A Short Series on the Disappearing Debtor – Debt Structure

PART 2: Debt Structure

Contributed by:
Robert S. Bernstein, Esquire
Bernstein-Burkley, P.C.

What happens when a business debtor closes up shop one day only to appear the next day under a slightly different name without going through bankruptcy? How does that happen and what do creditors do?

To answer that question, we need to review what ownership is, how debt is created and whether creditors have rights to attack property in a name other than the original customer. We attempt to do so in this four-part series. Should you have specific questions, please contact Bob Bernstein at bob@bernsteinlaw.com.

How your debt is created is very important in an analysis of your rights when your customer disappears one day and reappears in a different form the next.

Most credit is open account, which is another way of saying “unsecured.” It is created by a sale of goods or services on credit, with the customer promising to pay later. If the customer doesn’t pay, there is simply a right to sue, but usually no right to get the goods or services back. In order to have some greater right, the debt must either be in a special class (e.g. construction) or must be created with special rights (e.g. secured). A secured debt is one for which the creditor has rights (a lien) to recover specific property. For a full explanation of security interests, please see the series at A SHORT SERIES ON SECURITY INTERESTS FOR CREDIT MANAGERS.

If the creditor has a security interest in the assets of Jo’s Car Repair, Inc., there is a much greater likelihood that the creditor can follow the secured property whether it turns up the next day at Jo’s Garage, Inc. Sometimes, depending upon the business the customer is in, the customer may have the right to see secured inventory in the ordinary course of business, free and clear of the security interest.

The creation of a security interest is relatively easy when the account is set up, even if you are selling services that, of course, disappear after the sale. Consider taking a lien on other assets of the customer (equipment, inventory, real property). Since there are specific rules on how to create a security interest, it is important that you follow the right steps to make your lien effective. Once created, it is also important that you inspect your secured property occasionally. After all, if you never do an inventory check, it is more likely the inventory will not be around when you really need it!

Next – Part 3: Fraudulent Transfers

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