Types of Lien

Creditors come in two basic types: secured and unsecured. Although the amount of the debt
may be the same, the remedies available to the creditor are very different. Secured creditors
have a claim against a specific asset, whereas unsecured creditors do not.

Creditors can be unsecured or secured. An unsecured, or general, creditor has a general claim
against a debtor--this claim is not secured by any particular asset of the debtor. An unsecured
creditor has the weakest claim, which may go unpaid in a bankruptcy proceeding. However,
an unsecured creditor may become a secured creditor after a lawsuit and judgment. A
secured creditor, who has an interest (referred to as a lien) on a particular asset, can use the
court system to seize the asset and to satisfy the debt. This clearly presents a significant risk
for the business owner.

Liens Enable Creditors to Assert Rights Over Property

Unless the debtor is prudent and has taken measures to safeguard his assets, there is a risk
that the creditors can seize assets and take your wealth. In order to know if your assets are at
risk, it is imperative that you have an understanding of the different types of liens you may
encounter as a small business owner:

 Consensual
o Purchase-Money Security Liens
o Non-Purchase-Money Security Liens
 Statutory
o Mechanic's Liens
o Tax Liens
 Judgment

Once we discuss the different types of liens, we'll then examine how creditors might seek to
get your assets through these types of liens, and what you can do, as an individual and as a
small business owner, to maximize your protection against those creditors. The strategies
outlined will address a broad spectrum of topics, from forms of property ownership to
structuring debt to minimize exposure.

Consensual Liens Are Voluntary

As the name implies, consensual liens are those to which you voluntarily consent, as a result
of a loan or other advance of credit. The property purchased secures the buyer's obligation
to pay for the property. One common example is the residential mortgage: a home buyer
consents to a bank taking a security interest in the home when a mortgage is obtained.
Similarly, a security interest also is created when a car dealer arranges for financing for a car
buyer.

There are two broad classes of consensual liens:

  Purchase-Money Security Interest Liens. Here, the creditor extends credit to the
debtor specifically for the purchase of the property that secures the debt. Examples
include a first mortgage on a home, a car loan, and situations in which the seller
finances the purchase of property, such as furniture, through a credit agreement.
 Non-Purchase-Money Security Interest Liens. Here, the debtor puts up property he
or she already owns as collateral for a loan. The loan proceeds are then used to pay
expenses (or perhaps to buy other property). Examples include a second mortgage (or
refinancing of a mortgage) on a home or a loan used to pay operating expenses with
previously owned office equipment put up as collateral.

Both types of consensual liens are usually non-possessory. This means that the creditor does
not take or retain possession of the property; rather, the debtor takes, or retains, possession
of the property. However, it's possible for either type of consensual lien to be possessory. In
that case, the creditor takes possession of the collateral. A loan from a pawnbroker, for
example, usually would create a possessory, non-purchase-money security interest lien in the
collateral.

While this seems very straightforward, the type of debt can have a large impact on the
creditor's rights if a debtor defaults. The rules vary from state to state, but characteristics of
a debt are critical to understand if assets are to be protected. Issues include:

 Who is holding the property that secures the debt: the debtor or the creditor? In a car
loan, the debtor has possession of the property. When a loan is obtained from a
pawnshop, the creditor has possession of the property securing the loan.
 Was the debt incurred to purchase property or not? For example, a first mortgage loan
is a purchase money loan since the proceeds were used to purchase a residence. In
contrast, a refinancing loan is not a purchase money loan. The homeowner already
owned the property.
 What is the nature of the property to which the lien is attached? This is often the
essential inquiry when it comes to asset protection. The states, as well as the federal
government, have a wide variety of laws relating to what assets are protected from
creditors and how they are protected. The primary mechanism for protecting selected
assets is a concept called exemptions. In essence, the law may declare that certain
property simply cannot be seized by a creditor.

The other common types of liens are statutory liens and judgment liens.

Statutory and Judgment Liens Arise by Operation of Law

In addition to consensual liens, there are many different types of liens that creditors can use
to get at your assets to satisfy a debt. In certain circumstances, creditors obtain security
interests by the operation of state (or federal) laws. These liens include:

 Mechanic's Liens. This type of lien arises when a contractor or mechanic performs
work on property and is not paid. Examples include a contractor who installs a furnace
in a home, or an auto mechanic who performs repairs to a car. This lien is a security
interest in the property. If the owner tries to sell the property, the debtor will have a
 secured interest in the portion of the proceeds needed to pay the debt. In addition,
having a mechanic's lien can delay or prevent the sale of real property until debt is
satisfied and the lien released.
 Tax Liens. This type of lien is placed against property by the local, state or federal
government, as authorized by statute, for delinquent taxes, including property,
income and estate taxes.

Judgment Liens Arise As a Result of a Lawsuit

Of the three types of liens (consensual, statutory and judgment,) the judgment lien is the
most dangerous form, but one which the informed business owner may be able to eliminate.
A judicial lien is created when a court grants a creditor an interest in the debtor's property,
after a court judgment.

Judgment liens can arise in a wide variety of circumstances--basically, any incident that can
land you in court can end up generating a judgment lien. For example, if you are driving
negligently and injure someone in an accident, the injured person may to sue for damages.
To the extent that your insurance doesn't cover the judgment, a judicial lien may be placed
against your property to secure payment of the claim to the injured party.