Risk Management Manual of Examination Policies - FDIC

LOANS Section 3.2
Some of the more common are errors by abstractors or
attorneys include unauthorized corporate action, mistaken
legal interpretations, and unintentional errors in public
records by public officials. Once the bank determines title
and lien status of the property, the mortgage can be
prepared and funds advanced. The bank should record the
mortgage immediately after closing the loan. Form,
execution, and recording of mortgages vary from state to
state and therefore must conform to the requirements of
State law.
Collateral Assignment
An assignment is generally considered as the transfer of a
legal right from one person to another. The rights acquired
under a contract may be assigned if they relate to money or
property, but personal services may not be assigned.
Collateral assignments are used to establish the bank's
rights as lender in the property or asset serving as
collateral. It is generally used for loans secured by savings
deposits, certificates of deposit or other cash accounts as
well as loans backed by cash surrender value of life
insurance. In some instances, it is used in financing
accounts receivable and contracts. If a third party holder
of the collateral is involved, such as life insurance
company or the payor of an assigned contract, an
acknowledgement should be obtained from that party as to
the bank's assigned interest in the asset for collateral
purposes.
CONSIDERATION OF BANKRUPTCY
LAW AS IT RELATES TO
COLLECTABILITY OF A DEBT
Introduction
Familiarity with the basic terms and concepts of the
Federal bankruptcy law (formally known as the Bankruptcy
Reform Act of 1978) is necessary in order for examiners to
make informed judgments concerning the likelihood of
collection of loans to bankrupt individuals or
organizations. The following paragraphs present an
overview of the subject. Complex situations may arise
where more in-depth consideration of the bankruptcy
provisions may be necessary and warrant consultation with
the bank's attorney, Regional Counsel or other member of
the Regional Office staff. For the most part, however,
knowledge of the following information when coupled with
review of credit file data and discussion with bank
management should enable examiners to reach sound
conclusions as to the eventual repayment of the bank's
loans.
Forms of Bankruptcy Relief
Liquidation and rehabilitation are the two basic types of
bankruptcy proceedings. Liquidation is pursued under
Chapter 7 of the law and involves the bankruptcy trustee
collecting all of the debtor's nonexempt property,
converting it into cash and distributing the proceeds among
the debtor's creditors. In return, the debtor obtains a
discharge of all debts outstanding at the time the petition
was filed which releases the debtor from all liability for
those pre-bankruptcy debts.
Rehabilitation (sometimes known as reorganization) is
effected through Chapter 11 or Chapter 13 of the law and
in essence provides that creditors' claims are satisfied not
via liquidation of the obligor's assets but rather from future
earnings. That is, debtors are allowed to retain their assets
but their obligations are restructured and a plan is
implemented whereby creditors may be paid.
Chapter 11 bankruptcy is available to all debtors, whether
individuals, corporations or partnerships. Chapter 13
(sometimes referred to as the "wage earner plan"), on the
other hand, may be used only by individuals with regular
incomes and when their unsecured debts are under
$100,000 and secured debts less than $350,000. The
aforementioned rehabilitation plan is essentially a contract
between the debtor and the creditors. Before the plan may
be confirmed, the bankruptcy court must find it has been
proposed in good faith and that creditors will receive an
amount at least equal to what would be received in a
Chapter 7 proceeding. In Chapter 11 reorganization, all
creditors are entitled to vote on whether or not to accept
the repayment plan. In Chapter 13 proceedings, only
secured creditors are so entitled. A majority vote binds the
minority to the plan, provided the latter will receive
pursuant to the plan at least the amount they would have
received in a straight liquidation. The plan is fashioned so
that it may be carried out in three years although the court
may extend this to five years.
Most cases in bankruptcy courts are Chapter 7
proceedings, but reorganization cases are increasingly
common. From the creditor's point of view, Chapter 11 or
13 filings generally result in greater debt recovery than do
liquidation situations under Chapter 7. Nonetheless, the
fact that reorganization plans are tailored to the facts and
circumstances applicable to each bankrupt situation means
that they vary considerably and the amount recovered by
the creditor may similarly vary from nominal to virtually
complete recovery.
Functions of Bankruptcy Trustees
Loans (12-04) 3.2-58 DSC Risk Management Manual of Examination Policies
Federal Deposit Insurance Corporation