Law 19 Property Chp. 28 Secured
Transactions - West Bus. Law
- 6th edition
Introduction.
SECURED TRANSACTIONS
Whenever the payment of a debt is guaranteed, or secured, by personal
property owned by the debtor or in which the debtor has a legal
interest, the transaction becomes known as a secured transaction.
The concept of the secured transaction is as basic to modern business
practice as the concept of credit. Logically, sellers and lenders
do not want to risk nonpayment, so they will not sell goods or
lend money unless the promise of payment is somehow guaranteed.
Indeed, business as we know it could not exist without laws permitting
and governing secured transactions.
Article 9 of the Uniform Commercial Code (UCC) governs secured
transactions. This chapter first presents the basic concept and
terminology of the secured transaction and then discusses how
the rights and duties of creditors and debtors are created and
enforced. Debtor-creditor transactions that are not covered under
Article 9 are discussed in the next chapter. As will become evident,
the law of secured transactions tends to favor the rights of creditors.
Landmark in the Law: Article 9 Security Interest
Section 1: Terminology of Secured Transactions.
The UCCs terminology is now uniformly adopted in all documents
used in situations involving secured transactions. A brief summary
of the UCCs definitions of terms relating to secured transactions
follows.
1. A security interest is any interest in personal
property or fixtures which secures payment or
performance of an obligation [UCC 1201(37)].
2. A secured party is a lender, a seller, or any person in
whose favor there is a security interest, including a
person to whom accounts or chattel paper have been
sold [UCC 9105(1)(m)]. (Chattel paper is any
writing evidencing a debt secured by personal property)
The terms secured party and secured creditor are
used interchangeably.
3. A debtor is the party who owes payment or
performance of the secured obligation, whether or not
that party actually owns or has rights in the collateral
(defined below). When the debtor and the owner of
collateral are not the same person, the term debtor
may refer to the actual owner of the collateral, the
person responsible for the obligation, or both, depending
on the context in which the term is used
[UCC 9105(1)(d)].
4. A security agreement is the agreement that creates or provides
for a security interest between the debtor
and a secured party [UCC 9105(1)(e)].
5. Collateral is the property subject to a security interest,
including accounts and chattel paper that have been
sold [UCC 9105(1)(c)].
These basic definitions form the concept under which a debtor-creditor
relationship becomes a secured transaction relationship
Section 2: Creating Security Interests.
Before a creditor can become a secured party, the creditor must
have a security interest in the collateral of the debtor.
Three requirements must be met for a creditor to have an enforceable
security interest:
1. Either (a) the collateral must be in the possession of the
secured party pursuant to an agreement, or (b) there
must be a written security agreement describing the
collateral and signed by the debtor.
2. The secured party must give value.
3. The debtor must have rights in the collateral.
Once these requirements have been met, the creditors rights
are said to attach to the collateral. Attachment gives the creditor
an enforceable security interest against the debtor.[UCC 9203].
WRITTEN AGREEMENT
When the collateral is not in the possession of the secured party,
a security agreement must be in writing to be enforceable. To
be effective, (1) the security agreement must be signed by the
debtor, (2) it must contain a description of the collateral, and
(3) the description must reasonably identify the collateral [UCC
9203(1); UCC 9110]. At issue in the following case was whether
a security agreement had reasonably identified the collateral
and had, in fact, been signed by the debtor.
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Case 30.1
IN RE ZILUCK (a)
United States District Court, Southern District of Florida, 1992.
139 Bankr. 44.
COMPANY PROFILE In Fort Worth, Texas, in 1899, the Tandy family
opened a small leather store. During the 1950s, Charles Tandy
expanded the business into a national chain of leathercraft and
hobby stores. In the 1960s, Tandy Corporation expanded into other
retail areas, buying, among other businesses, Radio Shack, which
was an electronic parts supplier with a mail-order business and
nine stores in the Boston area. Stocking the stores with quick
turnover items and spending nearly 10 percent of the sales revenues
on advertising caused Radio Shacks earnings to soar. By 1973,
Radio Shack had grown to 3,000 stores, providing more than 50
percent of Tandys sales and 80 percent of its earnings. The company
sold off its other businesses to reposition itself as a consumer
electronics business. In 1976 alone, Tandy opened an additional
1,200 Radio Shack stores. The next year, Tandy sold the first
mass-marketed personal computer (PC) and, in 1984, the first IBM-compatible
PC priced under $1,000. By the 1990s, Tandy believed that Radio
Shack had exhausted its expansion possibilities and began to focus
on other retail outlets, such as Computer City, a computer warehouse
store. In 1992, Tandy, which had become the worlds largest retailer
of consumer electronics, opened its first Incredible Universea
gigantic electronics superstore with a sales floor as large as
three football fields.
BACKGROUND AND FACTS David Ziluck applied for a Radio Shack
credit card. The front of the application contained blanks for
various personal and employment information and a space for the
applicant to sign. Above the signature line was the following
statement: I have read the Radio Shack Credit Account and Security
Agreement, including the notice provision in the last paragraph
thereof, and it contains no blanks or blank spaces. I agree to
the terms of the Agreement and acknowledge receipt of a copy of
the agreement. The back of the application contained a Radio Shack
Credit Account and Security Agreement, which stated in part, We
retain a security interest under the Uniform Commercial Code in
all merchandise charged to your Account. If you do not make payments
on your Account as agreed, the security interest allows us to
repossess only the merchandise that has not been paid in full.
When Ziluck later filed for bankruptcy protection, the bankruptcy
court had to decide whether the application form constituted a
valid security agreement. The court concluded that it did not
for two reasons. First, Zilucks signature was not effective, because
it was not on the back side of the form, which stated the terms
of the security agreement. Second, the security agreements description
of the collateral (all merchandise charged to your Account) was
not sufficiently descriptive. The bankruptcy courts decision was
appealed.
IN THE LANGUAGE OF THE COURT
GONZALEZ, District Judge.
* * * *
Turning first to the signature issue, the Court finds that Ziluck
did in fact sign the security agreement. * * * The Court believes
that Zilucks signature on the front of the
credit card application * * * was sufficient to comply with Fla.
Stat. [Section] 679.203(1)(a) [Floridas version of UCC 9203(1)(a)].
The bankruptcy courts contrary finding was in error.
The Court also finds that the bankruptcy court erred in finding
that the description of the collateral in the security agreement
was insufficient. Florida Statute [Section] 679.110 provides that
any description of personal property. . . is sufficient whether
or not it is specific if it reasonably identifies what is described.
The Court believes that the language in
* * * the security agreement, * * * all merchandise charged to
your account, reasonably identifies the property subject to the
security interestnamely any property purchased with the subject
credit card. Accordingly, the Court finds that the security agreement
contains a sufficient description of the collateral as required
by Fla. Stat. [Section] 679.203(1)(a).
DECISION AND REMEDY The appellate court reversed the bankruptcy
courts decision and remanded the case.
Full text of case
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SECURED PARTY MUST GIVE VALUE
The secured party must give value, which, according to UCC 1201(44),
is any consideration that supports a simple contract. In addition,
value can be security given for a preexisting (antecedent) obligation
or any binding commitment to extend credit. Normally, the value
given by a secured party takes the form of a direct loan or involves
a commitment to sell goods on credit.
DEBTOR MUST HAVE RIGHTS IN THE COLLATERAL
The debtor must have rights in the collateral; that is, the debtor
must have some ownership interest or right to obtain possession
of that collateral. The debtors rights can represent either a
current or a future legal interest in the property. For example,
a retail seller-debtor can give a secured party a security interest
not only in existing inventory owned by the retailer but also
in future inventory to be acquired by the retailer.
Section 3: Purchase-Money Security Interest.
Often sellers of consumer durable goods, such as computers and
appliances, agree to extend credit for part or all of the purchase
price of those goods. Also, lenders not necessarily in the business
of selling such goods often agree to lend much of the purchase
price for them. There is a special name for the security interest
that the seller or the lender obtains when such a transaction
occurs. It is called a purchase-money security interest (PMSI).
Formally, such an interest exists when one or the other of the
following conditions arises:
1. A security interest is retained in, or taken by the seller
of, the collateral to secure part or all of its price.
2. A security interest is taken by a person who, by making
advances or incurring an obligation, gives something of
value that enables the debtor to acquire rights in the
collateral or to use it [UCC 9107].
In either situation, a lender or seller has essentially provided
a buyer with the purchase money to buy goods. Suppose that Benjamin
wants to purchase an entertainment center from USA Appliances.
The purchase price is $900. Not being able to pay cash, Benjamin
signs a purchase agreement to pay $100 down and $50 per month
until the balance plus interest is fully paid. USA Appliances
is to retain a security interest in the purchased goods until
full payment has been made. Because the security interest was
created as part of the purchase agreement, it is a PMSI.
The same result will occur if Benjamin goes to Statewide Bank
and borrows the $900 to buy the entertainment center from USA
Appliances. Once Benjamin has signed a loan agreement with Statewide
Bank, with the to-be-purchased goods as collateral, Statewide
Bank has a PMSI the moment the goods are purchased from the appliance
store. Obviously, if Benjamin uses the money for other purposes,
Statewide Bank will not have a security interest. For this reason,
Statewide Bank might arrange to pay the $900 directly to USA Appliances.
Section 4: Pefecting a Security Interest.
A creditor has two main concerns if the debtor defaults (fails
to pay the debt as promised): (1) satisfaction of the debt through
possession of the collateral and (2) priority over any other creditors
and purchasers who may have rights in the same collateral. The
concept of attachment, which establishes the criteria for creating
an enforceable security interest, deals with the former concern;
the concept of perfection deals with the latter.
Even though a security interest has attached, the secured party
must nevertheless take steps to protect its claim to the collateral
over claims that third parties may have. Third parties may be
other secured creditors, nonsecured creditors, trustees in bankruptcy
(see Chapter 32), or purchasers of the collateral that is the
subject matter of the security agreement. Perfection represents
the legal process by which secured parties protect themselves
against the claims of third parties who may wish to have their
debts satisfied out of the same collateral.
PERFECTION BY FILING
The most common method of perfecting a security interest is by
the filing of a financing statement with the appropriate state
or local official. A sample financing statement is shown in Exhibit
302. The UCC requires a financing statement to contain (1) the
signature of the debtor, (2) the names and addresses of both the
debtor and the creditor, and (3) a description of the collateral
by type or item [UCC 9402(1)].(1)
Image: Perfecting a Security Interest
THE DEBTORS NAME The UCC requires that a financing statement
be filed under the name of the debtor [UCC 9402(1)]. If the debtor
is an individual, the financing statement must be filed in the
name of the individual, but if the debtor is a partnership or
corporation, the financing statement must be filed under the partnership
or corporate name [UCC 9402(7)]. If a financing statement identifies
the debtor by an incorrect name, the statement may be ineffective
to perfect a security interest.
What happens to the perfected secured partys interest when the
debtor changes its name, as might happen as a result of a business
reorganization? In this situation, if the name change causes the
financing statement to become seriously misleading, the filing
is not effective to perfect a security interest in collateral
acquired by the debtor more than four months after the change,
unless a new appropriate financing statement is filed before the
expiration of that time [UCC 9402(7)]. To accomplish the change,
the secured party merely files a new financing statement, which
is signed by the secured party instead of the debtor [UCC 9402(2)(d)].
Assume that a debtor, Thomas T. Dibello, borrows money from a
Pennsylvania bank, which in turn takes a security interest in
Dibellos store inventory. The bank properly files a financing
statement that lists Thomas T. Dibello as the debtors name. Shortly
thereafter, Dibello incorporates his business and changes the
name of the business to Just for Kids, Inc. The bank will continue
to be protected as to the existing collateral and as to new collateral
acquired by the debtor during the four months following the name
change, even if the bank fails to refile. At the end of the four-month
period, however, the bank must refile under the new business name
of the debtor. Otherwise, its security interest in any collateral
acquired after this point will be unperfected.(2)
DESCRIPTION OF THE COLLATERAL Both the security agreement and
the financing statement must contain a description of the collateral
in which the secured party has a security interest. The UCC requires
that the security agreement include a description of the collateral,
because no security interest in goods can exist unless the parties
agree on which goods are subject to the security interest and
then describe these goods in writing. The purpose of describing
collateral in the financing statement is for the benefit of persons
who might later wish to lend to the debtor or purchase the collateral;
the description puts these persons on notice that certain goods
in the debtors possession are already subject to a security interest.
Sometimes, the descriptions in the security agreement and the
financing statement differ, with the description in the security
agreement being more precise and the description in the financing
statement more general. For example, a security agreement for
a commercial loan to a manufacturer may list all the manufacturers
equipment subject to the loan by serial number, whereas the financing
statement may simply state all equipment owned or hereafter acquired.
To avoid problems arising from such differences, a secured party
may repeat exactly the security agreements description in the
financing statement or file the security agreement itself as a
financing statement (assuming the security agreement meets the
previously discussed criteria). Alternatively, where permitted,
the creditor might file a combination security agreement-financing
statement form. If the financing statement is too general or vague,
a court may find it insufficient to perfect a security interest.
WHERE TO FILE Depending on the classification of collateral,
filing is done either centrally with the secretary of state, locally
with the county clerk or other official, or both, according to
state law. According to UCC 9401, a state may choose one of three
alternatives (see the text of UCC 9401 in appendix C for these
alternatives).(3) In general, financing statements for consumer
goods should be filed with the county clerk. Other kinds of collateral
require filing with the secretary of state [UCC 9401].(4) An improper
filing reduces a secured partys claim in bankruptcy to that of
an unsecured creditor.
The classification of collateral is important not only in determining
where to file but also in determining whether filing is necessary.
Exhibit 303 summarizes the various classifications of collateral
and the methods of perfecting a security interest in them.
PERFECTION WITHOUT FILING
In two types of situations, security interests can be perfected
without the filing of a financing statement. First, when the collateral
is transferred into the possession of the creditor, the creditors
security interest in the collateral is perfected. Second, a PMSI
in consumer goods is perfected automatically. These two situations
are discussed below. In addition, UCC 9302(1) mentions other security
interests that can be perfected without the filing of a financing
statement, including a security interest created by an assignment
of a beneficial interest in a trust or a decedents estate.
PERFECTION BY POSSESSION Certain items, such as stocks, bonds,
and jewelry, are commonly transferred into the creditors possession
when they are used as collateral for loans. This transfer is known
as a pledge. (When the debt is paid, the collateral is returned
to the debtor.) One of the benefits for creditors of having possession
of the collateral is that the security agreement is perfected
in these circumstances without filing.
For most collateral, however, possession by the secured party
is impractical, because it denies the debtor the right to use
or derive income from the property to pay off the debt. For example,
if a farmer took out a loan to finance the purchase of a piece
of heavy farm equipment, using the equipment as collateral, the
purpose of the purchase would be defeated if the farmer transferred
the collateral into the creditors possession.
Note that with respect to negotiable instruments, nonnegotiable
transferable instruments, and certain securities (such as stocks
and bonds), with a few exceptions, the only way to perfect a security
interest properly is through possession by the secured party.
Remember, a security agreement need not be in writing to create
a security interest [UCC 9203(1)]. Thus you can create and perfect
a security interest at the same time by possession of the collateral.
PURCHASE-MONEY SECURITY INTEREST In certain circumstances,
a security interest in tangible collateral can be perfected automatically
at the time of a credit salethat is, at the time that a PMSI is
created under a written security agreement. Note that this automatic-perfection
rule with regard to PMSIs applies only when the goods are consumer
goods (defined as goods bought or used by the debtor primarily
for personal, family, or household purposes). The seller in this
situation need do nothing more to protect his or her interest.
There are exceptions to this rule, however, that cover security
interests in fixtures and in motor vehicles [UCC 9302(1)(d)].
In states that have not adopted the 1972 UCC amendments(5) or
that have decided to retain certain pre-1972 sections, a PMSI
in farm equipment under a certain statutory value is also automatically
perfected by attachment.
Concept Summary 30-1
EXCEPTIONS TO PERFECTION
There are sources of law other than UCC Article 9 that deal with
the perfection of security interests. The three most important
sources are federal law, such as the Federal Aviation Act; UCC
Article 8, which deals with investment securities; and state certificate-of-title
laws that deal with motor vehicles.
Most states require a certificate of title for any motor vehicle,
boat, or motor home. The normal methods described above for perfection
of a security interest typically do not apply to such vehicles.
Rather, perfection of a security interest only occurs when a notation
of such an interest appears on the certificate of title that covers
the vehicle.
As an example, suppose that your commercial bank lends you 80
percent of the money necessary to purchase a new car. You live
in a state that requires certificates of title for all automobiles.
If your bank fails to have its security interest noted on the
certificate of title, its interest is not perfected. That means
that a good faith purchaser of your car would take it free of
the banks interest. In most states, purchasers of motor vehicles
can either buy or extend credit on those vehicles with the confidence
that no security interest exists that is not disclosed on the
certificate of title.(6)
COLLATERAL MOVED TO ANOTHER JURISDICTION
Obviously, collateral may be moved by the debtor from one jurisdiction
(state) to another. In general, a properly perfected security
interest in collateral moved into a new jurisdiction continues
to be perfected in the new jurisdiction for a period of four months
from the date on which the collateral was moved into the new jurisdiction
or for the period of time remaining under the perfection in the
original jurisdiction, whichever expires first [UCC 9103(1)(d);
UCC 9103(3)(e)]. Collateral moved from county to county within
a state (if local filing is required), rather than from one state
to another, however, may not be subject to a four-month limitation
[UCC 9403(3)].
To illustrate, suppose that on January 1, Smith secures a loan
from a Nebraska bank by putting up all his wheat-threshing equipment
as security. The Nebraska bank files the security interest centrally
with the secretary of state. In June, Smith has an opportunity
to harvest wheat crops in South Dakota and moves his equipment
into that state on June 15. The law just mentioned means that
the Nebraska banks perfection remains effective in South Dakota
for a period of four months from June 15. If the Nebraska bank
wishes to retain its perfection priority, it must perfect properly
in South Dakota, the jurisdiction in which the machine is located,
during this four-month period. Should the bank fail to do so,
its perfection would be lost after four months, and subsequent
perfected security interests in the same collateral in South Dakota
would prevail.
Among mobile goods, automobiles pose one of the biggest problems.
If the original jurisdiction does not require a certificate of
title as part of its perfection process for an automobile, perfection
automatically ends four months after the automobile is moved into
another jurisdiction. When a security interest exists on an automobile
in a state in which title registration is required, and when the
security interest is noted on the certificate of title, the perfection
of the security interest continues after the automobile is moved
to another state requiring a certificate of title until the automobile
is registered in the new state [UCC 9103(2)]. Because each title
state requires that the holder surrender the old certificate of
title to obtain a new one, and because the secured party typically
holds the certificate, the secured party usually is able to ensure
that the security interest is noted on the new certificate of
title.
EFFECTIVE TIME OF PERFECTION
A financing statement is effective for five years from the date
of filing [UCC 9403(2)]. If a continuation statement is filed
within six months prior to the expiration date, the effectiveness
of the original statement is continued for another five years,
starting with the expiration date of the first five-year period
[UCC 9403(3)]. The effectiveness of the statement can be continued
in the same manner indefinitely.
Section 5: The scope of a security interest.
A security agreement can cover various types of property in addition
to collateral already in the debtors possession, including the
proceeds of the sale of collateral, after-acquired property, and
future advances.
Business Law in Action: Has Anyone Seen the Proceeds
PROCEEDS
Proceeds include whatever is received when collateral is sold,
exchanged, collected, or disposed of. A secured party has an interest
in the proceeds of the sale of collateral. For example, suppose
a bank has a perfected security interest in the inventory of a
retail seller of heavy farm machinery. The retailer sells a tractor
out of this inventory to a farmer, a buyer in the ordinary course
of business. The farmer agrees, in a retail security agreement,
to pay monthly payments for a period of twenty-four months. If
the retailer should go into default on the loan from the bank,
the bank is entitled to the remaining payments the farmer owes
to the retailer as proceeds.
A security interest in proceeds perfects automatically upon perfection
of the secured partys security interest and remains perfected
for ten days after receipt of the proceeds by the debtor. One
way to extend the ten-day automatic period is to provide for such
extended coverage in the original security agreement. This is
typically done when the collateral is the type that is likely
to be sold, such as a retailers inventory.
The UCC provides that in the following circumstances the security
interest in proceeds remains perfected for longer than ten days
after the receipt of the proceeds by the debtor:
1. When a filed financing statement covers the original
collateral and the proceeds are collateral in which a
security interest may be perfected by a filing in the
office or offices with which the financing statement has
been filed. Furthermore, a secured creditors interest
automatically perfects in property that the debtor
acquires with cash proceeds, if the original filing would
have been effective as to that property and the
financingstatement indicates that typeof property
[UCC 9306(3)(a)]. Thus, in the farm equipment
of property example above, if the retailer used the
farmers monthly payments to acquire additional
inventory, the bank would be entitled to that inventory,
providing that the banks original filing was effective as
to that property and the financing statement indicated
that type of property.
2. Whenever there is a filed financing statement that
covers the original collateral and the proceeds are
identifiable cash proceeds [UCC 9306(3)(b)].
3. Whenever the security interest in the proceeds is
perfected before the expiration of the ten-day period
[UCC 9306(3)(c)].
AFTER-ACQUIRED PROPERTY
After-acquired property is collateral that is acquired by the
debtor after the execution of the security agreement. The after-acquired
property may consist of inventory, equipment, farm animals, or
virtually any other kind of property, except for consumer goods
acquired more than ten days after the secured party gives value
[UCC 9204(2)]. The security agreement itself may include a clause
to provide for coverage of after-acquired property [UCC 9204(1)].
This is particularly useful for firms that want to obtain financing
for the purchase of inventory (products to be sold in the ordinary
course of the firms business). A secured party whose security
interest is in existing inventory knows that the debtor will replace
that inventory, thereby reducing the collateral subject to the
security interest.
Generally, when the debtor purchases new inventory to replace
the inventory that is sold, the secured party wants this newly
acquired inventory to be subject to the original security interest.
Thus, the after-acquired property clause continues the secured
partys claim to any inventory acquired thereafter. This is not
to say that such an original security interest will be superior
to the rights of all other creditors with regard to this after-acquired
inventory, as will be discussed later.
Consider a typical example. Liberta buys factory equipment from
Stedler on credit, giving as security an interest in all of her
equipmentboth what she is buying and what she already owns. The
security interest with Stedler contains an after-acquired property
clause. Six months later, Liberta pays cash to another seller
for additional equipment. Six months after that, Liberta goes
out of business before she has paid off her debt to Stedler. Stedler
has a security interest in all of Libertas equipment, even the
equipment bought from the other seller.
FUTURE ADVANCES
Often, a debtor will arrange with a bank to have a continuing
line of credit under which the debtor can borrow funds intermittently.
Advances against lines of credit can be subject to a properly
perfected security interest in certain collateral. The security
agreement may provide that any future advances made against that
line of credit are also subject to the security interest in the
same collateral. For example, Holtzman is the owner of a small
manufacturing plant with equipment valued at $1 million. He has
an immediate need for $50,000 of working capital, so he secures
a loan from Northeastern Bank and signs a security agreement,
putting up all his equipment as security. The security agreement
provides that Holtzman can borrow up to $500,000 in the future,
using the same equipment as collateral for any future advances.
In such cases, it is not necessary to execute a new security agreement
and perfect a security interest in the collateral each time an
advance is made to the debtor [UCC 9204(3)].
THE FLOATING-LIEN CONCEPT
A security agreement may provide for the creation of a security
interest in proceeds of the sale of the collateral that was the
subject matter of the secured transactionafter-acquired property,
future advances, or both. Such an agreement is referred to as
a floating lien. Floating liens commonly arise in the financing
of inventories. A creditor is not interested in specific pieces
of inventory, because they are constantly changing, so the lien
floats from one item to another as the inventory changes.
For example, suppose that Ski Paradise, Inc., a cross-country
ski dealer, has a line of credit with New England Community Bank
to finance an inventory of cross-country skis. Ski Paradise and
New England Community enter into a security agreement that provides
for coverage of proceeds, after-acquired inventory, present inventory,
and future advances. This security interest in inventory is perfected
by a central filing (with the secretary of state). One day, Ski
Paradise sells a new pair of the latest cross-country skate skis,
for which it receives a used pair in trade. That same day, it
purchases two new pairs of skate skis from a local manufacturer
with an additional amount of money obtained from New England Community.
New England Community gets a perfected security interest in the
used pair of skate skis under the proceeds clause, has a perfected
security interest in the two new pairs of skate skis purchased
from the local manufacturer under the after-acquired property
clause, and has a security interest in all of these skis and those
in present inventory that were purchased with money advanced to
Ski Paradise and secured by the future-advance clause.
All of this is accomplished under the original perfected security
agreement. The various items in the inventory have changed, but
New England Community still has a perfected security interest
in Ski Paradises inventory, and hence it has a floating lien on
the inventory. Exhibit 30-4 illustrates graphically the concept
of a floating lien.
The concept of the floating lien can also apply to a shifting
stock of goods. Under Section 9205, the lien can start with raw
materials and follow them as they become finished goods and inventories
and as they are sold, turning into accounts receivable, chattel
paper, or cash.
Section 6: Resolving Priority Disputes.
What happens when several creditors claim a security interest
in the same collateral of a debtor? This important issue is addressed
by the UCC with a set of rules for determining which of the conflicting
security interests has priorityor the best claim to the collateralwhen
the debtor goes into default. The question of priority is particularly
important when the debtor is in bankruptcy. In this situation,
only the perfected secured party will recover, and other creditors
may end up with little or nothing.
SECURED VERSUS UNSECURED PARTIES
In general, secured creditors prevail over unsecured creditors
and over creditors who have obtained judgments against the debtor
but who have not begun the legal process to collect on those judgments
[UCC 9301]. In other words, once a security interest attaches,
it has priority over the claims of other creditors who do not
have a security interest. This priority does not depend on whether
the security interest has been perfected.
SECURED PARTY VERSUS LIEN CREDITOR
A lien creditor is one who has a lien on the property because
of a judgment.(7) Any security interest that is perfected has
priority over the claims of lien creditors who acquired their
liens after perfection. In contrast, a lien creditor has priority
over a party with a security interest that has not yet been perfected.
A so-called ten-day exception to this rule, however, provides
as follows: if a secured party files with respect to a PMSI during
a ten-day period after the debtor receives possession of the collateral,
the secured partys claim has priority over the lien creditors
rights that arise between the time the security interest attaches
and the time of filing [UCC 9301(2)]. In many states, this so-called
grace period has been extended to twenty days.
WHEN MORE THAN ONE PARTY IS SECURED
When more than one party has a secured interest in the collateral
of a defaulting debtor, the issues of perfection and timing become
critical, as does the type of collateral involved. There are several
general rules and, of course, exceptions to those rules.
THE GENERAL RULE Among secured parties, the general rule of
priority is as follows: The first security interest to be filed
or perfected has priority over other filed or perfected security
interests. If, however, none of the conflicting security interests
has been perfected, the first security interest to attach has
priority [UCC 9312(5)].
For example, suppose that West Bank filed a financing statement
covering Algers inventory on March 1, and Friendly Savings and
Loan filed a financing statement covering the same inventory on
April 1. West Banks interest would have priority over Friendlys
interest. It would not matter which lender made its loan and attached
its security interest first. If West Bank failed to perfect its
security interest, however, and Friendly perfected its interest,
then Friendlys interest would have priority as the only perfected
security interest. If both failed to perfect their interests,
then the first to attach would have priority. Thus, if West Bank
had a security agreement covering Algers inventory on March 1
and advanced money to Alger on the same day, and Friendlys agreement
and advance were made on April 1, West Bank would have priority
over Friendly.
AN EXCEPTION: THE PMSI The general rule, as previously stated,
is that the first in time to file or perfect is first in priority
rights to the collateral. This rule is always applicable when
the first in time to perfect is a PMSI. The UCC provides, however,
that under certain conditions a PMSI, properly perfected, will
prevail over a non-PMSI in after-acquired collateral, even though
the non-PMSI was the first in time to perfect.
If the collateral is inventory, a perfected PMSI will prevail
over a previously perfected non-PMSI provided that the holder
of the PMSI perfects and gives the holder of the non-PMSI security
interest written notice of his or her interest before the debtor
takes possession of the newly acquired inventory [UCC 9312(3)].
If the collateral is other than inventory, a PMSI will have priority
over a previously perfected non-PMSI provided that the PMSI is
perfected either before or within ten days after the debtor takes
possession. No notice is required [UCC 9312(4)].
To illustrate: Retailer Elena needs a loan of money to be used
as working capital. On May 1, she obtains a one-year installment
loan from West Bank, signing a security agreement and putting
up her present inventory plus any after-acquired inventory as
collateral. That same date, West Bank perfects its non-PMSI by
filing a financing statement centrally. On August 1, Elena learns
that she can purchase directly from Martin, a manufacturer, $10,000
worth of new inventory, which is a bargain. Because she cannot
pay this amount in cash, she signs a security agreement with Martin,
giving Martin a security interest in the newly purchased inventory.
The new inventory is delivered on September 1, as ordered. On
September 7, a fire destroys most of Elenas store and warehouse.
There remains only a part of the new inventory, and its value
is insufficient to cover both debts. Who has priority with regard
to the remaining inventory, West Bank or Martin? If Martin perfected
by filing and gave West Bank written notice of its security interest
prior to September 1, the date Elena received possession, Martin
prevails. If Martin did not meet these conditions, West Bank prevails.
Suppose that the collateral is equipment, rather than inventory,
and Martin perfected on September 8, after the fire. Because Martin
properly perfected its PMSI within ten days after Elena received
delivery, Martin prevails over West Bank for the remaining after-acquired
equipment.
SECURED PARTY VERSUS BUYER
In general, a security interest in collateral continues even after
the collateral has been sold unless the secured party has authorized
the sale [UCC 9306(2)]. There are exceptions, however, and they
allow the buyers of collateral sold without the secured partys
authorization to take that collateral free of the security interest,
even in situations when the security interest has been perfected.
We examine those situations next.
BUYERS IN THE ORDINARY COURSE OF BUSINESS To require buyers
to find out if there is an outstanding security interest on a
merchants inventory would impose a time-consuming restriction
and would certainly inhibit commerce. Therefore, the UCC provides
that a person who buys in the ordinary course of business will
take the goods free from any security interest attached to those
goods, even if the security interest is perfected and even if
the buyer knows of its existence [UCC 9307(1)]. A buyer in the
ordinary course of business is defined as any person who, in good
faith and without knowledge that the sale is in violation of the
ownership rights or security interest of a third party in the
goods, buys in ordinary course from a person in the business of
selling goods of that kind [UCC 1201(9)].(8)
Suppose retail seller Chad secures a loan from West Bank and puts
up his existing appliance inventory and any appliance inventory
thereafter acquired as collateral. Chad signs a security agreement
and a financing statement, which West Bank properly perfects.
Later Chad sells an appliance from inventory covered by the security
agreement to Lee, and Lee pays cash. If Chad goes into default
on the loan, West Banks prior perfected security interest has
no effect on Lee. Lee took the appliance completely free of West
Banks security interest, even though perfected, and West Bank
loses this item of collateral for satisfaction of the debt. (Of
course, West Bank has rights in any identifiable cash proceeds.)
In the following case, the court must determine at what point
a buyer becomes a buyer in the ordinary course of the sellers
business.
¾¾¨¾¾
Case 30.2
BIG KNOB VOLUNTEER FIRE CO. v. LOWE & MOYER GARAGE, INC.
Superior Court of Pennsylvania, 1985.
338 Pa.Super. 257,
487 A.2d 953.
BACKGROUND AND FACTS The Big Knob Volunteer Fire Company agreed
to buy a fire truck from Hamerly Custom Productions, Inc., which
was in the business of assembling component parts into fire trucks.
The Volunteer Fire Company paid Hamerly $48,000 toward the $51,836
purchase price. Under their contract, Hamerly agreed to deliver
the truck within twenty to seventy days of receiving the chassis
from a third party supplier. The contract also provided that title
to the truck would not pass to the Volunteer Fire Company until
the price had been paid in full. Hamerly ordered the chassis from
Lowe & Moyer Garage, Inc., and on receiving the chassis began
transforming it into a fire truck, painting Big Knob Volunteer
Fire Department on the cab. The chassis was subject to a security
interest. Hamerly, however, did not pay Lowe & Moyer for the
chassis, nor did it complete the truck or deliver it to the Volunteer
Fire Company. Consequently, both the Volunteer Fire Company and
Lowe & Moyer sued Hamerly. Hamerly surrendered the truck to
Lowe & Moyer, which dropped its suit. The Volunteer Fire Company
obtained a default judgment against Hamerly for specific performance
and then sued Hamerly and Lowe & Moyer to replevy (repossess)
the truck. The trial court found in favor of Lowe & Moyer
for the chassis or its value, reasoning that because title had
not passed, the Volunteer Fire Company was not a buyer in the
ordinary course of business. The Volunteer Fire Company appealed.
IN THE LANGUAGE OF THE COURT
SPAETH, President Judge:
* * * *
* * * The trial court held that the Volunteer Fire [Company] was
not a buyer in ordinary course because there was no sale to it.
Relying on the definition of sale as the passing of title from
the seller to the buyer for a price, [Section] 2106(a), the trial
court held that [n]either title to the truck passed, nor was delivery
made to plaintiff.
The point at which a person becomes a buyer in ordinary course
is subject to considerable controversy because the Code does not
specify the moment at which the status is conferred. The controversy
arises in the context of both [Section] 9307(a) and [Section]
2403(b) of the Code. * * *
The cases are * * * divided. Cases denying recovery to a party
on the ground that the party was not a buyer in ordinary course
reason that a sale is required, [Section] 1201; a sale requires
transfer of title, [Section] 2106(a); and a transfer of title
occurs either when agreed upon by the parties or upon physical
delivery, [Section] 2401(2). Absent satisfaction of these criteria,
the buyer will not prevail even though some or all of the purchase
price has been paid. * * * This reasoning places the buyer who
has paid in advance for goods not yet delivered in an extremely
vulnerable position.
* * * *
The modern trend in contests between a buyer without possession
and a secured creditor, typically the inventory financer, is to
ignore or deemphasize the concept of
sale. Instead of focusing on passage of title (delivery), courts
and commentators increasingly favor identification as the critical
moment that determines when a buyer becomes a buyer in ordinary
course. * * *
* * * *
* * * [C]ourts have with increasing frequency held that passing
of title (when agreed to or occurring upon delivery, [Section]
2401(2)) is not essential to a person becoming a buyer in ordinary
course of business. We agree with these courts, and hold that
identification rather than delivery is the point at which a person
becomes a buyer in ordinary course of business. Since here the
fire truck was identified to the contract, the Volunteer Fire
Company did become a buyer in ordinary course of business. Upon
entrusting the goods to Hamerly, which dealt in goods of that
kind, Lowe & Moyer gave Hamerly the power to transfer its
rights to a buyer in ordinary course of business, and Hamerly
exercised that power when it painted the Volunteer Fire Departments
name on the cab of the fire truck, identifying the goods to the
contract and making the Volunteer Fire [Company] a buyer in ordinary
course of business.
DECISION AND REMEDY The court held that the Volunteer Fire
Company was entitled to possession of the truck free of the security
interest.
Full text of case
¾¾¨¾¾
BUYERS OF FARM PRODUCTS Under the UCC, a buyer of farm products
takes the products subject to a security interest, even if the
buyer knows nothing about the existence of a security agreement
[UCC 9307(1)]. Under the Food Security Act of 1985,(9) however,
buyers in the ordinary course of business include buyers of farm
products from farmers. Under the Food Security Act, a secured
party is not protected against a buyer of farm products from a
farmer unless one of the following events occurs:
1. The buyer has received notice of the security interest
within one year before the purchase.
2. The buyer fails to register with the secretary of state
before the purchase, and the secured party has
properly perfected his or her interest centrally.
3. The buyer has received notice from the secretary of
state that the farm products being sold are subject to an
effective financing statement (EFS). An EFS is a
form that a secured party must file in addition to an
Article 9 financing statement to protect his or her
interest in a farmers products in those states with EFS
filing systems.
Profile: Article 9 Security Interest
BUYERS OF CONSUMER GOODS FROM CONSUMERS Carla, a consumer,
purchases a refrigerator from an appliance store on credit, because
she cannot pay the full purchase price. A written security agreement
exists in which the seller takes a PMSI in the consumer goods.
Further, the seller need not file a financing statement, because,
when a PMSI is taken in consumer goods, perfection occurs automatically
[UCC 9302(1)(d)]. Later, Carla sells the refrigerator to her next-door
neighbor, Nan, who purchases itas a purchaser not in the ordinary
course of businessfor home use without any knowledge of the credit
arrangements between Carla and the original seller. Subsequently,
Carla defaults on the credit payments to the seller. What are
the sellers rights? The seller had a perfected PMSI in the refrigerator
when it was held by Carla. Under UCC 9307(2), however, the perfection
is not good against the next-door neighbor.
UCC 9307(2) requires that a person in the position of this next-door
neighbor must purchase (give value for) the goods for personal,
family, or household use, and without knowledge of the original
sellers security interest, and that the purchase must take place
before the secured party has filed a financing statement. In this
case, recall that the seller took a PMSI, which is perfected automatically.
No filing was required. Hence, the next-door neighbor purchased
the refrigerator free and clear before the seller had filed a
financing statement. The seller could have avoided this possibility
simply by filing a financing statement, even though a PMSI had
been perfected.
BUYERS OF CHATTEL PAPER AND INSTRUMENTS Another purchaser who
may not be subject to a secured partys interest despite perfection
is the purchaser of chattel paper and instruments. This protection
is provided by UCC 9308. As previously defined, chattel paper
is a writing or writings that evidence both a monetary obligation
and a security interest in specific goods. Instrument means a
negotiable instrument as defined in UCC 3104, or a certificated
security as defined in UCC 8102, or basically any other writing
that evidences a right to the payment of money and is not itself
a security agreement or lease transferred in the ordinary course
of business by delivery with any necessary indorsement or assignment
[UCC 9105(1)(i)]. Security interests in instruments can be perfected
only by possession.
Chattel paper is a very important class of collateral used in
financing arrangements, especially in automobile financing. When
chattel paper is sold by a creditor, the creditor can deliver
it over to the assignee, who is then responsible for collecting
the debt directly from the debtor. This arrangement is known as
notification or direct collection. As an alternative, a creditor
can sell chattel paper to an assignee with the understanding that
the creditor will retain the chattel paper, make collections from
the debtor, and then remit the money to the assignee. This kind
of transaction is nonnotification or indirect collection. The
widespread use of both methods of dealing with chattel paper is
recognized by the UCC, and hence the UCC permits perfection of
a chattel paper security interest either by filing or by taking
possession of the chattel paper.
Problems arise when perfection of chattel paper is made by filing
only. If the chattel paper is thereafter sold to another purchaser
who gives new value and takes possession of the paper in the ordinary
course of the purchasers business, without knowledge that it is
subject to a security interest, the new purchaser will have priority
over the secured creditor. (Of course, the creditor has rights
in the proceeds.)
Concept Summary 30-2
Section 7: Other Rights and Duties under Article 9.
The security agreement itself determines most of the rights and
duties of the debtor and creditor. Article 9 of the UCC, however,
imposes some rights and duties that are applicable in the absence
of a security agreement to the contrary.
INFORMATION REQUEST BY CREDITORS
Under UCC 9407(1), a creditor has the option, when making the
filing, of asking the filing officer to make a note of the file
number, the date, and the hour of the original filing on a copy
of the financing statement. The filing officer must send this
copy to the person making the request. Under UCC 9407(2), a filing
officer must also give information to a person who is contemplating
obtaining a security interest from a prospective debtor. The filing
officer must give a certificate that provides information on possible
perfected financing statements with respect to the named debtor.
The filing officer will charge a fee for the certification and
for any information copies provided.
ASSIGNMENT, AMENDMENT, AND RELEASE
A secured party can assign part or all of the security interest
to another, called the assignee. That assignee becomes the secured
party of record if, for example, he or she either makes a notation
of the assignment somewhere on the financing statement or files
a written statement of assignment [UCC 9405(1), (2)]. Whenever
desired, a secured party of record also can release part or all
of the collateral described in a filed financing statement. This
ends his or her security interest in the collateral [UCC 9406].
It is also possible to amend a financing statement that has already
been filed. Note, however, that the amendment must be signed by
both parties. The debtor signs the security agreement, the original
financing statement, and the amendments [UCC 9402]. All other
secured transaction documents, such as releases, assignments,
continuations of perfection, perfections of collateral moved into
another jurisdiction, and termination statementsall of which are
discussed in this chapter) need only be signed by the secured
party.
REASONABLE CARE OF COLLATERAL
If a secured party is in possession of the collateral, he or she
must use reasonable care in preserving it. Otherwise, the secured
party is liable to the debtor [UCC 9207(1); UCC 9207(3)]. If the
collateral increases in value, the secured party can hold this
increased value or profit as additional security unless it is
in the form of money, which must be remitted to the debtor or
applied toward reducing the secured debt [UCC 9207(2)(c)]. Additionally,
the collateral must be kept in identifiable condition unless it
consists of fungible goods (goods that are naturally alike, such
as wheat or oil) [UCC 9207(2)(d)]. Finally, the debtor must pay
for all reasonable charges incurred by the secured party in preserving,
operating, and taking care of the collateral in possession [UCC
9207(2)(a)].
THE STATUS OF THE DEBT
During the time that the secured debt is outstanding, the debtor
may wish to know the status of the debt. If so, the debtor need
only sign a statement that indicates the aggregate amount of the
unpaid debt at a specific date (and perhaps a list of the collateral
covered by the security agreement). The secured party must then
approve or correct this statement in writing. The creditor must
comply with the request within two weeks of receipt; otherwise,
the creditor is liable for any loss caused to the debtor by the
failure to do so [UCC 9208(2)]. One such request is allowed without
charge every six months. For each additional request, the secured
party can require a fee not exceeding $10 per request [UCC 9208(3)].
TERMINATION STATEMENT
When a secured debt is paid, the secured party may send a termination
statement to the debtor or file such a statement with the filing
officer to whom the original financing statement was given. If
the financing statement covers consumer goods, the termination
statement must be filed by the secured party within one month
after the debt is paid, orif the debtor requests the termination
statement in writingit must be filed within ten days of receipt
of the request after the debt is paid, whichever is earlier [UCC
9404(1)]. In all other cases, the termination statement must be
filed or furnished to the debtor within ten days after a written
request is made by the debtor.
If the affected secured party fails to file such a termination
statement, as required by UCC 9404(1), or fails to send the termination
statement within ten days after proper demand, the secured party
will be liable to the debtor for $100. Additionally, the secured
party will be liable for any loss caused to the debtor.
Section 8: Default.
Article 9 of the UCC defines the rights, duties, and remedies
of a secured party and of the debtor upon the debtors default.
Should the secured party fail to comply with his or her duties,
the debtor is afforded particular rights and remedies.
The topic of default is one of great concern to secured lenders
and to the lawyers who draft security agreements. What constitutes
default is not always clear. In fact, Article 9 does not define
the term. Consequently, parties are encouraged in practice and
by the UCC to include in their security agreements certain standards
to be applied should default occur. In so doing, parties can stipulate
the conditions that will constitute a default [UCC 9501(3)]. Typically,
because of the disparity in bargaining position between a debtor
and a creditor, these critical terms are shaped by the creditor
in an attempt to provide the maximum protection possible. The
ultimate terms, however, are not allowed to go beyond the limitations
imposed by the good faith requirement of UCC 1203 and the unconscionability
doctrine.
Although any breach of the terms of the security agreement can
constitute default, default occurs most commonly when the debtor
fails to meet the scheduled payments that the parties have agreed
upon or when the debtor becomes bankrupt. If the security agreement
covers equipment, however, the debtor may have warranted that
he or she is the owner of the equipment or that no liens or other
security interests are pending on that equipment. Breach of any
of these representations can result in default.
BASIC REMEDIES
A secured partys remedies can be divided into two basic categories:
1. A secured party can relinquish a security interest and
proceed to judgment on the underlying debt, followed
by execution and levy. Execution is an action to carry
into effect the directions in a court decree or judgment.
Levy is the obtaining of money by legal process
through the seizure and sale of property, usually done
after an execution has been issued. Execution and levy
are rarely done unless the value of the secured
collateral has been reduced greatly below the amount
of the debt and the debtor has other nonexempt assets
available to satisfy the debt.
2. A secured party can take possession of the collateral
covered by the security agreement [UCC 9503].
Upon taking possession, the secured party can retain
the collateral for satisfaction of the debt
[UCC 9505(2)] or can sell the collateral and apply
the proceeds toward the debt [UCC 9504].
The rights and remedies under UCC 9501(1) are cumulative. Therefore,
if a creditor is unsuccessful in enforcing rights by one method,
another method can be pursued. The UCC does not require election
of remediesthat is, the creditor need not choose between an action
on the obligation and the repossession of the collateral.
When a security agreement covers both real and personal property,
the secured party can proceed against the personal property in
accordance with the remedies of Article 9. Alternatively, the
secured party can proceed against the entire collateral under
procedures set down by local real estate law, in which case the
UCC does not apply [UCC 9501(4)].
For example, this situation occurs when the security interest
on a corporate loan applies to the manufacturing plant (real property)
and also to the inventory (personal property). Determining whether
particular collateral is personal or real property can prove difficult,
especially in dealing with fixturesthings affixed to real property
(see Chapter 48). Under certain circumstances, the UCC allows
the removal of fixtures upon default; such removal, however, is
subject to the provisions of Article 9 [UCC 9313].
SECURED PARTYS RIGHT TO TAKE POSSESSION
UCC 9503 states that [u]nless otherwise agreed, a secured party
has on default the right to take possession of the collateral.
In taking possession, a secured party may proceed without judicial
process if this can be done without a breach of the peace. The
underlying rationale for this self-help provision of Article 9
is that it simplifies the process of repossession for creditors
and reduces the burden on the courts. Because the UCC does not
define breach of the peace, however, it is not always easy to
predict what will or will not constitute a breach of the peace.
Generally, the creditor or the creditors agent cannot enter a
debtors home, garage, or place of business without permission.
Consider a situation in which an automobile is collateral. If
the repossessing party walks onto the debtors premises, proceeds
up the driveway, enters the vehicle without entering the garage,
and drives off, it probably will not amount to a breach of the
peace. In some states, however, an action for wrongful trespass
could start a cause of action for breach of the peace or other
tortious action. Whether a creditors trespass onto a debtors property
was enough to breach the peace is at issue in the following case.
Law in the Extreme: All This for $370!
¾¾¨¾¾
Case 30.3
CHRYSLER CREDIT CORP. V. KOONTZ
Appellate Court of Illinois,
Fifth District, 1996.
277 Ill.App.3d 1078,
661 N.E.2d 1171,
214 Ill.Dec. 726.
BACKGROUND AND FACTS James Koontz bought a car and financed
the purchase with a loan from Chrysler Credit Corporation. When
Koontz failed to repay the loan, Chrysler sent M&M Agency
to take possession of the vehicle. M&M entered Koontzs yard,
where the vehicle was parked in the light of the front porch,
to repossess the vehicle. While the repossession was in progress,
Koontz, who was in his underwear, rushed outside and shouted,
Dont take it! The repossessor did not respond and proceeded to
take the vehicle. Chrysler sold the car and then filed a suit
in an Illinois state court against Koontz to recover the difference
between the purchase price and the amount that Koontz owed on
the loan. Koontz argued that Chryslers repossession of the car
over his oral protest was a breach of the peace. The court entered
a judgment in favor of Chrysler, and Koontz appealed.
IN THE LANGUAGE OF THE COURT
Justice MAAG delivered the opinion of the court:
* * * *
* * * [T]he likelihood of a breach of the peace increases in proportion
to the efforts of the debtor to prevent unauthorized intrusions
and the creditors conduct in defiance of those efforts.
* * * Chrysler enjoyed a limited privilege to enter Koontzs property
for the sole and exclusive purpose of effecting the repossession.
So long as the entry was limited in purpose (repossession), and
so long as no gates, barricades, doors, enclosures, buildings,
or chains were breached or cut, no breach of the peace occurred
by virtue of the entry onto his property.
DECISION AND REMEDY The Appellate Court of Illinois affirmed
the lower courts judgment.
Full text of case
¾¾¨¾¾
DISPOSITION OF COLLATERAL
Once default has occurred and the secured party has obtained possession
of the collateral, the secured party may sell, lease, or otherwise
dispose of the collateral in any commercially reasonable manner
[UCC 9504(1)]. Any sale is always subject to procedures established
by state law.
RETENTION OF COLLATERAL BY SECURED PARTY The UCC recognizes
that parties are sometimes better off if they do not sell the
collateral. Therefore, a secured party can retain collateral,
but this general right is subject to several conditions. The secured
party must send written notice of the intention to retain the
collateral to the debtor if the debtor has not signed a statement
renouncing or modifying his or her rights after default. In the
case of consumer goods, no other notice need be given. In all
other cases, notice must be sent to any other secured party from
whom the secured party in possession of the collateral has received
written notice of a claim of interest in the collateral in question.
If within twenty-one days after the notice is sent, the secured
party receives an objection in writing from a person entitled
to receive notification, then the secured party must sell or otherwise
dispose of the collateral in accordance with the provisions of
UCC 9504 (disposition procedures under UCC 9504 will be discussed
shortly). If no such written objection is forthcoming, the secured
party can retain the collateral in full satisfaction of the debtors
obligation [UCC 9505(2)].
CONSUMER GOODS When the collateral is consumer goods with a
PMSI, and the debtor has paid 60 percent or more of the cash price
or loan, then the secured party must sell or otherwise dispose
of the collateral in accordance with the provisions of UCC 9504
within ninety days. Failure to comply opens the secured party
to an action for conversion (the wrongful taking of anothers propertysee
Chapter 6) or other liability under UCC 9507(1) unless the consumer-debtor
signed a written statement after default renouncing or modifying
the right to demand the sale of the goods [UCC 9505(1)].
DISPOSITION PROCEDURES A secured party who does not choose
to retain the collateral must resort to the disposition procedures
prescribed under UCC 9504. The UCC allows a great deal of flexibility
with regard to disposition. The only real limitation is that it
must be accomplished in a commercially reasonable manner. UCC
9507(2) supplies some examples of what does or does not meet the
standard of commercial reasonableness:
The fact that a better price could have been obtained by a
sale at a different time or in a different method from that
selected by the secured party is not of itself sufficient to
establish that the sale was not made in a commercially
reasonable manner. If the secured party either sells the
collateral in the usual manner in any recognized market
therefor or if he sells at the price current in such a market
at
the time of sale or if he has otherwise sold in conformity with
reasonable commercial practices among dealers in the type
of property sold, he has sold in a commercially reasonable
manner.
A secured party is not compelled to resort to public sale to
dispose of the collateral. The party is given latitude under the
UCC to seek out the best terms possible in a private, commercially
reasonable sale. Generally, no specific time requirements must
be met; however, the time must ultimately meet the standard of
commercial reasonableness.
The secured party should diligently arrange to sell the collateral
at the best price possible and avoid self-serving acts that raise
suspicions of commercial unreasonableness. Assume that Boender,
a secured party, advertises a private sale in a newspaper that
is not likely to be read by potential purchasers, requires a minimum
deposit of $50,000 with each purchasers bid (while exempting himself
from the deposit requirement), and then purchases the property
at the sale for himself, only to resell it shortly thereafter
at a substantial profit to a prearranged buyer. Boenders conduct
unreasonably diminishes the number of potential purchasers available
at the sale. With fewer participants at the sale, the final purchase
price is likely to be reduced. When the purchase price is low,
the debtor may fail to satisfy its outstanding debt to Boender
or to enjoy a surplus from the sale of the collateral (deficiency
and surplus are discussed later in this chapter). In such a situation,
the debtor may recover any loss caused by Boenders failure to
comply with the requirement of commercial reasonableness under
the UCC [UCC 9507].(10)
Notice of any sale must be sent by the secured party to the debtor
if the debtor has not signed a statement renouncing or modifying
the right to notification of sale after default. For consumer
goods, no other notification need be sent. In all other cases,
notification must be sent to any other secured party from whom
the secured party in possession of the collateral has received
written notice of a claim of interest in the collateral [UCC 9504(3)].
Such notice is not necessary, however, when the collateral is
perishable or threatens to decline speedily in value or when it
is of a type customarily sold on a recognized market. Generally,
notice of the place, time, and manner of the sale is required
if the sale is to be classified as a sale conducted in a commercially
reasonable manner. At issue in the following case is whether a
sale of collateral was conducted in a commercially reasonable
manner.
¾¾¨¾¾
Case 30.4
FIRST WESTSIDE BANK V. FOR-MED, INC.
Supreme Court of Nebraska, 1995.
247 Neb. 641,
529 N.W.2d 66.
BACKGROUND AND FACTS David Anderson and For-Med, Inc., signed
a security agreement with the First Westside Bank for $79,924.89,
plus interest. The collateral for the loan was Andersons Blue
Bird motor home. Anderson and For-Med defaulted, and the bank
took possession of the Blue Bird. The bank solicited bids for
the motor home by word of mouth from other financial institutions,
Blue Bird dealers, and some of its customers. Ultimately, the
bank sold the motor home to a bank customer for $60,000. The buyer
repaired the motor home at a cost of $22,000 and sold it two and
a half years later for $58,000. Meanwhile, the bank sued For-Med
and Anderson in a Nebraska state court for the difference between
the amount due on the loan and the proceeds from the Blue Birds
sale. The court entered a judgment in favor of the bank. For-Med
and Anderson appealed, acknowledging that although the price in
the banks sale had not been wholly unreasonable, the sale had
not been commercially reasonable, because it had not been advertised
sufficiently.
IN THE LANGUAGE OF THE COURT
CAPORALE, Justice.
* * * *
* * * [I]t is the secured partys duty to the debtor to use all
fair and reasonable means to obtain the best price under the circumstances,
but the creditor need not use extraordinary means.
* * * *
* * * [U]nder particular circumstances, a sale may be commercially
reasonable notwithstanding the lack of advertising.
Among the other factors to be considered in determining whether
a sale of collateral was commercially reasonable is the adequacy
or insufficiency of the price at which it was sold. Here, the
collateral was resold 2 1/2 years after the purchaser acquired
it, for an amount far less than he had invested in its purchase
and repair. In light of that circumstance and the admission of
For-Med and Anderson that the price at which the collateral was
sold was not wholly unreasonable, it cannot be said that the [lower]
courts finding that the sale was commercially reasonable is clearly
wrong.
DECISION AND REMEDY The Supreme Court of Nebraska affirmed
the lower courts decision.
Full text of case
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PROCEEDS FROM DISPOSITION Proceeds from the disposition of
the collateral must be applied in the following order:
1. Reasonable expenses stemming from the retaking,
holding, or preparing for sale are paid first. When
authorized by law and if provided for in the agreement,
these expenses can include reasonable attorneys fees
and legal expenses.
2. Satisfaction of the balance of the debt owed to the
secured party must then be made.
3. Creditors with subordinate security interests whose
written demands have been received prior to the
completion of distribution of the proceeds are then
entitled to receive the remaining proceeds from the sale
[UCC 9504(1)].
4. Any surplus generally goes to the debtor.
DEFICIENCY JUDGMENT Often, after proper disposition of the
collateral, the secured party has not collected all that is still
owed by the debtor. Unless otherwise agreed, the creditor is entitled
to obtain a deficiency judgment, which makes the debtor liable
for any deficiency. Note, however, that if the underlying transaction
was a sale of accounts or of chattel paper, the secured party
can collect the deficiency by requesting a court to order a deficiency
judgment only if the security agreement so provides [UCC 9504(2)].
REDEMPTION RIGHTS Any time before the secured party disposes
of the collateral or enters into a contract for its disposition,
or before the debtors obligation has been discharged through the
secured partys retention of the collateral, the debtor or any
other secured party can exercise the right of redemption of the
collateral. The debtor or other secured party can do this by (1)
tendering performance of all obligations secured by the collateral
and (2) paying the expenses reasonably incurred by the secured
party in retaking the collateral and maintaining its care and
custody, including legal expenses and reasonable attorneys fees
if the security agreement so provides [UCC 9506].
Concept Summary 30-3