Secured Transactions – Spring 2013 – Henning
Cast of Characters
– Debtor – person having an interest, other than a security interest or other lien, in the collateral
– Secured Party – person in whose favor a security interest has been created
– Obligor – person with monetary indebtedness (may owe on the loan but have no interest in the collateral)
– Non-debtor obligor – one who is obligated on the loan but has no interest in the collateral (i.e. parent co-signing child’s promissory loan)
– Third Party – UCC deals with rights of some (but not all) others who may claim an interest in secured collateral
Contrasting Secured & Unsecured Creditors
Unsecured Creditors
– If debtor does not pay the price as it becomes due, seller does not have a right to repossess the goods:
· Must file suit against the debtor for breach of contract to recover judgment
· Judgment will entitle Seller to use the state’s execution process – will apply to the clerk of court that rendered judgment for a writ of execution, which is an order directing the sheriff to levy the debtor’s assets (sheriff acts as Seller’s agent for purposes of satisfying the judgment)
· Writ of execution allows levy on any of the debtor’s assets, including real property (no more or less right to levy on the goods sold than any other asset)
· Sheriff’s sale – proceeds go to Seller in full or partial satisfaction of judgment
o Any excess (debtor equity) goes to debtor
o Sheriff’s sale will divest debtor’s title in goods sold and vest title in buyer at sheriff’s sale
Secured Creditors
– After default, SP can repossess the goods without resort to judicial process
– Like sheriff’s sale, the function of Article 9 foreclosure sale is to divest debtor’s title and vest it in foreclosure sale buyer
– Surplus (debtor equity) goes to debtor
– If money is still owed after the foreclosure sale, SP can proceed as an unsecured creditor (file suit, recover judgment, utilize execution process)
Law of Personal Property
Rights of Third Persons Based on Priority Rules
– Derivative Title – person to whom goods were transferred voluntarily acquired the property rights of the transferor and no more (nemo dat)
· Codified in § 2-403(1) – “a purchaser of goods acquires all title which his transferor had or had power to transfer except that a purchaser of a limited interest acquires rights only to the extent of the interest purchased”
o “Purchaser” is broader than “buyer” and includes a person acquiring a property interest by means of any type of voluntary transaction, including sale, lease, or security interest – even a donee qualifies as a purchaser
o Reference to “power to transfer” incorporates agency principles, including the concept of apparent or ostensible authority – “power to transfer” means actual title that transferor had or situation where transferor had power because of agency principles (i.e. indicia of ownership)
· First sentence of § 2-403(1) – recognizes that purchaser may seek to acquire only a limited interest in goods
o Ex) Leasehold interest under Article 2A – lessor retains title and lessee acquires right to possession and use
o Ex) Article 9 security interest – Owner borrows money and grants lender security interest in goods – title remains with Owner and lender’s interest in the goods is that they serve as collateral
· Second sentence of § 2-403(1) – partial codification of the equitable doctrine of voidable title (provides rule for if person has voidable title but does not give circumstances giving rise to voidable title)
o Thief – void title – never acquired title – Owner can recover goods (replevin) or their value (conversion) – even a good-faith purchaser for value cannot take good title through thief
o Voidable title when Owner clothes fraudulent buyer with indicia of ownership
§ Fraudulent buyer acquires voidable title, meaning that Owner could rescind the transaction and recover goods from fraudulent buyer, but Owner’s rights are cut off if resold to bona fide purchaser
§ Voidable title is exception to derivative title doctrine because person with voidable title has power to transfer more rights than they have
· Third sentence of § 2-403(1) – expands the doctrine of voidable title by overruling some common law distinctions – so a person to whom goods have been delivered in a transaction of purchase has power to transfer good title to GFP for value even though:
o The transferor was deceived as to the identity of the purchaser;
o The delivery was in exchange for a check which is later dishonored
o It was agreed that the transaction was to be a “cash sale”
o The delivery was procured through fraud punishable as larcenous under criminal law
Entrustment
– Concept of voidable title cannot be used when an owner delivers goods to a bailee because the very essence of a bailment transaction is that the owner retains title
– “Entrusting” – § 2-403(3) – “any delivery of goods to a bailee and any acquiescence in retention of possession by the bailee
· “Delivery” – § 1-201(b)(15) – voluntary turnover of possession for certain types of assets dealt with under other articles of the Code but the definition does not apply to goods
o Despite the omission, delivery of goods means the same thing (voluntary transfer of possession)
· Entrustment can also arise through acquiescence in a bailee’s retention of possession
· The definition of entrustment is broad enough to cover almost any type of bailment, but the substantive rule of section 2-403(2) is limited to an “entrusting of possession to a merchant who deals in goods of that kind.”
o Delivery of goods to, or acquiescence in the retention of possession by a person in the business of, inter alia, repairing, storing, or transporting such goods constitutes an entrustment, but the entruster d/n run the risk of being divested of its property rights.
o However, an entrustee that is a merchant that deals in goods of that kind has the power to transfer all of the entruster’s rights to a buyer in the ordinary course of business.
o Buyer in ordinary course of business (BIOCOB)
§ Basic definition = “a person that buys in good faith, w/o knowledge that the sale violates the rights of another person in the goods, & in the ordinary course from a person, other than a pawnbroker, in the business of selling goods of that kind”
§ Typical BIOC is an innocent buyer of dealer’s inventory
Attachment
Three prerequisites to the creation of enforcement security interest:
1. Security Agreement
2. Value given by the secured party
3. Debtor having rights, or the power to transfer rights, in the collateral
– When these three elements are satisfied, in any order, the security interest “attaches”
– Unless another provision of Article 9 yields contrary result, terms of security agreement are effective between the parties to the agreement, any purchasers of collateral, and against creditors that assert a claim to the collateral
· If a third party is involved, there are many exceptions to this general rule:
– Perfection – best understood as a method for giving public notice of a security interest – becomes important only in the context of a dispute between a SP and a third party asserting claim to collateral
Creation of Enforceable Security Interest
– Unless the SP takes possession or control of the collateral, the debtor must authenticate the agreement and it must provide a description of the collateral
Security Agreement
– “Security Agreement” – agreement that creates or provides for a security interest
– “Agreement” – bargain of the parties in fact, as found in their language or inferred from other circumstances, including course of performance, course of dealing, or usage of trade
– Formalistic or magic words not required
1. Authenticated by the Debtor
· Unless the SP takes possession/control of the collateral, debtor must authenticate the agreement (serves as a statute of frauds, providing probative evidence)
· Agreement must be in record form
· “Authenticate” – means to sign; or to execute or otherwise adopt a symbol, or encrypt or similarly process a record in whole or in part, with the present intent of the authenticating person to identify the person and adopt or accept a record (validates electronic signatures)
· Exceptions: SP’s possession or control of collateral (provides alternative form of probative evidence that the parties entered into a security agreement)
2. Description of the Collateral
· Means to identify the property to which security interest attaches
· Not necessary if SP takes possession or control (b/c that provides identification)
· Subject to certain exceptions, “description of personal or real property is sufficient, whether or not it is specific, if it reasonably identifies what is described”
o Detailed description, though not required, helps to identify collateral with precision and lessens problems that flow from ambiguities
o Increased specificity can also lead to errors:
§ Could get serial number wrong
§ Description of location – debtor could move collateral
o Broad descriptions are often the most precise (i.e. “all equipment and inventory”) – both inclusive and precise –
§ “All commercial tort claims” – legally insufficient
· Adequate descriptions:
o Types of collateral:
§ Goods – consumer goods, equipment, inventory
§ Intangibles – accounts, deposit accounts, general intangibles, paper (stock/bonds)
o Classification
§ List
– Future advances clause:
· Concerns the money or other value that is advanced by SP
· Debtor’s interest in the collateral will be encumbered to the extent of the initial loan and all future loans
– § 9-205(a) repeals the Benedict rule (rule imposing extensive formalities on the ongoing financing of accounts and inventory)
· A security interest is not invalid or fraudulent against creditors solely because:
(1) the debtor has the right or ability to:
(A) use, commingle, or dispose of all or part of the collateral, including returned or repossessed goods;
(B) collect compromise, enforce, or otherwise deal with collateral;
(C) accept the return of collateral or make repossessions; or
(D) use, commingle, or dispose of proceeds; or
(2) the secured party fails to require the debtor to account for proceeds or replace collateral.
After-Acquired Property – § 9-204(a), (b)
– Article 9 explicitly validates the use of terms providing for a SI in after-acquired property
· Most important with “revolving” forms of collateral like inventory and accounts
– After-acquired property clause is part of the description of the collateral in the SA
· Rather than covering only property like the debtor’s existing inventory or accounts, the collateral is described to include any property of the type specified that is subsequently acquired by the debtor
– Attachment occurs immediately upon the debtor’s acquisition of rights in the collateral
· AA property clause provides the necessary agreement in advance, the value initially given by the SP is sufficient to support extension of the SI to the newly-acquired assets
– Problem: whether, in the absence of an explicit clause, a SA covering all of the particular category extends to AA property w/in the category
· Courts have generally been permissive with ordinary course financers of inventory and accounts (b/c they are revolving in nature)
· SP’s argument for implicit coverage of AA assets is much weaker if the collateral is not revolving in nature
– EXCEPTIONS:
· Article 9 limits the reach of AA property clauses in the context of consumer goods
o Precludes a security agreement created by such a clause from attaching to consumer goods, other than an accession, given as additional collateral unless the debtor acquires rights in the goods within 10 days after the SP gives value
o Limitation does not apply to an “accession” – an item of personalty that retains its separate identity even though attached to another item of personalty, meaning that it can be removed and sold separately (i.e. replacement tires, batteries)
· SP needs to be careful with respect to AA property clauses covering consumer goods:
o Best advice – not to use such a clause at all – want to avoid conversion liability
· SP must also be concerned about compliance with applicable state/federal consumer protection laws
o Ex) SP can’t take from a consumer a non-possessory SI in household goods other than a PMSI
· Another exception – commercial tort claims
· Cross-default clause – a default on any obligation is a default on all obligations
Future Advances – § 9-204(c)
– Future advances clause – provide that collateral will serve as security for advances or other value that might be extended in the future, whether such advances are obligatory or discretionary
– Article 9 uses the phrase “pursuant to commitment” to refer to advances or other value that a SP is required to extend under the terms of the SA or other agreement
– SP that advances additional money under a security agreement that lacks the clause will be unsecured with respect to the new advance unless it obtains a new SA to cover the advance
– Issues can arise concerning the scope of a future-advances clause:
