Law Offices of Michael E. Gross | Chevy Chase Real Estate Lawyer and Business Law Attorney

Banking and Finance Law

What protection do I have if funds are withdrawn from my bank account through use of a stolen credit card or debit card?
Is my money safe in a savings and loan association or a credit union?
Does a lender have a security interest in replacement inventory once the original business inventory that served as collateral is used in the ordinary course of business?
Does a previously granted security interest attach to a new loan?
Is a creditor entitled to a tax deduction if it forgives part of a debt pursuant to a workout plan?
May a creditor force the debtor to file for bankruptcy protection?
Must a mortgage be put in writing?
Is a lender's promise, made at the time the original loan is consummated, to make a second loan enforceable?
Can a bank be prevented from enforcing its right to a deficiency judgment following foreclosure and sale of a home?
Learn More: Banking and Finance Law

What protection do I have if funds are withdrawn from my bank account through use of a stolen credit card or debit card?

Credit cards and bankcards have allowed for speedier and more convenient transactions, to the benefit of banks, consumers and businesses. Unfortunately, they remain vulnerable to mistakes, theft, and misuse. Shifting the burden of loss to the banks and credit card companies which are more financially able to bear it, Congress has limited the liability of credit card holders to no more than fifty dollars of charges before the card holder notifies the credit card company of the fact that the card has been lost or stolen. A consumer who never accepted a credit card is not liable in any amount if an unauthorized person uses the card. For example, assume a merchandiser sends an unsolicited credit card to a consumer, and the consumer throws it in the trash. If a thief steals the card out of the trash and uses it, the consumer is not liable for even fifty dollars of the charges.

The Electronic Funds Transfer Act regulates bankcards. If a cardholder notifies his or her financial institution within two days after learning of the loss or theft of a card or access code, the cardholder's liability is limited to fifty dollars. A cardholder can be held liable for up to $500 when more than two business days elapse before notification. Finally, if a cardholder fails to report unauthorized transfers on a monthly statement within sixty days after the statement is mailed to the cardholder, the cardholder risks unlimited losses of the entire account balance. In other words, more than sixty days delay in notifying a bank of unauthorized transfers may waive the cardholder's right to object to the transfers. This does not serve to waive an action against the unauthorized user of the card, if he or she can be found.

To provide protection against billing mistakes, the Fair Credit Billing Act regulates procedures for credit cards. The Act ensures that consumers are provided with full disclosure of terms, interest rates, and penalties. It also provides cardholders be given at least fourteen days in which to pay a bill.

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Is my money safe in a savings and loan association or a credit union?

In the late 1980s, the savings and loan industry suffered a period of turmoil, largely due to an attempt by many savings and loan associations to enter the commercial real estate markets rather than stick to their traditional residential mortgage lending business. Credit unions did not experience the failures that savings and loan association suffered because they did not enter the risky commercial real estate market.

The Resolution Trust Corporation, incorporated in 1989, took over the assets of troubled savings and loan associations and succeeded in turning around the savings and loan industry by late 1995. It appears that both the savings and loan industry and the credit union industry learned from the savings and loan debacle, and that they will continue to operate within their risk capabilities.

In addition to internal industry reform, strengthened deposit insurance, examination, and supervision have made savings and loan associations and credit unions a more viable deposit alternative. The Federal Savings and Loan Insurance Corporation (FSLIC) insures savings and loan accounts to a maximum of $100,000. Nearly all savings and loan associations are presently insured under this program, and the remainder are insured under state insurance plans. Likewise, the National Credit Union Share Insurance Fund (NCUSIF), which is administered through the National Credit Union Administration, insures credit union deposits to a maximum of $100,000 per account. All federal credit unions, and the majority of state credit unions, are presently insured by the NCUSIF. Deposit insurance protects the same depositor only up to the $100,000 limit. Even if the same depositor has several accounts totaling more than $100,000, the depositor will be limited to $100,000 in insurance coverage. To avoid this result, many depositors who desire to deposit more than $100,000 in a savings and loan association or credit union set up trusts to serve as account holders.

In addition, stronger examination and supervision of savings and loan associations and credit unions have resulted in a more responsible management. Closer supervision has resulted in management changes where necessary, in most cases before serious damage has been done by irresponsible lending practices.

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Does a lender have a security interest in replacement inventory once the original business inventory that served as collateral is used in the ordinary course of business?

Under the Uniform Commercial Code (UCC), which has been adopted in whole or in part in nearly all states, "a security agreement may provide that any or all obligations covered by the security agreement are to be secured by after-acquired collateral." Typical security agreement clauses, which bring this provision into effect, are clauses stating that "all inventory now or hereafter acquired by debtor" is subject to the security interest. In the event accounts receivable are to be covered, a clause stating that "all accounts due or to become due to debtor" serves to attach the security interest to future accounts receivable. By utilizing these and like clauses, lenders and other creditors can ensure that they are granted a continuing general lien on the debtor's property regardless of the debtor's later business transactions.

Increases in or "products" of existing collateral may also be covered under an after-acquired property clause in a security agreement. For example, a security agreement that grants a lender a security interest in livestock may cover newborn livestock that is the issue of the existing livestock that is pledged as collateral. Likewise, when collateralized raw materials are converted by a debtor into finished goods, such as when a cabinetmaking enterprise constructs cabinets out of raw wood, the cabinets, which are the products of the original collateral, become collateral. In the event another trade creditor claims a security interest in the same collateral, the UCC must be consulted to determine which security interest has priority.

As relates to consumer transactions the UCC provides that "no security interest attaches under an after-acquired property clause to consumer goods other than accessions . . . when given as additional security unless the debtor acquires rights in them within ten days after the secured party gives value." This UCC provision protects consumers from encumbering all of their present and future assets in routine consumer transactions. Accessions, which are typically replacement parts, such as a replacement engine in an automobile, may be covered by an after-acquired property clause.

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Does a previously granted security interest attach to a new loan?

The Uniform Commercial Code (UCC), adopted in whole or in part in nearly all states, provides that "obligations covered by a security agreement may include future advances or other value." Recognition of the validity of security interests on after-acquired property and future advances facilitates the financing of inventory and accounts receivable where the collateral is frequently turned over. So long as the security agreement specifically provides that it applies to future advances, the secured party may make future advances (often referred to as revolving credit) secured by after-acquired inventory or accounts receivable, and does not have to go to the trouble of repeatedly obtaining a new security interest every time additional credit is granted.

A security interest in future advances will be recognized only if the security agreement specifically provides that is applies to future advances. An example of an enforceable "future advance" clause is "[t] he security interest herein created shall also secure all other indebtedness, obligations and liabilities of the debtor to the secured party, now existing and hereafter arising, including future advances."

Care must be taken by creditors to ensure that future loans are correctly addressed in the security agreement, and that future loans are granted only in accordance with the security agreement's future-advance clause. For example, a security agreement that provides that it "secures payment of the debt evidenced by the promissory note of the same date and any and all liabilities of debtor to creditor under this security agreement or the promissory note or any renewal or extension thereof" would not provide a security interest in future advances made pursuant to a new promissory note. The creditor in such case should have either renewed or extended the original note, or insisted on the debtor's execution of a new security agreement to secure the new loan.

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Is a creditor entitled to a tax deduction if it forgives part of a debt pursuant to a workout plan?

The tax ramifications associated with debt forgiveness are many and varied for both the debtor and creditor. A workout attorney with experience dealing with the Internal Revenue Code's "cancellation of debt" provisions can help debtors and creditors in structuring loan concessions to achieve tax goals or, at the very least, to proceed through a workout with full knowledge of the tax results that can be anticipated. These issues can be very important to a cash-strapped debtor who will be unable to pay taxes arising from a debt cancellation.

The Internal Revenue Code provides that a taxpayer's gross income includes "income from discharge of indebtedness." Typically, if an amount is forgiven the debtor has cancellation-of-debt income to the extent of the forgiven amount, taking imputed interest into account. The amount is calculated differently if the obligor is a debtor in bankruptcy, is insolvent, or if the debt constitutes a qualified farm indebtedness.

Another important issue under this provision is whether a debt has been effectively discharged or merely restructured. The restructuring of a debt through a longer payment term or a more advantageous interest rate, rather than a total or partial cancellation, is less likely to be classified as income arising from cancellation of debt. Likewise, if a debt is disputed in good faith and subsequently settled for less than the original amount, most likely the lower undisputed amount will be considered the actual amount of the debt and not a reduction in debt. Thus, any good-faith claim by a debtor against the lender (such as under a lender-liability statute) may serve to avoid cancellation-of-debt income.

The Internal Revenue Code defines "indebtedness" as "an unqualified obligation to pay a sum certain at a reasonably close fixed maturity date along with a fixed percentage in interest payable regardless of the debtor's income or lack thereof." Only a primary obligor, and not a guarantor, is treated as a debtor under this definition. Accordingly, where a personal guarantee is canceled or modified as part of a workout plan, the guarantor does not have to report or recognize cancellation-of-debt income.

In most cases, a creditor is entitled to a bad-debt deduction in the year in which its debtor has cancellation-of-debt income. The amount and timing of the deduction will depend on whether the creditor attempts to take a full or partial bad-debt deduction, and on whether the debtor was insolvent at the time the credit was given.

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May a creditor force the debtor to file for bankruptcy protection?

An involuntary bankruptcy may be commenced for purposes of obtaining a Chapter 7 liquidation or a Chapter 11 reorganization against any debtor who is eligible for voluntary bankruptcy. An involuntary bankruptcy is commenced by the filing of a petition with the bankruptcy court. In an involuntary case where a debtor has more than 12 creditors, the petition must be signed by three or more creditors holding an aggregate of at least $12,300 in unsecured claims who do not have contingent claims or claims that are subject to a bona fide dispute. If the debtor has fewer than 12 creditors, then the involuntary petition may be signed by only one or more creditors holding at least an aggregate of $12,300 of such claims. A bankruptcy or workout attorney can assist in contacting other creditors and preparing a petition in bankruptcy provided that the requisite number of creditors agrees to proceed with the filing.

The filing of a petition for involuntary bankruptcy has the same effect as the filing of a petition for voluntary bankruptcy in two important respects. The filing creates a bankruptcy estate and it brings into effect the automatic stay, which prevents creditors from taking action to enforce their claims unless relief from the automatic stay is granted by the bankruptcy court.

The debtor has the right to contest the involuntary bankruptcy filing. In the event the bankruptcy is contested, the bankruptcy court will look at whether the debtor is paying its debts as they become due, and whether the debtor has assigned property for the benefit of creditors or suffered the appointment of a receiver to take charge of the debtor's property.

An involuntary bankruptcy is a valuable tool for a creditor who has limited remedies with which to collect a debt. For instance, where other creditors have levied on all of the assets of the debtor and the claims of those creditors equal or exceed the value of the assets, a creditor who levies later will receive nothing. If the creditor can find two other creditors who have missed out in this manner, they can file an involuntary bankruptcy petition and force the other creditors who have levied on the assets to return the assets to the bankruptcy estate. The assets may then be distributed in a more equitable manner. Finally, the bankruptcy trustee has broad powers to investigate the financial affairs of the debtor to ascertain whether any preferential transfers of money or assets occurred prior to the filing.

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Must a mortgage be put in writing?

Although many contracts are enforceable whether written or oral, contracts that involve a transfer of real estate are deemed important enough that they are required, under the Statute of Frauds, to be in writing to be enforceable. The Statute of Frauds originated in England in 1677, and has been subsequently adopted in some variation in all states. As relates to mortgages, the purpose of the Statute of Frauds is to prevent a creditor from fraudulently contending that a debtor granted it an unwritten mortgage when in reality none existed.

There is an exception to the Statute of Frauds, called the part performance doctrine, under which an unwritten mortgage is deemed to arise by operation of law or is deemed enforceable even though unwritten. A mortgage will arise under this doctrine only when money is lent for the purchase of the specific real estate on which a mortgage is to be granted. If the money is lent and the borrower does not follow through with a mortgage as promised, an equitable mortgage can arise in favor of the lender by operation of law.

However, simply lending money does not constitute sufficient part performance to take an unwritten security arrangement out of the Statute of Frauds. The money has to be lent specifically for the purchase of the real estate on which the mortgage is to be granted. In cases where the loan proceeds are to be used for purposes other than the purchase of the real estate at issue, the lender will have to look to assets other than the real estate to satisfy a judgment on the defaulted loan.

Even where the part performance doctrine requirements for imposition of an equitable mortgage are met, it is highly advisable to get the mortgage in writing. First, oral testimony as to the mortgage agreement is subject to clouded recollections and intentional fabrication. On the other hand, a written mortgage speaks for itself and should avoid a credibility contest in court. Also, by definition, an unwritten mortgage is unrecordable. Therefore, other parties can record liens and mortgages on the real estate at issue subsequent to the initial loan. This can result in the holder of the unwritten mortgage losing the repayment priority to which he or she is entitled by virtue of the earlier loan.

It is clearly in the best interests of the lender in any situation to get the mortgage in writing. In many states there are standard "boilerplate" forms that can be used. It is also crucial that the mortgage actually be recorded, rather than placed in a file folder for future recordation if necessary.

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Can a bank be prevented from enforcing its right to a deficiency judgment following foreclosure and sale of a home?

Generally, a mortgage lender may obtain a deficiency judgment against the mortgagor and anyone else personally liable on the debt if the foreclosure sale proceeds are insufficient to satisfy the underlying debt.

Example: Suppose John and Sarah purchase a home for $100,000 through mortgage financing guaranteed by Sarah's father. Suppose that after John and Sarah pay a total of $20,000 on the mortgage loan, they run into financial difficulties and lose their home to foreclosure. If the mortgage lender is able to recover $70,000 out of the foreclosure sale, the mortgage lender will be able to obtain a judgment against John, Sarah and Sarah's father for $10,000, representing the difference between the outstanding debt ($80,000) and the sale proceeds ($70,000).

To alleviate the perceived harshness of this general rule, many jurisdictions have enacted legislation restricting the recovery of deficiency judgments. An approach used by some jurisdictions is to prohibit deficiency judgments in certain situations, such as where purchase money mortgages are involved or where the property was foreclosed upon and sold by power of sale rather than by judicial sale. Another approach is to limit deficiency judgments to the amount by which the debt exceeds the fair market value of the property. This serves to provide the mortgagee with an incentive to get the best price possible at the foreclosure sale. Waiver of the protection afforded by legislation which limits the right to enforce a deficiency judgment is in most cases considered to be against public policy, and therefore ineffective.

Anti-deficiency legislation varies greatly state-to-state. A debtor would be well advised to consult a mortgage lending attorney in his or her jurisdiction to obtain information concerning his or her rights. Such an attorney can be of assistance in the event the property is sold for more than the outstanding indebtedness, resulting in a surplus rather than a deficiency. In that case, the debtor is entitled to the surplus after all expenses are paid.

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Is a lender's promise, made at the time the original loan is consummated, to make a second loan enforceable?

Banks have been held liable for breaches of promises to lend additional sums to business debtors in the future. Banks have responded by being careful to avoid making promises concerning future lending and by inserting clauses into their loan agreements to the effect that the loan agreement, promissory note, and security agreement contain the entire agreement between the lender and borrower with respect to lending, and that any oral representations are superseded by the written agreements. Therefore, it would be advisable to carefully review the loan documentation with a banking and finance attorney to ascertain whether the oral promise of additional funding can be enforced.

In the event the bank not only refuses to grant additional lending, but seeks to accelerate the debtor's payment obligation under a loan agreement provision which gives the lender the right to accelerate the loan at will in the event it considers itself "insecure," the Uniform Commercial Code (UCC) provides some debtor protection. The UCC provides that a lender may only accelerate at its option under such a provision if the lender "in good faith believes that the prospect of payment or performance is impaired." This standard also applies to attempts by a lender to seek additional collateral from a borrower under a security agreement clause which grants the lender the right to require additional collateral in the event it believes its loan is not adequately secured. However, in court the burden of establishing a lack of good faith will be on the borrower.

Learn More: Banking and Finance Law

Banking and finance lawyers assist borrowers and lenders in achieving loan transactions that result in borrowers being provided with the capital they need to achieve their business or consumer objectives and that satisfy lenders' needs for repayment and collateral protection. State and federal laws and regulations govern the chartering of banks and other financial institutions, and ensure that banks and other financial institutions are operated in a safe manner. Banking and finance lawyers also assist in restructuring loan transactions when necessitated by changes in business or economic conditions.

Commercial banks are chartered by either the federal government or a state. They constitute a primary source of lending for businesses in need of working capital. To the extent commercial banks have involved themselves in mortgage lending, they have historically tended to concentrate on short-term construction lending.

Credit unions concentrate on the saving and borrowing needs of groups of persons with a common bond, such as state or county employees. They constitute a primary source for consumer loans for their members, such as for purchases of automobiles or home improvements.

International banking has assumed increased prominence because money, finance, and commerce are becoming increasingly international in character and scope. U.S. banks that desire to operate abroad, as well as foreign banks that wish to operate in the U.S., are subject to rigorous regulation by the U.S. and foreign governments.

Lending and secured transactions comprise major activities of banks and financial institutions. These transactions involve a consensual arrangement whereby a bank agrees to lend money to a borrower to enable the borrower to purchase an item for which he or she does not have adequate cash readily available. In consideration of the loan, the borrower grants the bank a security interest in collateral comprised of the item purchased or other assets owned by the borrower. In the event the borrower defaults on the loan, the bank's security interest entitles it to take possession of the collateral and sell it to reduce the debt.

Loan workouts occur when the condition of a debtor's business changes for the worse. It involves a process whereby the debtor and creditors, including financial institutions, reevaluate their repayment expectations and agree on a revised repayment plan that comports with business realities. Depending on the circumstances, the plan may include debt reduction or revised payment terms, or both. Workouts may be accomplished informally or pursuant to a Chapter 11 bankruptcy filing.

Mortgages and foreclosures comprise the most common means of real estate financing, and the procedure to be followed in the event of loan default. The typical mortgage transaction involves a home purchaser borrowing the purchase money from a lender and entering into a contract with the lender providing that the purchased real estate constitutes the collateral for the loan. If the homeowner fails to make his/her installment payments, the lender can cause the real estate to be sold to reduce the debt.

Public finance is the means by which states and municipalities pay for roads, public facilities, and improvements. Commercial banks normally lend funds to states and municipalities for these projects pursuant to bonds supported by the full faith and credit of the state or municipality.

Savings and thrifts include mutual savings banks, savings and loan associations, and credit unions. Originally created to serve the savings and credit needs of people of moderate means, they have weathered financial crisis to remain an important source of consumer financing for home purchases, home improvements, and automobiles.

State and municipal bonds and financing are provided by commercial banks where the full faith and credit of the state or municipal issuer is behind the bond issuance. This enables states and municipalities to construct roads, schools, and other improvements for the citizenry.

Venture capital includes bank loans and Small Business Administration loans provided to fledgling companies to finance start-up expenses and equipment acquisitions. Borrowers who seek venture capital loans from banks must be aware that they are in essence making the bank a business partner in the enterprise. Great care should be taken in entering into such relationships.

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DISCLAIMER: This site and any information contained herein are intended for informational purposes only and should not be construed as legal advice. Seek competent legal counsel for advice on any legal matter.

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