Law School Outline - Secured Finance - Thomas Gorman

Secured Transactions: Outline Disclaimer: These notes and outlines are provided asis without any warranty as to their correctness, completeness, or quality. They are not meant to be a substitute for your own efforts. You may copy and forward this document as long as you do not alter its contents. 10/14/2006 Revision 0.1 Author: Philip Larson Secured Transactions: Outline Table of Contents 1. SECURED TRANSACTIONS: OUTLINE ...................................................................... 3 1.1 INTRODUCTION .................................................................................................... 3 1.1.1 BACKGROUND - UCC ........................................................................................ 3 1.1.2 SCOPE OF ARTICLE 9......................................................................................... 3 1.1.1 CREATION OF A SECURITY INTEREST........................................................... 4 1.1.2 PERFECTION ....................................................................................................... 6 1.1.3 FILING .................................................................................................................. 8 1.1.4 PRIORITY............................................................................................................. 9 1.1.1 BANKRUPTCY .................................................................................................. 15 1.1.2 DEFAULT ........................................................................................................... 17 Philip Larson Page 2 Secured Transactions: Outline 1. SECURED TRANSACTIONS: OUTLINE 1.1 INTRODUCTION 1.1.1 BACKGROUND - UCC A. Article 9 – In General: UCC was adopted in every state. Article 9 sets forth comprehensive statutory framework covering all types of secured transactions in personal property. B. Goals of Debtor and Creditor: debtor wants to get as much credit as needed w/o giving any more security than necessary. A creditor wants to be repaid plus a profit and wants priority over other creditors. Security legislation balances these goals. a. Terminology: a debtor (owner, lessee, etc. of goods) grants a security interest in collateral to a secured party by executing a security agreement. The debtor owes the debt secured by the security interest. b. Goal of Security Interest Legislation: balance goals of debtors from creditors. Article 9 focuses on the creditor’s rights in the collateral. C. Revisions: revisions were made in 1972 and 1999. D. Liens: a lien is a property interest given to the creditor in the debtor’s property. a. Types of Liens: i. Judicial lien: liens acquired in judicial proceedings. Typically created when winning party in a lawsuit has the sheriff “levy” on (seize) the property. ii. “Statutory” liens: liens created by statute in favor of certain unsecured creditors. (e.g. landlords, attorneys, IRS) iii. Consensual liens: arise by agreement b/w debtor and creditor. Article 9 security interests are consensual liens. 1.1.2 SCOPE OF ARTICLE 9 A. Terminology a. “Security Interest”: interest “in personal property or fixtures that secures payment or performance of an obligation.” § 1-201(37). b. “Security Agreement”: an agreement that creates or provides for a security interest, no matter what it calls itself. § 9-102(a)(73). c. “Secured Party”: lender, seller or person in whose favor there is a security interest. § 9-102(72). d. “Debtor”: the owner, lessee of the goods used as collateral. § 9-102 e. “Obligor”: person who owes the debt to the creditor. § 9-102 B. Scope of Article 9 a. General: Article 9 applies to 1) “any transaction (regardless of form) which is intended to create a security interest in personal property or fixtures. § 9-109(a). b. Types of Collateral: many of the rules in Article 9 turn on the type of collateral. Article 9 covers 1) tangible collateral (i.e. goods), 2) quasi-tangible collateral (i.e. promissory notes), and 3) intangible collateral (i.e. accounts receivable). i. Goods: goods are “all things that are movable when a security interest attaches.” Includes unborn young of animals, crops, and fixtures. § 9-102. There are four categories of goods: 1. Consumer goods: bought primarily for “personal, family or household purposes.” § 9-102 2. Inventory: held for sale or lease to others in the ordinary course of business. § 9-102. 3. Farm products: used or produced in farming (e.g. crops, livestock, etc.) 4. Equipment: goods are equipment if they don’t fit into any other categories of goods. § 9-102. ii. Quasi-Tangible Collateral: legal rights usually represented by pieces of paper. These include: 1. Instruments 2. Documents: documents of title such as bills of lading and warehouse receipts. 3. Chattel paper: record that evidences both a monetary obligation and a security interest in or a lease of specific goods. 4. Investment property: iii. Intangible collateral: collateral that has no physical form. Five types: 1. Accounts: a right of payment for goods or services sold or leased that is not evidenced by an instrument or chattel paper. 2. Letter of credit tights 3. Deposit accounts: accounts maintained with a bank (but not consumer deposit accounts). Philip Larson Page 3 Secured Transactions: Outline Commercial Tort claims “General Intangibles”: vague category that includes anything that doesn’t fit into an above category. This is the catchall. c. Types of transactions: any financing transaction can be subject to Article 9 if the purpose is to create a security interest in collateral. i. Leases: a true lease is not a secured transaction and not subject to Article 9. However, leases are often structured so that the lessee may purchase the leased goods at the end of the term. Question is whether it is a lease or a financing arrangement. If it seems more like a financing statement, it is subject to Article 9. 1. True leases or sale on credit: depends on facts of the case. If the lessee has 1) no right to terminate the lease, 2) the goods have no economic value at the end of the lease or the lessee can purchase the goods for little or nothing, then it is a secured transaction. In re Marhoefer Packing Co., Inc (a lease may be intended as a security interest covered by Article 9 if it can be bought at the end for a nominal sum – a “disguised” security interest). ii. Consignments: wholesaler or manufacturer turns goods over to a retailer but retains title. If they are not sold, the manufacturer gets the goods back free from any claims of the retailers creditors. This is not covered by Article 9. However, if the retailer must pay for the goods in any event, this is a secured transaction. 1. If Article 9 Applies: it is treated as a purchase money security interest (PMSI) in inventory. iii. Sale of Accounts: these ARE covered by Article 9. However, under § 9-608, for a sale of accounts the debtor is not entitled to any surplus. However, if a security interest secures an indebtedness, the debtor does get surplus. Therefore, a common issue is whether a transaction is a sale of accounts or a financing arrangement. Major’s Furniture Mart, Inc. v. Castle Credit Corp (held this was not a true sale of accounts, it was a financing arrangement, so Castle owed Major’s the surplus); 1. C. TRANSACTIONS EXCLUDED FROM ARTICLE 9 a. Preempted by Federal law: Article 9 is not all encompassing. It does not apply to federal statutes that preempt it. In re Peregrine (copyrights are preempted by federal law. They are filed in a different place.); contrast with In re Cybernetics Services (filing with PTO not necessary to create security interest in a patent) b. Bank Set-offs: this article does not apply to any right of set-off. § 9-109(c)(10) However, a secured creditor can beat the bank if it has control by putting the account in its name. § 9-340(c). c. Real Property Interests: Article 9 applies only to personal property, and landlord’s liens and other interests in real property are all excluded. § 9-109. d. Mechanics liens: rights of artisans and service people are governed by local or common law. These are possessory liens under § 9-333. They get priority over a security interest unless the statute says otherwise. e. Insurance policies & consumer deposit accounts: if these are put up as collateral, they are excluded from Article 9. f. Sale of business: sale of business is not a normal financing transaction. If accounts, chattel paper, and all other assets are sold as part of a sale of the business, no compliance with Article 9 is needed. § 9-109. g. Subordination agreements: an agreement where two creditors having security interests in the same collateral decide to reverse which one is senior and which is junior. These are enforceable but are not themselves Article 9 security interests. § 9-339. 1.1.3 CREATION OF A SECURITY INTEREST A. Questions: a. Is there a security agreement that is complete? b. Did the secured party give value sufficient to support the agreement c. Does the debtor have existing rights in the collateral? B. Introduction: UCC provides a guarantee to lenders that if they follow its language and avoid the exceptions, their security interest will be effective “between the parties, against purchasers of the collateral, and against creditors.” § 9-201. a. Creation of a Security Interest – Overview i. Attachment and perfection: the process by which the debtor and creditor create a secrity interest in the debtor’s collateral effective b/w the two parties is called “attachment”. The process by which this security interest is then made good against the rest of the world is called “perfection.” ii. Security agreement & financing statement: the two primary documents usually involved in Article 9 are security agreements and financing statements. Security agreements are Ks b/w debtor and creditor that spell out the rights and duties of the parties regarding the collateral. This is required for attachment. The 4. 5. Philip Larson Page 4 Secured Transactions: Outline financing statement is a document containing information about eh creditor’s security interest and is typically needed for perfection. The creditor perfects by filing the financing statement in the public records indexed under the debtor’s name. C. ATTACHMENT – GENERALLY a. Definition: attachment is the process by which a security interest is created in the property of the debtor in favor of the secured party. A security interest is not perfected until it has attached. (e.g. it cannot be good against other parties until it is effective b/w the debtor and creditor). b. Limitation: if a security interest is only attached, it does not prevail over perfected secured creditors, lien holders, or trustee in bankruptcy. c. Requirements: three requirements for “attachment” of a security interest – i. Security Agreement: parties must have an agreement that the security interest attach. 1. Agreement plus possession 2. Agreement plus control 3. Agreement plus authenticated record. ii. Value from Creditor: value must be given by the secured party (creditor); and 1. Consideration (e.g. money) 2. Commitment of future value 3. Buyer’s acceptance of delivery under a preexisting K 4. A preexisting claim against debtor iii. Rights in Collateral: debtor must have rights in the collateral securing the value given by creditor. § 9203. 1. Debtor owns or has possession of collateral 2. in sale of goods, collateral has been identified by seller as intended for buyer. d. Timing: these three requirements can happen in any order. § 9-203 D. SECURITY AGREEMENT a. Necessity of Record: when an “authenticated record” of a security agreement is required depends on whether the secured party has possession or control of the collateral. i. Collateral in possession of secured party – oral agreements: if the secured party is in possession of the collateral, oral agreements are permitted and an authenticated record of the security agreement is not needed for attachment. § 9-203(b)(3)(B). Marlow v. Rollins (pre-petition transfers were not voidable under BC § 547(b) because had attached and perfected by possession) ii. Collateral under “control” of secured party – oral agreements: for collateral like deposit accounts, the secured party need only have “control” over the property for an oral agreement to be permitted. No authenticated record of the security agreement is needed for attachment. § 9-203(b)(3)(D). iii. No possession or control: a record authenticated by the debtor containing a description of collateral is required for attachment. § 9-203(b)(3)(A). In re Martin Grinding & Machine Works (description must reasonably identify collateral; if collateral is missing, security agreement is not valid). In re Bollinger Corp. (even though second lender had no security agreement, court said that financing statement + promissory note was sufficient to prove there was a security agreement). 1. Authenticated Record: Note: “authenticate” is broadly defined and includes anything where there was intent to “identify the authenticating party” and adopt or accept the record. § 9102(a)(7) 2. Agreement to secure: you have to intend to grant a security interest. In re Clark (no intention to create security interest in liquor license so no attachment). 3. Description of collateral: the description is sufficient if it reasonably identifies what is described. § 9-108. You must be able to determine what collateral the parties intended the security interest to cover. § 9-108(b). Commercial Trading Co. v. Bassin (“equipment” does not reasonably identify two Oldsmobile cars – too broad) a. Type: collateral can’t be described just by its type for 1) commercial tort claims, 2) consumer goods. It must be more specific. § 9-108(e). b. Supergeneric: a statement like “all the debtor’s property” is not sufficient. § 108(c). World Wide Tracers, Inc. v. Metropolitan Protection, Inc. (“any property of debtor” was not sufficient to create security interest in intangibles like receivables). In a financing statement, supergeneric descriptions are permitted b/c it would alert those looking at the financing statement about necessity to inquire further. § 9-504. Philip Larson Page 5 Secured Transactions: Outline c. “After-acquired property”: a security interest may be created in after-acquired property. § 9-204(a). This does not include after-acquired tort claims. The security agreement must expressly use this term, although “inventory” would also be sufficient. Floating liens: these attach to debtor’s accounts, stock, inventory, etc. However, debtor has the right to transfer and dispose of individual items of collateral. Thus, the collateral is always changing (e.g. inventory). d. E. VALUE FROM CREDITOR a. Introduction: the security interest cannot attach until the creditor has given “value.” § 9-203(b)(1). This is usually an advance of money or delivery of goods. This includes obtaining rights: i. in return for any consideration sufficient to support a simple contract. (e.g. money) ii. as security for a preexisting claim. iii. By accepting delivery under a preexisting K for purchase. iv. In return for a commitment to give future value (commitment must be definite) F. DEBTOR’S RIGHTS IN COLLATERAL a. Rights in Collateral: before a security interest can attach, the debtor must have rights in the collateral, obviously. § 9-203(b)(2). In re Whatley (held Whatley Farms had sufficient rights in collateral to grant a security interest). i. Definition: the debtor must have some ownership interest or right to obtain possession. ii. Title to collateral is irrelevant: b. Restrictions on Debtor’s Right to Transfer Collateral: any provision in a security agreement that tries to prohibit the transfer of the debtor’s rights in the collateral is void. § 9-401(b). However, clauses that give the secured party the right to accelerate payment in event of debtor transferring collateral is valid. 1.1.4 PERFECTION A. Questions: a. Filing a financing statement – appropriate office with description, etc. b. Possession of collateral c. Control over collateral – deposit accounts d. Automatic perfection – PMSI in consumer goods. Consider rules of temporary perfection. B. METHODS OF PERFECTION a. Summary: classification of collateral is important to determine how to perfect. However, correct classification can be a pain. In re Newman; In re Vienna Park Properties i. Filing: effective for all types of collateral except deposit accounts and letter of credit rights. ii. Possession: effective for goods, money, documents, certified securities, instruments, and chattel paper. iii. Automatic: PMSI in consumer goods, sale of promissory notes and payment intangibles. There are also temporary periods of automatic perfection that give 20 days from moment of attachment if secured party gives new value and collateral is a negotiable document, certified security, or instrument. iv. Control: effective for investment property, deposit accounts, letter of credit rights, and electronic chattel paper. b. Definition: UCC does not define perfection. However, § 9-317 lists creditors over whom unperfected security interests will not prevail. Perfection is a set of actions that, when complied with, give the secured party priority over certain other classes of the debtor’s creditors. c. Four methods of perfection: UCC provides four methods of perfection. It requires ATTACHMENT PLUS 1) filing a financing statement, 2) possession of the collateral, 3) control over the collateral, or 4) automatic perfection where attachment is sufficient. Applicability of each depends on the type of the collateral, although filing is available for almost everything. d. Filing a Financing Statement: a financing statement 1) notes the secured party’s interest, and 2) generally describes the type of collateral. It is filed in a public office. Knostman v. West Loop Savings Ass’n (court held the Bank had an unperfected security interest in an annuity K; they should have filed a financing statement for their general intangible. Trustee gets the annuity; Note: now § 9-312 allows both instruments and general intangibles to be perfected by filing). i. Accounts & Receivables: filing is the only method of perfection. § 9-310. e. Perfection by Possession: a pledge occurs when the creditor takes physical possession of the collateral and holds onto it during the term of the loan. This constitutes perfection as soon as requirements of attachment are complete. § 9-313. In re Coral Petroleum (held Paribas did not have a perfected security interest in a note because it lacked possession); Marlow v. Rollins (pre-petition transfers were not voidable under BC § 547(b) because had attached and perfected by possession) Philip Larson Page 6 Secured Transactions: Outline i. Pros and cons: this is probably the “best way” to perfect because it solves any Statute of Frauds problems (oral security agreements are fine) and assures perfection. § 9-310(b)(6). ii. Both Attachment & Perfection: possession is a way of obtaining both attachment and perfection. Thus, if a secured party takes possession of the collateral, the security interest is simultaneously attached and perfected, as long as the other attachment requirements are met. iii. Types of property covered: possession perfects security interest in goods, money, instruments, chattel paper, etc. § 9-313(a)-(b). The only property not covered are intangibles such as a liquor license, country club membership, etc. In re Coral Petroleum 1. Inventory: to obtain possession of inventory, it can be placed in a warehouse and then the creditor takes possession of the negotiable warehouse receipt issued by the warehouse. Since no one can get the goods without the warehouse receipt, possession of the document is possession of the goods. § 9-312(c). iv. Duration of perfection: when perfected through possession, it is effective as long as possession continues. § 9-313(d). v. Rights and duties of secured party in possession: the secured party must use reasonable care to preserve the collateral. the secured party may keep increase in profits on the collateral as additional security. However, any money received from the collateral must be returned to the debtor or applied against the secured obligation. § 9-207(c). Automatic Perfection: some transactions perfect automatically, for commercial convenience. i. Purchase money security interest (PMSI) in consumer goods: a security interest in consumer goods arising in connection with purchase of the goods is perfected automatically upon attachment. § 9-309(1). 1. Rationale: retail merchants should not have to file everytime they sell a consumer a toaster. 2. “Consumer goods”: goods bought “primarily for personal, family or household purposes.” Look to the purchaser’s primary use. However, if the consumer says the goods are for personal use and is lying, the creditor is still protected w/o filing if he believed the debtor. 3. “Purchase money” transactions: PMSI arises when the secured party advances money or credit to enable debtor to purchase the collateral. § 9-103. 4. Security agreement is required: even though creditor need not file notice of interest in PMSI for consumer goods, the creditor must still have an authenticated security agreement with debtor to obtain a valid security interest. 5. PMSI in other goods: a creditor with a PMSI in any type of goods has special priority (“super priority”) over most other creditors if he meets other requirements. 6. PMSI and Refinancing: there used to be controversy about whether PMSI lost status if the debt was refinanced or consolidated with other loans. For nonconsumer transactions, Article 9 adopts the dual status rule, saying that the creditor can retain PMSI status if the parties specify how payments are to be allocated to preserve the PMSI status of the original debt. § 9-103(e)(g).Billings v. Avco Colorado Industrial Bank (PMSI in furniture was refinanced. Still held valid to prevent BC § 522 exempt property provision). a. Default payment rule: if debtor gives no instructions, the payments are first applied to the unsecured debts. § 9-103(e)(3). b. Consumer transactions: are not discussed in the Code. Bankruptcy courts have discretion. ii. Sale of promissory notes and payment intangibles: these outright sales are Article 9 transactions, but the buyer is automatically perfected on attachment. § 9-309(3)-(4). iii. Temporary “automatic” perfection: the UCC provides for temporary perfection in some situations. § 9312. These typically involve security interests already in existence. 1. New value: if a secured party as to negotiable documents, certified securities, or instruments provides new value they obtain a 20-day perfection period from the moment of attachment, even if the secured party does not file and collateral stays with debtor. § 9-312(e). Control i. Control over Investment Property: for investment property (stocks, bonds, etc.) there are two methods of perfection: 1) filing a financing statement, and 2) getting “control” over the investment property. 1. Priority: if one creditor perfects by gaining control and another by filing, the creditor with control prevails over the creditor who perfected merely by filing. § 9-328(1). If two creditors have control, the first to gain control has priority. § 9-328. f. g. Philip Larson Page 7 Secured Transactions: Outline ii. Control over Deposit Accounts: filing is not an option for perfecting a security interest in a bank account. Getting control is the only way to perfect. § 9-312(b)(1). 1. Three ways to get control: 1) the bank in which the deposit account is maintained automatically has control, 2) creditors other than the bank can change the account name to that of the creditor, or 3) have the bank agree in an authenticated record that the bank will follow the instructions of the creditor w/o consent of debtor. § 9-104(a). C. TIME OF PERFECTION a. Completion of Filing or other requirements: a security interest is perfected when 1) it has attached and 2) all other required steps for perfection have taken place. A secured party can take steps to perfect prior to attachment but perfection only occurs with or after attachment. § 9-308(a). b. Intervening periods: if security interest is perfected more than once, the latter relates back to the date of the original perfection, as long as there is no intervening period. § 9-308(c). c. Priority: timing of perfection is important when determining which creditor has priority over the debtor’s collateral. D. PLACE OF PERFECTION a. Introduction: if a filing is not made in the proper state, the filing is not adequate for perfection. § 9-301. b. General Rule: the law of the jurisdiction in which the debtor is located generally governs perfection. i. Where is the debtor located? For corporations, regardless of where it is physically located, a corporation is located in the state of incorporation. § 9-307(e). For individuals, they are located at their primary residence. For noncorporate organizations (e.g. partnerships), they are located at their place of business or executive office. § 9-307. ii. Change of debtor’s location: if perfection is governed by law of where debtor is located, and debtor changes location, a reperfection is required within 4 months (even if the secured party does not know of the change. § 9-316(a)(2). If they fail to reperfect, the interest becomes unperfected as against any purchaser of the collateral. Metro Communications (when debtor changes location is largely a factual determination) 1. Automatic perfection: if the collateral is of the type that is perfected automatically, the fourmonth rule obviously does not apply. 1.1.5 FILING A. FINANCING STATEMENT a. Summary: SECURITY AGREEMENT vs. FINANCING STATEMENT Security Agreement Financing statement 1) language creating 1) debtor & creditor’s Requirements security interest names and addresses 2) description of collateral 2) description of 3) authentication by debtor collateral § 9-203 § 9-502, § 9-516 Yes (but not for inventory). After-acquired No. § 9-204(a) clause needed? No. § 9-108(c) Yes. § 9-504(2) Supergeneric descriptions? b. c. Notice filing – financing statement could be a copy of the security agreement or a briefer document. They are indexed under the debtor’s name. Required Contents of Financing Statement – make sure the financing statement has i. 1) the name and address of debtor, ii. 2) the name and address of secured party, and iii. 3) a description of collateral. § 9-502, § 9-516 iv. Debtor signature? A filing need only be “authorized by an authenticated record”, and the security agreement automatically provides the authorization for the secured party to file. § 9-509. The idea is to encourage electronic filings and speed things up. Sufficiency of filing statement: a financing statement substantially complying with the requirements of § 9-502 is effective even if it has minor errors that are not seriously misleading. § 9-506(a). In re Clairmont Pharmacy (“Clairmont Skyland Pharmacy” was minor and not seriously misleading for real name “Clairmont, Pharmacy, Inc.) i. Error’s in debtor’s name: Article 9 asks whether a later search under the debtor’s correct name, using the filing office’s standard search logic, would find the initial financing statement. § 9-506(c). Chemical d. Philip Larson Page 8 Secured Transactions: Outline Bank v. Title Services, Inc (“Bois Clair” was seriously misleading for “Boisclair” because search from title company did not reveal the financing statement). 1. Trade names: Individuals doing business under trade names must be identified by their real names because trade names are too uncertain. § 9-503(c). 2. Changes in Debtor’s Name: if the debtor changes her name (or the company changes its identify or structure – e.g. merger), such that the filed financing statement becomes “seriously misleading”, the filing ceases to be effective as to any new collateral acquired by the debtor after four months, unless a new statement is filed before then. § 9-507(c), § 9-508(b). Woods v. Bath Industrial Sales, Inc. (filing financing statement in bad faith w/ debtor’s name about to change meant PMSI in inventory did not have to provide notice to blanket lien holder). ii. Error’s in creditor’s Name: less important than debtors b/c the financing statement is filed under debtor’s name. In re Copper King Inn, Inc (failed to list creditor’s name on statement. Held: not a minor error and potentially seriously misleading. Not properly perfected.) iii. Errors in address: the address of both secured party and debtor need only be reasonable under the circumstances. If the filing office accepts the financing statement with an inadequate address, it is effective. iv. Description of collateral: description of collateral must be sufficient to allow a party to identify it by reasonable further inquiry. § 9-502(a); Thorp Commercial Corp v. Northgate Industries (description in financing statement is okay if it would “reasonably induce further inquiry) Therefore, less specificity is required than in the security agreement b/c the purpose is to provide mere notice to others to check further. A trade description or statement of type of collateral will suffice. § 9-504. 1. Supergeneric description allowed: statements like “all debtor’s assets” are sufficient, even though they wouldn’t be in a security agreement. § 9-504(2). 2. After-acquired property: this term does not have to be mentioned in the financing statement as long as the types of collateral subject to the after-acquired property are sufficiently described. (e.g. “motor vehicles” sufficient to cover after-acquired motor vehicles). Thorpe Commercial Corp v. Northgate Industries (“assignment accounts receivable” sufficient for accounts acquired after filing) e. Amendments: amendments to names or descriptions have no effect on perfection or priority. However, if the amendment adds collateral, the added collateral is only perfected as of the filing date of the amendment. § 9-512. B. WHERE TO FILE a. General Rules: default rule is that financing statement is filed in one central state office with the secretary of state in the state where the debtor is located (e.g. residence, incorporated). § 9-501. C. MECHANICS OF FILING a. When effective? Deemed effective upon the presentation of a financing statement for filing. What the filing officer does with the statement doesn’t matter as long as the secured party 1) presents a valid statement and 2) pays the fee. § 9-516(a). i. Indexing: is required to be done according to name of debtor. § 9-519. If misfiled, perfection is still valid. b. Duration of filing: financing statement is valid for five years from date of filing. § 9-515(a). i. Effect of lapse: security interest becomes unperfected and junior security interest holders or purchasers whose interests have attached before the lapse gain priority. § 9-515(c). c. Continuation statements: a secured party can extend the effectiveness of a financing statement about to expire by filing a continuation statement. This adds another five years to the effectiveness. § 9-515(d). In re Hilyard Drilling Co. (Worthen’s security interest lapsed due to failure to file a continuation statement in 6 months prior to expiration) d. Termination statement: once there is no outstanding secured obligation and no commitment to make advances, the secured party must, on authenticated demand of debtor, provide debtor with a termination statement within 20 days stating the secured party no longer claims security interest under the filing statement. The debtor can then file this termination statement. i. Demand requirement: for consumer goods, the secured party has to file the termination statement within a month following full payment, regardless of demand from consumer (debtor). 1.1.6 PRIORITY A. Questions Philip Larson Page 9 Secured Transactions: Outline Is the secured party’s interest perfected or unperfected? If unperfected, probably little priority. However, if perfected, that party may have priority over unperfected creditors or other perfected creditors under “first to file or perfect” rule, PMSI rules, control rules, and special rules for fixtures, etc. B. COMPELLING INTERESTS IN COLLATERAL – CLAIMANTS a. Introduction: when multiple parties claim the same piece of collateral, question of priority arises. UCC protects certain classes of interest holders over others. b. Types of Claimants i. Unsecured “General” Creditor: a creditor who has no security interest in the collateral but has a personal claim against the debtor is an unsecured creditor. This creditor may acquire an interest in the collateral if 1) debtor agrees to grant security interest, 2) creditor sues and gets a judicial lien. ii. Judicial “Lien Creditor”: a formerly unsecured (“general”) creditor that has acquired a lien on debtor’s property by judicial process (attachment, levy, etc.) is a judicial lien creditor. Under the UCC, lien creditors also include trustees appointed in bankruptcy to debtor’s estate, or a receiver appointed by court to take over and control the property. § 9-102(a)(52). 1. Time of Lien: a lien creditor’s interest arises at the time of “levy”, meaning the moment a judicial officer (e.g. sheriff) physically seizes the property. In bankruptcy, a judicial lien is automatically created on all the debtor’s nonexempt property when the petition is filed. § 9-102(a)(52). iii. Secured creditor: if debtor has agreed to give a security interest in specific collateral and it has “attached” (valid between the two parties), the creditor is “secured.” § 9-203. iv. Perfected and Secured Creditor: a secured creditor who has taken the steps necessary to protect the security interest from other claimants is both secured and perfected. v. Statutory Lien Creditor: a creditor whose lien interest arises automatically by statute (e.g. landlords, mechanics, lawyers, other services). vi. Buyers of property: if debtor sells the collateral, the buyer may face claims of debtor’s creditors. The general rule is that the law favors a good faith buyer over creditors. § 9-317(b). However, if the security interest is perfected it goes with the property. Octagon Gas v. Rimmer (sale of account to buyer did not protect it from the bankruptcy estate. Remanded to determine if Rimmer had a perfected security interest that would beat the trustee strong-arm). C. PRIORITY – UNPERFECTED CREDITORS a. Unperfected vs. Unperfected - First to Attach Rule: for two conflicting attached security interests in the same collateral, neither of which is perfected, the order of attachment determines priority. § 9-322(a)(3). Thorp Commercial Corp v. Northgate Industries. As a practical matter, this is never litigated because it is easier for a creditor to perfect prior to suit. b. Unperfected vs. Perfected: an unperfected creditor is junior (subordinate) to a creditor that has perfected the security in the collateral first. § 9-322(a)(2). i. Knowledge and time of attachment irrelevant: it doesn’t matter who attached first or even if the perfected creditor knew of the other’s interest in the collateral the whole time. J.I. Case Credit Corp v. Foos (§ 9-322 does not require good faith – it is a “pure race”) c. Unperfected vs. Judicial lien creditor: unperfected is junior to judicial lien creditor or trustee. § 9-317(a)(2). In re Vienna Park Properties. d. Unperfected vs. Statutory lien holder: unperfected is junior to these unless statute says otherwise. § 9-333. e. Unperfected vs. Buyer: purchasers of collateral from debtor who pay value and receive delivery take free of unperfected security interests in the collateral as long as they have no knowledge of the unperfected interest. § 9317(b). If collateral is intangible (e.g. account, investment property, or certified security, etc) no delivery requirement b/c there is nothing to deliver § 9-317(d) i. Inventory: if the collateral is inventory and the buyer purchases in the ordinary course of business (e.g. normal retail sale), the buyer takes free from all security interests in the inventory (perfected or not), even if the buyer knows of the security interest. § 9-320(a). D. PRIORITY - PERFECTED CREDITORS – GENERAL RULE a. Introduction: perfected security interests are senior to unperfected security interests. But what if two perfected security interest exist in the same collateral? b. General Rule – First to File or Perfect: priority goes to whichever secured party is first to either 1) file, or 2) perfect the security interest, whichever is earlier, provided there is no intervening period of nonperfection. § 9322(a)(1). Bank of the West v. Commercial Credit Financial Services, Inc; Delaware Truck Sales, Inc. v. Wilson i. Attachment: the first to file or perfect rule works even if the security interest of the creditor that is first to file has not attached yet. a. Philip Larson Page 10 Secured Transactions: Outline ii. Limitation: senior lien holder cannot induce an unsecured creditor to increase the value of their collateral or this is unjust enrichment Ninth District Production Credit Ass’n v. Ed Duggan (if the senior creditor takes over the debtor’s business – corn – junior lien holders may jump ahead if senior is unjustly enriched by encouraging the transaction). c. Marshalling: when there are two creditors of the same debtor, and two funds belonging to the debtor and one of them alone has right to resort to both funds, the senior creditor must exhaust the fund that only they have access to before going after the other fund so the junior creditor can collect part of the fund. In re The Computer Room, Inc. Note, this is not applied much by the courts. E. PRIORITY - PERFECTED CREDITORS vs PMSI INTERESTS a. Summary: GAINING PMSI SUPER-PRIORITY Method of Obtaining PMSI Proceeds Covered Automatic upon attachment all identifiable proceeds Perfection b/f or w/i 20 days after all identifiable proceeds debtor receives collateral Perfection and authenticated notice given to other filed secured parties b/f debtor receives inventory Cash proceeds received on or before delivery of inventory to buyer, instrument proceeds, and chattel paper proceeds All identifiable proceeds and unmanufactured products Consumer Goods Equipment/Farm Products (not livestock) Inventory Livestock Perfection and authenticated notice given to other filed secured parties b/f debtor receives livestock. b. c. d. Introduction: the general rule of priority (first to file or perfect) is subject to modification when certain security interests are involved. The first type of security interest getting “super priority” is PMSI. A creditor who advances value to a debtor enabling debtor to acquire interest in collateral has PMSI. Since the advance is directly related to the collateral, the creditor is given add’l protection. § 9-324(a)(1) MBank Alamo v. Raytheon (PMSIs are excepted from the first-to-file rule and take priority over other perfected security interests) PMSI (non-inventory and non-livestock): a PMSI takes priority over conflicting security interests in the same collateral and its identifiable proceeds. (i.e. things received upon the sale or disposition of the collateral) if the interest is perfected when the debtor takes possession or within 20 days thereafter. § 9-324(a). i. Rationale: the debtor would have no way to finance new purchases otherwise. This PMSI rule prevents debtors from being captives to existing creditors. ii. Limit: the priority of the PMSI is limited to the extent of the “purchase money” used in acquisition of the collateral. iii. PMSI in Consumer goods: remember that this is automatically perfected. § 9-309(1). Therefore, once a creditor attaches a PMSI in consumer goods, perfection is automatic and they get PMSI super-priority. PMSI in Inventory: a lender giving money to a retailer taking a security interest in retailer’s inventory expects to get top priority as to the debtor’s after-acquired inventory as well as existing inventory. If creditors selling inventory to retailer on credit could get PMSIs prevailing over this after-acquired property interest, the first lender’s security interest would become nonexistent over time. MBank Alamo v. Raytheon (PMSIs in inventory are limited to the specific inventory given or any identifiable cash proceeds from that inventory) Therefore, i. Exception: Therefore, super majority rule does not work for inventory unless two conditions are met: 1. 1) the PMSI is already perfected at the time the debtor receives possession of the collateral (no 20 day grace period), § 9-324(b)(1) and 2. 2) the purchase money secured party gives authenticated notice to any other security interest holder that has previously filed a financing statement covering inventory of the same type of goods. § 9-324(b)(2) The notice must be prior to the date the debtor takes possession of the collateral. Woods v. Bath Industrial (Woods PMSI was superior even without notice because H&G filed financing statement in bad faith by using an old name of debtor prior to name change) a. Notice Contents: notice must state the person filing expects to acquire a PMSI in the inventory and must describe the inventory. § 9-324(b)(4). Philip Larson Page 11 Secured Transactions: Outline Duration of notice: when properly given, the notice lasts five years. After 5 years, new notice must be sent to and received by the conflicting interest holder. § 9-324(b)(3). ii. Proceeds covered: the PMSI super-priority also extends to certain proceeds of inventory collateral, assuming the cash proceeds are identifiable. e. Two PMSI Creditors w/ Interest in Same Collateral: if debtor buys something from seller on credit (PMSI) and borrows money from lender to make downpayment (PMSI), the seller has priority over the lender. § 9-324(g). F. PRIORITY - PERFECTED CREDITORS – SPECIAL RULES a. Fixtures: Article 9’s only major involvement in real property financing arises when collateral is goods that are currently or about to become fixtures – personal property attached to real property. i. “Fixtures” Definition: fixtures is not defined in UCC but typically the ordinary building materials (e.g. bricks, lumber, cement, etc.) are excluded, and everything else that become fixtures are included. § 9334(a). Wyoming State Farm Loan Board v. Farm Credit System Capital Corp. (were drainage pipes added to a building fixtures? Held: pipes were not fixtures so real estate company got them. Wyoming was PMSI but they refinanced so they lost their priority.) Typically, permanent attachment of goods to real property is a fixture. 1. Mobile homes: are not fixtures. 2. “Readily movable” factory or office machines: hardly ever classified as fixtures. ii. Priority rules for Fixtures 1. PMSIs – fixture filing req.: most security interests in fixtures are PMSIs. These interests prevail against most existing and future interests in the real estate provided that the PMSI is perfected by a fixture filing at the time the goods are affixed to the property or w/i 20 days thereafter. a. “Fixture filing”: this is a perfection of the fixture financer’s security interest by filing a financing statement where real property records are filed. § 9-501(a)(1)(B). It must describe the goods and describe the related real estate. § 9-502(b). 2. Non-PMSIs: A non-PMSI in fixtures or PMSIs perfected more than 20 days after goods become a fixture, loses to prior recorded interests in the realty, even if the fixture financer perfects by a fixture filing. § 9-334(c). However, the non-PMSI financer can prevail over subsequent parties (i.e. later real property mortgagees and buyers) by making a fixture filing prior to obtaining rights in the realty. § 9-334(e)(1). b. Commingling Goods: goods physically united w/ other goods so that their identity is lost are “commingled”. (e.g. party w/ security interest in baled cotton that debtor spins into thread and weaves into a cotton blend with rayon. This is commingled.) § 9-336 i. Interest extends to ultimate product: a perfected security interest in goods that have become part of a product extends to the product if they have been manufactured or commingled so that they are no longer identifiable. § 9-336(b)-(d). ii. Competing interest: the UCC ranks the interests of the conflicting parties who each have security interests in raw materials used in a final product equally. Their interest in the total product is in proportion to thte value of the collateral at the time of commingling. § 9-336(f)(2). 1. Time of attachment and perfection is irrelevant: note that it makes no difference when the original interests in the commingled goods attached or were perfected. They are treated equally. c. Proceeds: Proceeds include anything received by the debtor on the sale or other disposition of the collateral, whether or not the disposition was authorized by the creditor. § 9-205. § 9-205 changed the rule under Benedict v. Ratner which said allowing debtor to dispose of collateral or to retain proceeds was a fraudulent transfer that could be set aside in bankruptcy. This frustrated modern commercial financing. Therefore, § 9-205 allows parties to agree to allow debtor to use or dispose of collateral or proceeds w/o secured party policing the matter. Issue: to what extent do secured party’s interests attach to proceeds? i. General Rule: § 9-315(a)(2) says, except as otherwise indicated…a security interest attaches to any identifiable proceeds of collateral. § 9-203(f) says that attachment in collateral gives secured party rights to proceeds covered in § 9-315. 1. 20-day grace period: § 9-315(d) creates a 20-day grace period. If the original collateral was perfected, the secured party has 20 days of temporary perfection for the proceeds. Perfection continues automatically for cash proceeds, § 9-315(d)(2), if affirmative steps are taken to perfect the proceeds, § 9-315(d)(3), and the “same office” rule, § 9-315(d)(1). ii. Background b. Philip Larson Page 12 Secured Transactions: Outline Second generation proceeds: are still proceeds. (e.g. D sells B car in C has interest. D gets cash and used car. D sells used car and gets more cash. All the cash are proceeds of initial car C has interest in. 2. Secured Party’s option b/w proceeds and collateral: in many cases, the secured party is not limited to asserting an interest in proceeds. If the security interest continues in the original collateral, notwithstanding the transfer to a third person, the secured party may claim both the proceeds and the original collateral – but only one satisfaction of the debt. § 9-315(a). Delaware Truck Sales, Inc. v. Wilson (priority of creditor w/ perfected security interest continues in proceeds from disposition) If the transfer cuts off the security interest, the secured party is limited to asserting an interest in the “proceeds.” iii. Rules regarding attachment and perfection of security interest in proceeds: as long as the secured party’s interest in the original collateral was perfected that interest often will continue automatically in any identifiable proceeds received by debtor for the sale, exchange or other disposition of the collateral. Date of priority: The date of priority in proceeds is the same as that for the original collateral. 1. “Same Office” Rule: if the financing statement for the proceeds received would have been filed in the same office as the original collateral, no new filing is required (unless filing office would be different). § 9-315(d)(1). 2. Cash Proceeds Rule: if cash proceeds are then used to buy new “second generation” proceeds. Then, secured party gets temporary perfection but must file new financing statement w/i 20 days. § 9-315(d)(1)(C). a. Cash Proceeds Tracing Rules: perfection of a security interest in original collateral continues to cash proceeds as long as they are identifiable. If they go into a bank account, it is assumed that withdrawals from that account are initially of money which no one claims an interest. 3. All other Cases: if neither the “same office” or “cash proceeds” rules apply, the creditor must obtain a perfected security interest in the proceeds within 20 days after the debtor receives the proceeds in order for it to relate back. iv. Rules of Priority in Proceeds: the usual priority rules (e.g. first to file or perfect) govern most priority disputes in proceeds. 1. Accounts as “proceeds” of inventory: anytime creditor A has interest in inventory and B in accounts receivable, there is a priority issue when inventory is sold on credit. The rule to apply is first-to-file-or-perfect, regardless of whether the security interest in the inventory is PMSI. a. Contrast w/ Cash proceeds: § 9-324(b) says that super-priority given a PMSI in new inventory continues to the cash proceeds. b. HYPO: A has interest in D’s accounts receivable and files first. B gets a PMSI in selling D more inventory. Some inventory is sold for cash and some on credit. B has superpriority over cash proceeds and any inventory left in the PMSI. A has priority for the ones sold on credit because he filed first. G. PRIORITY - PERFECTED CREDITORS – PERFECTION BY CONTROL a. Introduction: for investment property, deposit accounts, and letter of credit rights, the secured party can achieve perfection by obtaining control over the collateral. b. Priority in Deposit Accounts: a creditor that has control over a deposit account (the only method of perfecting a security interest in a deposit account), it prevails over all other claimants to the account who do not have control (e.g. those claiming a perfected security interest in the deposit account as proceeds of other collateral). This is the bank’s set-off rights. If more than one secured party has control, the secured parties rank in priority according to time of obtaining control (e.g. first to perfect). i. Exception to set-offs: the only exception to the bank’s superior right to set-off is if the other secured party obtained control of the account by putting it in its own name, in which case it prevails over the set-off rights of the bank. § 9-327(3), § 9-340(c). National Acceptance Co. v. Virginia Capital Bank (bank could not set-off debts when NAC had perfected security interest) H. PRIORITY - PERFECTED CREDITORS – TERMS OF SECURITY AGREEMENT a. Future Advances: § 9-204(c) says a security agreement can create security interests in the collateral covering not just the current loan, but also future loans from the same creditor. A new security agreement is not needed when the future loan is made. Moreover, the filed financing statement will perfect the security interest. 1. Philip Larson Page 13 Secured Transactions: Outline i. Effect on priority: this means that, based on the first-to-file-or-perfect rule, a creditor that files an initial financing statement will have priority even over its future advances because, even though perfection will take place when the future loans are given, priority will be based on the time of filing. ii. Multiple security agreements: even if the original security agreement fails to cover future loans, as long as its original financing statement is still on file, it wins the priority contest even if its loan is second in time. The rationale is that the second creditor had notice. b. Waiver of Security Interests: security agreements often say debtor cannot sell the collateral w/o written consent of secured party. However, debtor often does anyway and sometimes creditor finds out and does nothing. Does this constitute waiver or can the creditor go after the debtor’s buyer and repossess? i. Waiver: courts are mixed. Some say waiver is authorization and thus § 9-315(a)(1) applies. It says that a security interest continues in collateral notwithstanding the debtor’s sale, unless the disposition was authorized by the secured party. PRIORITY - PERFECTED CREDITORS vs OTHER CLAIMANTS a. Summary: i. A buyer of goods qualifies as a buyer “in the ordinary course of business” and thus takes goods free of any security interests if: 1. the purchase is “ordinary” purchase of seller’s inventory (no bulk sales). 2. the buyer purchased goods for value. 3. the buyer purchased goods in good faith w/o knowledge of violation of a security agreement. 4. security interest was created by the buyer’s seller. b. Buyers of the collateral – General Rule: the buyer of collateral subject to an unperfected security interest almost always gets the property free of the creditor’s right to reclaim it. However, a buyer of collateral covered by a perfected security interest generally takes the collateral subject to the security interest, with some exceptions. i. Exception – Buyers in “Ordinary Course of Business”: a buyer purchasing goods in the ordinary course of business from the dealer’s inventory takes free of the perfected security interest even if he knows the inventory is covered by a security interest, as long as the buyer does not know the sale is in violation of the security agreement. § 9-320(a). 1. Rationale: dealer’s creditor has a “floating lien” and everyone expects that the particular item sold is freed from the inventory lien. 2. Proceeds: note, the security interest does attach to the proceeds of the sale, although for non-cash proceeds that aren’t subject to the “same office” rule they probably have to file a new financing statement w/i 20 days. 3. “Ordinary course of business”: The transaction must be “run of the mill” and not an extraordinary sale (such as “bulk sales”). a. Secured party in possession trumps buyer in ordinary course of business: if the secured party keeps possession of the collateral, they have priority even over a buyer in the ordinary course of business. § 9-320(e). 4. Goods Other than Inventory: a security interest in goods other than inventory continues in the collateral, even in the hands of a good faith buyer for value. § 9-315(a)(1). Bank of the West v. Commercial Credit Financial Services, Inc. ii. Exception – Garage Sale - buyers of consumers goods from other consumers: § 9-320(b) says that a consumer buying consumer goods from another consumer for value takes free of a perfected security interest in the goods unless the buying consumer knows of the security interest or a financing statement covering the goods has been filed. Since PMSIs in consumer goods are automatically perfected without filing, this is a rare case. § 9-311(b). c. Statutory lien holders: (e.g. tax liens, services liens, etc.) § 9-333, a person who acquires under statute a lien on goods in that person’s possession as a result of materials or services furnished prevails over a prior perfected security interest in the goods. (e.g. car with perfected PMSI is taken to repair shop and consumer failed to pay repair bill. As long as repair shop possesses the car, its lien has priority). i. Exception : the only exception is where the statute expressly makes the statutory lien junior to prior security interests. § 9-333(b). d. Federal Tax Lien: § 6321 – IRS gets a lien when three things happen: 1) they assess tax, 2) they demand payment, and 3) TxP refuses to pay. a TxP that fails to pay federal taxes, the IRS gets a tax lien on all TxP’s property, real and personal, now owned or after-acquired. The federal tax lien arises at the moment of tax “assessment.” Rice Investment Co. v. United States (perfected security interest in inventory lost to IRS because the specific inventory was ever changing so the inventory after the tax lien arose was not choate). I. Philip Larson Page 14 Secured Transactions: Outline i. Choate: a tax lien has priority over nonfederal tax liens that are not choate. To be “choate”, requires three things be established beyond any possibility of dispute: 1) identity of lienor, 2) propery subject to lien, and 3) amount of the lien. ii. Priorities: the FTL is valid against most other parties even though only the IRS knows about it. Its validity against Article 9 security interests depends on whether the interests are perfected before notice of the lien is filed with the state. 1. Unperfected security interests: the FTL has priority over unperfected creditors. 2. Perfected security interests: these beat the FTL if perfected prior to FTL is filed. 3. Subsequent PMSI: the FTL is subordinate to perfected PMSI in property acquired after the FTL filing. 4. Security interest in after-acquired property: if the property is acquired within 45 days of FTL being filed, it is senior to FTL. Those after 45 days are junior. IRC § 6323. Rice Investment Co. v. US (Rice’s security interest in inventory lost out to an IRS tax lien because the inventory kept changing). Judicial lien creditors: while a judicial lien creditor is senior to unperfected security interests, they are junior to a perfected security interest. § 9-317(a)(2). i. Future advances: future advances retain priority if 1) made within 45 days after the judicial lien is acquired, or 2) after 45 days if the creditor has no knowledge of the judicial lien. § 9-323(b). e. 1.1.7 BANKRUPTCY A. Questions a. Main takeaway: analysis of rights of bankruptcy trustee against a secured party does not end when you find the creditor had a perfected security interest at the time the debtor filed bankruptcy. You must determine whether the creditor acted fraudulently or was given a preference, in which case the trustee has the power to make them invalid. b. Perfection: Key thing to watch for is whether the creditor has perfected. If so, collateral can be reclaimed from bankruptcy estate and used to satisfy the debt. If not, the trustee can avoid the security interest, add the property to the bankruptcy estate free and clear of the creditor’s interest, and relegate the creditor to “general” creditors. c. Fraudulent conveyance: even if there is a valid security interest, it may be subject to fraudulent conveyance or attacked as a preference. Look at when the interest was perfected and whether sufficient value was given (special rule for PMSI). B. DEBTOR’S BANKRUPTCY a. Introduction: a trustee in bankruptcy can assert the rights of almost everyone who can challenge the validity of a security interest. b. Bankruptcy proceedings: bankruptcy is a federal procedure for the relief of debtors, initiated by the filing of a petition. i. Note: in 2005, the Bankruptcy Code was rewritten to make it harder for debtors to discharge unsecured debts and force them into Chapter 13 proceedings. ii. Timing is crucial: the moment of filing of the petition is crucial because many bankruptcy issues focus on the status of the parties at that moment. iii. Trustee: creditors elect a representative called the “trustee” who has title to all the bankrupt’s property. This title relates back to the date the petition was filed. iv. Distribution of assets: trustee gathers debtor’s property, inventories it, and investigates the validity of any claims asserted against the property. 1. Exempt property: the trustee is under a duty § 522 of Bankruptcy Code to promply release any asset that is exempt. (such as clothes, household items, etc.) 2. Property subject to lien or security interest: collateral subject to a lien or perfected security interest that trustee determines was valid at moment of filing bankruptcy petition is released by trustee to the lien holder. Thus, lien creditors get their property intact. 3. Remaining property sold and proceeds distributed: the nonexempt property free from valid creditor liens and interests is sold and proceeds distributed as follows: a. “Special” (Priority) Creditors: first money goes to priority creditors listed in § 507 of BC to cover costs of bankruptcy proceeding, alimony, certain creditor expenses, etc. These are paid in full before general creditors get anything. b. “General” creditors: after priority claims are paid, remaining proceeds are distributed pro rata to the “general” (unsecured) creditors. Philip Larson Page 15 Secured Transactions: Outline v. Discharge: in return for surrendering nonexempt property, debtor is usually granted discharge (judicial forgiveness) of further personal liability for most debts. vi. Bifurcation: § 506(a) of BC says that creditor has a secured claim equal to value of collateral and the balance of the claim is unsecured. Associates Commercial Corp. v. Rash (Rash owed $41k on tractor. Rash said current value was $28.5k but company wanted $41k replacement value. Court held Rash should pay replacement value. However, sting taken out b/c typically replacement value is liquidation value.) Automatic Stay – Effect on Secure Party: once a petition in bankruptcy has been filed and the property of the debtor passes into the possession and control of the trustee, a secured creditor must seek permission of the court to enforce its rights. The filing of the bankruptcy petition creates an automatic stay against any creditor collection activity, violation os which leads to contempt of court and damages under § 362 of BC. Trustee’s powers: the trustee is given a number of statutory powers that enable the trustee to invalidate security interests that would be completely secure outside bankruptcy. i. All rights and powers of debtor: the trustee has full title to the property the debtor had at time petition was filed, including all rights of action the debtor had. He has benefit of all defenses. § 541 BC. ii. Power to set aside fraudulent interests: the trustee can assert the invalidity of any security interest that is fraudulent against any existing unsecured creditor. § 544(b) BC (strong-arm power). 1. Effect of setting aside: if the security interest is subject to attack as fraudulent against any creditor, the entire security interest is invalid and can be upset by the trustee benefiting not only the actual creditor as to whom the transaction was fraudulent, but all creditors. Moore v. Bay. 2. “Fraud” defined: fraud consists of transactions that limit a creditor’s remedies in an unlawful manner. a. Uniform Fraudulent Transfer Act: defines some forms of fraud under § 548 of BC. b. Presumption of fraud: transfers of property (including creation of security interests) made within 2 years of the filing of the bankruptcy petition by an insolvent debtor for less than “fair consideration” are presumed fraudulent. § 548(a)(2). c. Intent to defraud: in other cases, the concept of fraud applies only if there is actual intent to defraud other creditors. § 548(a)(1). iii. “Strong arm clause”: the trustee has whatever powers could have been exercised by a creditor with a writ of execution returned unsatisfied, or a creditor with a lien on all property of the debtor at the moment petition was filed. This gives the trustee an automatic judicial lien on all property of the debtor, so that if a judicial lien creditor could have priority over an Article 9 security interest as of the filing of the bankruptcy petition, the trustee has such priority on behalf of all the creditors filing claims. 1. What does this mean? The trustee will prevail against any claims, liens or interests that are not fully perfected at the time of bankruptcy. Moreover, even perfected liens can be defeated if they are preferences. Preferences: a security interest that is neither fraudulent nor attackable by trustee’s strong arm powers, may still be vulnerable if the perfection of the security interest constitutes a preference. Note, if you are secured, you can avoid preference because any payments on the debt would not affect what you would get anyway. i. What is a preference? A preference is: 1. a transfer of any property of the debtor (including the perfection of an unperfected security interest), 2. made to or for the benefit of a creditor, 3. on account of an antecedent debt, 4. made by the debtor while insolvent and within 90 days prior to filing petition for bankruptcy, 5. the effect of which was to allow the creditor to obtain a greater percentage of the debt than the creditor would otherwise have received in bankruptcy, 6. and, in a consumer case only, the aggregate value of affected property is > $600. § 547(b), (c)(8). ii. Result of finding a preference: if the challenge meets the test above, it is voidable by the trustee in bankruptcy. This means that the “preferred” creditor must repay the money to the trustee, or, where perfection of a security interest is found preferential, the security interest is simply invalid and the creditor becomes a “general” unsecured creditor. iii. Exceptions: 1. Insolvency: a transfer is only preferential if made when the debtor was insolvent. § 547(b)(3). However, there is a presumption that the debtor was insolvent during the 90 days prior to petition date. § 547(f). Insolvency typically hinges on whether they can generally pay their bills on time. c. d. e. Philip Larson Page 16 Secured Transactions: Outline Contemporaneous exchange: payments for value made to a fully secured creditor are not voidable as preferences even if made on the eve of bankruptcy. (e.g. D buys $80 of groceries day b/f filing petition. This is a contemporaneous exchange.) § 547(c)(1). 3. Routine payments: routine payments made in the ordinary course of debtor’s business are not preferential. § 547(c)(2). iv. Transfers to “insiders”: if the preferred creditor was an “insider” who received a preferential transfer in the period between 90 days and 1-yr prior to petition date, the trustee can recover the property transferred if the insider had reasonable cause to believe the debtor was insolvent at the time of the transfer. § 547(b)(4)(B). 1. “Insider” defined: an insider is someone having a close connection with the debtor, such as a spouse, relative, partner, corporate director, or anyone in control of the debtor. § 101(25) of BC. v. Special Grace Period for PMSI: where a PMSI creditor perfects within 30 days after the debtor receives possession of the property, no preference occurs even if the creditor gave value prior to the debtor’s possession (so that the attachment of the security interest now protects an antecedent debt). § 547(c)(3). 1. Effect: this provides more protection to PMSI creditors. C. AFTER-ACQUIRED PROPERTY IN BANKRUPTCY a. Introduction: major problem occurs when the security interest involves after-acquired collateral or a floating lien on the inventory or accounts receivable of the debtor. The issue arises if inventory or accounts receivable first come into existence and become covered by the perfected security interest w/i the 90-day period prior to bankruptcy, so that attachment of the security interest to them is arguably “preferential.” b. No preference: under § 547(c)(5), accounts receivable or inventory falling under a perfected creditor’s floating lien are not preferential even though first acquired in the 90 days (1-yr for insiders) prior to the petition. i. Exception – “build-up” prohibited: if in the 90-day period (1-yr for insiders), the secured party has the debtor acquire more inventory than were present at the start of the period, a preference occurs to the extent of the build-up if unsecured creditors are hurt as a result. § 547(c)(5). 1.1.8 DEFAULT A. Questions a. Has a default occurred? b. What remedies are provided in the security agreement? c. What remedies exist under the UCC? i. Creditor may sell the collateral; notice requirements, right of secured party to bid, debtor’s right to an accounting and to proceeds after disbursement, whether debtor is liable for deficiency. ii. Creditor may retain the collateral; in full or partial satisfaction of the debt – notice requirements and limitations on consumer goods. iii. Creditor may ignore the collateral and sue on the debt. Watch out for breach of peace by creditor in taking the property. If there is a breach, the creditor loses UCC authorization and basically is stealing. d. Has the debtor redeemed the collateral? e. What is the effect of the secured party’s failure to comply with the UCC provisions on disposing of collateral? B. INTRODUCTION a. Default: regardless of how careful a secured party is in choosing credit risks, in some cases the debtor will default on an obligation under a security agreement. Article 9 does not describe the conditions of default, but does provide the remedies for the creditor, although the parties are free to provide other remedies should they choose. § 9-601. b. Consumers & Article 9: consumer advocates worried that Article 9 would reduce consumer protection. Therefore, many of the UCC provisions state that they are not applicable to consumer transactions. C. OCCURRENCE OF DEFAULT a. Generally: conditions of default are based on the security agreement. Parties are free to establish the conditions they like. b. Acceleration clauses: these clauses give the secured party the option of declaring the entire unpaid balance immediately due upon the occurrence of some default. The UCC authorizes these clauses, but limits the secured party’s right to accelerate to cases in which he “in good faith believes the prospect of payment or performance is impaired.” c. Waiver of Defenses Against Assignees: lenders often require the buyer/borrower to “waive” defenses they may have had if they default, even if the suit is brought by an assignee rather than the lender. This means the lender could assign the security agreement to another party without them simply “buying a lawsuit.” 2. Philip Larson Page 17 Secured Transactions: Outline i. Validity of waiver: except for consumer goods, these are valid if the assignee purchased the agreement in good faith and w/o notice of any defenses the buyer might have against assignor-seller. § 9-403. ii. Consumer Goods Limitation: validity of waiver in consumer goods cases are determined by other statutes. § 9-403(e). D. REMEDIES – IN GENERAL a. Cumulative Remedies: UCC declares that secured party’s rights and remedies are cumulative. § 9-601(c). While the secured party can only recover once, they can pursue multiple remedies until they are made whole. b. Three basic remedies: There are three basic remedies: i. Retention: retaining the collateral. § 9-620 – 622. ii. Sale or other disposition: sale or other disposition of the collateral. § 9-610. iii. Bring an action for the debt: the lender can bring an court action for the debt. § 9-601(a). E. RIGHT OF POSSESSION UPON DEFAULT a. General: secured party gets the right to take possession of the collateral upon default, provided the parties have not otherwise agreed. § 9-609. Repossession sets the stage for other remedies like sale of collateral. Note, an unsecured creditor, cannot go after the property until after they get a judgment. Grupo Mexicano de Dessarrolo v. Alliance Bond Fund. b. Judicial process necessary? i. No “Breach of Peace”: as long as possession of the collateral can be obtained w/o breach of the peace, the secured party may proceed to seize it w/o judicial process (i.e. the “self-help” repossession). This makes secured creditors much better off than unsecured creditors that must wait for a judgment lien. Otherwise, legal proceedings are needed. § 9-609(b). Stone Machinery Co. v. Kessler (breach of peace does not require violence – intimidation and oppression may suffice) 1. Rationale: this lowers costs for secured party b/c he doesn’t have to go to court. 2. What constitutes “breach of peace”? violence or disturbance is not required. A repossession made over any protest by the debtor or anyone present is a breach of the peace. Phony shows of legal authority, implied threats, etc. breach the peace. Moreover, breaking and entering and trespass are typically breach of peace. Stone Machinery Co. v. Kessler; Salisbury Livestock Co. v. Colorado Central Credit Union (directed verdict improper because trespass + breaking a 2-by-4 could be considered a breach of peace); Williams v. Ford Motor Credit (repossessed car at 4:30 a.m. – polite & no threat of violence - court overturned trial court that said this did not breach the peace) 3. Effect of breach of peace: if the repossessing creditor does breach the peace, they lose the authorization of § 9-609 to repossess w/o the aid of the courts. It amounts to stealing. ii. Requirement of notice: the creditor does not have to provide debtor notice of planned repossession unless there is a provision in the security agreement requiring it. c. Duties of Secured Party in Possession: after taking possession, the secured party assumes the same duties as a party who perfects by possession: e.g. reasonable care, maintain it, insure its upkeep. § 9-207. i. Duty to return personal items repossessed w/ collateral: if there are personal items in the trunk of a car, for instance, the creditor must return them promptly. § 9-603 F. REALIZING ON THE COLLATERAL a. Summary: SELLER’S RETENTION vs. SALE OF COLLATERAL Retention of Collateral Sale of Collateral Is debtor’s consent needed? Yes No Must notice be given to debtor? Yes Yes (debtor may waive) Must secured party act with No Yes “commercial reasonableness”? Can secured party sue for No (unless collateral retained only in Yes deficiency? partial satisfaction of debt) i. Strict foreclosure: creditor keeps collateral and the rest of the debt is discharged. § 9-620. ii. Partial strict foreclosure: creditor keeps collateral and agree with debtor that the rest of the balance is still due. § 9-620. Philip Larson Page 18 Secured Transactions: Outline iii. Disposition of collateral by sale.: secured party can “sell, lease, license, or otherwise dispose of the collateral. He must give notice to debtor unless goods are perishable or sold in recognized market. § 9610 Strict Foreclosure: creditor who repossesses goods may elect to keep them and forget the rest of the debt. This is called strict foreclosure and is authorized under § 9-620. This is only used if the collateral is appreciating in value or if the cost of further action is prohibitive. Reeves v. Foutz & Tanner (even though pawn shop adhered to § 9-20 notifying Navajo Indians of his intent to keep jewelry, he had to give them the surplus pursuant to § 9-615). i. Exception for consumer goods: if repossessed collateral constitutes consumer goods, and debtor has already paid at least 60% of it, the creditor must sell the collateral and turn over any excess to the consumer. Otherwise, creditor will be liable either for conversion, or actual damages + punitive damages. ii. General Notice Requirement: if consumer goods are not involved (or where the consumer has not paid 60% of the original amount), the creditor electing strict foreclosure must send authenticated notice to the debtor of the creditor’s intention to keep the collateral in satisfaction of the debt. § 9-621 iii. Partial strict foreclosure: the code allows the secured party to keep the collateral in partial satisfaction of the debt and still have the rest owed. This occurs if: 1) secured party gives same authenticated notice to debtor and other secured parties, and 2) debtor consents in an authenticated record, and 3) no other perfected secured parties object w/i 20 days after the authenticated notice was sent. § 9-620. 1. Consumer goods not allowed: partial strict foreclosure is not allowed for consumer goods. § 9620(g). Disposition of the Collateral by Sale: UCC provides flexibility in rules governing disposition by sale. Under § 9610, secured party is not restricted to sale but can “sell, lease, license, or otherwise dispose of the collateral.” After sale, the secured party may pursue the debtor for any deficiency. i. Commercial reasonableness standard: the only real limitation on the power to sell is that it must be in good faith and in a commercially reasonable manner. This includes the method, manner, time, place, and terms of the sale all have to be reasonable. § 9-610(b). In re Excello Press, Inc (following procedural requirements and providing notice was enough to be commercially reasonable) In ensuing litigation, secured party has burden of proving sale was commercially reasonable. § 9-626(a)(2). 1. Low price not determinative: just b/c the amount realized on the sale is substantially below market value is not enough to make the sale commercially unreasonable. 2. Loss of deficiency: in nonconsumer goods, if secured party fails to conduct a commercially reasonable resale or send out the required notices, there is a rebuttable presumption that a foreclosure sale would have brought the amount still due. Therefore, there is no deficiency and debtor owes nothing more. § 9-626. (note: § 9-626 does not apply for consumer cases). ii. Notice requirement: authenticated notice of the sale of collateral must be given to debtor by the creditor. § 9-611(d). 1. Contents: under § 9-613, the notice to the debtor must include 1) description of debtor and secured party, 2) description of collateral, 3) method of sale, 4) time and place of the sale, 5) statement that debtor is entitled to an accounting. In re Excello Press (notice doesn’t have to provide much information. It simply has to provide debtor enough time to protect itself – e.g. find other buyers, bid on the collateral itself). 2. Addt’l Reqs for Consumer Goods: for consumer goods, the notice must also include 1) liability for deficiency, 2) telephone number to find amout that must be paid to secured party to redeem the collateral, 3) telephone number to get additional information regarding disposition. § 9-614. 3. Timing of Notice: the notice must be sent after default (security agreement not sufficient) and a reasonable time b/f date of disposition of collateral. § 9-612(a). a. Safe harbor: in nonconsumer transactions, if secured party sends notice at least 10 days prior to earliest possible disposition, it cannot be later attacked as unreasonable. § 9612(b). However, there is no safe harbor for consumer transactions. iii. Secured party’s right to bid on collateral: at a public sale, the secured party has a right to purchase the collateral. Indeed, the secured party is often the only bidder. § 9-610(c)(1). At a private sale, the secured party is entitled to bid for the goods only if they are of a type customarily sold in a recognized market or are of a type subject to standard price quotations. § 9-610(c)(2). iv. Application of proceeds: proceeds are applied to 1) expenses of the secured party in connection w/ default (e.g. sale, legal expenses, reasonable attorney fees, costs in holding the collateral), 2) debt owed the secured party, 3) debt owed to junior creditors. § 9-615. b. c. Philip Larson Page 19 Secured Transactions: Outline v. Surplus and deficiency: secured party must give the debtor any surplus proceeds left after the above disbursements. Conversely, debtor will still be liable for any deficiency. § 9-615. Reeves v. Foutz & Tanner, Inc (Navajo Indians were entitled to surplus from pawned jewelry). vi. Rights of purchaser of collateral: the purchaser of the collateral takes all rights the debtor had in the collateral together with the interest of the secured party and all interests subordinate thereto. § 9-504(4). 1. Junior creditors: therefore, purchaser takes free of all secured interests lower in priority to seller. 2. Senior creditors: however, the purchaser takes subject to the security interests of senior creditors. This will probably depress the amount paid by the purchaser. § 9-615(g). d. Allowing debtor to retain collateral and suing on debt: secured party may allow collateral to remain w/ debtor and sue on the debt. Any lien the secured party gets through a levy on the collateral dates back to date of perfection of original security interest. § 9-601(e). If the creditor decides to obtain a judgment against debtor rather than use self-hep repossession and sale/retention of collateral, many of the requirements (e.g. no breach of peace, commercial reasonableness) do not apply. Therefore, a uniformed sheriff’s deputy may seize the collateral, and the judicial sale is conclusively deemed to be reasonable. G. DEBTOR’S RIGHT OF REDEMPTION a. Generally: just b/c the debtor has defaulted does not mean disposition and retention of collateral by secured party is inevitable. Debtor may exercise the right of redemption any time prior to the secured party disposing of the collateral. § 9-623. b. Tender: to redeem, the debtor must tender the debt owed at the time of redemption by paying all delinquencies plus any expenses incurred by secured party in taking or caring for the collateral. § 9-623. c. NonWaivable: the right of redemption cannot be waived prior to default. H. EFFECT OF FAILURE TO COMPLY WITH DEFAULT PROVISIONS a. Generally: if secured party does not comply w/ default provisions of the Code in proceeding against the debtor, debtor may wait until the goods have been disposed and then proceed against secured party for damages. § 9-625. I. NONWAIVABLE RIGHTS UNDER SECURITY AGREEMENT a. Generally: the default provisions are flexible, but there are some things that can’t be waived. b. Accounting for surplus: can’t dispense with obligation to account for any surplus. § 9-602. c. Notice requirements: notice requirements for disposition and retention of collateral cannot be waived. § 9-602. d. Discharge upon retention: if secured party retains collateral in full satisfaction of the debt, the debtor’s obligation is satisfied and they can’t contract otherwise. § 9-602. e. Right of Redemption: parties can’t eliminate debtors right to redeem under § 9-623. § 9-602. J. SPECIAL DEFAULT RULES FOR INTANGIBLES & FIXTURES a. Fixtures: there is the obvious problem of taking the collateral for retention or sale when it is attached to real property or other goods. The UCC protects the rights of the secured party in fixtures by saying that when the secured party has priority over other interests in the real property, the secured party is entitled to remove the collateral. i. Damages caused by removal: secured party must reimburse owner for any damages or repair needed as a result of the removal. Philip Larson Page 20