AND SECOND AND THIRD Contra Costa County Bar Association

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					                                                                 MCLE Spectacular 11/18/2011

               WHO’S ON FIRST (AND SECOND AND THIRD):
               FROLICS AND DETOURS IN LIEN PRIORITY

                                  David Katzen
                                 David Schuricht
                                Katzen & Schuricht


I. The Basic Rules
   A. The Most Fundamental Rule
   B. The “Generally Applicable” Rules
       1. Real Estate Lien Perfection and Priority
       2. Personal Property Lien Perfection and Priority
           a. Perfection
           b. Priority
II. Frolics and Detours
   A. Adventures in Financing Statements
       1. Naming Problems
       2. Name Changes, Mergers and Relocations
           a. Debtor’s Name Change
           b. Mergers, Acquisitions and Other Changes in Corporate Structure
           c. Relocation Issues
   B. The Perfection of Security Interests in Promissory Notes Secured by Deeds of
       Trust on Realty—a Cautionary Tale
   C. Special Seller Priority Rights
       1. Vendor’s Liens on Realty
       2.. Purchase Money Priority
           a. Real Property Purchase Money Liens
           b. Purchase Money Liens on Personal Property
   D. Special “Government” Priorities
       1. Tax Lien Priority
           a. Property Tax Liens vs. Other Tax Liens
           b. IRS Trumping Rights
       2. Federal Non-Bankruptcy Priority
   E. Mechanic’s Liens
   F. Attorney’s Liens
   G. Judicial Lien Issues
       1. Relation Back
       2. “Order of Examination” (ORAP) Liens
       3. Retroactive Promotion of Expanded Exemption
   H. Equitable Subrogation of Unperfected Trust Deeds/Mortgages




                                        1
                           WHO’S ON FIRST (AND SECOND AND THIRD):
                           FROLICS AND DETOURS IN LIEN PRIORITY1

                                                  David Schuricht2
                                                 Katzen & Schuricht

             I. The Basic Rules.

                 A. The Most Fundamental Rule: The “basic rule” of lien priority is that liens are
          ranked in the order they are created.

                                    “Other things being equal, different liens upon the
                                    same property have priority according to the time of
                                    their creation, except in cases of bottomry and
                                    respondentia.”3 California Civil Code § 2897.

                  Thus, where a trustor simultaneously delivered two trust deeds securing separate
          obligations, they were determined, in 1883, to be of equal rank. See Walker v. Buffandeau
          63 Cal. 312 (1883). But the “first in time” rule is controlling only “other things being
          equal.” Waltrip v. Kimberlin 164 Cal. App. 4th 517, 531 [remanding for lower court for
          determination of whether equitable considerations outweighed “first in time” rule].
          Because lien priority is “wholly controlled” by statutory law (Mortgage Securities v.
          Pfaffmann, 177 Cal. 109, 112-113 (1917)), “other things” aren’t equal when another statute
          prescribes a different rule. It’s not an overstatement to say that rules provided for by other
          statutes have to a great extent “swallowed” the basic “first in time” rule.

                  B. The “Generally Applicable” Rules. California statutory law has created two
          separate systems for “perfecting” liens, one generally applicable to liens on real estate and
          the other generally applicable to liens on personal property.




   1
      Note: This memorandum is intended for use in conjunction with a presentation of the same title being given at the
Contra Costa County Bar Association’s November 18, 2011 “MCLE Spectacular.” This isn’t a comprehensive
overview of the entire field of lien priority, nor is it intended to survey all of the provisions of California or federal
statutory or common law governing lien priority. As suggested by the title of this memorandum, it is limited in scope to
(a) a description of some of the basic rules applicable to the priority of liens on real and personal property and (b) a
discussion of some “special” lien priority rules perceived by the authors to be “frolics and detours” from the generally
applicable rules. Further, there are a number of lien priority subjects that this memorandum doesn’t attempt to address,
including many “proceeds” and ‘tracing” issues, equitable marshaling, contractual and equitable subordination,
constructive trust, “preservation of priorty” for bankruptcy estates under 11 U.S.C. § 551, the impact of 11 U.S.C. § 552
on “after-acquired” property liens in bankruptcy cases, maritime liens, artisans’ possessory liens, liens under the
Perishable Agriculatural Commodies Act, etc.
    2
      Portions of this memo were derived from earlier outlines prepared by David Katzen of Katzen & Schuricht.
    3
      “Bottomry” was a (now almost obsolete) maritime contract under which a ship owner pledged the ship as security
for a loan that was to be repaid only in the event the ship survived a specfied voyage, risk, or time period.
“Respondentia” was a similar contract creating a security interest in the ship’s cargo. Encyclopedia Britannica (online)
at www.britannica.com.

                                                                1
                      1. Real Estate Lien Perfection and Priority. The California statutory rules
              generally governing real estate lien priority are known, of course, as “race/notice” and
              are enunciated in Civil Code §§ 1213, 1214, 1215 & 1217. Under those statutes, (i)
              “conveyances” of real property include all instruments in writing by which any interest
              in real property is created, “aliened” (i.e., transferred), mortgaged, or encumbered
              (Civil Code § 1215); (ii) recording a conveyance with the county recorder gives
              constructive notice of its contents to subsequent purchasers and encumbrancers (Civil
              Code § 1213); (iii) any conveyance (other than a lease for a term of one year or less) is
              void as against a subsequent purchaser or encumbrancer, in good faith and for valuable
              consideration, whose conveyance is recorded first (Civil Code § 1214); and (iv) an
              unrecorded instrument is valid as against those who otherwise have notice of it (Civil
              Code § 1217.)
                      So, the general rule is that competing purchasers and encumbrancers, who are
              in good faith and give value, have priority in the order in which their relevant
              conveyances are recorded, except when one or more of the purchasers or
              encumbrancers is otherwise on notice of a prior instrument. For this purpose, “notice”
              includes both (a) knowledge of the prior unrecorded conveyance (See Slaker v.
              McCormick-Saeltzer Co.,179 Cal 387 (1918) [mortgage entitled to priority over
              previously recorded certificate of sale issued to execution sale purchaser who had
              actual knowledge of the mortgage], and (b) knowledge of facts warranting an inquiry
              that would have led to knowledge of the prior unrecorded conveyance (See Gibbons v.
              Yosemite Lumber Co., 190 Cal. 168 (1922) [holder of record title was on inquiry notice
              of unrecorded, equitable rights of buyer who, at the time holder obtained record title,
              was occupying land, using it for pasturage, and maintaining exclusive possession by
              keeping others’ stock off the land]. Because the recording laws protect only those who
              have given value, an unrecorded trust deed retains priority over subsequent judicial
              liens and general (not property4) tax liens. Boye v. Boerner, 38 Cal. App. 2d 567, 101
              P. 2d 757 (1940).
                       Finally, note that because under federal law a bankruptcy trustee has the rights
              and powers of a bona fide purchaser of real property who recorded his deed at the time
              of commencement of the bankruptcy case, a transfer (including a lien) that hasn’t been
              perfected when the bankruptcy case is filed can often be avoided by the trustee. 11
              United States Code (“U.S.C.”) § 544(a). On the other hand, a trustee isn’t insulated
              from such constructive notice as would be charged to a bona fide purchaser as of the
              petition date. See Probasco v. Eads (In re Probasco), 839 F.2d 1352 (9th Cir. 1988).
              If (a) a purchaser would have actual notice of circumstances sufficient to put a prudent
              person on inquiry as to another’s rights, (b) prosecution of that inquiry might have
              disclosed the other’s rights, and (c) knowledge of those rights would subject the
              buyer’s interest to them, then the trustee has constructive notice of those rights and
              cannot not avoid them. See Cal. Civ. Code § 19. A “prudent purchaser” is charged
              with knowledge of (v) the nature of the property; (w) its current use; (x) the identities
              of the current occupants; (y) the relationship among them; and (z) the relationship
              between those in possession and the person whose purported interest in the property the


4
    See paragraph II(D)(1)(a), below, re property tax liens.

                                                               2
               purchaser intended to acquire. Robertson v. Peters (In re Weisman), 5 F.3d 417 (9th
               Cir. 1993).
                     2. Personal Property Lien Perfection and Priority. Except for vehicles and boats
               subject to the registration requirements of the Vehicle Code5, perfection and priority of
               security interests in personal property and agricultural liens are generally governed by
               the scheme set out in Chapter 3 of Division 9 of the Commercial Code (Commercial
               Code §§ 9301 et seq.)6.
                          a. Perfection. Under the Commercial Code scheme, security interests in
               personal property and agricultural liens are generally perfected by filing a financing
               statement with the California Secretary of State. (California Commercial Code §
               9310.) However, the Commercial Code also provides that (a) security interests in some
               types of personal property can be perfected either by filing or by another method, (b)
               security interests in some other categories of personal property can be perfected only by
               a method other than filing, and (c) some security interests are automatically perfected
               when they attach or needn’t be perfected at all.
                          For example, security interests in instruments, negotiable documents, and
               tangible chattel paper can be perfected by filing (under Commercial Code § 9312(a)) or
               by taking possession (under Comm. Code § 9313(a)). Security interests in investment
               property can be perfected by filing (under Comm. Code § 9312(a)) or by “control”
               (under Comm. Code § 9314)7. Security interests in electronic chattel paper may be
               perfected by filing (under Comm. Code § 9312(a)) or by control (under Comm. Code §
               9314). Security interests in deposit accounts and letter-of-credit rights ordinarily are
               perfected only by control, not by filing. (Comm. Code §§9312(b)(1)&(2).) A security
               interest in money can be perfected only by possession. (Comm. Code § 9312(b)(3)),
               and a security interest in an insurance policy, including a security interest in unearned
               premiums, can be perfected only by written notice to the insurer (Comm. Code §§
               9311(b)(11) & 9312.)
                         Security interests that are automatically perfected when they attach include
               (a) purchase money security interests in consumer goods, except when pre-empted by
               federal law or a U.S. treaty, (b) assignments of accounts or payment intangibles that
               don’t constitute the transfer to a single assignee of a significant part of the assignor's
               accounts or payment intangibles; (c) an assignment of a health care insurance
               receivable to the provider of health care goods or services, (d) a security interest
               created by the assignment of a beneficial interest in a decedent's estate; (e) the
               reservation of a security interest by a seller in goods shipped or delivered to a buyer;

   5
      See Division 3 of the California Vehicle Code §§ 4000 et seq., re vehicles, and Division 3.5, Vehicle Code §§ 9840
et seq., re vessels.
    6
      However, see Commercial Code § 9109(c) & (d) for a list of a number of circumstances where Division 9 of the
Commercial Code does not apply. These exceptions to the applicability of Division 9 include (but aren’t limited to)
situations where state law is pre-empted by a federal statute, regulation or treaty, and, of course (and except for some
particular, specified provisions) the creation or transfer of interests in or liens on real property. Another example of a
subject pre-empted by federal law is the perfection of security interests in aircraft, which is governed by a federal
recording system known as the Federal Aviation Administration (FAA) Registry. See 14 Code of Federal Regulations,
Part 49.
    7
      The definition of “control” varies for different types of collateral. See Comm. Code §§ 9104, 9105, 9106 & 9107.

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               and (f) others listed in Comm. Code § 9309. Generally, a security interest in collateral
               attaches to identifiable proceeds of collateral and the security interest in the proceeds is
               perfected if the security interest in the collateral itself was perfected. However, the
               security interest in the proceeds becomes unperfected 21 days after it attaches to the
               proceeds, unless (i) the secured party would otherwise have a perfected security interest
               in the proceeds (for example, the original filing covered inventory and accounts, and
               the proceeds of inventory are accounts); (ii) the original collateral was covered by a
               filed financing statement, a security interest in the proceeds could be perfected by such
               a filing (e.g., the original filing covered inventory but not accounts, though it could
               have included them), and the proceeds weren’t acquired with cash proceeds; or (iii) the
               proceeds are identifiable cash proceeds. See Comm. Code § 9315(d).
                          As is apparent, the perfection scheme in the Commericial Code is convoluted,
               shot through with exceptions, and, with respect to some situations, somewhat opaque.
               When parsing through its provisions to analyze whether a particular security interest is
               perfected, or in trying to determine how to perfect a particular security interest, it’s
               crucial that one first determine the category of collateral one is dealing with. Most
               definitions of the various categories of collateral are set forth in Comm. Code § 91028.
               It’s also necessary to carefully review at least Commercial Code §§ 9308 to 9316,
               where many, perhaps most, of the rules governing the perfection of security interests
               within the scope of Division 9 can be found. It isn’t practical to attempt to cover all of
               these rules in this memo. So, be careful when navigating in the gray areas, carefully
               review the Commercial Code and other authorities9, and, when in doubt, consider
               trying to perfect using more than one method, e.g., by both filing and (where feasible)
               possession, just in case.
                          b. Priority. Under the Commercial Code, security interests in the same
               collateral generally have priority according to the time of their perfection or filing,
               provided that there was no period after filing or perfection during which there was no
               filing or perfection.10 Comm. Code § 9322(a)(1). A perfected security interest
               generally has priority over an unperfected security interest (Comm. Code § 9322(a)(2)),
               and the first security interest to attach or become effective generally has priority if all
               conflicting security interests are unperfected (Comm. Code § 9322(a)(3). Buyers of
               tangible chattel paper, documents, goods, instruments, accounts, general intangibles,
               and some other categories of personalty, as well as lessees of goods, take free of
               security interests if the buyer gives value and (in the case of certain types of property
               including instruments, goods, documents, and tangible chattel paper) takes delivery
               without knowledge of the security interest and before it is perfected, except that the
               rights of such buyers and lessees aren’t entitled to priority over purchase money
               security interests if a financing statement was filed before or within 20 days after the
               debtor receives delivery of the collateral, unless the buyer is a buyer in the ordinary


   8
      The definitions of the terms “instrument” and “negotiable instrument” can be found in Comm. Code § 3104.
   9
      Note that the Commercial Code also includes “conflicts of law” provisions governing the applicability of
California law, or other states’ laws, to perfection and priority issues. See Comm. Code §§ 9301 to 9307.
    10
       Filed financing statements are generally effective for five years after the date of filing but their effectiveness can
be extended by another five years by filing a continuation statement within six months before the expiration of five
years from the filing of the initial statement or an effective continuation statement. Comm. Code § 9515.

                                                                   4
               course of business or the lessee is a lessee in the ordinary course of business, in which
               case the buyer or lessee generally takes free of a security interest created by the seller
               even if the security interest is perfected and the buyer knows about it. (Comm. Code
               §§ 9317, 9320 & 9321.)
                          There are special priority rules for future advances (See Comm. Code §
               9323), deposit accounts (See Comm. Code §§ 9327 & 9332), investment property (See
               Comm. Code § 9328), letter-of-credit rights (Comm. Code § 9330), chattel paper
               (Comm. Code § 9330), fixtures and crops (Comm. Code § 9334), goods covered by a
               certificate of title (Comm. Code § 9337), “commingled goods” (Comm. Code § 9336),
               and statutory “possessory liens” for services or materials provided with respect to
               goods (Comm. Code § 9333). Significantly, if the purchaser of an instrument (such as
               a promissory note) gives value and takes possession of the instrument in good faith and
               without knowledge that the purchase violates the rights of a secured party, the
               purchaser’s interest trumps the security interest if it was perfected by a method other
               than possession (e.g., by filing). Comm. Code § 9330. Thus, for priority purposes,
               some perfection methods can be “more equal” than others. Finally, note that Division 9
               doesn’t limit the rights of a holder in due course of a negotiable instrument, who can
               take priority over an earlier perfected security interest to the extent provided in other
               divisions of the Commercial Code. (See Comm. Code § 9331, which confers similar
               rights on holders of negotiable documents of title and protected purchasers of
               securities.)
                          As with its provisions governing methods of perfection, the Commercial
               Code’s provisions on priority are detailed and complex, aren’t all mentioned (much less
               summarized) in this memo (which is intended by its author only to touch on what he
               perceives to be “highlights”), and should be reviewed when priority is an issue. Most
               of the relevant statutes are found at Commercial Code §§ 9317 through 9342.

             II. Frolics and Detours.

                 A. Adventures in Financing Statements. Under Commercial Code § 9502, a
          financing statement is sufficient only if it provides the name of the debtor, provides the
          name of the secured party or a representative of the secured party, and indicates the
          relevant collateral.11 While this sounds simple, it isn’t always so, particularly with respect
          to naming the debtor.
                      1. Naming Problems. A financing statement adequately names the debtor only if
               (a) for debtor’s that are “registered organizations” (defined in Comm. Code
               §9102(b)(70) so as to include corporations, limited partnerships, and limited liability
               companies12), the financing statement provides the name of the debtor shown on the
               public record of the debtor's jurisdiction of organization; (b) for an unregistered debtor
               that has a name, the financing statement provides the individual or organizational name

   11
       There are additional requirements for financing statements that cover “as-extracted” collateral or timber to be cut
or which are filed as fixture filings and cover goods that are, or are to become, fixtures. Comm. Code § 9502(b) &(c).
    12
       Under Comm. Code § 9102(a)(70), a "registered organization" is an organization organized solely under the law
of a single state or the U.S. and as to which the state or the U.S. must maintain a public record showing the organization
to have been organized.

                                                                 5
of the debtor; and (c) if the debtor has no name, the financing statement provides the
names of the partners, members, associates or other persons comprising the debtor.
Comm. Code § 9503. Special rules apply if the debtor is a decedent's estate or a trust.
See Comm. Code § 9503(a)(2)&(3). Significantly, a financing statement that provides
only the debtor's trade name does not sufficiently provide the name of the debtor.
Comm. Code § 9503(c). Although a financing statement with “minor errors and
omissions” is effective unless the errors or omissions make the statement "seriously
misleading" (Comm. Code § 9506(a)), the failure to provide the name of the debtor in
accordance with § 9503 is deemed “seriously misleading” Comm. Code § 9506(b).
There is a potential safe harbor: If a search of the Secretary of State's records, using
the debtor's correct name and the filing office's standard logic, would disclose a
financing statement that fails sufficiently to provide the name of the debtor in
accordance with § 9503, the name provided does not make the financing statement
seriously misleading. Comm. Code § 9506(c). This “safe harbor,” however, won’t
save a creditor who makes a loan to finance a sole proprietorship known as “Joe’s Bar”
and lists only “Joe’s Bar,” but not the name of the bar owner, on the financing
statement (unless the proprietor’s name happens to be “Joe Bar”). If there is doubt
about which name to use—e.g., the debtor sometimes goes by “John Q. Smith,”
sometimes by “J. Quincy Smith,” sometimes by “Jay Smith,” etc.—the practical
solution is to file separately under each plausibly applicable name.
      2. Name Changes, Mergers and Relocations.
           a. Debtor’s Name Change. What if the debtor changes his/her/its name after
the filing of the financing statement? Commercial Code § 9507 addresses this problem.
If a debtor changes its name so as to make a filed financing statement seriously
misleading, then (a) the financing statement is effective to perfect a security interest in
collateral acquired by the debtor before, or within four months after, the change, and
(b) the financing statement is not effective to perfect a security interest in collateral
acquired by the debtor more than four months after the name change, unless an
amendment to the financing statement which makes it not "seriously misleading" is
filed within four months after the change. So, how is a new lender that is deciding
whether to rely on collateral offered by the debtor supposed to figure out that the debtor
has already encumbered the collateral using a different name that has since been
changed? One could require representations and warranties, but that won’t help if the
debtor is dishonest or inattentive.
          b. Mergers, Acquisitions and Other Changes in Corporate Structure.
Commercial Code §§ 9203 and 9508 deal with situations where a new debtor is bound
by a security agreement entered into by another debtor.
          Under § 9203 a new debtor becomes bound by a security agreement entered
into by an original debtor when by contract or operation of law the security agreement
becomes effective to create a security interest in a new debtor's property. This can
occur when the law applicable to corporate mergers provides that when Corporation A
merges into Corporation B, Corp. B becomes a debtor under Corp A's security
agreement. This can also happen when Corp B contractually assumes Corp. A's
obligations under the security agreement. Also under § 9203, a new debtor becomes
bound by an original debtor's security agreement when the new debtor (a) becomes


                                          6
               generally obligated for the obligations of the original debtor, including the obligation
               secured by the original debtor's security agreement, and (b) acquires or succeeds to all
               or substantially all of the assets of the original debtor.
                         Section 9508 governs the perfection of the security interest in the new
               debtor's collateral in these situations. Under § 9508, a filing against the original debtor
               generally is effective to perfect a security interest in covered collateral that a new
               debtor has at the time it becomes bound by the original debtor's security agreement and
               in any such additional collateral that the new debtor acquires within four month’s after
               the new debtor becomes bound by the security agreement.
                           In Bank of the West v. Commercial Credit Financial Services, Inc., 852 F.2d
                         th
               1162 (9 C. 1988), the court applied the “four month rule” (the rule giving the secured
               creditor of the “old debtor” corporation a security interest in collateral acquired by the
               “new debtor” corporation within four months after the new debtor becomes bound) to a
               fact pattern in which there hadn’t been any formal corporate reorganization (such as a
               merger) nor had the “new debtor” assumed obligations of the “old debtor.” Instead, a
               parent corporation had caused one of its subsidiaries to transfer a beverage sales
               business to another of its subsidiaries. A creditor of the transferor subsidiary had a
               perfected security interest in its existing and future accounts, and a creditor of the
               transferee subsidiary had a perfected security interest in its existing and future
               accounts. The court justified its conclusion that the creditor of the transferor had a
               perfected security interest in accounts acquired by the new debtor within four months
               after the transfer with the rationale that the transfer of assets between the subsidiary
               corporations wasn’t really an asset transfer so much as a change in corporate structure.
               852 F.2d at 1168-1171. 13
                          Whether perfection of the security agreement in the “after-acquired” assets of
               the new debtor continues beyond the four months depends, in part, on whether the
               difference between the names of the original debtor and the new debtor causes the filed
               financing statement to be “seriously misleading.” If it does, then the perfection of the
               security interest in the new debtor’s “after-acquired” collateral doesn’t apply to
               collateral acquired by the new debtor more than four months after the new debtor
               became bound by the security agreement unless an initial financing statement providing
               the name of the new debtor is filed during the four-month period. Comm. Code §
               9508(b)(2). Note that Comm. Code § 9509(b) likely authorizes—and a security
               agreement could expressly authorize—the secured party to file financing statements or
               amendments necessary to maintain its perfected status, and no debtor signature is
               required on a financing statement under section 9502, so supplemental filings are a
               practical solution if the need for them is recognized.


   13
       The court also concluded that in the circumstance where each creditor had perfected a security interest in the
assets of a different debtor, i.e., one creditor had perfected a security interest in one subsidiary’s accounts and the other
creditor had perfected a security interest in the other subsidiary’s accounts, the general rule giving priority to the “first
to file” didn’t apply. Instead, because the secured creditor of the transferor had a perfected security interest in the after-
acquired (within four months) accounts of the transferee and the transferee couldn’t give its creditor any greater rights
in the collateral than it (the transferee) owned, the transferor’s creditor’s security interest in the transferree’s accounts
acquired within four months after the transfer had priority over the security interest of the transferee’s creditor. 852
F.2d 1171-1174.

                                                                   7
                          Commercial Code § 9326(a) says that a security interest created by a new
               debtor that is perfected by a financing statement that is effective solely under § 9508 in
               collateral in which the new debtor has or acquires rights is subordinate to a security
               interest in the same collateral that is perfected other than by a financing statement that
               is effective solely under § 9508. (Comm. Code § 9326(a).) The author hasn’t found
               any case law interpreting this provision, but a literal interpretation would appear to
               mean that a secured creditor of the “old debtor” that is relying on § 9508 for perfection
               would be subordinate to a secured creditor of the “new debtor” that perfects by filing a
               financing statement that is otherwise effective. § 9326(b) also includes a provision that
               appears to preserve the priority rule of Bank of the West v. Commercial Credit
               Financial Services, Inc., supra, in situations where the security interests competing for
               priority in collateral acquired by a “new debtor” weren’t entered into by the same
               original debtor.
                        It’s worth noting that Commercial Code §§ 9302 and 9508 don't prejudice the
               continuing perfection (under § 9507(a)) of the creditor's security interest in existing (as
               opposed to after-acquired) collateral transferred to the new debtor by the original
               debtor.
                          c. Relocation Issues. Under former Commercial Code § 9402 (in effect before
               the 2001 revision of the Commercial Code), in order for a financing statement to be
               sufficient to perfect a security interest the statement was to provide the address of the
               secured party and the mailing address of the debtor. Gill v. United States of America
               (In re Boogie Enterprises, Inc)., 866 F.2d 1172, 1174 (9th C. 1989). This spawned
               litigation over whether financing statements complied with the address requirements.
               See, e.g., General Electric Credit Corp. v. Aurora Mobile Homes, Inc., 37 Cal App 3d
               1016 (1974, Cal App 4th Dist.). Current Commercial Code § 9502, the successor to
               former § 9402, doesn’t include the address requirements. Thus, although the official
               form for the UCC-1 Financing Statement (specified in Commercial Code § 9521)
               continues to include blanks for the mailing addresses of both the debtor and the secured
               party, it appears that addresses are no longer required for a financing statement to be
               sufficient to perfect a security interest. However, one wonders whether a reference to
               the debtor’s correct address might help to assure that other errors in a financing
               statement will be deemed “minor errors and omissions,” rather than “seriously
               misleading.”
                          Another “relocation issue” is potentially far more important, however: Under
               Commercial Code § 9301, while collateral is located in a jurisdiction (i.e., a state), the
               “local law”14 of that jurisdiction generally governs perfection of, the effect of
               perfection or nonperfection of, and the priority of a possessory security interest in that
               collateral, and , for negotiable documents, goods, instruments, money or tangible
               chattel paper, the effect of perfection or nonperfection of and the priority of a
               nonpossessory security interest in the collateral. Otherwise, the local law of the
               jurisdiction where the debtor is located generally governs perfection, the effect of



   14
     In this context, “local law” means that substantive law of a state, and not its choice of law rules. See Commercial
Code § 9301, Official Comments on Uniform Commercial Code.

                                                                8
               perfection and nonperfection, and the priority of a security interest.15 Comm. Code §
               9301; Official Comments on Uniform Commercial Code ¶ 5(a). Commercial Code §
               9307 contains rules for determining a debtor’s location for this purpose.
                           Because the local law of the state where collateral is located generally
               governs perfection of possessory security interests in that collateral while it’s in that
               state, the method of perfection can (at least in theory, where the relevant states’
               versions of the Uniform Commercial Code materially differ) change when the collateral
               is moved from one state to another. Even for nonpossessory security interests, where
               the method of perfection is governed by the law of the state where the debtor is located,
               the applicable law can change as a result of the debtor’s relocation to a different state.
               Because each state’s law presumably refers to its filing system as the appropriate place
               for filing financing statements (See Comm. Code § 9501, designating the office of the
               California Secretary of State for most filings), when the debtor relocates to a different
               state, the new state’s law will likely refer to a different office for filing.
                          Commercial Code § 9316 addresses these situations. Under § 9316, when
               collateral is subject to a perfected possessory security interest in one state and is then
               moved to another state, the security interest is continuously perfected if, upon entry into
               the new state, the security interest is perfected under the law of that jurisdiction.
               Comm. Code 9316(c). (This apparently means that when the collateral is brought into
               the new jurisdiction, it has to be “possessed” in a manner that satisfies the possession
               requirements for perfecting a possessory security interest in the new jurisdiction.) For
               security interests perfection of which is governed by the law of the state where the
               debtor is located, perfection under the “old” state’s law continues until the earliest of
               (a) the time perfection would have ceased under the “old” state’s law, (b) four months
               after the debtor’s relocation to the “new” state, or (c) one year after the collateral is
               transferred to a person that thereby becomes a debtor and is located in another state.
               Comm. Code § 9316(a)16. If the security interest is perfected under the law of the
               “new” jurisdiction before the earliest of these times, it continues to be perfected.
               Otherwise, it ceases to be perfected and is deemed never to have been perfected as
               against a purchaser of the collateral for value. Comm. Code § (b).
                          What does this mean? To take one plausible example, it appears that if a
               security interest is perfected by filing in California because the debtor is “located” here,
               but the debtor then moves to Arizona (which also presumably contemplates perfection
               by filing) and there’s no new filing there within four months, a perfectly good security
               interest becomes unperfected!


   15
       Commercial Code § 9301 contains the following exceptions to these rules: (1) The local law of the jurisdiction in
which the well or mine is located governs the perfection, effect of perfection or nonperfection, and priority of a security
interest in “as-extracted collateral” and (2) Perfection of security interests in timber to be cut and in goods (by filing a
fixture filing) is governed by the local law of the jurisdiction where those types of collateral are located). Other
exceptions to § 9301’s general choice of law rules are set out in Commercial Code §§ 9303 to 9306, which are
respectively applicable to goods covered by a certificate of title, deposit accounts, investment property, and letter-of-
credit rights.
    16
       Section 9316 also includes rules governing the continuing perfection (or termination of perfection) of security
interests in goods covered by a certificate of title, deposit accounts, letter-of-credit rights, and investment property,
when there is a change in the applicable jurisdiction.

                                                                  9
                   B. The Perfection of Security Interests in Promissory Notes Secured by Deeds of
          Trust on Realty—a Cautionary Tale. Under current law, a security interest in an
          instrument may be perfected by filing or by taking possession. Comm. Code § 9312(a)
          [filing] and Comm. Code § 9313(a) [taking possession]. There's an interesting history
          behind these provisions. In the 70's and early 80's, there were several bankruptcies of
          businesses engaged in soliciting funds from investors in exchange for interests in notes
          secured by deeds of trust on real estate.. Huffman v. Wikle (In re Staff Mortgage &
          Investment Corp.) 550 F2d 1228 (9th C. 1977) and Greiner vs. Wikle (In re Staff Mortgage
          & Investment Corp). 625 F.2d 281 (9th C. 1980), involved the bankruptcy of a company
          that took loans from investors in exchange for promissory notes secured by collateral
          assignments of fractional interests in third party notes that were themselves secured by trust
          deeds on realty. The company's business practice was to record the fractional assignments
          (of the trust deeds) to the investors but retain possession of the documents (including the
          assigned third party notes) other than the company's note to the investor. When Staff
          Mortgage went into bankruptcy, the issue arose as to whether recordation of the trust deed
          assignments (under the system for perfecting security interests in realty) was effective to
          perfect the investors’ security interests. The Ninth Circuit held that (1) a promissory note
          secured by a trust deed on realty is an "instrument" under the Commercial Code and (2)
          under the version of the Commercial Code then in effect (specifically Commercial Code
          9304(1), it was necessary for a secured party to take possession (either personally or
          through an agent) of the note to perfect a security interest in it. Because the investors
          didn’t have security interests in realty (but instead had security interests in notes secured by
          realty), the recording system for real property didn’t apply. Thus, the investors' security
          interests in the notes secured by the trust deeds were unperfected security interests and the
          investors were unsecured creditors in the bankruptcy case, rather than secured creditors
          with "dibs" on liens on the real estate.

                   This result led to the change to today's version of the Commercial Code, which
          allows security interests in instruments to be perfected by filing as well as by possession.
          However, it's important to know that even under today’s Commercial Code sections
          9330(d) & 9331(a)), the rights of a creditor who perfected a security interest in a note by
          filing (as distinct from perfecting by taking possession) aren’t always protected. This is
          because both (a) a holder in due course and (b) the purchaser of an instrument who gives
          value and takes possession in good faith and without knowledge of the rights of the secured
          party have priority over a secured creditor who perfected by filing.17

                   C. Special Seller Priority Rights.

   17
       The California Legislature also enacted a more specific fix for the situation involved in the Staff Mortgage cases.
In 1992, new Business & Professions Code (“B&P Code”) § 10233.2 was enacted. It provides that “[f]or the purposes
of [Division 3 and Division 9 of the Commercial Code] . . . .when a broker [acting within B&P Code §§ 10131(d) or (e)
or 10131.1] . . . has arranged a loan or sold a promissory note or any interest therein, and thereafter undertakes to
service the promissory note . . ., delivery, transfer, and perfection shall be deemed complete even if the broker retains
possession of the note or collateral instruments and documents, provided that the deed of trust or an assignment of the
deed of trust or collateral documents in favor of the lender or purchaser is recorded in the office of the county recorder
in the county in which the security property is located, and the note is made payable to the lender or is endorsed or
assigned to the purchaser. In Nielson v. Chang (In re First T.D. & Inv., Inc.) 253 F3d 520 (9th Cir. 2001),which
involved facts very similar to those in the Staff Mortgage cases, the court applied § 10233.2 to defeat a bankruptcy
trustee’s avoiding powers.

                                                                10
                     1. Vendor’s Liens on Realty. Under California law, a seller of real property has
              a lien on the property, independent of possession, for the unpaid portion of the purchase
              price that is unsecured. California Civil Code § 304618. La Hue vs. Daugherty 34 Cal.
              2d 1, 3-4 (1949). This lien, which is both statutory and a product of the common law
              (see La Hue referring to the rule creating vendor's liens as "an ancient rule independent
              of codification") is commonly referred to as a "vendor's lien." For a vendor's lien to
              exist, the unpaid portion of the purchase price must be a "fixed" or "ascertainable"
              consideration in money or its equivalent, not mere collateral obligations or duties." La
              Hue, 34 Cal.2d at 6. A vendor's lien is valid against everyone claiming under the
              debtor except a purchaser or encumbrancer in good faith and for value. Civil Code §
              3048. La Hue, 34 Cal.2d at 4. To be in good faith under Civil Code § 3048, an
              encumbrancer must act without knowledge of competing liens. Brock vs. First South
              Savings Assn. 8 Cal App 4th 661 (1992). If the buyer gives the seller a written contract
              for the payment of all or part of the purchase price, the vendor's lien is waived (to the
              extent of the sum payable under the contract) by the seller's outright transfer
              (presumably meaning a transfer other than the transfer of only a security interest) of the
              contract, other than a transfer in trust to pay debts. Civ Code § 3047.
                     Query: Can the seller record a document reciting the existence of the vendor's
              lien so as to give subsequent purchaser's and encumbrancers for value, who would
              otherwise be in good faith, constructive notice and assure that they can't get priority
              over his vendor's lien? See McGreevy vs. Constitution Life Ins. Co., Inc., 238 Cal App
              2d 364, 371 (1965) where the court indicated that the recordation of papers showing
              essential facts concerning ownership of leases was constructive notice to subsequent
              encumbrancers of the fact that the lessors hadn't been paid and that a vendor's lien was
              in effect. (In McGreevy there were also other facts that supported the courts'
              conclusion that the encumbrancers were on notice that the lessors hadn't been fully
              paid.)
                    Other Queries: Couldn’t a seller record a lis pendens when filing an action
              against a defaulting buyer to foreclose a vendor's lien, even though the seller couldn't
              record a lis pendens if the seller’s only cause of action was to seek judgment on the
              buyer’s unsecured note? This could obviously have priority consequences. Also ,
              wouldn’t a seller's vendor's lien have priority over the buyer's homestead exemption,
              and over a declared homestead, even though a judgment lien created on account of a
              money judgment on the purchaser's unsecured note wouldn’t have such priority?
                    Note that a vendor's lien is ineffectual as against a bankruptcy trustee (or debtor-
              in-possession), because 11 U.S.C. § 544 gives the trustee the rights and powers of a
              bona fide purchaser of real property.
                         2. Purchase Money Priority.
                         a. Real Property Purchase Money Liens. Civil Code section 2898(a)
              embodies the primary exception to the general rule that deeds of trust have priority in
              order of their date of creation or recordation. Powell v. Goldsmith, 152 Cal. App. 3d

   18
      Also note that under Cal Civ Code § 3050, a person who pays to the owner any part of the price to purchase real
property under a sale agreement has a lien on the property, independent of possession, for that part of what has been
paid that the buyer may be entitled to recover in case of failure of consideration.

                                                              11
               746 (1984). § 2898(a) says that a purchase money lien (“[a] mortgage or deed of trust
               given for the price of real property, at the time of its conveyance”) has priority against
               “all other liens created against the purchaser, subject to the operation of the recording
               laws.” The deed to a purchaser and the purchase money “mortgage back” are
               considered as contemporaneous acts and no lien against the purchaser can be prior to
               the rights of the vendor under the purchase money mortgage. Tolman v. Smith, 85 Cal.
               280 (1890); Walley v. P.M.C. Inv. Co., 262 Cal. App. 2d 218, 220 (1968). Thus, the
               lien of a mortgage previously recorded (before recordation of the purchase money
               mortgage) against the purchaser is subordinate to the purchase money mortgage, and
               the same is true of a previously recorded abstract of judgment against the purchaser19.
               Walley v. P.M.C. Inv. Co., supra at 220.
                           “Purchase money” priority applies not only to a trust deed given to the seller
               for all or part of the purchase price, but also to a deed of trust given to a third party
               lender who advances purchase money at the request of the purchaser. Id. To be a
               purchase money mortgage, it’s necessary that funds were loaned to the purchaser for
               the express purpose and used for the express purpose of paying for the property. Van
               Loben Sels v. Bunell, 120 Cal. 680 (1898). The intent of the statute in giving priority to
               purchase money liens is to protect sellers from “a third party attempting to insert a lien
               in ahead” of the seller’s right to security for the purchase price. Powell v. Goldsmith,
               supra, 152 Cal. App. 3d at 752.
                         The part of the statute that makes purchase money priority “subject to the
               recording laws” means essentially the same thing as the exception in Civil Code § 3048
               making vendor’s liens ineffective as against a purchaser or encumbrancer in good faith
               and for value (Brock vs. First South Savings Assn. 8 Cal App 4th 661,705 (1992). This
               apparently means that even a purchase money encumbrancer can lose its priority to a
               subsequent purchaser or encumbrancer, in good faith (without notice of the purchase
               money lien) and for valuable consideration, whose conveyance is recorded first. See
               Civil Code § 1214, supra.
                      In Brock vs. First South Savings Assn, supra, the court had to decide how to
               “break the tie” between as vendor’s lien and a recorded deed of trust in favor of a
               purchase money lender, when both liens attached simultaneously as part of the same
               transaction. The court ruled that although the purchase money lender was not “an
               encumbrancer in good faith under Civil Code § 3048 (because it was on notice that the
               plaintiff seller had taken an unsecured promissory note for part of the purchase price),
               the lender nevertheless was entitled to priority over the vendor's lien because the lien of
               the trust deed was “legal” while the vendor’s lien was only “equitable.” )20
                     b. Purchase Money Liens on Personal Property. This subject is addressed in
               Comm. Code § 9324. Among many other things, this statute provides that a perfected
               purchase money security interest (“PMSI”) in goods (other than inventory or livestock)

   19
       Note that section 2898(a) doesn’t by its terms give a purchase money lender’s trust deed priority over a previous
lien created by the seller. Section 2898(a) refers only to liens “created against the purchaser.”
    20
       For a different result under Oklahoma’s “race-notice” statute, see American Bank of Oklahoma v. Wagoner, 2011
Westlaw 2685832 (Okla. Civ. App.), where a purchase money deed of trust given to a seller prevailed over a lender’s
purchase money deed of trust, even though the lender filed its trust deed two weeks before recordation of the seller’s
trust deed. Both the seller and the lender know that a purchase money security interest had been given to the other.

                                                               12
               has priority over a conflicting security interest in the same goods, regardless of which
               security interest is perfected first, provided the PMSI is perfected when the debtor
               receives possession of the collateral or within 20 days thereafter . Also under § 9324, a
               perfected purchase money security interest in inventory has priority over a conflicting
               security interest in the same inventory and also has priority in identifiable cash
               proceeds of the inventory (received at the same time as or before delivery of the
               inventory to a buyer) if the purchase money security interest is perfected when the
               debtor receives possession of the inventory, subject to the following qualification: If
               the holder of the conflicting security interest filed a financing statement covering the
               same types of inventory before the purchase money security interest was perfected by
               the filing of a financing statement and before the beginning of any 20-day period
               during which the purchase money security interest was temporarily perfected without
               filing or possession under Comm. Code § 9312, then the holder of the purchase money
               security interest, in order to preserve its priority in the inventory and its identifiable
               cash proceeds, also has to send an “authenticated notification” to the holder of the
               conflicting security interest stating that the sender has or expects to acquire a purchase
               money security interest in described inventory of the debtor and that notification has to
               be received by the holder of the conflicting security interest within five years before the
               debtor gets possession of the inventory. Comm. Code § 9324(b) &(c).21
                      For an example of a case in which a purchase money lender lost its priority for
               failure to strictly comply with a similar notification requirement under another state's
               version of the UCC, see In the Matter of Sports Publishing, Inc., (Midland States Bank
               vs. Innerworkings, LLC, et al) 2010 U.S. Dist. LEXIS 19078 (C.D. Ill. 2010) [purchase
               money lender lost out to a lending bank that had previously filed a financing statement
               even though the bank had reviewed the security agreement between the purchase
               money lender and the debtor and had also reviewed the financing statement that
               perfected it.]
                      So, if your client takes a purchase money security interest in a debtor's inventory,
               your client can lose its priority in the proceeds if (i) your client's security interest isn't
               perfected until after the debtor receives the inventory OR (ii) even though the security
               interest is perfected before the debtor receives the inventory, another creditor
               previously perfected a security interest in the same inventory by filing and no
               authenticated notification was sent to that creditor within five years before the debtor
               received the inventory. Importantly, an inventory PMSI affords no priority whatsoever
               as to noncash proceeds. Therefore, if another lender already has a perfected security
               interest in accounts, the benefit conferred on the inventory supplier is often fleeting.
               This is because it appears that the supplier starts out in first place but then falls back if
               the buyer doesn’t pay cash.
                      Even if a seller with the purchase money security interest jumps through all of
               these hoops to maintain its priority, the seller will still lose out, with respect to proceeds
               of the collateral that are in a deposit account, to the holder of a conflicting security
               interest who has control of the deposit account--and a security interest held by the bank

   21
       When the “authenticated notification” requirement applies, the notification needs be renewed within five years
after it was given in order for it to continue to give the holder of the purchase money security interest priority in new
inventory deliveries to the debtor.

                                                                 13
with which the deposit account is maintained has priority over all other security
interests in the account except those perfected by control over the deposit account by a
secured party who has become the bank's customer. Comm. Code § 9324(b); Comm.
Code § 9327. Finally, if more than one security interest qualifies for priority under
Commercial Code § 9324, a security interest “securing an obligation incurred as all or
part of the purchase price of the collateral” has priority over a security interest
“securing an obligation incurred for value given to enable the debtor to acquire rights
in, or the use of, the collateral.” This seems to mean that a seller of collateral who
takes back a purchase money security interest prevails over a third party lender with a
purchase money security interest in the collateral. The statutes in this area are dense,
detailed and somewhat intricate. This memo doesn’t cover the subject completely.
When working in this subject area, read the statutes carefully.

   D. Special “Government” Priorities.
        1. Tax Lien Priority:
       a. Property Tax Liens vs. Other Tax Liens. Liens securing real property taxes or
special improvement assessments have priority over all other liens on real property,
regardless of when the liens were created. See California Revenue & Taxation Code
(“R&T Code”) § 2192.1. Even federal tax liens are subordinate to subsequently created
property tax liens. 26 U.S.C. §§ 6323(b)(6) & 6324(c)(1). Although there is a
procedure under the Revenue & Taxation Code by which a county tax collector can
record a notice creating a lien on real property and personal property on account of
some other kinds of taxes, including certain taxes on the unsecured roll, taxes on escape
assessments, taxes on improvements owned by a person other than the owner of the
land on which they are located, and taxes on some possessory interests and goods in
transit, those tax liens (unlike liens securing real property taxes) don't give the tax
collector priority over any other lien that attached before the recording creating the tax
lien and aren't valid against purchasers or encumbrancers for value who don't have
actual knowledge of the tax lien. R&T Code §§ 2191.3, 2191.4 & 2191.5. Other types
of state tax liens for non-property taxes, including liens for taxes owing to the
Franchise Tax Board (income tax), Employment Development Department
(employment and payroll tax), and Board of Equalization (sales and use tax) are
governed by Government Code (“Govt. Code”) sections 7150 to 7174. These tax liens
attach to both real property and personal property but under Govt Code section 7170
are subordinate to various other types of interests and liens including (among other
things) liens that were perfected before the recordation of the tax lien (with respect to
real property) or before its filing with the Secretary of State (with respect to personal
property).
       When property subject to a tax lien is property of a Chapter 7 bankruptcy estate,
the plot thickens. 11 U.S.C. section 724(b) provides that regardless of the fact that
property (real or personal) is subject to a lien securing a tax other than an "ad valorem"
property tax, unsecured non-tax claims (other than some Chapter 11 administrative
expense claims) that have priority over priority unsecured tax claims under Bankruptcy
Code 507(a) are entitled to payment from the property or its proceeds before payment
of the tax lien if other estate assets aren’t sufficient to pay them. In other words, the


                                         14
               specified priority unsecured claims get the dollars that would have gone to pay the non-
               property tax lien but for section 724(b).
                      A Chapter 7 trustee can avoid a lien to the extent it secures a tax penalty that
               arose before the earlier of the order for relief or the appointment of a trustee and isn’t
               compensation for actual pecuniary loss. 11 U.S.C. §§ 724(a) & 726(a)(4). Under the
               Chapter 7 scheme for distribution of the property of the estate, unsecured claims for
               such tax penalties are subordinated to most other general unsecured claims, including
               those that are filed after the bar date. 11 U.S.C. § 726(a)(4). See Holloway v. IRS (In
               re Odom Antennas, Inc.) 340 F. 3d 705, (8th Cir. 2003). One court has held that an 18%
               interest rate on delinquent property tax constitutes a penalty (which presumably would
               make at least part of a tax lien for interest accrued at that rate avoidable). In re Koger
               Properties, Inc., 172 B.R. 351, 353 (Bankr. M.D. Fla. 1994). Other courts disagree,
               finding that such a rate of interest is not a penalty. See Greaves v. Office of the Del.
               A.G. (In re Two Springs Membership Club) 424 B.R. 808, 819 (Bankr. N.D. Ohio
               2010); In re Cone Constructors, Inc., 304 B.R. 513 (Bankr. M.D. Fla. 2003).
                     b. IRS Trumping Rights: In United States vs. McDermott, 507 U.S. 447, 113 S.
               Ct. 1526, 123 L. Ed. 2d 128 (1993), the U.S. Supreme Court held that even though a
               judgment lien had been recorded before an IRS lien was filed and even though 26
               U.S.C. section 6323(a) provides that a federal tax lien isn't valid as against any
               purchaser, holder of a security interest, mechanic's lien creditor, or judgment lien
               creditor until notice of the tax lien is filed, the federal tax lien nevertheless had priority
               over the previously recorded judgment lien as to property the debtor acquired after
               both were in place.
                      The court (per Justice Scalia) reasoned that (a) absent a provision to the contrary,
               the “first in time” lien--first to be established--prevails, (b) because § 6323 says that a
               federal tax lien isn't valid as to a judgment lien creditor or others until a tax lien is filed,
               the tax lien came into existence for “first in time” purposes when it was recorded, and
               (c) the judgment lien wasn't in existence for "first in time" purposes until "perfected"
               and couldn't be so “perfected”22 until the specific property was identified--which didn't
               happen until the debtors acquired an interest in the property after the filing of the tax
               lien, (d) ergo, both liens attached at the same time, when the debtor acquired an interest
               in the property, and (e) “first to record” doesn't control here. At least one bankruptcy
               court has since relied on McDermott in ruling the a federal tax lien was entitled to
               priority with respect to property that was already owned by the debtor at the time the
               tax lien and a private creditor’s financing statement were simultaneously filed. Sullivan
               v. United States (In re Hulett Corp.), supra, 389 B.R. 610.
                       At first blush, it seems that the McDermott decision would apply equally to
               secured creditors and purchasers (who are mentioned in the same breath as judgment
               lien creditors in § 6323(a)). However, 26 U.S.C. § 6323(b) & (c) set forth a pretty long
               list of exceptions, i.e., interests that even filed federal tax liens don’t trump. Among


   22
      This is a different “perfection” concept than the concept of perfecting a security interest under state law. The
“perfection” concept involved in McDermott referred to an element of a federal “choateness” doctrine that has been
used in determining the priority of tax liens vis-à-vis private security interests. Sullivan v. United States (In re Hulett
Corp.) 389 B.R. 610, 617 (Bankr. N.D. Ill. 2008).

                                                                  15
them are the interests of purchasers and holders of security interests in securities who
didn’t have actual notice or knowledge of the tax lien, purchasers of motor vehicles
who didn’t have actual notice or knowledge of the tax lien, purchasers of tangible
personal property at retail (unless the purchaser intended to or knew that the purchase
would hinder, evade or defeat collection of the tax), real estate tax claims (the priority
of which is discussed above), attorneys’ liens on a judgment or settlement securing the
attorneys reasonable compensation for obtaining the judgment or settlement, security
interests (as defined in the statute) under commercial transaction financing agreements,
real property construction or improvement financing agreements, and obligatory
disbursement agreements which local law protects against judgment liens arising, as of
the time of tax lien filing, out of unsecured claims.
        Note that a competing security interest predates the tax lien filing only if, before
the filing, the property was already in existence and the creditor already held a
perfected interest in it (and even then only to the extent the creditor had already parted
with money or money’s worth). See 26 U.S.C. § 6323(h)(1). Therefore, a lien on after-
acquired property is subordinate to the filed tax lien except insofar as limited statutory
protection is available. Suffice it to say for present purposes that the ordinary
commercial lender will only have a superior claim to inventory or accounts that the
debtor acquired before or within 45 days after the tax lien filing—or which constitute
identifiable proceeds of such collateral—and then only to the extent that the lender
extended credit before or within the 45-day period and without actual notice or
knowledge of the tax lien filing. See id. § 6323(c)(1)(A)(i), (c)(2); Treas. Reg.
§ 301.6323(c)-1(d). Thus, absent effective tracing back to “old” collateral, a “floating
lien” may well sink to a junior position behind the federal tax lien simply because the
debtor continues doing business and cycling through the inventory and accounts pool.
       2. Federal Non-Bankruptcy Priority: 31 U.S.C. § 3713 says that when a person
indebted to the U.S. government is insolvent and the person either makes a voluntary
assignment of property, the debtor absconds and his or her property is attached, or "an
act of bankruptcy is committed," or when a deceased debtor's estate is insufficient to
pay the debtor's debts, (a) the claim owing to the U.S. government is entitled to be paid
FIRST (before other creditors are paid) AND (b) a representative of the insolvent
person or estate who pays any part of a debt before paying the government is liable to
the extent of the debt for the unpaid claim owing to the U.S. government. For the
statute to apply in the situation where the debtor makes a "voluntary assignment," a
transfer of assets must be a "general divestment of property," not just any transfer of
part of the debtor's property. Abrams v. Union Bank 1993 US App LEXIS 29158 (9th
C. 1993)(Nonpublished); United States v.. Hooe 7 U.S. 73 (1805). The statute has an
express exception saying that it doesn't apply in bankruptcy cases.
       In United States vs. Estate of Romani, 523 U.S. 517, 118 S.Ct. 1478, 140 L. Ed.
2d 710 (1998), the Supreme Court said that section 3713 does not apply to claims for
tax liability governed by 26 U.S.C. § 6323, because § 6323 was enacted long after the
predecessor of § 3713 and therefore must be held to control over § 3713 when the
government is seeking a preference to the insolvent estate of a delinquent taxpayer.
(Respecting 26 U.S.C. § 6323, see paragraph II(D)(1)(b) above, explaining that notice
must be given for a federal tax lien to be valid over perfected claims of judgment
lienors, purchasers, encumbrancers for value, etc.) However, in Law Offices of Joseph

                                          16
A. Stein vs. Cadle Co., 250 F.3d 716 (9th C. 2001), the court held that section 3713
entitled the government to priority over the claims of a judgment creditor who
perfected his judgment lien before the government perfected its judgment lien because
the government's lien wasn't a tax lien but a lien against a judgment a delinquent
taxpayer had obtained against a third party who was not the taxpayer. So, if this is
correct, then § 3713 can give the government priority over even a perfected lien.
(Note: In this case, there are indications in the opinion that the court decided that the
adverse party was conceding that it would lose if § 3713 applied, so that the court
wasn't really deciding whether § 3713 would give the government priority but only that
§ 3713, not § 6323, was applicable.)
       Of all the cases the author read in preparing this memo, the author’s favorite is
Abrams v. Union Bank, 1993 US App LEXIS 29158 (9th C. 1993)(Nonpublished). In
this case, the Abrams obtained an attachment lien on the assets of their financial adviser
for embezzling their money, and the financial adviser pled guilty to grand theft. Forty-
eight days later, the financial adviser made a general assigment for the benefit of
creditors. The IRS presented a claim for unpaid taxes exceeding $4 million (which was
more than the total amount available to pay the financial adviser’s creditors). After the
assignee for benefit of creditors instituted an interpleader proceeding, the Ninth Circuit
affirmed a summary judgment in favor of the IRS on the ground that § 3713 gave the
government priority. But here's the part that really hurts: From the opinion, it appears
that the income tax liability that was the subject of the IRS' claim was generated by the
income the investment adviser had realized by embezzling the Abrams' funds! The
court did note, citing cases, that the United States Supreme Court had "hinted for many
years" that a "specific and perfected" lien may have priority over the United States
claim but said that such specificity would have required the lien claimaint to take
"physical possession" of the attached property, citing United States v. Gilbert
Associates, Inc., 345 U.S. 361, 365-366 (1953), and United States v. Waddill, Holland
& Flinn, Inc., 323 U.S. 353, 355-360 (1945). The Supreme Court has never decided,
but has repeatedly reserved, the question whether even a specific and perfected lien is
sufficient to overcome the federal statutory priority. United States v. Vermont, 377
U.S. 351, 378, ftnt. 8 (1964); United States v. Romani, supra, 523 U.S. at 529 (1998).
       E. Mechanic’s Liens. Under California’s statutory scheme for mechanic’s liens,
recorded mechanic’s liens have priority (1) over encumbrances that attach subsequent
to the commencement of the work of improvement and (2) over any encumbrance of
which the lien claimant had no notice and that was unrecorded at the time the work
commenced. (Civil Code § 3134). (The rule is a bit more complicated for “site
improvements,” liens for which, with exceptions, have priority over liens securing
financing provided for the sole or primary purpose of financing the site improvements,
even if the latter are recorded before the work commences. Civ Code § 3137.) Of
course, in order to enforce a mechanic’s lien, contractors and suppliers must record a
claim of lien within strict deadlines (See Civ. Code §§ 3115 & 3116) and must then
bring an action to foreclose the lien within 90 days after its recordation or within one
year thereafter if “credit” is given and notice of the credit is recorded within the 90
days. Civ. Code § 3144.
    Under 11 U.S.C. § 546(b), when state law requires the seizure of property or
commencement of an action (as in the case of a mechanic’s lien) to perfect a security

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interest or maintain or continue perfection of a security interest and the property hasn’t
been seized and no action has been commenced before the filing of a bankruptcy
petition, the security interest is to be perfected, or maintained or continued, as the case
may be, by “giving notice within the time frame fixed by state law, and the rights of a
bankruptcy trustee are subject to the rights of a secured party who so “gives notice”.
(Giving such notice is not an act that is prohibited by the automatic stay. Bankrupty
Code § 362(b)(3) provides that it’s not a stay violation to perform any act to perfect or
to maintain or continue the perfection of an interest in property to the extent that the
trustee’s rights are subject to such perfection under § 546(b).)
       In Village Nurseries v. Gould (In re Baldwin Builders, et al.) 232 B.R. 406 (9th
BAP 1998), a California contractor (who had improved realty prepetition) both
recorded a mechanic’s lien claim and brought an action to foreclose the lien after the
property owner filed Chapter 11. The Bankrupty Appellate Panel for the Ninth Circuit
held that (a) because bringing an action to foreclose a mechanic’s lien is an
“enforcement action” rather than an act to perfect or to maintain or continue perfection
of a lien, bringing the action wasn’t protected by the 362(b)(3) exception for acts to
perfect a lien entitled to the benefit of section 546(b) and the foreclosure action
therefore was a violation of the automatic stay, (b) the only way to perfect a such a
security interest post-petition was to “give notice” under section 546(b); (c) the filing of
the action to foreclose the lien wasn’t “giving notice” so the perfection of the lien
hadn’t been maintained or continued, and (d) as a result, the mechanic’s lien claim was
no good as against the rights of the bankruptcy trustee. The court didn’t decide exactly
what is required to comply with the notice requirement but strongly suggested that filng
a pleading with the bankruptcy court would be sufficient. However, the contractor’s
filing of a proof of claim, asserting that its claim was secured by a mechanic’s lien,
wasn’t sufficient because the proof of claim wasn’t filed until a few days after the
expiration of the 90-day state law deadline for bringing an action to foreclose the lien.
       Interestingly, in Industrial Indemnity Co. v. Seattle First Naional Bank (In re
North Side Lumber Co.) 83 B.R. 735 (9th BAP 1987), the BAP held that if under state
law a lien doesn’t exist until a filing or recording is completed and the recording or
filing isn’t accomplished before the petition is filed, then 362(b)(3) doen’t apply, that
is, the creditor’s filing of a lien claim postpetition is a violation of the automatic stay [at
least absent an order granting stay relief] because 362(b)(3) excepts from the acts
prohibited by the stay only acts to perfect liens that are already in existence, and not
acts to create liens. Further, § 546(b) didn’t give the creditor rights superior to those of
the trustee because the statute didn’t solve the problem that the lien didn’t exist until
after the trustee’s rights took effect. It seems clear that the recordation of a mechanic’s
lien under California law is an act to perfect the lien, not create it, so that this scenario
shouldn’t apply here. See Baldwin Builders, supra 232 B.R. at 411 [referring to
recording a California mechanic’s lien as perfecting the lien.].
       F. Attorney’s Liens. Under California law, a lien in favor of an attorney, on the
proceeds of a prospective judgment in favor of the attorney’s client and securing a debt
for legal services rendered, may be created by express contract and may be implied if
the retainer agreement indicates that the attorney is to look to the recovery for payment
of his or her fee. Cetenko v. United California Bank, 30 Cal 3d 528 (1982); Waltrip v.
Kimberlin 164 Cal App 4th 517, 525, 531 (2008). An attorney’s contractual “charging

                                           18
lien” is created and takes effect at the time the retainer agreement is executed. Waltrip
at 525. It is a secret lien; no notice is requred before it is effective against a judgment
creditor who levies on the judgment. Cetenko at 533; Waltrip at 525.. Instead, the rule
of “first in time” applies, that is, when there are competing liens, all things being equal,
the first lien to be created has priority under Civil Code § 2897, so an attorney’s lien on
a judgment prevails over later encumbrances. Waltrip at 525; Cetenko at 534. In
Modtech Holdings, LLC v. Monteleone & McCrory LLP, 2011 U.S. Dist. LEXIS 42367
(C.D. Cal. 2011), the federal district court held, on an appeal from the bankruptcy
court, that the enforcabiity of an “unrecorded” attorney’s lien does not depend upon
whether the legal fees secured by the lien were related to securing the recovery
encumbered by the lien.
       Caution: First, equitable considerations can trump first in time priority. In Del
Conte Masonry Company v. Lewis (1971) 16 Cal. App. 3d 678, the court held that a
judgment creditor’s lien had priority over an attorney’s lien because the equities of the
competing claimaints were not equal: The attorney’s lien was not created until after the
judgment creditor had given notice that it intended to file a lien on the anticipated
judgment. The court noted that “an equitable preference” would be accorded to the
party that was first to assert its claim. Del Conte at 681. Second, to be valid an
attorney’s lien securing attorney fees based on an hourly rate (as opposed to a
contingent fee agreement) must comply with California Rule of Professional Conduct
3-300, which requires that the retention agreement be fair and reasonable to the client,
be fully disclosed in a writing that is reasonably understandable to the client, that the
client be advised in writing that he or she can seek the advice of an independent lawyer
and be given a reasonable opportunity to seek that advice, and that the client thereafter
consents in writing. Fletcher v. Davis, 33 Cal 4th 61 (2004). Whether Rule 3-300
applies to a provision creating an attorney’s charging lien in a contingent fee agreement
is apparently undecided. See Shopoff & Cavallo LLP v. Hyon 167 CA 4th 1489 (2008).
  G. Judicial Lien Issues
      1. Relation Back. Judgment liens on real property are ordinarily created by
recordation of an abstract of judgment with the county recorder (Cal Code Civ. Proc.
(“CCP”) § 697.310. Judgment liens on specified categories of personal property,
namely accounts receivable and tangible chattel paper of a judgment debtor located in
California, and equipment, farm products, inventory, and negotiable documents of title
located in California, are created by filing a notice of judgment lien with the Secretary
of State. CCP §§ 697.510 & 697.530. A judgment creditor can also get an execution
lien on a judgment debtor’s property, by levying on it. CCP § 697.710.
       Other categories of judicial liens include some prejudgment liens--attachment
liens under CCP § 488.500, liens created by service of a temporary protective order
under CCP § 486.110, liens on a pending action or proceeding under CCP § 491.410 et
seq., and liens created by service of an order to appear for a “third person” examination
(in aid of attachment) under CCP § 491.110. In addition to judgment liens and
execution liens, postjudgment judicial liens include liens created by service of an order
to appear for a debtor’s examination under CCP § 708.110 or a “third party”
examination under CCP § 708.120, the lien of an order in an examination proceeding
under CCP § 708.205, the lien of an earnings withholding order under CCP § 706.029,


                                          19
               the lien of a creditor’s suit under CCP § 708.250, a lien in a pending action or
               proceeding under CCP § 708.410, and liens on money owed to a judgment debtor by a
               public entity under CCP § 708.780.
                      Sometimes judicial liens relate back, for purposes of priority, to the creation of
               predecessor judicial liens obtained at an earlier stage of a court proceeding. For
               example, the priority of an attachment lien relates back to the creation of an earlier lien
               on the same property under a temporary protective order. CCP § 488.500(e). All of the
               postjudgment judicial liens described in the two preceding paragraphs, including
               judgment liens and execution liens, relate back to the date of creation of an earlier
               prejudgment attachment lien, temporary protective order lien, CCP § 491.410 et seq.
               lien, or CCP § 491.110 lien on the same property, provided the prejudment lien is still
               in effect when the postjudgment lien is created. CCP § 697.020(a). Similarly, all of
               the postjudgment liens described above relate back, for purposes of priority, to the
               creation of any previous postjudgment lien, of the types listed above, on the same
               property, provided the previous postjudgment lien is still in effect when the new
               postjudgment lien is created. CCP § 697.020(b).
                      Note, however, that these rules don’t vault a judicial lienholder in front of any
               interest that was senior to a pre-existing TPO lien or attachment lien even though
               acquired after the TPO lien or attachment lien took effect. CCP § 697.020(c); CCP §
               488.500(e). TPO liens and attachment liens may be subject to a variety of interests that
               were acquired after the effective date of the TPO or attachment lien. See CCP §§
               486.110(a), 488.500(d), & 697.740. These interests include, among other things, the
               interest of a purchaser for reasonably equivalent value without knowledge of the lien, a
               buyer in the ordinary course of business who would take free of a lien created by a
               seller or encumbrancer under Comm Code § 9320, a holder in due course of a
               negotiable instrument, etc. See CCP § 697.740.
                      2. “Order of Examination” (ORAP) Liens. Cal. Code Civ. Proc. § 708.110
               provides that service of an order requiring a judgment debtor to appear for a debtor’s
               examination creates a lien on the personal property of the judgment debtor for a period
               of one year from the date of the order, unless extended or sooner terminated by the
               court. Similarly, service of an order of examination on a third person who is shown to
               have possession or control of property in which the judgment debtor has an interest
               creates a lien of similar duration on any property in which the judgment debtor has an
               interest or any debt (sufficiently specified in the application for the order) owed by the
               third person to the judment debtor. Code Civ Proc § 708.120(c).
                     In Southern Cal Bank v. Zimmerman (In re Hilde) 120 F3d 950 (9th Cir. 1997),
               the Ninth Circuit held that (1) there is no requirment that the lien created by service of
               an order to appear (“ORAP”) be “perfected” in order for it to be entitled to priority over
               subsequently created interests23 and (2) so long as an ORAP lien was created more than
               90 days before the filing of a bankrupty petition, so as to be immune from avoidance as


   23
       ORAP liens are “hidden” liens in the sense that they won’t show up in a search of the public records (unless one
knows which Superior Court or federal court case file to search). A 131-page “Hidden Liens Report” prepared by the
UCC Committee is currently available on the California State Bar’s website, at
http://businesslaw.calbar.ca.gov/Publications/HiddenLiens.aspx.

                                                               20
a preferential transfer [and, presumably, was still in effect because the one year period
of its effectiveness under the applicable statute hadn’t expired], the judgment creditor’s
rights to the debtor’s non-exempt personal property trumped the rights of a Chapter 7
bankruptcy trustee. The court acknowledged that CCP § 708.205 authorizes a court to
make an order, at the conclusion of a debtor’s examination, that specified non-exempt
property of the judgment debtor be applied to satisfaction of the judgment and that such
a “turnover order” creates a lien on the property that relates back to the ORAP lien, but
the court rejected the contention that obtaining such a “turnover” order is required to
“perfect” the ORAP lien or to keep it in effect. So, serving an order to appear for a
debtor’s examination is a relatively easy way for a judgment creditor’s attorney to
establish a priority position on the debtor’s personal property without having to be
concerned about perfection issues.
       ORAP liens, however, are junior to subsequent transferees or encumbrancers
listed in Cal. Code Civ. Proc. § 697.740, including purchasers or encumbrancers for
reasonably equivalent value without knowledge of the lien, buyers in the ordinary
course of business, holders in due course of a negotiable instrument, holders of
purchase money security interests, and some others (Cal. Code Civ. Proc. § 697.920.)
But cf. Credit Suisse First Boston Mortgage Capital, LLC v. Danning, Gill, Diamond &
Kollitz, 178 Cal. App. 4th 1290, 101 Cal. Rptr. 3d 192 (Nov. 2009) [law firm that was
aware of ORAP lien when its retainer was paid from debtor’s bank account took
subject to the lien]. Note that under federal law. an ORAP lien on a registered
copyright has to be perfected by recordation in the U.S. Copyright Office. Morgan
Creek Productionss, Inc. vs. Franchise Pictures LLC (In re Franchise Pictures, LLC)
389 B.R. 131 (B.C.C.D. Cal. 2008).
       3. Retroactive Promotion of Expanded Exemption: In 1991, the U.S. Supreme
Court held that a state law homestead exemption, in a state that had opted out of the
federal exemptions, gave greater rights to a bankruptcy debtor than it would have
conferred on the debtor outside bankruptcy. Owen v. Owen 500 U.S. 305, 111 S. Ct.
1833, 114 .L Ed. 2d 350 (1991), involved a Florida judgment lien that had attached to a
condominium before the Florida homestead law was amended to allow such property to
be claimed as a homestead. The Florida courts had interpreted the law as not being
applicable to judgment liens that had attached before the law was amended. The debtor
filed Chapter 7 bankruptcy and moved to avoid the judgment lien under 11 U.S.C. §
522(f), which authorizes avoidance of judgment liens to the extent that such liens
impair “an exemption to which the debtor would have been entitled.” The bankrupty
court denied the motion, and the district court and the Eleventh Circuit affirmed,
concluding that the debtor wouldn’t have been entitled to the exemption under Florida
law and that where the exemption was created by state law, § 522(f) wasn’t intended to
expand the scope of the exemption. The Supreme Court reversed. The court reasoned
that the approach of the federal courts in applying § 522(f) to a federal exemption was
to ask whether the lien impairs an exemption to which the debtor would be entitled but
for existence of the lien, and, if so, to avoid the lien, rather than asking whether the lien
impairs an exemption to which the debtor is in fact entitled. The court concluded that
there was no basis for adopting a different interpretation of § 522(f) when dealing with
state exemptions. Therefore the judgment lien was avoidable because it impaired an
exemption to which the debtor would have been entitled if the lien didn’t exist. The


                                          21
               court determined that the extent to which a judgment lien can be avoided under § 522(f)
               is determined by federal law, even in a state that has opted out of the federal
               exemptions. In other words, a state can’t keep a lien from being avoided under § 522(f)
               by defining exempt property in such a way as to specifically exclude property subject
               to a judicial lien. Owen, 500 U.S. at 306. 24
                      In Hastings v. Holmes (In re Hastings) 185 B.R. 811 (9th BAP 1995) the court,
               citing Owen, ruled that California debtors were entitled to avoid a judgment lien on
               their residence even though the judgment lien had attached before the debtors moved
               into the property. This was so because under Owen, a judgment lien impairs an
               exemption if the debtor would be entitled to an exemption under state law if the lien did
               not exist. So, if your client owns residential real estate with a judgment lien on it but
               doesn’t live there, he or she can move onto the premises before filing bankruptcy and
               then avoid the lien to the extent the applicable exemption amount, the other liens, and
               the judgment lien exceed the value of your client’s interest in the property. This
               appears to be the case even though California CCP section § 704.710(c) defines a
               homestead, in part, as the principal dwelling in which the judgment debtor or the
               judgment debtor’s spouse resided on the date the judgment creditor’s lien attached to
               the dwelling. (However, it won’t work for your client to both purchase the interest in
               property and move into it after the judgment lien is recorded. If the abstract of
               judgment was recorded before debtor acquired the property, then the lien can’t be
               avoided. Farrey v. Sanderfoot 500 U.S. 291, 114 L. Ed. 2d 337, 111 S. Ct. 1825
               (1991).)
                     H. Equitable Subrogation of Unperfected Trust Deeds/Mortgages. Equitable
               subrogation allows a person who pays off an encumbrance to assume the same
               equitable position as the holder of the paid-off encumbrance. Taxel vs. Chase
               Manhattan Bank (In re Deuel) 361 B.R. 509 (9th Cir. BAP 2006). The elements of a
               claim for equitable subrogation are that (a) the entire encumbrance was paid by the
               subrogee to protect his own interest; (b) the subrogee did not act as a volunteer; (c) the
               debt was not one for which the subrogee was primarily liable; and (d) subrogation does
               not work any injustice to the rights of others. Grant vs. De Otte 122 Cal. App 2d 724
               (1954).
                      The classic situation where equitable subrogation becomes an issue is when one
               lender pays off another lien through a refinancing loan but fails to perfect the
               instrument (usually a trust deed or mortgage) securing the new loan. This was exactly
               the situation in Taxel vs. Chase Manhattan Bank, supra, except that it involved the
               further complication that the debtor had filed a bankruptcy petition after the new lender
               paid the loan secured by the since reconveyed trust deed to which the new lender
               sought to be subrogated. The court ruled that because 11 U.S.C. § 544 gives
               bankruptcy trustees the same rights as a bona fide purchaser of real estate, the
               bankruptcy trustee’s interest trumped the new lender’s equitable subrogation claim.

   24
      If you look at the Supreme Court’s Owen opinion on Lexis, you’ll see a red ‘stop sign”, indicating that Owen has
been “superceded by statute.” Lexis appears to be incorrect. The change in the law Lexis refers to is the 1994 addition
of § 522(f)(3), which affects only the avoidability of liens that are non-possessory, non-purchase money security
interests in implements, professional books, tools of the trade, farm animals and crops. See In re Parrish, 186 B.R. 246,
248 (W.D. Wisc. 1995).

                                                               22
Taxel at 518. Under California law, a bona fide purchaser who gave value in reliance
on the reconveyance of the senior lien and was without knowledge of the unperfected
lien of the party who’d paid the senior lien would prevail over a claimed right to
equitable subrogation. 361 B.R. at 517. See J.G. Boswell Co. vs. W.D. Felder & Co.
103 Cal. App. 2d 767 (1951) [equities favored bona fide purchaser over party asserting
equitable subrogation]. So, although the court noted that a canceled lien can be
“revived” for equitable subrogation purposes and that the holder of a junior lien or
interest is generally in no worse position if a party who paid a senior lien is equitably
subrogated to the senior lien’s priority, equitable subrogation wasn’t viable as against
the bankruptcy trustee.




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