The difference between contracts, liens, bonds and trust funds.(Column)

You know it is important to get signed contracts to help collect your receivables. You know it is even more important to preserve mechanic's lien, payment bond and trust fund rights in troubled economic times. Contracts, mechanic's liens, payment bonds and trust funds are each very different concepts legally, however. Each of these legal mechanisms could be useless in any particular situation, but exactly what you need in the next situation. Understanding the difference will help you evaluate your credit risk with each customer, improve your position in marginal projects and effectively enforce your rights at the first sign of trouble.

Contract Rights

When you purchased your last home or automobile, the bank required you to sign at least two pieces of paper. One was your promissory note. This was your "contract" with the bank in which you agreed to make certain monthly payments. This is your "personal promise to pay." This allows the bank to sue you personally in the event of default, obtain a judgment and then attach your assets.

The other paper you signed was a mortgage, deed of trust or other "security agreement." Your security agreement provides the bank rights against the "security property." In the event of default, the bank can foreclose upon the security property, whether it's a house, automobile or other property. If the debtor is solvent, security is not as important. The creditor will be able to go against the debtor on the "contract." The creditor will still be able to obtain a personal judgment against the debtor and will then be able to attach all assets owned by the debtor.

If the debtor is insolvent or disappears, security becomes critical. The contract or promise to pay will be worthless if the debtor cannot be found or has no assets. If the creditor has security, however, the creditor will be able to sell the security property to help obtain repayment.

Insolvency or bankruptcy is the same as a debtor disappearing. If a debtor stops doing business or does not have assets, the contract or promise to pay may be worthless. The creditor will not collect unless the creditor has security.

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