Purchase Money Definitions

Assignment 8: Automatic Perfection

(with an Introduction to the Purchase

Money Security Interest)

Reference: Understanding Secured

Transactions §§ 1.05, 7.01, 7.02

“Purchase Money” Financing

• Debtors often obtain financing to enable them

to acquire the item(s) in which they are

granting a security interest

– This is “purchase money” financing

• “Purchase money” status can be important

– For priority purposes (PMSI may get priority over previously filed UCC-1 covering collateral) – For perfection purposes

“Purchase Money” Definitions

• SI in goods is a “purchase-money SI” if goods

are “purchase-money collateral” [§ 9-103(b)(1)]

• Goods are “purchase-money collateral” if they

secure a “purchase-money obligation” with

respect to the collateral [§ 9-103(a)(1)]

• “Purchase-money obligation” is one:

– Incurred to seller, to secure all/part of the price of the collateral, or

– Incurred to lender, in exchange for value given to enable the debtor to acquire the collateral (and

actually so used by debtor) [§ 9-103(a)(2)]

Automatic Perfection

• PMSI in consumer goods is automatically

perfected upon attachment (no need for

secured party to make UCC-1 filing) [§

9-309(1)]

– Rationale 1: cost of filing would drive up price of consumer goods

– Rationale 2: even without a UCC-1 filing, lenders can anticipate that debtor may have obtained consumer goods using PM credit

Problem 1

• Carl H. Esbeck borrows

$20,000 from Putnam County

Bank to buy a guillotine

– He signs agreement granting Bank a SI in (1) 1,000 shares of Apple stock and (2) the guillotine – PCB files a UCC-1, but it

mistakenly identifies the debtor as “Carl Hesbeck”

• Does Bank have a perfected SI?

Problem 1: Questions

• PMSI in consumer goods is automatically

perfected upon attachment, even if no UCC-1

filing covers the collateral [§ 9-309(1)]

• Answer to Problem 1 thus depends on 2

questions:

– Question 1: Does Bank have a PMSI?

– Question 2: Is the collateral “consumer goods”?

Problem 1 Analysis

• Q1: PCB appears to have a PMSI in guillotine

[§ 9-103(a), (b)], but not the Apple stock

– PCB loaned $20K to Esbeck to buy the guillotine – Esbeck used that $20K to buy the guillotine – Esbeck granted PCB a SI in the guillotine

• Q2: Is the guillotine “consumer goods” in the

hands of Esbeck?

• If Esbeck acquired the guillotine for personal

use, it is “consumer goods” [§ 9-102(a)(23)],

and thus Bank’s PMSI in it was automatically

perfected when it attached [§ 9-309(1)]

– If so, the mistake in Esbeck’s name on UCC-1 is irrelevant, b/c PMSI was automatically perfected

• If Esbeck’s primary use was for a business

purpose, the guillotine is “equipment”

– No automatic perfection; UCC-1 would be necessary to perfect [§ 9-310(a)]

– Bank’s UCC-1 is ineffective (error in name was seriously misleading) [§§ 9-502(a), 9-506(b)]

Synthesis

Problem

Columbia Honda for personal use • Abrams agrees to pay $25,000

sale price in 72 equal monthly installments by contract stating “Debtor hereby grants Columbia Honda a PMSI in the collateral [the minivan].”

• Is Columbia Honda’s SI in the minivan automatically perfected upon attachment?

PMSIs and Titled Goods

• § 9-309(1) automatic perfection rule for PMSIs in consumer goods does NOT apply if the collateral is a titled vehicle (“Except as otherwise provided in Section 9-311(b) with respect to consumer goods that are subject to [certificate of title act]….)”

– Perfection requires compliance w/certificate of title act [§ 9-311(a)]

– This makes sense, as 3d parties will look to title certificate for relevant information

Problem 2

• You sold a 60-inch TV to

Joe Smith for $1,000

– Smith paid with a check, but it bounced

– You let Smith keep the TV if (1) he paid by end of month, with interest and (2) he granted you a SI in the TV – Smith signed an agreement to

this effect

• Do you have to file a

UCC-1 to perfect?

Problem 2

• Problem: at time Smith signed the security

agreement, Smith already had acquired

rights in the TV, which you originally sold

him on unsecured credit (by check)

– In that situation, is it proper to call the TV “purchase money collateral” and to call the SI a PMSI?

§ 9-103, Official Comment 3

“The concept of ‘purchase-money security interest’

requires a close nexus between the acquisition of

collateral and the secured obligation. Thus, a

security interest does not qualify as a

purchase-money security interest if a debtor acquires property

on unsecured credit and subsequently creates the

security interest to secure the purchase price.”

§ 9-103, Comment 3 Example

• January 1: X buys furniture from Dealer for

$5,000 on “90 days same as cash” basis

• April 1: X still hasn’t paid; offers to grant

Dealer a SI in the furniture if Dealer will give

X an additional 90 days to pay

– This SI would not be a PMSI, b/c it didn’t enable X to acquire the furniture (X already owned rights in the furniture)

Problem 2 Compared

• Question: Is Problem 2 different from the

previous example (where debtor bought

furniture “90 days same as cash”)? Is there an

argument for treating the secured party in

Problem 2 as having a PMSI?

• If so, what specific language in the UCC

supports that argument?

Problem 2: Your Argument?

• Because Smith paid for the TV with a “bad check,” his title in the TV was “voidable” [§ 2-403(1)(b)]

• Thus, you could “void” his title, and then agree to re-sell the TV to him on a secured basis

– If so, the re-extension of credit would have enabled him to re-acquire rights in the TV (after previous rights were “voided”), so this would be a “purchase money obligation” under § 9-103

• Note: This argument would not apply in the “90 days same as cash” hypo (in that example, X’s title would not have been “voidable” under § 2-403(1))

Troupe

Hypo

• Lambert buys a flat screen TV at BestBuy, signing a contract to pay in 24 monthly installments; BestBuy retains PMSI in TV

– Contract: “Buyer warrants that he is buying the goods for personal, family, or household use” – BestBuy doesn’t file a UCC-1 – But, Lambert places the TV in the

waiting room of his law office! • Is BestBuy’s SI perfected?

Troupe

• Court held that the secured party could rely on the debtor’s representation, in security agreement, that debtor was acquiring goods for personal use [p. 5]

– On this reasoning, TV is consumer goods, and Best Buy’s PMSI is automatically perfected under § 9-309(1), even if the representation turns out to have been false

• Is this a good result? Is there a persuasive counterargument?

• At one level, Troupe reasoning seems

problematic, if not wrong

– A 3rd party dealing with Lambert would believe that the TV was equipment, not consumer goods

– Here, because the issue is perfection (3rd party rights), why should a statement in the security agreement control?

• Still, other decisions are consistent with Troupe

– Contrary result would potentially increase consumer credit costs (additional secured party “due diligence” would increase cost of consumer credit)

Purchase Money Security Interests

• Most PMSI transactions are what might be

called “one-to-one” transactions, e.g.,

– Purchase money secured party extends credit for debtor to buy a specific asset (e.g., Seller of TV extends credit to Buyer of TV), and

– Purchase money secured party takes SI in only that asset (e.g., Seller takes SI in that TV)

• In some cases, however, this is not true

• E.g., Problem 1: Esbeck takes out loan to buy a guillotine and grants SI in the guillotine, but also in Apple stock he already owns

• E.g., a security agreement may “cross-collateralize” multiple loans

– Suppose that ABC, Inc. buys a bulldozer and a copier in separate secured transactions

– Each time, ABC borrows the money for the purchase price of each item, and signs a security agreement that says: “Debtor hereby grants Bank a SI in [the bulldozer] [the copier], and Debtor agrees that the collateral shall secure all sums owed to Bank, presently owed or incurred in the future.”

• In ABC, Inc. example, this agreement

would “cross-collateralize” the two loans

– I.e., the copier would now secure repayment of (a) the loan used to acquire the copier AND (b) the loan used to acquire the bulldozer

– Likewise, the bulldozer would secure

repayment of both (a) the loan used to acquire it AND (b) the loan used to acquire the copier

• What’s the advantage of such a clause?

“Transformation Rule”

• Prior to 2000, some courts held that if a SI in an item of collateral also secured a debt other than the purchase price of that collateral, the SI could not be a PMSI [see, e.g., In re Parish]

– Rationale: PM status required “one-to-one” nexus between debt and collateral; cross-collateralization destroyed PM character of each individual transaction • Transformation rule (if applied) could defeat

Secured Party’s ability to rely on automatic perfection rule

“Dual Status Rule”: Pre-2000

• Other courts instead applied the “dual

status” rule

– Old § 9-107: “A security interest is a PMSI to the extent that” it secures the purchase price – Under the “dual status” rule, a SI can be both a

PMSI (to the extent of the unpaid balance of the PM obligation) and a nonPMSI (to the extent it secures repayment of nonPM obligations)

“Dual Status Rule”

• Revised Article 9 adopted the “dual status”

rule [§§ 9-103(b)(1), 9-103(f)]

§ 9-103(f). In a transaction other than a consumer-goods transaction, a purchase money security interest does not lose its status as such, even if:

(1) the purchase money collateral also secures an obligation that is not a purchase money obligation;

(2) collateral that is not purchase money collateral also secures the purchase money obligation; or

(3) the purchase money obligation has been renewed, refinanced, consolidated, or restructured.

• Note, however, that § 9-103(f) does not mandate that the court apply the “dual status” rule in a

“consumer-goods transaction” [§ 9-102(a)(24)] • § 9-103(h): in a “consumer-goods transaction,”

courts are free to apply “established approaches,” which includes the transformation rule

– Thus, a court that had applied the transformation rule prior to 2000 (as in Parish) could continue to do so in consumer goods transactions

– In those states, a consumer lender whose documents use cross-collateralization provisions could not rely on automatic perfection (but would have to file to perfect)