Introduction

Importance of Secured Transactions

Our financial system involves creditors and debtors (typically are also obligors). The creditor will often loan money to the debtor. The debtor will then put up collateral as an obligation to support the loan. In other words, this is a secured transaction. The creditor has secured the loan will be repaid by ensuring that the debtor ties collateral (of some sort).

Article 9 of the UCC governs many transactions. A secured transaction is also known as a consensual lien. The purpose is to ensure that these transactions are enforceable and to provide protection to all the parties involved (creditors, debtors, and secondary creditors). Essentially, if a transaction occurs outside of Article 9 governance, the creditor is unsecured and may lose the money they are owed if the debtor defaults.

Once a debt is created, there are two ways to collect that debt: non-judicially or judicially. Non-judicially options include 1) asking for what is owed, 2) setoff, and 3) debt collection agencies. Judicially, the secured party most establish a judicial lien on the collateral. Usually recovery follows the following procedure:

  1. Obligor defaults.
  2. Lawsuit is filed.
  3. Judgment is entered.
  4. Writ of Execution is issued which gives the Sheriff the authority to collect the assets.
  5. The Sheriff levies the writ (seizes). This is the point where the secured creditor have a lien (in rem rights) to the personal property.
  6. Collateral is auctioned.
  7. Finally, the profits are distributed to the judgment creditor.

There are also statutory liens, where a creditor automatically has an interest in the collateral without consent from the debtor or a court order. Classic examples are mechanic liens, where a mechanic can hold a vehicle as collateral until they are paid for the repairs.

Overview

Secured transactions are primarily consensual. That means that the parties often contractually agree to establish a security in the collateral. This is a three step process. First, the security agreement must attach to the collateral. Second, the secured party must “save their place in line” by perfecting the security interest. Third, attachment and perfection help establish priority between creditors if the debtor defaults. Finally, if a debtor does default, we need to address the process for enforcing the secured interest.

Key Individuals

The difference between a debtor and obligor (a debtor can be both): A debtor has interest in the property and an obligor is obligated to repay the debt.

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;

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.

Attachment

Attachment occurs between the secured party and the debtor.

Article 9 § 9-203(a) and (b) explains the procedure for attachment and enforceability of that attachment. 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).
  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.

Attachment can occur for the following 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

Perfection

Whether a secured party is perfected informs other potential creditors who already has an interest in the collateral protected.

Perfection has two steps to be effective: 1) attachment must have occurred and 2) the parties need to have engaged in a perfection step. See 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 (primary method).
  2. Taking possession of the collateral
  3. Taking control of the collateral (the only way to perfect deposit accounts).
  4. Following other perfection laws
  5. Sometimes attachment is enough to perfect (automatic).

Priority

Priority determines who has first dibs (between creditors) on collateral the has been recovered if the debtor defaults.

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

There are several nuanced rules depending on the collateral or secured parties involved, that we will cover later in the outline.

Enforcement

If the debtor defaults, then the creditor is entitled to remove the collateral, sell it, and use the funds to cover the debt. There are two main types of enforcement: judicial and non-judicial. If possible, creditors will often choose non-judicial because it is cheaper and faster. This is permitted if the secured party recovers without “breaching the peace.”

Attachment

Creditor and Debtor Relationship

Essential Sections

  • 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

The Attachment Requirements

Requirements

9-203(a) and (b) – requirements

1-204 – value definition

A security interest arises when the creditor has attached rights in the collateral. There are three elements to attach:

  1. Value must be given (consideration). The most common method of providing value is the loan (obligation).
  2. The debtor must have rights in the collateral. A debtor cannot give away something that they do not have.
  3. One of the following must be satisfied:
    1. The debtor must have provided an authenticated agreement (signed). The typical method.
    2. Possession
    3. Delivery of the collateral
    4. Control of intangible collateral

Future Advancements

9-204(c) and Comment 5

A future advance is when the lender provides an additional loan to the borrower, without the need to draft a new security agreement for each additional loan. Future advances do not need to be connected to the original loan to be enforceable under the original security agreement.

Automatic Attachment

9-203(f), (g), (h), (i)

Certain types of collateral can automatically attach.

  • Certain investment property, specifically securities or commodities accounts.
  • A line of credit (e.g., mortgage (not covered by Article 9) has a promissory note. The promissory note is then used to secure a loan. The creditor accepting the promissory note as interest now automatically has those same rights to the mortgage).
  • A guarantee on an account.

Types of Collateral

Understanding the different types of collateral is important because each has a different definition and will attach and perfect in different ways. Below is a list of the collateral, where they are defined in Article 9, and how they can attach.

Additionally, the collateral must be properly described in order for the security agreement to be effective. See 9-108.

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, mere 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.

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

Types of collateral that can be possessed or controlled

Possessed:

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

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.

Attaching Collateral Acquired Later

After-Acquired Property

9-204

Article 9 authorizes the use of after-acquired property clauses. 9-204(a). The key to a successful clause is language. A party should state clearly state that they are securing future property as collateral. For instance, the description of “all of Party A’s current and after-acquired equipment” would satisfy the description.

There are some items that the clause will not cover. Specifically, consumer goods and household items, and after-acquired commercial tort claims are not covered except in special circumstances. 9-204(b).

Sometimes, there is a presumption that the collateral includes after-acquired property (especially if the collateral is in inventory or accounts).

Proceeds

9-102(a)(64) – definition of proceeds

9-315 – secured party rights

The idea with proceeds is that a creditor still has an interest when the original collateral is no longer available. In other words, if the collateral is sold or traded, the creditor still has an interest in the the value of the new collateral (either case, accounts, equipment, etc.).

proceeds from the collateral are always automatically assumed to be included as secured.

Tracing
  1. If the proceeds move outside of the scope of Article 9 (e.g., personal transferring to real property), proceeds may not trace.
  2. Can’t trace unidentifiable proceeds. See 9-315(b). Commingled goods are identifiable if they are goods as defined in 9-336. If they are not goods, then the items must be traded.

When attempting to trace proceeds creditors like the use of the lowest intermediate balance rule. The rule says that the identifiable proceeds is the lessor of either 1) the amount of deposited proceeds or 2) lowest account balance since the proceeds were demosited.

Commingled Goods and Accessions

9-102(a)(1) – accession definition

9-335 – accessions

9-336 – commingled goods

Commingled goods are goods that are combined and then are unidentifiable as some product or mass. (e.g. flour is no longer identifiable as flour once used to bake a cake; adding corn to more corn). There can be no security interest in the original goods after commingling. However, a security interest arises in the resulting product or mass.

Accession are goods fixed to another good where they are still identifiable. (e.g. an engine in a car is attached to the car but still identifiable as an engine). No automatic attachment here.

Attachment of Non-Traditional Secured Transactions (The Irrelevance of Form)

Article 9 will govern any kind of document that establishes a security interest. This is true regardless of the name the form applies to itself (e.g., “this document is a lease”). There are several types of documents that may establish a security interest, despite the name, these include: 1) retention of title, 2) some leases, 3) consignments, and 4) options.

See 1-201(b)(35)

Retention of Title

A retention of title is also known as a conditional sale. For instance, Party A transfers goods to Party B but Party A retains title of the goods until Party B has fully paid for those goods. In this instance, Party B owns the goods and Party A retains a security interest in those goods. So, a Party A needs to perfect the security interest to protect those goods against other creditors.

Some Leases

1-203

The challenge is to determine what is a true lease and what is not (i.e., a sale posing as a lease, such as a rent-to-buy agreement). To determine this, a simple test is to consider whether the seller/lessor retains possessory rights at the expiration of the lease. If the lessor gets the goods back at expiration, then the agreement was a true lease. If the lessor does not get the goods back at expiration (lessee performed), then this was a false lease (rent to buy), because the lessee was in reality a buyer. The legal test is outlined in § 1-203.

Consignments

To understand consignments, we also need to understand the terms “bailment” and “entrustment.” A bailment is where anyone agrees to hold goods for another person for any reason (e.g., pet sitting). An entrustment is a subcategory of a bailment where a merchant agrees to hold goods in their particular field for the entrustee (e.g., taking a ring to a jeweler for resizing). A consignment is still another subcategory of an entrustment. This is where an individual takes an item to a merchant, and the merchant is free to sell that item to another. At that point, the merchant would give the proceeds to the consignor and retain a commission from the sale.

Because consignments can be difficult to distinguish from a security interest, Article 9 establishes rules to determine whether a consignment falls under its scope. False consignments fall under the scope of Article 9 by § 9-109(a)(1). True consignments as defined by 9-102(a)(20) are governed by 9-109(a)(4) while true consignments that fall outside of the 9-102(a)(20) definition are outside the scope of Article 9.

In other words, there are three main types of consignments:

  1. False consignments (a security interest that looks like a consignment, governed by Article 9)
  2. True consignments governed by Article 9
  3. True consignments not governed by Article 9 (does not meet the definition outlined in 9-102(20). Essentially, low value products or consumer goods are consignments not governed by Article 9).

Options

If Party A sells an item to Party B and Party A is obligated to buy back the item at some future time, a security interest arises in that item. This is because if Party A fails to buy back the item, then Party B will keep the desk as a security interest

Scope of Article 9

True Sales that Establish a Security Interest

Sometimes sales (not just loans) establish a security interest. These can arise when the sale is in:

  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).

Other Types of Transactions

See 9-109 – scope of article 9 – covers:

  1. Retention of title
  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) excludes certain types of transactions

Analysis
  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)?”

Bankruptcy Effects on Types of Security Interests

  • After-Acquired Property Clauses become ineffective for property acquired after the bankruptcy petition is filed. Everything that has previously attached still retains a security interest.
  • No effect on proceeds.
  • Future Advances. Not automatically secured after bankruptcy proceedings. To be secured, there must be court approval.
  • 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.
  • The secured party has a secured claim on the collateral (not the obligation).
  • 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.

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.

  • The value of the collateral is usually evaluated in three ways:
    • Going concern value (the value of the asset to the ongoing efforts of the business)
    • Liquidation value (how much money can be obtained from a sale)
    • Replacement value (cost of replacing the asset)

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

Perfection

Creditor to Creditor Relationships

Perfection is the process a secured party protects their priority in some collateral against others who may want to have a claim on that same collateral. In other words, it is a way of letting others know, “hey, I already have some ownership rights in this property, if you also attach, I’m the first in line.”

Perfection occurs in one of five ways:

  1. Filing a financing statement (9-310, 9-500s) (Primary method)
  2. Taking possession of the collateral (9-313)
  3. Ensuring control of the collateral (9-314)
  4. Sometimes attachment is enough (9-309)
  5. Other laws may apply that determine perfection rules (9-311).

Essential Content of the Financing Statement

The essential elements of the financing statement are:

  1. The name of the debtor
  2. The name of the secured party
  3. An indication (not description) of the collateral.

See 9-502(a)

The whole point is to put the debtor on notice

Debtor Name

The name of the debtor is the most important part because the financing statements are indexed by the name of the debtor. So, when searching for potential security interests, potential creditors will search the name of the debtor. Therefore, it is essential that the debtor’s name is correct, and there may be disastrous effects for the original creditor if it is incorrect.

9-503(a) outlines the rules of the debtor’s name and 9-506 discusses what happens if errors occur.

9-503 – Rules for the debtor’s name

There are three different types of debtors and the best way to describe them:

  1. Registered Organizational Debtors (9-503(a)(1)) – registered with the state. Must be spelled as registered.
  2. Organizational Debtors (9-503(a)(6)) – Organizations not filed with the state. Go by the name of the owner.
  3. Individuals – There are two alternates: States can choose which alternatives to use. Most states use the first alternative.
    1. By the drivers license (if filing is made in the state of issuance) 9-504(a)(4)
      • If there is no drivers license, the filer needs to use the “individual name of the debtor” or “surname and first personal name.” 9-503(a)(5)
    2. By the safe harbor rule, the filer can use either 9-503(a)(4)
      • The individual name
      • Driver’s license
      • Surname and first personal name
Seriously Misleading

If the name is incorrect, it is misleading. However, if the searcher searches for the incorrect name and the search produces the correct filing, the mistake is not seriously misleading. The result of a seriously misleading financing statement is that the financing statement is ineffective and it is as if the creditor has never perfected.

So:

  1. Go to 9-503 to define a name
  2. If the name is an error, go to 9-506(a-c) to see if it is a “seriously misleading” mistake and whether the incorrect name would appear while searching the correct name.

Secured Party Name

Not too relevant, but can be helpful for knowing who a potential creditor may need to contract for details about their security interest.

Collateral Description

The description of the collateral can be much more broad than the security agreement. For instance, a financing statement describing the collateral as “all assets” is sufficient (the purpose is to put potential creditors on inquiry notice of what collateral might be covered by the security agreement).

Nonessential Content of the Financing Statement

The Role of the Filing Office

9-516 – 9-520.

Once a financing statement is sent to the filing office and the fee is paid, it is the responsibility of the filing office to index the statement. They have several responsibilities, including:

  1. Filing a received statement within two days.
  2. Responding to search requests within two days.
  3. Rejecting filing statements based on incomplete fields (not based on the quality or correctness of the statement). The incomplete fields include:
    1. Address of the secured party
    2. Address of the debtor
    3. Whether the debtor is an individual or an entity
  4. Assign each statement a number so any amendments can find the original statement easily

If the filing office makes an error in any of these responsibilities, the error does not affect the effectiveness of the financing statement (but some errors regarding rejections may effect priority).

How to File a Financing Statement

Authority to File

9-509

The filing of the original financing statement by secured parties must be authorized by the debtor. A security agreement counts (called ipso facto authorization). Any amendments will need to be authorized by the secured party.

Where to File

9-501

Most filings occur with the Secretary of State office (centralized office). The filing needs to occur where the debtor is located.

Other Filings

9-512

Continuation statements

9-515

A financing statement is effective for 5 years and then will expire unless a continuation statement is filed. A continuation statement can be filed as early as 6-months before the original statement will expire, but must be filed before the original statement expires. A gap will result in a lack of perfection (even back to the original date). A continuation statement extends the expiration for another 5 years.

Other Amendments

Include:

  • Termination
  • Change of name or address forms
  • Adding or removing collateral
  • Assigning to a new secured party

Other Perfection Methods

Other Filing Systems

There are three times when Article 9 does not apply to perfection:

  1. When federal law preempts the filing system with an alternate system (aircraft; ships; railroad transportation methods; some IP, that is registered copyrights).
  2. When a certificate of title statute applies (automobiles except for dealerships with automobiles as inventory).
  3. If the state has an alternate system for specific types of collateral.

Possession

9-310(b)(6)

The only way to perfect collateral of money (cash) is by possession. See 9-312(b)(3). Perfection may also (in addition to filing a financing statement) be accomplished by perfection for the following collateral:

  • Goods
  • Instruments
  • Tangible chattel paper
  • Tangible negotiable documents of title

See 9-313(a) – Requires Delivery

Special rules apply for documents which can be found in 9-312(c) (negotiable documents) and 9-312(d) (non-negotiable documents).

Control

Perfection by control is the only method of perfecting deposit accounts (9-104) and letter-of-credit rights (9-107). Additionally, perfection by control may also occur for the following collateral:

  • Investment property (9-106; 8-106)
  • Electronic chattel paper (9-105)
  • Electronic documents of title (7-106).

See 9-310(b)(8); 9-314.

Automatic

The purpose of automatic perfection is to avoid the costs of providing notice when the notice would provide little benefit.

Purchase Money Security Interest (PMSI) in Consumer Goods

9-309

A transaction can automatically perfect if the attachment is a purchase-money security interest (PMSI) in a consumer good. This rule has two parts:

  1. The transaction must be a PMSI (9-103) and;
  2. The collateral must be a consumer good that is not subject to certificate of title laws.

A transaction satisfies the first element (must be a PMSI) if:

  1. Seller-financed
  2. Third-party-financed for a specific purchase, and the money was used to purchase that product.

Typically a PMSI occurs in larger retail purchases such as purchasing an appliance (e.g., refrigerator, sofa, etc.).

A PMSI not in consumer goods needs to be perfected by another means within 20 days.

Associated Collateral

See 9-308(d).

Sometimes when collateral is so closely related to the original perfected collateral, the new collateral automatically perfects. The reasoning is that the new collateral’s relationship with the original collateral is sufficient notice for potential creditors to be aware of.

For instance, accounts often have “supporting obligations.”

Other Automatic Types

See §§ 9-310(b)(2), 9-309(2)-(14), 9-312(e)-(g).

Maintaining Perfection

If there is a gap between perfection methods, then it’ll be as if the once perfected party was never perfected at all. In other words, to keep your place in line, you cannot step out of line.

Barnes v. Turner

It is very easy to be liable for malpractice if you fail to either 1) issue a continuation statement, or 2) disclose that a continuation statement is necessary. This is because it is super easy to make this filing.

Below are some of the important changes that might affect the perfection status:

  1. Collateral or perfection method
  2. Loan
  3. Debtor
  4. Secured party – Hardly affects perfection status (because financing statement focuses on debtor’s information).

Changes to Collateral or Perfection Method

After-Acquired Collateral

Two questions. First, is the newly acquired collateral attached to the original financing agreement through a newly acquired collateral clause? Second, if so, is the financing statement sufficiently broad to perfect the newly-acquired collateral? If the answer to either of these questions is no, then the secured party will need to follow the steps of attachment and perfection for the new collateral.

Proceeds

As long as the original collateral was attached and perfected properly, proceeds will also automatically attach and perfect. However, perfection of proceeds lasts for only 21 days (9-315(c-d)) and any proceeds require additional perfection to avoid a lapse. There are three ways to extend this perfection:

  1. Same office rule. Three conditions are satisfied:
    • Financing statement covers the original collateral.
    • The proceeds could (hypothetically) be perfected by filing a financing statement within the same office as the original collateral.
    • The proceeds are not cash (and are not acquired with cash) proceeds. (9-315(d)(1)(A-C))
  2. If the proceeds are identifiable cash proceeds. (See 9-315(d)(2); 9-102(a)(9))
  3. The security interest is perfected by another perfection method within the first 20 days. So, having a financing statement that covers “all assets,” then all assets will already be perfected. (9315(d)(3))
Location or Classification

Depending on what caused the change will determine whether there is a need to perfect again.

  1. Does the financing statement still describes the collateral and there was no change in perfection method? Regardless of the change, there is no need to have a new filing.
  2. Does the financing statement no longer describes the collateral. A new filing is needed only if non-cash proceeds were obtained with cash proceeds.
  3. Was there was a change to the perfection method? If this is the case, immediate action is necessary if the cause was a change in location or use (characterization) of the collateral.

Changes to the Loan

Usually, changes to the loan amount does not change perfection status. But there may be potential changes depending on whether there is a future advances clause or if the transaction was a PMSI.

Changes to the Debtor

Name

After a name change, the original financing statement is effective for four months. During that period, a new financing statement needs to be filed to ensure that there is no lapse in perfection.

See 9-507(b), (c); 9-506

Location

9-316(a) and (b)

For instance, if the new address does not alter the governing law (see 9-502), then there is no need to refile. However, if the governing law changes, then the secured party has four months (unless the old financing statement will expire sooner than four months) to issue a new filing.

New Debtors

If a new debtor authorizes an amendment, a secured party may file an amendment to add or remove a debtor. A security interest in the new debtor’s collateral becomes perfected from the time of the amendment. See 9-512(d-e); 9-509(a-c).

Bankruptcy

Can’t acquire new collateral, but may maintain existing statements.

Choice of Law Issues

Every state has adopted Article 9’s choice of law statutes found in §§ 9-301 through 9-307.

9-301(1) that is, the location of the debtor governs the perfection step. 9-307 defines the location of the debtor: 1) individual is at their place of residence 2) a business is going to be the principal place of business, state of incorporation, or the headquarters. There are exceptions for these rules based on collateral. These exceptions are found in §§ 9-303 (certificate of title), 9-304 (deposit accounts), 9-305 (investment property), and 9-306 (letter-of-credit rights).

However, other exceptions may apply (focusing on the collateral location rather than the debtor’s location). This applies when the secured party takes possession of the collateral (9-301(2)), the collateral is a fixture (9-301(3)(A)), or when the collateral is timber (9-301(3)(B)).

Priority

First dibs between creditors

9-201(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 purchases of the collateral, and against creditors.

In other words, a security interest prevails over purchasers and creditors, unless there is an exception.

The analysis needs to be done for each item of collateral.

Lien Creditor

Secured Party v. Lien Creditor

9-317(a)(2)

A lien creditor can have priority over a secured party if the creditor interest arises before the secured party either 1) perfects or 2) authenticates a security agreement and files a sufficient financing statement.

PMSI v. Lien Creditor

9-317(e)

The exception to the exception of 9-317(a)(2).

a secured party will win (9-201(a)) unless they fail to perfect or file before a lien creditor takes interest (9-317(a)(2)), unless the security interest is a PMSI (notice that this is different than a PMSI in a consumer good that would automatically attach).

Future Advances

9-323(b)

Picture the following timeline:

  1. Initial loan is secured.
  2. Perfection occurs by filing
  3. A third-party obtains a levy on the collateral
  4. A future advance is issued by the initial loan provider.

Who wins? If the advance is made within 45 days after the levy, or if the advance was made later than 45 days if the secured party did not know about the levy, then the security interest will have priority.

Security Interest vs. Statutory/Possessory Creditor

A possessory lien over collateral will have priority over a security interest if 1) the lien holder has possession of the collateral and 2) the statute that created the lien does not have an exception.

See 9-333.

Secured Party v. Secured Party

Basic Rule

When there are multiple competing secured parties 9-322(a) outlines three basic rules:

  1. 9-322(a)(3) – If nobody is perfected, then the first to attach wins.
  2. 9-322(a)(2) – If one party is perfected and another is not, the perfected party wins.
  3. Finally, 9-322(a)(1) – “First to file or perfect” rule – If both parties are perfected, then the first party who filed an effective financing statement, or perfected, first, that party will win.

So, the analysis that we need to run is:

  1. Have the parties attached? When
  2. Have the parties perfected? When
  3. Is there a filing? If so, when?

Tacking

Secured parties can tack multiple perfection methods (filing a financing statement + possession) to ensure that there are no gaps in perfection. If there is a gap, then it would be as if they were never perfected.

Incorrect Non-Essential Information in the Filing

If a searcher relies on incorrect non-essential information in an effective filing statement (was approved, but shouldn’t have been), then the financing statement will be subordinate to the reliant searcher. Same thing with a certificate of file. 9-338(1) and (2).

Proceeds

Proceeds are separate from the original collateral and thus a fresh analysis must apply for proceeds. See 9-315(c-d).

Secured Party v. Buyer

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.

Exceptions

The exceptions include:

  1. The secured party’s interest is unperfected.
  2. Buyer makes the purchase in the ordinary course of business.
  3. Garage sale rule.
Unperfected Security Interest

According to 9-317(b), a buyer will have priority over a secured party if:

  1. The buyer gives value and takes delivery of the collateral (must be tangible).
  2. The buyer does not know about the security interest.
  3. Finally, the security interest was not perfected by the secured party.
Ordinary Course of Business

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.

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:

  1. First, the buyer doesn’t know about the security interest.
  2. Second, the buyer buys for value.
  3. Third, the secured party did not file a financing statement before the purchase was made.

The rule is described fully in 9-320(b).

Purchase Money Security Interests

According to 9-324(a), a PMSI will have priority over any other security interest (unless there is another conflicting PMSI). This is often referred to as a super priority. But there are rules depending on when that super priority arises or the type of the collateral.

Goods other than inventory or livestock

9-234(a)

If SP1 has a perfected security interest in equipment and SP2 has a PMSI in the same equipment, then the PMSI will win as long as it is perfected within 20 days after delivery.

Inventory

9-234(b)

The PMSI party needs to have 1) perfection by the time delivery occurs, 2) provided notice to any other secured parties that there is a PMSI on the inventory, 3) that notice is received within five years before the debtor receives possession of the inventory, and 4) the notice needs to say that there is a PMSI and that the PMSI is about the inventory.

Proceeds

These rules also apply to the proceeds of goods. To determine whether the proceeds attach and are perfected we need to follow the standard process.

  1. First, determine the priority of the original collateral.
  2. Second, determine whether the proceeds attach and are perfected. See 9-315(a), (c) and (d).
    1. This process needs to be done for each type of collateral.
  3. Figure out the priorities of the proceeds. See 9-322(a).

When it comes to goods as covered by 9-324(a), then super priority rules do not change for proceeds. However, for inventory, a PMSI would only maintain a super priority for cash proceeds and the remaining proceeds would follow the analysis of the general rule of 9-322(a).

The Double Debtor Problem

9-325 protects creditors who may make a purchase and not have notice of other debtors.

Deposit Accounts

Deposit accounts can only be perfected by control. However, there are several ways to control a deposit account and each different method shapes what kind of priority the secured party may have. For instance, a control agreement will beat no control, control by a depositary bank will beat a control agreement, and control by becoming the depositary bank’s customer will beat control by a depositary bank.

Enforcement

The whole purpose of taking a security interest is to receive payment in case of a default. As such, the entire purpose of enforcement is designed to, well, enforce the security interest. Enforcement often comes as a result of a default.

Default

Default Clauses

The definition for default is often included in default clauses, not by the law (although the clause may be subject to contractual defenses). Default clauses outline what types of activities will constitute a default. Usually, a default can consist of more than a missed payment. Instead, the creditor can define default to include events where the debtor increases the risk of making payments on time, or the collateral value depreciates significantly in a short period of time. Additionally, the creditor can say that a default occurs if it “deems itself insecure.” However, enforcement of a claim of default based on insecurity must be made in good faith.

Acceleration

An acceleration clause simply states that once the debtor is in default, the entire debt is due. Generally, if a debtor goes into default and the loan accelerates, there is no way to “de-accelerate” the debt. However, with the permission of the creditor, the missed payment may be made up. Without this permission however, the only way to cure the debt is to pay the debt in full.

Rights of the Parties

  • Secured Party
    • First and foremost, the ability to recover the collateral.
    • 9-601(a) says that the secured party has the right to a judicial lien, foreclose, etc.
  • Debtor
    • First and foremost, Article 9-623 does allow the debtor to redeem the collateral (by paying in full) after default.
    • 9-601(d) – Any agreement by the parties.

Enforcement Against Tangible Collateral

Recovery

Recovery can occur through the judicial or non-judicial process.

Non-judicially, a secured party has the right to go and repossess without a court process as long as 1) there is no trespass violation and 2) the repossession proceeds without “breach of the peace.”

Two rules to determine whether there is a breach of the peace:

Rule 1

“If a Creditor repossesses in disregard of the debtor’s unequivocal oral protest, the creditor commits a breach of the peace.”

– Russell v. Santander Consumer USA, Inc., 2020 WL 3077944 (E.D. Wis. 2020).

Rule 2

  1. Was there violence
  2. Where did the repossession take place
  3. Did the debtor provide express or constructive consent
  4. What was the reaction of third parties
  5. What was the type of the premises entered
  6. Did the creditor use deception

Noise and commotion are insufficient to determine a breach of the peace.

– Giles v. First Virginia Credit Services, Inc., 560 S.E.2d 557 (N.C. Ct. App. 2002).

Disposition

Disposition refers to when the secured party either sells, leases, or licenses the recovered collateral (typically disposition occurs by public or private sale).

Notice

§§ 9-611 through 9-614. The purpose of which is to provide the debtor with enough information to exercise their rights in an attempt to recover the collateral (redeem, bid, etc.).

Proper notice requires several elements to be satisfied. The letter must:

  1. Determine who needs to be contacted (several parties may be required).
  2. State the the debtor is free to redeem by paying the balance of the debt.
  3. Indicate the anticipated date and method of the disposition.
Commercial Reasonableness

Disposition must be commercially reasonable to be considered effective. Depending on the action taken, several factors may be relevant. For example, courts will need to consider the time and location of the sale or auction; whether the sale should have been public or private; how the sale or auction was advertised; the price of the collateral; etc. See 9-610(b); 9-610 comments 3 and 4; and 9-627(b).

A low price may indicate unreasonableness but is not final. However, when the courts see a low price, the other factors are considered much more carefully.

Managing Proceeds

9-615 outlines the rules for how cash proceeds are to be distributed. Below is the order of operations (as to who gets paid first). After disposition is made and cash proceeds are received, :

  1. Expenses of repossessing and disposition.
  2. Foreclosing secured party gets paid.
  3. Junior security interests gets paid.
  4. Remainder goes to the debtor (not usually anything left over).

Sometimes purchases are made on credit rather than in cash. In this situation, the secured party may either turn the collateral into a new security interest for the new debtor, or wait until they are paid in cash once the obligation is satisfied.

The result of a sale of collateral is that the buyer takes the item free and clear of any security interest the foreclosing party and any junior party (junior creditors must demand to be paid or else they do not get paid). Note that the foreclosing party may not necessarily be the most senior secured party. In that situation, the purchaser takes the collateral subject to a security interest of any secured party who was senior to the foreclosing party.

Full and Partial Acceptance of Collateral

See 9-620 through 9-622.

Sometimes a creditor may want to retain the collateral instead of selling it and extracting the value to satisfy the debt.

Acceptance in Full

f a creditor wishes to accept collateral to satisfy debt, they must obtain the consent of the debtor. As such, the creditor is required to send the debtor a proposal which will outline that the creditor wishes to accept the collateral to satisfy the entirety of the debt.

In this situation, the debtor does not need to send an authenticated consent form for the proposal to take effect. If the debtor fails to make a timely objection, the proposal can be seen as accepted. As such, creditors often include a date by which the proposal will become effective and failure to object before that date will result in an effective agreement.

In the proposal, creditors will also say that the proceeds are to be included as acceptance. That way, the debtor is unable to extract the value before the proposal goes into effect and leave the creditor with valueless collateral.

Partial Acceptance

The main difference between acceptance to fully satisfy the debt and partially satisfy the debt is the manner of consent. Acceptance to partially satisfy a debt requires an authenticated consent of the proposal by the debtor.

Failure to obtain consent will require the creditor to follow the regular foreclosure procedures.

Other Notes

  1. A creditor can hold onto the collateral for a long time and it will not be considered as accepted until a proposal is sent out.
  2. Acceptance of the collateral by a junior secured party does not diminish the rights of a senior secured party. That is, the collateral is still utilized to secure the senior party’s interest.
  3. No notice is required to be provided to secondary obligors.

Enforcing Against Obligations Owed to the Debtor

Certain types of collateral is actually debt that is owed to the debtor. For instance, say Secured Party 1 has a security interest in the debtor’s accounts. In that situation, the debtor may have sold an item in exchange for payment in 30 days from the sale. This is an example of an account as collateral, but also an account is debt that is owed to the debtor. There is no value in the collateral until the debt to the debtor has been satisfied. So, how does Secured Party 1 enforce against that obligation? By notifying the “account debtor.”

The types of collateral that fall into this situation are:

  1. Accounts
  2. Chattel paper
  3. Instruments
  4. Payment intangibles

Notifying the “Account Debtor”

9-404(a) – Affects payment amount

9-406(a); 9-607(a) – Affects who payments need to be made to.

  1. The secured party must notify the account debtor that the payment is now due to the secured party, rather than the debtor.
    1. The only way the account debtor can resolve the obligation to the debtor is by paying the secured party (so account debtor’s should do a little research to avoid paying twice).
  2. Secured party can distribute some of the collections to the debtor, if agreed upon in the security agreement.

A debtor may likely agree to this arrangement because the secured party has more experience collecting or can collect for loss costs. Additionally, if the debtor defaults, then having this arrangement at the beginning will help maintain the relationships the debtor may have with customers.

END OF SECURED TRANSACTIONS

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.

Categories: 2L Fall, 2L Fall Outlines, Secured Transactions

Will Laursen

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