Creditors' Rights

When a debtor fails to pay his or her debts, the creditor, i.e. the person or business to which the debt is owed, has several available remedies to help collect the money. These methods include remedies that do not require court involvement, called self-help remedies, and remedies that do involve the courts, including pre-judgment legal remedies and formal court proceedings in which a judgment against the debtor is obtained.

Many creditors' first attempts at debt collection do not involve the courts. First, the creditor may simply contact the debtor directly and demand payment. If these attempts fail, the creditor may transfer the debtor's account to another business whose focus is debt collection. The practices of these debt collection agencies are regulated in order to avoid abuses. For instance, the Fair Debt Collection Practices Act (FDCPA), which is a federal law, prescribes how, when, and where debtors may be contacted and prohibits deceptive practices. If a debt collector violates the act, the debtor may be entitled to recover damages. The FDCPA applies only to persons who regularly collect debts owed to someone else, not to creditors collecting their own debts.

Other processes, too, are available to increase the likelihood of payment of bad debts. Secured transactions, for instance, are sale or loan transactions in which the debtor gives the creditor a claim to the debtor's property in order to ensure payment of the debt. A secured creditor takes priority over an unsecured creditor if there are competing claims to the property or to the proceeds from the sale of the property. To attain this higher status, however, the creditor must "perfect" its security interest, usually by filing certain required documents. Most consumer transactions are unsecured, but home and motor vehicle financing are usually secured by the property being purchased. If a car loan is secured and the debtor fails to make the payments, the lender can take back the car in order to cover at least part of the remaining debt.

Sometimes, a creditor will initiate court proceedings in order to collect on a debt. In cases involving emergencies, the creditor may be able to seize the debtor's property even before the court decides the matter. These are extraordinary measures, however, and should be employed only when other methods would be futile or useless, such as when perishable goods are involved, or when the collateral, if left in the debtor's control, would rapidly decline in value.

Two of the more common pre-judgment remedies are replevin and attachment. In a replevin action, a creditor that holds title to property that is the subject of a debt may take that property back if the debt is not repaid. A lessor of furniture, for example, may be able to take back its property if the lease payments are not made, but often notice and hearing requirements must be met before that can happen. These requirements may be waived if the property is in imminent danger of destruction, or under other exceptional circumstances. Ordinarily, the county sheriff must execute the order of replevin, seize the property and deliver it to the creditor.

Attachment, which is similar to garnishment, is a procedure set forth in state statutes, and the particular details vary from state to state. In an attachment proceeding there is usually a court hearing, after which the court issues an order authorizing the creditor to take the debtor's property or title to the property. Like replevin, attachment is available in only extraordinary cases such as when the debtor is about to dispose of the property.

If all of the remedies described above fail, the creditor can sue to collect the debt. The creditor will be entitled to an enforceable judgment if it proves its case or if the debtor fails to contest the claim. Once a judgment is obtained, the creditor can enforce the judgment by claiming enough of the debtor's property to cover the debt, usually with the assistance of the local sheriff. The sheriff may actually take the property, or will record the creditor's lien against the property, such as when real estate is involved. The sheriff can arrange for a sale of the property, the proceeds of which are used to satisfy the debt. Often, more than one creditor is involved and they will be paid in a particular order of priority, which is usually based on the order in which the creditors established their legal claims to the property.

A lien is another type of legal claim to the debtor's property that helps ensure debt repayment. There are several types of liens. Judgment liens can arise if a creditor goes to court to collect on a debt and proves its case, or the debtor fails to contest the matter. The court will order a judgment in the creditor's favor in the amount owed to it by the debtor, and the creditor then has a lien against the debtor's property in the amount of the judgment. Other types of liens can arise when, for instance, the creditor has done work on or supplied materials for the debtor's property and the debtor fails to pay for the goods or services. Materialmen's and mechanic's liens are two examples of this type of property interest that ensures the creditors' recovery. A creditor with a lien on the debtor's property may in certain circumstances foreclose on the lien and sell the property to satisfy the debt.

If none of these debt-collection tactics is successful and the debtor owes a substantial amount to several creditors, the creditors may be able to initiate an involuntary bankruptcy proceeding. If the court accepts the petition, the debtor may be forced to liquidate its assets to pay off its debts, or it may be able to file a reorganization plan that sets out how its debts will be paid. However, if the creditors initiate such a proceeding in bad faith, they may be subject to severe financial penalties, including punitive damages.

An experienced lawyer can help a creditor determine the best method for collecting the debts owed to it, both before entering into credit transactions and after repayment becomes an issue.

Checklist: What To Do When A Customer Files For Bankruptcy

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What to Do When a Customer Files for Bankruptcy

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This publication and the information included in it are not intended to serve as a substitute for consultation with an attorney. Specific legal issues, concerns and conditions always require the advice of appropriate legal professionals.