The General Rule
A secured party will have a security interest in the collateral even if that collateral is purchased by a third-party. This is true, unless 1) the secured party authorized the collateral to be sold “free and clear” of all other interests, or 2) an exception applies.
Unperfected Security Interest
According to 9-317(b), a buyer will have priority over a secured party if:
- The buyer gives value and takes delivery of the collateral (must be tangible).
- The buyer does not know about the security interest.
- Finally, the security interest was not perfected by the secured party.
So, if the secured party has perfected the security interest, then they will have priority over a buyer (unless another exception applies).
Ordinary Course of Business
So, if the secured party is perfected, a buyer can obtain certain collateral “free and clear of the security interest” if they are engaging in the ordinary course of business. For instance, going to the market and buying clothes.
This rule is outlined in 9-320(a): A buyer will take the collateral free and clear if they are acting in the ordinary course of business (even if they know about the security interest and the perfection status).
The ordinary course of business is defined in 1-201(b)(9) and outlines several requirements:
- Buys goods;
- In good faith;
- Without knowledge that the sale violates the rights of another person in the goods (i.e., without knowledge of violating the secured party rights);
- In the ordinary course;
- From a merchant selling goods of the kind;
- Properly takes possession (or have the right to take possession) according to Article 2.
Naturally, this applies only to inventory.
The main exception to rule 9-320(a) is 9-320(e) where if the secured party has perfected by possession, then the buyer does not take the collateral free and clear.
Garage Sale Rule
If consumer goods are in possession of a consumer and is then sold to another consumer as consumer goods (like at a garage sale), then the buyer would take the goods free and clear of any security interest. There are certain elements for this rule to apply:
- First, the buyer doesn’t know about the security interest.
- Second, the buyer buys for value.
- Third, the secured party did not file a financing statement before the purchase was made.
The rule is described fully in 9-320(b).
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.