If you have ever taken out a loan from a bank, received a mortgage, or have purchased a new car, you are most likely at least slightly aware of the law of liens. A lien is a creditor’s interest in property held by a debtor to ensure that the debtor satisfies payment or performance of an obligation. A typical example is when a borrower obtains a loan from a bank. Banks will often require the borrower to grant to the bank a security interest in the borrower’s personal property assets (“collateral”). If the borrower grants such an interest to the bank, the bank has obtained a lien on the borrower’s personal property. As a result, if the borrower fails to make repayment on the loan, the bank has the ability to repossess the borrower’s personal property and, in many circumstances, sell it. From the borrower’s point of view, this can be a frightening situation to be in. From the bank’s perspective, however, taking a lien on the borrower’s property is one of the only ways it can protect itself against default. It is this relationship between the borrower (debtor) and the lender (creditor) that gives rise to laws on liens and security interests.
II. Basic Terminology
Before endeavoring to understand the legal implications surrounding liens and security interests, it will be beneficial to become familiar with some of the common terms associated with this area of the law. The following terms are some of the most common:
- Debtor: An individual or entity who is indebted to a creditor.
- Creditor: An individual or entity to whom a debt is owed.
- Security Agreement: The contractual pledge of collateral by a debtor to a creditor (“secured party”).
- Lien: A creditor’s interest in specific property owned by a debtor, which has been secured as collateral for payment or performance of an obligation.
- Collateral: Property upon which the creditor has been given a lien or security interest.
- Repossession: The act of seizing property subject to a creditor’s security interest.
- Execution Sale: The sale of repossessed property by an authorized party on behalf of the creditor in order to satisfy an obligation.
- Garnishment: A procedure for collecting a debt from a third party who owes the debtor.
III. Types of Liens
Liens can arise in a number of different ways. For the most part, liens can be placed into two categories: consensual and nonconsensual. A consensual lien, intuitively, is one that has been agreed to by both parties involved. This will often involve the signing of a security agreement, or other similar agreement, where a debtor grants to a creditor an interest or lien in the debtor’s property. Since these types of agreements are essentially contracts, courts will usually enforce them if they are signed and are otherwise enforceable. As a result, the contract will be deemed to be the “law” of the relationship; creating legal obligations that will be exceedingly difficult to revoke. It is therefore important to exercise caution when entering into such an agreement.
Nonconsensual liens, on the other hand, include judicial liens (liens created by judicial/court procedures) and statutory liens (liens which arise by statute/operation of law). A judicial lien, for example, arises when a court renders a judgment in favor of a particular party. Since the prevailing party will usually be entitled to judgment in the form of money, the judgment automatically creates a lien against the losing party’s real property (real estate) as a security for payment. This lien on real property will not only attach to the current property of the debtor, but also to any property acquired in the future. So, for example, if there is a judicial lien on your house, but you decide to go buy a new lake cabin thinking the lien won’t carry over, think again. The lien will attach to any other real property you acquire after the judgment (with some exceptions) until your obligation has been satisfied. Judicial liens last for ten years after the judgment was entered (20 years in the case of child support), but can be renewed quite easily.
The prevailing party may also be able to obtain a lien against the personal property (money, possessions, etc.) of the judgment debtor. Therefore, if you are a prevailing party in a judgment and have a judicial lien against the judgment debtor’s real estate, but would like to obtain a lien against the debtor’s other stuff, you need to apply to the court for a writ of execution. The writ of execution will enable the sheriff to levy (seize) the judgment debtor’s property and sell it at an execution sale in order to satisfy the judgment. Judicial liens, therefore, can be quite harsh for a delinquent debtor.
Statutory liens, on the other hand, are a somewhat different animal. Statutory liens arise by operation of law. The triggering action is most commonly the debtor’s simple non-payment of an obligation for a given situation. Some of the most common statutory liens include mechanic’s liens, federal and state tax liens, landlord’s liens, and agricultural supplier and processor liens. Although these liens arise by operation of law, there is often a filing requirement by the lien holder as well as a grace period within which the filing must occur. Furthermore, depending on the type of statutory lien, some lien holders can “jump ahead” of other lienholders and obtain priority. Federal and state tax liens are the perfect example of this priority. Tax liens are powerful, and demand special treatment.
IV. What are the Implications of a Lien?
The fundamental implication of a lien is the lien holder’s rights in the property or collateral of the debtor. Therefore, if a borrower pledged “all personal property assets” in a security agreement as collateral, the lien holder is legally permitted to seize any or all personal property assets of the debtor in order to satisfy the defaulted obligation. Such repossession can be accomplished using judicial processes (commonly known as “claim and delivery” or “replevin”), or can be done individually by the secured party as long as there is not a breach of the peace (referred to as “self-help repossession”). Secured parties who attempt to use self-help repossession tactics need to exercise extreme caution so that they do not violate repossession laws. These laws emphasize that self-help repossession can only be used in an atmosphere devoid of violence or physical resistance. If there is the slightest risk of violence, self-help repossession efforts must be abandoned. The secured party will then need to resort to the courts for repossession.
Following the repossession of the collateral, the secured party is able to sell the collateral to satisfy the debt. The creditor is required to give written notice to the debtor, as well as other creditors, and must sell the collateral in a commercially reasonable manner. If the sale is of the judgment debtor’s personal property, a notice of the sale must be posted for ten days before the sale occurs. For real property, a notice of the sale must be posted and published for six weeks before the sale occurs. While commercial reasonableness is a hotly debated topic, courts have stated that selling collateral for low prices is not necessarily commercially unreasonable. The sale will allow other creditors to potentially receive payment, and may also allow the debtor to receive any excess funds from the sale. The debtor may also “redeem” (repurchase) repossessed property before or after the execution sale. There are, however, certain limitations to this option.
A noteworthy component of the execution sale is the creditor’s ability to purchase the collateral he has already repossessed. For example, let’s say a judgment debtor owes $100,000. In an effort to satisfy the judgment, the judgment creditor obtains a writ of execution from the court, and has the sheriff go and seize the debtor’s classic car (worth $100,000). At the execution sale, the judgment creditor ends up buying the classic car himself for only $50,000. The debtor still owes $50,000. If the creditor then goes and sells the classic car at a private sale for $100,000, he has profited $50,000. However, this does not mean that the debtor’s obligation is satisfied; the debtor will still owe $50,000!
V. Other Methods of Satisfying a Debt
If liens, repossession, and execution sales still do not satisfy a debt, there are other methods that creditors can take advantage of. These procedures are typically statutory in nature, and can include things like discovery of non-obvious sources of collateral, judicial prevention of the debtor’s disposal of collateral, the appointment of a receiver to manage the debtor’s property, and an order for the sale or other disposition of the debtor’s intangible property.
Garnishment is another procedure creditors can utilize to satisfy a debt. The garnishment procedure, though often a lengthy and complicated process, can be quite effective. Garnishment allows a creditor to force third parties who owe the debtor to pay the creditor instead. Common forms of garnishment include garnishment of wages (forcing the debtor’s employer to pay the creditor instead of the debtor) and garnishment of bank accounts (forcing the debtor’s bank to freeze the debtor’s accounts, and hold all money for the creditor). The garnishment process, though effective for the creditor, also allows for some protection of the debtor if the debtor qualifies for certain exemptions (e.g., the debtor has dependents).
VI. Criminal Implications for Debtors
Although failing to pay a debt will not automatically land a debtor in jail, there are criminal implications for certain actions taken by a debtor. Issuing a bad check, for example, has criminal penalties. Other actions that carry criminal penalties include defrauding secured creditors, fraudulently conveying property that has a lien, concealing assets from creditors, and giving certain creditors preference over others. Additionally, if a debtor fails to satisfy a judgment, the debtor may be held in contempt of court orders; resulting in arrest and jail time. There are also criminal implications for a debtor who refuses to pay state and federal taxes.
In conclusion, the subject of lien laws is not one that is easily understood. Indeed, the areas of the law that deal with debtors, creditors, and liens are not confined to one small section of a statute. Instead, the subject is woven into nearly every area of the law. It is a subject that should not be taken lightly, and should not be handled without the guidance of experienced professionals. If not handled correctly, the implications could be disastrous. For more information, contact an attorney who is experienced in handling issues pertaining to debtor and creditor relations.