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What's on Tap Recap: Cross Collateralization, Set-Offs, and the Impact of Bankruptcy

What goes together better than talking bankruptcy law and sipping on your favorite brew?

Our third episode of the What’s on Tap? webinar series doves into the world of collateralization. Together, shareholder and Philadelphia office managing attorney Michael Dougherty and attorneys Cameron Deane and Andrew Condiles explored the impact of cross collateralization and set-offs on collections accounts while also examining the use of motions for relief, chapter 7 reaffirmation agreements, and so much more. 
 

But first, this episode’s beer of the day was…

This Little Piggy: Idaho by Sterling Pig Brewery, located in the cities of Media and West Chester, Pennsylvania. It’s an American IPA bursting with bright grapefruit, orange rind and other citrus flavors. Cheers!

Okay, now onto this episode’s top takeaways and questions answered by our team. We’ve summarized some of the key points below and highly encourage you to watch the full episode along with your favorite brew or drink of choice. 
 

1. What is a set-off clause?

A set-off gives a lender the authority to seize a debtor’s deposits if they default on a loan. It’s typically included in loan agreements where the debtor holds other assets such as a checking, savings or money market account, or a certificate of deposit. 

A set-off is a highly effective legal tool that does not mandate the lender to gain affirmative consent from the debtor when seizing the funds. With that said, there are some restrictions regarding the funds that can be used to set off the unpaid debt. For instance, the lender cannot seize funds in which they are the custodian of the assets, such as IRAs or a 401k account. 
 

2. What is cross collateralization?

Essentially, cross collateralization is the act of using the collateral for an initial loan as the collateral for a second loan. If the debtor cannot make their loan’s scheduled payments within the agreed-upon time schedule, the lender can force the liquidation of the asset and use the proceeds to recoup the payments. 
 

3. Does cross collateralization apply to credit card debts?

Yes, cross collateralization clauses can be applied to various forms of financing, including credit cards and mortgages. For instance, if a default occurs in one account, you can collect on it through another loan’s security interest (collateral). 

With that said, wording is extremely important when it comes to cross collateralization clauses. There must be consensual acknowledgement of the security interest. It’s recommended that the clause is bolded for your customers to read and sign off on. 
 

4. How does all of this work when my borrower files for bankruptcy?

First and foremost, be aware of the automatic stay and its impact on your collection efforts. Generally, this means ceasing all collection efforts, including calls and letters (including billing statements), and directing all communication to their bankruptcy attorney. 

Next, did your borrower file for chapter 7 or chapter 13? Chapter 7 cases are oftentimes “no asset” filings that simply result in the obligation owed to you being discharged. For auto & home mortgage loans, you may want to offer reaffirmation agreements, which are entered into between the lender and debtor that “reaffirm” the debtor’s obligation on the contract, despite the bankruptcy filing. While you can include the balances from cross-collateralized loans, keep in mind the bankruptcy court can refuse to permit reaffirmation agreements, and often will do so on under-secured debts. 

In chapter 13 cases, on the other hand, your loans can be enforced via proof of claim. A claim is filed with the bankruptcy court to evidence the debt owed to your institution, and can either be secured or unsecured. The amount of your claim to receive payment depends on the income and assets of the debtor and their ability to pay a feasible payment plan over the course of three to five years.
 

Watch the full episode

To learn more about set-offs, cross collateralization and how they play into the world of bankruptcy, you can watch the full episode of What’s on Tap? today
If you have any questions or need further clarification about the content discussed throughout the episode, connect with Mike, Cameron, or Andrew at any time for the most up-to-date and accurate information.

This blog is not a solicitation for business and it is not intended to constitute legal advice on specific matters, create an attorney-client relationship or be legally binding in any way.

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Michael J. Dougherty

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