Overview of Statutory Scheme – Credit transactions in which one party (debtor) buys something from another (creditor or secured party) but does not pay immediately. The creditor wants to be able to rely on something other than debtor’s promise to repay, which is the security interest. A security interest is a limited right in specific personal property (collateral) of the debtor that allows the creditor to take the property if the debtor fails to fulfill the credit obligation. A security interest is effective between parties when steps are taken to attach the interest. Once the interest attaches, if the debtor defaults, the creditor has some right to take the collateral to satisfy the obligation. However, attachment generally does not provide the creditor with rights against third parties who might also have an interest in the same collateral. To gain rights over third parties, the creditor must take steps to perfect the security interest. Perfection serves as a form of notice that the creditor has a security interest in the collateral, and because of this notice, the creditor has rights in the collateral superior to certain third parties who might also have an interest in the same collateral (there are rules of priority to determine superiority).
Scope of Article 9
i. In General – Article 9, with exceptions, applies to all kinds of contractual Sis in personal property and fixtures (i.e. personal property that is firmly affixed to real property). A Security Interest is an interest in personal property or fixtures that secures payment or performance of an obligation.
1. Sales of Receivables – Outright sales of accounts, chattel paper, payment intangibles, and promissory notes are also treated as SIs and are covered by Article 9.
2. Consignments – In a typical consignment, the consignor (i.e., the owner of goods, such as manufacturer or wholesaler) retains title to goods and delivers them to the consignee (e.g., a retailer) for sale to the public. If the goods are not sold, the consignee may return them to the consignor. In cases where a creditor of the consignee would have difficulty distinguishing inventory that a consignee is selling on consignment from inventory that the consignee actually owns, Article 9 considers the consignment to be a SI and requires the consignor to comply with its provisions to give notice to the consignee’s creditors. A consignor must comply with Article 9 to protect its interest in consigned goods against creditors of the consignee if:
a. The consigned goods are worth a total of $1000 or more;
b. The consignor did not use the goods for personal, family, or household purposes (e.g., a person’s consignment of his old clothes would not be covered by Article 9); and
c. The consignee is a person who:
i. Deals in goods of that kind under a name other than the consignor’s;
ii. Is not an auctioneer; and
iii. Is not generally known by her creditors to be substantially engaged in selling the goods of others (i.e., the goods are not being sold at a “consignment store”).
3. Agricultural Liens – Article 9 also covers agricultural liens, i.e., non-possessory liens on farm products (crops, livestock, etc) that are created by state statute in favor of a person providing goods, services, or rental land to a farmer. While the statutes creating the liens govern their creation and enforcement, Article 9 governs their perfection and priority. The rules for perfection and priority of agricultural liens generally are the same as those for security interests.
ii. Lease-Purchase Agreements – Certain types of transactions that the parties attempt to characterize as legal arrangements other than SIs may be governed by Article 9 if the transactions are, in fact, intended to have effect as security. The most common of these are lease-purchase agreements intended for security, rather than as “true” leases. Whether a lease of goods is intended as security is determined on a case-by-case basis. However, a transaction will be deemed to create a SI rather than a lease if the rental obligation is not terminable by the lessee and either: (i) the lease term is equal to or greater than the remaining economic life of the goods; (ii) the lessee is bound to purchase the goods at the end of the lease or to renew the lease for the remaining economic life of the goods; or (iii) at the end of the lease, the lessee has an option to purchase the goods or renew the lease for the remaining economic life of the goods for no or nominal consideration.
Exceptions – Article 9 does not apply to certain transactions, including:
i. Transactions governed by other federal, state, or foreign laws;
ii. Most transactions involving interests in or liens on land (except transactions involving fixtures);
iii. Assignments of tort claims (other than commercial tort claims, i.e., claims filed by organizations or claims filed by individuals that arose out of the individuals’ business and that do not involve personal injury), except with respect to proceeds of the tort claims and priority in those proceeds;
iv. Assignments of deposit accounts in consumer transactions (i.e., transactions in which an individual creates a SI in property brought or used for personal, family, or household purposes), except with respect to consumer deposit accounts that are proceeds of collateral, and priorities in those proceeds;
v. State statutory or common law liens (other than agricultural liens) given for services or materials, such as mechanics’ liens, except with respect to priorities in the personal property covered by the liens; and
vi. Assignment of claims for wages.
Security Interests – SIs generally relate to financing. There are three major types of financing: consumer, business, and agricultural. Article 9 contains rules that apply generally to all three methods of financing and special rules that relate to each specific type.
i. Typical security interests – In a typical Article 9 SI, one party (the creditor) gives another party (the debtor) something of value in exchange for the debtor’s giving the creditor an interest in the debtor’s personal property or fixtures (the collateral). The creditor’s interest in the collateral is not a full ownership interest, but rather is the right to keep or sell the collateral if the debtor defaults on his obligation to the creditor.
ii. Purchase money security interests – A PMSI is a special type of SI in goods that has priority over all other security interests in the same goods if certain requirements are met. A PMSI arises when:
a. A creditor sells the goods to the debtor on credit, retaining a SI in the goods for all or part of the purchase price (creditor and seller are the same person); or
b. A creditor advances funds that are used by the debtor to purchase the goods (creditor and seller are different persons).
c. (Note: A good rule of thumb is: A PMSI exists if (i) credit was advanced or a loan was made for the purpose enabling the debtor to acqui
rty, use of a credit card, or lottery winnings that is not evidenced by an instrument or chattel paper (e.g., the money owed to a doctor after she sees pt). This term does not include deposit accounts, investment property, commercial tort claims, or rights to payment for funds that are advanced or sold (e.g., a bank’s right to payment for a loan).
5. Deposit accounts – accounts maintained with a bank, such as savings or passbook accounts. Article 9 only applies to non-consumer deposit accounts and deposit accounts that are claimed as proceeds of other collateral.
6. Investment property – items such as stocks, bonds, mutual funds, and brokerage accounts.
7. Commercial tort claims – Tort claims that are filed by organizations (e.g., partnerships and corporations) are commercial tort claims. Tort claims that are filed by individuals that arose out of the individuals’ business and that do not involve personal injury are also commercial tort claims.
8. General intangibles – Any intangible not coming within the scope of the definitions of the other types of intangibles – e.g., software, patent and trademark rights, copyrights, and goodwill. A general intangible in which the principal obligation of one of the parties is the payment of money is also called a payment intangible.
iii. Proceeds – Whatever is received upon the sale, lease, exchange, license, collection, or other disposition of collateral or proceeds. Proceeds differ from the other types of collateral in that they constitute any collateral that has changed in form from a previous category. For instance, if a farmer borrows money from a creditor and gives the creditor a SI in the wool from the farmer’s sheep, the wool is collateral of the farm product type. If the farmer exchanges the wool for a tractor or money, the tractor or money now becomes a proceed of the wool. In addition, the tractor can also be classified as equipment. Proceeds are sometimes divided into cash and non-cash proceeds because of the application of certain rules to each. Money, checks, deposit accounts, and the like are cash proceeds. All other proceeds are non-cash proceeds.
1. “Proceeds” include second generation proceeds – Proceeds can go through several transformations and still retain their character as proceeds.
2. Insurance payments and claims for damage are “proceeds” – If the collateral is insured and money is received from the insurance company on account of loss or damage to the collateral, the money is a proceed of the collateral (up to the value of the collateral) unless it is payable to someone other than the debtor or the secured party claiming it. Furthermore, any claims arising out of the loss of, defects in, or damage to collateral are proceeds of the collateral up to the value of the collateral.
Creation (attachment) of security interest