien may be "stripped down" to the value of the property at the time the bankruptcy is filed.
Since a lender has rights in the items themselves and in any profit from their sale, you may not be free to sell the asset and pocket the profits or even spend the profits paying other business debts. Spending the profits without the lender's permission may be a form of fraud creating a debt you can't get rid of in bankruptcy.
While sorting out the different kinds of security interests is complex and sometimes confusing, it can help you decide whether bankruptcy is a good option for you and your business.
Cathy Moran is a business and bankruptcy lawyer in the San Francisco Bay Area, and was one of the first bankruptcy specialists certified by the California State Bar. Her Web site Bankruptcy in Brief includes a wealth of information on bankruptcy.
http://bankruptcy.lawyers.com/Security-Interests-in-Bankruptcy.html
