Attachment, Perfection, and Priority

A secured transaction is a transaction that creates a security interest. “A “security interest” means an interest in personal property or fixtures which secures payment or performance of an obligation.” Article 9 § 1-201(b)(35). These interests are created by contract. See Article 9-109(a)(1). That is, secured transactions are consensual liens.

One of the largest benefits of being a secured creditor is that there is a lot of protection in the form of priority if the debtor defaults. Essentially, a secured creditor arises during a consensual lien. The simplest way of thinking about a secured creditor is the use of the word collateral. The creditor loans the money and the debtor promises something as collateral if he or she fails to repay the debt. This collateral is the creditor’s security.

However, there arises several problems if more than one individual has been promised the same security by the debtor. If the debtor defaults, who gets the collateral? This is why it is important to be a secured creditor, because you have first priority in recovering the collateral.

Essentially, this process is called attachment, perfection, and priority. In simple terms, attachment is the promise of the collateral. Perfection is where the creditor provides notice to the public of that promise. Priority is the order who who gets the collateral first, if it was promised to multiple people.

So far, this process sounds very similar to the recording acts involved in real estate property. However, secured transactions applies only to personal property, which is much more liquid than real property. Thus, the rules for attachment, perfection, and priority can become and require a more complex structure.

Attachment

So, how does one attach a security interest? Article 9 § 9-203(a) and (b) explains the procedure for attachment and enforceability of that attachment. According to (a), attachment occurs when a security interest becomes enforceable against a debtor in respect to the collateral. According to (b), this attachment can only be enforced if three elements are satisfied.

1. The security agreement meets special requirements. For our purposes, the special requirement is that “the debtor has authenticated a security agreement that provides a description of the collateral.” 9-203(b)(3)(A). Another method of attaching is through a “pledge” this is where there is an exchange, or a “pawn” (the creditor holds onto the collateral until the debt is repaid). The largest problem with pawning is that these assets are always physical (which is not often the case). And there are times where we have productive assets (e.g. equipment) that one would not want to exchange.
2. There is a value that is given (often seen as contractual consideration but is not necessarily required).
3. The debtor had rights in the collateral and the power to transfer those rights to a secured party.

There are several different types of collateral:

• Goods
  • Consumer Goods
  • Equipment
  • Farm Products
  • Inventory
• Intangibles
  • Accounts
  • Deposit Accounts
  • General Intangibles
  • Some investment property
  • Commercial tort claims
• Quasi-Intangibles
  • Chattel paper instruments
  • Documents of Title
  • Some investment property

These types are so important because it affects the collateral description, method of perfection, law governing perfection, etc.

Perfection

Although attachment focuses on the relationship between the creditor and the debtor, the focus of perfection shifts to the relationship between creditor and creditor.

Perfection is the process utilized by the secured party to protect their collateral against others who may wish to claim it. Essentially, perfection provides the rest of the commercial world notice of the secured interest in the collateral. There are two requirements to establish perfection, found in Article 9 § 9-308(a) and (b). There are five methods one may follow to establish perfection (depending on the type of collateral):

1. Filing a financing statement with the government.
2. Taking possession of the collateral
3. Taking control of the collateral
4. Following other perfection laws
5. Sometimes attachment is enough to perfect.

The most common method is perfection by filing. After collateral is attached (a prerequisite for perfection), filing is required unless there is an exception (see 2-5 above for those exceptions). So, there are a lot of questions that need to be asked by both the filer and the searcher. As a quick example, a filer needs to know where to file, a searcher needs to know where to look.

The filing is often completed by filling out a financing statement, which outlines the debtors, creditors, and a description of the collateral.

Priority

Priority has dozens of rules within Article 9. The two most important considerations to establish priority is whether the debtor had the rights to give the collateral and which creditor was first. If there was a secured creditor (attached), the next consideration is which creditor perfected the transaction first. Other considerations include:

• What the collateral type is.
• Whether the security interest is a purchase money security interest.
• What other creditors exists such as buyers, judgement liens, another security interest, or statutory lien.

In addition, there are a few important notes:

1. Creditors are asset-specific, not debtor specific. That means that priority is based on one specific collateral, not all of the debtors assets.
2. How much parties rely is important. A purchaser is always reliant on receiving the collateral. Next in the list of reliance are secured creditors. Finally,

If there is a dispute between two secured parties, there are several potential outcomes:

• When both parties are unperfected – First to attach wins
• If only one party is perfected – perfected wins
• However, if both parties are perfected – first to file or perfect wins

Analytical Method

When determining who gets the collateral, we need to follow the process:

1. Attachment
   • Classification of collateral
   • Scope
   • Requirements
   • Description
   • Special Rules
   • Proceeds
2. Perfection
   • Governmental laws
   • Method of perfection
   • Proper Filing
   • Proceeds
   • Changes
3. Priority
   • Is there a security interest attached
   • Is it perfected
   • Classification of claimants
   • Follow rules that govern priority
4. Repeat for every asset.

Disclaimer

The content contained in this article may contain inaccuracies and is not intended to reflect the opinions, views, beliefs, or practices of any academic professor or publication. Instead, this content is a reflection on the author’s understanding of the law and legal practices.