Collateral

There are two requirements for a security agreements to be valid. First, the agreement must be authenticated. Second, there must be a sufficient description of the collateral.

Authentication

The authentication requirement is similar to the statute of frauds. The creditor and debtor needs to enter into a written agreement or that agreement must be submitted through some electronic record. See § 9-203(b)(A). Otherwise, the agreement is invalid. The exception to this rule is if the secured party takes possession of the collateral. In this instance, the level of control is sufficient to establish an authenticated transaction. See § 9-203(b)(B-D).

Key Sections

Debtor: § 9-102(a)(28). A debtor is:

1. A person having an interest, other than a security interest or other lien, in the collateral, whether or not the person is an obligor;
2. A seller of accounts, chattel paper, payment intangibles, or promissory notes; or
3. A consignee

In other words, to be a debtor, you need to have interest rights in the property

Obligor: (a)(59):

“Obligor” means a person that, with respect to an obligation secured by a security interest in an agricultural lien on the collateral, (i) owes payment… (iii) is otherwise accountable…

The obligor is person who is responsible to make the obligation.

Secondary Obligor: (a)(72)

… an obligor to the extent that

1. the obligor’s obligation is secondary
2. the obligor has a right of recourse with respect to an obligation secured by collateral against the debtor, another obligor, or property of either.

Collateral Description

There are two primary purposes for providing a description of the collateral:

1. Identify the property involved
2. Provide evidence for enforcement

Sometimes, this description does not need to be very specific, as long as it is clear what property the description is referring to. But essentially, there are different rules depending on the collateral types, so it becomes important to know what those different types are.

Key Sections

Sufficiency of Description § 9-108:

(a) A description is sufficient if it reasonably identifies what is described (does not need to be specific. (b) Outlines the exceptions of what is reasonably identified. This includes either a specific listing, category, type of collateral, quantity, etc.

The reasonable identification may change depending on the circumstances.

• A specific listing often refers to a serial number, model number, etc.
• A category refers to the product kind: for example a car or truck would fall into the category of automobile.
• The category kinds are described by the UCC. These really matter and will be discussed later.

(c) says that a super generic description is not a sufficient description. For instance, a party listing “all personal property” will find that the description is insufficient.

Different Types of Collateral

There are three main categories that describe the several main types of collateral.

• Tangibles
• Intangible personal property
• Quasi-intangible personal property.

Within each of these types there are other subcategories:

Goods

Tangibles (goods) ( § 9-102(a)(44) “…all things that are moveable when a security interest attaches”). Goods will always be one of the four following things.

• Consumer goods (23) – Used or bought primarily for personal, family or household purposes.
• Equipment (33) – Everything other than inventory, farm products or consumer goods.
• Farm products (34) – Debtor is engaged in “farming operations” (defined in 35) and include crops, livestock, supplies, or products of the same in their unmanufactured state (e.g. milk turned into cheese, the cheese is no longer a farm product).
• Inventory (48) – “Not farm products that are either leaded by a person as a lessor, are held by a person for sale or lease, furnished by a person under a contract, or consists of raw materials, work in process, or materials used [up] or consumed in a business.”

Intangible Personal Property

Intangible personal property (Not physical, more rights)

• Account (a)(2) – A right to payment of a monetary obligation, whether or not earned by performance… and does not include rights to payment by chattel paper or an instrument, commercial tort claim, loans. The classic example are accounts receivable (A business’ account receivable for goods sold on credit or for services provided on credit. Writing is not required in this situation.
• Deposit account (29)
• Commercial tort claim (13)
• Documents (30)
• Chattel paper (electronic) (11) – A record or records that shows both a monetary obligation and either a security interest in specific goods or a lease of specific goods.
• Letter of credit right
• General intangibles (42) – personal property that includes things in actions where the item does not fit into any of the other categories.
• Investment property – Certified and uncertified securities, securities accounts, commodity accounts (e.g. stocks).

Writing is required (except in rare cases of electronic chattel paper) for instruments, chattel paper, and documents.

Debtors have a right to be paid and they want to collateralize those rights. These categories include the accounts,

Quasi-intangible Personal Property

Quasi-intangible personal property (intangible that represents a tangible)

• Instrument (47) – “a negotiable instrument or any other writing that evidences a right to the payment of a monetary obligation, is not itself a security agreement or lease, and is of a type that in ordinary course of business is transferred by delivery with any necessary endorsement or assignment.” Ninety-Nine% of the time, these will be either promissory notes or checks.
• Chattel paper (tangible) – See the intangible definition above.
• Document of title (30) – Document of title or receipt as described in 7-201(b). This includes warehouse receipts, and records that show that someone has rights to something stored in a bailee’s possession.
• Certificated security
• Money

Knowing these classifications are very important for several reasons. First, regardless of how parties decide to categorize their assets, the assets will always fall into the definitions governed by the UCC. Second, parties do not necessarily need to provide their classifications, meaning that they could define the property however they wish. Finally, sometimes the description under the categories (specifically for commercial tort claims), classification is not enough. There needs to be some additional form of specificity.

Possession or Control of Collateral Pursuant to an Unauthenticated Security Agreement

If a party possesses or controls collateral, they have established a security interest in that collateral, even if there was no written agreement or the security agreement was unauthenticated. See 9-203(b)(3)(B).

Types of collateral that can be possessed:

• Goods
• Instruments
• Money
• Certificated securities
• Tangible chattel paper
• Tangible negotiable documents of title

Types of collateral that can be controlled:

• Deposit accounts
• Investment property
• Letter-of-credit rights
• Electronic chattel paper
• Electronic documents of title

The Composite Agreement Rule

In simple terms, the composite agreement rule states that if a single document does not satisfy the requirements to establish a security interest (authentication and collateral description), multiple documents can be combined to meet the standards.

In re Sabol

337 B.$. 195 (Bank. C.D. Ill. 2006).

Question

Can the composite agreement rule establish that there was a security interest for the bank?

Rule

The requirements to establish a security interest (words denoting the intent of the debtor to establish the interest), must be found within the several agreements of the transaction.

Holding

There was no intent to establish a security interest, the bank loses.

Facts

Sabol went to the bank for a SBA loan. The bank authorized the loan and the parties began filling out documents to close the deal. There are four documents at issue:

1. The loan application.
2. A promissory note provided by the debtor which generally listed “collateral.”
3. The letter from the debtor authorizing the bank to execute the necessary financing statements do whatever it needs to establish a security interest.
4. A financing statement that describes the collateral, but was only completed by the bank and was not ever signed by the debtor before filing.

The debtor defaulted and filed bankruptcy. The bank is trying to assert priority by saying they have a security interest in some of the assets. Here, the trustee is arguing that there was not a security agreement.

Analysis

The court first emphasizes that Article 9 of the UCC has made it extremely easy to create a security interest, simply by completing a security agreement. Although the court uses the composite agreement rule, there is no doubt that the court would rather avoid the problem entirely by following the guidance of the UCC.

The crux of the problem rests in the financing statement. There is no doubt that the filing was authenticated by the debtor in the first agreement. However, the financing statement is the only place where the collateral was properly described. This document was never provided to the debtor and never signed by him. As such, there is no way that the debtor ever intended to provide a security interest in the collateral that was described. The other references to collateral in the promissory note and loan agreement are inconsequential because the debtor was only signing because that’s the only way he would have received the loan.

As such, the composite agreement rule does not create a security interest in the collateral in this case

Additional Notes

Ultimately, there are two parts of this agreement. First, do we have all requirements present that are necessary to create a security interest. Second, was there an intent to establish that security interest?

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.