bulw 301 exam 2 sg

Chapter 9 - Contract Formation

Sec. 1: An Overview of Contract Law• Contract law provides stability, predictability and certainty for buyers and sellers in the

marketplace by giving parties confidence that their contractual agreements can be enforced.

• Contracts may be created by written words or through oral agreements (“express contracts”).

• Contracts may also be inferred by actions of the parties even where there is no written or oral agreement (“implied contracts”).

• Contracts

• Contract law deals with the formation of contracts (Ch. 9) and the enforcement of contracts (Ch. 10).

• Contract law is primarily by state common law. It may be modified by state statutes that establish requirements for particular types of contracts.

• Article 2 of the Uniform Commercial Code (UCC), which has been adopted by 49 states, governs contracts for the sale of goods, and modifies the common law in some respects for those contracts.

• “Freedom to contract” is an important principle underlying contract law.

• Contract Definitions• Restatement, Second, of Contracts (a scholarly treatise summarizing the common

law of contracts):• Contract: “A promise or a set of promises for the breach of which the law gives

a remedy, or the performance of which the law in some way recognizes a duty.”

• Promise: “A manifestation of the intention [of a party] to act or refrain from acting in a specified manner.”

• Other definitions of “contract:”• An agreement between competent parties enforceable in court.• An agreement, supported by consideration, to do or not do a particular thing.

• Objective Theory of Contracts• Courts adhere to the “objective theory of contracts” when they have to determine

whether the parties intended to form a contract. • A party’s intention to enter into a contract is judged by outward, objective facts, as

would be interpreted by a reasonable person—rather than a party’s subjective

Business Law 301 Exam 2 Study Guide

intentions. Importance is placed on what the parties said; how they acted or appeared; and the circumstances surrounding the transaction.

• Lucy v. Zehmer (p. 191), covered in Sec. 3, illustrates how courts apply this objective theory of contracts when determining whether a contract exists.

• Elements of a Contract• Four requirements are essential to the formation of a valid contract (all four must

be satisfied):1. Agreement (offer + acceptance = agreement)

• Agreement (mutual assent to a bargain) is reached through the process of an “offer” by one party and an “acceptance” of the offer by the another party.

2. Consideration

• Something of value (such as money) must be given or promised by each party to convince the other party to make a deal; consideration must be “bargained for” by the parties

• Note that the promise of a gift does not create a contract because no consideration is given.

3. Contractual capacity • Legal ability to enter into a contractual agreement.

• Capacity issues for minors, intoxicated persons, and the mentally incompetent will be discussed.

4. Legality

• Purpose of the contract must be to accomplish a legal goal and cannot violate public policy.

• Defenses to Enforceability

• Even though the four contract elements are satisfied and a “valid” contract exists, the contract may not be enforceable if a party successfully raises one of the following issues as a defense to enforcement.

• Consent was not voluntary. Consent to a contract must be genuine and voluntary (without fraudulent inducement, duress, or undue influence).

• Contract was not in the required form. Contract must comply with any law that requires it to be in a specified form.

• For example, each state has a Statute of Frauds that requires certain types of contracts to be in writing.

• Contract Terminology


• The first step in making a contract is an offer by one party to another party.

• The party making the offer is the offeror. • The party receiving the offer is the offeree.• Once the offer is accepted by the offeree, the offeror is bound to a contract.

• Failure to perform one’s contractual obligations is a breach of the contract, and the non-breaching party is entitled to remedies.

Sec. 2: Types of Contracts• Contracts are classified as either bilateral or unilateral, depending on what the offeree

must do in order to accept the offer. The offeree must: • make a promise to accept a bilateral contract offer

• perform an act to accept a unilateral contract offer• A bilateral contract provides more protection to offeree because all it takes to accept

the offer—and thereby bind the other party to a contract—is to make a return promise (offeree does not have to perform the act immediately in order to accept the offer).

• If it is unclear what type of contract offer is made, there is a presumption that the offeror intended a bilateral contract.

• Bilateral Contracts• In a bilateral contract, the parties exchange promises (“a promise for a promise”).

An offeree can accept a bilateral contract offer by• (i) promising to perform an act (such as promising to make a payment or

provide services)• (ii) promising to refrain from an act (as in a non-compete agreement). • Examples: employment agreement, purchase agreement, settlement

agreement• Most contracts are bilateral contracts, meaning that the contract is formed at the

time the offeree promises to do or not do something--even though the act may be performed at a later date. Once the offer is accepted, the offeror is immediately bound to the deal.

• Unilateral Contracts• In a unilateral contract, the offeror makes a promise, and in exchange asks for the

offeree to perform an act (“a promise for an act”).• Offer can only be accepted by completing the requested act. Therefore the

contract is formed only when the contractual act is performed by the offeree.


• Ex. “Zach, if you cut my grass on Saturday, I’ll pay you $50.” No contract exists until Zach cuts the grass on Saturday.

• Additional rule: offeror cannot revoke the offer once the offeree has begun performing the requested act.

• Types of Contracts• Formal versus informal contracts . Most contracts are considered “informal”

because no particular form of writing is required.• An express contract is stated completely in words (either oral or written); the

parties explicitly agree on all important terms of their agreement.

• An implied-in-fact contract (or “implied contract”) is inferred from the parties’ conduct, not from anything written or stated orally.

• Implied-in-Fact Contracts • In disputes over the existence of a contract, a judge may impose a contract on the

parties based on their actions, even though no express contract exists.

• This implied in fact doctrine is used to prevent “unjust enrichment” (where someone enriches himself at another’s expense).

• If a party accepts a benefit that is normally paid for, then payment equal to the reasonable value of the benefit is required—even though there is no express contract between the parties.

• The following requirements must be satisfied in order for a judge to impose an implied-in-fact contract:

• Plaintiff furnished some service/property to defendant. • Plaintiff expected to be paid for the service/property, and defendant knew or

should have known payment was expected.

• Defendant had a chance to reject the services/property and did not.• Contract Performance

• Executed contract: a contract that has been fully performed by both parties.• Executory contract: a contract that has not yet been performed by one or both

parties.

• Contract Enforceability• Valid contract: one that meets the requirements (agreement, consideration,

capacity, legality) for the formation of a contract. • A valid contract is “enforceable” if there are no legal defenses against it.


• If a party raises a legal defense, then a valid contract may be “voidable,” or “unenforceable.”

• Unenforceable contract: a valid contract that is unenforceable by a court because of certain legal defenses against it

• (e.g., not complying with a Statute of Frauds that requires that certain types of contracts to be in writing).

• Voidable contract: a valid contract where one party has the option to either “avoid” (rescind) the contract or enforce it

• (e.g., where one party to the contract is a minor; where a party was induced to enter the contract by fraud).

• Example: A minor may enter into contracts, but the minor has the option to disaffirm (rescind) the contract, in which case it would become unenforceable against the minor.

• Void contract: one that does not exist at law (“no contract at all”).

• A void contract typically arises when one of the 4 contract requirements is not satisfied (e.g., contract has an illegal purpose; a party has been declared mentally incompetent by a court and lacks capacity; no consideration).

• If a contract is declared “void,” neither party has any legal obligations to perform under the contract.

Sec. 3: Agreement

• There must be agreement (or mutual assent) between the parties as to the terms of a proposed contract in order for the contract to exist.

• Agreement has two components: an offer by one party and acceptance by the other.

• Offer + Acceptance = Agreement• Once there is agreement, a contract is formed, provided that the other required

elements (consideration, capacity, and legality) are satisfied.• Offer

• An offer by one party (“offeror”) to another party (“offeree”) is the first step in making a contract.

• An offer is an indication of what the offeror will do (or will refrain from doing) and what he wants in return from the offeree.

• Communication of an offer gives the offeree the power to form a binding contract simply by accepting the offer.


• Requirements of an Offer

• Intention: Offeror must intend to become bound by the offer.• Communication: Offer must be communicated to the offeree in some manner; then

the offeree has the power to accept and bind the offeror to the offer.

• Terms: The terms of the offers must be reasonably certain and definite.• Intention to be Bound

• Serious intent on the part of the offeror is determined by a person’s words and actions and not by their secret, unexpressed thoughts or feelings (the “objective theory of contracts”).

• Lucy v. Zehmer (Sup. Ct. App. Va. 1954), p. 191. Defendant’s assertion that he was drunk and just joking when he agreed to sell his farm to Lucy was rejected by the court, and he was required to complete the sale.

• Rule: “The law imputes to a person an intention corresponding to the reasonable meaning of his words and acts. If his works and acts, judged by a reasonable standard, manifest an intention to agree, it is immaterial what may be the real but unexpressed state of his mind.”

• Acts That Are Not Offers• “Offers” made in anger, jest, or undue excitement are usually not offers because

the speaker does not intend to form a contract.

• Expressions of opinion, statements of future intent, and preliminary negotiations are not offers.

• Advertisements, such as catalogues, circulars, and price lists, are not offers; they are treated as invitations to negotiate or invitations to make an offer.

• Preliminary agreements may be enforceable if the parties’ intent to be bound by the agreement is clear.

• Communication

• An offer must be communicated to the offeree. One can not accept an offer without knowing that it exists (e.g., reward offer).

• Case 9.2, Alexander v. Lafayette Crime Stoppers, Inc. (Ct. of App. LA, 2010), p. 194. Plaintiffs’ attempt to collect reward money was unsuccessful because they failed to comply with the terms of the offer, which specified the way and time in which the reward offer could be accepted.

• Rule: For an acceptance to be effective, it must be communicated in the manner prescribed in the offer.

• Definiteness of Terms


• The offer must include at least the following essential terms:

• Identification of the parties• Object or subject matter of the contract• Consideration to be paid

• Time of payment, delivery, or performance• A court may refuse to enforce a contract if an essential term is missing.

• Termination of Offers• Offers may be terminated by actions of a party (revocation, rejection, or counter

offer) or by operation of law.

• Revocation• Offeror may revoke an offer any time before acceptance.

• Revocation is effective when offeree actually receives the revocation.• An offer may be irrevocable in some situations:

• An option contract where consideration is given;

• If offeree has changed his position in justifiable reliance on the offer.• Rejection

• If offeree refuses the offer, then the offer ends. An offer cannot be effectively accepted after the offeree has rejected it.

• Counteroffer

• Occurs when offeree rejects the offer and makes a new offer.• Offeree’s alterations to the original offer constitute a counteroffer.

• Common law mirror image rule vs. UCC rule is covered in the following “Acceptance” slides.

• Offers may terminate by operation of law for the following reasons.

• Time lapse (based on time for acceptance stated in offer)• If offeror does not state how long the offer is open, then a reasonable time.

• Death or incompetence of offeror or offeree• Triggers termination of offer

• Destruction of essential subject matter

• Supervening illegality• Acceptance of Offer


• “Acceptance” is the voluntary act by the offeree that shows agreement to the terms of the offer.

• Acceptance must be communicated to the offeror by word or act.• Acceptance must be unequivocal—no new conditions or terms can be added.

• Upon acceptance, the offer and acceptance are merged into a binding contract (provided the other contract elements are satisfied).

• Offer can only be accepted by the offeree.• To accept an offer, the acceptance must be made in the same manner and within

the timeframe that the offeror requests it to be made.

• Silence is generally not acceptance• Exceptions: trade customs and previous dealings

• Under federal law, unordered goods delivered via USPS may be treated by recipient as “gifts,” and do not have to be returned or paid for.

• Acceptance of Contracts

• Acceptances that include language adding to or varying from the offer can be a rejection, depending on whether the common law or UCC Art. 2 governs.

• UCC Art. 2 only applies to contracts for the sale of goods (tangible personal property); the common law rule exactness rule applies to all other contracts.

• Common law exactness rule (“mirror image rule”) requires that the terms as stated in the acceptance must exactly mirror the terms in the offer; modified or additional terms included in an acceptance are treated as a rejection of the offer and a counteroffer.

• UCC Article 2 (which only governs sales of goods) relaxes the common law “mirror image rule” for acceptances, making it easier to form a contract.

• Under the UCC, as long as there is a definite expression of acceptance of the original offer, a contract is formed on the original terms, even if the acceptance contains additional or different terms.

• In this case, the offeror has the option to accept or reject the additional terms proposed by the offeree.

• However, if both parties are “merchants,” a contract is formed on the modified terms unless an exception applies.

• When Revocation and Acceptance Are Effective• An offer can be revoked by the offeror any time before it is accepted by the offeree. • A revocation of an offer is effective when received by the offeree.


• An acceptance is effective when sent via an authorized method (e.g., deposited in a mailbox); if method is not indicated by offeror, then any reasonable method is acceptable.

• Once an offer is accepted, the offer cannot be revoked because the contract has been formed.

• Revocation and Acceptance

• Illustration of the “Mailbox Rule:” Alice offered to sell her camera to Bill for $100 and said he had to let her know in one week. The next day, she calls Bill and says “I don’t want to sell you my camera after all.” Bill says “Too bad, I mailed my acceptance and check yesterday.” Alice says, “Well, I haven’t received it yet, so my offer is revoked.”

• Who wins?

Sec. 4: Consideration

• An agreement is binding provided there is consideration—meaning that both sides to the contract are giving something to the other party that has been bargained for.

• Consideration is something of legal value given in exchange for a promise. Examples:• A promise to do something that one does not have a legal duty to do.• Performance of an action one is not otherwise obligated to perform.

• Refraining from an action that one has legal right to do.• In bilateral contracts, consideration is usually in the form of a promise exchanged for a

promise.• Consideration means that both the offeror and offeree to the contract must bargain for

and give up something of legal value in order to make the other’s promise or act enforceable.

• A promise of a gift is not a contract because there is no consideration.

• As long as the consideration is “bargained for” by the parties, the value of the consideration will usually not be questioned by a court.

• Consideration often takes the form of money, property, or services but can be in other forms, such a promise not to exercise a legal right (e.g., right to sue; right to engage in a legal activity).

• A promise to refrain from exercising a legal right is consideration.• Example: Hamer v. Sidway (classic case but not in textbook). Uncle offers nephew

$5,000 if he would not drink, use tobacco, swear, play cards or billiards for money until he was 21. Nephew followed through on promise not to do these things, but


his uncle died before paying the nephew. The executor of the estate refused to pay, arguing that was no contract due to lack of consideration by the nephew. The nephew won because his refraining from these legal activities was deemed to be consideration.

• Rule: A waiver of any legal right by one party at the request of another party is a sufficient consideration for a promise (even if the waiver does not benefit the requesting party).

• Adequacy of Consideration• Courts won’t question the adequacy of the consideration (or fairness of the

bargain) so long as the consideration has been bargained for by the parties.• The law does not protect a person who gets a “bad deal” in their contract.

• In rare cases (such as grossly unfair consumer financing contracts), a court may find that a contract is “unconscionable” when grossly excessive payments are required by an individual who had no bargaining power when entering into the contract.

• Agreements That Lack Consideration

• Preexisting duty: A promise to do something that the promisor is already obligated to do is not consideration.

• Example: where there is a previous contract, and one party is trying to get more money for doing what they had promised to do in the contract.

• Past consideration: promises made in return for past consideration are unenforceable.

• Skip “Promissory Estoppel” on pp.200-201.

Sec. 5: Contractual Capacity• For a contract to be valid, the parties must have legal capacity to enter into the

agreement. Legal capacity is usually presumed.• Minors who enter into contracts can usually disaffirm (or avoid) a contract if they

choose (the contract is “voidable”).

• An intoxicated person may or may not have capacity, depending on the level of intoxication. An intoxicated person lacks capacity if he is incapable of understanding the nature of the transaction--in which case the contract is “voidable.”

• A person declared by a court to be incompetent does not have legal capacity, and a contract made by that person is void.


• However, an incompetent person who has not been declared incompetent by a court may enter into a “voidable” contract (meaning the insane person has the option to disaffirm it).

Sec. 6: Legality• A contract is void if its terms are contrary to a statute governing the subject matter of

the contract (e.g., criminal laws, usury laws, gambling prohibitions)• A contract is void if its terms are contrary to public policy.• Depending on the facts and circumstances, the following agreements may or may not

be considered contrary to public policy:• Contracts in restraint of trade--covenants not to compete

• Unconscionable contracts or clauses• Exculpatory clauses• Skip Case 9.3, page 203.

Sec. 7: Voluntary Consent

• Lack of voluntary consent is a defense to the enforceability of a contract. In the following circumstances, voluntary consent may be lacking.

• Mutual (bilateral) mistake regarding a material fact—contract can be rescinded by either party.

• Unilateral mistakes regarding a material fact—contract is enforceable unless

• (i) other party knew or should have know there was a mistake• (ii) mistake was due to substantial math error, and was made inadvertently w/o

gross negligence.

• Voluntary Consent• Fraudulent misrepresentation can make consent involuntary

• Elements: misrepresentation of a material fact; intent to deceive; innocent party justifiably relies on the misrepresentation; and to collect damages the innocent party must have been harmed due to the misrepresentation.

• Non-fraudulent misrepresentation (where there is no intent to deceive) can make consent involuntary.

• Undue influence can make consent involuntary.• Duress can make consent involuntary.


Sec. 8: Form—The Statute of Frauds• Most states have a Statute of Frauds which requires that contracts dealing with certain

subjects be written and signed by the person against whom enforcement is sought in order for the contract to be enforceable.

• A contract that violates the SOF is an unenforceable contract, even though it is a valid contract.

• The SOF prevents persons from trying to fraudulently prove the formation of oral contracts dealing with important, costly, complex matters.

• The required writing must identify the parties and subject matter, indicate that a contract exists, state the essential terms, AND be signed by the person “to be charged” with the contractual obligation (i.e., the defendant).

• The Statute of Frauds• Contracts that fall under the SOF requirement for a signed writing generally include

(“MY LEGS”):• M: Promises in consideration of marriage

• Y: Contracts that cannot be completed within one year (commencing on the date the contract is formed)

• L: Transfers of interests in land/real estate (including long-term leases)

• E: Promise by the executor of an estate to personally pay estate debts • G: Guaranty contracts (whereby one person guarantees the debt of another)

• S: Sale of goods priced over $500

Additional Information

• Skip Sec. 9: Third Party Rights (pp. 208-9)• Review the following questions at the end of the chapter:

• 9-1• 9-2• 9-3

• 9-4


Chapter 10 - Contract Performance, Breach, and Remedies

Sec.1: Discharge by Performance • A party usually discharges its contractual obligations by performing the required

duties.• Performance of a bilateral contract obligation can be accomplished when a party

tenders performance--offering to perform and being ready and able to perform.• The contract ends when both parties fulfill their respective duties by performing the

acts they promised.

• Failure to perform is a breach of the contract.• See Exhibit 10-1: Contract Discharge

• Conditional Contracts• Most contracts are based on unconditional promises; however, sometimes a

contractual obligation may be contingent on a future event (a “condition”).

• A “condition” is a possible future event, the occurrence or nonoccurrence of which will trigger the performance of a legal obligation or terminate an existing obligation under a contract. (e.g., house sale contingent on a certain appraisal amount or upon buyer getting financing)

• If a required condition is not satisfied, the parties are released from their obligations, unless the condition is “waived” by the party whose performance is contingent on the condition.

• Types of Performance• Complete performance occurs when a party perfectly performs its contractual

obligations.

• Substantial performance occurs when a party in good faith performs substantially all of its contractual obligations, and the other party gets substantially the benefits promised in the contract.

• As long as a party has given substantial performance, the contract can be enforced against the non-breaching party; however, the non-breaching party may be entitled to damages since the performance is not perfect.

• Carefully read Case 10.1, Jacobs & Youngs v. Kent (Ct. App. NY 1921).

• Material Breach of a Contract• A breach is the nonperformance of a contractual duty by a party to a contract.


• A material breach occurs if the promisor fails to give substantial performance. If a material breach occurs, the non-breaching party is excused from performing his obligations under the contract and may sue the breaching party for damages.

• A minor breach may suspend the non-breaching party’s obligations for a period of time, but does not excuse performance; however, a minor breach may entitle the non-breaching party to sue for damages.

• Anticipatory Repudiation• Anticipatory repudiation is treated as a material breach (even though the time for

performance has not expired), and the non-breaching party can immediately sue for damages (instead of waiting until after the time for performance has passed).

• If a contract does not state a time for performance of contractual duties, then a reasonable time is implied.

• When a contract states that “time is of the essence,” time may be treated as a condition.

Sec. 2: Discharge by Agreement

• Rescission: The parties may agree to mutually rescind the contract, in which case the contract will cancelled (by another agreement) and the parties will be restored to their positions prior to the contract.

• Novation: A novation occurs when both parties agree to substitute a third party for one of the original parties to the contract. The novation discharges the prior contract.

• Settlement agreement: The parties to a contract may form a new agreement to substitute for the original one.

• Skip discharge by accord and satisfaction.

• Skip Sec. 3: “Discharge by Operation of Law”

Sec. 4: Remedies for Breach of Contract• When a party breaches a contract, the non-breaching party can file a civil lawsuit sue

to ask the court to grant one or more remedies. See Exhibit 10-3 (p. 229).

• Remedies at law: monetary damages• Remedies in equity (typically awarded only when money damages are not adequate):

• Rescission and restitution• Specific performance of the contract• Reformation of the contract


• Monetary Damages

• Monetary damages in contract cases are intended to compensate the non-breaching party for the “loss of the bargain.”

• Four types of monetary damages: compensatory; consequential; punitive; and nominal damages.

• Compensatory damages relate to direct losses (and incidental expenses) of the non-breaching party and are designed to make the plaintiff whole. This is the most common type of damages awarded in a contract lawsuit.

• Compensatory damages are usually computed as the difference between the value of breaching party’s actual performance and the value of the performance that was promised.

• Compensatory Damages• Sale of goods contract: Where one party breaches its obligation to deliver goods,

the non-breaching party’s compensatory damages would be the difference between the contract price and the market price of the goods at the time of the breach.

• If the non-breaching party purchases substitute goods, they may recover the difference between the contract price and the amount paid for the substitute goods, plus incidental costs incurred in making the new purchase arrangements.

• Damages

• Consequential (“special”) damages are indirect and foreseeable losses related to the contract breach (e.g., loss of anticipated profits). These damages relate to special circumstances beyond just the contract and can be hard to prove. If awarded, these damages would be in addition to any compensatory damages.

• To be awarded consequential damages, plaintiff must prove that the breaching party was aware, or should have been aware, that the breach would cause the additional loss.

• Punitive damages are generally are not available for a breach of contract.

• Nominal damages (very small amounts, such as $1) are awarded when there is no financial loss to the plaintiff.

• Mitigation of damages: When a breach of contract occurs, the injured party is obligated to try to reduce the damages that he or she suffered.

• Liquidated damages: A fixed dollar amount stated in a contract that the parties agreed will paid as damages in the event of a future default, breach of contract, or


termination. Often stipulated in contracts where actual damages would be hard to calculate.

• Liquidated damages are common in coaching and entertainment contracts.• Equitable Remedies

• Rescission is an equitable remedy whereby a contract is canceled, and the parties are restored to the original positions that they occupied prior to the transaction.

• When a contract is rescinded, both parties must make restitution, whereby both parties must return goods, property, or money previously conveyed to each other.

• Reformation is an equitable remedy allowing a contract to be “reformed,” meaning revised by the court to reflect the parties true intentions. Read Case 10.3, Drake v. Hance (Ct. App NC 2009).

• Specific performance is an equitable remedy calling for the performance of the act promised by the breaching party in the contract.

• Only granted if money damages are not adequate to compensate the non-breaching party.

• Rarely awarded in contracts for sale of non-unique goods.

• Commonly awarded in contracts for the sale of land. • Not awarded in personal services contracts.

Additional Topics• Skip election of remedies (p.228).


Chapter 14 - Intellectual Property

Introduction• Article I Sec. 8 of the U.S. Constitution authorizes Congress “To promote the Progress

of Science and useful Arts, by securing for limited times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.”

• Intellectual property rights are protected both by common law and federal and state statutes.

Types of Intellectual Property• The following types of intellectual property will be covered in this course:

• Trademarks (for products); • Service Marks (for services)• Trade Dress (image/overall appearance of a product)

• Trade Names (business names)• Patents (for inventions and designs)

• Copyrights (for literary and artistic work)• Trade Secrets (business processes and information)

• Skip Sections 2, 5, and 7.

• See Exhibit 14-1 (p. 326) for a summary chart.

Sec. 1: Trademarks and Related Property• A trademark is a distinctive mark, motto or device or emblem affixed to goods so their

source can be easily identified and so they can be distinguished from goods produced by other manufacturers.

• A service mark is similar to trademark (and receives the same protection) but is used to distinguish services of one company from those of another company. (e.g., transportation, telecommunications, insurance services)

• These marks may or may not include the name of the company providing the goods or services.

• Trademarks/Service Marks


• The use of identical or similar marks by competitors may lead to consumer confusion about the source of the goods. Therefore, a person who owns and uses a trademark or service mark is protected in its use by common law and statutes.

• The following case illustrates common law protection of trademarks that existed before the 1946 Lanham Trademark Act.

• Case 14.1: The Coca Cola Company v. The Koke Co. of America (U.S., 1920). A Coca Cola competitor was prohibited from calling their soft drink product “Koke.”

• Lanham Trademark Act (1946)

• Lanham Trademark Act (1946) is a federal statute that incorporates the common law of trademarks and provides remedies for trademark infringement in lawsuits brought under this act (exclusive jurisdiction in federal courts).

• The Lanham Act prohibits unauthorized use of the same or confusingly similar marks on competing goods or services—or on noncompeting but related goods or services.

• Did not protect use against the use of same or confusingly similar marks on unrelated goods and services, so it was amended in 1995 to expand its protection (next slide).

• Federal Trademark Dilution Act (1995)

• Federal Trademark Dilution Act (1995) amended the Lanham Act to provide for a cause of action for trademark dilution.

• Protects distinctive and/or famous marks from unauthorized use on noncompeting goods—even in cases where the use is unlikely to confuse consumers.

• Dilution of a mark occurs if a similar mark reduces the value of the famous mark or lessens its ability to identify goods and services.

• The mark’s distinctive quality may become “blurred” or “tarnished” by the use of the similar mark even on noncompeting/nonrelated goods.

• Trademark/Service Mark Dilution• Use of either “identical” or “similar” marks owned/used by another party may

constitute trademark dilution.• Trademark dilution is more likely when the company using a similar mark is a direct

competitor or provides related goods, but can also occur when used on noncompeting/nonrelated goods.

• “Sambuck’s Coffehouse” (name used by an Oregon coffee shop) was held to dilute the Starbucks mark, and thereby reduce its value.


• Trademark/Service Mark Registration

• Trademarks and service marks can be registered with the USPTO or applicable state agencies, subject to a rigorous approval process. Registration grants nation-wide protection for the mark.

• Registration is not required to sue for infringement, but it can provide proof of when the mark was first used .

• A mark can be registered if it is currently used in commerce, or the applicant intends to put it into commerce within six months. Registration can be renewed every 10 years after the original renewal, which occurs between the fifth and sixth years.

• Trademarks can be protected from infringement indefinitely as long as they are used, regardless of whether they are registered.

• Trademark/Service Mark Infringement• Marks must be “distinctive” in order to be registered. Generic terms receive no

protection. Arbitrary and fanciful marks are highly distinctive. Skip details in the “Distinctiveness of Mark” section (p.311).

• Trademark infringement occurs when a trademark is copied to a substantial degree or used without consent.

• Trademark owner has a cause of action against an infringer. Infringement does not have to be intentional.

• An injunction prohibiting the infringer from using a mark is the most commonly granted remedy and should prevent further infringement.

• Trade Dress and Trade Names• Trademark protection extends to “trade dress,” which includes aspects of the

product such as shape, design, color scheme of packaging (e.g., iPod shape, Coke bottle shape; restaurant décor/menu/service style). Owner must show an exclusive link to the product source in the consumer’s mind to get trademark protection for trade dress.

• A “trade name” is all or part of a business’s name. Valuable because it is related to the business’s products, business, goodwill, marketing.

• May be protected from infringement under common law.

• May receive trademark protection if it is also part of the company’s trademarks or service marks (e.g., Coca-Cola).

• Counterfeit Goods


• Counterfeit goods imitate trademarked goods, and may carry a fake trademark or a confusingly similar mark.

• Textbook states that nearly 7% of goods imported into the U.S. are counterfeit.• The Stop Counterfeiting in Manufactured Goods Act make it a crime to intentionally

traffic in counterfeit goods or to use a counterfeit mark on or in connection with goods or services.

• Penalties up to $2 million and imprisonment up to 10 years.• Skip Sec. 2: Cyber Marks

Sec. 3: Patents• A patent is a grant of rights from the U.S. Patent and Trademark Office that gives the

patent holder the right to exclude others from making, using, and selling an invention for 20 years from the date of the application in exchange for public disclosure of the invention (which is included in the application). (Note: term is 14 years for design patents)

• Types of patents:

• (i) utility (machines, processes)• (ii) design (ornamental design for an article of manufacture)• (iii) plant (biological plants).

• Patents• Almost anything is patentable

• Not laws of nature• Not natural phenomena• Not abstract ideas

• To be patentable, an item must be• Useful (easily satisfied test)

• Novel• Nonobvious• Skip details on p. 316 and Case 14.2.

• Software patentable since 1981• Skip “Business Processes”


• Under legislation effective Mar. 2013, the first person to file a patent application for an invention is entitled to the patent.

• Previously, the first person to invent a product or process was entitled to the patent. (note this change in your book)

• A patent’s “effective life” may be considerably shorter than its 20-year term because it can take several years for the application to be reviewed and the patent issued.

• A patent owner can exclude others from using the patent even if the owner does not use it. Read the posted article about “patent trolls.”

• Federal courts have exclusive jurisdiction over patent infringement lawsuits. Remedies: injunctions and royalties.

Sec. 4: Copyrights• Copyright protection is an intangible property right granted by the Copyright Act of

1976 (federal statute) to an originator or author of certain types of work (e.g., literary, musical works, film, computer software). Author has the sole right reproduce the work and to profit from its publication and sale.

• Works created after January 1, 1978, are automatically protected for the life of the author plus 70 years (general rule).

• Works can be registered with the U.S. Copyright Office. Registration not required for protection, but is required in order to file an infringement lawsuit.

• Copyright Act Protection• To be copyrightable, the work must be original, creative and fixed in a durable

medium, and fall within one of these categories:

• literary works; musical works and words; dramatic works; choreographic work; pictorial, graphic and sculptures; motion pictures; sound recordings; architectural plans; and computer software.

• The expression of an idea can be copyrighted, but not the idea itself.• Copyright Infringement

• Copyright infringement occurs when there is unauthorized copying of a protected work. Infringement also includes publicly performing (or playing) music in public without a license from the copyright holder or collective rights organization (e.g., ASCAP)

• Infringers may be subject to criminal penalties and substantial civil damages.


• “Fair use” exception: certain uses of copyrighted materials are legally permitted without the payment of a royalty. See p. 320 for uses that fall under this exception (e.g., teaching, criticism, news reporting, research, scholarship).

• When a copyright has expired, the work is said to be in the “public domain” and can be used by anybody.

• Skip Sec. 5.

Sec. 6: Trade Secrets• Trades secrets include secret processes, formulas, methods, procedures, and

customer lists that give the owner an advantage over competitors. These secrets may not be protectable under patent, trademark, or copyright laws, or the owner may choose not to seek available protection if it would require disclosure of the secrets.

• Trade secrets are protected by common law (tort and contract theories) and state and federal statutes. State laws usually provide for civil damages; the federal Economic Espionage Act of 1996 makes it a criminal offense to steal trade secrets.

• No registration or filing requirements are required for trade secrets; protection is of unlimited duration as long as the owner protects the confidentiality of the trade secrets.


Chapter 15 - Debtor-Creditor Relations and Bankruptcy

Sec. 1: Laws Assisting Creditors• Debt is classified as “secured” or “unsecured.” The type of debt determines a

creditor’s collection options in the event a debtor fails to pay the debt when it is due (“defaults”).

• Unsecured debt is not tied to any item of property that serves as security for the debt.• Examples: credit card debt, medical bills, utilities

• If collection efforts fail, an unsecured creditor may sue the debtor to obtain a court judgment for the amount due. If debtor does not pay the judgment, the creditor may take additional legal actions to try to collect payment. (See slide 7).

• Liens and Secured Debt• A lien is the claim a creditor (“lienholder”) has against a debtor’s property

(“collateral”) to secure payment of a debt.

• A debtor can voluntarily grant a creditor a lien on property to induce the creditor to make a loan. This often happens with the purchase of goods on credit, such as cars, furniture, and appliances. Liens may also arise in connection with other types of loans where the lender demands collateral as a condition of the loan.

• Some lenders also require a third party guaranty of the loan. (covered in Sec. 2, which we are omitting)

• Some liens are involuntary-see slides 6-7.

• A creditor with a lien on personal property (meaning anything other than real property) is said to have a “security interest” in such property.

• Extensive rules regarding the creation and perfection of security interests in personal property are established by UCC Article 9, but will not be covered in this course. Mortgages create liens on real property and will be covered in Chapter 16.

• Secured debt is debt for which the creditor has a lien on specific items of the debtor’s property to help ensure payment of the debt. Secured debt typically must be paid before the collateral can be sold/transferred to pay other debts (primary exception is for inventory).

• If the debtor defaults on a secured loan, the secured creditor can generally repossess the collateral on which it has a lien to satisfy the debt.

• Repossessions do not require a court order, but must be “peaceful” and in compliance with state statutes.


• Foreclosures on real property are covered in Ch. 16.

• If the lienholder repossesses and sells the collateral, the proceeds are applied to the debt. If the sale proceeds are insufficient to satisfy the debt, the debtor generally remains liable for any deficiency.

• The deficiency becomes an unsecured debt (because the collateral has been sold), and the creditor must then sue to get a judgment for the deficiency.

• Other Types of Liens• A “mechanics lien” can be recorded on real property by a party who provides

materials or services and is unpaid (subject to strict notice and filing/recording procedures). This is a nonpossessory lien.

• An “artisan’s lien” is a possessory lien arising from the failure of a debtor to pay for labor or materials furnished in connection with repair of personal property (e.g., auto or jewelry repair). The lienholder can retain possession of the property until paid (or may be permitted to sell the property under state statutes).

• Liens• A “judicial lien” typically arises when a debtor fails to pay a judgment (a court order

to pay an amount to a creditor), and the unpaid creditor petitions the court to grant a lien on certain items of the debtor’s nonexempt property.

• The creditor may petition the court for an order permitting the seizure and sale of the debtor’s assets:

• Writ of Attachment: a prejudgment order permitting debtor’s property to be taken into custody by the sheriff before a judgment is issued in a collection case.

• Writ of Execution: a post-judgment order directing the sheriff to seize debtor’s real or personal property located in the county and sell it to satisfy the judgment.

• Garnishments• A garnishment is a court order directing a third party (“garnishee”) who is in

possession of nonexempt property owned by a debtor to turn over such property (e.g., bank accounts; personal property held by others) to the creditor for the payment of debts.

• A wage garnishment is a court order directing an employer to withhold a portion of debtor’s wages for payment of debts to a creditor (e.g., delinquent child support payments owed to custodial parent).

• Subject to federal and state statutory limits, typically 25% of take-home pay.• Composition Agreements


• Creditors may enter into binding contractual agreements (“creditors’ composition agreements”) with debtors, whereby the outstanding debt will be satisfied by a lesser amount than actually owed.

• Omit Sec. 2: Suretyship and Guaranty.

Sec. 3: Protection for Debtors

• Debtors are protected by state and federal consumer protection statutes and regulations and federal bankruptcy law.

• Certain items of property owned debtors may be protected under state laws from seizure to satisfy claims of creditors (“exempt property”). Exempt property may include all or a portion of a debtor’s interest in their home and certain personal property. (See examples in sections 3 and 5 of the textbook.)

• Debtor Options for Overdue Debts• Try to work out a payment plan and/or a debt reduction plan with creditors

(“composition agreement”); refinance debts; or consolidate debts.• Try to protect assets by keeping current on secured debt payments, even if

unsecured debts are delinquent.• If sued for collection, or if foreclosure or repossession proceedings are

commenced, filing for bankruptcy protection may be the best alternative.

• Bankruptcy occurs when a debtor is who is unable to pay their bills when due seeks protection from creditors by filing a bankruptcy petition under the U.S. Bankruptcy Code. Debtor does not have to be “insolvent.”

• Consumer Bankruptcy Factors• Loss of employment

• Medical bills• Divorce

• Excessive consumer debt• Inability to pay mortgage• Failed business

• Personal guarantee of business debt• Judgement

• Bankruptcy Purpose


• “[I]t gives to the honest but unfortunate debtor…a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preexisting debt.”

• Local Loan Co. v. Hunt, 292 U.S. 234, 244 (1934)

Sec. 4: Bankruptcy Law

• The goal of bankruptcy law is to protect debtors by giving them a “fresh start” free from creditors’ claims; and

• It also ensures equitable treatment for creditors who are competing for a debtor’s assets.

• Secured creditors can repossess their collateral.

• Unsecured creditors share in the debtor’s assets (if any) in proportion to the unpaid debt owed to them.

• Types of Bankruptcy Filings (Important)

• Chapter 7 (liquidation or “straight” bankruptcy)• Individuals and businesses seeking to liquidate and have their debts

discharged (extinguished)• Chapter 13 (repayment)

• Individuals with regular income seeking to establish a repayment plan for debts.

• Chapter 11 (reorganization)• Businesses (and some individuals) seeking to reorganize and continue

operations• Chapter 9 (municipalities) and Chapter 12 (family farmers)—Not covered in this

class.

• Bankruptcy Benefits • Automatic Stay becomes effective the day petition is filed.

• Creditors cannot commence or continue most lawsuits or attempt to collect debts or judgments while automatic stay is in effect. Secured creditors may petition the court to lift the stay (generally, where debtor has no equity in the secured property).

• Discharge of most debts (Ch. 7)

• Fresh start: debtor’s earnings after the filing date are not subject to creditors’ pre-bankruptcy claims (Ch. 7)


• For Chapter 13 debtors, the opportunity to save house and car (and other assets subject to secured debt) by entering into a repayment plan; discharge of remaining unsecured debts at end of plan.

• Chapter 11, an opportunity to reorganize businesses without creditors trying to collect debts (due to automatic stay).

• Bankruptcy Costs

• Ch. 7 debtors forfeit all “nonexempt” assets• Exempt assets are defined by state law and the Bankruptcy Code (which

permits states to require that debtors use the state exemptions).

• Filing goes on credit report for 10 years• Filing costs (estimates)

• $300 court fees (for Ch. 7 &13)• Chapter 7 (consumer) attorney fees $1,200 up• Chapters 13 attorney fees $3,000 up

• Chapter 11—very high attorney fees.

Sec. 5: Liquidation Proceedings (Ch. 7)• Bankruptcies under Chapter 7 are called “liquidation” bankruptcies. Most debts are

discharged in Chapter 7, and secured creditors get to repossess collateral held by debtors.

• Chapter 7 is the most common form of bankruptcy; it is available to individuals and businesses (only once every 8 years). Purpose: a fair distribution to creditors of debtor’s non-exempt property and a “fresh start” for the debtor (protects future income and assets from old claims).

• May be voluntary (filed by debtor) or involuntary (filed by creditors if debtor has unsecured debt of at least $14,425 and is not paying debts as they become due; usually 3 creditors are must join in an involuntary filing).

• Chapter 7• Individuals must pass a “means” test to be eligible to file under Chapter 7.

• If debtor’s average annual income (measured by looking at prior 6 months) does not exceed the median income for debtor’s home state (currently: $39,891 annually for a single earner in TN) then debtor is eligible to file under Chapter 7,


• If the debtor’s income exceeds the median income for his state and debtor projects “disposable income” over next 5 years that exceeds certain limits, then debtor is ineligible for Chapter 7, but may file under Chapter 13.

• Filing the bankruptcy petition constitutes an “order for relief.”

• Chapter 7 Case Process• Meet with attorney to determine eligibility and complete forms; complete credit

counseling; pay attorney up front.• Debtor files bankruptcy petition and supporting schedules disclosing all creditors

and assets and other financial information. Sworn statement; federal crime to make false statements.

• “Automatic stay” becomes effective as soon as petition is filed, meaning almost all creditor collection efforts are temporarily stayed, including repos and commencement or continuation of litigation . Skip case 15.2.

• A Chapter 7 Trustee is appointed; a “meeting of creditors” is set approximately 30-40 days after filing.

• A notice of the meeting of creditors and a Proof of Claim form are mailed by the Bankruptcy Court to each creditor listed in the schedules to the petition.

• At the creditors meeting, the debtor is interviewed by the trustee, and creditors are given the opportunities to ask the debtor questions.

• The trustee examines the debtor’s schedules and may instruct the debtor to turn over nonexempt property (alternatively, the trustee may “abandon” the property to the debtor if the value so low it is not worth selling).

• If debtor has nonexempt assets of value, the trustee will sell them and distribute the proceeds to unsecured creditors based on the payment priority system established by the Code.

• If there are no assets and no unresolved issues with creditors, the trustee typically will file a “No Asset” report and close the case within a few months.

• Bankruptcy Estate (Test Question)• Upon filing a Chapter 7 petition, an “estate” in property is formed. The “bankruptcy

estate” includes:• All nonexempt property owned by debtor at the time of filing (including any

property of debtor held by third parties);• Property transferred in pre-filing transactions that may be avoided (“set aside”)

by the trustee; and


• Inherited property and life insurance proceeds to which debtor becomes entitled within 180 days after the filing date.

• Married persons can file jointly or separately, which impacts what property is included in the bankruptcy estate.

• Exempt Property• The U.S. Bankruptcy Code provides exemptions (property that debtor can retain)

from the bankruptcy estate, but permits states to require its citizens to use the state’s statutory exemptions (generally lower).

• Tennessee exemptions include:

• Homestead (equity in home): $5,000 individual/$7,500 married couple filing jointly; up to $25,000 for couple 62 or older.

• Personal property: up to $4,000• Retirement plans: generally 100% • Tools of trade: up to $1,900

• Disability payments: 100%• Miscellaneous other exemptions

• Trustee’s Powers• Trustee has the right to recover certain property that was transferred to creditors

prior to the filing by asserting his “avoidance powers” (e.g., avoiding liens on property subject to a security interest that was unperfected or not timely perfected; claiming property that was preferentially and/or fraudulently transferred before the bankruptcy filing).

• Trustee can demand the return of preferential transfers-- payments of pre-existing debts made within 90 days prior to filing for most creditors—but 1 year prior to filing for payments to “insiders.” (important)

• Under the Bankruptcy Code, trustee may avoid fraudulent transfers made within 2 years before the bankruptcy petition was filed. Trustee may also proceed under state fraud laws, which may have a longer statute of limitations.

• Distributions to Secured Creditors

• In connection with a bankruptcy filing, consumer debtors must state their intention to surrender, reaffirm or redeem secured collateral within 30 days of filing the petition. This intention must generally be performed within 45 days after filing the statement.

• “Reaffirmation of debt” (an agreement to pay debt that is dischargeable in bankruptcy) is subject to strict procedural requirements and is usually discouraged.


• Collateral is typically surrendered to secured creditors, who can keep or sell it. If a creditor keeps the property, it is in full satisfaction of the debt. If the creditor sells it and there is a deficiency, the creditor will have an unsecured claim against the estate in the amount of the deficiency.

• Distributions to Unsecured Creditors• If there are estate funds available for distribution (after payment of selling

expenses), unsecured creditors are paid according to the priority established under the Code (e.g., family support, administrative expenses, taxes... and in last place—general unsecured creditors.)

• All creditors of one class must be paid in full before distributions can be paid to next class of creditors.

• If there are not enough funds to pay all creditors within a class in full, the creditors are paid in proportion to their debt.

• Discharge of Debts

• Most debts of a Chapter 7 debtor are discharged, meaning that the debtor is no longer obligated to pay them (but see next slide on nondischargeable debts).

• The discharge is a court order prohibiting creditors of the debtor from taking any action to collect discharged debts.

• The discharge usually occurs automatically about 4 months after filing if there is no objection by the trustee or creditors (discharges granted in 99% of Ch. 7 cases).

• Secured creditors may still enforce valid liens to recover collateral.

• Nondischargeable Debts (know these)• Debts not listed by debtor in the petition and schedules• Domestic support obligations

• Student loans (discharge based on undue hardship exception is very rare)• Debts for injuries caused in DUI accident

• Debts for willful and malicious injuries to person or property (but not debts due to ordinary negligence)

Section 7: Chapter 13 Bankruptcy• Available to individual debtors who have regular income and debts that do not exceed

statutory limits. Petitions must be voluntary or by court conversion of a Chapter y petition.


• Debtor submits a plan (with bankruptcy petition) to repay all or a portion of his debts over the life of the plan (3 or 5 years) out of “disposable income” as defined by the Bankruptcy Rules.

• Plan must pay unsecured creditors at least as much as they would have received had the debtor’s assets been liquidated under Chapter 7.

• Chapter 13

• The plan must be approved (“confirmed”) by the bankruptcy court. Ch. 13 trustee and creditors are given an opportunity to object to the plan prior to confirmation.

• A Chapter 13 debtor retains all of his assets (exempt & non-exempt) provided that he complies with his plan.

• Provides an opportunity for debtor to save home from foreclosure and cure delinquent mortgage payments over life of plan. Must pay current secured debt payments when due.

• Plan payments are made regularly to the Chapter 13 trustee, who distributes the money to creditors.

• Case will be dismissed (or converted to Chapter 7) if debtor fails to make plan payments.

• Plan must be completed in order for debtor to receive a discharge of remaining balance of dischargeable debts. Some debts that are non-dischargeable under Chapter 7 may be discharged at the end of a Chapter 13 plan (but not student loans!).

• Skip Case 15.3 and Chapter 12 coverage.

Sec. 6: Chapter 11 Reorganization

• Available to both businesses and individual debtors.• Individuals do not typically go this route unless they own and operate businesses

or do not qualify under other chapters.• Typically voluntary; good faith requirement for filing.

• Expensive to file and operate under. Very high failure rate; vast majority converted to Chapter 7 or are dismissed.

• Chapter 11 is increasingly used as a vehicle for an orderly sale of the business’s assets to new owners who will operate a new business (“liquidating Chapter 11 plans”).

• The new owners generally acquire the assets free and clear of liens.

• Such sales must be approved by the court.


• Chapter 11

• The debtor becomes a “debtor in possession” and continues to control the assets and run the business—subject to the oversight of the U.S. Trustee and the court. Usually, there is no trustee in a Chapter 11 case.

• Actions outside the ordinary course require a court order.• A creditors committee is appointed by the U.S. Trustee in larger cases.

• Obtaining post-petition credit is essential to success.• Likely on COD terms w/suppliers

• Debtor can assume or reject most contracts during reorganization process.

• Collective bargaining agreements are subject to special protections. • Debtor has the exclusive right to file a plan of reorganization during the first 120

days after filing (but this may be extended up to 18 months). If this “exclusive period” expires without the debtor filing a plan, then any party may file one.

• The reorganization plan must be voted on and approved by creditors (subject to “cram-down” provisions) and the Bankruptcy Court.

• In recent years, the trend for larger companies is toward “prepackaged” Chapter 11 bankruptcies, where the primary creditors have agreed to the reorganization plan prior to the bankruptcy filing. This approach greatly reduces time in bankruptcy (from years to weeks/months).


Chapter 16: Mortgages and Foreclosures

Sec. 1: Mortgages• When a party borrows money to purchase real property (land and buildings), a

mortgage loan document is executed whereby the purchaser grants a lien on the real property to the lender as security for the loan (making it “secured debt”) The real property is considered “collateral” for the loan.

• Mortgages are used in connection with both home loans and commercial property loans.

• Interest paid by individuals for mortgages on their primary residence, and one additional residence, is tax-deductible for federal income tax purposes (on total loans up to $1 million).

• Other personal interest expenses (car loan, credit card, etc.) are not tax-deductible.

• Types of Mortgages• A variety of mortgage loans are described in this section, but we will only cover

these three:• Fixed rate mortgages: Interest rate is fixed for the term of the loan, and

monthly payments (P&I) stay the same for the life of the loan (typically 15 or 30 years).

• Adjustable-rate mortgages: Interest rate is initially lower than for a fixed rate loan, but will be adjusted upward periodically, with a lifetime cap. Monthly payments will increase as the interest rate increases.

• Balloon mortgages: Low amounts (sometimes just the interest) are paid for a set period (7-10 years), after which a payment for the total balance of the loan is due. These final “balloon payments” are typically refinanced by the borrower—but this is risky.

• Home Equity Loans• Home equity is the difference between the market value of the home and the

amount of debt owed on the primary mortgage on the property. • The homeowner may be able to get a “home equity loans” using the home equity

as collateral. A home equity loan lien is subordinate to the lien of the primary mortgage lender, meaning that the primary lender gets paid first (making home equity loans risker for the lender, which is why they often have higher interest rates than primary mortgages).


• Interest paid on home equity loans (on indebtedness up to $100,000) is tax-deductible, regardless of what the funds are used for.

• Skip Creditor Protection (p. 361) and Section 2 (Real Estate Financing Law).

Sec. 3: Foreclosures• Skip “How to Avoid Foreclosure,” except for the following topics:

• Short sale: Instead of foreclosing on the property, lender allows the borrower to sell the property to a third party for less than the balance due on the mortgage loan, and forgives the unpaid balance.

• Voluntary conveyance: With a “deed in lieu of foreclosure” agreement, the lender agrees to accept a voluntary transfer of ownership of the property by the borrower in full satisfaction of the mortgage debt.

• A bankruptcy filing by the borrower temporarily stops foreclosure proceedings while the automatic stay is in effect.

• Foreclosure Procedures• If the borrower defaults on their mortgage loan by failing to make the loan

payments when due, the lender can declare the entire debt “due and payable” under an acceleration clause in the mortgage agreement.

• If the mortgage debt is not paid, the lender can “foreclose” on the real estate, which means that the lender can sell the property at an auction (consistent with state law procedures) and apply the proceeds of the sale to the loan balance.

• State laws establish procedures for foreclosure sales, which vary by states. • In about half the states, judicial action (arising from a lawsuit filed by the lender) is

required before foreclosure can occur. This process is a “judicial foreclosure.”

• The remaining states, including Tennessee, permit foreclosures to occur pursuant to a “power of sale” clause in a Deed of Trust executed in connection with the original mortgage. No judicial action is required. This type of foreclosure is called a “non-judicial foreclosure” or a “power of sale foreclosure.”

• The foreclosure process is faster with non-judicial foreclosures than judicial foreclosures.

• Skip Case 16.2.

• Debtor is entitled to receive notice of foreclosure sale prior to the sale. Method of notice may be set by statute or stipulated in the mortgage.

• In TN, notice must be published 3 times in a newspaper, with the first notice at least 20 days prior to the sale.


• Prior to the foreclosure sale, a debtor has the right to redeem the property by paying the full amount of the debt, plus interest and legal costs (“equitable right of redemption”).

• Some states provide a “statutory right of redemption” that permits the borrower to repurchase property for a period of time after a judicial foreclosure sale. This right is not available after a power of sale foreclosure.

• Foreclosure sales in Tennessee must take place at a public auction on the courthouse steps in the county where the property is located.

• The lender can make a bid in the amount of the debt it is owed (“credit bid”), so that the lender buys the property for the amount of the loan balance if there are no higher bidders.

• Foreclosure sale proceeds go first to expenses of the sale, and then to creditors with liens on the property (in order of priority). Excess funds, if any, are paid to the debtor.

• If the sale proceeds are insufficient to fully pay the mortgage debt, the debtor may be liable for the deficiency (which is an “unsecured debt”). Some states do not permit deficiency judgments on residential real estate debt.


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