Creditors with secured debts often have much more leverage against you than with unsecured debts.
The last couple months we have been discussing your bankruptcy options with debts secured by your vehicle, by your home, and by investment or business real estate. You can have debts secured by many other kinds of security—furniture and appliances, other personal property you buy or else had owned beforehand, business equipment and inventory, personal possessions that are subject to an income tax or judgment lien. These are just some of the possibilities. Before we get into these, and how bankruptcy handles them, let’s get a better understanding of secured debts in general.
It’s quite simple. An unsecured debt is not legally tied to any interest in or right to anything you own. A secured debt IS legally tied to something you own through a lien on it. A lien is defined in the U.S. Bankruptcy Code as a “charge against or interest in [your] property to secure payment of a debt or performance of an obligation.” (Section 101(37).)
For example, vehicle loan is a secured debt. Your creditor has a lien on your vehicle. Your title shows the creditor as the lienholder on the vehicle. That lien is on the title because of what you agreed to in the documents you signed with that creditor. The lien secures your payment of the debt and your performance of other obligations you agreed to in those documents. If you don’t pay the debt your creditor can of course repossess your vehicle. If you don’t pay insurance and it lapses, your creditor can likely “force-place” its own insurance to protect its security interest in the vehicle and make you pay for that insurance.
Voluntarily and Involuntarily Secured Debts
You intentionally give a creditor a lien by entering into a “security agreement”—part of the paperwork you sign when you buy a vehicle, or when you take out a loan and provide collateral in the form or your vehicle or some other collateral you own. (See Section 101(51 of the Bankruptcy Code.)
But there are many kinds of secured debts in which you don’t directly agree to give a lien on your property but it happens by operation of the law. Generally these happen when you don’t pay an unsecured debt and the law provides ways for the creditor to convert that unsecured debt into a secured one.
If you don’t pay almost any unsecured debt or claim against you, the creditor can file a lawsuit against you. If you lose that lawsuit—which you usually do if you owe the debt or the claim is valid—the creditor gets a judgment against you. That judgment can turn into a judgment lien against your home. That judgment lien gives that creditor certain rights against your home, including often the right to foreclose on that lien to force you to pay that judgment.
If you don’t pay income taxes, the IRS or state tax agency can put a tax lien on both your real estate and personal possessions. That tax lien in effect turns those possessions into collateral on the tax you owe.
There are numerous other similar kinds of liens that can be created on your property.
Debts that May or May Not Be Secured
For a creditor to have a lien in your property—whether voluntary or not on your part—the creditor must initially go through the appropriate legal steps create that lien, to turn that debt into a legally secured one.
As a result some debts that you might think are secured debts are not. For example, when you buy some furniture or appliance, whether the debt you owe is secured—whether the creditor could repossess what you bought if you don’t pay—depends on whether it took the legally necessary steps to create a legally enforceable lien. This depend on whether you sign appropriate paperwork that gives the creditor that right in the contract, and then whether the creditor followed any additional required legal steps to create the lien.
Sometimes a debt is intended to be secured but the creditor does not do what the law requires, and so the debt ends up being completely unsecured. The creditor would not have rights to repossess whatever of yours it could have otherwise.
In our next blog post in a couple days we’ll look at how bankruptcy can give you certain powers and advantages over your secured debts.