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By: Travis Knobbe
Creditors’ rights, practiced properly, is a truly unique intersection in the law. When I clerked with the Honorable William F. Stone, Jr., in the United States Bankruptcy Court for the Western District of Virginia, he said a couple things that stick with me through my practice. First, he told me that he started practicing bankruptcy because it often saw the intersection of seemingly disparate areas of the law that challenged him professionally. He was right. Depending on the background of a case, pursuit of unpaid loan money can cross into criminal law, family law, commercial torts, contract law, real estate law, construction law, and various places in between.
Second, he told me that bankruptcy was unique in that he often found himself turning over pebbles on the surface, to find a layer of stones underneath that he would turn over to find a layer of boulders. “The more you dig, the more you find,” he said. Again, he was right. Indeed, those stones are the ones we are trying to squeeze for cash when we pursue the panoply of rights available to creditors.
As we go through our series on creditors’ rights and tell you how you might best protect those rights–and how we can help–there are various concepts we will rely upon that we wish to introduce here. At root, when seeking to collect debts, lenders always start with the chattel paper: the group of loan documents that memorialize any specific debt. Often, that begins with a loan agreement and a promissory note. From there, a lender might require several other types of documents, a guaranty (obligating a non-borrower to pay on certain triggers, sometimes conditional, sometimes not; sometimes limited, other times, unlimited), and a packet of security documents that could include pledges of anything from real property to life insurance policies.
Each of those documents contributes something to the contractual relationship. For the note, it is generally very simple: if a borrower misses a payment, the borrower is in default. For the loan agreement, things can get complicated. Loan agreements contain various provisions including minimum debt to liability ratios, minimum loan to collateral value ratios, etc. Even if a borrower makes every payment, the borrower could still default under one of these provisions. Options open up further with security documents. Depending on the document, non-payment of premiums to third parties, failure to pay taxes, failure to make repairs, failure to provide books and records, and various other things can trigger a default.
Then, when the borrower does default and the lender sends notice of that default, borrowers respond in myriad ways. Sometimes, they simple refinance the loan elsewhere. Other times, they start moving money in ways that they think make it harder for the creditor to be paid. Still other times, they start developing defensive theories that generally fall under the “lender liability” umbrella. Then again, a borrower might also file bankruptcy and seek a liquidation or restructure.
We have seen it all (plus more) over the years. While there are thousands of minute variations in each credit’s “story,” they follow similar trajectories that allow us to spot quickly the best path for recovery. Sometimes, that path takes the form of a workout, typically structured through a forbearance agreement or loan modification. If there are flaws in the loan documents, this path makes most sense, as the workout documents can provide a useful opportunity to repair those flaws. Other times, the path is straightforward: repossess and liquidate collateral and file a suit for a deficiency balance. Then, there are the difficult cases. Some borrowers who find themselves in financial trouble engage in all manner of chicanery to preserve the lifestyle into which they have largely borrowed their way. Receiverships, injunctions, involuntary bankruptcy petitions all come into play in these situations.
Most practically, though, every new credit file we get starts with a simple analysis. How much does the borrower owe, and, on the best day, what assets should a lender be able to chase? As you can imagine, the complex cases in particular can become expensive, and, if all the lender can chase has minimal worth, then there will be a disconnect between what we can do and what we should do.
As we progress through this series, we will offer tips on what lenders can do throughout the process to make this threshold inquiry easier, as that is the single most useful question to ask at the outset. Is it worth your time and money? We take this question very seriously.
This is Part 1 of Travis Knobbe’s Creditor’s Rights Spotlight series. View the rest of the series here.