Secured Transactions Outline

SECURED TRANSACTIONS
[MRR1]  Fall 2003 Prof. East Room 760
(713) 646-1879 [office] (281) 367-3356 [home]  
OVERALL TOPICS COVERED
1)       Classification of collateral;
2)       Attachment (creation) of a security interest
3)       Perfection of an attached security interest, and
4)       Priority rules between secured creditors.
 
Purposes; Rules of Construction—§1.102
1)       The UCC shall be liberally construed to promote its underlying purposes and policies;
2)       The purposes and policies of the UCC are
a)       To simplify, clarify and modernize the law governing commercial transactions;
b)       To permit the continued expansion of commercial practices through custom, usage and agreement of the parties;
c)       To make uniform the law among the various JDs.
 
Obligation of Good Faith—§ 1.203
1)       Every K or duty w/in the UCC imposes an obligation of good faith
2)       In its performance or enforcement.
TEXAS CL EXCEPTION: Texas Sup Ct declined to imply a duty of good faith in non-UCC K obligations.  
 
Supplementary General Principles of Law Applicable—§ 1.103
1)       Unless displaced by the particular provisions of this title, the principles of
2)       Law an equity, including the law merchant and contract, principal/agent,
3)       Etoppel, fraud, misrepresentation, duress, coercion, mistake, BR,
4)       Or other validating or invalidating cause shall supplement its provisions.
EFFECT: security interest arises from a security agreement, which is a contract. So, to the extent that a security agreement has terms unaddressed by article 9, ordinary contract laws apply.
 
Security Interest § 1.201(37)(A) (general)/Obligor vs. Debtor
1)       “Security interest” means an interest in personal property or fixtures that
2)       secures payment or performance of an obligation, and the
3)       person who owes payment or other performance of the secured obligation is the obligor;
4)       the owner of the collateral is the debtor (usually debtor/obligor same person). 
OVERVIEW OF SECURED FINANCING: a secured transaction is a credit transaction, and a security interest secures the debt.
NON-OBLIGOR SECURITY INTEREST: the security interest does not have to be against the assets of the obligor. The security interest may be created against a third party, who is doing so on behalf of the obligor. The 3rd party though that puts up collateral is the “debtor” because the 3rd party has the “rights in the collateral” for purposes of a secured creditor attaching an interest to the 3rd party’s collateral. The party owing the obligation in this situation is not the “debtor” but the “obligor” under article 9.
HYPO: East’s nephew may need tuition money and East allows him to use his watch as a pledge for a loan. Note the security interest is created in East’s property, but East is not the obligor. This is a credit transaction, as it must be for a secured transaction. East is the debtor and his nephew is the obligor for purposes of article 9.
 
Secured versus unsecured credit—advantages
1)       Two basic types of credit relationships exist: secured, and unsecured credit.
2)       The difference lies in the creditor’s legal rights in the event of debtor default and its
3)       ability to fend off other creditor claims to be paid first.
TWO CORE LEGAL QUESTIONS: commercial financing involves two core legal questions—(1) a creditor’s rights against a debtor and the debtor’s assets (foreclosure issues) and its rights vis-à-vis others holding claims against the debtor (priority issues), including other private, consensual lien holders and non-consensual statutory (M&M liens), judgment (judgment creditor), or public (taxing authorities) lien holders.
IMPORTANCE: a security interest grants the secured creditor a property interest in the debtor’s, or other party’s personal property or fixtures to secure payment or performance of an obligation. An unsecured loan is characterized by the absence of this property interest.
STEPS FOR UNSECURED CREDITOR TO ENFORCE:
1)       Ask D for payment of the amount owed or for the goods sold to be returned; can’t engage in self-help b/c not have a security interest and if do so ML committing civil conversion, criminal trespass and theft.
2)       Engage in formal (judicial) debt collection.
a)       Sue for breach of the agreement/K;
b)       Awarded a judgment, but must wait until the judgment is “final” (usually 30 days); the judgment alone does not create a property interest in any of the judgment-∆s assets; thus,
c)       Enforcing the judgment calls for requesting the court clerk to issue a
d)       writ of execution to the sheriff, which commands the sheriff to satisfy the judgment from the judgment-∆s assets; the sheriff will attempt to “execute” the writ, by locating property of the debtor that is not beyond the reach of judgment creditors, that is, assets that are non-exempt from execution according to state law, so-called “nonexempt assets.” The writ directs the sheriff to satisfy judgment first from the debtor’s personal property, and if that is insufficient, from the debtor’s real property.
i)         If non-exempt assets are located, the sheriff will seize (constructively or actually) enough of them to satisfy the judgment debt and the sheriff’s collection costs.
e)       The sheriff’s seizure of ∆’s assets creates a lien (a property interest) in them, typically referred to as an “execution lien,” or “judgment lien.” Note the property seized may not be the actual goods sold b/c, inter alia, those assets may not be exempt.
i)         When the judgment lien takes effect, the unsecured creditor becomes a “judgment lien creditor,” or simply “lien creditor,” and is now a secured creditor. A judgment lien is nonconsensual.
(1)     A “lien creditor” is defined at § 9.102(a)(52) as a
(a)     A creditor who was formerly unsecured but who has acquired a lien on
(b)     By judicial process (attachment, levy, etc.) is a judicial “lien creditor,” and
(c)     This includes trustees appointed in BR from the petition date, and
(d)     An assignment for benefit of creditors from date of assignment, which is a voluntary transfer by D all assets to a receiver to sell them and pay creditors.
ii)       RELATION BACK NOT IN TEXAS: in Texas, the lien does not relate back to the date of judgment for the time of attachment for priority (as in some states). Instead, in Texas, the date of seizure is the date the judgment lien attaches for priority.
iii)      DOCKET: In most JDs, a judgment creditor may also “docket” its judgment in the county or counties in which the judgment-∆ owns real estate, and that “docketing” will attach, usually, to after-acquired realty in that county. 
f)        If the ∆ still does not pay, the sheriff will auction off the seized assets and apply the proceeds to satisfy the judgment and collection costs.
 
Advantages of a Secured Creditor—REPOSSESSION RIGHTS:
Under § 9.609(a), a secured creditor may, after a default
1)       take possession of the collateral; and
2)       w/o removal, may render equipment unusable and dispose of collateral on the ∆’s premises,
3)       and a secured party may do so
a)       per the judicial process, or
b)       w/o judicial process, if it proceeds w/o breach of the peace.
EFFECT: an art 9 secured creditor, by agreement, has a property interest in some or all of a ∆s assets to secured the debt; the secured creditor can look to its collateral if the debt is unpaid; if the debtor defaults, the creditor has a right to sell the collateral and apply the proceeds to satisfy the indebtedness; but note the existence of a security agreement does not supplant or eliminate a secured creditor’s right to take action against a debtor’s assets generally; a secured creditor has the same right to proceeds against a debtor’ assets as an unsecured creditor. Thus, a secured creditor can reduce its claim to judgment and enforce that judgment by taking the requisite steps described by state law, but a secured creditor can also rely on its collateral to satisfy the debt. 
NON-EXCEPTION—EXEMPT PROPERTY: a consensual security interest granted in assets that are otherwise “exempt” under Texas property law is still enforceable. The reason is the ∆, by entering into the agreement, voluntarily waived that exemption by the security agreement. Some states only allow certain kinds of security interest in exempt property, e.g., Texas only permits purchase-money mortgages on homestead property. But a judgment lien, statutory, or public lien is nonconsensual and therefore usually exempt property is protected. 
POLICY OF LEVERAGE: one of the implied benefits of a security interest, is that it makes it more likely the debtor will pay b/c they will lose what they have, e.g., a car, a business’ equipment that goes to principal operations.
 
History of Modern Security Law 
                The transactions covered in article 9 are a collection of historical secured transactions involving personal property. The following are three prevalent examples.
1)       The Pledge: as late as the 18th century, the law only recognized one personal property security device, the “pledge.”
a)       In a pledge transaction, the ∆ transfers possession of property to the creditor
b)       in pledge to secure its payment obligation, thus, the creditor’s
c)       possession creates the security interest. 
POLICY: The law validated the pledge b/c the creditor’s possession gave 3rd parties notice of the creditor’s claim.
NATURE: The pledge represents a possessory security interest.
HYPO: the pawning of goods to borrow money represents a pledge transaction.
NUANCE: eighteenth century law viewed nonpossessory security interests as fraudulent conveyances.
2)       Chattle Mortgage: a non-possessory security device, which is a mortgage on goods (“chattel”) akin to nonpossessory mortgages on realty.
a)       Following the real estate model, states enacted chattel mortgage recording statutes
b)       Which required public notice of the creditor’s interest for it to be
c)       effective against third parties.
LIMITATION: the ∆ had to actually own the collateral.
3)       Conditional Sales Contract (title retention contract): unlike the chattel mortgage for which a debtor had to own the property to grant a security interest in it,
a)       Conditional sales K allowed a debtor to acquire property on secured credit, where the
b)       Seller retained a security interest in the property to secure its purchase price. 
               
Classification of Collateral
IMPORTANCE: Classification of collateral is vital for accurate perfection and priority. Classification turns on definitions. There are two basic subsets of personal property that serve as collateral—(1) goods, and (2) intangibles.
 
“Goods:” §9.102(a) recognizes four different types of “goods,” in addition to “goods” per se.
1)       “Goods:” means all things that movable when a security interest attaches, including
a)       fixtures,
b)       standing timber that is to be cut and removed under a conveyance or K for sale;
c)       the unborn young of animals;
d)       crops grown, growing, or to be grown, even if the crops are produced on trees, vines, or bushes, and
e)       manufactured homes; the term also includes a
f)        computer program embedded in goods and any supporting information provided in connection w/ a transaction relating to the program if
(1)     the program is associated w/ the goods in such a manner that is customarily is considered part of the goods, or
(2)     by becoming the owner of the goods, a person acquires a right to use the program in connection w/ the goods.
EXCEPTION: goods do not include accounts, 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 (after extraction, hydrocarbons become goods b/c becomes personalty). 
HYPO: the operating system software that comes with a PC when purchase is a good example of a software embedded in the goods, the computer, to be part of the computer, versus buying a game and installing it on the computer (which would be a general intangible).
 
2)       “Inventory” § 9.102(a)(47): means goods, other than farm products, that are
a)       leased by a person as lessor;
b)       held by a person for sale or lease or to be furnished under a K of service;
c)       furnished by a person under a K or service; or
d)       consist of raw materials, WIP, or materials used or consumed in a business;
Std for goods held for sale or lease for “inventory:”
i)                     The definition of “inventory” makes clear that the term includes goods
ii)                   held for lease or sale yy the D to others, but
iii)                  implicit in the definition is the criterion that the sales or leases are or will be
iv)                 in the ordinary course of business.
HYPO: machinery used in manufacturing is equipment, not inventory, even though it is the policy of the D to sell machinery when it becomes obsolete or worn, e.g., clothes merchant moving its obsolete computers to the showroom floor for sale; the PCs still equipment.
USED UP IN A SHORT PERIOD OF TIME: goods are inventory even though not held for sale if they are used up or consumed in a short period of time in the production of a service of a good. 
 
3)       “Equipment” § 9.102(a)(33): goods other than inventory, farm products, or consumer goods.  
e)       Std: in general, goods used in a business are equipment
i)         when they are fixed assets or have,
ii)       as identifiable units, a relatively long period of use.
NUANCE: if faced w/ a question of equipment or inventory, remember that classification of collateral is not as important in the attachment (creation) of a security interest as it is in perfection and priority. E.g., if you buy a car for personal use, it is a consumer transaction, but it’s a commercial between the seller and its lenders. And, the attys must structure and document the transactions and security transactions are imperative. So, proceed and document the transaction so that it does not matter whether it’s equipment or inventory, you perfect it as though you are dealing with both.
MUTUALLY EXCLUSIVE: the classes of inventory and equipment are mutually exclusive. The same property cannot simultaneously be both equipment and inventory. But goods can fall into different classes at different times, e.g., a radio may be inventory in the hands of a dealer and consumer goods in the hands of a consumer. “The principal purpose (use) to which the property is put is determinative.”
 
4)       “Consumer goods” § 9.102(a)(23):
a)       goods used or bought for use primarily for
b)       personal, family, or household purposes.
 
5)       Farm equipment
 
Std for morphing classification when the “use” of the goods
1)       Understand that the classification of collateral can morph, and the
2)       Determinable factor is the principal purpose/use to which the property is put.
EFFECT: inventory on the shelves of a merchant may be a consumer good in the hand of a purchaser if the consumer/purchases uses the collateral for household purposes primarily.
 
Intangibles: (instruments, general intangibles, and accounts)
1)       “Instrument” § 9.102(a)(47)
a)       A negotiable instrument or other writing that evidences a right to payment that’s
b)       Not itself a security agreement or lease, and is of a type that in the
c)       ordinary course of business is transferred by delivery
d)       w/ any necessary indorsement or assignment.
Std: a writing is transferable in the ordinary course of business
i)         if a reasonable professional would attach importance to
ii)       possession of the writing itself.
EFFECT: if transferable in the ordinary course of business, the intangible right at issue cannot be a general intangible or an account. And, the element that the right to payment not itself by a security agreement or lease goes to the right to payment not qualifying as “chattel paper” which is a right to payment combined with a security interest, e.g., a conditional sales K that evidences the right to payment but because it retains title until final payment, it is also security interest. But these can be separated. That is, a promissory note executed simultaneously, but apart from a separate writing evidencing title retention, is still an “instrument” if that is the only property that has a security interest attached (is this correct? Remember a chattel paper is a group of records together is chattel paper, so perfect as “chattel” paper, but maybe belt and suspenders perfect as to instruments and chattel paper in case a note gets separated from the other writing). Together, though, you have chattel paper.
EXCEPTIONS: the following are not instruments
a)       investment property,
b)       letters of credit,
c)       writings that evidence a right to payment arising out of the use of a credit card, or
d)       *nonnegotiable certificates of deposit ((1)is a nonnegotiable CD not a nonnegotiable instrument? Or is this merely a specific exclusion? It is a non-negotiable instrument, a non-negot CD cannot be a negotiable instrument it’s a specific exclusion it could be under the UCC but not in Texas b/c specifically excluded (2) how can a non-negotiable instrument be an “instrument” if the definition of “instrument” says that it covers negotiable instruments?).
EXAMPLE: promissory note is an example of an “instrument,” and a check is an example of an “instrument” because a reasonable professional attaches importance to the possession of a check. 
NON-NEGOTIABLE INSTRUMENTS: in Texas non-negotiable instruments are “instruments” under article nine (ordinarily transferred w/o indorsement) but are not negotiable under article three. To be “negotiable” under article three there must be “order” or “bearer” language, e.g., a check payable to the order of X is negotiable, or payable to bearer would be negotiable as well. But if merely say “Y promises to pay X,” that is not negotiable under § 3.109.
 
2)       “Account” §9.102(a)(2)
a)       except as used in “account for,” an “account” is a right to payment,
b)       whether or not earned by performance, 
i)         for property sold or 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 K;
vii)    arising out of the use of a credit card; or
viii) as winnings in a lottery or other game of chance in a state legally; or
ix)      health care insurance receivables.
EXCEPTIONS: an “account’ does not include rights to payment evidenced by
(1)     chattel paper or an instrument;
(2)     Commercial tort claims;
(3)     Deposit accounts;
(4)     Letters-of-credit rights or letters of credit; or
(5)     Rights to payment for money or funds advanced or sold, other than arising out of the use of a credit card.
EXCEPTION: “accounts receivable” in accounting terms does not automatically mean “account” for article 9 b/c “account” under art 9 has a precise definition.
 
3)       “General Intangible” § 9.102(a)(42)
a)       personal property, including things in action, other than
b)       accounts, chattel paper, commercial tort claims, deposit accounts, documents,
c)       goods, instruments, investment property, letter-of-credit rights, letters of credit,
d)       money, and oil, gas, or other minerals before extraction, but this term includes
e)       payment intangibles and software.
EFFECT: this definition merely states what is not a “general intangible.” A “general intangible,” as described by official comment 5(d), is the residual category of personal property. Thus, if the collateral issue falls under another provision, it should be classified as such, versus a “general intangible.”
PAYMENT INTANGIBLE 9.102(a)(62): a general intangible under which the account debtor’s obligation is a monetary obligation. Thus, must be a general intangible first, and every payment intangible is a general intangible per se, but not vice versa.
SOFTWARE § 9.102(a)(76): general intangible includes computer programs and any supporting information that does not include a computer program included in the definition of “goods.” E.g., buying software at Best Buy on a CD-ROM is not a “good” because software is not incidentally included, it is what you are buying; whereas the computer program in your car for ABS brakes is a “good” embedded in the car such that it can be considered part of the car.
COMMENT 5(d): examples of GI include various categories of IP and the right to payment of a loan that is not evidenced by chattel paper or an instrument. The definition has been revised to exclude commercial tort claims, deposit accounts, and letter-of-credit rights. Each of the three is a separate type of collateral.   
THINGS IN ACTION: generally means the right to bring a cause of action. 
 
4)       “Proceeds” § 9.102(a)(65) means:
a)       whatever is acquired upon the
i)         sale, lease, license, exchange, or other disposition of collateral;
b)       whatever is collected on, or distributed on account of, collateral;
c)       rights arising out of collateral;
d)       to the extent of the value of the collateral,
i)         claims arising out of the loss, nonconformity, or interference
ii)       w/ the use of, defects or infringement of rights in, or damage to the collateral.
EFFECT: under § 9.315(a), a security inte