True Sales that Establish a Security Interest

In addition to some consignments, fake leases, and some options, the scope of Article 9 can extend to true sales (rather than just a loan. This occurs in the following ways:

  1. Sales of accounts
  2. Chattel Paper
  3. Promissory Notes
  4. Payment Intangibles

The reason for including a security interest with these sales is because the sale can look quite similar to a security interest. Thus, it makes sense to just let Article 9 cover it (better safe than sorry).

Consider the following example: Party A purchases furniture from Party B on credit paying monthly installments. Party B then seeks a loan, or immediate cash, from Party C by either treating that account as a sale or as collateral.

However, these sales do not fall under the scope of Article 9 if they were made in the process of selling a business. See 9-109(d)(4).

Other Interests

Sometimes, there are transactions that are governed by Articles other than Article 9. However, by 9-109 brings certain transactions under the scope of Article 9. These include:

  1. Retention of title (Party A sells to Party B but retains title until Party B pays in full. Although Party A is “retaining title,” the title shifts to Party B upon delivery. Thus, Party A has a secured interest in the goods and should follow the procedure for perfection)
  2. Shipment under reservation (Party C delivers goods to Carrier D to deliver to Party D. Party C tells the carrier not to deliver the goods until Party D has paid in full. In this situation, Party C retains a security interest in the goods carried by Carrier D)
  3. Pre-paid prices and damages upon rightful revocation of acceptance (Party F received defective goods from Party G. Party F revokes acceptance of the goods and demands compensation for those defects. Party F then has a secured interest in the defective goods until Party G makes the reimbursement)
  4. Agricultural and other statutory liens (defined in 9-102(a)(5) where a statute puts a lien on property for agricultural use. Similar statutory liens would include mechanic liens)

9-109(d) outlines 13 ways a transaction is excluded from the scope of Article 9.

Procedure for determining if a security interest is governed by Article 9:

  1. Determine what the parties are attempting to establish a security interest in.
  2. Ask, “Is this item naturally covered by 9-109(a)”?
  3. If so, ask, “Is this item excluded by any provisions under 9-109(d)?”

Effect of Bankruptcy

After-Acquired Property Clauses

After-acquired clauses become ineffective for property acquired after the bankruptcy petition is filed. Everything that has previously attached still retains a security interest.

Proceeds

Bankruptcy has no effect on proceeds (they still automatically attach). The challenge becomes tracing those proceeds.

Future Advances

Not automatically secured after bankruptcy proceedings. To be secured, there must be court approval.

The Estate

All secured interests within the estate are stayed and the secured party is not able to recover. Thus, the secured party must move to lift the stay if they wish to recover these items.

Secured Claims

The secured party has a secured claim on the collateral. Note that this is on the collateral, not the debt money due. For instance, if the bankrupt party owed 5,000 to the bank which was secured with a 1,000 TV, the bank has a secured claim for 1,000 (the value of the TV). The remaining balance is still a claim, it is just not secured and thus the benefit of priority is removed.

Post-Petition Interest

Over-secured creditors (those where their security interest is fully satisfied by the value of the collateral) are entitled to receive interest value for the time the bankruptcy proceedings take.

Adequate Protection

If the value of the collateral continues to depreciate (or can be spent by the debtor), then the secured party may receive adequate protection. Often times, this protection comes in the form of replacement collateral. If the collateral depreciates and there are no other assets to attach, the secured party may receive priority over any unsecured party. However, if there are several secured parties with the same issue, many of these parties will be out of luck.

The value of the collateral is usually evaluated in three ways:

  1. Going concern value (the value of the asset to the ongoing efforts of the business)
  2. Liquidation value (how much money can be obtained from a sale)
  3. Replacement value (cost of replacing the asset)

Debtor Use of Collateral

Without Court Approval

Debtors can use collateral without court approval if the use is consistent with the ordinary course of business.

With Court Approval

If the collateral is “cash” or is utilized out of the ordinary course of business, court approval is required (usually allowed to pay the bills).

Essential Sections for Attachment

  • 9-203(a); (b)(1-3) Focusing primarily on 9-203(b)(3)(A) – Requirements for attachment
  • 9-102 – Definitions; especially focusing on the definitions of the different categories, proceeds
  • 9-109 – Scope of Article 9, what is covered and what is not

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.

Will Laursen

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