secured financing moll

Secured Financing Prof. Moll—Spring 2007

I. Remedies of Unsecured Creditors Under State Law...............................................................1A. Who Is an Unsecured Creditor?...........................................................................................1B. How Do Unsecured Creditors Compel Payment?...............................................................1C. Limitations on Compelling Payment...................................................................................2D. Is the Law Serious About Collecting Unsecured Debts?.....................................................2E. Problem Set 1.......................................................................................................................2

II. Security and Foreclosure.........................................................................................................5A. The Nature of Security.........................................................................................................5B. Foreclosure Procedure.........................................................................................................6

1. Judicial Foreclosure.........................................................................................................62. Power of Sale Foreclosure...............................................................................................73. U.C.C. Foreclosure by Sale.............................................................................................7

C. Problem Set 2.......................................................................................................................8III. Repossession of Collateral.................................................................................................10

A. The Importance of Possession Pending Foreclosure.........................................................10B. The Right to Possession Pending Foreclosure—Real Property.........................................10

1. The Debtor’s Right to Possession During Foreclosure..................................................102. Appointment of a Receiver............................................................................................113. Assignment of Rents......................................................................................................11

C. The Right to Possession Pending Foreclosure—Personal Property..................................11D. The Article 9 Right to Self-Help Repossession.................................................................12E. The Limits of Self-Help: Breach of the Peace..................................................................12F. Self-Help Against Accounts as Collateral.........................................................................13G. Problem Set 3.....................................................................................................................15

IV. Judicial Sale and Deficiency..............................................................................................19A. Strict Foreclosure...............................................................................................................19B. Foreclosure Sale Procedure...............................................................................................19C. Problems with Foreclosure Sale Procedure.......................................................................20

1. Advertising....................................................................................................................202. Inspection.......................................................................................................................203. Title and Condition........................................................................................................214. Hostile Situation............................................................................................................215. The Statutory Right to Redeem.....................................................................................21

D. Antideficiency Statutes......................................................................................................21E. Credit Bidding at Judicial Sales.........................................................................................22F. Judicial Sale Procedure: A Functional Analysis...............................................................22G. Problem Set 4.....................................................................................................................22

V. Article 9 Sale and Deficiency................................................................................................25A. Strict Foreclosure Under Article 9.....................................................................................25B. Sale Procedure Under Article 9.........................................................................................27C. Problems with Article 9 Sale Procedure............................................................................29

1. Failure to Sell the Collateral..........................................................................................292. The Requirement of Notice of Sale...............................................................................293. The Requirement of a Commercially Reasonable Sale.................................................32

D. Article 9 Sale Procedure: A Functional Analysis.............................................................34E. Problem Set 5.....................................................................................................................34

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VI. Bankruptcy and the Automatic Stay..................................................................................39A. The Federal Bankruptcy System........................................................................................39B. Filing a Bankruptcy Case...................................................................................................40C. Stopping Creditors’ Collection Activities.........................................................................40D. Lifting the Stay for Secured Creditors...............................................................................40E. Strategic Uses of Stay Litigation.......................................................................................42F. Problem Set 6.....................................................................................................................42

VII. The Treatment of Secured Creditors in Bankruptcy..........................................................43A. The Vocabulary of Bankruptcy Claims.............................................................................43B. The Claims Process............................................................................................................43C. Calculating the Amount of an Unsecured Claim...............................................................44D. Payments on Unsecured Claims........................................................................................44E. Calculating the Amount of a Secured Claim.....................................................................44F. Selling the Collateral.........................................................................................................45G. Who Pays the Expenses of Sale by the Trustee.................................................................45H. Chapters 11 and 13 Reorganization...................................................................................45I. Valuing Future Payments..................................................................................................47J. Problem Set 7.....................................................................................................................47

VIII. Formalities for Attachment................................................................................................49A. A Prototypical Secured Transaction..................................................................................49B. Formalities for Article 9 Security Interests.......................................................................50

1. Possession or Authenticated Security Agreement.........................................................512. Value Has Been Given...................................................................................................523. The Debtor Has Rights in the Collateral........................................................................52

C. Formalities for Real Estate Mortgages..............................................................................53D. Problem Set 8.....................................................................................................................53

IX. What Collateral and Obligations Are Covered?................................................................54A. Interpreting Security Agreements......................................................................................54

1. Debtor Against Creditor................................................................................................542. Creditor Against Third Party.........................................................................................543. Interpreting Descriptions of Collateral..........................................................................54

B. Sufficiency of Description: Article 9 Security Agreements.............................................54C. Describing the After-Acquired Property...........................................................................55D. Sufficiency of Description: Real Estate Mortgages..........................................................56E. What Obligations Are Secured?........................................................................................56F. Problem Set 9.....................................................................................................................56

X. Proceeds, Products and Other Value-Tracing Concepts........................................................57A. Proceeds.............................................................................................................................57

1. Definition.......................................................................................................................572. Termination of Security Interest in the Collateral After Authorized Disposition.........583. Continuation of Security Interest in the Collateral After Unauthorized Disposition....584. Limitations on the Secured Creditor’s Ability to Trace Collateral................................59

B. Other Value-Tracing Concepts..........................................................................................60C. Non-Value-Tracing Concepts............................................................................................60D. Problem Set 10...................................................................................................................61

XI. Tracing Collateral Value During Bankruptcy....................................................................62

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A. Distinguishing Proceeds from After-Acquired Property...................................................62B. “Cash Collateral” in Bankruptcy.......................................................................................63C. Problem Set 11...................................................................................................................63

XII. The Legal Limits on What May Be Collateral..................................................................63XIII. Default, Acceleration, and Cure Under State Law............................................................63

A. Default...............................................................................................................................63B. When Is Payment Due?.....................................................................................................64

1. Installment Loans...........................................................................................................642. Single Payment Loans...................................................................................................643. Lines of Credit...............................................................................................................64

C. Acceleration and Cure.......................................................................................................641. Acceleration...................................................................................................................642. Limits on the Enforceability of Acceleration Clauses...................................................643. The Debtor’s Right to Cure...........................................................................................64

D. The Enforceability of Payment Terms...............................................................................65E. Procedures After Default...................................................................................................66F. Problem Set 13...................................................................................................................66

XIV. Default, Acceleration, and Cure Under Bankruptcy Law..............................................66XV. The Prototypical Secured Transaction...............................................................................66

A. The Parties.........................................................................................................................66B. Deutsche Approves Bonnie’s Loan...................................................................................66C. Deutsche and Bonnie’s Document the Loan.....................................................................66

1. Security Agreement and Statement of Transaction.......................................................672. The Financing Statement...............................................................................................673. The Personal Guarantee.................................................................................................67

D. Bonnie’s Buys Some Boats...............................................................................................671. The Floorplan Agreement..............................................................................................672. The Buy.........................................................................................................................67

E. Bonnie’s Sells a Boat.........................................................................................................67F. Monitoring the Existence of the Collateral........................................................................67G. Problem Set 15...................................................................................................................67

XVI. The Personal Property Filing Systems...........................................................................68A. Competition for the Secured Creditor’s Collateral............................................................68B. What Is Priority?................................................................................................................68C. How Do Creditors Get Priority?........................................................................................69D. The Theory of the Filing System.......................................................................................69E. The Multiplicity of Filing Systems....................................................................................69F. Methods and Costs of Searching.......................................................................................69G. Problem Set 16...................................................................................................................69

XVII. Article 9 Financing Statements: The Debtor’s Name...................................................70A. The Components of a Filing System.................................................................................72

1. Financing Statements.....................................................................................................722. The Index.......................................................................................................................723. Search Systems..............................................................................................................72

B. Correct Names for use in Financing Statements................................................................721. Individual Names...........................................................................................................73

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2. Corporate Names...........................................................................................................743. Partnership Names.........................................................................................................744. Trade Names..................................................................................................................745. The Entity Problem........................................................................................................74

C. Errors in the Debtors’ Names on Financing Statements....................................................74D. Problem Set 17...................................................................................................................75

XVIII. Article 9 Financing Statements: Other Information.....................................................76A. Introduction........................................................................................................................76B. Filing Office Errors in Acceptance or Rejection...............................................................76

1. Wrongly Accepted Filings.............................................................................................762. Wrongly Rejected Filings..............................................................................................77

C. Filer Errors in Accepted Filings........................................................................................781. Information Necessary Only to Qualify for Filing........................................................782. Required Information.....................................................................................................79

D. Authorization to File a Financing Statement.....................................................................80E. U.C.C. Insurance................................................................................................................81F. Problem Set 18...................................................................................................................82

XIX. Exceptions to the Article 9 Filing Requirement............................................................84A. Collateral in the Possession of the Secured Party..............................................................84

1. The Possession-Gives-Notice Theory............................................................................842. What Is Possession?.......................................................................................................863. Possession as a Means of Perfection.............................................................................86

B. Collateral in the Control of the Secured Party...................................................................86C. Purchase-Money Security Interests in Consumer Goods..................................................87

1. Purchase-Money Security Interest (PMSI)....................................................................882. Consumer Goods...........................................................................................................88

D. Security Interests Not Governed by Article 9 or Another Filing Statute..........................88E. What Became of the Notice Requirement?.......................................................................88F. Problem Set 19...................................................................................................................89

XX. The Land and Fixtures Recording Systems.......................................................................91XXI. Characterizing Collateral for the Purpose of Perfection................................................91

A. Determining the Proper Place of Filing.............................................................................911. Personal Property Distinguished from Real Property....................................................912. Inventory Distinguished from Equipment.....................................................................91

B. Determining the Proper Method of Perfection..................................................................911. Instruments Distinguished from General Intangibles....................................................912. True Leases Distinguished from Leases intended as Security.......................................913. Realty Paper...................................................................................................................914. Chattel paper and Instruments Distinguished from Accounts.......................................91

C. Multiple Items of Collateral...............................................................................................91D. Problem Set 21...................................................................................................................91

XXII. Maintaining Perfection Through Lapse and Bankruptcy...............................................92A. Removing Filings from the Public Record........................................................................92

1. Satisfaction....................................................................................................................922. Release...........................................................................................................................923. Article 9 Termination and Release................................................................................92

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B. “Self-Clearing” and Continuation in the Article 9 Filing System.....................................92C. The Effect of Bankruptcy on Lapse and Continuation......................................................92D. Problem Set 22...................................................................................................................92

XXIII. Maintaining Perfection Through Changes of Name, Identity, and Use........................93A. Changes in the Debtor’s Name..........................................................................................93B. Changes Affecting the Description of Collateral...............................................................93C. Exchange of the Collateral.................................................................................................94

1. Barter Transactions........................................................................................................952. Collateral to Cash Proceeds to Noncash Proceeds........................................................953. Collateral to Cash Proceeds (No New Property)...........................................................96

D. Problem Set 23...................................................................................................................96XXIV. Maintaining Perfection Through Relocation of Debtor or Collateral............................98

A. State-based Filing in a National Economy........................................................................98B. Initial Perfection..............................................................................................................100

1. At the Location of the Debtor......................................................................................1002. At the Location of the Collateral.................................................................................100

C. Relocation of the Debtor..................................................................................................101D. Nation-based Filing in a World Economy.......................................................................102E. Problem Set 24.................................................................................................................102

XXV. Maintaining Perfection in Certificate of Title Systems...............................................104XXVI. The Concept of Priority: State Law............................................................................104

A. Priority in Foreclosure.....................................................................................................104B. Reconciling Inconsistent Priorities..................................................................................106C. The Right to Possession Between Lien Holders..............................................................106D. Problem Set 26.................................................................................................................107

XXVII. The Concept of Priority: Bankruptcy Law.............................................................109XXVIII. Lien Creditors Against Secured Creditors: The Basics..........................................109

A. How Creditors Become “Lien Creditors”........................................................................109B. Priority Among Lien Creditors........................................................................................109C. Priority Between Lien Creditors and Secured Creditors.................................................110D. Priority Between Lien Creditors and Mortgage Creditors...............................................112E. Purchase-Money Priority.................................................................................................113F. Problem Set 28.................................................................................................................113

XXIX. Lien Creditors Against Secured Creditors: Future Advances.....................................115A. Priority of Future Advances: Personal Property.............................................................115B. Priority of Nonadvances: Personal Property...................................................................116C. Priority of Future Advances and Nonadvances: Real Property......................................116D. Problem Set 29.................................................................................................................116

XXX. Trustees in Bankruptcy Against Secured Creditors: The Strong Arm Clause............118XXXI. Trustees in Bankruptcy Against Secured Creditors: Preferences...............................118

A. Priority Among Unsecured Creditors..............................................................................1181. Priority Under State Law: A Review..........................................................................1182. Priority Under Bankruptcy Law: A Review...............................................................1183. Reconciling the State and Bankruptcy Policies...........................................................118

B. What Security Interests Can Be Avoided as Preferential?..............................................1181. Generally......................................................................................................................120

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2. When Does the “Transfer” of a Security Interest Occur?............................................1203. The §547(c)(5) Exception for Accounts Receivable and Inventory............................1214. Relation-Back Rules....................................................................................................122

C. Strategic Implications of Preference Avoidance.............................................................122D. Problem Set 31.................................................................................................................122

XXXII. Secured Creditors Against Secured Creditors: The Basics.....................................123A. The Basic Rule: First to File or Perfect..........................................................................125B. Priority of Future Advances.............................................................................................125C. Priority in After-Acquired Property.................................................................................125D. Priority of Purchase-Money Security Interests................................................................125

1. Purchase-Money Security Interests Generally.............................................................1262. Purchase-Money Security Interests in Inventory.........................................................126

E. Purchase-Money Priority in Proceeds.............................................................................127F. Priority in Commingled Collateral..................................................................................127G. Problem Set 32.................................................................................................................128

XXXIII. Secured Creditors Against Secured Creditors: Land and Fixtures.........................130XXXIV. Competitions Involving Cross-Collateralization and Marshaling Assets................130XXXV. Sellers Against Secured Creditors...........................................................................130XXXVI. Buyers Against Secured Creditors...........................................................................130

A. Introduction......................................................................................................................130B. Buyers of Real Property...................................................................................................130C. Buyers of Personal Property............................................................................................130

1. The Authorized Disposition Exception: U.C.C. §9-315(a)(1)....................................1312. The Buyer-in-the Ordinary-Course Exception: U.C.C. §9-320(a).............................1313. The Buyer-Not-in-the-Ordinary-Course Exception: U.C.C. §9-323(d) and (e) and 9-317(b)...................................................................................................................................1324. The Consumer-to-Consumer-Sale Exception: U.C.C. §9-320(b)...............................132

D. Problem Set 36.................................................................................................................133

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I. Remedies of Unsecured Creditors Under State Law

A. Who Is an Unsecured Creditor?A debtor-creditor relationship shows up in many settings. A creditor is someone owed a legal obligation reducible to money. A obligor is someone who owes such an obligation. A debtor is someone with an interest other than a security interest in collateral for a secured debt. For example, all of the following may create such a relationship tort borrowing valid legal claim fiduciary/beneficiary relationshipDebtor-creditor relationships may be entered either voluntarily or involuntarily. Unless a creditor contracts with a debtor for secured status, the creditor is unsecured. An unsecured creditor that has obtained a court judgment becomes a judgment creditor. However, this fact does not change the creditor into a secured creditor.

An unsecured creditor does not have any security interest to protect his debt. A security interest is a contingent property right that the creditor has in the debtor’s property. If the obligor defaults on the debt, then the contingency has been satisfied and the creditor’s security interest springs to life.

B. How Do Unsecured Creditors Compel Payment?In most cases, obligors pay their unsecured debts. When debtors do not pay their unsecured debts, the creditor’s path to payment is narrow. The law provides strict procedures for the collection of unsecured debts. The law proscribes both the actions and the methods of collecting the debt. A creditor has no self-help remedies; however, an unsecured creditor may exercise the right of setoff.

If the creditor wrongfully seizes the debtor’s property, then the creditor may be liable for the tort of conversion or guilty of the crime of larceny. If the creditor employs wrongful collection practices, then the creditor may violate debt collection acts and also incur liability.

The procedure for obtaining payment of an unsecured debt a creditor must go to court and receive a judgment. After receiving a judgment, the creditor may get from the court the following: writ of execution – court order to a sheriff to seize the assets of the debtor, sell the

assets and turn over the proceeds to the creditor. If a levy under a writ of execution does not satisfy the debt, then the creditor may levy the writ of execution again until the debt is satisfied.

writ of garnishment – a court order to a debtor of the debtor assigning the creditor’s debtor’s rights in the debtor’s debtor’s debt to the creditor (wages, bank accounts)

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An unsecured creditor can encounter numerous problems while attempting to collect an unsecured debt if the debtor does not want to pay. For example, the debtor can take various actions to obstruct collection such as hide assets deny access to premises keep funds in cash to avoid garnishment of accounts create legal roadblocks

CaseVitale v. Hotel Cal., Inc. (p. 5)

Unsecured creditorCollection problemsAmercement

C. Limitations on Compelling PaymentCollecting on a judgment can be difficult for many reasons. Debtors often are evasive and attempt to conceal their assets. Although a judgment creditor has the right to obtain information about the judgment debtor’s assets through discovery, the process can be long and painful.

Many states also have exemption statutes that protect certain categories of assets from creditors. For example, Wisconsin’s exemption statutes protect the following: provisions for burial; business and farm property with a value not to exceed $7,500; consumer goods with a value not to exceed $5,000; motor vehicles not to exceed $1,200; 75% of net income depository accounts not to exceed $1,000 homestead not to exceed $40,000The particulars vary from state to state but the categories are fairly stable. Some states have unlimited homestead exemptions. Other states exempt all earnings from personal services.

D. Is the Law Serious About Collecting Unsecured Debts?The law compelling payment of unsecured debts is often ineffective. However, the law does have mechanisms for compelling payment. Of course, secured creditors enjoy

E. Problem Set 11.1 Jeff lends Lisa $1000 to buy lawn furniture. Lisa signs IOU and doesn’t pay him back. Jeff wants to take the lawn furniture. Can he?

NO; Jeff must go through the court system and become a judgment creditor. Here, Jeff does not have the right to do a self-help execution. He is an unsecured CR with no special rights to do self-help execution. He would be liable for conversion and larceny if he takes the furniture. Jeff should sue Lisa for breach of K (valid K, enforceable, Lisa

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breached; Jeff would have the burden of proof on all these issues). Jeff needs a judgment, which will entitle him to: Writ of execution: court order directing the sheriff to go get particular property of the

DR located at a particular place. You must enclose a copy of the judgment. Writ of garnishment: writ where the DR of a DR is instructed to pay the debt over to

the CR

RULES: Unsecured CRs have NO self help remedy. Sec’d CRs have rights of self help. An unsecured CR is one who lacks a security interest in the collateral. Unsecured CRs must sue to become a judgmt CR.

Jeff could try to negotiate with Lisa’s attorney to resolve situation without litigation. Also, Jeff gets 4 hours of free legal advice. These will pass very quickly and litigation will be expensive. Jeff could have protected himself by writing into the contract provisions for attorney fees, interest, collateral, and added a rightt of self help.

1.2 Kostandin owes Look $30,000 that Look hasn’t been able to recover. Look tricks Kostandin into delivering a whole bunch of lobsters to Look who Kostandin thinks is Stephen King, which Look takes and sells for $19,000. Look wants to recover the other $11,000. Look used self-help to get Lobsters. May have civil trouble for fraud or conversion

or criminal prosecution. If K sues L for $19,000, L will counter for $30,000. Judgmt to L for $11,000. L has potential criminal charge for larceny by K if K can persuade authorities. As L’s

attorney, maybe you should talk to DA and persuade not to prosecute L, but to prosecute K for criminal fraud. Might try to get the authorities interested in prosecuting Kostandin for criminal fraud for borrowing money with the intent to not pay it back (this is hard to prove, however)

You might want to advise L to pay back the $19,000 NOW to avoid penalties/litigation.

1.3 Karen loans Knopf $10,000 for his day-care center which is well-liked. He moves it, the rent goes up, and the management begins to suck. Karen wants to replace the manager and is afraid that Knopf will default on the loan. Can’t use self-help. Here, the DR is not in default so have to wait until they are and

get a judgment. When DR is not in default, CR can’t file a lawsuit. You can’t take any action until you get a judgment so will have to wait until they miss a payment. CR could sue for anticipatory breach, but very hard to prove.

A CR is like a partner of a DR because if the DR fails to fulfill his part, the CR will not get paid because the DR will likely not have the resources to pay back the money.

What could have been done to prevent the problem? Affirmative and negative covenants . Typical provisions might include financial ratios, changes in management, cross default provisions, etc. We could have put a clause in the agreement that Knopf would be in default if his debt to asset ratio falls below X or to give Karen management rights or if there is a change in mgmt or if default to any

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other CR then it’s a default to Karen. Even with a clause in the agreement, Karen could not use self help unless she provided for a self help clause in the K.

If you can get a judgment, you may be able to enjoin Knopf from liquidating more assets if you can prove that he is fraudulently liquidating assets. He can liquidate for legitimate business purposes even if this screws Karen out of money.

A judgment gives the CR a lot of leverage because Karen could send the sheriff over at any time.

1.4 Has judgment now and wants money. What does the attorney need to know? Karen has to compel payment thru legal channels (writ of execution or garnishment).

How to find assets? Every collection suit allows discovery. Ask for a deposition in aid of execution. It may be hard to serve a subpoena on the DR because DR is being evasive. Formal discovery is very expensive.

Other ways to find assets:o Public records would tell me if Knopf owns real estate or has cars registered

in his name. o Could hire a private investigator to research what other personal property

Knopf might have. o Use discovery proceedings to depose Knopf and gain information that way or

through a request for production of records. Use interrogatories.o Search for lawsuits that DR is involved in.

Deposition in aid of execution : a deposition to determine where assets are located (to aid in preparing a writ of execution). You must serve the DR with the notice of the deposition. Many times the DR has fled the jurisdiction at this point. Additionally, depositions are extraordinarily expensive b/c you must hire a court reporter and pay for binding and mailing

Taking the day care center’s equipment is dicey. The judgment is against Knopf, not the day care center, which might be its own corporate entity. Levying property that belongs to Knopf clearly is permissible. It may be possible to go after the day care equipment, but unsecured CRs of the day care center probably also want the equipment and the writ of execution must identify the equipment for the sheriff.

1.5 Every state has exempt property statutes. SO you may not be able to touch some of the DR’s assets because they are exempt. The statutes keep the DR’s from becoming wards of the state. Toyota: The motor vehicle is worth $4,800 more than is exempt so it is partially

exempt and might be able to force a sale of the vehicle to take that amount per 815.18(9), except that Knopf has not claimed any consumer goods, so the $5,000 consumer goods exemption can be added to the motor vehicle exemption, making the vehicle untouchable. Vehicle can be consumer goods.

House: House is worth $35,000. The homestead exemption gives you $40,000 but you must reside there. Also, can only exempt land up to 40 acres. Assuming that the house is his homestead, it probably is exempt from execution because it is worth less than $40,000 per §815.20. If he is not occupying the house, it is not exempt, and can be levied against, and, if the land exceeds 40 acres, some of the land may be levied against.

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Equipment: The day care center’s property is probably fair game for levying for any amount above the business exemption of $7,500, which would get me another $2,500 (see § 815.18(3)(b)). Knopf can pick the equipment that he wants to exempt. You could argue that the day care equipment is not “equipment used in the business” because the day care is out of business, and therefore not exempt.

Bank account: Serve a writ of garnishment on bank to get the $1,265.92 assuming that Knopf doesn’t hide the money before it is garnished or spend the money on a legitimate personal use (see § 815.18(3)(k)).

NotesUncovering assets during a deposition can be tricky. The questions need to uncover current and potential sources of funds and current and potential assets. Once you have a writ of execution, you must identify specific assets for the sheriff to levy.

Partially exempt property can be seized, sold and the exempt amount turned over to the debtor.

II. Security and Foreclosure

A. The Nature of Security9-109. SCOPE(a)Except as otherwise provided in subsections (c) and (d), this article applies to:

(1) a transaction, regardless of its form, that creates a security interest in personal property or fixtures by contract;(2) an agricultural lien;(3) a sale of accounts, chattel paper, payment intangibles, or promissory notes;(4) a consignment;(5) a security interest arising under Section 2-401, 2-505, 2-711(3), or 2A-508(5), as provided in Section 9-110; and(6) a security interest arising under Section 4-210 or 5-118.

As can be seen, the legal remedies for unsecured creditors suck. Persons in the business of making loans want better remedies and collection rights. This more effective set of collection rights is known as a lien.

A lien is a charge against or an interest in property to secure payment of a debt or performance of an obligation. A lien is a relationship between a property (the collateral) and a debt. If a debt is not paid, then creditor may demand the application of the value of the collateral to pay the debt. The process for accomplishing this is termed foreclosure.

Liens may take several forms. The most common form is a security interest. A security interest in property may arise in three ways: contract between debtor and creditor; statute—mechanic’s liens judicial—court orders arising from judgments

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Therefore, a security interest may be created voluntarily or involuntarily. In creating a security interest through contract, the debtor may offer almost any property as collateral. The usefulness of the property as collateral depends on 1) the resale value and 2) the leverage provided. The contract may impose obligations upon the debtor beyond simple repayment.

The impact of enhanced collection rights for secured creditors further diminishes the collection rights of unsecured creditors. So, why would anyone be an unsecured creditor? status was involuntary (tort); receipt of higher interest rate; ignorance business custom

Lending could go on without security interests through sales and options to repurchase. However, security interests are more efficient and less cumbersome. Lawyers constantly create hybrid instruments by combining existing transactions in new ways. Courts tend to look at the substance of the transaction over the form. If a transaction is intended to create a security interest, then the intended as security doctrine creates a security interest regardless of the actual forms used. See U.C.C. § 9-109(a)(1). Even with security interests, the problem of collecting on a debt through foreclosure is difficult, time-consuming and expensive.

CaseBasile v. Erhal Holding Corp. (p. 25)

Security interest – mortgageIntended as security doctrine

B. Foreclosure ProcedureForeclosure procedures for real estate vary widely from state to state. However, Article 9 provides a standard template for the foreclosure process upon personal property. Foreclosure on personal property however is distinct from taking possession of the collateral. Foreclosure is a process that leads to the transfer of ownership of the collateral free from any right of the debtor to redeem the collateral. Usually the transfer in ownership occurs coincidentally with a transfer in possession. But, the transfer in possession may occur earlier or later.

1. Judicial ForeclosureA foreclosure is said to be a judicial foreclosure if it is accomplished through a court order. In order to get the court order, the creditor must sue the debtor and request that the equity of redemption be foreclosed. If the creditor succeeds, then the court sets a date for a foreclosure sale. On that date, the sheriff conducts an auction and the winner pays the entire purchase price to the sheriff immediately. The foreclosure sale is confirmed by the court. At this time, the debtor may raise any objections such as the following:

the sale was not advertised in accord with the final judgment;

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the auction was not held in precisely the location advertised; someone was prevented from attending; or some arrangement between interested parties “chilled” the bidding.

After the confirmation order is entered and the time for appeal has expired, the sheriff distributes the proceeds of the sale to the creditor. If the proceeds exceed the amount of the debt, then the surplus is distributed first to junior creditors and then to the debtor. If the proceeds are less than the amount of the debt, then the creditor may sue for the deficiency.

After the foreclosure sale, the debtor must give up possession of the property. If the debtor does not give up possession, then the creditor may get a writ of assistance to have the sheriff seize the property. In this way the writ of assistance operates similarly to a levy of a writ of execution.

The foreclosure process can be arduous if the debtor opposes foreclosure. Additionally, many states have laws that benefit the debtor when the debt is secured by the debtor’s residence. For this reason, creditors may seek alternative solutions such as a deed in lieu of foreclosure or purchase the debtor’s equity of redemption.

2. Power of Sale ForeclosureAn alternative to foreclosure in 25 states is the power of sale. If the security agreement contains appropriate language, then the collateral will be held in trust by the creditor or a third party such as a bank or title company. In the event of default, the trustee can sell the property and pay the loan from the proceeds of sale.

Foreclosure is still required under this system. However, the process does not involve filing a lawsuit and getting a court order. The creditor simply records the default in the public records and then upon the expiration of a grace period without cure, the trustee sells the property at auction and turns over the proceeds to the creditor.

The primary advantage of this system is the avoidance of costly litigation.

3. U.C.C. Foreclosure by Sale9-601. RIGHTS AFTER DEFAULT; JUDICIAL ENFORCEMENT; CONSIGNOR OR BUYER OF ACCOUNTS, CHATTEL PAPER, PAYMENT INTANGIBLES, OR PROMISSORY NOTES(a) After default, a secured party has the rights provided in this part and, except as otherwise provided in Section 9-602, those provided by agreement of the parties. A secured party:

(1) may reduce a claim to judgment, foreclose, or otherwise enforce the claim, security interest, or agricultural lien by any available judicial procedure; and(2) if the collateral is documents, may proceed either as to the documents or as to the goods they cover.

9-610. DISPOSITION OF COLLATERAL AFTER DEFAULT

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(a) After default, a secured party may sell, lease, license, or otherwise dispose of any or all of the collateral in its present condition or following any commercially reasonable preparation or processing.

9-617. RIGHTS OF TRANSFEREE OF COLLATERAL(a) A secured party's disposition of collateral after default:

(1) transfers to a transferee for value all of the debtor's rights in the collateral;(2) discharges the security interest under which the disposition is made; and(3) discharges any subordinate security interest or other subordinate lien.

9-623. RIGHT TO REDEEM COLLATERAL(a) A debtor, any secondary obligor, or any other secured party or lienholder may redeem collateral.(b) To redeem collateral, a person shall tender:

(1) fulfillment of all obligations secured by the collateral; and(2) the reasonable expenses and attorney's fees described in Section 9-615(a)(1).

(c) A redemption may occur at any time before a secured party:(1) has collected collateral under Section 9-607;(2) has disposed of collateral or entered into a contract for its disposition under Section 9-610; or(3) has accepted collateral in full or partial satisfaction of the obligation it secures under Section 9-622.

The Article 9 of the UCC offers default provisions that govern foreclosure by creditors on personal property. The procedure is less cumbersome than the procedure for foreclosure on real property.

C. Problem Set 22.1: See problem 1.6 for background. Now, Karen has a security interest in the car, house, day care equipment, and bank account. Karen can foreclose on the car, day care equipment, and bank account, as §

815.18(12) prevents Ted from claiming that the property is exempt from a secured CR. § 815.18(12) says that a creditor can get personal prop if the creditor holds a security interest. Karen may be able to take the house though, but the only people able to foreclose on a homestead are mortgages, laborers, mechanics, and purchase money lenders per § 815.20(1). If Karen only had an Art. 9 security interest, then that applies only to personal property and house still would be exempt.

Every state’s exemption statute gives way to those with security interests or liens. Secured creditors are not affected by exemption statutes. They only stop unsecured creditors.

A purchase money lien is when someone loans you money to buy a particular item ONLY.

2.3: Your client, a bank, wants to foreclose on the Hurleys, who have missed payments on their house. Linda Hurley comes to see you, saying that her husband has cancer and

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that she has been trying to sell the house to no avail. The house is worth more than the amount she owes the bank, and she wants you to draft a contract by which she will give the house to the bank without a foreclosure on her record. (She wants a deed in lieu of foreclosure)

1. Can we give her a deed in lieu of foreclosure? A DILOF eliminates the need to foreclose. A foreclosure suit can be long and

expensive. A DILOF immediately extinguishes the mortgage and transfers ownership

immediately. A DILOF eliminates the possibility of a deficiency judgment. This would be

good for the creditor. Also good for the debtor DILOF cuts off the debtor’s right to redeem even if DR pays the debt. Contra: In a CL foreclosure suit, every DR has a CL right to redeem which

ends at the time of the foreclosure sale. If DR pays balance owed and interest before sale then DR has CL right to redeem the property.

2. Are there any problems? No, not as long as the Hurleys understand that I represent only the bank, and that they are free to get their own attys. Put any agreements in writing to CYA.

3. *What if the Hurleys deed the property over today, with the understanding that you will return the deed if they make the back payments within 60 days? This would present a problem for my client, as this would be a secured credit transaction under the Supreme Court’s view, so the Hurleys would still be able to exercise their right of redemption. Here you have given the right to redeem within 60 days so you would have to foreclose after that. A DILOF won’t work anymore because not immediate exchange due to the 60-day grace period. You have created a contingent property interest here causing a secured transaction. If they don’t pay in 60 days then file DILOF and still have to foreclose. This is like Basile v. Erhal case. If DILOF is executable immediately=ok. If DILOF is not executable immediate=NOT ok because now contingent

which creates a secured transaction and need to foreclose.

2.4: Same facts as above. What if, in creating new loan contracts, the debtor agrees to appoint a trustee bank to hold the title and deliver it to creditor in the event that DR defaults for an extended period? Would this be problematic?

1. Yes, unless authorized by DOT statute. This is essentially a deed of trust, and, unless authorized by statute, will be viewed as a normal secured transaction requiring judicial foreclosure. The facts say that the jurisdiction only allows judicial foreclosure (see 2.3, above), so this arrangement would not work – the bank would still have to judicially foreclose.

2. Here, if you were in a DOT state that allowed for nonjudicial foreclosure then could include a power of sale provision in the agreement and CR can use statutory process to foreclose. In many deed of trust jurisdictions, there is a power-of-sale provision in their

statutes that, if included in the mortgage K, allows the lender a way to

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foreclose non-judicially. Power of sale foreclosure is expedited as compared to judicial foreclosure.

3 types of foreclosure:judicial foreclosure (requires lawsuit)nonjudicial foreclosure (no suit required; POS statutory procedure in documents)Art 9 foreclosure (no suit; allows to avoid suit)

2.5: Same facts as above. What if, instead of putting the deed in a trust, you put a corporate borrower’s stock in trust, knowing that, upon default, the bank will foreclose on the stock, take control of the corporation, and sign the deed to the bank? Assume this is okay with respect to securities law.

1. Mashimoto rec’s Art. 9 sec interest in stock and mortgage in real property which both need foreclosure and are legitimate. If you foreclose on an Art. 9 security interest in the stock, it is much faster than the normal judicial foreclosure. Some courts have upheld this type of arrangement as valid.

2. You can make company sell personal property assets (stock) because § 9.610(a) and § 9.623 allows sale of stock by foreclosing on it. This process has worked. Can foreclose on stock, buy it at sale, and can make corporations sell assets to pay the debt.

III. Repossession of Collateral

A. The Importance of Possession Pending ForeclosureWhen a secured creditor has placed a debtor in default and is seeking to foreclose, the creditor’s interest in the collateral is much greater than the debtor’s interest. In order to protect that interest, the creditor should take possession of the collateral at the first opportunity for several reasons. First, the debtor’s incentive to maintain the collateral is non-existent and the debtor may destroy the collateral out of spite. Second, the use of the collateral between the time the right to foreclose accrues and the time the foreclosure sale is confirmed may have significant economic value. Third, if the debtor is in possession of the property, then potential buyers may have difficulty determining the collateral’s true value.

Creditors who can take possession of key collateral have enormous bargaining leverage. This leverage alone may be enough to enable the creditor to get paid, to raise the interest rate, to demand additional collateral, etc. Alternatively, a debtor that can deny effectively possession of collateral has bargaining leverage that enables the debtor to extend payments, renegotiate payment terms, etc.

B. The Right to Possession Pending Foreclosure—Real Property

1. The Debtor’s Right to Possession During ForeclosureThe general rule is that mortgagees never become entitled to possession of mortgaged real property in their capacity as mortgagees. The debtor remains owner of the property and is entitled to possession of it until the court forecloses the debtor’s

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equity of redemption and the sale is held. Only the purchaser at the foreclosure sale (who may, of course, be the mortgagee) is entitled to dispossess the debtor.

2. Appointment of a ReceiverWhile a foreclosure case is pending, any interested party can apply for the appointment of a receiver to preserve the value of the collateral. A foreclosing mortgagee does not always succeed in winning the appointment of a receiver. Explicit provision for a receiver in the mortgage helps. Many states have statutes governing the appointment of receivers

3. Assignment of RentsIf the real property that is serving as collateral is an income producing property, then the creditor should include in the mortgage a provision allowing the creditor to take an assignment of rents. This provision gives the mortgagee the right to collect the rents directly form the tenants in the event of default.

C. The Right to Possession Pending Foreclosure—Personal Property

9-609. SECURED PARTY'S RIGHT TO TAKE POSSESSION AFTER DEFAULT(a) After default, a secured party:

(1) may take possession of the collateral; and(2) without removal, may render equipment unusable and dispose of collateral on a debtor's premises under Section 9-610.

(b) A secured party may proceed under subsection (a):(1) pursuant to judicial process; or(2) without judicial process, if it proceeds without breach of the peace.

(c) If so agreed, and in any event after default, a secured party may require the debtor to assemble the collateral and make it available to the secured party at a place to be designated by the secured party which is reasonably convenient to both parties.

9-610. DISPOSITION OF COLLATERAL AFTER DEFAULT(a) After default, a secured party may sell, lease, license, or otherwise dispose of any or all of the collateral in its present condition or following any commercially reasonable preparation or processing.(b) Every aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable. If commercially reasonable, a secured party may dispose of collateral by public or private proceedings, by one or more contracts, as a unit or in parcels, and at any time and place and on any terms.(c) A secured party may purchase collateral:

(1) at a public disposition; or(2) at a private disposition only if the collateral is of a kind that is customarily sold on a recognized market or the subject of widely distributed standard price quotations.

(d) A contract for sale, lease, license, or other disposition includes the warranties relating to title, possession, quiet enjoyment, and the like which by operation of law accompany a voluntary disposition of property of the kind subject to the contract.

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(e) A secured party may disclaim or modify warranties under subsection (d):(1) in a manner that would be effective to disclaim or modify the warranties in a voluntary disposition of property of the kind subject to the contract of disposition; or(2) by communicating to the purchaser a record evidencing the contract for disposition and including an express disclaimer or modification of the warranties.

(f) A record is sufficient to disclaim warranties under subsection (e) if it indicates "There is no warranty relating to title, possession, quiet enjoyment, or the like in this disposition" or uses words of similar import.

Article 9 favors creditors for possession. The creditor does not need to involve courts or public officials if the creditor can take possession of the collateral without a breach of the peace. If the debtor resists repossession, then the creditor can file an action for replevin.

The replevin action gives a writ to any party entitled to take possession of tangible personal property. The writ directs the sheriff to repossess the property and turn it over to the creditor. Simply, filing the action the creditor can move for an order granting immediate possession pending the outcome of the case. Normally, the creditor must post a bond to protect the debtor in case of an adverse ruling.

CaseDel’s Big Saver Foods, Inc. v. Carpenter Cook, Inc. (p. 40)

Repossession of collateral – personal propertyWrit of replevin

D. The Article 9 Right to Self-Help RepossessionA creditor with an Article 9 security interest in tangible, personal property can bypass the courts and the sheriff and do its own work. The authority to do this can be found in § 9-609(b)(2). Most security agreements require the debtor to surrender the collateral. However, not all debtors willingly do this.

This creates the need for repo men, who act as independent contractors recovering property from defaulted debtors. Despite their independent contractor status, the courts still will hold the secured creditor liable for any breach of the peace by the repo men. An alternative to repossession is to render the collateral unusable.

E. The Limits of Self-Help: Breach of the PeaceThe U.C.C. permits self-help repossession. The U.C.C. also limits the means to accomplish self-help repossession to means that do not create a breach of the peace.

Breach of the peace is not defined statutorily. Case law determines the definition of breach of peace. As a result, it is difficult to know before acting whether an action will constitute a breach of the peace. The two primary factors considered in making the determination are the following:

the potential for immediate violence; and

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the nature of the premises intruded upon.These factors are not completely independent. The likelihood of violence increases when the trespass occurs at a dwelling. A creditor’s entry to recover collateral may be privileged and not constitute a breach of peace if

the entry does not involve a confrontation; and the timing and manner of entry are reasonable.

When recovering collateral, if the collateral is located on a Θ’s property, then notice to the Θ supports the reasonableness of the repossessor’s actions. Trespass is not a per se breach of the peace. In order for a trespass to be a breach of the peace, the trespass must be considered in light of the two primary factors. However, actual confrontation or violence is not necessary to find a breach of the peace; the standard is the potential for immediate violence.

In reading the cases where breach of peace has been found, it appears that breach occurs when either of the two factors is violated. The potential for immediate violence requires the actual presence of the debtor or some agent of the debtor. Also, the confrontation must occur before the repossession is effected.

Class notesBreach of the peace has two elements

physical presence verbal objection

CaseSalisbury Livestock Co. v. Col. Cent. Credit Union (p. 44)

Repossession of collateralLimits of self-help – breach of peace

Factors to considerPotential for immediate violenceNature of the premises intruded upon – res v. comm’l

F. Self-Help Against Accounts as Collateral9-406. DISCHARGE OF ACCOUNT DEBTOR; NOTIFICATION OF ASSIGNMENT; IDENTIFICATION AND PROOF OF ASSIGNMENT; RESTRICTIONS ON ASSIGNMENT OF ACCOUNTS, CHATTEL PAPER, PAYMENT INTANGIBLES, AND PROMISSORY NOTES INEFFECTIVE(a) Subject to subsections (b) through (i), an account debtor on an account, chattel paper, or a payment intangible may discharge its obligation by paying the assignor until, but not after, the account debtor receives a notification, authenticated by the assignor or the assignee, that the amount due or to become due has been assigned and that payment is to be made to the assignee. After receipt of the notification, the account debtor may discharge its obligation by paying the assignee and may not discharge the obligation by paying the assignor.

9-607. COLLECTION AND ENFORCEMENT BY SECURED PARTY(a) If so agreed, and in any event after default, a secured party:

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(1) may notify an account debtor or other person obligated on collateral to make payment or otherwise render performance to or for the benefit of the secured party;(2) may take any proceeds to which the secured party is entitled under Section 9-315;(3) may enforce the obligations of an account debtor or other person obligated on collateral and exercise the rights of the debtor with respect to the obligation of the account debtor or other person obligated on collateral to make payment or otherwise render performance to the debtor, and with respect to any property that secures the obligations of the account debtor or other person obligated on the collateral;(4) if it holds a security interest in a deposit account perfected by control under Section 9-104(a)(1), may apply the balance of the deposit account to the obligation secured by the deposit account; and(5) if it holds a security interest in a deposit account perfected by control under Section 9-104(a)(2) or (3), may instruct the bank to pay the balance of the deposit account to or for the benefit of the secured party.

(b) If necessary to enable a secured party to exercise under subsection (a)(3) the right of a debtor to enforce a mortgage nonjudicially, the secured party may record in the office in which a record of the mortgage is recorded:

(1) a copy of the security agreement that creates or provides for a security interest in the obligation secured by the mortgage; and(2) the secured party's sworn affidavit in recordable form stating that:

(A) a default has occurred; and(B) the secured party is entitled to enforce the mortgage nonjudicially.

(c) A secured party shall proceed in a commercially reasonable manner if the secured party:

(1) undertakes to collect from or enforce an obligation of an account debtor or other person obligated on collateral; and(2) is entitled to charge back uncollected collateral or otherwise to full or limited recourse against the debtor or a secondary obligor.

(d) A secured party may deduct from the collections made pursuant to subsection (c) reasonable expenses of collection and enforcement, including reasonable attorney's fees and legal expenses incurred by the secured party.(e) This section does not determine whether an account debtor, bank, or other person obligated on collateral owes a duty to a secured party.

A debtor may use accounts receivable (A/R) as collateral for a loan. This arrangement may be accomplished in several ways.

debtor has complete freedom to collect and use the proceeds from the A/R. debtor may collect the A/R but creditor may require the debtor to apply a

specified portion of collected A/R to the line (receivables line, factoring) debtor may assign A/R to the creditor either with or without notification debtor may be required to use a lockbox

If the creditor has properly secured himself, then the creditor may pursue the A/R directly.

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G. Problem Set 33.1: Look at problem 1.1. Jeff now has a security interest in Lisa’s lawn furniture. Does your advice change?

Yes, Jeff can take the furniture through self-help possession if he can avoid a breach of the peace. UCC §§ 9-102(a)(72) and (73), 9-609.

§ 9-609: after default, a secured party may take possession of the collateral and without removal may render the equipment unusable. A party may proceed under subsection (a) through judicial process (writs of

replevin) or without a judicial decision if he can avoid a breach of the peace. A breach of the peace occurs when there is a possibility for violence (ex. possibility of violence, leaving property unprotected, actual violence).

9-609(a)(1) allows the repo man to do his job. 9-609 says self-help repossession is allowed for secured creditors as long as there is no breach of the peace. 9-609(b)(2) says that secured creditors have right of self help after default as long as they do not commit a breach of the peace.

§ 9-102(a)(72)-(73) define secured party and security agreement.

3.2: Faye is head of a collections dept and wants you to make some guidelines for the repossession of a bulldozer owned by a subcontractor on a site owned by a developer, and fences and security are provided by the general contractor. Focus on: 1) sites where there is neither a guard nor a fence 2) sites where there is a fence but no guard 3) sites where there is a guard. 4) As regular counsel, you should also consider whether there is anything that should be in Faye’s security agreements about repo that might make Faye’s job easier.a) Sites where there is neither a guard nor a fence. Does it matter if property is

residential or commercial? For breach of peace, you need something less than an actual violent confrontation.

Usually just possibility of violence is enough for a breach of the peace. Trespass per se is not a breach of the peace.

On residential property, there is probably a greater chance for violence resulting from the repossession trespass because people have an impulse to protect their homes. Additionally, people have an expectation of privacy. (See Salisbury v. Colorado – a jury should determine reasonableness of entry; courts look at the potential for immediate violence and the nature of the premises intruded upon (residential v. commercial; DR v. 3dp; rural v. urban).

Trespass on a Θ’s property is more likely to lead to a breach of the peace, because the Θ might not know why you are there, whereas the DR would know why you are there. Generally, trespass on commercial property is less of a breach of the peace than is residential property.

b) Sites where there is a fence but no guard Global Casting case allowed the CR to get locksmith to pick locks, but you have

to relock it when you leave. However, this case was based on a contractual agreement giving the creditor permission to enter the debtor’s premises.

Sometimes, this won’t be allowed, especially if this approach leaves expensive equipment unguarded. See Laurel Coal – you can cut the locks to the fence but

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will have problems if leave the property unsecured/unprotected afterwards which will amount to a breach of the peace. However, if the fence is owned by a Θ, the client should probably not enter the premises without permission of the Θ owner.

c) Sites where there is a guard If the repo crew encounters a guard, usually MUST withdraw. However, Williams case – even if confronted by Θ if the discussion remains calm

then can go ahead and repo. Can you lie to the guard? KB Oil case suggests a little harmless fraud is not a

problem. However, for an attorney, it is against the ABA MRPC for a lawyer to counsel a client to engage in such fraudulent activity. See R. 1.2

d) What should the client put in her contracts to make repossession easier? A Global Casting type provision that gives permission to enter premises.

However, 9-602(6) does not allow waiver of lawsuit in K for breach of peace. Art 9 is contractual and 9-602 tells you provisions you CANNOT change via contract.

9-609(a)(2) says after default a secured party can take the collateral and can render the equipment unusable. So, can take it OR render it unusable.

9-609(c) – DR will assemble the collateral and make it available for creditor. This gives you justification to enter property and take it.

Can add in whatever you want contractually as long as can overcome contract defenses such as unconscionability.

DR must inform Θ’s of repossession. Liquidated damages clause in case DR resists repo.

3.3: How do you resist a self-help repossession? Your client, Sal Ferragamo, is having problems collecting on his accounts and is behind on payments to ITT Finance, whose loan is secured by Ferragamo’s equipment. Ferragamo needs 2 weeks to turn around financially. Ferragamo has received a letter from ITT to collect the collateral and present it to ITT, which Ferragamo is required by contract to do. What can client do to avoid bankruptcy and repossession? If ITT comes for the equipment, what should he do? The jurisdiction has a statute prohibiting the concealment of personal property with a security interest, and ABA rules prohibit advising clients to act criminally or fraudulently, although you can advise your client as to the effect of fraudulent activities.

1. Key to preventing a self-help repossession is to create a possibility of violence. General Rule – physical presence of debtor AND a verbal objection is enough for

breach of peace. Morris case – don’t need physical violence. Telling CR’s to leave your property

is enough. If DR tells them to get off his property and not to take it and they take it anyway,

the DR can sue because there was a breach of the peace and cause of action is trespass and conversion. However, reality is suit is expensive and time consuming and you’ve lost your property while you are trying to sue.

2. Best advice is to tell Sal to sleep on top of his collateral. Suggest that he lock it up in some way and if lock is broken later it is a breach per Laurel Coal. Further, if Sal locks it up in his house then it creates residential concerns.

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3. Advise Sal of the penalties for fraudulent concealment. However, explain (without advising) that, should he decide to hide the property, and if he is able to repay the debt within 2 weeks, he could possibly avoid repossession. Additionally, in bankruptcy court, you cannot get a discharge if you conceal property.

4. If ITT brings a sheriff, he should ask to see the court order permitting replevin, because without this, the repossession cannot take place over Ferragamo’s objections. Writ of replevin – CR asks for judicial help in repossession which asks sheriff to go take DR’s property for you.

5. In some states, the sheriff can use force to carry out a writ of replevin. In other states, the sheriff will have to get a warrant to use force. Walker v. Walthill held that the mere presence of a sheriff in a self-help repossession (in the absence of a writ of replevin) constituted a breach of the peace. See also § 9-609 comment 3, which states that the Code does not authorize (but does not prohibit) the assistance of law enforcement officials in self-help repossession. So, if you are in a Walker jurisdiction, advise client to call the cops so that there is a breach of the peace.

6. To resist a repossession, be physically present and verbally object. That is all that is required in most jurisdictions to resist repossession (but see Rainwater, page 60-61 #9, which held that there had to be more than mere presence and objections).

3.4: If both ITT and Ferragamo have the best available legal counsel, who wins? The DR wins because he has an easier time creating a breach of the peace (presence +

objection). The secured creditor cannot self-help repossess over the DR’s objections without a court order because this would breach the peace. Until ITT can get to the property without a breach of the peace, or until ITT gets a court order for replevin, Ferragamo’s property is safe. A writ of replevin can be obtained in as little as 20 days, however, so Ferragamo won’t be protected for long.

Many people, especially consumers without lawyers, do fall “victim” to self-help repossessing CRs when they could resist.

3.5: Deare sells farm equipment on credit to farm supply retailers. Firstbank lends Deare an amount equal to 60% of Deare’s A/R. When Deare collects an account, it must send 60% of the amount collected to Firstbank under their agreement. Deare doesn’t want its customers to know of Firstbank’s interest in the accounts because it might make the customers nervous. Firstbank is considering honoring Deare’s request to not make its interest known to the customers, but wants to know of the risks. How can Firstbank prevent Deare from cheating it by not reporting that certain accounts have been paid?

UCC § 9-102(a)(2) defines accounts receivable (A/R) – when someone owes you money on acct of a good sold or service rendered. Anything that is worth money a DR can offer as collateral. It is common to take a security interest in a DR’s AR so that CR can directly collect on those accts.

What are the risks here? Underestimating the risk of noncollection Deare might collect on an acct but not pay money over to bank like supposed to –

bank can discover this problem via invoices.

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What if Deare fraudulently creates invoices? Bank should conduct audits of Deare’s accounts but this is expensive.

3.6: A year later, Deare defaults, and four months ago Firstbank notified the customers to pay invoices directly to Firstbank. a) Horne’s feed and seed refuses to pay an invoice, saying that it paid Deare a month

ago. Can Firstbank collect the money from Horne? Yes. Once the acct DR has rec’d authenticated notification f/the assignee CR the

only way to dx the debt is to pay the assignee. Here, Horne was notified to pay firstbank, so Horne’s debt can only be discharged by paying Firstbank. See § 9-406(a).

§ 9-406(a): Discharge of acct DR; effect of notification.Subject to subsections (b)-(i), an acct DR on an acct, chattel paper, or a pymt intangible may discharge its obligation by paying the assignor until, but not after, the acct DR receives a notification, authenticated by the assignor or the assignee, that the amount due or to become due has been assigned and that pymt is to be made to the assignee. After receipt of the notification, the acct DR may discharge its obligation by paying the assignee and may not discharge the obligation by paying the assignor. § 9-102 defines “authenticated” signature

b) Wilson refuses to pay an invoice for $42,000, claiming that Deare breached a warranty on the goods amounting to $19,000 in damages. Firstbank can recover $23k (the difference between $42,000 and $19,000), but

Firstbank cannot touch the amount subject to dispute per 9-404(a)(1). The assignee takes the acct subject to all defenses that could have been raised by the acct DR against the account CR. Assignee steps into account creditor’s shoes. So, Wilson is entitled to its warranty defense.

§ 9-404(a): Assignee’s rights subject to terms, claims, and defenses; exceptionsUnless an acct DR has made an enforceable agreement not to assert defenses or claims, and subject to subsections (b) through (e), the rights of an assignee are subject to:all terms of the agreement between the acct debtor and assignor and any defense or claim in recoupment arising from the transaction that gave rise to the contract [warranty claims]any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives a notification of the assignment authenticated by the assignor or the assignee [non-warranty claims]

3.7 – SEE HANDOUT 3.9: Mel Farr sells used cars to customers with bad credit. Cars are equipped with a computerized device that will allow the car to start only if the driver correctly enters a new code each week. Is this device legal? Under UCC § 9-609(a)(2), the secured creditor can render equipment unusable, but is

the car equipment or a consumer good. If the car is a consumer good, then § 9-609(a)(2) does not apply. Still, the right to render the car unusable may be contractually created, unless the

consumer cannot contract out of this per § 9-602.

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So, a secured creditor can self-help repossess without breach of peace. And, a secured creditor can render the collateral unusable.

IV. Judicial Sale and DeficiencyA secured creditor may foreclose on his collateral via a judicial foreclosure. Once a judgment has been entered in a judicial foreclosure and the property seized, the next step required by law is a public sale. This procedure usually cannot be varied by contract. Of course, most Article 9 security interests do not go through judicial foreclosure; they follow the path of nonjudicial foreclosure.

A. Strict ForeclosureOne exception exists to the public sale requirement for strict foreclosures. Strict foreclosures are associated with real estate transactions known as contract for deed or installment land contract. In these types of transactions, the seller finances the sale to the buyer and retains title to the real property as security until the debtor pays the full purchase price. If the debtor defaults, then after a grace period the debtor’s interest in the property is forfeited and the court confirms that title remains with the seller.

B. Foreclosure Sale ProcedureThe foreclosure sale procedure is specified by statute in most states. The sales usually occur at specific times and locations and conducted by a public official, such as the sheriff or a clerk of the court. Upon completion, the highest bidder must pay. The sale is not finalized however until the court confirms the sale after reviewing the sale for procedural compliance.

After confirmation, the public official distributes the sale proceeds. If the amount distributed is not sufficient to satisfy the debt, then the creditor may ask the court to enter a deficiency judgment.

Transfer of property through foreclosure is not easy. The debtor has the common law right to redeem the property by paying the amount due anytime before confirmation. Confirmation cuts of this right to redeem. But, in many states the debtor has a statutory right to redeem the property ranging in length from six months to three years after the sale. When redeeming from the buyer, the debtor must include interest on the sale price and other expenses in connection with the sale, but the debtor does not need to pay for any improvements that the buyer made to the property. Statutory rights to redeem are transferable. Laws vary from state to state as to whether the statutory redeemer takes the property free and clear of any liens.

Class notesUpon completion of a foreclosure sale, the money goes to the following:

1. Repay the costs of the sale2. Foreclosing creditor’s debt3. Subsequent lienholders4. Any surplus goes to the debtor

Any deficiency judgment is an unsecured debt.

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C. Problems with Foreclosure Sale ProcedureForeclosure sales are not true market sales. Seldom does property sold at a foreclosure sale bring anything close to the market value. The following reasons contribute to this outcome: the sales are poorly advertised; prospective buyers are given little opportunity to inspect the property before the

bidding, but they must accept the property “as is;” the rule of caveat emptor applies in this setting; the sale takes place in a hostile environment that impedes the flow of information;

and the buyer may be unable to use the property until the statutory redemption period

expires.All of these factors increase the buyer’s uncertainty and risk and drive down the sale price at foreclosure sales.

A foreclosure sale may be overturned for procedural violations. However, in two circumstances the sale may be overturned for inadequate price. The first occurs when the disparity between the foreclosure sale price and the market value is so great as to shock the conscience of the court. The second occurs when procedural irregularities combine with inadequate price to make the sale inequitable.

Class notesShock the conscience price—10% - 40%Inadequate price—66%

CaseArmstrong v. Csurilla (p. 58)

Judicial sale and deficiencyProblems with foreclosure sale

Shock the conscience priceInadequate price plus procedural violations

1. AdvertisingThe statutory procedure for a foreclosure sale requires that the sale be advertised. Because the sale does not occur between a willing seller and a willing buyer, the advertisements tend to lack useful information and are placed in small circulation papers. Instead the advertisement is the minimum required to satisfy the statute. Consequently, the only people that see the advertisements are professional bargain hunters.

2. InspectionUnder the foreclosure sale procedure, the debtor is entitled to remain in possession of the property until after the sale is confirmed. Although the foreclosing creditor has the right to inspect the property, other potential bidders cannot go onto the property to inspect it. The buyer does not the floor plan, the condition of the building or if the utilities work prior to bidding on the property.

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3. Title and ConditionThe foreclosing secured creditor is not responsible for disclosing information about the property. This particularly is true with respect to information that is publicly available such as title information. The buyer of property at a foreclosure sale is well-advised to perform a title search in order find all liens and encumbrances on the property. Additionally, patent defects that could have been discovered or protected against will not provide the buyer any relief after the sale has been completed. The rule of caveat emptor still applies.

CaseMarino v. United Bank of Ill., N.A. (p. 64)

Judicial sale and deficiencyProblems with foreclosure sale

Title problemRule of caveat emptor

4. Hostile SituationBecause foreclosure sales are unwilling transactions, the debtor may not be forthcoming with information or access to the property to prospective buyers. The public official conducting the sale is not a good source of information. Even the foreclosing creditor may not have good information about the property. Furthermore, the debtor frequently will try to obstruct the sale by creating procedural irregularities.

5. The Statutory Right to RedeemIn jurisdictions with a statutory right to redeem, the debtor may redeem the property even after foreclosure. As a result, the buyer may have to wait months or years for possession

D. Antideficiency StatutesThe prices at foreclosure sales reflect the adverse conditions. As a result, the secured creditor is highly likely to have a deficiency after the sale. The secured creditor pursues this deficiency against the debtor with a deficiency judgment. In many states though, the debtor benefits from an antideficiency statute that prevents the creditor from being unjustly enriched by capping a deficiency judgment at the difference between the debt and the fair market value of the collateral.

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Sales Price FMV Debt Amount

Deficiency

SP’s Loss with Antideficiency Statute


E. Credit Bidding at Judicial SalesThe foreclosing secured creditor has one significant advantage over other bidders at a foreclosure sale. The foreclosing creditor may bid for the collateral with a credit bid. In doing this, an equivalent amount of the debtor’s debt is canceled. The secured creditor then can resell the property and make a profit.

Because the debtor is judgment proof and any deficiency would be uncollectible, the foreclosing creditor may bid the full amount of the debt. This assures that the debt is canceled and provides strong evidence that the sale price is not inadequate. If someone else bids higher, then the creditor is happy. If no one bids higher, then the creditor has the opportunity to inspect, evaluate, improve and resell the property at its leisure. Any profit on resale belongs to the creditor.

F. Judicial Sale Procedure: A Functional AnalysisAlthough some see the foreclosure sale process as a method to value the collateral, for the reasons above it rarely functions that way. The process does provide an incentive to knowledgeable debtors to come to terms with their secured creditors in order to avoid excessive deficiency judgment. The process however is far from elegant or efficient.

Class notesA bidder’s strategy is affected by many things including the following:

antideficiency statute estimated fair market value statutory right of redemption number of bidders

G. Problem Set 44.1: I represent a bank foreclosing on a piece of property. The debt is $53,232, but the house is worth $40-45,000. My state doesn’t allow deficiency judgments.a) If the bank is the only bidder, what should I advise them to bid?Moll says bid the full amount of the debt. There is no incentive to bid low because the bank cannot get a deficiency judgment. CB can credit bid the full amount it is owed so it has nothing to lose. This creates a high redemption price.

Why do we want to do this?

This will prevent a lawsuit for inadequate price because the debtor cannot argue for an unfair sale. Per the Armstrong case, value is adequate as long as it is 40% of the collateral’s value. A judicial sale only gets overturned if it “shocks the conscience.”

Additionally, (Depends on State) CB wants to set the price high if debtor has a statutory right to redeem. Debtor has a common law right to redeem before the sale if the debtor can come up with amount of debt plus interest. But, the common law right ends with the sale. Some states allow a statutory right of redemption after the sale. It gives the debtor a period of time to redeem by paying the amount of the purchase price at the foreclosure

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sale. The debtor usually gets to stay in possession during the statutory redemption period.

Order of payment in foreclosure sale:Pay the costs of salePay the 1st CRPays the next CR in lineAny surplus left goes back to DR. Any deficiency is owed by DR and CR can sue for it.

b) A 3rd party has bid $53,232. Should the bank bid higher?No. The value of the house is between $40,000 and $45,000 and CB won’t make a profit if it gets house and then sells it. So, if CB bids higher, it is a losing venture. Also, no deficiency judgment is allowed by statute. So, CB cannot recover the difference. If deficiency judgments were allowed by statute, then CB may want to bid higher.

c) A 3rd party has bid $44,000. Should the bank bid higher?Can say no because $44,000 is the fair market value of the house. Although, can say yes and credit bid full amt because the bank is not positive of the house’s value. If a person is willing to bid $44,000 at a foreclosure sale, then a market sale may draw more money. You may change your mind based on who the bidder is. So, can credit bid, buy house, do assessment of value, can resell it if it is worth more or if it is not then can contact the 3 rd

party to see if they still are willing to buy the house for $44,000. If they say no, then just sell it. This is a judgment call.

4.3: What do you need to know before buying foreclosed property?Four types of information are useful prior to bidding at a foreclosure sale:1. Information regarding the value of the house. You can get an appraisal – an estimate

of value based on sale prices of similar houses in the area. Get information from public records. Hire a realtor to give you information about comparable sales in the area.

2. Information regarding the state of the title to the house. A foreclosure sale will wipe out the lien being foreclosed on and any subsequent liens, but not liens created before the foreclosing lien. Per the Marino, the rule at judicial sales of real estate is caveat emptor! Check the real property records or have a title company do a search.

3. You also want information about the condition of the house. It would be useful to get inside the house to look at it

4. Information about the amount of the debt. The amount of the mortgage is sometimes in the notice of sale, and is almost always in the court file. The credit bidder is probably going to credit bid up to the amount of the mortgage if the house is worth more than the debt. So, if you aren’t willing to pay at least as much as the debt balance, don’t bother going (this only applies in a no-deficiency jurisdiction) (...?)

If you are willing to pay more than the mortgage balance, go to the DR and try to buy the common law right to redeem. Then, you can get the property cheap and won’t have to bid.

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You also can buy the DR’s statutory right of redemption and steal the house away from the highest bidder after the sale.

If you are the debtor, do you want a lot of people at your sale or a little? This depends upon several factors. If you are in a state with a deficiency statute, then you want a lot of bidder to increase

the price and prevent you from owing a deficiency. If you are in a state with an antideficiency statute, then you don’t care how many

bidders are there. Furthermore, if there is a statutory right to redeem, then a low sale price is advantageous.

Common law right of redemption allows the debtor, before the sale, to retain the house by paying back the outstanding mortgage debt plus interest and attorneys’ feesFind out if the debtor is interested in selling the house to raise money to exercise this rightNever buy a house from a foreclosing creditor within the statutory right of redemption period. The debtor (or his assignee) can steal the house from you for what the creditor paid at the auction, which is probably lower than what you paid to the creditor!

4.4: My client holds a $20 million dollar mortgage on a building worth about $18 million. There are four wealthy guarantors from whom the client can likely recover any deficiency.a) If your client is the only bidder, how much should they bid?Bid the lowest price possible because you can collect the rest through deficiency and then sell the $18 million building. There is a $38 million profit from the resale. The debtor gets none of the surplus because the debtor only gets money from surplus from the foreclosure sale. The strategy in a deficiency jurisdiction is to bid as low as possible.

However, the creditor must be careful not to bid so low as to “shock the conscience (<40%).” Still, it is difficult for the debtor to win a case for inadequate price. If the debtor does win an inadequate price suit, the court orders a new sale. The building sits longer. The creditor has to wait longer and will pay more for attorney fees. Here, the debtor will attack the sale per the Armstrong case because the creditor is the only one at the sale and it smacks of improper notice. Improper notice plus an inadequate price will help the debtor overturn the sale. Also, if the creditor bids too low, the debtor can redeem the property by exercising his statutory right of redemption.

b) A mysterious bidder bids $20 million, but you doubt he can afford it. If he can’t pay, a new sale will be set for the next month. What should you do?

Can bid higher OR can not bid higher and receive $20 million. If you bid higher, it is probably not very smart because you will owe that amount above the credit bid.c) What if you let the bid stand and then the bidder doesn’t pay? The court will set a new sale. This causes the building to sit idle for longer and not earn rent and attorney fees increase.

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In this jurisdiction, if the top bidder cannot pay, the property is sold to the next highest bidder. Following a bid of $12 million, someone bids $25 million, which you don’t think they can afford. What should your client do?HYPO: 3 bidders: 1st bids $12, 2nd bids $25, and 3d should not bid >$25k. If you don’t get $25M then get $12M and 8M deficiency.

V. Article 9 Sale and DeficiencySales under Article 9 serve essentially the same purpose as judicial sales. They determine the value of the collateral and convert that value into cash. If the debtor has equity in the collateral, the secured creditor deducts the amount owed from the proceeds of the sale and sends the remainder to the debtor.

A. Strict Foreclosure Under Article 99-620. ACCEPTANCE OF COLLATERAL IN FULL OR PARTIAL SATISFACTION OF OBLIGATION; COMPULSORY DISPOSITION OF COLLATERAL(a) Except as otherwise provided in subsection (g), a secured party may accept collateral in full or partial satisfaction of the obligation it secures only if:

(1) the debtor consents to the acceptance under subsection (c);(2) the secured party does not receive, within the time set forth in subsection (d), a notification of objection to the proposal authenticated by:

(A) a person to which the secured party was required to send a proposal under Section 9-621; or(B) any other person, other than the debtor, holding an interest in the collateral subordinate to the security interest that is the subject of the proposal;

(3) if the collateral is consumer goods, the collateral is not in the possession of the debtor when the debtor consents to the acceptance; and(4) subsection (e) does not require the secured party to dispose of the collateral or the debtor waives the requirement pursuant to Section 9-624.

(b) A purported or apparent acceptance of collateral under this section is ineffective unless:

(1) the secured party consents to the acceptance in an authenticated record or sends a proposal to the debtor; and(2) the conditions of subsection (a) are met.

(c) For purposes of this section:(1) a debtor consents to an acceptance of collateral in partial satisfaction of the obligation it secures only if the debtor agrees to the terms of the acceptance in a record authenticated after default; and(2) a debtor consents to an acceptance of collateral in full satisfaction of the obligation it secures only if the debtor agrees to the terms of the acceptance in a record authenticated after default or the secured party:

(A) sends to the debtor after default a proposal that is unconditional or subject only to a condition that collateral not in the possession of the secured party be preserved or maintained;

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(B) in the proposal, proposes to accept collateral in full satisfaction of the obligation it secures; and(C) does not receive a notification of objection authenticated by the debtor within 20 days after the proposal is sent.

(d) To be effective under subsection (a)(2), a notification of objection must be received by the secured party:

(1) in the case of a person to which the proposal was sent pursuant to Section 9-621, within 20 days after notification was sent to that person; and(2) in other cases:

(A) within 20 days after the last notification was sent pursuant to Section 9-621; or(B) if a notification was not sent, before the debtor consents to the acceptance under subsection (c).

(e) A secured party that has taken possession of collateral shall dispose of the collateral pursuant to Section 9-610 within the time specified in subsection (f) if:

(1) 60 percent of the cash price has been paid in the case of a purchase-money security interest in consumer goods; or(2) 60 percent of the principal amount of the obligation secured has been paid in the case of a non-purchase-money security interest in consumer goods.

(f) To comply with subsection (e), the secured party shall dispose of the collateral:(1) within 90 days after taking possession; or(2) within any longer period to which the debtor and all secondary obligors have agreed in an agreement to that effect entered into and authenticated after default.

(g) In a consumer transaction, a secured party may not accept collateral in partial satisfaction of the obligation it secures.

The debtor can consent to the secured party retaining the collateral in full or partial satisfaction of the debt. This consent can be implied if the debtor fails to object in writing within 20 days after notification was sent. The debtor’s right to consent is constrained by three conditions

no one else holding a lien against the collateral may object; in the case of consumer goods, the collateral is not in the possession of the debtor;

and in the case of consumer goods, the consumer has not paid at least 60% of any debt

secured by the consumer goods.

B. Sale Procedure Under Article 99-610. DISPOSITION OF COLLATERAL AFTER DEFAULT(a) After default, a secured party may sell, lease, license, or otherwise dispose of any or all of the collateral in its present condition or following any commercially reasonable preparation or processing.(b) Every aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable. If commercially reasonable, a secured party may dispose of collateral by public or private proceedings, by one or more contracts, as a unit or in parcels, and at any time and place and on any terms.(c) A secured party may purchase collateral:

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(1) at a public disposition; or(2) at a private disposition only if the collateral is of a kind that is customarily sold on a recognized market or the subject of widely distributed standard price quotations.

(d) A contract for sale, lease, license, or other disposition includes the warranties relating to title, possession, quiet enjoyment, and the like which by operation of law accompany a voluntary disposition of property of the kind subject to the contract.(e) A secured party may disclaim or modify warranties under subsection (d):

(1) in a manner that would be effective to disclaim or modify the warranties in a voluntary disposition of property of the kind subject to the contract of disposition; or(2) by communicating to the purchaser a record evidencing the contract for disposition and including an express disclaimer or modification of the warranties.

(f) A record is sufficient to disclaim warranties under subsection (e) if it indicates "There is no warranty relating to title, possession, quiet enjoyment, or the like in this disposition" or uses words of similar import.

9-611. NOTIFICATION BEFORE DISPOSITION OF COLLATERAL(a) In this section, "notification date" means the earlier of the date on which:

(1) a secured party sends to the debtor and any secondary obligor an authenticated notification of disposition; or(2) the debtor and any secondary obligor waive the right to notification.

(b) Except as otherwise provided in subsection (d), a secured party that disposes of collateral under Section 9-610 shall send to the persons specified in subsection (c) a reasonable authenticated notification of disposition.(c) To comply with subsection (b), the secured party shall send an authenticated notification of disposition to:

(1) the debtor;(2) any secondary obligor; and(3) if the collateral is other than consumer goods:

(A) any other person from which the secured party has received, before the notification date, an authenticated notification of a claim of an interest in the collateral;(B) any other secured party or lienholder that, 10 days before the notification date, held a security interest in or other lien on the collateral perfected by the filing of a financing statement that:

(i) identified the collateral;(ii) was indexed under the debtor's name as of that date; and(iii) was filed in the office in which to file a financing statement against the debtor covering the collateral as of that date; and

(C) any other secured party that, 10 days before the notification date, held a security interest in the collateral perfected by compliance with a statute, regulation, or treaty described in Section 9-311(a).

(d) Subsection (b) does not apply if the collateral is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market.

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(e) A secured party complies with the requirement for notification prescribed by subsection (c)(3)(B) if:

(1) not later than 20 days or earlier than 30 days before the notification date, the secured party requests, in a commercially reasonable manner, information concerning financing statements indexed under the debtor's name in the office indicated in subsection (c)(3)(B); and(2) before the notification date, the secured party:

(A) did not receive a response to the request for information; or(B) received a response to the request for information and sent an authenticated notification of disposition to each secured party or other lienholder named in that response whose financing statement covered the collateral.

9-623. RIGHT TO REDEEM COLLATERAL(a) A debtor, any secondary obligor, or any other secured party or lienholder may redeem collateral.(b) To redeem collateral, a person shall tender:

(1) fulfillment of all obligations secured by the collateral; and(2) the reasonable expenses and attorney's fees described in Section 9-615(a)(1).

(c) A redemption may occur at any time before a secured party:(1) has collected collateral under Section 9-607;(2) has disposed of collateral or entered into a contract for its disposition under Section 9-610; or(3) has accepted collateral in full or partial satisfaction of the obligation it secures under Section 9-622.

§ 9-610 gives the creditor broad discretion in disposing of collateral. One significant difference between judicial sales and Article 9 sales is that the creditor conducts Article 9 sales and distributes the proceeds. However, in conducting the sale, the foreclosing creditor must follow a commercially reasonable process. Additionally, the creditor must give prior notice to the debtor of the sale. § 9-611(c)(1). The U.C.C. incorporates the common law right to redeem. § 9-623. No statutory right to redeem exists after an Article 9 sale. Once the sale is complete, the debtor has no recourse unless the creditor uses a commercially unreasonable procedure. If the collateral is consumer goods, then the debtor also may recover a statutory penalty.

If collateral is sold through the Article 9 sale procedure and an inadequate price is received, the debtor may suffer an injury either through a loss of equity or through a larger deficiency judgment. Although a debtor may be injured through a loss of equity, no legal action is likely to result because either the debtor may not have the financial resources to bring a suit or the amount of the loss does not financially justify the suit. Litigation is more common for injury suffered from a deficiency judgment. Although a creditor may sue over a deficiency judgment, the debtor usually can mount a credible defense without great trouble by focusing on one of the following areas:

the creditor retained the collateral instead of conducting a sale; the creditor did not give proper notice of the sale; or

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the creditor did not conduct the sale in a commercially reasonable manner.

Class notesArticle 9 sales bring higher prices than judicial sales for the reason previously cited. Judical foreclosure is possible for Article 9 secured creditor.

C. Problems with Article 9 Sale Procedure

1. Failure to Sell the CollateralThe secured party may sell collateral, but the creditor does not have to sell the collateral. And, the creditor, except for consumer goods, can wait indefinitely before selling the collateral. The decision to retain the collateral instead of selling immediately may be influenced by many factors:

creditor can use the collateral; creditor waits to see if the debtor brings the debt current; creditor does not have the necessary license to sell the collateral; the collateral has been destroyed or become obsolete; or procrastination.

While the secured party has possession of the collateral, the collateral may decline in value. If this delay is commercially unreasonable, then the loss in value must be absorbed by the creditor. § 9-626(a).

2. The Requirement of Notice of Sale9-613. CONTENTS AND FORM OF NOTIFICATION BEFORE DISPOSITION OF COLLATERAL: GENERALExcept in a consumer-goods transaction, the following rules apply:

(1) The contents of a notification of disposition are sufficient if the notification:(A) describes the debtor and the secured party;(B) describes the collateral that is the subject of the intended disposition;(C) states the method of intended disposition;(D) states that the debtor is entitled to an accounting of the unpaid indebtedness and states the charge, if any, for an accounting; and(E) states the time and place of a public disposition or the time after which any other disposition is to be made.

(2) Whether the contents of a notification that lacks any of the information specified in paragraph (1) are nevertheless sufficient is a question of fact.(3) The contents of a notification providing substantially the information specified in paragraph (1) are sufficient, even if the notification includes:

(A) information not specified by that paragraph; or(B) minor errors that are not seriously misleading.

(4) A particular phrasing of the notification is not required.(5) The following form of notification and the form appearing in Section 9-614(3), when completed, each provides sufficient information:

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NOTIFICATION OF DISPOSITION OF COLLATERAL

To: ___ [Name of debtor, obligor, or other person to which the notification is sent]

From: ___ [Name, address, and telephone number of secured party]

Name of Debtor(s): ___ [Include only if debtor(s) are not an addressee]

[For a public disposition:] We will sell [or lease or license, as applicable] the ___ [describe collateral] [to the highest qualified bidder] in public as follows: Day and Date: ___ Time: ___ Place: ___[For a private disposition:] We will sell [or lease or license, as applicable] the ___ [describe collateral] privately sometime after ___ [day and date]. You are entitled to an accounting of the unpaid indebtedness secured by the property that we intend to sell [or lease or license, as applicable] [for a charge of $ ___]. You may request an accounting by calling us at ___ [telephone number]

9-614. CONTENTS AND FORM OF NOTIFICATION BEFORE DISPOSITION OF COLLATERAL: CONSUMER-GOODS TRANSACTIONIn a consumer-goods transaction, the following rules apply:

(1) A notification of disposition must provide the following information:(A) the information specified in Section 9-613(1);(B) a description of any liability for a deficiency of the person to which the notification is sent;(C) a telephone number from which the amount that must be paid to the secured party to redeem the collateral under Section 9-623 is available; and(D) a telephone number or mailing address from which additional information concerning the disposition and the obligation secured is available.

(2) A particular phrasing of the notification is not required.(3) The following form of notification, when completed, provides sufficient information:

___ [Name and address of secured party]___ [Date] NOTICE OF OUR PLAN TO SELL PROPERTY

___ [Name and address of any obligor who is also a debtor]

Subject: ___ [Identification of Transaction]

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We have your ___ [describe collateral], because you broke promises in our agreement.

[For a public disposition:] We will sell ___ [describe collateral] at public sale. A sale could include a lease or license. The sale will be held as follows: Date: ___ Time: ___ Place: ___ You may attend the sale and bring bidders if you want.[For a private disposition:] We will sell ___ [describe collateral] at private sale sometime after ___ [date]. A sale could include a lease or license.

The money that we get from the sale (after paying our costs) will reduce the amount you owe. If we get less money than you owe, you ___ [will or will not, as applicable] still owe us the difference. If we get more money than you owe, you will get the extra money, unless we must pay it to someone else. You can get the property back at any time before we sell it by paying us the full amount you owe (not just the past due payments), including our expenses. To learn the exact amount you must pay, call us at ___ [telephone number]. If you want us to explain to you in writing how we have figured the amount that you owe us, you may call us at ___ [telephone number] [or write us at ___ [secured party's address]] and request a written explanation. [We will charge you $ ___ for the explanation if we sent you another written explanation of the amount you owe us within the last six months.] If you need more information about the sale call us at ___ [telephone number]] [or write us at ___ [secured party's address]]. We are sending this notice to the following other people who have an interest in ___ [describe collateral] or who owe money under your agreement:___ [Names of all other debtors and obligors, if any]

(4) A notification in the form of paragraph (3) is sufficient, even if additional information appears at the end of the form.(5) A notification in the form of paragraph (3) is sufficient, even if it includes errors in information not required by paragraph (1), unless the error is misleading with respect to rights arising under this article.(6) If a notification under this section is not in the form of paragraph (3), law other than this article determines the effect of including information not required by paragraph (1).

Article 9 has strict rules to follow regarding notification of the debtor of an Article 9 sale of collateral. Any deviation from the rules will cause the creditor to lose the right to a deficiency judgment. Fortunately

CaseIn re Downing (p. 78)

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Article 9 sale and deficiencyRequirement of notice

3. The Requirement of a Commercially Reasonable Sale9-625. REMEDIES FOR SECURED PARTY'S FAILURE TO COMPLY WITH ARTICLE(a) If it is established that a secured party is not proceeding in accordance with this article, a court may order or restrain collection, enforcement, or disposition of collateral on appropriate terms and conditions.(b) Subject to subsections (c), (d), and (f), a person is liable for damages in the amount of any loss caused by a failure to comply with this article. Loss caused by a failure to comply may include loss resulting from the debtor's inability to obtain, or increased costs of, alternative financing.(c) Except as otherwise provided in Section 9-628:

(1) a person that, at the time of the failure, was a debtor, was an obligor, or held a security interest in or other lien on the collateral may recover damages under subsection (b) for its loss; and(2) if the collateral is consumer goods, a person that was a debtor or a secondary obligor at the time a secured party failed to comply with this part may recover for that failure in any event an amount not less than the credit service charge plus 10 percent of the principal amount of the obligation or the time-price differential plus 10 percent of the cash price.

(d) A debtor whose deficiency is eliminated under Section 9-626 may recover damages for the loss of any surplus. However, a debtor or secondary obligor whose deficiency is eliminated or reduced under Section 9-626 may not otherwise recover under subsection (b) for noncompliance with the provisions of this part relating to collection, enforcement, disposition, or acceptance.(e) In addition to any damages recoverable under subsection (b), the debtor, consumer obligor, or person named as a debtor in a filed record, as applicable, may recover $ 500 in each case from a person that:

(1) fails to comply with Section 9-208;(2) fails to comply with Section 9-209;(3) files a record that the person is not entitled to file under Section 9-509(a);(4) fails to cause the secured party of record to file or send a termination statement as required by Section 9-513(a) or (c);(5) fails to comply with Section 9-616(b)(1) and whose failure is part of a pattern, or consistent with a practice, of noncompliance; or(6) fails to comply with Section 9-616(b)(2).

(f) A debtor or consumer obligor may recover damages under subsection (b) and, in addition, $ 500 in each case from a person that, without reasonable cause, fails to comply with a request under Section 9-210. A recipient of a request under Section 9-210 which never claimed an interest in the collateral or obligations that are the subject of a request under that section has a reasonable excuse for failure to comply with the request within the meaning of this subsection.(g) If a secured party fails to comply with a request regarding a list of collateral or a statement of account under Section 9-210, the secured party may claim a security

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interest only as shown in the list or statement included in the request as against a person that is reasonably misled by the failure.

9-626. ACTION IN WHICH DEFICIENCY OR SURPLUS IS IN ISSUE(a) In an action arising from a transaction, other than a consumer transaction, in which the amount of a deficiency or surplus is in issue, the following rules apply:

(1) A secured party need not prove compliance with the provisions of this part relating to collection, enforcement, disposition, or acceptance unless the debtor or a secondary obligor places the secured party's compliance in issue.(2) If the secured party's compliance is placed in issue, the secured party has the burden of establishing that the collection, enforcement, disposition, or acceptance was conducted in accordance with this part.(3) Except as otherwise provided in Section 9-628, if a secured party fails to prove that the collection, enforcement, disposition, or acceptance was conducted in accordance with the provisions of this part relating to collection, enforcement, disposition, or acceptance, the liability of a debtor or a secondary obligor for a deficiency is limited to an amount by which the sum of the secured obligation, expenses, and attorney's fees exceeds the greater of:

(A) the proceeds of the collection, enforcement, disposition, or acceptance; or(B) the amount of proceeds that would have been realized had the noncomplying secured party proceeded in accordance with the provisions of this part relating to collection, enforcement, disposition, or acceptance.

(4) For purposes of paragraph (3)(B), the amount of proceeds that would have been realized is equal to the sum of the secured obligation, expenses, and attorney's fees unless the secured party proves that the amount is less than that sum.(5) If a deficiency or surplus is calculated under Section 9-615(f), the debtor or obligor has the burden of establishing that the amount of proceeds of the disposition is significantly below the range of prices that a complying disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor would have brought.

(b) The limitation of the rules in subsection (a) to transactions other than consumer transactions is intended to leave to the court the determination of the proper rules in consumer transactions. The court may not infer from that limitation the nature of the proper rule in consumer transactions and may continue to apply established approaches.

Commercially reasonable is deliberately vague. The methods, manners, times or places of an Article 9 sale may vary depending on the type of collateral. As a result, the creditor is well-advised to err on the side of reasonableness in conducting an Article 9 sale by pretending that the creditor’s own money is at stake.

Determining commercial reasonableness always will require a close factual inquiry. The court will consider such things as the following:

prevailing practices;

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disparity between sale price and fair market value;For prevailing practices, the court will look at issues relating to

timing; location; advertising; method of sale; and preparation for sale.

This standard is radically different from the standard used in a judicial sale. If a creditor does not establish commercial reasonableness, then the creditor is unlikely to receive a deficiency judgment. The failure to conduct the sale in a commercially reasonable manner creates a rebuttable presumption that the value of the collateral was at least equal to the amount of the debt. § 9-626(a)(4).

CaseChavers v. Frazier (p. 81)

Article 9 sale and deficiencyCommercial reasonableness

Prevailing practices

D. Article 9 Sale Procedure: A Functional AnalysisThe Article 9 sale procedure gives the secured creditor an opportunity to abuse the system by purchasing the collateral at a discount during the sale and then pursuing a deficiency judgment. Information on actual practices is scant.

Class notesJudicial Foreclosure Art. 9 Foreclosure

Prices Lower HigherAdvertising Legal Commercially ReasonableConducted By Sheriff CreditorInspection Rights None Creditor may have

possession § 9-609Right of Redemption Yes Not after sale - § 9-623

E. Problem Set 55.1: Bank repo’d Maxwell’s silver Mercedes and sent him notification that bank would sell it in a private sale “after ten days from this notice.” The balance owing on the loan, including principal, interest, attorneys fees, and expenses of sale is $10,000.a) If the fair market value of the car is $8,000, but it sells for $7,000 in a commercially

reasonable sale. What is the proper deficiency award? $3000 per UCC § 9-626 Section 9-626 says don’t include consumer transactions. § 9-102 (a)(26) defines

consumer transactions stating it is an obligation incurred primarily for personal, family or household purposes. This is a consumer transaction so 9-626(a) does not apply. 9-626(b) applies because court has discretion.

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Courts are split when failure to follow Art 9 requirements & is not commercially reasonable. Here, they followed Art 9 and is commercially reasonable so use UCC § 9-615(d): Surplus or deficiency if obligation secured. If the security interest under which a disposition is made secures payment or performance of an obligation, after making the payments and applications required by …(1) pay surplus to DR(2) the DR is liable for any deficiency

b) How much does Maxwell have to pay to redeem the car? $10,000 UCC § 9-623 Right to redeem collateral (refers to the common law right to

redeem) Persons that may redeem: A debtor, any secondary obligor, or any other secured

party or lienholder may redeem collateral Requirements for redemption. To redeem collateral, a person shall tender:

o Fulfillment of all obligations secured by the collateral; ando The reasonable expenses and attorney’s fees described in § 9-615(a)

When redemption may occur: A redemption may occur at any time before a secured party:

o Has collected collateral under § 9-607;o Has disposed of collateral or entered into a K for its disposition under § 9-

610; oro Has accepted collateral in full or partial satisfaction of the obligation it

secures under § 9-622 After the sale the debtor has no right to redeem. If before sale, 9-623(b) says pay all debt secured by collateral AND reasonable

expenses/attorney feesc) If Maxwell has enough money to redeem the car, would you recommend that he do so

or that he purchase another identical car for $8000? Redeem for $10,000. If he buys the new car for $8,000, he will also have a

deficiency judgment for $3000. Advice is to redeem.d) A friend of Maxwell’s offers $8000 for the car, but the bank refused because it has a

policy of only selling at dealer sales. The car sells for $7000 at a dealer sale. What is the proper deficiency judgment? $3000 -- § 9-627(a) says that the fact that more money could have been obtained

through a different sale doesn’t make the transaction commercially unreasonable. § 9-627(b) is a safe harbor. Disposition is commercially reasonable if (b)(1-3) are

met. So, if selling repossessed cars at dealer auctions is a reasonable commercial practice for selling cars then it is commercially reasonable. § 9-627(b) protects dealer auctions.

§ 9-627(b)(3): A disposition is commercially reasonable if made in conformity with reasonable commercial practices among dealers in the type of property that was the subject of the disposition

5.2: Your client is a Bank which recently repossessed and sold some equipment. The debt was secured to $57,345, plus interest of $3541. Your fees are $3000 for replevy and $650 for preparing for the sale. You want to charge $350 for your opinion on the distribution of the sale proceeds. Bank spent $1500 preserving the collateral and $750 in

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advertising. Another creditor, Auto Parts Depot, is unsecured and wants $4200 out of the proceeds.a) The highest bid is $47,136. You have the money. Who do you pay? How much is

the deficiency? § 9-615(a) provides order of payment (what happens to the money in Art 9

foreclosure sale)1) expenses, preparing, processing for sale and reasonable attorney fees (costs of sale)2) debt owed to secured CR that is foreclosing (pay foreclosing CR)3) pay any subordinate secured interests (pay next jr lien holder)4) 9-615(d) - pay DR surplus or DR is liable for deficiency.

This means that I will get paid $4000 ($3000 for replevy of the collateral, $650 for preparing the sale, and $350 for my legal opinions). Bank will receive $2250 ($1500 for preserving the collateral and $750 for advertising the sale).

The $350 for the opinion on how to distribute the proceeds might be unreasonable.

Next, money is distributed for the satisfaction of obligations secured by the security interest or agricultural lien under which the disposition is made. The remainder of the money will go to bank under this provision. Because bank is not paid in full on its security interest, Auto Parts Depot will not get anything.

The deficiency is $20,000 (secured amount plus bank’s expenses, plus interest, plus my expenses, minus the sale price). (§ 9-615(d) provides that the DR is obligated to pay the deficiency. Deficiency judgments are unsecured).

** Remember–to collect attorney fees it must be provided for in the agreement - § 9-615(a)(1)

b) If the highest bid was $75,000, how would you pay? Is Bank permitted to pay Auto Parts Depot? $75,000-6250 costs-60,886 debt=$7864 surplus is distributed to the DR per § 9-

615(d)(1). Do not pay Auto Parts the $4200 because you are not permitted to pay any other parties who do not have security interests in the property. § 9-615(a)(3) says don’t pay because they don’t have a security interest or lien.

However, if there had been other subordinate liens, these would get paid out of the remainder.

5.4: Your client, Bank, recently repossessed what should have been a $345,000 helicopter, only to find that the engine had been removed, leaving a hull with no resale value. The amount of the debt is $345,000. The debt is guaranteed by wealthy individuals.a) Can Grizzly throw the hull away?

§ 9-610(a) – after default, a secured party may sell, lease, license or otherwise dispose of collateral in its present condition or following any commercially reasonable preparation. BUT (b) have to be commercially reasonable in disposition of collateral. If it is relatively inexpensive to fix it up, you cannot just trash it – see comment 4 to § 9-610 which says can’t dispose of collateral if it is commercially unreasonable to do so. See also Chavers v. Frazier Lear jet case which said must be commercially reasonable. Here, Grizzly should fix the helicopter up and sell it or sell it to a scrap dealer. You should hire experts to

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advise you on sale of helicopter in this condition to see what is commercially reasonable.

Costs of experts may fall into “costs of preparation and processing” authorized by the comment to § 9-610.

b) If threw it away but Grizzly could spend $245,000 to install a new engine and get $345,000 for the fixed helicopter, to what deficiency judgment is Bank entitled? If the property could be fixed up at a low cost so as to greatly increase its value,

my client may have a duty to do that per comment 4 to § 9-610. Paying $245,000 isn’t a low cost, so the deficiency is $245,000.

If it was unreasonable to throw away this hull, though, the deficiency will be $0. § 9-626(a)(3): if the secured party fails to prove that the … disposition .. was

conducted in accordance with this part … the liability of the debtor … for a deficiency is limited to … the amount by which the sum of the secured obligation exceeds the greater of:

o the proceeds of the collection, enforcement, disposition, or acceptance0o the amount of proceeds that would have been realized had the

noncomplying secured party proceeded in accordance with the provisions of this part … (this applies to the current situation: amount of the proceeds would have been $345,000, the secured debt was $345,000 no recovery)100,000

Here, § 9-626(a)(1) says you don’t have to prove commercial reasonableness unless the debtor objects. Section § 9-626(a)(2) says the creditor has BOP to show commercial reasonableness. See cmt. 3.§ 9-626(a)(3) – if secured party fails to prove disposition was conducted properly then the deficiency is limited to the greater of:

Proceeds (here 0 because threw away) Amount that would have been realized had they sold it properly (if use (a)

(4) then $345-345=0) BUT can make the argument that the realized amount would not be $345 b/c $245 would reimburse sale expenses. So, only $100 was realized and there was a $245 deficiency.

§ 9-626(a)(4) – amount that would have been realized is equal to the sum of the secured obligation unless secured party proves amt is LESS THAN that sum. § 9-626(a)(4) assumes NO deficiency UNLESS creditor can prove otherwise.Here, secured party says secured obligation is $345 BUT secured party can use evidence of spending $245k to sell it for $345k. So, if done right, would have sold it for $345kCosts of sale=$245k to creditorPay foreclosing creditor=$100kDeficiency is $345,000-$100,000 (greater of a or b) =$245k deficiency§ 9-627 defines what is commercially reasonable.

5.6: You represent the Chavers from the case above. They have repossessed another jet from an insolvent debtor. The jet is worth $800,000, the debt is $850,000. The Chavers want to keep the jet, but don’t think they can get deficiency.a) What should they do?

Strict foreclosure is allowed in § 9-620. Strict foreclosure is useful when CR is not interested in getting deficiency or there is no equity in the collateral.

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§ 9-620(a) a secured party may accept in full or partial satisfaction only if:o DR consentso 9-620(a)(1) – If retain in full satisfaction then there is NO deficiencyo (c)(1) – DR has to agree in a record after default for partialo (c)(2) – DR consents in full satisfaction if agrees in record after default

OR A) secured party can send unconditional proposal; B) secured party says keep in full satisfaction; C) DR has to object in signed fashion within 20 days.

o ** MUST meet 9-620(a)(1-4) PLUS (c)(1) or (2) § 9-610(a) allows the Chavers to sell, lease, license, or otherwise dispose of the

collateral § 9-611 requires that the CR give notification to the DRs prior to the disposition. § 9-620 allows the Chavers to accept the jet in full satisfaction of the debt if they

send a notification that they are accepting the jet in full satisfaction and the DR doesn’t object within 20 days (§ 9-620(c)(2)(A-C)). This is called a strict foreclosure

During the 20-day notice period, the DR may redeem the property per § 9-623(c). § 9-623(c)(3) – DR can redeem during 20 day waiting period in (c)(2)(C). Look also at § 9-621(a)(1) – there is no deficiency if the collateral is taken in full

satisfaction If the DR objects, you can foreclose on the property. A DR will generally object only if he has equity in the property. § 9-621 requires that the proposal to accept in full satisfaction be sent to any

person who the Chavers have received an authenticated notification of a claim of an interest in the collateral and anyone else with a lien in the property 10 days before the DR consented to the acceptance.

What if the DR does not object? This is consent.b) What if the DR objects to their retention of the collateral and they ignore that

objection? If they keep the jet and ignore the objection then the Chavers have violated the

statute and don’t get to keep the debt in full or partial satisfaction of debt. If you can’t keep it, then you have to put it up for sale. If you just keep it after objection, the DR can sue you. 9-625 indicates DR can sue and ask ct to order a sale or sue CR for damages for failing to conduct the sale.

Here, the collateral is worth less than the debt so the DR’s would not care because they are not prejudiced.

Title Problem? 9-622(a)(2) – if accept the collateral correctly then all of the debtor’s rights

transfer to the secured creditor. If you don’t do it correctly, then you don’t get the title or benefits of 9-622(a)(2) and the debtor technically still owns the jet.

The Chavers can issue a transfer stmt per 9-619, which forces the legal title to be changed over to a transferee.

Even if the Chavers don’t comply with the article, all subordinate interests are terminated once they accept the collateral in full acceptance. § 9-622(b).

The CR doesn’t actually own the property until the foreclosure sale.c) What if the Chavers say that they have sold the jet to themselves for $800,000?

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Can have a private sale per § 9-610(b) as long as commercially reasonable. Even in private sale you have to give notice per § 9-611. If don’t do sale right, then court will just use § 9-626 formula and CR may get the $50k deficiency!

When Chavers sell it to self, they don’t have title problem because § 9-617(a)(1) transfers all DR’s rights in property if sold it correctly. § 9-617(b) – if in GF then still take free of DR’s ownership rights.

The Chavers may be subject to the DR’s rights and other lienholders’ rights in the collateral if they do not take title in good faith per § 9-617(c).

§ 1-203 also requires good-faith throughout the code. Good faith means “honesty in fact and the observance of reasonable commercial standards of fair dealing.” Since the sale was for fair market value, the court may allow the sale to stand. The Chavers would be able to pursue a deficiency, too.

If the transfer is not for value, the lien may not be discharged per § 9-617(a)(3). The Chavers may run into problems under § 9-610(c) because this type of

property probably must be sold at a public sale. CR & DR can choose to define commercially reasonable in their security

agreement.

VI. Bankruptcy and the Automatic Stay

A. The Federal Bankruptcy SystemThe U.C.C. gives the default rules for collecting on secured and unsecured debts in state courts. However, many debtors avoid the state courts by declaring bankruptcy. Bankruptcy issues are decided in federal court. In many ways, the bankruptcy courts operate a federal collection system.

The bankruptcy system has pluses and minuses. The state collection system can drag out over long periods of time. The bankruptcy system is relatively quick. The debtor’s debt is either discharged or extended. Because bankruptcy law is federal law, it superseded state law.

Although most cases between debtors and creditors do not end up in bankruptcy, the bankruptcy laws influence relationships between debtors and creditors. Debtors can resort to the bankruptcy courts if the creditor is unreasonable. Similarly, creditors can force a debtor into bankruptcy if the debtor is unreasonable.

B. Filing a Bankruptcy CaseBankruptcy cases can be initiated either voluntarily by the debtor or involuntarily by the creditor. However, almost all cases are initiated by the debtor. Business cases are more likely to be initiated by creditors than consumer cases.

Upon filing the petition, two things happen immediately: (1) a bankruptcy estate is created that consists of all of the debtor’s property; and (2) an automatic stay is placed on any collection activities against the debtor, the debtor’s property and the bankruptcy estate. The debtor is not to pay any prepetition debts and the creditor is not to collect anything from the bankruptcy estate until the case is resolved.

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The property in the bankruptcy estate is controlled by a trustee if the case is a liquidation case. The contents of the bankruptcy estate depend upon state laws. Every state allows exclusions and exemptions that keep some property out of the bankruptcy estate. The trustee in a liquidation case converts the bankruptcy estate property into cash and distributes the proceeds pro rata to the unsecured creditors. The trustee performs a role in liquidation bankruptcy that is analogous to the role of a sheriff.

If the case is a reorganization case, then the bankruptcy estate is left under the control of the debtor, who is known as the debtor-in-possession (DIP). The debtor proposes a plan to repay all or part of the debts owing. The plan covers either three or five years and is designed to give all creditors at least as much as they would have received under a liquidation case. During the life of the plan, the debtor regularly pays money to a trustee who distributes the money on a pro rata basis to the unsecured creditors.

At the end of the bankruptcy, the debtor gets a fresh start.

C. Stopping Creditors’ Collection ActivitiesOnce the bankruptcy petition is filed, the unsecured creditors can file claims with the bankruptcy court but their other collection remedies are limited. The automatic stay prevents other activities. For creditors, bankruptcy is a collective and largely passive proceeding. The trustee and the court administer the collection process. Consequently, aggressive creditors usually fare better outside of bankruptcy while less aggressive creditors fare better in bankruptcy.

The automatic stay serves a useful purpose. The stay allows an opportunity to account for all the assets in the estate and all the charges against the estate. Then, an orderly resolution to the problem can be done without endless litigation.

Although the stay halts the activities of most creditors, some creditors and legal actions are not stayed. Criminal proceedings are not stayed. Regulatory violations are not stayed. So, the debtor does not get a free pass during the bankruptcy case.

D. Lifting the Stay for Secured CreditorsSecured creditors are affected differently by a debtor’s bankruptcy. Secured creditors get better treatment under bankruptcy law just as they do in the state courts. The secured creditor still will get access to their collateral. The secured creditor probably will not collect the full amount of the debt, but the secured creditor will collect the value of its collateral.

Because secured creditors each have their own interest in the bankruptcy estate, secured creditors are allowed to pursue their individual rights in the bankruptcy case. Some collateral will lose its value quickly if the trustee does not liquidate the collateral rapidly. Other collateral will hold its value for an extended period. This contrasts sharply with the collective interest of the unsecured creditors.

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The secured creditor is affected by the automatic stay just as the unsecured creditor is affected. But, the secured creditor may be able to get the stay lifted and continue with its nonbankruptcy collection efforts with respect to its collateral if (1) there is no equity in the collateral that the trustee or debtor might realize for unsecured creditors and (2) the collateral is not necessary to an effective reorganization. These two reasons are known as bankruptcy purposes for retaining the property in the bankruptcy estate.

If a bankruptcy purpose prevents the stay from being lifted, the secured creditor still must be provided adequate protection against a loss. If the value of the collateral would decline with the passage of time, then the secured creditor clearly has been disadvantaged by the automatic stay. The debtor must provide some protection to the secured creditor for the anticipated decline in the value of the collateral. If the debtor does not provide adequate protection, then the creditor may have the stay lifted and sell the collateral regardless of any bankruptcy purpose. If the secured creditor is oversecured, then a cushion of equity may provide adequate protection. The cushion of equity needed to provide adequate protection depends upon several circumstances such as the following:

the nature of the factors that might change the value of the collateral; the volatility of the market in which the creditor might have to sell the collateral;

and, the rate at which the secured debt is likely to increase in amount.

The secured creditor’s entitlement to adequate protection only applies to losses due to a decline in the value of the collateral. Other losses are not entitled to adequate protection from other consequences of the automatic stay such as the time value of money. Any additional collateral added to provide adequate protection necessarily reduces the pool of money available to the unsecured creditors.

For protection to be adequate, the value of any assurance must be sufficient to conform with the benefit initially bargained for by the creditor. This value does not contemplate a distress sale, but a commercially reasonable disposition. In many cases, the parties may encounter difficulties simply determining the value of the collateral.

Class notesFinancial hardship of the creditor is not a ground for lifting a stay. A creditor may file a motion to lift a stay any time that conditions change.

CaseIn re Craddock-Terry Shoe Corp. (p. 101)

Bankruptcy and the automatic staySecured creditors – lifting the stay

No equity & not necessary to reorganizationAdequate protection

Valuation issues

E. Strategic Uses of Stay LitigationThe effect of an order lifting or modifying the automatic stay differs greatly depending on the nature of the collateral and importance of the collateral to the debtor’s business or

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life. Stay litigation may provide a creditor the necessary leverage to get repaid or at least get additional collateral.

F. Problem Set 66.1Upon filing of a petition, an automatic stay is placed on the debtor’s assets. 11 U.S.C. § 362(a). Violations of the stay may result in

damages; attorneys’ fees; or punitive damages.

Unsecured creditors can file a claim.

6.2The automatic stay prevents any repossession. 11 U.S.C. § 362(a)(2). The stay stops secured creditors too.

6.3The automatic stay prevents foreclosure actions also. 11 U.S.C. § 362(a)(4), (a)(6). But, secured creditors can lift the stay under § 362(d) for cause if

1. lack of adequate protection or2. no equity and not necessary for reorganization.

Adequate protection prevents loss caused by delay in foreclosure caused by the stay.

6.5You still cannot foreclose because of the automatic stay. § 362(a). However, you can attempt to have the stay lifted under § 362(d). The debtor is attempting to reorganize. Under § 362(d)(2), the stay is lifted for cause if there is no equity and the collateral is not necessary for reorganization. The debtor has equity and the collateral is necessary for reorganization. Under § 362(d)(1), the stay is lifted for cause if there is a lack of adequate protection to prevent loss cause by delay in foreclosure caused by the stay. The collateral is not insured. Lack of insurance is an event of default. Insurance cannot be obtained. The collateral may lack adequate protection.

6.6.a. Debtor is protected by the automatic stay. Creditors must cease collection efforts. Unsecured creditor cannot lift the stay for any reason. Unsecured creditor may file a proof of claim and get in line.b. Debtor is protected by the automatic stay. Creditors must cease collection efforts. Secured creditors may lift the stay for cause. Although debtor does not have any equity in the collateral, the collateral is necessary for reorganization. This prevents lifting the stay under § 362(d)(2). The collateral however is decreasing in value. If creditor can show that the loss is caused by delay in foreclosure, then creditor may lack adequate protection. This would permit a lifting of the stay under § 362(d)(1).

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VII. The Treatment of Secured Creditors in Bankruptcy

A. The Vocabulary of Bankruptcy ClaimsA debt is a sum of money owing. A debt may be discharged in bankruptcy. The discharged debt continues to exist after discharge, but the creditor is enjoined from attempting to collect the debt. A discharged debt is nonrecourse debt because it cannot be enforced against the debtor.

Even with security, a nonrecourse debt cannot be collected. However, the collateral remains encumbered by any liens in place prior to discharge. Therefore, a lienholder may foreclose on collateral after a bankruptcy if the lien has not been removed.

The special collection rights that a secured creditor has in personal property are known as a security interest. The special collection rights of a previously unsecured creditor who has levied against property of the debtor are called a lien. The special collection rights that a secured creditor has in real property are known as a mortgage, or a deed of trust. In the Bankruptcy Code, the generic term of security interest is used to refer to collectively to an Article 9 security interest, mortgage or deed of trust; the term lien refers to a Bankruptcy Code security interest plus any other secured status created by statutory or judicial liens.

A creditor’s claim in bankruptcy is the amount of debt owed to the creditor under nonbankruptcy law at the time the bankruptcy case is filed. The bankruptcy code does not treat all claims equally. Only claims that are allowed by statute are eligible to share in the distributions made in a bankruptcy case. Generally, the terms allowed claims and claims are used synonymously.

A debtor’s debt and the creditor’s claim generally are not the same amount. During bankruptcy, the debt continues to grow as interest accrues. However, a creditor’s claim is fixed as of the date of petition. This fact becomes significant if the debtor emerges from bankruptcy without the debt being discharged.

B. The Claims ProcessThe amount that a creditor collects from the bankruptcy process depends upon

how much the various creditors are owed; the creditors’ relative priorities in the estate; and the value available to pay the creditors.

The bankruptcy system determines the amount paid to each creditor via the claims process.

Not all claims are treated equally. Claims are separated into classes with common characteristics. Some claims grow through the accrual interest during the bankruptcy. Other claims are not allowed to accrue interest. The separation is done based upon the priorities of the claims and other factors.

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The actual distribution of funds to the creditors’ claims also is accomplished by different means depending upon the type of bankruptcy. For a liquidation bankruptcy, the trustee sells the assets and distributes the proceeds. For a reorganization bankruptcy, distributions are done according to the plan developed through negotiation with the creditors and approved by the court.

Once a bankruptcy petition has been filed, the rules for collection of debts change. Creditors no longer compete against one another to recover their debts. The automatic stay stops collection efforts. The creditors file a proof of claim and the claims process distributes the proceeds from the bankruptcy estate. The resolution time for claims decreases because many of the incentives to dispute the amounts have disappeared.

C. Calculating the Amount of an Unsecured ClaimMost debts scheduled in a bankruptcy case are undisputed. The debtor owes the money and has no defense. Still, the calculation of the amount of an unsecured claim requires some knowledge of bankruptcy laws.

The amount of the unsecured claim is the debt owed at the time that the bankruptcy petition is filed. If the creditor’s contract with the debtor provides for prepetition interest, the collection of attorneys’ fees or the reimbursement of other fees, then those amounts also are included in the claim. The claim does not accrue interest during the bankruptcy. Traditionally, postpetition attorneys’ fees are not included in the claim.

D. Payments on Unsecured ClaimsCreditors with unsecured debts typically do not receive anything in a liquidation bankruptcy because the bankruptcy estate does not contain any nonexempt assets. Occasionally, the creditor may get a small payment. For reorganization bankruptcies, the creditor normally fares much better. Over 40% of the debtors promise full repayment of unsecured debts. Another 20% promise partial repayment of unsecured debts.

E. Calculating the Amount of a Secured ClaimThe calculation to determine the amount of a secured claim begins the same way as the calculation for an unsecured claim—the calculation of the amount of the claim. However, a secured claim exists only to the value of the collateral. If the claim exceeds the value of the collateral, then the remaining amount becomes an unsecured claim.

A secured claim also may be entitled to accrue postpetition interest, attorneys’ fees or costs. The secured creditor’s entitlement depends on

1. whether the attorneys’ fees and costs are reasonable;2. whether payment of the attorneys’ fees and costs are provided for under the

agreement or state statute under which the claim arose; and3. limits the accrual to the equity cushion, if any, in the collateral.

As a result, only oversecured claims can increase postpetition; undersecured claims cannot grow postpetition. Still, the secured creditor typically recovers substantially from the debtor.

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F. Selling the CollateralCollateral in the bankruptcy estate normally is disposed of through one of three processes:

collateral is sold with the security interest in place; collateral is abandoned by the trustee; or collateral is sold free and clear of liens.

In a liquidation bankruptcy, the trustee sells any collateral with equity in the bankruptcy estate. The bankruptcy trustee enjoys much more leeway in the conduct of the sale than the sheriff in a judicial foreclosure. In fact, the trustee has a duty to sell the collateral in the way that maximizes the net proceeds. In the case of collateral subject to a security interest, the trustee normally sells the collateral with the security interest in place. The proceeds are distributed then to the unsecured creditors. The secured creditor and the new owner then negotiate a resolution regarding the security interest.

If the property does not have any equity, then the trustee may abandon the property as being burdensome or of inconsequential value. Abandoned property ceases to be part of the bankruptcy estate and ownership reverts to the debtor. Because the automatic stay protects not only the bankruptcy estate but also the debtor and the debtor’s property, the secured creditor still cannot foreclose until the stay is lifted.

In some circumstances, the trustee can sell the collateral “free and clear of liens.” These circumstances are identified later.

G. Who Pays the Expenses of Sale by the TrusteeDuring a bankruptcy, the trustee incurs expenses relating to the sale of collateral. If the secured creditor benefits from the sale of the collateral, then the secured creditor bears the expenses. In the case of an undersecured creditor, the expenses are deducted from the creditor’s recovery. In the case of an oversecured creditor, the expenses are not deducted from the creditor’s recovery.

H. Chapters 11 and 13 Reorganization11 U.S.C. § 1325. Confirmation of plan (a) Except as provided in subsection (b), the court shall confirm a plan if—

. . . .(5) with respect to each allowed secured claim provided for by the plan—

(A) the holder of such claim has accepted the plan;(B) (i) the plan provides that—

(I) the holder of such claim retain the lien securing such claim until the earlier of—(aa) the payment of the underlying debt determined under nonbankruptcy law; or(bb) discharge under section 1328; and(II) if the case under this chapter is dismissed or converted without completion of the plan, such lien shall also be

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retained by such holder to the extent recognized by applicable nonbankruptcy law;

(ii) the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim; and(iii) if—

(I) property to be distributed pursuant to this subsection is in the form of periodic payments, such payments shall be in equal monthly amounts; and(II) the holder of the claim is secured by personal property, the amount of such payments shall not be less than an amount sufficient to provide to the holder of such claim adequate protection during the period of the plan; or

(C) the debtor surrenders the property securing such claim to such holder;

In reorganization case, the debtor typically seeks to keep the property that is subject to a security interest and to continue using it. The debtor must create a plan to repay all debts. The debt payments are reduced or rescheduled.

The effect of the plan upon the debtor’s debts is different under Chapter 11 and under Chapter 13. Under Chapter 11, the court’s approval of the plan discharges the debtor’s old debts and substitutes the new debts from the plan. Under Chapter 13, the debtor’s debts are discharge only upon successful completion of the plan.

The court will approve a plan only if the secured creditors are accommodated in one of three ways:

the creditors accept the plan; the collateral is surrendered to the creditor; or the debtor provides the creditor both a lien securing the claim and a promise of

future property distributions whose total value as of the effective date of the plan is not less than the allowed amount of the claim.

No such provisions protect the unsecured creditors. The third option is referred to as the cramdown provision because it allows a debtor to cram a plan down the creditor’s throat regardless of the creditor’s opinion.

In order for a plan to use the cramdown provision, the distribution to the creditors must pass a three step process

determine the amount of the allowed secured claim; determine the value of the proposed distribution; and ensure that the value of the proposed distribution is greater than or equal to the

allowed secured claim.

I. Valuing Future PaymentsIt is not sufficient that the payments total the amount of the allowed secured claim. The payments must have a value as of the effective date of the plan of that amount. The effective date of the plan is generally understood to be a date, specified in the plan,

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about 10 to 30 days after confirmation. Because of the time value of money, future payments are discounted at the market rate of interest. The market rate of interest also incorporates the risk of default. The courts determine the market rate of interest by adjusting the prime rate according to a number of factors including the following:

the circumstances of the estate; the nature of the security; the duration; and the feasibility of the reorganization plan.

This single market rate of interest is used for all secured creditors as similarly situated creditors are treated similarly.

CaseTill v. SCS Credit Corp. (p. 123)

Treatment of secured creditor in bankruptcyValuing future payments

Prime plus margin

J. Problem Set 77.1How do you determine the allowed amount of an unsecured claim in bankruptcy?The allowed unsecured claim is calculated as follows

Allowed Claim = Principal + Prepetition Interest + Prepetition Fees (if allowed) = $30,000 + (($30,000 * 18%)*0.5) + 0 = $30,000 + $2,700 + 0 = $32,700

No prepetition fees are allowed because the contract does not address. U.C.C. § 9-615(a)(1).

7.2How are funds distributed to general unsecured creditors?Funds are distributed to general unsecured creditors on a pro rata basis.

Recovery = (Allowed Claim/Total Claims) * Funds Available = ($32,700/$1,191,500) * $59,575 = $1,635

7.3(a) How do you determine the allowed amount of a secured claim in bankruptcy?The allowed secured claim is calculated as follows:


(b) Can the secured creditor recover more than the allowed claim?The secured creditor may recover post-petition interest as limited by the remaining equity in the collateral. Additionally, the secured creditor may recover post-petition fees if agreed to in the contract.

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Post-petition Interest = (($360,400 * 12%)*0.25)= $10,812

In a reorganization plan bankruptcy, the secured creditor cannot be made worse off. Therefore, the secured creditor will be allowed to recover the allowed claim plus the post-petition interest or at least $371,212.(c) What happens if the reorganization plan is delayed for a year?The secured creditor’s post-petition interest is limited by the remaining equity in the collateral.

Post-petition Interest = (($360,400 * 12%) * 1)= $43,248

But, only $39,600 of equity remains in the collateral. So, the secured creditor only can recover the value of the collateral or $400,000.

7.4Debt is $340,000. Prepetition interest at 12%. Collateral is worth $325,000. Unsecured debts paid at 10%.(a) How do you determine the allowed amount of a secured claim in bankruptcy when undersecured?The allowed claim is calculated as follows:


The secured portion of the allowed claim is limited by the value of the collateral. So, the allowed claim is split into a secured portion and an unsecured portion.

Allowed Secured Claim = $325,000Allowed Unsecured Claim = $35,400

(b) What should the creditor expect to recover?Recovery = Secured Claim + Pro Rata Unsecured Recovery

= $325,000 + ($35,400 * 10%)= $325,000 + $3,540= $328,540

(c) Does it matter if the plan is confirmed today or a year from today?Yes, creditor is not collecting interest.

7.5(a) How do you determine the allowed amount of an unsecured claim?

Allowed Claim = Principal + Prepetition Interest + Prepetition Fees (if allowed) = $340,000 + (($340,000 * 12%)*0.5) + 0 = $340,000 = $20,400 + 0 = $360,400

The creditor’s claim is entirely unsecured if no security agreement is signed.(b) What should the creditor expect to recover?

Recovery = Secured Claim + Pro Rata Unsecured Recovery= $0 + ($360,400 * 10%)= $36,040

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7.7Sale of aircraft nets $214,000. Secured creditor owed $150,000. Pool for unsecured also includes $28,200(a) What distributions do you make? What is the percentage paid to the unsecured creditors?

Recovery = Secured Claim + Pro Rata Unsecured Recovery= $150,000 + 0= $150,000 to secured creditor

Percentage = Pool/Total Unsecured Debts= (($214,000 - $150,000) + $28,200)/$300,000= $92,200/$300,000= 30.73%

(b) What distributions do you make? What is the percentage paid to the unsecured creditors?

Percentage = Pool/Total Unsecured Debts= $216,200/($300,000 + ($150,000 - $26,000))= $216,200/$424,000= 50.99%

Recovery = Secured Claim + Pro Rata Unsecured Recovery= $26,000 + (50.99% * $124,000)= $26,000 + $63,228.30= $89,228.30

VIII. Formalities for AttachmentA creditor obtains his status as a secured creditor by contract with the debtor.

A. A Prototypical Secured TransactionMost security interests are created as part of a transaction in which money is lent or property is sold. The details vary, but usually the debtor grants the security interest in the collateral to the creditor, who provides money to the debtor. The debtor uses the money to acquire the collateral.

The creditor has an enforceable security interest against the debtor after the debtor signs the security agreement. In order for the creditor to have priority in the collateral over other creditors, the creditor must perfect the security interest by filing a financing statement in the public records. Creation and perfection are two distinct concepts and should not be confused.

B. Formalities for Article 9 Security Interests9-203. ATTACHMENT AND ENFORCEABILITY OF SECURITY INTEREST; PROCEEDS; SUPPORTING OBLIGATIONS; FORMAL REQUISITES(a) [Attachment.] A security interest attaches to collateral when it becomes enforceable against the debtor with respect to the collateral, unless an agreement expressly postpones the time of attachment.

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(b) [Enforceability.] Except as otherwise provided in subsections (c) through (i), a security interest is enforceable against the debtor and third parties with respect to the collateral only if:

(1) value has been given;(2) the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party; and(3) one of the following conditions is met:

(A) the debtor has authenticated a security agreement that provides a description of the collateral and, if the security interest covers timber to be cut, a description of the land concerned;(B) the collateral is not a certificated security and is in the possession of the secured party under Section 9-313 pursuant to the debtor's security agreement;(C) the collateral is a certificated security in registered form and the security certificate has been delivered to the secured party under Section 8-301 pursuant to the debtor's security agreement; or(D) the collateral is deposit accounts, electronic chattel paper, investment property, or letter-of-credit rights, and the secured party has control under Section 9-104, 9-105, 9-106, or 9-107 pursuant to the debtor's security agreement.

(c) [Other UCC provisions.] Subsection (b) is subject to Section 4-210 on the security interest of a collecting bank, Section 5-118 on the security interest of a letter-of-credit issuer or nominated person, Section 9-110 on a security interest arising under Article 2 or 2A, and Section 9-206 on security interests in investment property.

U.C.C. § 9-203(b) lists three formalities required for the creation of a security interest enforceable against the debtor: (1) either the collateral must be in the possession of the secured creditor or the debtor must have “authenticated a security agreement which contains a description of the collateral;” (2) value must have been given; (3) the debtor must have rights in the collateral. Only when all three of these requirements have been met does the security interest attach to the collateral and become enforceable against the debtor.

Class notesAttachment occurs only once all three requirements have been satisfied. These requirements may be satisfied in any order. Attachment establishes the security interest, makes the creditor a secured creditor and gives the creditor rights in the collateral.

Attachment is distinct from perfection. Attachment has to do with the relationship between the debtor and creditor. Perfection has to do with the relationship between the creditors.

Attachment PerfectionDebtor-Creditor Creditor-Creditor§ 9-203 PrioritySecurity agreement Financing statement

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1. Possession or Authenticated Security AgreementA security agreement can take three forms. The most common type of security agreement is a signed document which contains a description of the collateral, a description of the obligations secured, and provisions defining default, specifying the rights of the secured creditor on default, requiring that the debtor care for the collateral and keep it insured, and imposing other obligations on the debtor. A security interest may attach if the creditor takes possession of the goods. The third kind of security agreement is inscribed on some tangible medium such as a computer disk.

Despite the relative ease of creating a security interest, many times the parties fail to do it. The security agreement may not authenticated by the debtor or the security agreement may not contain a description of the collateral. The absence of an authenticated security agreement means that the creditor is an unsecured creditor.

When the documents are not clear, the creditor must try to establish the existence of a security agreement. No special language is required to create a security agreement, but the language must indicate some intent to convey a security interest. In some cases, the creditor must resort to the composite document rule allowing multiple documents to be read together to establish a security interest. However, all documents used to establish the security interest must be authenticated by the debtor.

The reasons for an authenticated security agreement are relatively clear preventing fraud minimizing litigation cautioning debtors channeling transactions discouraging secured credit

Another possible problem emerges with the fill-in-the-blanks later problem, when the security agreement does not contain a description of the collateral at the time the security agreement is authenticated. Some courts believe that this does not create a security interest while other courts allow for the collateral description to be added later. Although in cases where the collateral description is added later, the courts will look at the intent of the debtor.

Class notesThe composite document rule is not recognized universally. In order to use the composite document rule, the creditor must show

objective evidence of a security interest; and subjective evidence of intent

A security agreement accomplishes three things ??? defines default describes the collateral

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Because of description problems, using the U.C.C. Article 9 defined types of collateral is highly recommended.

CasesIn re Thompson (p. 134)

Article 9 security interestsCreation

IntentIn re Ace Lumber Supply, Inc. (p. 136)

Article 9 security interestsCreation

IntentComposite document rule

Attachment vs. perfectionSecurity agreement – attachmentFiling – perfection

2. Value Has Been GivenBoth sides to the transaction must give value. The creditor promises to give money; the debtor promises to repay the debt. Value in this context closely tracks the contract concept of consideration, but the concepts are not identical. Past value is give credence unlike past consideration. For this reason, an unsecured debt may be converted easily into a secured debt. The key significance to the value requirement is when each party gave value because value is required for the creation of a security interest.

3. The Debtor Has Rights in the CollateralThe debtor cannot grant a security interest in property that the debtor does not own. As a result, if the debtor owns a limited interest in property, the debtor only can grant a security interest in the limited interest. If the debtor only has a leasehold interest, then the debtor only can grant a security interest in the leasehold interest. Owners with voidable title to property may pass valid title to bona fide purchaser. U.C.C. § 2-403. If a debtor does not own the property, then an authenticated security agreement creates a security interest in the property at the time the debtor acquires the property.

C. Formalities for Real Estate MortgagesThe formalities of real estate mortgages vary from state to state. Most states require that the mortgage be in writing and signed by the debtor in the presence of witnesses. Strict compliance with the formalities is necessary.

D. Problem Set 88.1Examine each of the three documents to see if they create a security agreement

Promissory note

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o No description of the collateralo Authenticationo No magic language, but intent is manifested

Financing statemento Description of the collateralo No authenticationo No intent from the document

Lawyer’s lettero Possible authentication through agency theoryo Description of the collateralo Intent

The composite document rule may allow the court to objectively determine if there is a security interest and there was intent to create a security interest. But, the composite document rule is not universally recognized.

8.2The security interest attaches when the requirements of U.C.C. § 9-203(b) have been satisfied. Three requirements must be satisfied

value has been given—loan proceeds and promise to repay debtor has rights in the collateral—debtor owns the collateral the collateral has been identified—signed security agreement identifying the

collateralUpon the completion of the last of these items, the security interest attached to the collateral.

8.3(a) Is there a security interest?Three requirements must be satisfied

value has been given—loan proceeds and promise to repay debtor has rights in the collateral—debtor owns the collateral the collateral has been identified--??

No security interest attaches.(b) If list is later stapled to the agreement, does the security interest attach?Now the collateral has been identified. But, has the debtor authenticated this list? When the debtor signed the agreement, no list was attached. Courts are split on this. Some will allow the security interest as long as this was consistent with the intent of the debtor.(c) Does the passage of two years make any difference to the analysis? Not really.(d) Can the parties do this after a bankruptcy filing?No, the automatic stay prevents this action.

IX. What Collateral and Obligations Are Covered?A security agreement gives the creditor the right to apply the value of the collateral to the debt. In order to be enforceable, the security agreement must describe the collateral and describe the

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obligations secured. If the descriptions are insufficient, then the creditor may not have a security interest.

A. Interpreting Security Agreements

1. Debtor Against CreditorA security agreement is a contract between the debtor and creditor. Therefore, the rules of contract interpretation apply. The court looks first to the agreement for the intention of the parties as objectively expressed in the document. If the document is ambiguous, then parol evidence may be introduced. Where the writing results from mutual mistake, the contract may be reformed.

2. Creditor Against Third PartyA security agreement also binds third parties because collateral that goes to the creditor is not available for other creditors.

3. Interpreting Descriptions of CollateralMany common types of collateral have definitions in Article 9. Many courts will use these definitions when asked to interpret a security agreement. The definitions may not reflect the intentions of the debtor and creditor.

B. Sufficiency of Description: Article 9 Security Agreements§ 9-108. SUFFICIENCY OF DESCRIPTION(a) [Sufficiency of description.] Except as otherwise provided in subsections (c), (d), and (e), a description of personal or real property is sufficient, whether or not it is specific, if it reasonably identifies what is described.(b) [Examples of reasonable identification.] Except as otherwise provided in subsection (d), a description of collateral reasonably identifies the collateral if it identifies the collateral by:

(1) specific listing;(2) category;(3) except as otherwise provided in subsection (e), a type of collateral defined in [the Uniform Commercial Code];(4) quantity;(5) computational or allocational formula or procedure; or(6) except as otherwise provided in subsection (c), any other method, if the identity of the collateral is objectively determinable.

(c) [Supergeneric description not sufficient.] A description of collateral as "all the debtor's assets" or "all the debtor's personal property" or using words of similar import does not reasonably identify the collateral.(d) [Investment property.] Except as otherwise provided in subsection (e), a description of a security entitlement, securities account, or commodity account is sufficient if it describes:

(1) the collateral by those terms or as investment property; or(2) the underlying financial asset or commodity contract.

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(e) [When description by type insufficient.] A description only by type of collateral defined in [the Uniform Commercial Code] is an insufficient description of:

(1) a commercial tort claim; or(2) in a consumer transaction, consumer goods, a security entitlement, a securities account, or a commodity account.

The functions of the description are to identify the collateral and to notify interested parties of the security interest. The interested parties include not only the debtor and the creditor but also other affected parties such as the trustee in bankruptcy, unsecured creditors and the courts. If a security agreement does not sufficiently identify the collateral, then the creditor has no security interest in the collateral.

CaseIn re Shirel (p. 151)

Rules of interpretationContract of adhesion

Sufficiency of descriptionIdentify the collateral by type/classNotice to third parties

C. Describing the After-Acquired Property9-204 AFTER-ACQUIRED PROPERTY; FUTURE ADVANCES(a) [After-acquired collateral.] Except as otherwise provided in subsection (b), a security agreement may create or provide for a security interest in after-acquired collateral.(b) [When after-acquired property clause not effective.] A security interest does not attach under a term constituting an after-acquired property clause to:

(1) consumer goods, other than an accession when given as additional security, unless the debtor acquires rights in them within 10 days after the secured party gives value; or(2) a commercial tort claim.

Creditors frequently take a security interest in accounts receivable. However, a debtor’s accounts receivable change constantly as their customer’s pay off their accounts and the debtor makes new sales. These new sales represent after-acquired property. A problem exists, therefore, for a security interest in accounts receivable because the accounts may not have existed when the debtor signed the security agreement. Article 9 addressed the problem by extending the description of collateral to after-acquired property. Most security agreements now include an after-acquired property clause to invoke the Article 9 provisions.

Courts have applied the after-acquired property concept to other types of collateral that turnover besides accounts receivable. A good example is inventory. However, courts are not willing to find a security interest in after acquired property that does not turnover

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rapidly, such as equipment or fixtures. The lien on property that is subject to constant turnover is referred to as a floating lien.

CaseStoumbos v. Kilimnik (p. 155)

Description of collateralAfter-acquired property

Inventory YesEquipment No

D. Sufficiency of Description: Real Estate MortgagesUsually not an issue.

E. What Obligations Are Secured?9-204 AFTER-ACQUIRED PROPERTY; FUTURE ADVANCES(c) [Future advances and other value.] A security agreement may provide that collateral secures, or that accounts, chattel paper, payment intangibles, or promissory notes are sold in connection with, future advances or other value, whether or not the advances or value are given pursuant to commitment.

Virtually any obligation can be secured if the parties make their intention clear. A security interest can secure a debt that does not yet exist. Such a debt is referred to as a future advance. Such clauses are permitted and can be phrased to include any obligation whatsoever.

Usually a security agreement will provide that in the event of default, the debtor will pay the creditor’s attorney fees. Furthermore, the agreement also will allow the creditor to add these fees to the secured debt.

F. Problem Set 99.1a. § 9-203(b)(3)(A) requires a description. § 9-108(a) gives the standard, “reasonably identifies what is described. Here we also have a problem with after-acquired property. However, court may imply an after-acquired property clause if collateral is of a type that turns over rapidly. See Stoumbos v. Kilimnik.b. Possible actions include the following:

Refinance the entire amount

9.2§ 9-102(a)(34) defines “farm products,” which includes crops. “Crops” is not defined anywhere in the code. Courts may interpret crops to include livestock and livestock products. In deciding, courts may refer to dictionaries, course of performance, course of dealing or usage of trade.

9.4

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Because the security agreement needs to “reasonably identify what is described,” the store needs greater specificity in the collateral. One solution is to print the security agreement on the receipt.

9.5The bank cannot use an omnibus clause per § 9-108(c). However, the bank can incorporate the § 9-102 categories and accomplish nearly the same thing.

Account - § 9-102(a)(2) Deposit account - § 9-102(a)(29) Equipment - § 9-102(a)(33) Farm products - § 9-102(a)(34) Fixtures - § 9-102(a)(41) General intangible - § 9-102(a)(42) Instrument - § 9-102(a)(47) Inventory - § 9-102(a)(48) Proceeds - § 9-102(a)(64)

X. Proceeds, Products and Other Value-Tracing Concepts

A. Proceeds

1. Definition§ 9-102. DEFINITIONS AND INDEX OF DEFINITIONS(a) [Article 9 definitions.] In this article:

(12) "Collateral" means the property subject to a security interest or agricultural lien. The term includes:

(A) proceeds to which a security interest attaches;(B) accounts, chattel paper, payment intangibles, and promissory notes that have been sold; and(C) goods that are the subject of a consignment.

(64) "Proceeds", except as used in Section 9-609(b), means the following property:

(A) whatever is acquired upon the sale, lease, license, exchange, or other disposition of collateral;(B) whatever is collected on, or distributed on account of, collateral;(C) rights arising out of collateral;(D) to the extent of the value of collateral, claims arising out of the loss, nonconformity, or interference with the use of, defects or infringement of rights in, or damage to, the collateral; or(E) to the extent of the value of collateral and to the extent payable to the debtor or the secured party, insurance payable by reason of the loss or nonconformity of, defects or infringement of rights in, or damage to, the collateral.

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§ 9-203. ATTACHMENT AND ENFORCEABILITY OF SECURITY INTEREST; PROCEEDS; SUPPORTING OBLIGATIONS; FORMAL REQUISITES (f) [Proceeds and supporting obligations.] The attachment of a security interest in collateral gives the secured party the rights to proceeds provided by Section 9-315 and is also attachment of a security interest in a supporting obligation for the collateral.

Proceeds are whatever collateral was exchanged for. Some courts have expanded this definition to come closer to economic equivalence.

Class notesThe definition of collateral includes proceeds. Therefore, the collateral value may be traced through multiple conversions of form.

2. Termination of Security Interest in the Collateral After Authorized Disposition

§ 9-315. SECURED PARTY'S RIGHTS ON DISPOSITION OF COLLATERAL AND IN PROCEEDS(a) [Disposition of collateral: continuation of security interest or agricultural lien; proceeds.] Except as otherwise provided in this article and in Section 2-403(2):

(1) a security interest or agricultural lien continues in collateral notwithstanding sale, lease, license, exchange, or other disposition thereof unless the secured party authorized the disposition free of the security interest or agricultural lien; and

Creditors sometimes will authorize a debtor to sell collateral free of the security interest.

3. Continuation of Security Interest in the Collateral After Unauthorized Disposition


(2) a security interest attaches to any identifiable proceeds of collateral.

§ 9-401. ALIENABILITY OF DEBTOR'S RIGHTS(a) [Other law governs alienability; exceptions.] Except as otherwise provided in subsection (b) and Sections 9-406, 9-407, 9-408, and 9-409, whether a debtor's rights in collateral may be voluntarily or involuntarily transferred is governed by law other than this article.(b) [Agreement does not prevent transfer.] An agreement between the debtor and secured party which prohibits a transfer of the debtor's rights in collateral or makes the transfer a default does not prevent the transfer from taking effect.

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Most security agreements prohibit the unauthorized disposition of collateral. If the debtor wishes to dispose of the collateral, then the debtor must work with the purchaser and the creditor to facilitate the payoff of the debt and the transfer of the title.

Despite the provisions of security agreements, many debtors sell collateral in contravention of the agreement. Many states have enacted statutes that make such actions criminal. The U.C.C. does not prohibit such sales. § 9-401(b). However, the U.C.C. allows the security interest to continue to be on the collateral even in the hands of the new owner. § 9-315(a)(1). The U.C.C. also allows the security interest to attach to the proceeds from the sale of the collateral. § 9-315(a)(2). Although a creditor may decide not to enforce provisions preventing the sale when the debtor is current, the creditor risks losing the ability to enforce the provision later by so doing.

4. Limitations on the Secured Creditor’s Ability to Trace Collateral§ 9-315. SECURED PARTY'S RIGHTS ON DISPOSITION OF COLLATERAL AND IN PROCEEDS(b) [When commingled proceeds identifiable.] Proceeds that are commingled with other property are identifiable proceeds:

(1) if the proceeds are goods, to the extent provided by Section 9-336; and(2) if the proceeds are not goods, to the extent that the secured party identifies the proceeds by a method of tracing, including application of equitable principles, that is permitted under law other than this article with respect to commingled property of the type involved.

§ 9-332. TRANSFER OF MONEY; TRANSFER OF FUNDS FROM DEPOSIT ACCOUNT(a) [Transferee of money.] A transferee of money takes the money free of a security interest unless the transferee acts in collusion with the debtor in violating the rights of the secured party.(b) [Transferee of funds from deposit account.] A transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party.

A secured creditor’s ability to trace collateral is not unlimited. In particular, a security interest only can encumber proceeds so long as they remain identifiable. If the proceeds are commingled with similar assets that are not encumbered, then problems may arise in identifying the encumbered proceeds. Nonetheless, the secured creditor has the burden of proof of tracing the proceeds in order for the security interest to transfer to the collateral in its new form.

Frequently, cash is mixed in a bank account. If funds are disbursed from the account, then no easy way exists to tell if the funds still are in the account. The courts resolve this problem by using the lowest intermediate balance between the time the collateral was deposited to the account and the time the rule is applied.

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Cash transferred from a deposit account is not encumbered unless the recipient knows of the encumbrance.

CaseIn re Oriental Rug Warehouse Club, Inc. (p. 171)

Proceeds and value-tracingIdentifiabilityComminglingBurden of proof

B. Other Value-Tracing Concepts§ 9-102. DEFINITIONS AND INDEX OF DEFINITIONS(a) [Article 9 definitions.] In this article:

(34) "Farm products" means goods, other than standing timber, with respect to which the debtor is engaged in a farming operation and which are:

(A) crops grown, growing, or to be grown, including:(i) crops produced on trees, vines, and bushes; and(ii) aquatic goods produced in aquacultural operations;

(B) livestock, born or unborn, including aquatic goods produced in aquacultural operations;(C) supplies used or produced in a farming operation; or(D) products of crops or livestock in their unmanufactured states.

Proceeds is not the only value-tracing possibility. The value of collateral also may be transferred via products, profits, rents and offspring. Products arise frequently in an agricultural setting. Wool is a product of sheep; milk is a product of cows; maple syrup is a product of trees. Profits are generated from collateral attached to the soil such as minerals, timber and oil. Rents are fees charged by the debtor for the use of the collateral. Offspring are young borne to collateralized animals.

C. Non-Value-Tracing ConceptsCreditors also may take other security interests that are not related to value-tracing. These non-value-tracing concepts track property that does not derive any of its value from preceding collateral. Such concepts as after-acquired property, replacements, additions and substitutions are non-value-tracing concepts. Non-value-tracing concepts do not rely upon the source of funds.

D. Problem Set 1010.1Proceeds always are included as collateral. § 9-203(f). Other things such as products, offspring, substitutions, additions or replacements are not included automatically. The creditor may reach the collateral in two ways

squeeze the new collateral into the collateral described in the security agreement; or

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argue that the new collateral is proceeds of the collateral described in the security agreement.

10.2Description Proceeds

a. Money No Yesb. Parrot No Yes, form doesn’t matterc. New computer No, after-acquired Maybe, where did the

money come from?d. Myna bird No Yes, if from accounts.

10.3Race horse winnings:

products – nope profits – not likely because profits generally applies to extractive minerals; plus

after acquired property problem proceeds – analogize to depreciation, but horse was not disposed of

10.4Proceeds always are included in any security agreement. § 9-203(f). If the value of the inventory can be traced, then accounts and many other things may be encumbered.

10.5a. Proceeds always are included in any security agreement. § 9-203(f). Claims arising from the loss of the collateral are considered to be proceeds. § 9-102(a)(64)(D). The claim is the collateral.b. Proceeds includes to the extent of the value of collateral and to the extent payable to the debtor or the secured party, insurance payable by reason of the loss or nonconformity of, defects or infringement of rights in, or damage to, the collateral.§ 9-102(a)(64)(E).c. This is a commingling problem. We must trace the proceeds using the lowest intermediate balance rule. § 9-315(b)(2).

Debits Credits BalanceOpening Balance 5,000Insurance Proceeds 35,000 45,000If the collateral value can be traced, then the creditor can lay claim to the $35,000 in the deposit account.d. Another commingling problem.

Debits Credits BalanceOpening Balance 5,000Insurance Proceeds 35,000 40,000Copier Rent 2,000 38,000Here the guidance is that the debtor uses his own funds first. So, the $35,000 is still in the account.e. Another commingling problem

Debits Credits BalanceOpening Balance 5,000

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Debits Credits BalanceInsurance Proceeds 35,000 40,000Copier Rent 2,000 38,000IRS 32,000 6,000Now, by the lowest intermediate balance rule the creditor only can reach $6,000 regardless of later deposits.

10.6There are two ways to fit collateral into a security agreement

squeeze it into the description determine that it is proceeds.

Here the initial description was so specific that it will be impossible to squeeze it into the description. If the value can be traced, then the new copier may be proceeds. In such a situation, the creditor would have a lien for $29,000 on the new copier and $6,000 on the deposit account.

XI. Tracing Collateral Value During BankruptcyA debtor may continue to transform his property after the debtor is in bankruptcy. These changes may result in increases or decreases in the categories of property originally described in the security agreement.

A. Distinguishing Proceeds from After-Acquired PropertyAfter a debtor declares bankruptcy the rules change. A secured creditor can no longer pick up additional collateral by means of an after-acquired property clause. The bankruptcy laws only allow the secured creditor to increase his collateral through the use of the five value-tracing concepts: proceeds, products, profits, rents and offspring. This prevents the secured creditor from enhancing his position at the expense of unsecured creditors.

If the debtor is attempting reorganization, then the bankruptcy judge must allow the debtor to benefit in some manner from its labor. Revenues generated from the use of the secured creditor’s collateral must be split between the secured creditor, the unsecured creditors and the debtor. Any other solution provides the wrong incentives for the debtor. As a result, bankruptcy courts have developed four views of the scope of the secured creditor’s right to proceeds under the Bankruptcy Code:

“proceeds” as defined in § 9-102(a)(64); “proceeds” as defined under the 1978 Official Text of Article 9; only that portion of proceeds that represent the contribution of the collateral in the

proceeds; or only the net proceeds from the use of the collateral.

CasesIn re Delbridge (p. 179)

Tracing collateral value during bankruptcyProductsEquities of the case

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In re Hotel Sierra Vista Ltd. P’ship (p. 184)Tracing collateral value during bankruptcy

RentsEquities of the case

B. “Cash Collateral” in BankruptcyCash collateral presents special problems because of its fungible nature. The court may allow the use of cash collateral by placing a lien on the resulting inventory. Special rules for cash collateral require the debtor to notify the secured creditor and allow an opportunity for a hearing before the debtor or trustee can use the cash collateral.

C. Problem Set 11

XII. The Legal Limits on What May Be Collateral

XIII. Default, Acceleration, and Cure Under State Law

A. DefaultA debtor defaults on a loan by either doing something that he should not have done or failing to do something that he should have done. Security agreements define the events of default that will result in the debt being accelerated. A typical list of events of default might include the following;

debtor fails to pay any obligation to the creditor when due; debtor breaches any warranty or provision of any agreement with the creditor; debtor dies, becomes insolvent or ceases to do business; collateral is lost or destroyed; debtor files for bankruptcy or an involuntary petition is filed; creditor believes in good faith that ability for repayment is impaired; any guarantor defaults in any obligation to the creditor

The creditor may waive an event of default. Typically, the security agreement contains language that any waiver of default does not constitute waiver of future events of default.

B. When Is Payment Due?

1. Installment LoansInstallment loans require the debtor to repay the debt in a series of payments. As long as the debtor makes each payment by the due date and otherwise complies with the loan agreement, the debtor will not be in default or subject to creditor remedies.

2. Single Payment LoansSingle payment loans require the debtor to pay the loan balance on a given day. If the debtor does not have the money, then the creditor may either roll the note or place the debtor in default.

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3. Lines of CreditWith a line of credit, the creditor contracts to lend up to a specific amount of money up to the credit limit to the debtor during a period of time. The debtor then borrows against the line of credit as necessary.

C. Acceleration and Cure

1. Acceleration

Acceleration clauses allow the creditor to collect for the full amount of a debt (not just the delinquent payment) upon default by the debtor. Acceleration is a powerful leverage tool for the creditor.

2. Limits on the Enforceability of Acceleration ClausesCourts will not allow a secured creditor to enforce an acceleration clause arbitrarily.

CaseJ.R. Hale Contracting Co. v. United New Mexico Bank (p. 216)

Acceleration and cureWaiver, modification and estoppel

Course of dealingGood faith

3. The Debtor’s Right to CureThe debtor has the right to cure a default by paying the amounts then due. If the debtor pays before the creditor accelerates, then the debtor only must pay the delinquent amount. If the creditor accelerates, then the debtor must pay the entire debt.

This right to cure may be enhanced by statute. Some states allow the debtor to cure by paying only the delinquent amount and requiring the creditor to reinstate the debt on the original terms.

CaseOld Republic Ins. Co. v. Lee (p. 221)

Acceleration and cureRight to cure

D. The Enforceability of Payment Terms§ 1-309. OPTION TO ACCELERATE AT WILLA term providing that one party or that party's successor in interest may accelerate payment or performance or require collateral or additional collateral "at will" or when the party "deems itself insecure," or words of similar import, means that the party has power to do so only if that party in good faith believes that the prospect of payment or performance is impaired. The burden of establishing lack of good faith is on the party against which the power has been exercised.

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§ 9-102. DEFINITIONS AND INDEX OF DEFINITIONS(a) [Article 9 definitions.] In this article:

(43) "Good faith" means honesty in fact and the observance of reasonable commercial standards of fair dealing.

Debtors and creditors often agree to payment terms that the debtors have no real hope of satisfying. Because default has severe consequences for the debtor, courts have sought ways to soften the contracts. One means that courts have developed is the concept of lender liability.

Lender liability rests upon the premise that the debtor and creditor deal with each other in good faith. When the creditor does not deal with the debtor in good faith, the courts may find that the creditor’s actions create liability for damages befalling the debtor. A creditor cannot be found to not act in good faith if the creditor complies with the terms of the contract. Only where the contract is silent does good faith become relevant. Alternatively, the creditor may engage in inequitable conduct if the creditor breaches the contract plus takes advantage in some way.

Class notesPer § 1-309, a lender may include words that allow it to accelerate a loan at will. But, the lender must exercise this power in good faith.

After acquired property clauses die in bankruptcy. 11 U.S.C. § 555(a).

CaseKham & Nate’s Shoes No. 2 v. First Bank of Whiting (p. 224)

Default, accelerationLender liabilityInequitable conduct

Requirement of breach and advantage taking

E. Procedures After DefaultAfter default, the creditor has a choice of remedies. Those remedies fall into two basic categories:

judicial remedieso foreclosureo replevin

self-help remedieso repossessiono notification of account debtorso refusal to make further advances

Self-help remedies tend to have dramatic impact on the business. As a result, many creditors may proceed more cautiously by using the judicial remedies. Of course, these remedies are slower.

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F. Problem Set 13

XIV. Default, Acceleration, and Cure Under Bankruptcy Law

XV. The Prototypical Secured Transaction

A. The PartiesThe prototypical secured transaction occurs between a lender and a borrower. A lender may loan money for a variety of reasons including floorplanning, the purchase of the inventory that is on the dealer’s showroom floor.

The borrower typically is a business that has a timing problem with money.

B. Deutsche Approves Bonnie’s LoanBefore a lender will loan money, the borrower needs to apply for the loan. The application process normally requires the borrower to provide financial information about the business and the owners of the business.

After the application is submitted, the lender performs some credit analysis. Usually the lender will obtain credit reports on the business and its owners. Credit analysis involves looking at the borrower’s capacity, capital, character, conditions and collateral. If the analysis is satisfactory, then the loan will be approved.

C. Deutsche and Bonnie’s Document the LoanOnce the loan is approved, the parties must document the loan. This process puts an enforceable agreement in place that defines the relationship between the parties.

1. Security Agreement and Statement of TransactionIf the loan is approved, then the parties will document the loan with both a promissory note and a security agreement. The security agreement will identify the collateral, the conditions of default and . . .

2. The Financing StatementThe borrower also will sign a financing statement. The lender will file the financing statement with the state to give public notice that the lender has a security interest in the listed assets of the borrower. This process is known as perfection.

3. The Personal GuaranteeThe owners of the business also will sign personal guarantees of the business’ debt. In this way, the lender protects itself from the borrower transferring assets to the owners and disappearing.

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D. Bonnie’s Buys Some BoatsOnce the loan is documented, the lender disburses funds to the borrower and the borrower may use the funds for the specified purposes.

1. The Floorplan AgreementLenders that perform the same kind of transaction again and again will have additional protections in place. The lender may have agreements with the borrower’s suppliers such as floorplan agreements that specify that the supplier will repurchase repossessed collateral at the full invoice price. Furthermore, agreements with the suppliers provide checks and balances that prevent fraud by the borrower. The floorplan agreement also benefits the borrower because the lender is more likely to extend credit if its risks are mitigated.

2. The BuyWhen the borrower wants to use the funds, the lender, supplier and borrower exchange information to make sure that all parties agree to the transaction.

E. Bonnie’s Sells a BoatIf the borrower sells some inventory, then a portion of the debt may become due. Also, the lender may have a new opportunity for financing with the purchaser.

F. Monitoring the Existence of the CollateralAn additional responsibility of the lender is monitoring the condition of the loan. The lender does this by periodically collecting information from the borrower and by actual site inspection.

G. Problem Set 1515.1Fraud is possible.

15.2a. The creditor must look for ways to mitigate the risks of fraud. One way is to require the buyer’s lender to direct the payment to Deutsche.

b. This type of fraud is particularly difficult to detect. The creditor must investigate for signs that the collateral is being used or that someone is exercising dominion over the collateral.

15.3A guarantee makes the guarantor contractually liable for the debts. The guarantor cannot simply walk away from the company’s debts. Although the guarantee can be discharged in bankruptcy, this option is not particularly attractive.

15.6

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b. Lease of the boatyard. Does the description incorporate the desired collateral? Contract rights may be able to be interpreted to include the lease. However, some types of property cannot be used as collateral. § 9-109(d). Leases on real property are listed. § 9-109(d)(11).

d. Bank accounts. Does the description include the desired collateral? The creditor may try to include bank accounts within the definition of accounts. But, Article 9 clearly defines accounts. The creditor also may try to include bank accounts within contract rights as the deposit relationship is based upon a contract. However, the U.C.C. clearly provides a separate category called deposit accounts. So, the creditor is working uphill.

One way to avoid problems is to define terms. Defining terms can avoid many future problems.

XVI. The Personal Property Filing Systems

A. Competition for the Secured Creditor’s CollateralWhen a party has a security interest, two relationships exist: the creditor/debtor relationship; and the creditor/creditor relationship. The secured creditor not only must establish the security interest, but also must maintain a superior position to other creditors in the collateral. When things go wrong, all of the creditors are competing for the debtor’s limited assets. The law resolves contests over the rights to collateral through a priority system. Creditors with higher priority get first rights to the collateral.

B. What Is Priority?Collateral may have more than one lien. The lien with higher priority is referred to as the senior lien. The other lien is referred to as the subordinate lien. Creditors may agree contractually to subordinate their debt. Creditors with a security interest have priority over unsecured creditors. Creditors who have perfected their security interests get priority over creditors who have not perfected their security interests. Among creditors who have perfected their security interests, first in time is first in rights.

CasePeerless Packing Co. v. Malone & Hyde, Inc. (p. 273)

Personal property filing systemsPriority

C. How Do Creditors Get Priority?Lien priority is determined in chronological order. However, the creditor must take steps to publish the lien so that prospective lenders can be notified. The steps that must be taken differ with the type of lien, but usually involve one of four types of acts:

filing notice in a public record system established for that purpose; taking possession of the collateral; taking control of the collateral; or posting notice on the collateral.

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Filing notice is the usual method, but sometimes other methods are required.

D. The Theory of the Filing SystemThe filing system gives constructive notice of the existence of a lien. The system also is designed to give actual notice. A creditor provides notice to successive creditors by filing a financing statement in the filing system. As a result, a creditor needs to search the filing system before extending debt to a borrower.

E. The Multiplicity of Filing SystemsUnfortunately, a single filing system does not exist. Many states have a separate filing system in each county and the filing systems are not cross-referenced. Furthermore, security interests in different types of collateral are filed in different filing systems.

CasesNat’l Peregrine, Inc. v. Capital Federal Sav. & Loan Ass’n of Denver (p. 279)

Personal property filing systemsMultiplicity of filing systems

Copyrights – central filingIn re Pasteurized Eggs Corp. (p. 285)

Personal property filing systemsMultiplicity of filing systems

Copyrights – state law

F. Methods and Costs of SearchingMethods for searching the filing system vary with location. In many locations, service companies have sprung up to provide these search services. The cost for these searches can be considerable depending on a number of variables. Still, the search costs usually are dwarfed by the transaction amount.

G. Problem Set 1616.3a. Tools – What category is the collateral in the hands of the debtor?There are four major categories of collateral: inventory; consumer goods; farm products; and equipment. Equipment is the residual category. The tools are equipment as defined in § 9-102(a)(33).

The default filing requirements in order to perfect a security interest are found in § 9-501(a). A financing statement for real estate is filed in the county office. § 9-501(a)(1). For everything else, the financing statement is filed in the Office of the Secretary of State. § 9-501(a)(2).

b. Patent – What category is the collateral in the hands of the debtor?The patent is a general intangible. The financing statement should be filed in the Office of the Secretary of State. The default filing requirements may be preempted by other federal or state statutes. § 9-109(c).

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c. Royalty payment – What category is the collateral in the hands of the debtor?The classification of the collateral is ambiguous. The collateral may be an account, a general intangible or a copyright associated item. If the collateral is an account or a general intangible, then the financing statement must be filed with the Office of the Secretary of State. If the collateral is a copyright item, then federal law preempts and the financing statement must be filed with the copyright office.

Note: This filing could be very expensive if a separate financing statement must be completed for each copyrighted work.

16.4Normally, you file first and search later because of the delays in updating the system any search is meaningless until you see your own name and can evaluate your priority.

XVII.Article 9 Financing Statements: The Debtor’s Name§ 9-519. NUMBERING, MAINTAINING, AND INDEXING RECORDS; COMMUNICATING INFORMATION PROVIDED IN RECORDS(a) [Filing office duties.] For each record filed in a filing office, the filing office shall:

(1) assign a unique number to the filed record;(2) create a record that bears the number assigned to the filed record and the date and time of filing;(3) maintain the filed record for public inspection; and(4) index the filed record in accordance with subsections (c), (d), and (e).

(b) [File number.] A file number [assigned after January 1, 2002,] must include a digit that:(1) is mathematically derived from or related to the other digits of the file number; and(2) aids the filing office in determining whether a number communicated as the file number includes a single-digit or transpositional error.

(c) [Indexing: general.] Except as otherwise provided in subsections (d) and (e), the filing office shall:

(1) index an initial financing statement according to the name of the debtor and index all filed records relating to the initial financing statement in a manner that associates with one another an initial financing statement and all filed records relating to the initial financing statement; and(2) index a record that provides a name of a debtor which was not previously provided in the financing statement to which the record relates also according to the name that was not previously provided.

(d) [Indexing: real-property-related financing statement.] If a financing statement is filed as a fixture filing or covers as-extracted collateral or timber to be cut, [it must be filed for record and] the filing office shall index it:

(1) under the names of the debtor and of each owner of record shown on the financing statement as if they were the mortgagors under a mortgage of the real property described; and(2) to the extent that the law of this State provides for indexing of records of mortgages under the name of the mortgagee, under the name of the secured party as if the secured

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party were the mortgagee thereunder, or, if indexing is by description, as if the financing statement were a record of a mortgage of the real property described.

(e) [Indexing: real-property-related assignment.] If a financing statement is filed as a fixture filing or covers as-extracted collateral or timber to be cut, the filing office shall index an assignment filed under Section 9-514(a) or an amendment filed under Section 9-514(b):

(1) under the name of the assignor as grantor; and(2) to the extent that the law of this State provides for indexing a record of the assignment of a mortgage under the name of the assignee, under the name of the assignee.

[Alternative A](f) [Retrieval and association capability.] The filing office shall maintain a capability:

(1) to retrieve a record by the name of the debtor and by the file number assigned to the initial financing statement to which the record relates; and(2) to associate and retrieve with one another an initial financing statement and each filed record relating to the initial financing statement.

[Alternative B](f) [Retrieval and association capability.] The filing office shall maintain a capability:

(1) to retrieve a record by the name of the debtor and:(A) if the filing office is described in Section 9-501(a)(1), by the file number assigned to the initial financing statement to which the record relates and the date [and time] that the record was filed [or recorded]; or(B) if the filing office is described in Section 9-501(a)(2), by the file number assigned to the initial financing statement to which the record relates; and

(2) to associate and retrieve with one another an initial financing statement and each filed record relating to the initial financing statement.

[End of Alternatives](g) [Removal of debtor's name.] The filing office may not remove a debtor's name from the index until one year after the effectiveness of a financing statement naming the debtor lapses under Section 9-515 with respect to all secured parties of record.(h) [Timeliness of filing office performance.] The filing office shall perform the acts required by subsections (a) through (e) at the time and in the manner prescribed by filing-office rule, but not later than two business days after the filing office receives the record in question.[(i) [Inapplicability to real-property-related filing office.] Subsection[s] [(b)] [and] [(h)] do[es] not apply to a filing office described in Section 9-501(a)(1).]

A. The Components of a Filing SystemSome states have gone to a paperless filing system. As a result, Article 9 is written in media neutral language. However, every filing system must have certain subsystems: a way to add records; a way to search the records; and, a way to delete records.

1. Financing StatementsFinancing statements are entered into the filing system in different ways in different states. Although states originally kept the paper records, technology has moved financing statements onto other media such as microfilm, microfiche or computer images.

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2. The IndexEvery financing statement is assigned a unique number, usually referred to as the file number. To find a financing statement, the searcher must have the file number. However, most people only have either a description of the collateral or the debtor’s name. Descriptions of collateral most frequently are useful with tracts of land or motor vehicles because the collateral has a stable identity. For other types of collateral, the debtor’s name is the only stable element. Indices are needed to cross-reference the debtor’s name or collateral with the file numbers.

3. Search SystemsComputer systems enable the filing system to be searched effectively using the indices. The computer systems search logic determines the effectiveness of any search. Misspellings, alternate spellings or abbreviations compound the problems of doing an effective search of the filing system. Delays between the time that the financing statement is recorded and the time that the financing statement is indexed also introduce errors.

Class Notes§ 9-519(h) gives the filing office two days to update their records. If the filing office takes more than two days, it suffers no penalties. § 9-524. Moreover, if the filing office screws up, that doesn’t affect the validity of the filing and the filing office will not be held liable. § 9-517.

B. Correct Names for use in Financing Statements§ 9-503. NAME OF DEBTOR AND SECURED PARTY(a) [Sufficiency of debtor's name.] A financing statement sufficiently provides the name of the debtor:

(1) if the debtor is a registered organization, only if the financing statement provides the name of the debtor indicated on the public record of the debtor's jurisdiction of organization which shows the debtor to have been organized;(2) if the debtor is a decedent's estate, only if the financing statement provides the name of the decedent and indicates that the debtor is an estate;(3) if the debtor is a trust or a trustee acting with respect to property held in trust, only if the financing statement:

(A) provides the name specified for the trust in its organic documents or, if no name is specified, provides the name of the settlor and additional information sufficient to distinguish the debtor from other trusts having one or more of the same settlors; and(B) indicates, in the debtor's name or otherwise, that the debtor is a trust or is a trustee acting with respect to property held in trust; and

(4) in other cases:(A) if the debtor has a name, only if it provides the individual or organizational name of the debtor; and(B) if the debtor does not have a name, only if it provides the names of the partners, members, associates, or other persons comprising the debtor.

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§ 9-506. EFFECT OF ERRORS OR OMISSIONS(a) [Minor errors and omissions.] A financing statement substantially satisfying the requirements of this part is effective, even if it has minor errors or omissions, unless the errors or omissions make the financing statement seriously misleading.(b) [Financing statement seriously misleading.] Except as otherwise provided in subsection (c), a financing statement that fails sufficiently to provide the name of the debtor in accordance with Section 9-503(a) is seriously misleading.(c) [Financing statement not seriously misleading.] If a search of the records of the filing office under the debtor's correct name, using the filing office's standard search logic, if any, would disclose a financing statement that fails sufficiently to provide the name of the debtor in accordance with Section 9-503(a), the name provided does not make the financing statement seriously misleading.(d) ["Debtor's correct name."] For purposes of Section 9-508(b), the "debtor's correct name" in subsection (c) means the correct name of the new debtor.

Minor errors or omissions do not negate the effect of a financing statement if the errors are not seriously misleading. Of course, determining the correct name that should appear on the financing statement is not a simple matter. The guidelines for the correct name are found in section 9-503.

1. Individual NamesThe legally correct name for an individual is the name by which the person is generally known. The situation is complicated by the fact that a person may change their name by filing court papers, marrying or divorcing. As a result, the correct name for an individual is an elusive concept. Furthermore, more than one person may have the same name. Some courts have required that a financing statement contain the full legal name of an individual by analogizing with the U.C.C.’s treatment of tradenames.

CaseIn re Kinderknecht (p. 296)

Financing statementsDebtor’s name

Individuals—exact full legal name

2. Corporate NamesThe exact full legal name of a corporation can be found on the articles of incorporation filed with secretary of state of the state of incorporation. Also, no state permits the formation of two corporations with the same name. Corporate names must be unique within a state. However, two corporations can have the same name if they are incorporated in different states.

3. Partnership NamesA limited partnership also must file paperwork with the state and be issued a certificate. A general partnership does not need to register. The legal name of a general partnership is the name by which it is generally known in the community.

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4. Trade Names§ 9-503. NAME OF DEBTOR AND SECURED PARTY(b) [Additional debtor-related information.] A financing statement that provides the name of the debtor in accordance with subsection (a) is not rendered ineffective by the absence of:

(1) a trade name or other name of the debtor; or(2) unless required under subsection (a)(4)(B), names of partners, members, associates, or other persons comprising the debtor.

(c) [Debtor's trade name insufficient.] A financing statement that provides only the debtor's trade name does not sufficiently provide the name of the debtor.

A trade name is not a legal name. The user of a trade name may or may not register the trade name with the state. As a result, the use of a trade name on a financing statement does not identify the debtor.

5. The Entity ProblemFrequently, a creditor encounters problems in identifying the debtor’s entity type or the correct organizational level of the debtor in the case of multi-level debtors.

C. Errors in the Debtors’ Names on Financing StatementsFinancing statements filed under the debtor’s incorrect name are ineffective; financing statements filed under the debtor’s correct name are effective. If a search fails to turn up all of the financing statements filed under the debtor’s correct name, then the creditor may have a case against the person conducting the search. Also, if a search under the debtor’s correct name would fail to turn up a financing statement, then the financing statement is ineffective. The test is to enter the debtor’s correct name and apply the official search logic. However, the IRS gets a free pass as long as the filing would be discovered by a reasonable and diligent search.

CaseIn re Spearing Tool & Mfg. Co. (p. 302)

Financing statementDebtor’s name

ErrorsTax liens

D. Problem Set 1717.1First, what type of entity is it? Resolution of this question will determine what name to search under. Several ways exist to determine the type of entity including the following:

ask the debtor; search public records.

If the entity is a general partnership, then search should be done for the name of the partnership—McErny Leasing. If the entity is a sole proprietorship, then McErny Leasing is a trade name. A financing statement filed under a trade name is ineffective per

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§ 9-503(b)-(c). The financing statement must be filed under the full legal name of the owner—Robert Joseph McErny.

After filing, an official search under the full legal name will determine if any other liens are valid even if filed under a different name because they are not seriously misleading.

17.2(a) Susan Alexander(b) John Phillip Smith(c) Same discussion as for 17.1 and sole proprietorships on p. 300.

17.3By the definition, all 112 financing statements are not seriously misleading. So, all 112 financing statements must be checked.

Each state’s official search logic is unique. Do not rely upon unofficial searches.

17.6(a) First, file the financing statement. Second, search the index three business days later. If the secretary of state is in compliance, then the financing statement should appear in the record. You will be ready in plenty of time.(b) First, file the financing statement. Second, run an “expedited” search on the index at two weeks plus one day. You still will be ready, but with less margin for error.

A financing statement can be filed before the security agreement is signed. The significance of a financing statement only is to give notice of a need for further investigation. The debtor’s signature on the security agreement gives the creditor a security interest.

XVIII. Article 9 Financing Statements: Other Information

A. IntroductionAlthough electronic filing is permitted in some states, financing statements typically are written documents prepared on pre-printed forms. The U.C.C. provides a standard form, but a creditor may devise its own form as long as the form contains the required information. To comply with all of the U.C.C.’s requirements, the form must contain the following:

name of the debtor; name of the secured creditor; description of the collateral covered; mailing address of the debtor; mailing address of the secured creditor; indication of whether the debtor is an individual or an organization; and for organizations

o the type of organization;o debtor’s jurisdiction of organization; and

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o debtor’s organization identification number.If the form does not contain all of the required information, the filing office will reject the form and the security interest will not be perfected. The filing office does not check the information for accuracy.

B. Filing Office Errors in Acceptance or Rejection

1. Wrongly Accepted Filings§ 9-502. CONTENTS OF FINANCING STATEMENT; RECORD OF MORTGAGE AS FINANCING STATEMENT; TIME OF FILING FINANCING STATEMENT(a) [Sufficiency of financing statement.] Subject to subsection (b), a financing statement is sufficient only if it:

(1) provides the name of the debtor;(2) provides the name of the secured party or a representative of the secured party; and(3) indicates the collateral covered by the financing statement.

. . . .

§ 9-506. EFFECT OF ERRORS OR OMISSIONS(a) [Minor errors and omissions.] A financing statement substantially satisfying the requirements of this part is effective, even if it has minor errors or omissions, unless the errors or omissions make the financing statement seriously misleading.(b) [Financing statement seriously misleading.] Except as otherwise provided in subsection (c), a financing statement that fails sufficiently to provide the name of the debtor in accordance with Section 9-503(a) is seriously misleading.(c) [Financing statement not seriously misleading.] If a search of the records of the filing office under the debtor's correct name, using the filing office's standard search logic, if any, would disclose a financing statement that fails sufficiently to provide the name of the debtor in accordance with Section 9-503(a), the name provided does not make the financing statement seriously misleading.. . . .

§ 9-520. ACCEPTANCE AND REFUSAL TO ACCEPT RECORD(a) [Mandatory refusal to accept record.] A filing office shall refuse to accept a record for filing for a reason set forth in Section 9-516(b) and may refuse to accept a record for filing only for a reason set forth in Section 9-516(b).. . . .(c) [When filed financing statement effective.] A filed financing statement satisfying Section 9-502(a) and (b) is effective, even if the filing office is required to refuse to accept it for filing under subsection (a). However, Section 9-338 applies to a filed financing statement providing information described in Section 9-516(b)(5) which is incorrect at the time the financing statement is filed.. . . .

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A filing office may refuse to accept a filing if the financing statement does not contain any of the information required by section 516(b). However, if a filing office mistakenly accepts an incomplete financing statement, the financing statement may still be effective if the missing information is not the debtor’s name, the secured party’s name or the description of the collateral. Even if the error is in one of these three fields, the financing statement will be effective if the error or omission is not seriously misleading. If the information specified in section 9-516(b)(5) is missing or incorrect, then the secured party’s security interest is subordinated to another secured party that relied upon the incorrect information in the financing statement and a purchaser takes the collateral free of the security interest.

Class notesSection 9-506(a) applies to the collateral description. Section 9-506(b)-(d) applies to the debtor’s name. Errors in the secured party’s name cannot be seriously misleading.

2. Wrongly Rejected Filings§ 1-201. GENERAL DEFINITIONS. . . .(b) Subject to definitions contained in other articles of [the Uniform Commercial Code] that apply to particular articles or parts thereof:

. . . .(29) "Purchase" means taking by sale, lease, discount, negotiation, mortgage, pledge, lien, security interest, issue or reissue, gift, or any other voluntary transaction creating an interest in property.(30) "Purchaser" means a person that takes by purchase.. . . .

§ 9-516. WHAT CONSTITUTES FILING; EFFECTIVENESS OF FILING. . . .(d) [Refusal to accept record; record effective as filed record.] A record that is communicated to the filing office with tender of the filing fee, but which the filing office refuses to accept for a reason other than one set forth in subsection (b), is effective as a filed record except as against a purchaser of the collateral which gives value in reasonable reliance upon the absence of the record from the files.

When a filing office rejects a financing statement, the filing office stamps the financing statement with the date and time of the attempt to file. If a filing office mistakenly rejects a financing statement, the filing is effective against lien creditors but not against purchasers.

C. Filer Errors in Accepted FilingsIf required information is omitted, then the filing office should reject the financing statement. However, incorrect information on the financing statement will not result in rejection by the filing office. The effect of the incorrect information on the filing is

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different depending upon whether the incorrect information is among the three elements required for effectiveness or the six elements required to qualify for filing.

1. Information Necessary Only to Qualify for Filing§ 9-516. WHAT CONSTITUTES FILING; EFFECTIVENESS OF FILING. . . .(b) [Refusal to accept record; filing does not occur.] Filing does not occur with respect to a record that a filing office refuses to accept because:

. . .(4) in the case of an initial financing statement or an amendment that adds a secured party of record, the record does not provide a name and mailing address for the secured party of record;(5) in the case of an initial financing statement or an amendment that provides a name of a debtor which was not previously provided in the financing statement to which the amendment relates, the record does not:

(A) provide a mailing address for the debtor;(B) indicate whether the debtor is an individual or an organization; or(C) if the financing statement indicates that the debtor is an organization, provide:

(i) a type of organization for the debtor;(ii) a jurisdiction of organization for the debtor; or(iii) an organizational identification number for the debtor or indicate that the debtor has none;

§ 9-338. PRIORITY OF SECURITY INTEREST OR AGRICULTURAL LIEN PERFECTED BY FILED FINANCING STATEMENT PROVIDING CERTAIN INCORRECT INFORMATIONIf a security interest or agricultural lien is perfected by a filed financing statement providing information described in Section 9-516(b)(5) which is incorrect at the time the financing statement is filed:

(1) the security interest or agricultural lien is subordinate to a conflicting perfected security interest in the collateral to the extent that the holder of the conflicting security interest gives value in reasonable reliance upon the incorrect information; and(2) a purchaser, other than a secured party, of the collateral takes free of the security interest or agricultural lien to the extent that, in reasonable reliance upon the incorrect information, the purchaser gives value and, in the case of chattel paper, documents, goods, instruments, or a security certificate, receives delivery of the collateral.

The six elements required to qualify for filing include mailing address of the debtor; mailing address of the secured party; indication of whether the debtor is an individual or an organization; and for organizations

o the type of organization;

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o debtor’s jurisdiction or organization; ando debtor’s organization identification number.

An error in any of these elements limits the effectiveness of the filing. The filing will be effective against lien creditors and bankruptcy trustees but will not be effective against purchasers who give value in reasonable reliance on the incorrect information.

2. Required Information§ 9-502. CONTENTS OF FINANCING STATEMENT; RECORD OF MORTGAGE AS FINANCING STATEMENT; TIME OF FILING FINANCING STATEMENT(a) [Sufficiency of financing statement.] Subject to subsection (b), a financing statement is sufficient only if it:

(1) provides the name of the debtor;(2) provides the name of the secured party or a representative of the secured party; and(3) indicates the collateral covered by the financing statement.

. . . .

The three elements required for effectiveness of a filing include name of the debtor; name of the secured creditor; and description of the collateral covered.

A financing statement containing correct information on all three of these elements will be effective. An incorrect name of the secured creditor prevents a searcher from obtaining termination statements and prevents a searcher from verifying information with the secured creditor. An incorrect description fails to put searchers on notice. The standards for description are different for security agreements and financing statements. In a financing statement a secured creditor may employ super-generic terms.

CaseIn re Pickle Logging, Inc. (p. 314)

Financing statementFiler errors

Required information—description

D. Authorization to File a Financing Statement9-509. PERSONS ENTITLED TO FILE A RECORD(a) [Person entitled to file record.] A person may file an initial financing statement, amendment that adds collateral covered by a financing statement, or amendment that adds a debtor to a financing statement only if:

(1) the debtor authorizes the filing in an authenticated record or pursuant to subsection (b) or (c); or(2) the person holds an agricultural lien that has become effective at the time of filing and the financing statement covers only collateral in which the person holds an agricultural lien.

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(b) [Security agreement as authorization.] By authenticating or becoming bound as debtor by a security agreement, a debtor or new debtor authorizes the filing of an initial financing statement, and an amendment, covering:

(1) the collateral described in the security agreement; and(2) property that becomes collateral under Section 9-315(a)(2), whether or not the security agreement expressly covers proceeds.

9-510. EFFECTIVENESS OF FILED RECORD(a) [Filed record effective if authorized.] A filed record is effective only to the extent that it was filed by a person that may file it under Section 9-509.

9-518. CLAIM CONCERNING INACCURATE OR WRONGFULLY FILED RECORD(a) [Correction statement.] A person may file in the filing office a correction statement with respect to a record indexed there under the person's name if the person believes that the record is inaccurate or was wrongfully filed.[Alternative A](b) [Sufficiency of correction statement.] A correction statement must:

(1) identify the record to which it relates by the file number assigned to the initial financing statement to which the record relates;(2) indicate that it is a correction statement; and(3) provide the basis for the person's belief that the record is inaccurate and indicate the manner in which the person believes the record should be amended to cure any inaccuracy or provide the basis for the person's belief that the record was wrongfully filed.

[Alternative B](b) [Sufficiency of correction statement.] A correction statement must:

(1) identify the record to which it relates by:(A) the file number assigned to the initial financing statement to which the record relates; and(B) if the correction statement relates to a record filed [or recorded] in a filing office described in Section 9-501(a)(1), the date [and time] that the initial financing statement was filed [or recorded] and the information specified in Section 9-502(b);

(2) indicate that it is a correction statement; and(3) provide the basis for the person's belief that the record is inaccurate and indicate the manner in which the person believes the record should be amended to cure any inaccuracy or provide the basis for the person's belief that the record was wrongfully filed.

[End of Alternatives](c) [Record not affected by correction statement.] The filing of a correction statement does not affect the effectiveness of an initial financing statement or other filed record.

The presence of a financing statement clouds the title to the collateral described in the financing statement. In the past, judgment-proof people have filed financing statements

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on collateral solely to cause problems to the collateral owner. Some states have responded by making such actions a crime.

The U.C.C. now requires a secured party to obtain authorization from a debtor before filing a financing statement. If the financing statement was not authorized, then the financing statement is not effective. However, the lack of effectiveness does not remove the false financing statement from the system. The debtor may file a correction statement in order to provide notice to searchers. The U.C.C.’s system does not require notarization as the real estate system does.

A creditor may get authorization to file a financing statement in two principal ways: express authorization; or ipso facto authorization. Express authorization is obtained by getting the debtor to authenticate a record allowing the filing of a financing statement. The creditor gets ipso facto authorization by having the debtor sign a security agreement

E. U.C.C. InsuranceThe consequences of U.C.C. filing problems can be severe. As a result, U.C.C. insurance has been developed to mitigate the risks. U.C.C. insurance is analogous to title insurance. The critical difference is that U.C.C. insurance does not protect against the possibility that the debtor does not own the collateral.

Class NotesThere are two questions that need to be answered with respect to a financing statement:

1. Should the financing statement be rejected?2. Is the financing statement effective?

To determine if a financing statement should be rejected, you first go to section 520(a). If all of the boxes from section 516(b) are filled in, then the financing statement should be accepted. The filing office does not evaluate the information for correctness.

To determine if a filing statement with errors or omissions is effective, identify if the error or omission is in one of the required fields. If the error or omission is in one of the required fields, then determine if the error or omission is seriously misleading. If the error is not in one of the required fields or the error or omission in the required field is not seriously misleading, then the financing statement is effective. If the error is in one of the fields required by section 516(b)(5), then the secured party’s security interest is subordinated to the security interests of secured parties that relied upon the incorrect information and a purchaser takes the collateral free of the security interest. The secured party retains priority over judicial lien creditors (bankruptcy trustee) and liens placed by operation of law.

F. Problem Set 1818.1(a) A financing statement with missing information should be rejected; a financing statement with incorrect information should be accepted. The secured party may amend the financing statement later. Additionally, even if the secured party does not correct the financing statement, the secured party only will lose ground per section 338.

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(b) If the filing office wrongly rejects the financing statement, then what?The financing statement is of limited value. Any purchaser, as defined in section 1-201(b)(30), who has done a search has priority over the secured party with the wrongly rejected financing statement. However, the secured party with the wrongly rejected financing statement has priority over involuntary liens (statutory, judicial, bankruptcy trustee). You are not perfected.(c) If the financing statement is accepted with incorrect information from section 516(b)(5), then the financing statement is effective. However, the financing statement is subject to the limitations of section 9-338.

18.2(a) The F/S is missing the secured party’s address.The F/S should have been rejected per section 9-520(a) because the F/S was missing information from section 9-516(b)(4). But, is the F/S effective? Yes, look to section 9-520(c). The F/S contains the information in section 9-502(a). The incorrect information is referenced in section 9-516(b)(4). So the effectiveness is not limited by section 9-338.(b) The F/S contains an incorrect debtor mailing address.The F/S should not have been rejected per section 9-520(a) because the filing office is not supposed to evaluate the F/S for the correctness of the information and some information was present in all of the section 9-516(b) fields. But, is the F/S effective? Yes, look to section 9-520(c). The F/S contains the information in section 9-502(a). The incorrect information is referenced in section 9-516(b)(5)(A). So, the effective is limited by section 9-338 with respect to purchasers and other voluntary liens.(c) The F/S contains an incorrect secured party’s name.The F/S should not have been rejected per section 9-520(a) because the filing office is not supposed to evaluate the F/S for the correctness of the information and some information was present in all of the section 9-516(b) fields. But, is the F/S effective? Yes, look to section 9-520(c). The F/S contains incorrect information for field in section 9-502(a)(2). To determine if the error is seriously misleading, go to section 9-506. Errors in the secured party’s name are not seriously misleading. So, the F/S is effective.(d) The F/S contains a totally wrong secured party’s name.The F/S should not have been rejected per section 9-520(a) because the filing office is not supposed to evaluate the F/S for the correctness of the information and some information was present in all of the section 9-516(b) fields. But, is the F/S effective? Yes, look to section 9-520(c). The F/S contains incorrect information for field in section 9-502(a)(2). To determine if the error is seriously misleading, go to section 9-506. Errors in the secured party’s name are not seriously misleading. So, the F/S is effective, but perhaps this fits the last sentence in cmt. 3 and is seriously misleading.(e) The F/S describes the wrong collateral.The F/S should not have been rejected per section 9-520(a) because the filing office is not supposed to evaluate the F/S for the correctness of the information and some information was present in all of the section 9-516(b) fields. But, is the F/S effective? No, look to section 9-520(c). The F/S contains incorrect information for field in section 9-502(a)(3). To determine if the error is seriously misleading, go to section 9-506(a). This error in the description may be seriously misleading because it would not put the searcher on notice. So, the F/S is not effective.

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18.3(a) The F/S does not specifically reference the property.The F/S should not have been rejected per section 9-520(a) because the filing office is not supposed to evaluate the F/S for the correctness of the information and some information was present in all of the section 9-516(b) fields. But, is the F/S effective? No, look to section 9-520(c). The F/S contains incorrect information for field in section 9-502(a)(3). To determine if the error is seriously misleading, go to section 9-506(a). This error in the description may be seriously misleading because it would not put the searcher on notice. So, the F/S is not effective. If the F/S is not effective, then the secured party is not perfected. However, this does not affect status as a secured creditor. The secured party still is attached.(b) For the judgment creditor, the next step is to have the sheriff levy on the property.

18.4 You represent a bank that filed an incorrect F/S. You get a call from potential lien filer.(a) What do you say? Fuck off.(b) What if the caller is another client/bank? Answer should be the same.

18.5 Purchase of consumer goods collateral without knowledge of the security interest (statutory or judicial), for value, for personal use, and if no F/S has been filed is free of the security interest.(a) Can you file a F/S to avoid this problem in the future?Section 9-510(a) says that a F/S statement only is effective if an authorized person files it. Section 9-509 governs when a person is authorized file a F/S. The requirements are an authenticated record or ipso facto authorization via a signed security agreement. If the creditor has a signed security agreement, then the creditor can file the F/S without talking with the debtor.(b) What should the creditor file?The creditor needs to file a F/S that uses the exact wording of the security agreement in order to take advantage of ipso facto authorization.(c) What problems may arise?If the collateral description is vague, then the collateral may not be reasonably identified in order to provide notice.

18.6 Noncompliance with the requirements of filing may cause problems for a creditor. For example, creditor gets verbal authorization to file a F/S and files it. Later, bank gets debtor to sign a security agreement. Between the filing of the F/S and the signing of a security agreement, another creditor files a F/S on the same collateral.(a) How can creditor make a case for a perfected security interest?The creditor’s initial filing of the F/S was not effective because the creditor was not authorized. No signed security agreement existed and not authenticated record existed. After the signing of the security agreement, the F/S is authorized. But, no F/S is filed after the security agreement was signed. The composite doctrine rule does not apply because all documents are not signed by the debtor and this is not a security agreement.

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An argument can be made that the second creditor was on notice of the first creditor’s interest and did not bargain for a first position. Therefore, the second creditor is not harmed if the second creditor is estopped from asserting priority.(b) Can a creditor prevent this problem?Yes, by having the debtor authenticate a record authorizing the filing of a F/S.

XIX. Exceptions to the Article 9 Filing RequirementThe general rule is that perfection is accomplished by a public record filing. But, there are a number of exceptions to the filing requirement. The most common other means for perfecting a security interest besides filing are as follows:

possession; control; operation of law.

A. Collateral in the Possession of the Secured Party

1. The Possession-Gives-Notice Theory9-310. WHEN FILING REQUIRED TO PERFECT SECURITY INTEREST OR AGRICULTURAL LIEN; SECURITY INTERESTS AND AGRICULTURAL LIENS TO WHICH FILING PROVISIONS DO NOT APPLY(a) [General rule: perfection by filing.] Except as otherwise provided in subsection (b) and Section 9-312(b), a financing statement must be filed to perfect all security interests and agricultural liens.(b) [Exceptions: filing not necessary.] The filing of a financing statement is not necessary to perfect a security interest:

. . .(6) in collateral in the secured party's possession under Section 9-313;. . . .

9-313. WHEN POSSESSION BY OR DELIVERY TO SECURED PARTY PERFECTS SECURITY INTEREST WITHOUT FILING(a) [Perfection by possession or delivery.] Except as otherwise provided in subsection (b), a secured party may perfect a security interest in negotiable documents, goods, instruments, money, or tangible chattel paper by taking possession of the collateral. A secured party may perfect a security interest in certificated securities by taking delivery of the certificated securities under Section 8-301.(b) [Goods covered by certificate of title.] With respect to goods covered by a certificate of title issued by this State, a secured party may perfect a security interest in the goods by taking possession of the goods only in the circumstances described in Section 9-316(d).(c) [Collateral in possession of person other than debtor.] With respect to collateral other than certificated securities and goods covered by a document, a secured party takes possession of collateral in the possession of a person other than the debtor, the secured party, or a lessee of the collateral from the debtor in the ordinary course of the debtor's business, when:

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(1) the person in possession authenticates a record acknowledging that it holds possession of the collateral for the secured party's benefit; or(2) the person takes possession of the collateral after having authenticated a record acknowledging that it will hold possession of collateral for the secured party's benefit.

(d) [Time of perfection by possession; continuation of perfection.] If perfection of a security interest depends upon possession of the collateral by a secured party, perfection occurs no earlier than the time the secured party takes possession and continues only while the secured party retains possession.(e) [Time of perfection by delivery; continuation of perfection.] A security interest in a certificated security in registered form is perfected by delivery when delivery of the certificated security occurs under Section 8-301 and remains perfected by delivery until the debtor obtains possession of the security certificate.(f) [Acknowledgment not required.] A person in possession of collateral is not required to acknowledge that it holds possession for a secured party's benefit.(g) [Effectiveness of acknowledgment; no duties or confirmation.] If a person acknowledges that it holds possession for the secured party's benefit:

(1) the acknowledgment is effective under subsection (c) or Section 8-301(a), even if the acknowledgment violates the rights of a debtor; and(2) unless the person otherwise agrees or law other than this article otherwise provides, the person does not owe any duty to the secured party and is not required to confirm the acknowledgment to another person.

(h) [Secured party's delivery to person other than debtor.] A secured party having possession of collateral does not relinquish possession by delivering the collateral to a person other than the debtor or a lessee of the collateral from the debtor in the ordinary course of the debtor's business if the person was instructed before the delivery or is instructed contemporaneously with the delivery:

(1) to hold possession of the collateral for the secured party's benefit; or(2) to redeliver the collateral to the secured party.

(i) [Effect of delivery under subsection (h); no duties or confirmation.] A secured party does not relinquish possession, even if a delivery under subsection (h) violates the rights of a debtor. A person to which collateral is delivered under subsection (h) does not owe any duty to the secured party and is not required to confirm the delivery to another person unless the person otherwise agrees or law other than this article otherwise provides.

People lending against certain types of collateral will want to see the collateral before lending. If the collateral is in the possession of a third party, then the lender constructively will have been given notice of a security interest in the collateral under the possession-gives-notice theory.

2. What Is Possession?Two factors determine if a party has possession:

1. physical control2. legal right.

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Someone has possession of an object only if they have the legal right to exercise physical control over the object. A party that only has physical control has naked possession.

3. Possession as a Means of PerfectionPossession as a means of perfection has different impact depending upon the type of collateral. Possession may serve

as an alternative means of perfection; as the sole means of perfection; as an ineffective means of perfection.

For goods, possession is an alternative means. For instruments, tangible chattel paper, negotiable documents and certificated securities, possession is the preferred means. In fact possession for the later collateral has priority over a filing. Because possession is an alternative or superior means of perfection, a lender must check the records and see the collateral.

B. Collateral in the Control of the Secured Party9-104. CONTROL OF DEPOSIT ACCOUNT(a) [Requirements for control.] A secured party has control of a deposit account if:

(1) the secured party is the bank with which the deposit account is maintained;(2) the debtor, secured party, and bank have agreed in an authenticated record that the bank will comply with instructions originated by the secured party directing disposition of the funds in the deposit account without further consent by the debtor; or(3) the secured party becomes the bank's customer with respect to the deposit account.

(b) [Debtor's right to direct disposition.] A secured party that has satisfied subsection (a) has control, even if the debtor retains the right to direct the disposition of funds from the deposit account.

9-310. WHEN FILING REQUIRED TO PERFECT SECURITY INTEREST OR AGRICULTURAL LIEN; SECURITY INTERESTS AND AGRICULTURAL LIENS TO WHICH FILING PROVISIONS DO NOT APPLY(a) [General rule: perfection by filing.] Except as otherwise provided in subsection (b) and Section 9-312(b), a financing statement must be filed to perfect all security interests and agricultural liens.(b) [Exceptions: filing not necessary.] The filing of a financing statement is not necessary to perfect a security interest:

. . .(8) in deposit accounts, electronic chattel paper, investment property, or letter-of-credit rights which is perfected by control under Section 9-314;. . . .

9-314. PERFECTION BY CONTROL

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(a) [Perfection by control.] A security interest in investment property, deposit accounts, letter-of-credit rights, or electronic chattel paper may be perfected by control of the collateral under Section 9-104, 9-105, 9-106, or 9-107.(b) [Specified collateral: time of perfection by control; continuation of perfection.] A security interest in deposit accounts, electronic chattel paper, or letter-of-credit rights is perfected by control under Section 9-104, 9-105, or 9-107 when the secured party obtains control and remains perfected by control only while the secured party retains control.(c) [Investment property: time of perfection by control; continuation of perfection.] A security interest in investment property is perfected by control under Section 9-106 from the time the secured party obtains control and remains perfected by control until:

(1) the secured party does not have control; and(2) one of the following occurs:

(A) if the collateral is a certificated security, the debtor has or acquires possession of the security certificate;(B) if the collateral is an uncertificated security, the issuer has registered or registers the debtor as the registered owner; or(C) if the collateral is a security entitlement, the debtor is or becomes the entitlement holder.

Control is a means to perfect a security interest in deposit accounts. Section 9-104 defines the three ways that a secured party can exercise control over a deposit account. However, the control is potential control, not actual control, because the depositor/debtor still may exercise control over the funds in the deposit account. Notice is a potential problem if the control is established via section 9-104(a)(2).

C. Purchase-Money Security Interests in Consumer Goods9-309. SECURITY INTEREST PERFECTED UPON ATTACHMENTThe following security interests are perfected when they attach:(1) a purchase-money security interest in consumer goods, except as otherwise provided in Section 9-311(b) with respect to consumer goods that are subject to a statute or treaty described in Section 9-311(a);. . . .

Purchase-money security interests in consumer goods are perfected by operation of law.

1. Purchase-Money Security Interest (PMSI)A purchase-money security interest in collateral is granted to the seller who finances the sale or a lender who expressly finances the purchase. For a lender to maintain its PMSI status, the lender generally must disburse the funds directly to the seller.

Class notesThere are two types of PMSI

Seller-financed Financer-financed

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In a financer-financed transaction, money is not fungible. The money that the financer loaned must be used to buy the goods. Usually, the financer addresses this problem by paying the seller directly. A PMSI is difficult to uncover and may only be uncovered by inquiring into the source of funds for acquisition.

2. Consumer Goods§ 9-102. DEFINITIONS AND INDEX OF DEFINITIONS(a) [Article 9 definitions.] In this article:

. . . .(23) "Consumer goods" means goods that are used or bought for use primarily for personal, family, or household purposes.. . . .

The PMSI security interest only is perfected automatically in consumer goods.

CaseGallatin Nat’l Bank v. Lockovich (p. 328)

Exceptions to the Article 9 filing requirementOperation of law

PMSI in consumer goods

D. Security Interests Not Governed by Article 9 or Another Filing Statute

CaseBluxome Street Assocs. v. Fireman’s Fund Ins. Co. (p. 332)

E. What Became of the Notice Requirement?

F. Problem Set 1919.1 There are two steps to the process of perfecting a security interest in collateral. The first step is classifying the collateral. The second step is following the rules for perfection. The basic rules are found in sections 9-312 to 9-314. In cases where the security interest in collateral may be perfected in multiple ways, some ways are better than others. This is covered in sections 9-324 to 9-334.(a) Cash in the registerThe cash is classified as money. Per section 9-312(b)(3) and 9-313(a), a security interest in money can be perfected only through possession.(b) Negotiable promissory notePer the definition in section 9-102(a)(65), a promissory note is an instrument. A security interest in a promissory note can be perfected as follows:

Filing a F/S § 9-312(a)Possession § 9-313(a)

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Per section 9-330(d), possession is better than filing a F/S because possession operates against a purchaser.(c) Money in a bank accountMoney in a bank account is a deposit account per the definition in section 9-102(a)(29). A security interest in a deposit account can be perfected only through control. § 9-312(b)(1); § 9-104. Does this apply to consumer and business deposit accounts?(d) Stock certificateStock certificates are investment property per the definition in section 9-102(a)(49). A security interest in investment property can be perfected as follows:

Filing a F/S § 9-312(a)Possession § 9-313(a)Control § 9-314(a); § 9-106.

Per section 9-328(1), control is the best method of perfection.(e) Promissory notes and security agreements for sale of goodsThe combination of a note and security agreement makes this chattel paper per section 9-102(a)(11). A security interest in chattel paper may be perfected as follows:

Filing a F/S § 9-312(a)Possession § 9-313(a) – tangibleControl § 9-314(a) - electronic

Per section 9-330(b)-(c), possession or control is the best method of perfection.

19.2 Borrowers have a document titled “Contract for Payment.” You want to use the document as security.

a. How do you perfect?What is the document? If the document is an account as defined in § 9-102(a)(2), then perfection is done by filing per § 9-312(a). If the document is an instrument as defined in § 9-102(a)(47), then perfection may be done by filing per § 9-312(a) or by possession per § 9-330(d). But, possession is the better method of perfection by § 9-330(d). To be safe, you may want to do both.

b. If the borrowers have a perfected security interest, then the borrowers now have chattel paper as defined in § 9-102(a)(11). A security interest in chattel paper may be perfected by filing per § 9-312(a) or by possession per § 9-313(a). However, § 9-330(a) implies that possession is the better method of perfection.

19.4 Borrower is offering various items as collateral for a loan. Can their be liens that wouldn’t show up on even a diligent search that included a viewing of the collateral? What steps do you advise?

a. Mobile home with no requirement for a certificate of title.What is the collateral? The mobile home could be a consumer good per § 9-102(a)(23). If the mobile home is a consumer good, then a PMSI may exist under § 9-309(1). PMSI is defined in § 9-103. This PMSI would have priority over other security interests per § 9-324(a).

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b. Rare book collection on display at the Library of Congress.What is the collateral? The rare book collection could be a consumer good per § 9-102(a)(23). If the rare book collection is a consumer good, then a PMSI may exist under § 9-309(1). If the rare book collection is not a consumer good but just goods, a security interest may exist that has been perfected by possession per § 9-313(a). The Library of Congress may be holding the goods for the secured party. If so, the Library of Congress does not have to reveal this fact per § 9-313(f).

c. Mercedes-Benz automobile. Certificate of title shows no liens.What is the collateral? Item is a good covered by a certificate of title. Perfection must by done in accordance with § 9-303. This defers to local law. No lien is recorded on the certificate of title. So, no perfected liens exist. No PMSI is possible if you look at § 9-309(1) there is an exception for § 9-311(a)(2).

d. a solid gold ingot and 20 unset diamonds.What is the collateral? Item is goods per § 9-102(a)(44). Perfection of a security interest in tangible goods is done by possession per § 9-313(a).

e. computer equipment used to review stock quotes in borrower’s officeWhat is the collateral? Item may be consumer goods or equipment. If the collateral is consumer goods, then a PMSI may exist. If the collateral is equipment, then perfection is by filing or possession. As between the two, possession is better.

f. a checking accountWhat is the collateral? Item is a deposit account per § 9-102(a)(29). Perfection must be by control per § 9-312(b)(1). Control of a deposit account can be done by the methods in § 9-104(a). But, article 9 does not apply to consumer deposit accounts per § 9-109(d)(13).

19.5 Borrower has a lawsuit to offer as collateral. How do you perfect?

What is the collateral? Some items are not covered by Article 9 per § 9-109(d). § 9-109(d)(12) excludes tort claims except commercial tort claims. Commercial tort claim is defined in § 9-102(a)(13). Also, commercial tort claims must be described more specifically per § 9-108(e)(1). If this claim is in tort, then it will not qualify. But, if the claim is not in tort, then Article 9 does apply. In this case, the lawsuit is a general intangible per § 9-102(a)(42). The security interest will be perfected by filing.

XX. The Land and Fixtures Recording Systems

XXI. Characterizing Collateral for the Purpose of Perfection

A. Determining the Proper Place of Filing

1. Personal Property Distinguished from Real Property

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2. Inventory Distinguished from Equipment

B. Determining the Proper Method of Perfection

1. Instruments Distinguished from General Intangibles

CaseOmega Environmental Inc. v. Valley Bank, N.A. (p. 355)

2. True Leases Distinguished from Leases intended as Security

3. Realty Paper

4. Chattel paper and Instruments Distinguished from Accounts

C. Multiple Items of Collateral

CaseIn re Leasing Consultants, Inc. (p. 360)

D. Problem Set 21Automatic

§ 9-309Filing

§§ 9-310, 9-312Cert. of Title

§ 9-311Possession

§ 9-313Control§ 9-314

Accounts — — — —Certificate of title goods — — — —Certificated securities — — —Chattel paper — — (tangible) (electronic)Deposit account — — — — Documents — — (tangible) (electronic)General intangible — — — —Goods Consumer goods Equipment Farm products Fixtures Inventory PMSI Consumer Good

—————

— —

Instruments — — —Investment property — — — Letter-of-credit right — — — — Money — — — —Proceeds, identifiable — — —Tort claims Commercial — — — —

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Other — N/A — N/A N/A

XXII.Maintaining Perfection Through Lapse and Bankruptcy

A. Removing Filings from the Public Record

1. Satisfaction

2. Release

3. Article 9 Termination and Release

B. “Self-Clearing” and Continuation in the Article 9 Filing System

CaseWorthen Bank & Tr. Co., N.A. v. Hillyard Drilling Co. (p. 373)

C. The Effect of Bankruptcy on Lapse and Continuation

CaseIn re Schwinn Cycling & Fitness, Inc. (p. 377)

D. Problem Set 22

XXIII. Maintaining Perfection Through Changes of Name, Identity, and Use

Perfecting a security interest can be complicated. The creditor needs to get the correct debtor name and clearly describe the collateral. However, even if the creditor gets the debtor name correct and clearly describes the collateral, the searchers efforts can be thwarted if the debtor changes his name or the collateral changes form. In these cases, where does the burden fall? On the searcher or the filer? The U.C.C. uses different approached depending upon the circumstances.

A. Changes in the Debtor’s Name9-507. EFFECT OF CERTAIN EVENTS ON EFFECTIVENESS OF FINANCING STATEMENT(a) [Disposition.] A filed financing statement remains effective with respect to collateral that is sold, exchanged, leased, licensed, or otherwise disposed of and in which a security

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interest or agricultural lien continues, even if the secured party knows of or consents to the disposition.(b) [Information becoming seriously misleading.] Except as otherwise provided in subsection (c) and Section 9-508, a financing statement is not rendered ineffective if, after the financing statement is filed, the information provided in the financing statement becomes seriously misleading under Section 9-506.(c) [Change in debtor's name.] If a debtor so changes its name that a filed financing statement becomes seriously misleading under Section 9-506:

(1) the financing statement is effective to perfect a security interest in collateral acquired by the debtor before, or within four months after, the change; and(2) the financing statement is not effective to perfect a security interest in collateral acquired by the debtor more than four months after the change, unless an amendment to the financing statement which renders the financing statement not seriously misleading is filed within four months after the change.

Debtors can change their names for a variety of reasons. If a debtor changes his name, then a search conducted under the new name will not reveal any filings under the old name. Section 9-507 states that a financing statement filed under the old name remains effective with respect to collateral acquired before the name change or within four months after the name change. To perfect a security interest in collateral acquired more than four months after the name change, the creditor must use the debtor’s new name. These rules do impact collateral that turns over.

B. Changes Affecting the Description of CollateralCollateral may undergo changes after perfection. For example, collateral may

change its appearance; change its use; or change its location.

Any of these changes may make a searcher’s task more difficult. More generally, these changes fit into two broad categories:

changes in circumstances that do not control the place or method of perfection, but makes identification difficult; and

changes in circumstances that do control the place or method of perfection.Changes that affect the place or method of perfection are true problems to the creditor. If a debtor converts automobile inventory into equipment, then the creditor no longer is perfected. An automobile as inventory may be perfected with a filing at the secretary of state. An automobile as equipment must be perfected with a notation on the certificate of title. The failure to perfect the security interest correctly results in perfection lapsing.

C. Exchange of the Collateral9-315. SECURED PARTY'S RIGHTS ON DISPOSITION OF COLLATERAL AND IN PROCEEDS(a) [Disposition of collateral: continuation of security interest or agricultural lien; proceeds.] Except as otherwise provided in this article and in Section 2-403(2):

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(1) a security interest or agricultural lien continues in collateral notwithstanding sale, lease, license, exchange, or other disposition thereof unless the secured party authorized the disposition free of the security interest or agricultural lien; and(2) a security interest attaches to any identifiable proceeds of collateral.

(b) [When commingled proceeds identifiable.] Proceeds that are commingled with other property are identifiable proceeds:

(1) if the proceeds are goods, to the extent provided by Section 9-336; and(2) if the proceeds are not goods, to the extent that the secured party identifies the proceeds by a method of tracing, including application of equitable principles, that is permitted under law other than this article with respect to commingled property of the type involved.

(c) [Perfection of security interest in proceeds.] A security interest in proceeds is a perfected security interest if the security interest in the original collateral was perfected.(d) [Continuation of perfection.] A perfected security interest in proceeds becomes unperfected on the 21st day after the security interest attaches to the proceeds unless:

(1) the following conditions are satisfied:(A) a filed financing statement covers the original collateral;(B) the proceeds are collateral in which a security interest may be perfected by filing in the office in which the financing statement has been filed; and(C) the proceeds are not acquired with cash proceeds;

(2) the proceeds are identifiable cash proceeds; or(3) the security interest in the proceeds is perfected other than under subsection (c) when the security interest attaches to the proceeds or within 20 days thereafter.

(e) [When perfected security interest in proceeds becomes unperfected.] If a filed financing statement covers the original collateral, a security interest in proceeds which remains perfected under subsection (d)(1) becomes unperfected at the later of:

(1) when the effectiveness of the filed financing statement lapses under Section 9-515 or is terminated under Section 9-513; or(2) the 21st day after the security interest attaches to the proceeds.

9-509. PERSONS ENTITLED TO FILE A RECORD(b) [Security agreement as authorization.] By authenticating or becoming bound as debtor by a security agreement, a debtor or new debtor authorizes the filing of an initial financing statement, and an amendment, covering:

(1) the collateral described in the security agreement; and(2) property that becomes collateral under Section 9-315(a)(2), whether or not the security agreement expressly covers proceeds.

1. Barter TransactionsA debtor may execute a non-cash exchange of the collateral for some new item. This barter transaction invokes different rules depending upon the relationship between the former collateral and the new collateral.

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A type 0 exchange is one where the new collateral is covered by the existing financing statement. In this case, the creditor remains perfected. Furthermore, the security interest attaches to the new collateral as proceeds of the old collateral.

A type 1 exchange is one where the new collateral is not described by the existing financing statement, but a new financing statement would be filed at the same office. In this case, the security interest attaches to the new collateral as proceeds and the security interest is perfected in the new collateral despite the lack of description.

A type 2 exchange is one where the new collateral is not described by the existing financing statement and the security interest in the new collateral would be perfected in a different location or method. Because a searcher would have no indication of the perfected security interest, the perfection in the proceeds will lapse unless the security interest in the new collateral is perfected as required.

A creditor does not need to get a new authorization in order to perfect in the new collateral under section 9-509(b)(2).

CaseNat’l Bank of Alaska v. Erickson (p. 390)

Changes of Name, Identity and UseExchange of collateral

Type 2 - barter transactionNeed to perfect

2. Collateral to Cash Proceeds to Noncash ProceedsDebtors may sell collateral and then use the cash to buy new property. Again, the law differentiates between different types of new collateral.

For type 0, the perfected security interest continues without interruption.

For type 1, the perfection is not effective after 21 days unless the creditor files a new financing statement.

For type 2, the perfection is not effective after 21 days unless the creditor files a new financing statement.

3. Collateral to Cash Proceeds (No New Property)The U.C.C. grants secured parties continuous, perpetual perfection in identifiable, cash proceeds.

D. Problem Set 2323.1 Client has loaned money to borrower.a. Client has changed the use of the collateral.

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Item has changed from inventory to equipment. The definition of consumer goods is not met because the goods are owned by the company. Inventory is perfected by filing; equipment is perfected by filing. No problem per § 9-507(b)

c. Change in collateral.Item has changed from inventory to equipment through barter. The new equipment is identifiable proceeds. So a security interest attaches to the new equipment per § 9-315(a)(2). But, is it perfected? Under § 9-315(c), the security interest in the new equipment is perfected. However, the perfection expires in 21 days unless the conditions of § 9-315(d) are met. Under § 9-315(d)(1), the perfection continues because

a filed financing statement covers the original collateral; the proceeds are not acquired with cash proceeds; and, the proceeds are collateral in which a security interest may be perfected by filing

in the office in which the financing statement has been filed.

d. Change in collateral to cash to new collateral.Collateral has changed form twice. The collateral became cash and then the collateral became equipment. So, a security interest attaches to the cash per § 9-315(a)(2). Under § 9-315(c), the security interest in the cash is perfected. However, the perfection expires in 21 days unless the conditions of § 9-315(d) are met. Under § 9-315(d)(2), the perfection continues because the proceeds are identifiable cash proceeds. Under § 9-315(a)(2), a security interest attaches to the new equipment because the new equipment is identifiable proceeds. Under § 9-315(c), the security interest in the new equipment is perfected. However, the perfection expires in 21 days unless the conditions of § 9-315(d) are met. Perfection is not automatic under § 9-315(d)(1) or (2). New financing statement must be filed. Authority to file the new financing statement comes from § 9-509(b)(2).

23.2 Debtor changes corporate name from South West Appliance Corporation to South West General, Inc. six months ago. Does lender need to do anything to remain perfected?

The threshold question is “Is the new name seriously misleading?” The lender resolves this by doing a search under the debtor’s new name. If the old name shows up, then the new name is not seriously misleading. If the old name does not show up, then the new name is seriously misleading. § 9-506(c).

If the new name is not seriously misleading, then the lender has no problems. If the new name is seriously misleading, then the lender remains perfected in all collateral acquired before the name change or within four months after the name change. In order to perfect a security interest in collateral acquired more than four months after the name change, the lender must file a financing statement that is not seriously misleading. § 9-507(c)

Here, six months have passed. The lender does not have a perfected security interest in any property acquired by the debtor during the last two months.

23.4 U.C.C. search turns up one financing statement taking a security interest in “lawn dogs manufactured by Suti.” A visual inspection of debtor’s property shows only

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$25,000 in lawn dogs manufactured by Suti. Can the financing statement perfect a security interest in anything else?

Yes, the financing statement could encumber other items such as the following: proceeds from barter transactions and a new financing statement could be filed in

the same location—§ 9-315(d)(1) less than 21-days after sale for cash and purchase of identifiable proceeds—§ 9-

315(d)(3). cash proceeds—§ 9-315(d)(2) proceeds from barter transactions and purchases using cash proceeds where a

security interest would be perfected in another system (land, timber to be cut, automobile)

23.5 You represent a creditor that lent $1 million to company that manufactures equipment. You filed a financing statement showing a security interest in equipment, inventory, accounts, chattel paper, general intangibles, fixtures, money and bank accounts. Borrower has a deposit account at another financial institution.

a. Do you have a security interest in the deposit account at the other financial institution?

Yes, the creditor has a security interest in the deposit account because the creditor has a signed security agreement describing the deposit account. Moreover, under § 9-315, creditor has a security interest in any identifiable proceeds.

b. Is the security interest perfected?

Security interest in a deposit account is perfected by control per § 9-312(b)(1) and § 9-314(a). Control of a deposit account is determined by § 9-104(a). But, if the deposit account is proceeds, then security interest may be perfected through § 9-315(a)(2) and § 9-315(d)(2).

c. Not at all.

d. No, use the lowest intermediate balance rule.

XXIV. Maintaining Perfection Through Relocation of Debtor or Collateral

A. State-based Filing in a National Economy9-301. LAW GOVERNING PERFECTION AND PRIORITY OF SECURITY INTERESTSExcept as otherwise provided in Sections 9-303 through 9-306, the following rules determine the law governing perfection, the effect of perfection or nonperfection, and the priority of a security interest in collateral:

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(1) Except as otherwise provided in this section, while a debtor is located in a jurisdiction, the local law of that jurisdiction governs perfection, the effect of perfection or nonperfection, and the priority of a security interest in collateral.(2) While collateral is located in a jurisdiction, the local law of that jurisdiction governs perfection, the effect of perfection or nonperfection, and the priority of a possessory security interest in that collateral.(3) Except as otherwise provided in paragraph (4), while negotiable documents, goods, instruments, money, or tangible chattel paper is located in a jurisdiction, the local law of that jurisdiction governs:

(A) perfection of a security interest in the goods by filing a fixture filing;(B) perfection of a security interest in timber to be cut; and(C) the effect of perfection or nonperfection and the priority of a nonpossessory security interest in the collateral.

(4) The local law of the jurisdiction in which the wellhead or minehead is located governs perfection, the effect of perfection or nonperfection, and the priority of a security interest in as-extracted collateral.

9-303. LAW GOVERNING PERFECTION AND PRIORITY OF SECURITY INTERESTS IN GOODS COVERED BY A CERTIFICATE OF TITLE(a) [Applicability of section.] This section applies to goods covered by a certificate of title, even if there is no other relationship between the jurisdiction under whose certificate of title the goods are covered and the goods or the debtor.(b) [When goods covered by certificate of title.] Goods become covered by a certificate of title when a valid application for the certificate of title and the applicable fee are delivered to the appropriate authority. Goods cease to be covered by a certificate of title at the earlier of the time the certificate of title ceases to be effective under the law of the issuing jurisdiction or the time the goods become covered subsequently by a certificate of title issued by another jurisdiction.(c) [Applicable law.] The local law of the jurisdiction under whose certificate of title the goods are covered governs perfection, the effect of perfection or nonperfection, and the priority of a security interest in goods covered by a certificate of title from the time the goods become covered by the certificate of title until the goods cease to be covered by the certificate of title.

9-304. LAW GOVERNING PERFECTION AND PRIORITY OF SECURITY INTERESTS IN DEPOSIT ACCOUNTS(a) [Law of bank's jurisdiction governs.] The local law of a bank's jurisdiction governs perfection, the effect of perfection or nonperfection, and the priority of a security interest in a deposit account maintained with that bank.(b) [Bank's jurisdiction.] The following rules determine a bank's jurisdiction for purposes of this part:

(1) If an agreement between the bank and the debtor governing the deposit account expressly provides that a particular jurisdiction is the bank's jurisdiction for purposes of this part, this article, or [the Uniform Commercial Code], that jurisdiction is the bank's jurisdiction.

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(2) If paragraph (1) does not apply and an agreement between the bank and its customer governing the deposit account expressly provides that the agreement is governed by the law of a particular jurisdiction, that jurisdiction is the bank's jurisdiction.(3) If neither paragraph (1) nor paragraph (2) applies and an agreement between the bank and its customer governing the deposit account expressly provides that the deposit account is maintained at an office in a particular jurisdiction, that jurisdiction is the bank's jurisdiction.(4) If none of the preceding paragraphs applies, the bank's jurisdiction is the jurisdiction in which the office identified in an account statement as the office serving the customer's account is located.(5) If none of the preceding paragraphs applies, the bank's jurisdiction is the jurisdiction in which the chief executive office of the bank is located.

9-307. LOCATION OF DEBTOR(a) ["Place of business."] In this section, "place of business" means a place where a debtor conducts its affairs.(b) [Debtor's location: general rules.] Except as otherwise provided in this section, the following rules determine a debtor's location:

(1) A debtor who is an individual is located at the individual's principal residence.(2) A debtor that is an organization and has only one place of business is located at its place of business.(3) A debtor that is an organization and has more than one place of business is located at its chief executive office.

(c) [Limitation of applicability of subsection (b).] Subsection (b) applies only if a debtor's residence, place of business, or chief executive office, as applicable, is located in a jurisdiction whose law generally requires information concerning the existence of a nonpossessory security interest to be made generally available in a filing, recording, or registration system as a condition or result of the security interest's obtaining priority over the rights of a lien creditor with respect to the collateral. If subsection (b) does not apply, the debtor is located in the District of Columbia.(d) [Continuation of location: cessation of existence, etc.] A person that ceases to exist, have a residence, or have a place of business continues to be located in the jurisdiction specified by subsections (b) and (c).(e) [Location of registered organization organized under State law.] A registered organization that is organized under the law of a State is located in that State.(f) [Location of registered organization organized under federal law; bank branches and agencies.] Except as otherwise provided in subsection (i), a registered organization that is organized under the law of the United States and a branch or agency of a bank that is not organized under the law of the United States or a State are located:

(1) in the State that the law of the United States designates, if the law designates a State of location;(2) in the State that the registered organization, branch, or agency designates, if the law of the United States authorizes the registered organization, branch, or agency to designate its State of location; or(3) in the District of Columbia, if neither paragraph (1) nor paragraph (2) applies.

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(g) [Continuation of location: change in status of registered organization.] A registered organization continues to be located in the jurisdiction specified by subsection (e) or (f) notwithstanding:

(1) the suspension, revocation, forfeiture, or lapse of the registered organization's status as such in its jurisdiction of organization; or(2) the dissolution, winding up, or cancellation of the existence of the registered organization.

(h) [Location of United States.] The United States is located in the District of Columbia.(i) [Location of foreign bank branch or agency if licensed in only one state.] A branch or agency of a bank that is not organized under the law of the United States or a State is located in the State in which the branch or agency is licensed, if all branches and agencies of the bank are licensed in only one State.(j) [Location of foreign air carrier.] A foreign air carrier under the Federal Aviation Act of 1958, as amended, is located at the designated office of the agent upon which service of process may be made on behalf of the carrier.(k) [Section applies only to this part.] This section applies only for purposes of this part.

B. Initial Perfection

1. At the Location of the DebtorThe correct state to file a financing statement is the location of the debtor. The location of the debtor is determined from section 9-307. For an individual, the correct state is the state containing the debtor’s principal residence. For a registered organization, the correct state is the state of registration. For an unregistered organization, the correct state is the location of the chief executive office. The chief executive office is located in the place from which it is managed.

2. At the Location of the CollateralA fixture filing must be made in the office designated for the filing or recording of a mortgage on the real property to which the fixture is attached. § 9-501(a)(1). Sometimes this location is a location other than where the debtor is located.

C. Relocation of the Debtor9-316. CONTINUED PERFECTION OF SECURITY INTEREST FOLLOWING CHANGE IN GOVERNING LAW(a) [General rule: effect on perfection of change in governing law.] A security interest perfected pursuant to the law of the jurisdiction designated in Section 9-301(1) or 9-305(c) remains perfected until the earliest of:

(1) the time perfection would have ceased under the law of that jurisdiction;(2) the expiration of four months after a change of the debtor's location to another jurisdiction; or(3) the expiration of one year after a transfer of collateral to a person that thereby becomes a debtor and is located in another jurisdiction.

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(b) [Security interest perfected or unperfected under law of new jurisdiction.] If a security interest described in subsection (a) becomes perfected under the law of the other jurisdiction before the earliest time or event described in that subsection, it remains perfected thereafter. If the security interest does not become perfected under the law of the other jurisdiction before the earliest time or event, it becomes unperfected and is deemed never to have been perfected as against a purchaser of the collateral for value.(c) [Possessory security interest in collateral moved to new jurisdiction.] A possessory security interest in collateral, other than goods covered by a certificate of title and as-extracted collateral consisting of goods, remains continuously perfected if:

(1) the collateral is located in one jurisdiction and subject to a security interest perfected under the law of that jurisdiction;(2) thereafter the collateral is brought into another jurisdiction; and(3) upon entry into the other jurisdiction, the security interest is perfected under the law of the other jurisdiction.

(d) [Goods covered by certificate of title from this state.] Except as otherwise provided in subsection (e), a security interest in goods covered by a certificate of title which is perfected by any method under the law of another jurisdiction when the goods become covered by a certificate of title from this State remains perfected until the security interest would have become unperfected under the law of the other jurisdiction had the goods not become so covered.(e) [When subsection (d) security interest becomes unperfected against purchasers.] A security interest described in subsection (d) becomes unperfected as against a purchaser of the goods for value and is deemed never to have been perfected as against a purchaser of the goods for value if the applicable requirements for perfection under Section 9-311(b) or 9-313 are not satisfied before the earlier of:

(1) the time the security interest would have become unperfected under the law of the other jurisdiction had the goods not become covered by a certificate of title from this State; or(2) the expiration of four months after the goods had become so covered.

(f) [Change in jurisdiction of bank, issuer, nominated person, securities intermediary, or commodity intermediary.] A security interest in deposit accounts, letter-of-credit rights, or investment property which is perfected under the law of the bank's jurisdiction, the issuer's jurisdiction, a nominated person's jurisdiction, the securities intermediary's jurisdiction, or the commodity intermediary's jurisdiction, as applicable, remains perfected until the earlier of:

(1) the time the security interest would have become unperfected under the law of that jurisdiction; or(2) the expiration of four months after a change of the applicable jurisdiction to another jurisdiction.

(g) [Subsection (f) security interest perfected or unperfected under law of new jurisdiction.] If a security interest described in subsection (f) becomes perfected under the law of the other jurisdiction before the earlier of the time or the end of the period described in that subsection, it remains perfected thereafter. If the security interest does not become perfected under the law of the other jurisdiction before the earlier of that time or the end of that period, it becomes unperfected and is deemed never to have been perfected as against a purchaser of the collateral for value.

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Debtors can relocate. This issue arises most frequently when an individual debtor changes his principal residence. However, an unregistered organization may change the location of the chief executive office. When a debtor relocates, the correct filing location also changes. In order to maintain perfection when a debtor relocates, the creditor has four months in which to file in the new filing location under section 9-316(a)(2). Registered organizations can accomplish a change in location by either merging the existing organization into an organization registered in a different state or selling the assets of the existing organization to an organization registered in a different state. In this case, the transfer of assets brings the transaction under section 9-316(a)(3) which allows the creditor one year to file a financing statement in the new location.

D. Nation-based Filing in a World EconomyThe perfection of security interests internationally is an issue of increasing importance due to the global economy. The rise of the global economy encourages the centralization of perfection on a national basis.

E. Problem Set 2424.1 Client makes $250,000 loan to William Shatner. The collateral is the equipment, accounts and inventory of Shatner Engineering in AZ. Shatner is the sole owner. Ex-wife runs the business and gets salary and share of profits. Shatner is the decider. Shatner lives in KS and works in MO. He may move to MO. He sometimes lives in AZ. He plans to move to HI in a couple of years.

a. Where do you file?From the problem, WS is the obligor per § 9-102(a)(59). But, is WS the debtor per § 9-102(a)(28)? Debtor has an interest, other than a SI in the collateral. The collateral is owned by Shatner Engineering.

What is Shatner Engineering? SE is not corporation, LLC or LLP because no appropriate indicator. SE could be sole proprietorship of William Shatner or SE could be general partnership because ex-wife works in business and gets a share of the profits.

If SE is a sole proprietorship, then SE normally considered as synonymous with WS. WS is an individual. Under § 9-307(b)(1), location of an individual debtor is the individual’s place of principal residence, KS. Under § 9-301(1), filing must be in the jurisdiction where the debtor is located, KS. File in KS

If SE is a general partnership, then SE is a separate entity from WS. SE is an organization. Under § 9-307(b)(3), a debtor that is and organization and has more than one place of business is located at its chief executive office. A place of business means a place where a debtor conducts its affairs. SE has a place of business in AZ. SE has a place of business in KS where WS makes the decisions. Chief executive office is not defined. Decisions are made in KS. So, it could be the chief executive office. Under § 9-301(1), file in the jurisdiction where the debtor is located. So, file in KS. Cmt. 2 of §

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9-307 says if there is ambiguity, then file in both jurisdictions. So, may be wise to file in AZ.

Definition of organization in § 1-201(b)(25) is vague. Organization is a person other than an individual. Person as defined in § 1-201(b)(27) includes “other legal or commercial entity.” Perhaps a sole proprietorship is an “other legal or commercial entity. Under this theory, the logic for a general partnership should be applied to a sole proprietorship. File in KS and AZ.

b. What name should be listed on the filings?The filing must satisfy § 9-503(4) in all cases because sole proprietorships and general partnerships are not registered organizations.If SE is a sole proprietorship, then “William Shatner.”If SE is a general partnership, then “Shatner Engineering.”If SE is a sole proprietorship organization, then “Shatner Engineering.”

c. SE is incorporated in NV. Where do you file?Under § 9-301(1), filing must be done in jurisdiction where the debtor is located. Under § 9-307(e), a registered organization that is organized under the law of a State is located in that State. A corporation is a registered organization. SE is organized in NV. SE is located in NV. File in NV.

d. Business is unincorporated. Ex-wife owns 1/3. Where do you file? What names should be listed?If SE is a general partnership, then file in KS and AZ to be safe. Name on the filing should be “Shatner Engineering.”

24.2a. How do you monitor the location of the debtor?Under § 9-316(a)(2), a SI remains perfected until 4 months after the debtor moves to a location in a different jurisdiction. For our problem, this involves keeping track of the location of WS. Require WS to provide updated financial information per the loan covenants.

b. What if the loan were for $25 million?Require WS to provide updated financial information at least quarterly.

24.3 Bank lends $1.9 million to TAP to purchase the assets of AI. Bank wants a first SI in the assets. What inquiries do you make?

State of organization for AI.Location of TAPAny change in location of TAP and any entity merged into TAP or AI in last four months.Any merger for TAP and AI in the last 18 months.Any name change for TAP, AI and any merged entity.

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U.C.C. searches under TAP, AI and any merged entity and prior names in all locations.Collateral could become proceeds and filed in a different system.

24.4 Bank loans to AI. AI is incorporated in Afghanistan. Afghanistan does not have a filing system. AI headquarters and operations are in NY. Where do you file a financing statement?Under § 9-301(1), file in the jurisdiction where the debtor is located. A debtor that is an organization and has more than one place of business is located at its chief executive office. AI is an organization. From the facts, all places of business and chief executive office are in NY. File in NY. § 9-307(3) is not applicable because Afghanistan is not a State.

XXV.Maintaining Perfection in Certificate of Title Systems

XXVI. The Concept of Priority: State LawPriority means that if the value of the collateral is sufficient to pay only one creditor, the law requires that value be used to pay the creditor who has priority. These rules only come into play when there is more than one interest in the property.

A. Priority in Foreclosure§ 9-615. APPLICATION OF PROCEEDS OF DISPOSITION; LIABILITY FOR DEFICIENCY AND RIGHT TO SURPLUS(a) [Application of proceeds.] A secured party shall apply or pay over for application the cash proceeds of disposition under Section 9-610 in the following order to:

(1) the reasonable expenses of retaking, holding, preparing for disposition, processing, and disposing, and, to the extent provided for by agreement and not prohibited by law, reasonable attorney's fees and legal expenses incurred by the secured party;(2) the satisfaction of obligations secured by the security interest or agricultural lien under which the disposition is made;(3) the satisfaction of obligations secured by any subordinate security interest in or other subordinate lien on the collateral if:

(A) the secured party receives from the holder of the subordinate security interest or other lien an authenticated demand for proceeds before distribution of the proceeds is completed; and(B) in a case in which a consignor has an interest in the collateral, the subordinate security interest or other lien is senior to the interest of the consignor; and

(4) a secured party that is a consignor of the collateral if the secured party receives from the consignor an authenticated demand for proceeds before distribution of the proceeds is completed.

(b) [Proof of subordinate interest.] If requested by a secured party, a holder of a subordinate security interest or other lien shall furnish reasonable proof of the interest or lien within a reasonable time. Unless the holder does so, the secured party need not comply with the holder's demand under subsection (a)(3).

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(c) [Application of noncash proceeds.] A secured party need not apply or pay over for application noncash proceeds of disposition under Section 9-610 unless the failure to do so would be commercially unreasonable. A secured party that applies or pays over for application noncash proceeds shall do so in a commercially reasonable manner.(d) [Surplus or deficiency if obligation secured.] If the security interest under which a disposition is made secures payment or performance of an obligation, after making the payments and applications required by subsection (a) and permitted by subsection (c):

(1) unless subsection (a)(4) requires the secured party to apply or pay over cash proceeds to a consignor, the secured party shall account to and pay a debtor for any surplus; and(2) the obligor is liable for any deficiency.

(e) [No surplus or deficiency in sales of certain rights to payment.] If the underlying transaction is a sale of accounts, chattel paper, payment intangibles, or promissory notes:

(1) the debtor is not entitled to any surplus; and(2) the obligor is not liable for any deficiency.

(f) [Calculation of surplus or deficiency in disposition to person related to secured party.] The surplus or deficiency following a disposition is calculated based on the amount of proceeds that would have been realized in a disposition complying with this part to a transferee other than the secured party, a person related to the secured party, or a secondary obligor if:

(1) the transferee in the disposition is the secured party, a person related to the secured party, or a secondary obligor; and(2) the amount of proceeds of the disposition is significantly below the range of proceeds that a complying disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor would have brought.

(g) [Cash proceeds received by junior secured party.] A secured party that receives cash proceeds of a disposition in good faith and without knowledge that the receipt violates the rights of the holder of a security interest or other lien that is not subordinate to the security interest or agricultural lien under which the disposition is made:

(1) takes the cash proceeds free of the security interest or other lien;(2) is not obligated to apply the proceeds of the disposition to the satisfaction of obligations secured by the security interest or other lien; and(3) is not obligated to account to or pay the holder of the security interest or other lien for any surplus.

§ 9-617. RIGHTS OF TRANSFEREE OF COLLATERAL(a) [Effects of disposition.] A secured party's disposition of collateral after default:

(1) transfers to a transferee for value all of the debtor's rights in the collateral;(2) discharges the security interest under which the disposition is made; and(3) discharges any subordinate security interest or other subordinate lien [other than liens created under [cite acts or statutes providing for liens, if any, that are not to be discharged]].

(b) [Rights of good-faith transferee.] A transferee that acts in good faith takes free of the rights and interests described in subsection (a), even if the secured party fails to comply with this article or the requirements of any judicial proceeding.

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(c) [Rights of other transferee.] If a transferee does not take free of the rights and interests described in subsection (a), the transferee takes the collateral subject to:

(1) the debtor's rights in the collateral;(2) the security interest or agricultural lien under which the disposition is made; and(3) any other security interest or other lien.

First, any lien holder may foreclose while the debtor is in default to that lien holder. Second, no lien holder is compelled to foreclose. Section 9-617 governs the general transfer of collateral that a creditor has foreclosed upon. Although the transfer discharges any subordinate liens, the prior liens are not discharged and remain upon the property. The prior lien holders cannot demand payment of the secured debt, but they can foreclose upon the collateral if not paid. Section 9-615(a) gives the order of payment of proceeds from the sale of the collateral. The proceeds go first for administrative expenses, then to the foreclosing creditor, then to subordinate creditors, then to consignors. Any surplus goes to the debtor; any deficiency stays with the debtor.

B. Reconciling Inconsistent PrioritiesHunh?

CaseBank Leumi Trust Co. v. Liggett (p. 427)

PriorityReconciling inconsistent priorities

C. The Right to Possession Between Lien HoldersIf more than one lien holder pursues foreclosure against the debtor, then the senior lien holder has the right to possession. A junior judgment lien holder is not authorized to exercise control over the collateral and may end up needing to reimburse the senior lien holder for his actions. However, the senior lien holder’s actions are not without limits. The senior lien holder may not prevent the junior lien holder from foreclosing and then fail to foreclose themselves.

CasesGrocers Supply Co. v. Intercity Inv. Properties, Inc. (p. 430)

PriorityPossession between lien holders

Senior lien holder trumpsFrierson v. United Farm Agency, Inc. (p. 431)

PriorityPossession between lien holders

Senior lien holder trumps

D. Problem Set 2626.1 Client is bidding on property sold at foreclosure sale. Property has three mortgages. The senior lien is for $17,000; the middle lien is for $10,000; and the junior lien is for

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$29,000. The middle lien holder foreclosed. Client values the property at $25,000. Sale expenses are $200. How much should the client bid?

Client should bid $8,000 or $8,200 to cover the expenses. The junior lien will be wiped out in the sale. The property will pass with the senior lien of $17,000 in place.

26.2 Judgment creditor with $8,000 judgment executes on $75,000 car. Car has two prior liens. Senior lien is for $60,000; middle lien is for $30,000; judgment creditor is last in line. Expenses of conducting the sale are $200. What will be the maximum bid?

There should be no bid. The sale will not remove either the senior lien of $60,000 or the middle lien of $30,000. No one should take on $90,000 of liens with only a $75,000 car.

26.3 Client is a bank. Client holds a first security interest in equipment owned by HW on a debt for $27,000. Equipment should bring $40,000 at a sheriff’s sale. HW is in financial difficulties. Rumor is that a second lien holder is foreclosing on the equipment.

a. If this information is correct, should client be concerned?

§ 9-611(c) requires second lien holder to notify Client

§ 9-617(b) allows a good-faith transferee to take collateral free of client’s lien even if secured party did not comply with section 9-611(c).

§ 9-625(b) allows recovery for damages caused by noncompliance.

Normally, this action is an event of default. Client’s lien is senior. Client should advertise its lien. Client should foreclose to protect its interest. Although client could pursue an action for damages, that does not seem like an efficient course of action.

b. Can client protect its position by purchasing the equipment at the sale?

Yes, but money goes to second lien holder. Client’s position is not improved.

c. Can client prevent the sale?

§ 9-609(a) right to repossess if debtor defaults.

§ 9-401 state/federal law governs the ability of a debtor’s rights to be transferred. Agreements between the debtor and the secured party do not overrule this state/federal law.

Client can repossess if the debtor is in default. Usually, foreclosure constitutes an event of default. So, client can take possession of the collateral. See Grocers Supply Co. v. Intercity Inv. Properties, Inc.

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d. Was client entitled to receive notice of the sale?

Yes, as long as client had complied with § 9-611(c)(3)(B). 10-days before notification date the SI was perfected Collateral identified Filed under debtor’s name Filed in the correct office

What if debtor recently changed names?

26.4 Friend borrows $10,000 from you. Friend offers a second mortgage on house. House has $80,000 first mortgage. House is worth least $90,000.

a. If friend defaults, then what?

Foreclosure.

b. Will taking that action assure recovery of your $10,000?

No, first lien holder may foreclose. House value may decline. Debtor may cure. Sale may not net $10,000.

c. What will happen if your friend makes the payments on your mortgage, but defaults on first mortgage?

First mortgage holder may foreclose. If house is sold for $90,000 or less, you have a deficiency and the house transfers free of your mortgage. You are left with an unsecured debt.

26.5 Frierson v. United Farm Agency, Inc. may limit the actions of Grocers Supply Co.

Grocers Supply allows a prior perfected Article 9 secured creditor to take collateral away from a judgment lien creditor if there is a default.

A judgment lien creditor may try to change this result by attacking attachment attacking perfection attacking priority attack the default condition giving notice foreclosure sale without possession arguing Frierson

26.6 Statute places state property tax liens above all other liens. Client is a first mortgage holder.

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a. What effect on first mortgage holder?

Property sold in foreclosure on property tax lien transfers free of any mortgage.

b. If such a foreclosure happens, what can client do to protect itself?

Pay the property taxes.

c. How can client avoid this problem?

Collect the property taxes with the mortgage payment and pay the property taxes directly.

XXVII. The Concept of Priority: Bankruptcy Law

XXVIII. Lien Creditors Against Secured Creditors: The Basics

There are three basic conflicts between

A. How Creditors Become “Lien Creditors”A typical lien creditor is an unsecured creditor that has won a judgment, obtained a writ of execution and then obtained a lien by levying on specific property of the debtor. A creditor also may achieve lien creditor status through garnishment which attaches to debts owed to the debtor from third parties. The third method is recordation of a judgment in the real property system. Some states also allow a judgment to be recorded in the U.C.C. filing system. Lastly, a trustee in bankruptcy is a lien creditor.

B. Priority Among Lien CreditorsThe priority among lien creditors depends upon state law. Most state laws order priority by some critical date. The dates most commonly used are as follows:

Date of levy. The date on which the sheriff or other officer took possession of particular property. Some states allow constructive possession; other states only honor physical possession.

Date of delivery of the writ. The date that the writ of execution is delivered by the creditor to the sheriff. Most states only recognize the date of delivery for writs of execution that have been levied.

Date of service of a writ of garnishment. The date the writ of garnishment is delivered to the garnishee.

Date of recordation of judgment. The date the judgment is delivered to the filing office.

C. Priority Between Lien Creditors and Secured Creditors§ 9-203. ATTACHMENT AND ENFORCEABILITY OF SECURITY INTEREST; PROCEEDS; SUPPORTING OBLIGATIONS; FORMAL REQUISITES

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(b) [Enforceability.] Except as otherwise provided in subsections (c) through (i), a security interest is enforceable against the debtor and third parties with respect to the collateral only if:

(3) one of the following conditions is met:(A) the debtor has authenticated a security agreement that provides a description of the collateral and, if the security interest covers timber to be cut, a description of the land concerned;(B) the collateral is not a certificated security and is in the possession of the secured party under Section 9-313 pursuant to the debtor's security agreement;(C) the collateral is a certificated security in registered form and the security certificate has been delivered to the secured party under Section 8-301 pursuant to the debtor's security agreement; or(D) the collateral is deposit accounts, electronic chattel paper, investment property, or letter-of-credit rights, and the secured party has control under Section 9-104, 9-105, 9-106, or 9-107 pursuant to the debtor's security agreement.

§ 9-309. SECURITY INTEREST PERFECTED UPON ATTACHMENTThe following security interests are perfected when they attach:

(1) a purchase-money security interest in consumer goods, except as otherwise provided in Section 9-311(b) with respect to consumer goods that are subject to a statute or treaty described in Section 9-311(a);

§ 9-317. INTERESTS THAT TAKE PRIORITY OVER OR TAKE FREE OF SECURITY INTEREST OR AGRICULTURAL LIEN(a) [Conflicting security interests and rights of lien creditors.] A security interest or agricultural lien is subordinate to the rights of:

(1) a person entitled to priority under Section 9-322; and(2) except as otherwise provided in subsection (e), a person that becomes a lien creditor before the earlier of the time:

(A) the security interest or agricultural lien is perfected; or(B) one of the conditions specified in Section 9-203(b)(3) is met and a financing statement covering the collateral is filed.

(e) [Purchase-money security interest.] Except as otherwise provided in Sections 9-320 and 9-321, if a person files a financing statement with respect to a purchase-money security interest before or within 20 days after the debtor receives delivery of the collateral, the security interest takes priority over the rights of a buyer, lessee, or lien creditor which arise between the time the security interest attaches and the time of filing.

§ 9-322. PRIORITIES AMONG CONFLICTING SECURITY INTERESTS IN AND AGRICULTURAL LIENS ON SAME COLLATERAL(a) [General priority rules.] Except as otherwise provided in this section, priority among conflicting security interests and agricultural liens in the same collateral is determined according to the following rules:

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(1) Conflicting perfected security interests and agricultural liens rank according to priority in time of filing or perfection. Priority dates from the earlier of the time a filing covering the collateral is first made or the security interest or agricultural lien is first perfected, if there is no period thereafter when there is neither filing nor perfection.(2) A perfected security interest or agricultural lien has priority over a conflicting unperfected security interest or agricultural lien.(3) The first security interest or agricultural lien to attach or become effective has priority if conflicting security interests and agricultural liens are unperfected.

(b) [Time of perfection: proceeds and supporting obligations.] For the purposes of subsection (a)(1):

(1) the time of filing or perfection as to a security interest in collateral is also the time of filing or perfection as to a security interest in proceeds; and(2) the time of filing or perfection as to a security interest in collateral supported by a supporting obligation is also the time of filing or perfection as to a security interest in the supporting obligation.

(c) [Special priority rules: proceeds and supporting obligations.] Except as otherwise provided in subsection (f), a security interest in collateral which qualifies for priority over a conflicting security interest under Section 9-327, 9-328, 9-329, 9-330, or 9-331 also has priority over a conflicting security interest in:

(1) any supporting obligation for the collateral; and(2) proceeds of the collateral if:

(A) the security interest in proceeds is perfected;(B) the proceeds are cash proceeds or of the same type as the collateral; and(C) in the case of proceeds that are proceeds of proceeds, all intervening proceeds are cash proceeds, proceeds of the same type as the collateral, or an account relating to the collateral.

(d) [First-to-file priority rule for certain collateral.] Subject to subsection (e) and except as otherwise provided in subsection (f), if a security interest in chattel paper, deposit accounts, negotiable documents, instruments, investment property, or letter-of-credit rights is perfected by a method other than filing, conflicting perfected security interests in proceeds of the collateral rank according to priority in time of filing.(e) [Applicability of subsection (d).] Subsection (d) applies only if the proceeds of the collateral are not cash proceeds, chattel paper, negotiable documents, instruments, investment property, or letter-of-credit rights.(f) [Limitations on subsections (a) through (e).] Subsections (a) through (e) are subject to:

(1) subsection (g) and the other provisions of this part;(2) Section 4-210 with respect to a security interest of a collecting bank;(3) Section 5-118 with respect to a security interest of an issuer or nominated person; and(4) Section 9-110 with respect to a security interest arising under Article 2 or 2A.

(g) [Priority under agricultural lien statute.] A perfected agricultural lien on collateral has priority over a conflicting security interest in or agricultural lien on the same collateral if the statute creating the agricultural lien so provides.

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§ 9-324. PRIORITY OF PURCHASE-MONEY SECURITY INTERESTS(a) [General rule: purchase-money priority.] Except as otherwise provided in subsection (g), a perfected purchase-money security interest in goods other than inventory or livestock has priority over a conflicting security interest in the same goods, and, except as otherwise provided in Section 9-327, a perfected security interest in its identifiable proceeds also has priority, if the purchase-money security interest is perfected when the debtor receives possession of the collateral or within 20 days thereafter.

An Article 9 secured creditor takes priority over a lien creditor if one of the following is true:

the Article 9 secured creditor perfected before the lien creditor perfected; or the Article 9 secured creditor filed a financing statement and has a signed security

agreement before the lien creditor perfected.In the second case, the Article 9 secured creditor still must take the necessary steps to attach the security interest. However, a perfected security interest is not required. Perfection does not have to be achieved through the filing of a financing statement. Perfection can be done via operation of law. See §§ 9-309(1) and 9-324(a).

Class notesUnsecured creditor that gets a judgment becomes a judgment creditor. A judgment creditor that levies a writ of execution or writ of garnishment becomes a judgment lien creditor. However, a judgment lien is not a security interest because the debtor did not give the security interest through a security agreement to the secured party. See § 1-201(b)(35) and § 9-102(a)(72)-(73).

CasePeople v. Green (p. 457)

Priority between lien creditors and secured creditors

D. Priority Between Lien Creditors and Mortgage CreditorsPriority between lien creditors and mortgage creditors is governed by real estate law. Real estate law generally gives priority to the first lien created, and then reverses the result only if the failure to perfect offends the state’s recording statute. In most states, a judgment lien creditor against real property is not entitled to the benefit of the recording statute. The result is that a mortgage granted before the judgment creditor became a lien creditor by recording its judgment has priority over the judgment lien, even though the judgment lien was the first lien perfected.

E. Purchase-Money Priority§ 9-317. INTERESTS THAT TAKE PRIORITY OVER OR TAKE FREE OF SECURITY INTEREST OR AGRICULTURAL LIEN(e) [Purchase-money security interest.] Except as otherwise provided in Sections 9-320 and 9-321, if a person files a financing statement with respect to a purchase-money security interest before or within 20 days after the debtor receives delivery of the

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collateral, the security interest takes priority over the rights of a buyer, lessee, or lien creditor which arise between the time the security interest attaches and the time of filing.

§ 9-324. PRIORITY OF PURCHASE-MONEY SECURITY INTERESTS(a) [General rule: purchase-money priority.] Except as otherwise provided in subsection (g), a perfected purchase-money security interest in goods other than inventory or livestock has priority over a conflicting security interest in the same goods, and, except as otherwise provided in Section 9-327, a perfected security interest in its identifiable proceeds also has priority, if the purchase-money security interest is perfected when the debtor receives possession of the collateral or within 20 days thereafter.

The fundamental principle underlying the system of priority among liens is that liens rank in the order in which they become public. When a second-in-time interest takes precedence over an earlier interest, the event is known as priming. Priming occurs frequently with purchase-money security interests. The creditor with a PMSI takes priority over other secured creditors that perfected between the PMSI creditor’s attachment and perfection as long as the creditor perfects the security interest within 20 days of the debtor receiving possession.

F. Problem Set 2828.1 RFT has a $50,000 unsecured obligation with CC. SE has received a $125,000 judgment against CC. RFT is concerned that SE will have priority in CC’s assets. What can RFT do?

SE is a judgment creditor of CC. SE is not a judgment lien creditor of CC until SE has the sheriff levy a writ of execution on CC’s assets. Until the levy, SE has no interest in any of CC’s assets. RFT has satisfied two of the three requirements for a SI: value and CC has rights in the collateral. If RFT gets CC to sign a security agreement and files a financing statement before SE levies on CC’s assets, RFT will have a security interest with priority over SE’s lien. CC may be open to this idea as CC’s feelings towards SE probably are negative. Furthermore, RFT then may be able to Grocers Supply SE.

28.2 PG lends $20,000 to MH that is secured with equipment on MH’s property. On 3/7, MH signs a F/S, SA and note for PG. On 3/7, PG files the F/S but does not disburse funds. On 3/10, the sheriff levies on the equipment for SP. On 3/11, PG receives back her U.C.C. search showing a first priority on the equipment.a. On 3/11, is PG perfected? Under § 9-308(a), a SI is perfected if it has attached and the requirements for perfection have been satisfied. A SI is perfected when it attaches if the perfection requirements are satisfied before the SI attaches. PG has satisfied the filing requirement for perfection of a SI in equipment under § 9-310(a). PG has not disbursed funds. So, PG may not have satisfied the value requirement of § 9-203(b)(1) that is necessary for attachment. PG may have given value if PG committed to disburse the funds upon a clear U.C.C. search.b. PG disburses despite the levy. Who has priority? Under § 9-317(a)(2)(B), a lien creditor has priority in the collateral if the lien is levied before a SI interest is perfected or a SA is signed and a F/S is filed on the collateral. MH signed a SA granting a SI in the

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collateral to PG on 3/7. PG filed a F/S on the collateral on 3/7. SP levied on the collateral on 3/10. PG has priority over SP under § 9-317(a)(2)(B). Moreover, PG can Grocer Supply SP.

28.3 NBC makes non-PMSI loans to small businesses secured by tangible personal property. How does NBC avoid priority problems?

NBC should follow a four-step process Get a signed SA and file a F/S to qualify for § 9-317(a)(2)(B) and § 9-322(a)(1). Conduct a U.C.C. search to protect against other Article 9 security interests. Look at the collateral to ensure no perfection by possession. Disburse the funds.

28.6 BBW sells a boat to EJ. BBW finances the sale. EJ signed a note, SA and F/S. EJ takes delivery of the boat. EJ’s ex-husband OJ has the sheriff levy a judgment on the boat and take possession of the boat. The SA contains a clause that any levy is an event of default. Can BBW get the boat back from the sheriff today? Is there anything else BBW should do?

Upon the sheriff’s levy, OJ has perfected his judgment lien. Under § 9-317(a)(2), a lien creditor has priority if the lien is levied before a security interest is perfected on the collateral or a SA is signed and a F/S is filed on the collateral. When the sheriff levied on the boat, BBW had not filed a F/S. Therefore, OJ will have priority unless BBW perfected prior to the levy or BBW finds an exception.

Under § 9-103, a PMSI in goods is created to the extent that an obligor incurs an obligation for all or part of the purchase price of the collateral that secures the obligation. Because a SI in the boat secures EJ’s obligation incurred for part of the purchase price of the boat, the SI is a PMSI in goods.

Because no information is given as to EJ’s intended use for the boat, the problem does not identify the type of goods. Under § 9-309(1), a SI in consumer goods perfects upon attachment if the SI is a PMSI in consumer goods if there are no state or federal law requirements for perfection. Under § 9-102(a)(23), consumer goods are goods that are used or bought for use primarily for personal, family, or household purposes. Under § 9-203(b), attachment occurs when value has been given, the debtor has rights in the collateral and the debtor signs a SA. Under § 9-317(e), “if a person files a F/S with respect to a PMSI before or within 20 days after the debtor receives delivery of the collateral, the SI takes priority over the rights of a . . . lien creditor which arise between the time the SI attaches and the time of filing.”

If the boat is consumer goods because of EJ’s intent, then BBW’s SI is perfected upon attachment. BBW and EJ exchanged value; EJ has rights in the boat; EJ signed a SA naming the boat as collateral. So, BBW’s SI in the boat attached before EJ left the premises. As a result, BBW was perfected provided that no state or federal laws regarding perfection exist and BBW has priority under § 9-317(a)(2)(A).

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If the boat is not consumer goods, then under § 9-317(e) BBW may file a F/S with respect to the boat before of within 20 days after EJ received delivery of the boat and take priority over the rights of OJ because BBW has a PMSI.

28.7 BBW sells a boat to EJ. BBW finances the sale. EJ signed a note and F/S but not a SA. EJ takes delivery of the boat. EJ’s ex-husband OJ has the sheriff levy a judgment on the boat and take possession of the boat. The SA contains a clause that any levy is an event of default. Can EJ sign the SA now?

BBW’s SI has not attached because she has not satisfied § 9-203(b)(3). Because BBW has no SI, § 9-317(e) does not give BBW any priority over the judgment lien creditor. Under § 9-317(a), the judgment lien creditor has priority.

XXIX. Lien Creditors Against Secured Creditors: Future Advances

A. Priority of Future Advances: Personal Property§ 9-323. FUTURE ADVANCES(a) [When priority based on time of advance.] Except as otherwise provided in subsection (c), for purposes of determining the priority of a perfected security interest under Section 9-322(a)(1), perfection of the security interest dates from the time an advance is made to the extent that the security interest secures an advance that:

(1) is made while the security interest is perfected only:(A) under Section 9-309 when it attaches; or(B) temporarily under Section 9-312(e), (f), or (g); and

(2) is not made pursuant to a commitment entered into before or while the security interest is perfected by a method other than under Section 9-309 or 9-312(e), (f), or (g).

(b) [Lien creditor.] Except as otherwise provided in subsection (c), a security interest is subordinate to the rights of a person that becomes a lien creditor to the extent that the security interest secures an advance made more than 45 days after the person becomes a lien creditor unless the advance is made:

(1) without knowledge of the lien; or(2) pursuant to a commitment entered into without knowledge of the lien.

Section 9-323(b) gives the priority rule for future advances between an Article 9 secured creditor and a lien creditor.

Future Advance Made <= 45 Days After Person

Becomes Lien Creditor

Future Advance Made > 45 Days After Person

Becomes Lien CreditorSecured Creditor Has No Knowledge of Lien Creditor

Secured Creditor Secured Creditor

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Future Advance Made <= 45 Days After Person

Becomes Lien Creditor

Future Advance Made > 45 Days After Person

Becomes Lien CreditorSecured Creditor Committed to Future Advance

Secured Creditor Secured Creditor

Otherwise Secured Creditor Lien Creditor

B. Priority of Nonadvances: Personal PropertyAdvances are only part of the expenses that an Article 9 secured creditor incurs. If a lien creditor attempts to collect, the secured creditor will incur legal costs and have interest expense. These costs are incurred after the lien creditor has perfected. The code relates back these nonadvances to their associated advance and gives them the same priority.

CaseUni Imports, Inc. v. Exchange Nat’l Bank of Chi. (p. 466)

Priority between secured creditor and lien creditorSecured creditor expenses other than advances after lien creditor perfects

C. Priority of Future Advances and Nonadvances: Real PropertyReal estate law follows the same rationale as personal property. Some courts distinguish between optional and obligatory future advances.

CaseShutze v. Credithrift of Am., Inc. (p. 470)

Priority between secured creditor and lien creditor in real propertyFuture advances

Future advance clauseRelate back

D. Problem Set 2929.1 Mortgagor borrows $50,00 secured by real property. Mortgage has a future advances clause for an additional $25,000 but no obligation to lend. Mortgage states interest at 10% and attorneys’ fees are collectible. J obtains a judgment for $100,000 against debtor. J records a lien on the real property. Mortgagee knows of lien. Mortgagee makes mortgagor an additional $25,000 advance. Mortgagor defaults on the loan owing $75,000 plus $10,000 in interest. Mortgagee incurs $5,000 in attorneys’ fees. Who has priority in the property?

The future advances clause in the mortgage is not a commitment, but under real estate law the future advance clause puts subsequent creditors on notice. Consequently, the mortgagee may make the advance even with knowledge of the lien. The advances, attorneys’ fees and interest relate back to the initial advance. The mortgagee has priority for the entire amount. This scenario is decided under real estate law.

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29.2 Debtor borrows $50,000 from secured party and executes a note and SA that allows future advances up to an additional $25,000. Creditor has no obligation to make the future advances. SA states interest is 10% and creditor can collect attorneys’ fees. Judgment creditor for $100,000 levies on the property. Creditor knows of judgment lien creditor. Sixty days after the levy, creditor advances another $25,000. Debtor defaults owing the principal, $10,000 of interest and $5,000 of attorneys’ fees to Creditor. Who has priority?

For the initial advance of $50,000, the conflict is between an Article 9 secured creditor and a judgment lien creditor. Under § 9-317(a)(2)(A), creditor wins because creditor perfected before the judgment creditor levied. For the future advances, attorneys’ fees and interest, the conflict is between an Article 9 secured creditor and a judgment lien creditor. Under § 9-323(b), a future advance of a secured creditor takes priority over a judgment lien creditor if the advance was made within 45 days of the lien, if the advance was made without knowledge of the lien, or if the advance was made pursuant to a commitment. The advance was made 60 days after the lien; the advance was made with knowledge of the lien; the advance was not made pursuant to a commitment because creditor has no obligation to make the future advances. The judgment lien creditor has priority over the secured creditor’s subsequent advances, interest and attorneys’ fees.

29.3 CD lends $1,000 to BM. BM gives a SI in his boat worth $32,000. CD perfected. BCA has a judgment against BM. BCA levies on the boat and takes possession. BM wants from CD an additional advance of $31,000 secured by the boat. Will this work?

Assume that the SA contains a future advances clause. The conflict is between an Article 9 secured creditor and judgment lien creditor. For future advances § 9-323(b) gives priority to an Article 9 secured creditor over a judgment lien creditor if the advance was made within 45 days of the lien, if the advance was made without knowledge of the lien, or if the advance was made pursuant to a commitment. CD has knowledge of the lien and no commitment to make a future advance was signed. So, CD can have priority over BCA only if CD makes the future advance within 45 days of BCA’s levy on the boat.

If the sheriff holds a sale, BCA may want to redeem

29.4 You represent BCA. What do you do?

CD can Grocers Supply BCA. Send notice to CD to make sure that CD cannot advance without knowledge before the sale under § 9-323(b)(1). Credit bid for the value of the boat and notify CD of the sale to prevent CD from making advances after the sale under § 9-323(d). Under § 9-623, BCA may want to redeem the collateral by paying off CD.

29.5 Insolvent debtor has new F/S on its collateral.a. What is happening?Debtor is showing preference to unsecured creditors and making them Article 9 secured creditors.b. What should you do?

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Try to force an involuntary bankruptcy on the debtor so that the preferences can be avoided.

XXX. Trustees in Bankruptcy Against Secured Creditors: The Strong Arm Clause

XXXI. Trustees in Bankruptcy Against Secured Creditors: Preferences

A. Priority Among Unsecured Creditors

1. Priority Under State Law: A ReviewFor unsecured creditors, priority was established by perfecting a judgment. The time of that perfection depends upon state law. Alternatively, the unsecured creditor can enlist the help of the debtor, sign a security agreement and file a financing statement.

2. Priority Under Bankruptcy Law: A ReviewUpon a debtor filing for bankruptcy, the automatic stay prevents unsecured creditors from pursuing further collection efforts. The creditors file claims with the estate and are paid on a pro rata basis.

3. Reconciling the State and Bankruptcy PoliciesDespite their differences, no serious conflict exists between state and bankruptcy law because upon the filing of a bankruptcy petition, bankruptcy law preempts state law. Bankruptcy requires that all unsecured creditors be treated equally after the petition is filed. Additionally, unsecured creditors must be treated equally for a period of one year against creditors who are insiders and for a period of 90 days against other creditors. These periods are known as the preference period. Transactions within the preference period may be avoided if they show preference to an unsecured creditor.

B. What Security Interests Can Be Avoided as Preferential?11 U.S.C. § 547. Preferences(b) Except as provided in subsections (c) and (i) of this section, the trustee may avoid any transfer of an interest of the debtor in property—

(1) to or for the benefit of a creditor;(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;(3) made while the debtor was insolvent;(4) made—

(A) on or within 90 days before the date of the filing of the petition; or(B) between ninety days and one year before the date of the filing of the petition, if such creditor at the time of such transfer was an insider; and

(5) that enables such creditor to receive more than such creditor would receive if—(A) the case were a case under chapter 7 of this title;

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(B) the transfer had not been made; and(C) such creditor received payment of such debt to the extent provided by the provisions of this title.

(c) The trustee may not avoid under this section a transfer—(1) to the extent that such transfer was—

(A) intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and(B) in fact a substantially contemporaneous exchange;

(2) to the extent that such transfer was in payment of a debt incurred by the debtor in the ordinary course of business or financial affairs of the debtor and the transferee, and such transfer was—

(A) made in the ordinary course of business or financial affairs of the debtor and the transferee; or(B) made according to ordinary business terms;

(3) that creates a security interest in property acquired by the debtor—(A) to the extent such security interest secures new value that was—

(i) given at or after the signing of a security agreement that contains a description of such property as collateral;(ii) given by or on behalf of the secured party under such agreement;(iii) given to enable the debtor to acquire such property; and(iv) in fact used by the debtor to acquire such property; and

(B) that is perfected on or before 30 days after the debtor receives possession of such property;

(4) to or for the benefit of a creditor, to the extent that, after such transfer, such creditor gave new value to or for the benefit of the debtor—

(A) not secured by an otherwise unavoidable security interest; and(B) on account of which new value the debtor did not make an otherwise unavoidable transfer to or for the benefit of such creditor;

(5) that creates a perfected security interest in inventory or a receivable or the proceeds of either, except to the extent that the aggregate of all such transfers to the transferee caused a reduction, as of the date of the filing of the petition and to the prejudice of other creditors holding unsecured claims, of any amount by which the debt secured by such security interest exceeded the value of all security interests for such debt on the later of—

(A) (i) with respect to a transfer to which subsection (b)(4)(A) of this section applies, 90 days before the date of the filing of the petition; or

(ii) with respect to a transfer to which subsection (b)(4)(B) of this section applies, one year before the date of the filing of the petition; or

(B) the date on which new value was first given under the security agreement creating such security interest;

(6) that is the fixing of a statutory lien that is not avoidable under section 545 of this title;(7) to the extent such transfer was a bona fide payment of a debt for a domestic support obligation;

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(8) if, in a case filed by an individual debtor whose debts are primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $ 600; or(9) if, in a case filed by a debtor whose debts are not primarily consumer debts, the aggregate value of all property that constitutes or is affected by such transfer is less than $ 5,000.

1. GenerallySection 547(b) of the bankruptcy code allows the trustee to avoid any preferential transfers that meet the criteria. These criteria work to exclude security interests that were created as part of the initial transaction. Only transfers related to antecedent debts can be avoided. If the transfer is part of a substantially contemporaneous exchange, then the transaction was not related to an antecedent debt. Also, any preferences made while the debtor is solvent cannot be avoided. Under § 547(f), the debtor is presumed to be insolvent on and during the 90 days immediately preceding the date of the filing of the petition. Preferences made before the preference period cannot be avoided. Finally, preferences that do not improve the creditor’s position cannot be avoided. However, section 547(c) provides several classes of otherwise avoidable transactions that cannot be avoided.

2. When Does the “Transfer” of a Security Interest Occur?11 U.S.C. § 547. Preferences(e) (1) For the purposes of this section—

(A) a transfer of real property other than fixtures, but including the interest of a seller or purchaser under a contract for the sale of real property, is perfected when a bona fide purchaser of such property from the debtor against whom applicable law permits such transfer to be perfected cannot acquire an interest that is superior to the interest of the transferee; and(B) a transfer of a fixture or property other than real property is perfected when a creditor on a simple contract cannot acquire a judicial lien that is superior to the interest of the transferee.

(2) For the purposes of this section, except as provided in paragraph (3) of this subsection, a transfer is made—

(A) at the time such transfer takes effect between the transferor and the transferee, if such transfer is perfected at, or within 30 days after, such time, except as provided in subsection (c)(3)(B);(B) at the time such transfer is perfected, if such transfer is perfected after such 30 days; or(C) immediately before the date of the filing of the petition, if such transfer is not perfected at the later of—

(i) the commencement of the case; or(ii) 30 days after such transfer takes effect between the transferor and the transferee.

(3) For the purposes of this section, a transfer is not made until the debtor has acquired rights in the property transferred.

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Because transfers only can be avoided if they occur during the preference period, a critical step to determining if a transfer can be avoided by the trustee is the date of the transfer. Under § 547(e)(1)(B), a transfer is perfected when a creditor cannot acquire a judicial lien that is superior to the interest of the transferee. Difficulties arise because both bankruptcy law and state law sometimes allow the taking of a security interest to relate back to an earlier date. See 11 U.S.C. § 547(e)(2)(A); § 9-317(a)(2); § 9-323(b). When working with security interests, the date of transfer usually is the date of perfection. The date of perfection is determined by state law. With after-acquired collateral, perfection occurs when the debtor acquires ownership. As a result, the secured party’s SI in after acquired equipment will have a later transfer date than the filing of the F/S and may be avoidable by the trustee if it falls within the preference period.

3. The §547(c)(5) Exception for Accounts Receivable and Inventory

11 U.S.C. § 547. Preferences(c) The trustee may not avoid under this section a transfer—

(5) that creates a perfected security interest in inventory or a receivable or the proceeds of either, except to the extent that the aggregate of all such transfers to the transferee caused a reduction, as of the date of the filing of the petition and to the prejudice of other creditors holding unsecured claims, of any amount by which the debt secured by such security interest exceeded the value of all security interests for such debt on the later of—

(A) (i) with respect to a transfer to which subsection (b)(4)(A) of this section applies, 90 days before the date of the filing of the petition; or

(ii) with respect to a transfer to which subsection (b)(4)(B) of this section applies, one year before the date of the filing of the petition; or

(B) the date on which new value was first given under the security agreement creating such security interest;

Because accounts and inventory constantly turn over, a special exception was crafted to avoid the harsh consequences of the after-acquired collateral rules. The courts use a two-point test to determine if an avoidable transfer has occurred.

The first step in applying section 547(c)(5) is to determine the amount of the loan outstanding 90 days prior to filing and the value of the collateral on that day. The difference between these figures is then computed. Next, the same determinations are made as of the date of filing the petition. A comparison is made, and, if there is a reduction during the 90-day period of the amount by which the initially existing debt exceeded the security, then a preference for section 547(c)(5) purposes exists. The effect of 547(c)(5) is to make the security interest voidable only to the extent of the preference. Of course, if the creditor is fully secured 90 days before the filing of the petition, then that creditor will never be subject to a preference attack.

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4. Relation-Back RulesSeveral relation-back rules are relevant. The major provisions are as follows:

11 U.S.C. § 547(e)(2)(A) § 9-317(e)

Class notesThe major exceptions to preference avoidance are as follows:

§ 547(c)(1)—contemporaneous exchange § 547(c)(3)—PMSI § 547(c)(5)—after acquired accounts and inventory

C. Strategic Implications of Preference AvoidanceThe 90-day preference period affects the behavior of debtors and creditors. Debtors will create a security interest and then wait 90-days before filing a petition for bankruptcy. Sophisticated creditors will monitor weak debtors for new public filings. Any changes will result in pressure for similar treatment or an involuntary bankruptcy petition.

D. Problem Set 3131.1 GI files chapter 11 bankruptcy. On 12/30, the case was converted to chapter 7. Can the following transactions be avoided?

Under 11 U.S.C. § 348(a), conversion of a case from a case under one chapter to case under another chapter does not effect a change in the date of the filing of the petition. GI’s date of the filing of the petition remains the date that GI filed a petition for chapter 11 bankruptcy. Under 11 U.S.C. § 348(d), a claim against the estate or the debtor that arises after the order for relief but before conversion from chapter 11 to chapter 7 shall be treated as if such claim had arisen immediately before the date of the filing of the petition. All claims against GI that arise between the filing of chapter 11 and conversion to chapter 7 are treated as if such claim had arisen immediately before the date of the filing of the petition, which is the date that GI filed a petition for chapter 11 bankruptcy.

a. On 8/15, GI borrowed $300,000 from F. GI executed a note, SA and F/S covering equipment. F filed the F/S on 8/16.

Under 11 U.S.C. § 547(b), the trustee may avoid any transfer of an interest of the debtor in property—

(1) to or for the benefit of a creditor;(2) for or on account of an antecedent debt owed by the debtor before such transfer

was made;(3) made while the debtor was insolvent;(4) made on or within 90 days before the date of the filing of the petition;(5) that enables such creditor to receive more than the creditor otherwise would

receive.However, under 11 U.S.C. § 547(c)(1), the trustee may not avoid a transfer to the extent that such transfer was intended by the debtor and creditor to be a contemporaneous exchange for new value given to the debtor and in fact a substantially contemporaneous

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exchange. Under 11 U.S.C. § 547(e)(2)(A), a transfer is made at the time such transfer takes effect between the transferor and the transferee, if such transfer is perfected at, or within 30 days after such time. GI’s transfer of a SI occurred on 8/15. GI’s transfer was perfected within 30 days on 8/16. So, the date of transfer is 8/15. These dates are substantially contemporaneous. GI’s transfer was for new value in the form of a $300,000 loan. Consequently, the trustee cannot avoid this transfer.

b. On 2/7, GI borrowed $300,000 from S. On 7/11, GI signed a SA giving S a SI in equipment. S perfected the SI by filing a F/S on 7/11.

Under 11 U.S.C. § 547(b), the trustee may avoid any transfer of an interest of the debtor in property—

(1) to or for the benefit of a creditor;(2) for or on account of an antecedent debt owed by the debtor before such transfer

was made;(3) made while the debtor was insolvent;(4) made on or within 90 days before the date of the filing of the petition;(5) that enables such creditor to receive more than the creditor otherwise would

receive.However, under 11 U.S.C. § 547(c)(1), the trustee may not avoid a transfer to the extent that such transfer was intended by the debtor and creditor to be a contemporaneous exchange for new value given to the debtor and in fact a substantially contemporaneous exchange. Under 11 U.S.C. § 547(e)(2)(B), a transfer is made at the time such transfer is perfected, if such transfer is perfected after such 30 days. S made the loan on 2/7. S perfected the SI on 7/11. Because there is over 5 month’s difference between these dates, these transfers are not in fact a substantially contemporaneous exchange. The transfer of the SI is for or on account of the antecedent debt that GI owes to S. Consequently, the trustee can avoid this transfer.

c. On 2/7, GI borrowed $300,000 from T. GI signed a F/S

XXXII. Secured Creditors Against Secured Creditors: The Basics

§ 9-322. PRIORITIES AMONG CONFLICTING SECURITY INTERESTS IN AND AGRICULTURAL LIENS ON SAME COLLATERAL(a) [General priority rules.] Except as otherwise provided in this section, priority among conflicting security interests and agricultural liens in the same collateral is determined according to the following rules:

(1) Conflicting perfected security interests and agricultural liens rank according to priority in time of filing or perfection. Priority dates from the earlier of the time a filing covering the collateral is first made or the security interest or agricultural lien is first perfected, if there is no period thereafter when there is neither filing nor perfection.(2) A perfected security interest or agricultural lien has priority over a conflicting unperfected security interest or agricultural lien.

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(3) The first security interest or agricultural lien to attach or become effective has priority if conflicting security interests and agricultural liens are unperfected.

(b) [Time of perfection: proceeds and supporting obligations.] For the purposes of subsection (a)(1):

(1) the time of filing or perfection as to a security interest in collateral is also the time of filing or perfection as to a security interest in proceeds; and(2) the time of filing or perfection as to a security interest in collateral supported by a supporting obligation is also the time of filing or perfection as to a security interest in the supporting obligation.

(c) [Special priority rules: proceeds and supporting obligations.] Except as otherwise provided in subsection (f), a security interest in collateral which qualifies for priority over a conflicting security interest under Section 9-327, 9-328, 9-329, 9-330, or 9-331 also has priority over a conflicting security interest in:

(1) any supporting obligation for the collateral; and(2) proceeds of the collateral if:

(A) the security interest in proceeds is perfected;(B) the proceeds are cash proceeds or of the same type as the collateral; and(C) in the case of proceeds that are proceeds of proceeds, all intervening proceeds are cash proceeds, proceeds of the same type as the collateral, or an account relating to the collateral.

(d) [First-to-file priority rule for certain collateral.] Subject to subsection (e) and except as otherwise provided in subsection (f), if a security interest in chattel paper, deposit accounts, negotiable documents, instruments, investment property, or letter-of-credit rights is perfected by a method other than filing, conflicting perfected security interests in proceeds of the collateral rank according to priority in time of filing.(e) [Applicability of subsection (d).] Subsection (d) applies only if the proceeds of the collateral are not cash proceeds, chattel paper, negotiable documents, instruments, investment property, or letter-of-credit rights.(f) [Limitations on subsections (a) through (e).] Subsections (a) through (e) are subject to:

(1) subsection (g) and the other provisions of this part;(2) Section 4-210 with respect to a security interest of a collecting bank;(3) Section 5-118 with respect to a security interest of an issuer or nominated person; and(4) Section 9-110 with respect to a security interest arising under Article 2 or 2A.

(g) [Priority under agricultural lien statute.] A perfected agricultural lien on collateral has priority over a conflicting security interest in or agricultural lien on the same collateral if the statute creating the agricultural lien so provides.

§ 9-325. PRIORITY OF SECURITY INTERESTS IN TRANSFERRED COLLATERAL(a) [Subordination of security interest in transferred collateral.] Except as otherwise provided in subsection (b), a security interest created by a debtor is subordinate to a security interest in the same collateral created by another person if:

(1) the debtor acquired the collateral subject to the security interest created by the other person;(2) the security interest created by the other person was perfected when the debtor acquired the collateral; and(3) there is no period thereafter when the security interest is unperfected.

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(b) [Limitation of subsection (a) subordination.] Subsection (a) subordinates a security interest only if the security interest:

(1) otherwise would have priority solely under Section 9-322(a) or 9-324; or(2) arose solely under Section 2-711(3) or 2A-508(5).

A. The Basic Rule: First to File or PerfectThe basic rule to determine priority between two Article 9 secured creditors is found in section 9-322(a)(1). The first to file or perfect has priority. This statute is a pure race statute.

Section 9-325 contains an important exception to this rule that covers the sale of collateral in the ordinary course of business. The seller’s perfected creditor has priority over the buyer’s perfected creditor.

B. Priority of Future AdvancesThe priority rule between secured creditors regarding future advances is the same as the priority rule for real estate. Future advances relate back to the initial lien if the security agreement for the initial lien contains a future advances clause. However, the Article 9 secured creditor establishes his priority with respect to other Article 9 secured creditors by simply filing. Perfection is not necessary to establish position although perfection is necessary to establish a lien.

C. Priority in After-Acquired PropertyThe priority rule between secured creditors regarding after-acquired property is the same as the priority rule for future advances. After-acquired property relates back to the initial lien if the security agreement for the initial lien contains an after-acquired property clause.

D. Priority of Purchase-Money Security Interests§ 9-324. PRIORITY OF PURCHASE-MONEY SECURITY INTERESTS(a) [General rule: purchase-money priority.] Except as otherwise provided in subsection (g), a perfected purchase-money security interest in goods other than inventory or livestock has priority over a conflicting security interest in the same goods, and, except as otherwise provided in Section 9-327, a perfected security interest in its identifiable proceeds also has priority, if the purchase-money security interest is perfected when the debtor receives possession of the collateral or within 20 days thereafter.(b) [Inventory purchase-money priority.] Subject to subsection (c) and except as otherwise provided in subsection (g), a perfected purchase-money security interest in inventory has priority over a conflicting security interest in the same inventory, has priority over a conflicting security interest in chattel paper or an instrument constituting proceeds of the inventory and in proceeds of the chattel paper, if so provided in Section 9-330, and, except as otherwise provided in Section 9-327, also has priority in identifiable cash proceeds of the inventory to the extent the identifiable cash proceeds are received on or before the delivery of the inventory to a buyer, if:

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(1) the purchase-money security interest is perfected when the debtor receives possession of the inventory;(2) the purchase-money secured party sends an authenticated notification to the holder of the conflicting security interest;(3) the holder of the conflicting security interest receives the notification within five years before the debtor receives possession of the inventory; and(4) the notification states that the person sending the notification has or expects to acquire a purchase-money security interest in inventory of the debtor and describes the inventory.

(c) [Holders of conflicting inventory security interests to be notified.] Subsections (b)(2) through (4) apply only if the holder of the conflicting security interest had filed a financing statement covering the same types of inventory:

(1) if the purchase-money security interest is perfected by filing, before the date of the filing; or(2) if the purchase-money security interest is temporarily perfected without filing or possession under Section 9-312(f), before the beginning of the 20-day period thereunder.

(g) [Conflicting purchase-money security interests.] If more than one security interest qualifies for priority in the same collateral under subsection (a), (b), (d), or (f):

(1) a security interest securing an obligation incurred as all or part of the price of the collateral has priority over a security interest securing an obligation incurred for value given to enable the debtor to acquire rights in or the use of collateral; and(2) in all other cases, Section 9-322(a) applies to the qualifying security interests.

1. Purchase-Money Security Interests GenerallyUnder section 9-324(a), a puchase-money security interest in collateral other than inventory has priority over other Article 9 secured creditors if the security interest is perfected within 20 days of delivery.

2. Purchase-Money Security Interests in InventoryThe rules for a purchase-money security interest in inventory are different. The burden is upon the seller of the inventory to notify any prior holders of a security interest in inventory that the seller will be taking a purchase-money security interest in the inventory. If the seller complies with this rule and the others in section 9-324(b), then the seller will have priority.

E. Purchase-Money Priority in ProceedsOf course, collateral can change its form. The creditor with the purchase-money security interest now must be concerned about his priority in the proceeds. Under section 9-324(a), the purchase-money priority extends to the proceeds. However, the same rules do not apply to inventory. For inventory, the purchase-money priority only extends to proceeds that are cash, chattel paper and instruments. Furthermore, security interest in cash, chattel paper and instruments are impacted by the provisions in sections 9-327 and 9-330. Under section 9-327, a security interest with control over a deposit account has priority over a conflicting security interest. Under section 9-330, a purchaser of chattel

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paper or instruments has priority over a security interest in the chattel paper or instruments as the proceeds from the sale of inventory.

F. Priority in Commingled Collateral§ 9-335. ACCESSIONS(a) [Creation of security interest in accession.] A security interest may be created in an accession and continues in collateral that becomes an accession.(b) [Perfection of security interest.] If a security interest is perfected when the collateral becomes an accession, the security interest remains perfected in the collateral.(c) [Priority of security interest.] Except as otherwise provided in subsection (d), the other provisions of this part determine the priority of a security interest in an accession.(d) [Compliance with certificate-of-title statute.] A security interest in an accession is subordinate to a security interest in the whole which is perfected by compliance with the requirements of a certificate-of-title statute under Section 9-311(b).(e) [Removal of accession after default.] After default, subject to Part 6, a secured party may remove an accession from other goods if the security interest in the accession has priority over the claims of every person having an interest in the whole.(f) [Reimbursement following removal.] A secured party that removes an accession from other goods under subsection (e) shall promptly reimburse any holder of a security interest or other lien on, or owner of, the whole or of the other goods, other than the debtor, for the cost of repair of any physical injury to the whole or the other goods. The secured party need not reimburse the holder or owner for any diminution in value of the whole or the other goods caused by the absence of the accession removed or by any necessity for replacing it. A person entitled to reimbursement may refuse permission to remove until the secured party gives adequate assurance for the performance of the obligation to reimburse.

Collateral is commingled when it is mixed with other property. Commingling may occur with cash, mixing or through the manufacturing process. For commingled funds, the lowest intermediate balance approach is used. For commingled goods, two situations may arise (1) the identity of the collateral is lost or (2) the identity of the collateral is not lost. If the identity of the collateral is lost, then the creditor’s security interest continues in the transformed collateral. If more than one creditor has a security interest in the transformed collateral, then each creditor will receive his proportional value resulting from the liquidation of the collateral. If the identity of the collateral is not lost, then it is more proper to speak of accession rather than commingling and section 9-335 controls.

G. Problem Set 3232.1 Dawgs applies for a loan from B1 secured by Dawgs’ equipment. On 8/1, B1 files a F/S against the equipment before approving the loan. Dawgs applies for a loan from B2 secured by Dawgs’ equipment. On 8/5, B2 approves the loan, Dawgs signs a note and SA, B2 advances the money and B2 files a F/S. On 8/7, C-Dogs a judgment creditor levies on the equipment. On 8/10, B1 approves its loan to Dawgs, Dawgs signs a note and SA and B1 advances the money. Dawgs defaults. Who has priority in the equipment?

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Between B1 and B2, § 9-322(a)(1) gives priority to the first perfected security interest to file or perfect. B1 has priority over B2 because B1 filed on 8/1 before B2 filed or perfected on 8/5.

Between B2 and C-Dogs, § 9-317(a)(2) gives priority to a security interest perfected before a judgment creditor levies. B2 has priority over C-Dogs because B2 perfected on 8/5 before C-Dogs levied on 8/7.

Between B1 and C-Dogs, § 9-317(a) gives priority to a security interest perfected before a judgment creditor levies and to a person who files a F/S and gets a signed SA before a judgment creditor levies. C-Dogs has priority over B1 because C-Dogs levied on 8/7 before B1 got a signed SA on 8/10 and before B1 perfected on 8/10 per § 9-308(a).

32.2 On 9/21 CNB loaned FA $250,000 secured by a perfected S/I in flight simulation equipment. CNB discovers that FNB perfected a S/I in FA’s flight simulation equipment on 7/21. CNB also perfected a S/I in the flight simulation equipment and after-acquired equipment of PU on 3/21. CNB wants FA to sell its flight simulation equipment to PU. Can CNB use this method to move ahead of FNB in FA’s flight simulation equipment?

This is the double debtor problem

32.4 a. CD loans $1,000 to BM. Loan is secured by a perfected S/I in boat. BCA loans $45,000 to BM. BCA takes a perfected S/I in boat and other items of collateral. BM defaults to BCA. BCA repossesses the boat. Bob wants CD to make an additional advance of $31,000 to prevent sale netting any money for BCA. Will this work? Assume that CD’s SA has a future advances clause.

Under § 9-323(a)(2), perfection of a S/I dates from the time an advance is made to the extent that the S/I secures an advance that is not made pursuant to a commitment entered into before or while the S/I is perfected by other than strange methods. Advances made pursuant to a commitment entered into before or while the S/I is perfected by other than strange methods date from the time of perfection. CD’s S/I was perfected a year ago. BCA perfected its S/I a month later. CD’s S/I is perfected by filing. If CD enters into a commitment now, then all advances will have the perfection date of a year ago. Under § 9-322(a)(1), between conflicting perfected S/I the first to file or perfect has priority. CD has priority because CD perfected before BCA perfected.

b. Assume CD filed a F/S before BCA repossessed but BM did not sign a SA and CD did not lend money. Will this scheme now work?

Now, this is not a future advances problem because there was no initial advance or S/I. Under § 9-322(a)(1), between conflicting perfected S/I the first to file or perfect has priority. CD has priority because CD filed before BCA filed or perfected.

32.5 What can BCA do to protect itself?BCA can try four approaches:

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attack the perfection attack the attachment redeem the collateral ask for a subordination agreement

32.7 SW is a manufacturer losing money on bad debts. She provides inventory to retailers.a. How can she get first priority?Under § 9-324(b), a perfected PMSI in inventory can get priority over other types of S/Is in inventory provided that the PMSI holder complies with the requirements of § 9-324(b)-(c). These requirements include the following: identify conflicting secured parties through a U.C.C. search perfect the PMSI before delivering the goods to the debtor; notify the conflicting secured party before delivering the goods to the debtor; renotify the conflicting secured party every five years;This priority extends to identifiable cash proceeds and chattel paper but it does not extend to accounts. SW can get a perfected PMSI in the inventory she sells and thereby get priority.

b. What problems might she encounter?If SW’s customers sell on credit, SW’s collateral may change into accounts. SW would lose her priority in the collateral

32.9 ELG wants to finance inventory for SM. FNB has a perfected S/I in SM’s inventory and accounts. Can ELG get priority?

Under § 9-324(b), a perfected PMSI in inventory can get priority over other types of S/Is in inventory provided that the PMSI holder complies with the requirements of § 9-324(b)-(c). These requirements include the following: identify conflicting secured parties through a U.C.C. search perfect the PMSI before delivering the goods to the debtor; notify the conflicting secured party before delivering the goods to the debtor; renotify the conflicting secured party every five years;This priority extends to identifiable cash proceeds and chattel paper but it does not extend to accounts under § 9-324(b). ELG can get a perfected PMSI in SM’s inventory by financing the inventory and thereby get priority over FNB in SM’s inventory. If SM sells the inventory on credit, ELG still has an S/I in an account that is identifiable proceeds under § 9-315(a)(2). Furthermore, ELG’s S/I in the account is perfected under § 9-315(c)-(d)(1) because a F/S was filed on the inventory, a F/S in accounts would be filed in the same office and an account is not cash proceeds. Under § 9-322(b)(1), EGL’s date of perfection in the account is the same as the date of EGL’s perfection in the inventory. But, FNB’s perfected S/I in accounts has priority over ELG’s perfected S/I in accounts under § 9-322(a)(1) because FNB perfected before ELG perfected or filed and the special rule in § 9-324(b) does not cover accounts.

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XXXIII. Secured Creditors Against Secured Creditors: Land and Fixtures

XXXIV. Competitions Involving Cross-Collateralization and Marshaling Assets

XXXV. Sellers Against Secured Creditors

XXXVI. Buyers Against Secured Creditors

A. IntroductionThe sale of collateral by a debtor may or may not release the security interest of the creditor. Sometimes the buyer may acquire ownership of the property without a lien; other times the creditor’s lien remains in place. The applicable law reflects the expectations of buyers and sellers.

B. Buyers of Real PropertyFor real property, the rule is that if the mortgage was created before the debtor sold the property to the buyer, then buyer takes subject to the mortgage. If the jurisdiction uses a recording statute, then a good faith buyer for value without notice may have priority over the creditor. With other types of statutes, the good faith buyer prevails only if the buyer records first.

C. Buyers of Personal Property§ 9-201. GENERAL EFFECTIVENESS OF SECURITY AGREEMENT(a) [General effectiveness.] Except as otherwise provided in [the Uniform Commercial Code], a security agreement is effective according to its terms between the parties, against purchasers of the collateral, and against creditors.


(1) a security interest or agricultural lien continues in collateral notwithstanding sale, lease, license, exchange, or other disposition thereof unless the secured party authorized the disposition free of the security interest or agricultural lien; and(2) a security interest attaches to any identifiable proceeds of collateral.

For personal property, the general rule is that buyers take subject to encumbrances of record. However, exceptions exist.

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1. The Authorized Disposition Exception: U.C.C. §9-315(a)(1)The authorized disposition exception states that a security interest does not continue in the collateral if “the secured party authorized the disposition free of the security interest.” This exception has several interesting features.

the buyer’s knowledge of the security interest is not relevant. the creditor’s authorization to sell can be express or implied. the creditor’s authorization to dispose of the collateral free of the security

interest can be express or implied.Courts disagree on the effect of conditional authorizations. The majority view is that conditional authorization only allow disposition of the collateral free of the security interest if all of the conditions have been satisfied.

CaseRFC Capital Corp. v. EarthLink, Inc. (p. 579)

Priority between buyer and secured creditorPersonal property

Authorized disposition exceptionConditional authorization

2. The Buyer-in-the Ordinary-Course Exception: U.C.C. §9-320(a)§ 9-320. BUYER OF GOODS(a) [Buyer in ordinary course of business.] Except as otherwise provided in subsection (e), a buyer in ordinary course of business, other than a person buying farm products from a person engaged in farming operations, takes free of a security interest created by the buyer's seller, even if the security interest is perfected and the buyer knows of its existence.(e) [Possessory security interest not affected.] Subsections (a) and (b) do not affect a security interest in goods in the possession of the secured party under Section 9-313.

Unlike real property, most buyers in the ordinary course of business of personal property do not conduct a search of the public records before completing the sale. The buyer in the ordinary course of business can take ownership of property without being encumbered by the creditor’s lien on the property when the seller is a person in the business of selling goods of that kind. The buyer’s knowledge of the creditor’s security interest is not relevant. The only security interests that can be removed on the collateral by the buyer in the ordinary course of business are security interests that have been placed by the buyer’s seller. If a security interest remains on the collateral from the creditor to the seller’s seller, then that security interest continues to encumber the collateral. A buyer that “takes possession of the goods or has a right to recover the goods from the seller under Article 2 may be a buyer in the ordinary course of business.” § 1-201(b)(9) & cmt. 9.

CaseDaniel v. Bank of Hayward (p. 585)

Priority between buyer and secured creditor

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Personal propertyBuyer in the ordinary course of business

Date that a buyer becomes a buyer

3. The Buyer-Not-in-the-Ordinary-Course Exception: U.C.C. §9-323(d) and (e) and 9-317(b)

§ 9-317. INTERESTS THAT TAKE PRIORITY OVER OR TAKE FREE OF SECURITY INTEREST OR AGRICULTURAL LIEN(b) [Buyers that receive delivery.] Except as otherwise provided in subsection (e), a buyer, other than a secured party, of tangible chattel paper, documents, goods, instruments, or a security certificate takes free of a security interest or agricultural lien if the buyer gives value and receives delivery of the collateral without knowledge of the security interest or agricultural lien and before it is perfected.

§ 9-323. FUTURE ADVANCES(d) [Buyer of goods.] Except as otherwise provided in subsection (e), a buyer of goods other than a buyer in ordinary course of business takes free of a security interest to the extent that it secures advances made after the earlier of:

(1) the time the secured party acquires knowledge of the buyer's purchase; or(2) 45 days after the purchase.

(e) [Advances made pursuant to commitment: priority of buyer of goods.] Subsection (d) does not apply if the advance is made pursuant to a commitment entered into without knowledge of the buyer's purchase and before the expiration of the 45-day period.

If a buyer is not a buyer in the ordinary course of business, then the creditor’s security interest in the collateral continues through the sale.

4. The Consumer-to-Consumer-Sale Exception: U.C.C. §9-320(b)§ 9-320. BUYER OF GOODS(b) [Buyer of consumer goods.] Except as otherwise provided in subsection (e), a buyer of goods from a person who used or bought the goods for use primarily for personal, family, or household purposes takes free of a security interest, even if perfected, if the buyer buys:

(1) without knowledge of the security interest;(2) for value;(3) primarily for the buyer's personal, family, or household purposes; and(4) before the filing of a financing statement covering the goods.

(c) [Effectiveness of filing for subsection (b).] To the extent that it affects the priority of a security interest over a buyer of goods under subsection (b), the period of effectiveness of a filing made in the jurisdiction in which the seller is located is governed by Section 9-316(a) and (b).(e) [Possessory security interest not affected.] Subsections (a) and (b) do not affect a security interest in goods in the possession of the secured party under Section 9-313.

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A security interest passes even with a sale between consumers unless the collateral is consumer goods in both the hands of the buyer and the seller and the security interest is a unrecorded purchase-money security interest in consumer goods under section 9-309(1). This exception is known as the consumer-to-consumer-sale exception.

D. Problem Set 3636.1 DDS sold consumer goods to Beavis on credit for $1,925. Beavis signed a note, SA and F/S. DDS filed the F/S and perfected its SI. SA says that Beavis will not sell the consumer goods. Beavis sells the consumer goods to Butthead for $960. Butthead paid with a check. Butthead purchased the consumer goods without knowledge of DDS’ SI. Can DDS repossess the consumer goods from Butthead? If so, does DDS need to refund Butthead his $960?

Under § 9-315(a)(1), a SI continues in collateral notwithstanding sale unless the secured party authorized the disposition free of the SI. DDS did not authorize Beavis to dispose of the consumer goods. Under § 9-320(a), a BIOCOB takes free of a SI created by the buyer’s seller, even if the SI is perfected and the buyer knows of its existence. A BIOCOB buys goods in good faith without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person in the business of selling goods of that kind. Butthead is not a BIOCOB because Beavis is not a person in the business of selling consumer goods. Under § 9-320(b), a buyer of goods from a person who used or bought goods for use primarily for personal, family or household purposes takes free of a SI, even if perfected, if they buyer buys (1) without knowledge of the SI; (2) for value; (3) primarily for the buyer’s personal, family, or household purposes; and (4) before the filing of a F/S covering the goods. Butthead bought the consumer goods from Beavis who used the goods as consumer goods without knowledge of DDS’s SI, for value, to use as consumer goods, but after DDS filed a F/S covering the consumer goods. DDS still has a perfected SI because Butthead bought the consumer goods after DDS filed a F/S covering the consumer goods. Under § 9-609, after default a secured party may take possession of the collateral pursuant to judicial process or without judicial process, if it proceeds without breach of the peace. Beavis committed an event of default by selling the consumer goods. The consumer goods are DDS’s collateral. DDS may take possession of the consumer goods. DDS did not receive the $960 from Butthead. So, DDS does not have to refund Butthead the $960.

36.2 UCB has a SI in the inventory of SC. The SA authorized sales in the ordinary course of business, prohibited sales on credit, and required SC deposit all proceeds from the sale of inventory into a deposit account maintained at UCB. UCB perfected the SI. On 10/20, SC filed a petition for bankruptcy. After liquidating the inventory, UCB has a $36,000 deficiency.a. SC sold inventory to RF for $2,000 in cash and $10,000 account. RF did not know of UCB’s SI. SC deposited the check in a deposit account at another bank and used the money. SC sold RF’s note for $9,200. Can UCB repossess the inventory from RF?

Under § 9-315(a)(1), a SI continues in collateral notwithstanding sale unless the secured party authorized the disposition free of the SI. RF does not acquired the inventory free of

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UCB’s SI because UCB did not authorize SC to dispose of the inventory on credit free of the SI. Under § 9-320(a), a BIOCOB takes free of a SI created by the buyer’s seller, even if the SI is perfected and the buyer knows of its existence. A BIOCOB buys goods in good faith without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person in the business of selling goods of that kind. RF is a BIOCOB because RF bought the inventory without knowledge that the sale violates the rights of UCB in the inventory, and in the ordinary course from SC, which is in the business of selling its inventory. UCB’s SI was created by RF’s seller, SC. Consequently, RF acquired the inventory free of UCB’s SI.

b. GP was owed a debt of $16,458 by SC. SC gave inventory to GP to partially satisfy its debt to GP. Can UCB repossess the inventory from GP?

Under § 9-315(a)(1), a SI continues in collateral notwithstanding sale unless the secured party authorized the disposition free of the SI. GP does not acquire the inventory free of UCB’s SI because UCB did not authorize SC to dispose of the inventory to satisfy a money debt. Under § 9-320(a), a BIOCOB takes free of a SI created by the buyer’s seller, even if the SI is perfected and the buyer knows of its existence. A BIOCOB buys goods in good faith without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person in the business of selling goods of that kind. However, the definition of BIOCOB does not include a person that acquires goods in a transfer in partial satisfaction of a money debt. GP does not acquire the inventory free of UCB’s SI because GP is not a BIOCOB because GP acquired the inventory in a transfer in partial satisfaction of a money debt. Under § 9-320(b), a buyer of goods from a person who used or bought goods for use primarily for personal, family or household purposes takes free of a SI, even if perfected, if they buyer buys (1) without knowledge of the SI; (2) for value; (3) primarily for the buyer’s personal, family, or household purposes; and (4) before the filing of a F/S covering the goods. GP does not take free of UCB’s SI because SC did not use the goods for personal, family or household purposes. UCB still has a perfected SI in the inventory after the transfer to GP. Under § 9-609, after default a secured party may take possession of the collateral pursuant to judicial process or without judicial process, if it proceeds without breach of the peace. SC committed an event of default by using the inventory to partially satisfy a money debt. The inventory still is UCB’s collateral. UCB may take possession of the inventory.

36.3 AC bought a used vehicle from SRV. AC paid with a cashier’s check. SRV did not transfer title to AC. Previously, KE bought the vehicle from ASRV. ASRV perfected a SI in the vehicle. KE’s SA said that KE would not transfer any interest in the vehicle. KE transferred the vehicle to SRV without paying off his $17,000 to ASRV. SRV did not use AC’s money to pay off KE’s loan.a. AC wants to remove ASRV’s lien from the title. Can she?

Under § 9-315(a)(1), a SI continues in collateral notwithstanding sale unless the secured party authorized the disposition free of the SI. SRV did not acquire the vehicle free of ASRV’s SI because ASRV did not authorize KE to dispose of the vehicle free of the SI. Under § 9-320(a), a BIOCOB takes free of a SI created by the buyer’s seller, even if the

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SI is perfected and the buyer knows of its existence. A BIOCOB buys goods in good faith without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person in the business of selling goods of that kind. SRV did not acquire the vehicle free of ASRV’s SI because KE in not in the business of selling vehicles. Under § 9-320(b), a buyer of goods from a person who used or bought goods for use primarily for personal, family or household purposes takes free of a SI, even if perfected, if they buyer buys (1) without knowledge of the SI; (2) for value; (3) primarily for the buyer’s personal, family, or household purposes; and (4) before the filing of a F/S covering the goods. ASRV still has a perfected SI because SRV bought the vehicle to use as inventory.

Under § 9-315(a)(1), a SI continues in collateral notwithstanding sale unless the secured party authorized the disposition free of the SI. AC did not acquire the vehicle free of ASRV’s SI because ASRV did not authorize SRV to dispose of the vehicle free of the SI. Under § 9-320(a), a BIOCOB takes free of a SI created by the buyer’s seller, even if the SI is perfected and the buyer knows of its existence. A BIOCOB buys goods in good faith without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person in the business of selling goods of that kind. AC is a BIOCOB because AC bought the vehicle without knowledge that the sale violates the rights of ASRV in the vehicle, and in the ordinary course from SRV, which is in the business of selling vehicles. ASRV’s SI was created by KE. KE is not AC’s seller. AC does not acquire the vehicle free of ASRV’s SI because KE is not AC’s seller. Under § 9-320(b), a buyer of goods from a person who used or bought goods for use primarily for personal, family or household purposes takes free of a SI, even if perfected, if they buyer buys (1) without knowledge of the SI; (2) for value; (3) primarily for the buyer’s personal, family, or household purposes; and (4) before the filing of a F/S covering the goods. ASRV still has a perfected SI because AC bought the vehicle from SRV used the vehicle as inventory.

b. If AC had seen the certificate of title before paying, what would she have learned?If AC had seen the certificate of title, she would have seen ASRV’s lien on the title.

36.4 AC is buying a used piano from APC.a. Should AC be afraid of anything?

Under § 9-320(a), a BIOCOB takes free of a SI created by the buyer’s seller, even if the SI is perfected and the buyer knows of its existence. A BIOCOB buys goods in good faith without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person in the business of selling goods of that kind. APC is in the business of selling pianos. AC will qualify as a BIOCOB and take the piano free of any SI created by APC. However, if the piano has an SI not created by APC, then AC will acquire the piano subject to the SI.

b. Can the problem be dealt with by a thorough search of the public records?

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No. Under § 9-507(a), a filed F/S remains effective with respect to collateral that is sold or otherwise disposed of and in which a SI continues, even if the secured party of or consents to the disposition. A search under APC will not uncover the SI.

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