Assignment 12 Legal Limits on What Can Be Collateral. Which Statement Is Correct?

Assignment 12

Legal Limits on What Can Be

“Collateral”

Reference: Understanding Secured

Transactions §§ 1.04[C][2], 1.05[A],

1.07, 16.07[B], 18.03

– Security agreement says: “Any attempt by the debtor to create a security interest in the collateral in favor of any other person is void.”

• Litton later signs an agreement that purports to grant a SI in the car to ABC Title Loans

Which Statement Is Correct?

A. ABC Title Loans does not have a valid SI in Litton’s car (based on the language in Bank’s security agreement) B. ABC Title Loans does have

a valid SI in Litton’s car

ABC  Title  Loa ns do es no ... ABC  Title  Loan s do es h ave.. 50% 50%

§ 9-401. Alienability of Debtor’s Rights

(a) [Other law governs alienability;

exceptions.] Except as otherwise provided in

subsection (b) and Sections 9-406, 9-407, 9-408, and 9-409, whether a debtor’s rights in collateral may be voluntarily or involuntarily transferred is governed by law other than this Article.

(b) [Agreement does not prevent transfer.] An agreement between the debtor and secured party which prohibits a transfer of the debtor’s rights in collateral or makes the transfer a default does not prevent the transfer from taking effect.

General Principles [§ 9-401]

other than Article 9, anything that is personal property can be “collateral” under Article 9 (i.e., a security interest can attach to it)

• Generally, contractual prohibitions on a person’s ability to create a security interest in their property are not effective (akin to “unreasonable restraint on alienation” rule in Property law)

Problem 12.1

• Bank is loaning KROK-TV $20 million.

Proposed collateral:

– Debtor’s broadcast equipment – Debtor’s “peacock” logo – Debtor’s broadcast license – Debtor’s goodwill

– Debtor’s slander action vs. former employee – Debtor’s advertising revenues

• Can Bank take a valid SI in each item?

• For some of the collateral, clearly yes

– Broadcast equipment (“equipment”) – Advertising revenues (“accounts”) – Logo (“general intangible”)

– Slander (“commercial tort claim”) [note that this would have to be described specifically; a generic description would be insufficient, § 9-108(e)(1)]

• As to goodwill and the license, it’s doubtful

– Is goodwill “property”? How could it be disposed of? – Broadcast license is subject to FCC “no lien” policy

(license is not KROK’s “property”)

Problem 12.3

• Bank has been asked to lend $250,000 to Saul Finkel, who plans to use it to buy Harry’s Bar

– Harry’s Bar assets include: its rights under the lease of the real estate the bar sits on; all of the furniture, fixtures, and inventory of the bar; and the bar’s liquor license – State law says: liquor license is a “personal privilege,”

“nothing herein shall constitute the license as property” • What collateral should Bank take for the loan?

• Traditional view: a license isn’t “property,” so it can’t be subject of a security interest [In re Chris-Don, Inc., p. 211]

– § 1-201(b)(35): security interest means “an interest in personal property …which secures payment or performance of an obligation”

– § 9-109(a)(1): Art. 9 applies to transaction “that creates a security interest in personal property”

• Note: a liquor license has significant economic value (as it enables its holder to sell alcohol at a profit) • If it isn’t “property,” how

can the holder of the license monetize its value (in a sale or loan transaction)?

• Often, licensee will “sell” the business, with

buyer’s obligation being contingent on

licensor’s consent to transfer of the license

• Media Properties (p. 211): if a licensor

allows a transfer of the license, then the

licensee’s right to payment in exchange for

that allowed transfer is a property right,

even if the license itself is not “property”

– This right to payment would be a “payment intangible,” § 9-102(a)(42), 9-102(a)(61)

• Bank could draft the collateral description to

include “all of debtor’s present and

after-acquired equipment, inventory, accounts and

payment intangibles”

– If Saul later sold bar’s assets (incl. liquor license) to Buyer for $350K, and State approved Buyer as transferee, Bank’s SI would attach to Saul’s right to $350K due from Buyer (Media Properties) – Right to payment would be partly “proceeds” of

equipment and inventory and partly a “payment intangible” (to extent of value of license)

Problem 12.3(b)

• Assume Bank makes the loan to Finkel, who buys Harry’s Bar

• Later, Finkel defaults. Bank wants Finkel to sell the bar, but Finkel will not agree to sell

• What can the Bank do to enforce its SI in this situation?

• Bank faces several practical problems

– Bank can’t compel sale of the license (b/c it isn’t property, and State Liquor Control Board doesn’t have to consent to transfer of license to Bank or another third party)

– Bank can repossess the liquor inventory, but it can’t re-sell that liquor without a license!

– Bank can repossess all of the equipment and shut the bar down, but the Bank’s ability to get maximum value for the collateral may depend on selling bar as a “going concern” (rather than piecemeal)

Problem 12.3(c)

• Would there be an advantage in requiring Saul to form a corporation to buy/operate Harry’s Bar?

– Bank could then take its SI in 100% of the stock, rather than the individual assets

– Upon default, Bank could sell the stock, and the buyer of the stock could then argue it can operate the bar b/c there’s been no legal transfer of the license (the corporation still has the license)

– But, efficacy of this may depend on the state’s liquor licensing provisions (state may still be able to require approval of buyer of the stock of the licensee)

Problem 12.4

• Desmond owes significant debt to Takki Equipment

• Desmond has a vested interest in his employee pension plan

– Takki’s attorney: I’ll recommend a workout proposal to my client, if Desmond will agree to grant a security interest in his pension • Desmond is willing to do it in

order to get Takki to consent to Desmond’s workout proposal

Which Statement Is Correct?

A. Takki has a valid SI in

Desmond’s pension rights

B. Takki does not have a valid

SI in Desmond’s pension

rights

• ERISA contains anti-alienation provision: “(1) Each pension plan shall provide that benefits provided under the plan may not be assigned or alienated ....”

– Except: assignment of pension rights permitted in “qualified domestic relations order”

• Here, even if Desmond purports to grant a SI in his pension rights, grant would be unenforceable

§ 9-408(c). [Legal restrictions on assignment generally ineffective.] A rule of law, statute, or

regulation that prohibits, restricts, or requires the consent of [certain persons] to the assignment or transfer of, or creation of a security interest in …[a] general intangible, including a contract, permit, license, or franchise between an account debtor and a debtor, is ineffective to the extent that the rule of law, statute, or regulation:

(1) would impair the creation, attachment, or perfection of a security interest; or

(2) provides that the assignment or transfer or the creation, attachment, or perfection of the security interest may give rise to a default ….

Problem 12.4

• § 9-408(c) would permit Desmond to create a security interest in his pension, despite contrary state law • But, ERISA’s anti-alienation

provisions override § 9-408(c) under Supremacy Clause [§ 9-408 comment 9] • If you know the assignment

would be invalid, can you make the deal anyway?

Garnishment Options?

voluntary and involuntary alienation

– Takki could not garnish Desmond’s pension administrator to get to his pension funds

• But, once Desmond begins collecting his pension, Takki can execute on any pension dollars after they’re paid to Desmond (if Takki can find them!)

– ERISA prohibits alienation of the right to future payments, but not dollars actually paid to pensioner

Consumer Goods

• Article 9 generally permits security interests in “consumer goods”

– “Consumer goods” means “goods that are used or bought for use primarily for personal, family, or household purposes [§ 9-102(a)(23)]

• Still, both Article 9 and non-Article 9 law do place some legal constraints on a creditor’s ability to secure a loan w/consumer goods

UCC Rules re: Consumer Goods

• SI “does not attach under a term constituting an after-acquired property clause to consumer goods, other than an accession when given as additional security, unless the debtor acquires rights in them within 10 days after the secured party gives value” [§ 9-204(b)(1)]

– This negates the effectiveness of an after-acquired property clause with respect to consumer goods

• In consumer transaction, security agreement not effective to create a SI in consumer goods if goods are described generically (e.g., “all of debtor’s consumer goods”) [§ 9-108(e)(2)]

FTC Rule [16 C.F.R. § 444.2]

to take from a consumer a “a nonpossessory security interest in most household goods other than a purchase money security interest”

– Concern: such goods are personal, have little value, creditors taking SI in such goods were doing so primarily as a means of harassing debtors into payment

• “Purchase-money collateral” = goods that secure a purchase-money obligation [§ 9-103(a)(1)]

• “Purchase-money obligation” = debt incurred as

– all/part of price of the collateral, or

– for value given to enable the debtor to acquire rights in the collateral [§ 9-103(a)(2)]

• SI is a “purchase-money security interest” to the extent goods are “purchase-money” collateral [§ 9-103(b)(1)

• If Zelda purchases a refrigerator from Downtown Appliance (DA) on credit and grants DA a SI in the refrigerator, DA has a PMSI

• If Zelda purchases a refrigerator from DA using cash she obtained with a loan from Bank for that purpose, and she grants Bank a SI in the

refrigerator, DA has a PMSI

Problem 12.5

from IFF, and granted IFF a security interest in the following items:

– Video game system – Family photographs – Jewelry

– Toyota automobile – Home computer

Problem 12.5: Assume that the only

applicable state law is Article 9. Does IFF

have a valid SI in Zelda’s home computer?

A. No, b/c IFF violated the

FTC Rule

B. Yes, b/c IFF did not

violate the FTC Rule

C. Yes, even though IFF

violated the FTC Rule

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FTC Rule [16 C.F.R. § 444.2]

security interest would NOT be “household goods” under the FTC Rule

– Jewelry (assuming it is not her wedding ring), video game system (“electronic entertainment equipment”) are excluded from definition

– Car is not covered by “household goods” definition

FTC Rule [16 C.F.R. § 444.2]

under the FTC Rule

• But, violation of FTC Rule would not invalidate a SI that is otherwise valid under applicable state law • FTC Rule violation is punishable by administrative

penalties or fines, but not by invalidation of a SI taken in violation of the Rule!