CPA REG: Debtor-Creditor Relationships
Master debtor-creditor law for the CPA REG exam, including liens, guaranty and suretyship, creditor rights and remedies, fraudulent transfers, and the Fair Debt Collection Practices Act.
Debtor-Creditor Relationships for the CPA REG Exam
Debtor-creditor law governs the rights and remedies available when a debtor fails to satisfy obligations. The REG exam tests various aspects of this area, including types of creditors, suretyship and guaranty, secured transactions, and fraudulent conveyances. Understanding the priority of claims and the protections available to both debtors and creditors is essential.
Types of Creditors
Creditors are classified based on their rights and the security they hold. Secured creditors have a lien or security interest in specific property of the debtor. Unsecured creditors with priority have claims that are preferred in bankruptcy (such as certain tax claims and employee wages). General unsecured creditors have no security interest or priority and are paid last in any distribution of the debtor's assets.
A lien is a legal claim against property to secure payment of a debt. Liens may arise by agreement (mortgage, security interest), by statute (mechanic's lien, tax lien), or by judicial action (judgment lien, attachment lien). The priority among competing liens is generally determined by the time of perfection or recording, though certain statutory liens (such as property tax liens) take priority regardless of timing.
Suretyship and Guaranty
A suretyship is a three-party arrangement in which the surety promises to be primarily liable for the debtor's obligation. A guaranty is similar, but the guarantor's liability is secondary, meaning the creditor must first attempt to collect from the debtor before pursuing the guarantor (unless the guaranty is absolute). Under the Statute of Frauds, a promise to pay the debt of another must be in writing to be enforceable, unless the main purpose doctrine applies (the surety's primary purpose is to benefit themselves).
A surety has several important rights. The right of exoneration allows the surety to compel the debtor to pay. The right of reimbursement allows the surety to recover from the debtor any amounts paid on the debt. The right of subrogation allows the surety who pays the full debt to step into the creditor's shoes and enforce the creditor's rights against the debtor. If there are co-sureties, each has the right of contribution, meaning each co-surety is liable for only their proportional share of the debt.
Surety Defenses
A surety may assert certain defenses against the creditor. Valid defenses include fraud or duress by the creditor, the statute of limitations, discharge of the debtor in bankruptcy (though the surety's obligation may survive), material modification of the original agreement without the surety's consent, release of collateral by the creditor (to the extent of the value of the collateral released), and extension of time given to the debtor without the surety's consent (if the surety is a non-compensated surety).
Defenses that are personal to the debtor and cannot be raised by the surety include the debtor's incapacity, the debtor's discharge in bankruptcy (in some jurisdictions), and the debtor's setoff rights against the creditor.
Secured Transactions (UCC Article 9)
UCC Article 9 governs secured transactions in personal property. A security interest is created through attachment, which requires a security agreement (authenticated by the debtor, describing the collateral), value given by the creditor, and the debtor's rights in the collateral. Perfection, typically achieved by filing a financing statement (UCC-1) with the appropriate state authority, gives the secured creditor priority over unperfected creditors and subsequent lien creditors.
Special perfection rules exist for different types of collateral. Purchase money security interests (PMSI) in consumer goods are automatically perfected upon attachment. PMSI in inventory must be perfected before the debtor takes possession and requires notice to prior perfected secured parties. Deposit accounts are perfected by control, and investment property may be perfected by control or filing.
Priority of Claims
When multiple creditors claim the same collateral, priority generally follows these rules: a perfected creditor has priority over an unperfected creditor; among perfected creditors, the first to file or perfect has priority; a PMSI has priority over a prior perfected non-PMSI interest (subject to the inventory notice rule); and a buyer in the ordinary course of business takes free of a security interest created by the seller, even if the security interest is perfected.
Fraudulent Transfers
Under the Uniform Voidable Transactions Act (formerly the Uniform Fraudulent Transfer Act), a transfer is voidable if made with actual intent to hinder, delay, or defraud creditors, or if the debtor received less than reasonably equivalent value and was insolvent or became insolvent as a result of the transfer. Indicators of actual fraud (badges of fraud) include transfers to insiders, retention of possession or control by the debtor, transfers made after a lawsuit was threatened, and transfers of substantially all assets.
Exam Tips
- Know the differences between surety (primary liability) and guarantor (secondary liability)
- Surety defenses focus on creditor conduct that prejudices the surety
- Attachment creates the security interest; perfection establishes priority
- PMSI in consumer goods is automatically perfected; other collateral requires filing
- Buyers in the ordinary course take free of perfected security interests
- Fraudulent transfer analysis examines both actual intent and constructive fraud
Practice What You Learned
Study with 1,200+ flashcards and 140 practice exams across all 4 CPA sections.