Debtors and Creditors (2024)

Module1: Debtors and Creditors

The Debtor-Creditor Landscape

Debt is a very important partof our economy. Nearly every American owes some kind of debt to someone else.These debts come in all shapes and sizes -- home mortgages, credit cards,automobile loans or leases, apartment leases, medical bills, student loans andtaxes are all examples.

Consumer debt is a primaryengine of the United States economy. As of 2019, total debt in the UnitedStates added up to almost $4 trillion in an annual economy of about $20 trillion.[1] Just credit card and otherrevolving debt exceeded $1 trillion.[2] In 2018, Americansborrowed about $88 billion to pay for healthcare alone.[3]

The largest percentage of debtis held in home mortgages (about a third of total debt), followed by studentloans, credit cards, automobile loans and leases and medical debt. Medical debtis the number one cause of bankruptcy.[4] To break that downindividually, the average American is about $12,000 in debt, corresponding toabout a quarter of the average income. The economy, both household andnational, runs well when debts get paid on time. When they are not paid ontime, litigation may result, and debtor-creditor law is engaged.

This course presents anoverview of the legal relationship between debtors and creditors. Specifically,it is about what happens when a debtor-creditor relationship is established bythe parties and then broken by one of them. The course is not about how thoserelationships are established - that is the purview of contract law and some otherlaws, such as torts and taxation. The course is, for the most part, aboutunsecured debt obligations. Secured obligations are covered by our video-courseon secured transactions.

In this module, we’ll overviewmany of the laws that affect this area, including those coming from common law,state law and federal law.

A debtor is a person or other legal entity who owes money or servicesto another person or company. This party to whom the debt is owed is called thecreditor. The money or service thatthe debtor owes to the creditor is called the debt or the obligation. Adebtor may also be referred to as the obligorand the creditor, the obligee.

A debtor’s obligation canarise from various circ*mstances, including loans, extensions of credit, taxes,leases, medical bills and tort claims for damages. Debts can be written or oral,and agreements can be express or implied, in accordance with contractlaws. Debts can also be created by law, as in taxation or when a defendantloses a court case.

Debts can be secured by collateral,such as a house or car, or they can be unsecured. Unsecured debts like creditcard debts, personal taxes and unsecured loans, can start as unsecured andbecome secured through actions of law, as when an enforcement of judgmentaction is filed, and a lien attached, or property seized to satisfy a judgmentdebt.

Debtor-Creditor Law

The debtor-creditorrelationship consists of both rights andduties. “Rights” describe what isowed to the creditor, such as the right to repayment of a loan or the right ofa landlord to enter property if the rent is not paid. “Duties” describe therequired actions of the debtor, such as the duty to pay taxes or to repay loans.However, those roles may be expanded under some state and federal statutes. Forexample, under federal law, a creditor has the right to collect on a debt, buthas the duty to report accurate information to credit reporting agencies.Likewise, a debtor has the duty to repay a debt, but has the right to live freefrom telephone harassment in the collection efforts for that debt.

There are numerous federal andstate laws that deal with the rights and obligations of debtors and creditors.These laws stretch back virtually to the beginning of money and trade, butmodern laws have become primarily concerned with consumer protection. Theytouch other areas of the law as well, such as taxation and landlord-tenant law.

Debtor-Creditor law is civil innature, though criminal laws may be involved in cases involving certain kindsof fraud. Being unable to pay a debt is not a criminal offense, although owingmoney to the government in the form of unpaid fines or taxes can triggercontempt charges that can land a person in jail. Still, the “debtors’ prisons”of the eras of Charles Dickens and Daniel Defoe are relics of the past. Dickenswrote three books in which protagonists went to prison because they could notpay their debts. This era of law gave rise to such phrases as “the poorhouse.”One famous debtor’s prison was called “Clink,” and gave rise to the phrase“being thrown in the clink.”

Debtor’s prisons originated inEngland in medieval times and were operating until the country passed theDebtor’s Act in 1869.[5] Other countries around theworld followed suit, and the United States has never allowed formal debtor’sprison.

Unlike tort and contract law,most debtor-creditor law is statutory, state or federal. That is especiallytrue when it comes to protecting debtors from unfair collection practices, as inthe case of the Fair Debt Collections Practices Act.[6] However, there are a fewcommon law causes of action which can limit the collection process, even ifthey are rarely used or successful. They typically operate where debtor andcredit law intersects the law of contracts and torts.

Applicable Torts

Before consumer protection anddebtor protection statutes were created, it was difficult for a debtor to respondagainst creditor bad behavior like persistent phone calls, home visits and thelike. Debtors through the years have responded to this behavior by filinglawsuits against obnoxious creditors under several tort theories, including defamation,invasion of privacy and intentional infliction of emotional distress.

Defamation is atort that means making false statementsabout another that are damaging to reputation. If thedefamatorystatement is printedor broadcast over media, it iscalled libel. Otherwise, it is called it isslander[7].

An example of this tort in thedebt collection process could be publishing a notice in a newspaper that aperson owes a debt when, in fact, there is no debt, or when the amount of thedebt is incorrect. Truth is a defense to this tort, so there is no cause ofaction, for instance, for publicizing a true debt. In addition, an element ofthis tort is damages, so a plaintiff would have to prove that the falseinformation caused some kind of damage to succeed.

Invasion of privacy has severalapplications, including public disclosure of private facts, wrongful intrusion,misappropriation of a person’s name or likeness and casting a person in a falselight.[8] This tort can be used ifcollection practices are egregious.[9] Unlike defamation,invasion of privacy can apply where true information is released. Actualdamages are also required of this tort, such as loss of business.

Invasion of privacy issometimes alleged where the creditor has contacted the debtor’s place ofemployment and informed the employer of the debt. While a creditor may contactan employer of a debtor for legitimate purposes, such as effecting a wagegarnishment and to confirm information provided by the debtor, courts havefound that egregious behavior, such as multiple harassing contacts can amountto invasion of privacy.

Courts have also found for thedebtor in invasion of privacy cases where the creditor has contacted thedebtor’s neighbors, published the debt in a local newspaper or posted a noticeof the debt at the debtor’s place of employment.

Invasion of privacy forintrusion on the solitude of the debtor can apply when debt collection effortsrise to the level of harassment. For example, a creditor or debt collector maynot camp out in front of the debtor’s house, constantly knock on the door,constantly phone, follow the debtor around, harass the debtor’s family and soon. Debtors who are experiencing that sort of harassment may seek a restrainingorder.

Beyond invasion of privacy, extremeharassment can constitute intentional infliction of emotional distress,which can bring compensatory and punitive damages. This means the plaintiff acts outrageously with the intention ofcausing the defendant to suffer severe emotional distress.[10] Thismay include, for example, the collector threatening physical harm to aplaintiff or threats of financial harms that are outlandish or unrealistic. Forexample, threatening to sue if the debtor doesn’t pay a debt is legal, butthreatening to “make it so that you’ll never get a loan or job in this townagain” may constitute intentional infliction of emotional distress. Thebehavior must be so severe that “it could be expected to adversely affectmental health.” It may also take the form of behavior that seemsdesigned to disrupt the debtor’s life rather than realistically trying tocollect a debt.

This cause of action isdifficult to prove in many jurisdictions, often requiring “actual damages” asan element of the tort. These damages may be proved by medical bills from apsychotherapist who could testify that the harassment caused the debtor to seektherapy.

While these common law causesof action remain available to harassed debtors, many state and federal consumerprotection laws also provide their own civil actions against creditors and debtcollectors, with some statutes pre-empting or rendering unnecessary thesecommon law torts.

Assignment for the Benefit of Creditors

Sometimes, debtors may agreeto give something to creditors in exchange for some relaxation of collectionefforts. For example, the debtor might give an unsecured creditor a securityinterest in his car in exchange for the creditor’s agreement to stop collectionactions for three months.

On common type of transfer ofproperty interests for the benefit of creditors is the “assignment for the benefitof the creditors.”[11] The debtor assigns thetitle to a piece of property to a trustee for a liquidation sale for thebenefit of debtors.

For example, assume Bob is adebtor who owns a building. Bob owes money to multiple creditors and is havingtrouble paying all of them on schedule. Bob could assign or transfer ownershipof the building under these laws to Nancy, who is then put in the legalposition of a trustee. Nancy would then be tasked with selling the building anddistributing the proceeds of the sale to the creditors. In doing so, she isrequired to follow the same state fiduciary laws as any other trustee. Theprocess is very similar to the creation of a trust and is often governed by astate’s trust laws.[12]

The concept works similarly toa bankruptcy proceeding, but is simpler, applies only to the building and doesnot require court supervision. Of course, unlike a bankruptcy filing, thismaneuver does nothing to stop other collection efforts. Still, the assignmentcan be used as a way to avoid bankruptcy if the debtor’s financial life can behelped with these simpler transactions.[13]

After the sale of theproperty, the trustee must distribute the proceeds from the sale in order of legalpriority. This is usually in the order that the debts were created. If thetrustee favors some creditors over others in a manner to which they are notlegally entitled, that may constitute a fraudulent conveyance, and it may beunwound by a court.

If there is a shortfall inthat not all debts are paid completely, the remaining debts are still owed tothe various creditors. Unlike a bankruptcy proceeding, there is usually nodischarge of remaining debt after liquidation of the property. Any attempt bythe debtor or trustee to discharge an unpaid debt under a common law assignmentmay be considered a fraudulent conveyance.

States that allow this kind ofaction generally do not require that the creditors approve the assignment, saleand distribution. On the other hand, the entire process is sometimes consideredunnecessary, since the debtor can just sell the property and distribute thefunds itself. Still, it is a solution that is available to debtors that mayprovide some organization and process to satisfying an array of debts.

Assignments for the benefit ofcreditors are now regulated in most states, while in others, they are governedsolely by common law rules.[14] In some states, debtorsmay choose between “common law” assignments and “statutory” assignments.

Differences between “commonlaw” assignments and “statutory” assignments include:

-- Moststate statutes do not allow the trustee to determine preferences among thecreditors, while the common law does allow this. This means that, under moststate laws, the trustee has virtually no control over which creditors get paidwhen. State law governs the order of payment. Secured creditors and employees owed unpaidwages generally get paid first, and then payments to unsecured creditors are distributedproportionately.

-- Virtuallyall state statutes require recording the assignment, filing schedules of assetsand liabilities, bonds to be secured by the trustees and notice to thecreditors.[15]

-- Somestate laws allow the discharge of a debt in the case of a shortfall. Somecommentators feel that this kind of law is unconstitutional, because it seemsto usurp bankruptcy laws. Bankruptcy law is exclusively reserved for the USCongress by the Constitution.[16] However, the SupremeCourt has determined that debt discharge may be allowed without interfering withfederal powers of bankruptcy law[17].