Secured Transactions Outline
Basic Definitions:
“Secured Transaction”
– Contract where the debt of the debtor is secured by some of the debtor’s present or future property as collateral“Lien”
– An interest in the debtor’s property given by the law to protect the creditor* If the debtor voluntarily grants such an interest a “consensual lien” is created
“Mortgage”
– A consensual lien taken in the debtor’s real property“Security Interest”
– A consensual lien taken in personal property“Judicial Lien”
– A lien that arises from judicial proceedings (the creditor sues, recovers judgment, and sends the sheriff out to seize the ∆’s property).“Statutory Lien”
– A lien imposed by either a statute or the common law in favor of certain creditors the law deems worthy of protection [Example – mechanic’s lien]Pre-UCC Security Devices:
Benedict v. Ratner (1925)
Facts – Hub Carpet Co. was adjudicated bankrupt. Benedict, who was appointed receiver and later trustee, collected the book accounts of the company. Ratner, a creditor, filed in that court a petition in equity praying that the amounts so collected by paid over to him. Benedict resisted the petition; claiming that the original assignment was void under the New York Law of fraudulent conveyance;
that for this reason, the delivery of the September list of accounts was inoperative to perfect a lien in Ratner; and that it was a preference under the Bankruptcy Act.
Issue – Whether the May 23rd assignment was in law fraudulent?
Rule – The full control by the mortgagor might well prevent the effective creation of a lien in the mortgagee and that the New York cases hold such a mortgage void upon that doctrine.
Reasoning – In the case at bar, the arrangement for the unfettered use by the company of the proceeds of the accounts precluded the effective creation of a lien and rendered the original assignment fraudulent in law. Consequently the
payments to Ratner and the delivery of the September list of accounts were inoperative to perfect a lien in him, and were unlawful preferences. On this ground, and also because the payment was fraudulent under the law of the State, the trustee was entitled to recover the amount….
* The evil under attack in Benedict v. Ratner is the “secret lien” [ostensible ownership] that other creditors do not know about.
~ Article 9 solves the secret lien problem by making sure that the creditor’s interest in the debtor’s property is obvious so that no later creditors are deceived
(typically by the filing of a notice, called a “financing statement,” in the public records, though there are other methods, such as taking possession of the collateral, that serve the same function).
Major Devices to get around the problems encountered in Benedict v.
Ratner:
(1) “Pledge” – the debtor gives physical possession of the collateral to the creditor (called a pledge) until the debt is paid.
* Pledging is a superior way to perfect the creditor’s security interest, but it has 2 drawbacks:
1. Only tangible objects can be pledged, and
2. For some types of collateral the debtor needs to keep possession.
~ Example – Machines used in manufacturing
(2) “Conditional Sale” – the creditor retains title and may sell the property purchased by the debtor if all payments are not made.
* A conditional sale has the Benedict v. Ratner problem of the debtor-in- possession and a secret lien in the seller’s favor, and the fictitious title retention theory had as short a life here as it did in the real property mortgage situation.
Article 9 Definitions ~ §9-102
“Lien Creditor”
–(A) A creditor that has acquired a lien on the property involved by attachment, levy, or the like;
(B) An assignee for benefit of creditors from the time of assignment;
(C) A trustee in bankruptcy from the date of the filing of the petition; or (D) A receiver in equity from the time of appointment.
“Secured Property”
– [the person granted a security interest] -(A) A person in whose favor a security interest is created or provided for under a security agreement, whether or not any obligation to be secured is outstanding;
(B) A person that holds an agricultural lien;
(C) A consignor;
(D) A person to which accounts, chattel paper, payment intangibles, or promissory notes have been sold;
(E) A trustee, indenture trustee, agent, collateral agent, or other representative in whose favor a security interest or agricultural lien is created or provided for; or (F) A person that holds a security interest arising under §§ 2-401, 2-505, 2-711(3), 2A-508(5), 4-210, or 5-118.
“Security Agreement”
– An agreement that creates or provides for a security interest“Collateral”
– The property subject to a security interest or agricultural lien. The term includes:(A) Proceeds to which a security interest attaches;
(B) Accounts, chattel paper, payment intangibles, and promissory notes that have not been sold; and
(C) Goods that are the subject or a consignment.
“Debtor”
–(A) A person having an interest, other than a security interest or other lien, in the collateral, whether or not the person is an obligor;
(B) A seller of accounts, chattel paper, payment intangibles, or promissory notes;
or
(C) A consignee.
“Obligor”
– A person that, with respect to an obligation secured by a security interest in or an agricultural lien on the collateral, (i) owes payment or other performance of the obligation, (ii) has provided property other than the collateral to secure payment or other performance of the obligation, or (iii) is otherwise accountable in whole or in part for payment or other performance of the obligation. The term does not include issuers or nominated persons under a letter of credit.§1-103
– Construction of UCC is to Promote its Purposes and Policies;Applicability of Supplemental Principles of Law.
(a) The UCC must be liberally construed and applied to promote its underlying purposes and policies, which are:
(1) to simplify, clarify, and modernize the law governing commercial transactions;
(2) to permit the continued expansion of commercial practices through custom, usage, and agreement of the parties; and
(3) to make uniform the law among the various jurisdictions.
(b) Unless displaced by the particular provisions of the UCC, the principles of law and equity, including the law merchant and the law relative to capacity to contract, principal and agent, estoppel, fraud,
misrepresentation, duress, coercion, mistake, bankruptcy, and other validating or invalidating cause supplement its provisions.
§1-304
– Obligation of Good Faith – Every contract or duty within the UCC imposes an obligation of good faith in its performance and enforcement.§9-109 – The Scope of Article 9
(a) Except as otherwise provided in subsections (c) and (d), this article applies to:
(1) a transaction, regardless of its form, that creates a security interest in personal property or fixtures by contract;
(2) an agricultural lien;
(3) a sale of accounts, chattel paper, payment intangibles, or promissory notes;
(4) a consignment;
(b) Security interest in secured obligation – The application of this article to a security interest in a secured obligation is not affected by the fact that the obligation is itself secured by a transaction or interest to which this article does not apply.
(c) Extent to which Article 9 does not apply – This article does not apply to the extent that:
(1) A statute, regulation, or treaty or the United States preempts this article;
(2) Another statute of this State expressly governs the creation, perfection, priority, or enforcement of the security interest created by this State or a governmental unit of this State;
(3) A statute of another State, a foreign country, or a governmental unit of another State or a foreign country, other than a statute generally applicable to security interests, expressly governs creation, perfection, priority, or enforcement of a security interest created by the State, country, or governmental unit; or
(4) The rights of a transferee beneficiary or nominated person under a letter of credit are independent and superior under §5-114.
(d) Inapplicability of Article 9 – This article does not apply to:
(1) Landlord’s lien, other than an agricultural lien;
(2) A lien, other than an agricultural lien, given by statute or other rule of law for services or materials, but §9-333 applies with respect to priority of the lien;
(3) An assignment of a claim for wages, salary, or other compensation of an employee;
(4) A sale of accounts, chattel paper, payment intangibles, or promissory notes as part of a sale of the business out of which they arose;
(5) An assignment of accounts, chattel paper, payment intangibles, or promissory notes which is for the purpose of collection only;
(6) An assignment of a right to payment under a contract to an assignee that is also obligated to perform under the contract;
(7) An assignment of a single account, payment intangible, or promissory note to an assignee in full or partial satisfaction of a preexisting indebtedness;
(8) A transfer of an interest in or in assignment of a claim under a policy of insurance, other than an assignment by or to a health-care provider of a heath-care-insurance receivable and any subsequent assignment of the right to payment, but §§ 9-315 and 9- 332 apply with respect to proceeds and priorities in proceeds;
(9) An assignment of a right represented by a judgment, other than a judgment taken on a right to payment that was collateral;
(10) A right of Recoupment or set-off, but:
(A) §9-340 applies with respect to the effectiveness of rights of Recoupment or set-off against deposit accounts; and
(B) §9-404 applies with respect to defenses or claims of an account debtor;
(11) The creation or transfer of an interest in or lien on real property, including a lease or rents thereunder, except to the extent that provision is made for;
(A) liens on real property in §§ 9-203 and 9-308;
(B) fixtures in §9-334;
(C) fixture filings in §§ 9-501, 9-502, 9-512, 9-516, and 9-519; and (D) security agreements covering personal and real property in §9-604;
(12) An assignment of a claim arising in tort, other than a commercial tort claim, but §§
9-315 and 9-332 apply with respect to proceeds and priorities in proceeds; or
(13) An assignment of a deposit account in a consumer transaction, but §§ 9-315 and 9- 322 apply with respect to proceeds and priorities in proceeds.
Official Comments:
(4) Sales of Accounts, Chattel Paper, Payment Intangibles, Promissory Notes, and Other Receivables – Under subsection (a)(3), as under former §9-102, this Article applies to sales of accounts and chattel paper. This approach generally has been successful in avoiding difficult problems of distinguishing between transactions in which a receivable secures an obligation and those in which the receivable has been sold outright. In many commercial financial transactions the distinction is blurred.
The Scope of Article 9 ~
1) Security Interest Defined:
“Security Interest”
-§1-201(35)
– An interest in personal property or fixtures which secures payment or performance of an obligation. “Security Interest”includes any interest of a consignor and a buyer of accounts, chattel paper, a payment intangible, or a promissory note in a transaction that is subject to Article 9. “Security Interest” does not include the special property interest of a buyer of goods on
identification of those goods to a contract for sale under §2-401, but a buyer may also acquire a “security interest’ by complying with Article 9.
§9-109 – Scope of Article 9:
(a) Except as otherwise provided in subsections (c) and (d), this article applies to:
(1) a transaction, regardless of its form, that creates a security interest in personal property or fixtures by contract;
(2) an agricultural lien;
(3) a sale of accounts, chattel paper, payment intangibles, or promissory notes;
(4) a consignment;
Problem #2 – Assume that a state statute gives someone doing repairs a possessory artisan’s lien on the property repaired. Mr. Baker took his car into Mack’s Garage for repair, but, being strapped for funds, couldn’t pay the full bill, and Mack wouldn’t let him have the car back.
Is Mack’s artisan’s lien an Article 9 security interest? NO, there’s no agreement. If, prior to the repair work, Mr. Baker signed a statement giving Mack’s garage a right to repossess the car if the
bill wasn’t paid, does this agreement create a security interest under the Code? Yes, there’s agreement.
Problem #3 – To raise money, Farmer Brown’s Fresh Vegetable Roadside Stand sold all of its accounts receivable to Nightflyer Finance Company, which notified the customers that henceforth all payments should be made directly to Nightflyer. [Note that this is not a loan from the finance company to the farmer with the accounts put up as collateral; it is an outright sale. If it were a loan, and if the collectible accounts exceeded the amount of the loan, the excess would be returned to Farmer Brown; in an actual sale Nightflyer can keep the surplus. Is this sale nonetheless an Article 9 “security interest?” Yes. If so, even though Farmer Brown has no further obligations to Nightflyer, he would of necessity be termed an Article 9 “debtor.” Then Nightflyer would have to file an Article 9 financing statement to perfect its interest against later parties. Why would the Code drafters have brought an outright sale of accounts
2) Consignments
10 Factors Indicating a Consignment:
(1) The consignor reserves title to the delivered goods until they are sold;
(2) The consignor reserves the right to demand return of the goods at will;
(3) The consignee has the right to return goods which are not sold;
(4) The consignor exerts control over the sale price;
(5) The consignee is obligated to segregate the consigned goods from its own inventory;
(6) The consignee is obligated to hold the proceeds of sales and forward them to the consignor;
(7) The consignee is required to keep separate books and records pertaining to the goods;
(8) The consignor has the right to inspect the goods and the books, records, and premises of the consignee;
(9) Shipping papers and other documents refer to the transaction as a consignment;
(10) The risk of loss remains with the consignor.
* Look at these 10 factors first, then determine if it is an Article 9 consignment
7 Necessary Requirements for an Article 9 Consignment:
(1) The consignor must deliver goods to a “merchant” for sale;
(2) The merchant must deal in such goods under a name other than the name of the consignor;
(3) The merchant is not an auctioneer;
(4) The merchant is not generally known by its creditors to be substantially engaged in selling the goods of others;
(5) The delivered goods are valued at $1,000 or more;
(6) The goods were not being used as consumer goods before the delivery; and (7) The transaction is not a credit sale with a security interest merely disguised as a consignment.
* * Analyzing a transaction under these requirements will lead to one of 3 possible determinations:
1. If all the requirements in §9-102(20) are met, the transaction is a consignment subject to Article 9. As you will learn, however, certain remedies that normally apply to a security interest do not apply to Article 9 consignments.
2. If at least one of the first six requirements in §9-102(20) is not met, the transaction is a consignment NOT subject to Article 9; common law governs.
3. If the 7th requirement in §9-102(20) is not met the transaction is NOT a consignment by a sale and security interest. Article 9 governs this transaction. The factors listed on the reverse side of this page will assist in making this determination.
Problem #4 – Antiques Are Us was the largest antiques store in the city, well known as a place where antique dealers could hire out space and exhibit their wares, with the store handling the sales and taking a commission on each one, and returning to the dealers items that remained unsold. When the store takes out a loan from Octopus National Bank and uses as collateral “all its property,” will the bank’s security interest reach the items in the store that belong to the dealers if the dealers have never taken the steps required of consignors under Article 9?
* This involves a True Consignment, however, it is not an Article 9 consignment. Here, the “not generally known by its creditors to be substantially engaged in selling the goods of others” element is violated. Everyone had notice that this place sold goods of others.
In re Fabers, Inc. (1972)
[consignment vs. agreement intended for security]Facts – Carpet company goes bankrupt. The consignment agreement provided that title to the rugs remained in the dealer until fully paid for; that the consignee had the right to sell the rugs in the ordinary course of business and only at a price in excess of the invoice price; that the proceeds of any sale were the property of the dealer and held in trust for the dealer; that the proceeds of any sale were to be remitted to the dealer immediately with a report of the sale; and that all rugs were held at the risk of the consignee.
∆’s Arg [carpet dealer] – the transaction was a true consignment, that at all times the consignee was acting as the agent of the dealer and, therefore, the transaction came under the exception allowed in §2-326…
Reasoning and Holding – As between the parties, the transaction was a consignment agreement. As to the creditors, it was a sale or return and bound by the provisions of §2-326. Since the petitioner does not come under the exceptions in this section, it was required to comply with the filing provisions of Article 9 to preserve its secured position…It is found that the agreement was intended for security and subject to the requirements of §2-326. There was no perfection of the security interest and the agreement did not come under the exceptions set forth in §2-326(3). Accordingly, it is held that the goods are subject to the claims of creditors, §2-326(2). The reclamation petition is denied, and it is so ordered.
Problem #5 – When Luke Skywalker inherited a valuable sword collection from his father, he took it down to Weapons of the World (WOW), a large gun and weapons dealer, which mostly sold items that it either manufactured itself or bought from other dealers around the globe.
The collection was appraised as being worth over $25,000. Luke asked WOW to sell the collection for him. Is this an Article 9 consignment so that Luke needs to take Article 9 steps to protect himself from WOW’s other creditors who have an interest in the store’s inventory?
* This involves a true consignment. However, it is not an Article 9 consignment. The swords were consumer goods before consignment, thus an element of Article 9 is violated.
Common law governs this consignment.
3) Leases
“Lease” – [§2A-103(j)]
- means transfer of the right to possession and used of goods for a term in return for consideration.Rule – True Leases are NOT within Article 9.
§1-203 – Lease Distinguished From Security Interest –
(a) Whether a transaction in the form of a lease creates a lease or security interest is determined by the facts of each case.
(b) A transaction in the form of a lease creates a security interest if the consideration that the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease and is not subject to termination by the lessee, and:
(1) the original term of the lease is equal to or greater than the remaining economic life of the goods;
(2) the lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods;
(3) the lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or for nominal consideration upon compliance with the lease agreement; or
(4) the lessee has an option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease agreement.
(c) A transaction in the form of a lease does not create a security interest merely because:
(1) the present value of the consideration the lessee is obligated to pay the lessor for the right to possession and used of the goods is substantially equal to or is greater than the fair market value of the goods at the time the lease is entered into;
(2) the lessee assumes the risk of loss of the goods;
(3) the lessee agrees to pay, with respect to the goods, taxes, insurance, filing, recording, or registration fees, or service or maintenance costs;
(4) the lessee has an option to renew the lease or to become the owner of the goods;
(5) the lessee has an option to renew the lease for a fixed rent that is equal to or greater than the reasonably predictable fair market rent for the use of the goods for the term of the renewal at the time the option is to be performed; or
(6) the lessee has an option to become the owner of the goods for a fixed price that is equal to or greater than the reasonably predictable fair market value of the goods at the time the option is to be performed.
(d) Additional consideration is nominal if it is less that the lessee’s reasonably
predictable cost of performing under the lease agreement if the option is not exercised.
Additional consideration is not nominal if:
(1) when the option to renew the lease is granted to the lessee, the rent is stated to be the fair market rent for the use of the goods for the term of the renewal determined at the time the option is to be performed; or
(2) when the option to become the owner of the goods is granted to the lessee, the price is stated to be the fair market value of the goods determined at the time the option is to be performed.
(e) The “remaining economic life of the goods” and “reasonably predictable” fair market rent, fair market value, or cost of performing under the lease agreement must be
determined with reference to the facts and circumstances at the time the transaction is entered into.
Summary - §1-203 – True Lease vs. Disguised Sale of Security Interest:
Step 1
– Is there a right to terminate the agreement at-will by the lessee?* if right to terminate - - it’s a LEASE
* if no right to terminate - - Keep Going.
Step 2
– It’s a Security Interest if any of the following are met:(1) the original term of the lease is equal to or greater than the remaining economic life of the goods;
(2) the lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods;
(3) the lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or for nominal consideration upon compliance with the lease agreement; or
(4) the lessee has an option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease agreement.
* When Step 1 is met (i.e, there’s no right to terminate), but Step 2 is not met, then you must go to Step 3. [Step 3 involves ‘guidelines’ for the court to use]
Step 3
– A Transaction in the Form of a Lease does not create a Security Interest merely because:(1) the present value of the consideration the lessee is obligated to pay the lessor for the right to possession and used of the goods is substantially equal to or is greater than the fair market value of the goods at the time the lease is entered into;
(2) the lessee assumes the risk of loss of the goods;
(3) the lessee agrees to pay, with respect to the goods, taxes, insurance, filing, recording, or registration fees, or service or maintenance costs;
(4) the lessee has an option to renew the lease or to become the owner of the goods;
(5) the lessee has an option to renew the lease for a fixed rent that is equal to or greater than the reasonably predictable fair market rent for the use of the goods for the term of the renewal at the time the option is to be performed; or
(6) the lessee has an option to become the owner of the goods for a fixed price that is equal to or greater than the reasonably predictable fair market value of the goods at the time the option is to be performed.
In Re Architectural Millwork of Virginia, Inc. (1998)
[lease vs.disguised sale]
Facts – Debtor enters into 2 agreements:
1. “Freightliner” agreement [truck]
2. “Komatsu” agreement [forklift]
Then, debtor goes bankrupt.
Reasoning –
(1) The court held that the “freightliner” agreement was a LEASE
~ Step 1 – Can lessee terminate agreement at-will?
* Doesn’t say
~ Step 2 – Is it a sale of a security interest? [any of the 4 factors met?]
* The only factor that is closely related is (4) – [the lessee has an option to become the owner of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement.]
However, the court determines that the option to purchase was NOT nominal.
~ Step 3 – [Guidelines]
(3) lessee assumes risk of loss
(4) lessee has option to renew or become the owner
* Weighing all the circumstance the court decided that the “Freightliner”
agreement was a True Lease
(2) The court held that the “Komatsu” agreement was a SECURED SALE.
~ Step 1 – Can the lessee terminate the agreement at-will?
* Doesn’t say
~ Step 2 – Is it a Sale of a Security Interest [any 4 factors met?]
* YES – the Komatsu agreement clearly provides the option to purchase the forklift for $1 [obviously, a nominal charge] after all scheduled payments are completed.
Problem #6 – B.I.G. Machines, Inc. leased a duplicating machine to Connie’s Print Shop. The lease was for five years, and the rental payments over this period exactly equaled the current market price of the machine. The lease contract further provided that at the end of the five years Connie’s Print Shop might purchase the machine outright by paying B.I.G. Machines
$5.00. B.I.G. Machines did not file an Article 9 financing statement. Thereafter, Connie’s Print Shop borrowed money from the Octopus National Bank and signed a security agreement with the bank granting it an interest in all of the print shop’s “equipment.” Octopus National duly perfected its security interest by filing a financing statement in the appropriate place. When Connie’s Print Shop failed to repay the loan, Octopus National seized all the shop’s equipment, including the duplicating machine. In the lawsuit of Octopus National Bank v. B.I.G. Machines, Inc., who gets the machine?
* Step 1 – Does the lessee have the right to terminate the agreement at-will?
~ NO
* Step 2 – Is it a sale of a security interest? [any 4 of the factors met?]
~ YES, (4) the lessee has the option to purchase the good for a nominal charge.
* Conclusion – This is a sale of a security interest [Because both Step 1 and 2 are met].
Problem #7 – Business Corporation leased a massive copier from Copies, Inc. for a five-year period. At the outset of the lease the copier had a fair market value of $300,000 and a predicted ten-year useful life. Over the course of the five-year lease the rental payments would total to $330,000. The lease provides the Business Corporation has the option to become the owner of the copier at the end of the five-year period by paying Copies, Inc. the amount of
$10,000. Is this a true lease or a secured sale? Would we reach a different result if the copier’s useful life were only five years?
* Step 1 – Does the lessee have the right to terminate the agreement at-will?
~ NO
* Step 2 – Is it a sale of a security interest [any 4 of the factors met?]
~ MAYBE – Depends on whether $10,000 is nominal. If it is “nominal” then the agreement is a Sale of security interest, however, if it is not nominal then go to Step 3.
* Step 3 – Guidelines [not necessarily indicative of a sale]:
~ YES –
(1) the present value of the consideration the lessee is obligated to pay the lessor for the right to possession and use of the goods is substantially equal to or is greater than the fair market value of the goods at the time the lease is entered into;
(6) the lessee has an option to become the owner of the goods f ro a fixed price that his equal to or greater than the reasonably predictable fair market value of the goods at the time the option is to be performed.
* It’s still a judgment call for the court to determine whether it is a lease or a sale; it is not clearly indicative of either.
* If the copier’s useful life were only 5 years then the result would be different. Then, it would be clearly a Sale of a security interest. It meets factors within Step 2.
Attorney Advice – If you’re in doubt as to whether the agreement is a sale or a lease, you should advise you client to go ahead and provide “notice” under Article 9.
§9-505
– Filing and Compliance With Other Statutes and Treaties for Consignments, Leases, Other Bailments, and Other Transactions:(b) [Effect of financing statement under subsection (a)] This part applies to the filing of a financing statement under subsection (a) and, as appropriate, to compliance
that is equivalent to filing a financing statement under §9-311(b), but the filing or compliance is not of itself a factor in determining whether the collateral secures an obligation. If it is determined for another reason that the collateral secures an obligation, a security interest held by the consignor, lessor, bailor, licensor, owner, or buyer which attaches to the collateral is perfected by the filing or compliance.
4) Other Transactions:
“Surety”
–[§1-201(39)]
– includes a guarantor or other secondary obligor Problem #8 – When Mercy Hospital’s administrators decided to build a new addition, they hired a general contractor named Crash Construction Co. and required it to get a surety to guaranty the performance of the construction job and the payment of all the workers and material suppliers (to avoid a mechanic’s lien on the hospital). Standard Surety issued such a performance and payment bond covering Crash’s obligation to Mercy Hospital. To finance the construction, Crash borrowed money from Octopus National Bank (ONB) and gave as collateral the right to collect the progress payments from Mercy Hospital as they came due. ONB duly filed an Article 9 financing statement. Halfway through the job, Crash went bankrupt, and Standard Surety had to finish and pay off the employee’s and suppliers. At this point, by virtue of the common law right to subrogation (the equitable right given to sureties to step into the legal shoes of persons they have paid), Standard Surety claimed a superior right to unpaid monies retained by Mercy Hospital, which were to be paid to Crash. ONB also claimed this fund, pointed to its filed security interest, and stated that Standard Surety’s subrogation right was only an unfilled Article 9 security interest. Who should win?* Common Law ‘subrogation’ is not within Article 9 [because it is not a consensual agreement; it’s “equitable.”] This Standard Surety’s remedy is not within Article 9.
5) Exclusions From Article 9:
§9-109 – Scope of Article 9
(c) Extent to which Article 9 does not apply – This article does not apply to the extent that:
(1) A statute, regulation, or treaty or the United States preempts this article;
(2) Another statute of this State expressly governs the creation, perfection, priority, or enforcement of the security interest created by this State or a governmental unit of this State;
(3) A statute of another State, a foreign country, or a governmental unit of another State or a foreign country, other than a statute generally applicable to security interests, expressly governs creation, perfection, priority, or enforcement of a security interest created by the State, country, or governmental unit; or
(4) The rights of a transferee beneficiary or nominated person under a letter of credit are independent and superior under §5-114.
(d) Inapplicability of Article 9 – This article does not apply to:
(1) Landlord’s lien, other than an agricultural lien;
(2) A lien, other than an agricultural lien, given by statute or other rule of law for services or materials, but §9-333 applies with respect to priority of the lien;
(3) An assignment of a claim for wages, salary, or other compensation of an employee;
(4) A sale of accounts, chattel paper, payment intangibles, or promissory notes as part of a sale of the business out of which they arose;
(5) An assignment of accounts, chattel paper, payment intangibles, or promissory notes which is for the purpose of collection only;
(6) An assignment of a right to payment under a contract to an assignee that is also obligated to perform under the contract;
(7) An assignment of a single account, payment intangible, or promissory note to an assignee in full or partial satisfaction of a preexisting indebtedness;
(8) A transfer of an interest in or in assignment of a claim under a policy of insurance, other than an assignment by or to a health-care provider of a heath-care-insurance receivable and any subsequent assignment of the right to payment, but §§ 9-315 and 9- 332 apply with respect to proceeds and priorities in proceeds;
(9) An assignment of a right represented by a judgment, other than a judgment taken on a right to payment that was collateral;
(10) A right of Recoupment or set-off, but:
(A) §9-340 applies with respect to the effectiveness of rights of Recoupment or set-off against deposit accounts; and
(B) §9-404 applies with respect to defenses or claims of an account debtor;
(11) The creation or transfer of an interest in or lien on real property, including a lease or rents thereunder, except to the extent that provision is made for;
(A) liens on real property in §§ 9-203 and 9-308;
(B) fixtures in §9-334;
(C) fixture filings in §§ 9-501, 9-502, 9-512, 9-516, and 9-519; and (D) security agreements covering personal and real property in §9-604;
(12) An assignment of a claim arising in tort, other than a commercial tort claim, but §§
9-315 and 9-332 apply with respect to proceeds and priorities in proceeds; or
(13) An assignment of a deposit account in a consumer transaction, but §§ 9-315 and 9- 322 apply with respect to proceeds and priorities in proceeds.
Federal Statutes:
Philko Aviation, Inc. v. Shacket (1983)
Issue – Whether the Federal Aviation Act of 1958 prohibits all transfers of title to aircraft from having validity against innocent third parties unless the transfer has been evidenced by a written instrument, and the instrument has been recorded with the Federal Aviation Administration (FAA)?
* YES, the Act does have this effect
Facts – Robert Smith sold the same airplane to 2 different people. First, he sold it to the Shackets, however, the Shackets did not record their title to the plane with the FAA. Smith never gave the Shackets any of the original documents from the transactions; he only gave them photocopies. Next, Smith sold the same plane to Philko Aviation. However, he told Philko the plane was in Michigan being repaired. Smith did give Philko original documents of their transactionl.
Subsequently, Philko files with the FAA.
Rule – “No conveyance or instrument the recording of which is provided for by [§503(a)(1)] shall be valid in respect of such aircraft….against any person other than the person by whom the conveyance or other instrument is made or given, his heir or devise, or any person have actual notice thereof, until such conveyance or other instrument is filed for recordation in the office of the Secretary of
Transportation.
Holding – “Accordingly, we hold that state laws allowing undocumented or unrecorded transfers of interests in aircraft to affect innocent third parties are preempted by the federal Act. Philko wins the plane.
Landlord’s Lien and Other Statutory Liens
Problem #9 – When Christopher Morley opened his bookshop, the landlord wanted security for the rent. They signed a lease agreement providing that all of the inventory (the books) would be subject to a lien in the landlord’s favor and could be seized and sold if
Christopher defaulted in the rent payments. Is the landlord’s lien required to be perfected under Article 9?
* It appears from the text of §9-109(d)(1) that landlord’s liens are NOT covered by Article 9. However, look at the drafter’s intent in Comment #10. This is not a consensual security interest.
Comment 10 to §9-109
– Certain Statutory and Common Law Liens;Interests in Real Property – With a few exceptions (nonconsensual agricultural liens being one), this Article applies only to consensual security interests in personal property…..
Wage Assignments
Problem #10 – Carl Jugular was an independent insurance agent who sold policies for many companies, though his primary sales were the life and automobile policies of the Montana Insurance Association (MIA). In order to float a loan to buy a car, Carl gave the lending bank a security interest in “all present and future commissions earned or to be earned” from the MIA.
Does Article 9 cover this assignment?
* Article 9 does not apply to an assignment of a claim for wages, salary, or other compensation of an employee [§9-109(d)(3)].
Comment 11 to §9-109 – Wage and Similar Claims
– As under former§9-104(d), subsection (d)(3) excludes assignments of claims for wages and the like from this Article. These assignments present important social issues that other law addresses.
The Federal Trade Commission has ruled that, with some exceptions, the taking of an assignment of wages or other earnings is an unfair act or practice under the Federal Trade Commission Act. State statutes also may regulate such assignments.
Non-Financing Assignments:
The §9-109(d)(4)-(7) exclusions of some transfers of accounts, chattel paper, payment intangibles, and promissory notes is meant to be an exclusion of all such assignments of a non-financing nature. Generally, as we have seen, such sales would be Article 9 matters, but in the listed situations no one would think to comply with Article 9, and the possibility of the deception of later parties is small.
Problem #11 – When Michael Logan sold his lucrative art business to John Pivarski, he sold not only all the tangible assets but his outstanding accounts receivables as well. Must the buyer take the steps required by Article 9 of a secured party?
* NOT Within Article 9 because of §9-109(d)(4).
If Logan received a commission to paint the portrait of the city’s mayor but decided he was too busy to perform the task and (with the mayor’s permission) transferred the job (and the right to the payment for it) to another artist, must the new artist take Article 9 steps?
* NOT within Article 9 because of §9-109 (d)(6)
When one of Logan’s clients refused to pay for a delivered painting, Logan sold the account to Trash Collection Agency. Must Trash comply with Article 9?
* NOT within Article 9 because of §9-109(d)(5)
Finally, pressed by his art supplies store for payment of his outstanding tab, Logan transferred to the store the money due him from a client whose portrait he had printed the month before.
Must the art supplies store take Article 9 steps?
* NOT within Article 9 because §9-109(d)(7)
* Important – Obviously, these transactions fall within §9-109(a)(3), but §9-109(d) kicks them out - - They don’t involve serious secrecy problems that need to be protected against with Article 9.
Real Estate:
Except for fixtures, real estate security interests are NOT covered by Article 9, but what happens when the paperwork creating them (the mortgage itself and the promissory note the debtor signs) are used as security when the mortgagee itself seeks a loan?
Problem #12 – Local Loan Company (LLC) needed to borrow money, and Octopus National Bank (ONB) agreed to loan it the requisite amount, taking into ONB’s possession as collateral the real property mortgages and accompanying promissory notes given to LLC by its borrowers. Need ONB do anything either in the real property recording office or under the UCC’s Article 9 to protect its interest in this collateral?
* Mortgage – excluded from Article 9, because it’s a security interest in real property.
* However, if a loan co. uses a promissory note from a mortgage as collateral then it is within Article 9
§9-109(b) Security interest in secured obligation – The application of this article to a security interest in a secured obligation is not affected by the fact that the obligation is itself secured by a transaction or interest to which this article does not apply.
§9-109(d)(11) the creation or transfer of an interest in or lien on real property, including a lease or rents thereunder, except to the extent that provision is made for:
(D) security agreements covering personal and real property.
Comment 7 to §9-109
– Security Interest in Obligation Secured by Non- Article 9 Transaction. Subsection (b) is unchanged in substance from former §9-102(3).The following example provides an illustration.
Example 1: O borrows $10,000 from M and secures its repayment obligation, evidenced by a promissory note, by granting to M a mortgage on O’s land. This Article does not apply to the creation of the real-property mortgage. However, if M sells the promissory note to X or gives a security interest in the note to secure M’s own obligation to X, this Article applies to the security interest thereby created in favor of X. The security interest in the promissory note is covered by this Article even though the note is secured by a real-property mortgage. Also, X’s security interest in the note gives X an attached security interest in the mortgage lien that secures the note and, if the security interest in the note is perfected, the security interest in the mortgage lien likewise is perfected.
It also follows from subsection (b) that an attempt to obtain or perfect a security interest in a secured obligation by complying with non-Article 9 law, as by an assignment of record of a real-property mortgage, would be ineffective. Finally, it is implicit from subsection (b) that one cannot obtain a security interest in a lien, such as a mortgage on real property, that is not also coupled with an equally effective security interest in the secured obligation.
The Creation of a Security Interest
1) Classifying the Collateral:
Three Classes of Collateral:
1. Goods
2. Rights wrapped-up within paper [quasi-tangible]
3. Intangibles
1.
“Goods”
–[§9-102(a)(12)]
– means all things that are movable when a security interest attaches. The term includes (i) fixture, (ii) standing timber that is to be cut and removed under a conveyance or contract for sale, (iii) the unborn young of animals, (iv) crops grown, growing, or to be grown, even if the crops are produced on trees, vines, or bushes, and (v) manufactured homes. The term also includes a computer program embedded in goods and any supporting information provided in connection with a transaction relating to the program if (i) the program is associated with the goods in such a manner that it customarily is considered part of the goods, or (ii) by becoming the owner of the goods, a person acquires a right to use the program in connection with the goods. The term does not include a computer program embedded in goods that consist solely of the medium in which the program is embedded. The term also does not includeaccounts, chattel paper, commercial tort claims, deposit accounts, documents, general intangibles, instruments, investment property, letter-of-credit rights, letters of credit, money, or oil, gas, or other minerals before extraction.
4 Types of Goods:
1. Consumer Goods [§9-102(a)(23)]
2. Equipment [§9-102(a)(33)]
3. Farm Products [§9-102(a)(34)]
4. Inventory [§9-102(a)(48)]
(1)
“Consumer Goods”
–[§9-102(a)(23)]
– means goods that are used or bought for use primarily for personal, family, or household purposes.(2)
“Equipment”
–[§9-102(a)(33)]
– means goods other than inventory, farm products, or consumer goods. {this is a ‘catch-all’ provision}(3)
“Farm Products”
–[§9-102(a)(34)]
– means goods, other than standing timber, with respect to which the debtors is engaged in a farming operation and which are:(A) crops grown, growing, or to be grown, including:
(i) crops produced on trees, vines, and bushes; and (ii) aquatic goods produced in aquacultural operations;
(B) livestock, born or unborn, including aquatic goods produced in aquacultural operations;
(C) supplies used or produced in a farming operation; or
(D) products of crops or livestock in their unmanufactured states.
“Farming Operation”
– [§9-102(a)(35)] – means raising, cultivating,propagating, fattening, grazing, or any other farming, livestock, or aquacultural operation.
(4)
“Inventory”
–[§9-102(a)(48)]
– means goods, other than farm products, which:(A) are leased by a person as lessor;
(B) are held by a person for sale or lease or to be furnished under a contract of service;
(C) are furnished by a person under a contract or service; or (D) consist of raw materials, work in process, or materials used or consumed in a business.
2.
Rights Wrapped-Up Within Paper [quasi-tangible]
5 Types of Quasi-tangible property:
(1) Instruments [§9-102(a)(47)
(a) Promissory Notes [§9-102(a)(65) (2) Investment Property [§9-102(a)(49)]
(3) Documents (warehouse receipts and bills of lading) [§9-102(a)(30)]
(4) Chattel Paper [§9-102(a)(11)]
(5) Letters of Credit Rights [§9-102(a)(51)]
(1)
“Instruments”
–[§9-102(a)(47)]
– means a negotiable instrument or any other writing that evidences a right to the payment of a monetary obligation, is not itself a security agreement or lease, and is of a type that in ordinary course of business is transferred by delivery with any necessary endorsement or assignment. The term does not include (i) investment property, (ii) letters of credit, or (iii) writings that evidence a right to payment arising out of the use of a credit or charge card or information contained on or for use with the card.(a)
“Promissory Notes” [§9-102(a)(65)]
– means an instrument that evidences a promise to pay a monetary obligation, does not evidence an order to pay, and does not contain an acknowledgment by a bank that the bank has received for deposit a sum of money or funds.(2)
“Investment Property”
–[§9-102(a)(49)]
– means a security, whether certified or uncertified, security entitlement, securities account, commodity contract, or commodity account.(3)
“Documents” [§9-102(a)(30)]
– means a document of title or a receipt of the type described in §7-201(2).(4)
“Chattel Paper” [§9-102(a)(11)]
– means a record or records that evidence both a monetary obligation and a security interest in specific goods, a security interest in specific goods, a security interest in specific goods and software used in the goods, a security interest in specific goods and license of software used in the goods, a lease of specific goods, or a lease of specific goods and license of software used in the goods. In this paragraph, “monetary obligation” means a monetary obligation secured by the goods or owed under a lease of the goods and includes a monetary obligation with respect to software used in the goods. The term does not include (i) charters or other contracts involving the use or hire of a vessel or (ii) records that evidence a right to payment arising out of the use of a credit or charge card or information contained on or for use with the card. If a transaction is evidenced by records that include an instrument or series of instruments, the group of records taken together constitutes chattel paper.(5)
“Letters of Credit Rights” [§9-102(a)(51)]
– means a right to payment or performance under a letter of credit, whether or not the beneficiary has demanded or is at the time entitled to demand payment or performance. The term does not include the right of a beneficiary to demand payment or performance under a letter or credit.3.
Intangibles
5 types of Intangibles:
(1) Accounts [§9-102(a)(2)]
(a) Health-Care-Insurance Receivables [§9-102(a)(46)]
(2) Deposit Accounts [§9-102(a)(29)]
(3) General Intangibles [§9-102(a)(42)]
(a) Payment Intangibles [§9-102(a)(61)
(1)
“Account”
–[§9-102(a)(2)]
– except as used in “account for,” means a right to payment of a monetary obligation, whether or not earned by performance, (i) for property that has been or is to be sold, leased, licensed, assigned, or otherwise disposed of, (ii) for services rendered or to be rendered, (iii) for a policy of insurance issued or to be issued, (iv) for a secondary obligation incurred or to be incurred, (v) for energy provided or to be provided, (vi) for the use or hire of a vessel under a charter or other contract, (vii) arising out of the use of a credit or charge card or information contained on or for use with the card, or (viii) as winnings in a lottery or other game of chanceoperated or sponsored by a State, governmental unit of a State, or person licensed or authorized to operate the game by a State or governmental unit of a State. The term includes health-care insurance receiveables. The term does not include (i) rights to payment evidenced by chattel paper or an instrument, (ii) commercial tort claims, (iii) deposit accounts, (iv) investment property, (v) letter-of-credit rights or letters of credit, or (vi) rights to payment for money or funds advanced or sold, other than rights arising out of the use of a credit or charge card or information contained on or for use with the card.
(a)
“Health-Care-Insurance Receivables”
–[§9-102(a)(46)]
– means an interest in or claim under a policy of insurance which is a right to payment of a monetary obligation for health-care goods or services provided or to be provided.(2)
“Deposit Accounts”
–[§9-102(a)(29)]
– means a demand, time, savings, passbook, or similar account maintained with a bank. The term does not include investment property or accounts evidenced by an instrument.(3)
“General Intangibles”
–[§9-102(a)(42)]
– means any personal property, including things in action, other than accounts, chattel paper, commercial tort claims, deposit accounts, documents, goods, instruments, investment property, letter-of- credit rights, letters of credit, money, and oil, gas, or other minerals before extraction.The term includes payment intangibles and software.
(a)
“Payment Intangibles”
–[§9-102(a)(61)]
– means a general intangible under which the account debtor’s principal obligation is a monetary obligation.Problem #13 – Fill in the blanks with the proper classifications of these items of collateral:
(a) A professional pianist’s piano =
* Equipment [within the catch-all]
(b) Cattle fattened by a farmer for sale =
* Farm Products (b2) The farmer’s tractor =
* Equipment
(b3) The farmer’s chickens =
* Farm Product
(b4) Manure from the farmer’s dairy herd =
* Farm Product (c) A mobile home =
* Consumer Good
(d) A right to sue someone for breach of contract =
* General Intangible [this is a chose in action]
(d2) A right to sue some for negligence arising out of an automobile accident =
* General Intangible
(d3) A right to sue a corporation for wooing away a trusted employee =
* This involves a “Commercial Tort Claim”
(d4) A security interest in a lawsuit plaintiff has already won and that has been reduced to settlement agreement =
* Payment Intangible [§9-102(61)] – means a general intangible under which the account debtor’s principal obligation is a monetary obligation.
(e) Pencils and other stationery supplies used by Sears or a similar large retailer in its credit offices =
* Inventory – [Comment 4 to §9-102] – Inventory includes goods that are consumed in a business.
(f) A liquor license =
* General Intangible – [Comment 5(d) to §9-102] – “As used in the definition of
“general intangible,” “things in action” includes rights that arise under a license of intellectual property.”
(f2) A right to the return of a security deposit held by a landlord =
* Payment Intangible – [Comment 5(d) to §9-102] – … “The term ‘payment intangible,’ however, embraces only those general intangibles “under which the account debtor’s principal obligation is a monetary obligation.”
(f3) A newspaper carrier’s right to payments for papers already delivered =
* Payment Intangible; not an Account Receivable [Comment 5 to §9-102] –
“Among the types of property that are expressly excluded from the definition is a “right to payment for money or funds advanced or sold.”
(f4) A newspaper carrier’s right to payments for papers to be delivered in the future =
* General Intangible
(g) Curtains bought by a lawyer for the law office =
* Equipment
(g2) What if after purchasing the curtains the lawyer decides to use them at home? Do they become consumer goods?
* Equipment ~ once collateral has been classified, it’s classification NEVER CHANGES
(h) Aunt Augusta loaned her nephew $5000 with an oral agreement he would repay the money the following year. If she wants to use this agreement as collateral, how would it be classified?
* Payment Intangible
In re Morton (1971)
Facts – П purchased a Ford Bronco for personal use, but later used it primarily for business purposes.
Issue – What type of Collateral is the Bronco? “Consumer good” or
“Equipment?”
Conclusion – Since the bankrupt bought the vehicle primarily for personal purposes, it constituted “consumer goods.”
Problem #14 – Mercy Hospital needs financing and calls you, its attorney, with this question. Many of its patients are members of various health plans and when they come in for treatment they sign paperwork authorizing the hospital to seek payment from their health insurance coverage provider. The hospital always has a large number of such receivables in the process of collection. When the hospital borrows money can it use the monies due it from the various health plans as collateral?
* Type of Collateral = “Health-Care-Insurance Receivable” (“an interest in or claim under a policy of insurance which is a right to payment of a monetary obligation for health-care goods or services provided or to be provided.)
* YES, they can use the money as collateral. §9-109(d)(8) – “a transfer of an interest in or an assignment of a claim under a policy of insurance, other than an assignment by or to a health-care provider of a health-care-insurance receivable and any subsequent assignment of the right to payment, but §§9-315 and §9-322 apply with respect to proceeds and priorities in proceeds.
Problem #15 – Passport Credit Card Company issued millions of credit cards
internationally, sending them to cardholders, who then used them in millions of transactions with merchants. The merchants would then send the resulting paperwork to Passport for
reimbursement (minus Passport’s fee). You are the attorney for Passport. When it needs to borrow money, can it use these credit card transactions as collateral? Remember that the outright sale of such property by Passport is also an Article 9 transaction; §9-109(a)(3).
* YES, they can use the credit card transactions as collateral. It’s an “Account
Receivable. §9-102(a)(2)(vii) - … “Account”, except as used in “account for”, means a right to payment of a monetary obligation, whether or not earned by performance……(vii) arising out of them use of credit or charge card information contained on or for use with the card.
Problem #16 – Fill in the blanks with the proper collateral classifications:
(a) Milk in the hands of the farmer?
* Farm Product [because it’s unmanufactured]
~ In the hands of the grocery store?
* Inventory
~ In the hands of the store’s customer who is buying the milk for consumption?
* Consumer Good
~ Would your answer to the 2nd question change if “restaurant” were used in place of
“grocery store?”
* Inventory
(b) A certificate of deposit issued by a bank?
* Instrument – [§9-102(a)(47)] – means a negotiable instrument or any other writing that evidences a right to the payment of a monetary obligation, is not itself a security agreement or lease, and is of a type that in the ordinary course of business is transferred by delivery with any necessary endorsement or assignment….
* Negotiable Instrument – [3-104(a)(j) – “Certificate of Deposit” – means an instrument containing an acknowledgement by a bank that a sum of money has been received by the bank and a promise by the bank to repay the sum of money. A certificate of deposit is a note of the bank.
~ An airbill issued by an airline as a receipt for frozen shrimp shipped by air?
* Document
* “Bill of Lading” – [§1-201] – means a document evidencing the receipt of goods for shipment issued by a person engaged in the business of transporting or forwarding goods.
~ The receipt given to a farmer by a silo operator when the farmer stored grain there?
* Document
* “Warehouse Receipt” – [§1-201] – means a receipt issued by a person engaged in the business of storing goods for hire.
(c) Rare coins bought by a hobbyist for addition to his collection?
* “Money” as collateral – [is this a good?] – “Goods” - …. “the term does not include…money.”
* “Money” [§1-201(24)] – means a medium of exchange currently authorized or adopted b a domestic or foreign government.
* However, these Rare Coins are probably a “Consumer Good.” - - They are not being used as a ‘medium of exchange,’ but rather as a ‘commodity.’
(d) A tax refund?
* General Intangible – because it is a right to repayment which is not “for goods sold, leased, or for services rendered.”
(e) A debenture bond issued by a corporation?
* Investment Property – [9-102(a)(49)] – means a security, whether certified or uncertified, security entitlement, securities account, commodity contract, or commodity account.
~ A right to 100 shares of stock recorded on the books of the debtor’s stockbroker?
* Investment Property ~ “Security Entitlement”
(f) The checking account you have down at your bank?
* Deposit Account – [§9-102(a)(29)] – means a demand, time, savings,
passbook, or similar account maintained with a bank. The term does not include include investment property or accounts receivable evidenced by an instrument.
(g) A computer program?
* General Intangible
* [9-102(a)(44)] – Software embedded within goods, is a good, however, software by itself is a General Intangible.
(h) The monthly rental obligations owed to a landlord, who wants to use these obligations as collateral for a loan?
* Account – [§9-102(a)(2)] – right to payment; these facts don’t specify if it is a lease of real property.
* * Look Out – [§9-109(d)(11)(D)] – Article 9 does not apply to leases in real property.
~ The promissory notes signed for the tenants to pay their rent?
* Instruments
