Distinguishing Secured From Unsecured Debt

Secured debts differ from unsecured debts in that the obligation of the debtor to pay the secured debt is “secured” by a right given to the lender in certain property of the debtor. Two common examples are (1) a deed of trust which gives a lender the right to foreclose on a property if the debtor fails to pay their mortgage and (2) a lien placed on an automobile’s title which gives a lender the right to repossess the automobile. Unlike an unsecured debt, if a debtor fails to pay, the secured lender may have recourse to the pledged property to satisfy the debt. In practice, if the debtor fails to pay their secured debt, the secured lender sells the pledged property and applies the proceeds to the debt. A secured lender is in a better position than that of an unsecured lender as the secured lender has both a right to proceed against the debtor based on the debt and also a claim against the pledged property if the debtor fails to pay the debt.

While the secured lender has an interest in the pledged property, this interest does not amount to the lender having title to the property or having a present possessory interest. Instead, the lender has a charge against the pledged property. So, the lender does not acquire ownership of the property once they are granted a security interest. The ownership remains with the debtor, but that ownership is now encumbered by the lender’s interest. Only upon the debtor’s default can the lender become entitled to take action to terminate the debtor’s ownership and to sell the property or take transfer of it.

Secured debts arise either by contract or by operation of law. Cited above, a deed of trust is an example of a secured debt that comes about as the result of a contract. The secured lender gives the debtor the funds to purchase a house in exchange for the debtor’s promise to repay the funds and the debtor’s granting the lender a security interest in the house. An example of a security interest arising by operation of law is when a judgment attaches to real property. If a judgment is granted against a debtor and that debtor owns real property, even though the judgment is unrelated to the real property, the judgment can attach to the debtor’s property interest. By attaching, the judgment becomes a lien on the property. In Virginia, in order for the judgment to attach it must be properly docketed with the Circuit Court Clerk’s Office in the jurisdiction where the debtor owns real property. In this way, an unsecured debt that is reduced to judgment may become a secured debt if the debtor owns real property and the judgment is properly docketed.

Ronald Page represents clients in the areas of Business and Consumer Bankruptcy, Business Planning, Commercial Litigation, Creditors’ Rights, and Estate Planning. Ronald Page is a Richmond Bankruptcy Attorney who represents secured and unsecured creditors, trustees, and corporate debtors in insolvency matters, including Chapter 11 reorganizations, business liquidations, loan workouts and personal reorganizations under Chapter 7, Chapter 11, and Chapter 13.