Debts are either secured or unsecured. With a secured debt – such as a mortgage – the debtor’s personal obligation to pay the debt is accompanied by a creditor’s right against certain property of the debtor. Unsecured debts – such as credit card debt – only create a personal obligation by the debtor to pay the debt. Unsecured debts do not give the creditor a right against any of the debtor’s property.
If the creditor fails to pay a secured debt, the secured creditor then has the right exercise its security interest in order to terminate the debtor’s ownership in the property at issue, seize it, sell the property, and use the proceeds to recoup some or all of what it is owed. This security interest of the creditor is what is known as a lien.
Generally speaking, liens on either real or personal property fall into one of five categories:
- Consensual liens;
- Judicial lines;
- Statutory liens;
- Common law liens; &
- Equitable liens.
Within each of these five categories, there are many different lien types.
A consensual lien is created by a contract between the debtor and the creditor. The most common example of consensual liens are security interests created when folks purchase an automobile or a home. The granting of the lien by the debtor is usually part of the creditor’s price for extending the credit necessary to purchase the home or automobile at issue. If a debtor defaults on the car loan or home mortgage, the creditor can then exercise its lien and terminate the debtor’s ownership interest in the property at issue.
Judicial liens are created after an unsecured creditor initiates court proceedings for recovery of a debt. If an unsecured creditor obtains a judgment and records it against some of the debtor’s property, that unsecured creditor may now be partly secured.
Statutory liens are liens that legislatures have codified into law and are not created by contract or by a court. An example of a statutory lien is the construction lien. Under this lien, if a contractor or subcontractor, or material supplier is not paid for their work on the debtor’s real property (such as a home), then under construction lien statutes, the provider of the work or supplies is entitled to assert a lien on the property that was constructed, repaired, or improved.
Common Law Liens
Common law liens – like statutory liens – arise by operation of law and not by contract or the judicial process. An example of a common law lien is the lien given to landlords in property brought in to their premises in order to secure the price of room and board.
Finally, equitable liens, like judicial liens, arise out of the judicial process. Equitable liens can only be granted by a court after a creditor shows that traditional legal remedies are inadequate. For example, a creditor may have been entitled to a statutory lien, but failed to follow one of the steps outlined in the statute to perfect the lien. In that case, the creditor may ask the court to overlook that defect and, out of fairness, create an equitable lien in their favor so as to recoup some or all of what they are allegedly owed.
Bottom line: Secured debts put creditors in a much stronger position in the event of the debtor’s default than an unsecured creditor. These differences between secured and unsecured debts are extremely important in bankruptcy cases. If you have questions about how your debts and property will be treated if you file for bankruptcy give our office a call. Initial consultations are always free.