Commercial Law: Secured Transactions
Chapter 1 Creditors’ Remedies under State Law
· UCC – Governs transactions in goods
o Article 9 – Secured transactions (using goods as collateral in financing a transaction)
o Articles2, 2A – Sales and leases of goods (center of the UCC)
o Articles 3, 4, 4A – Checks, wire transfers, etc. (how the buyer pays for the goods)
o How the UCC came into existence – ALI (American Law Institute: A group of lawyers who write up a code that can be enacted into state law; So the UCC is state law)
· On exam, make sure you start at the beginning and show why the plaintiff wins
Assignment 1. Remedies of Unsecured Creditors under State Law
A. Who is an Unsecured Creditor?
· Anyone who is owed a legal obligation that can be reduced to a money judgment is a creditor of the party owing the obligation.
· Unless a creditor contracts with the debtor for secured status or is granted it by statute, the creditor will be unsecured.
o Unsecured creditors are the general creditors that populate state collection proceedings.
o If the unsecured creditor has already obtained a court judgment to establish liability, the creditor is a judgment creditor, but the mere grant of a judgment does not alter the creditor’s unsecured status.
B. How do Unsecured Creditors Compel Payment?
· Remedies prohibited to unsecured creditors:
o Self-help seizure of the debtor’s property (Will constitute the tort of conversion.)
o A creditor has a right to demand payment from the debtor, but if the creditor does so in an unreasonable manner, the creditor may incur liability for wrongful collection practices.
· First step in the debt collection process: File a complaint with an appropriate court, and serve process on the debtor-defendant
o The next step is a hearing, usually in a small claims court
o If the debtor does not defend the case, a default judgment may be entered
C. Limitations on Compelling Payment
· Exemption laws prevent creditors from taking many of the most valuable and easy-to-locate assets that debtors own.
D. Fraudulent Transfers
· Any transfer made “with actual intent to hinder, delay, or defraud any creditor” is fraudulent
· Any transfer made “without receiving a reasonably equivalent value in exchange for the transfer” is fraudulent if the debtor was insolvent at the time of the transfer.
· Garnishment – Go after the defendant’s employer
o Defendant has a duty to pay money to the plaintiff, which is a judgment debt
o The court issues a writ to the employer saying that the employer needs to pay the plaintiff (creditor’s creditor)
· Writ of execution – Executing the order of the court so that the plaintiff can gain access to the defendant’s property
o The writ is a piece of paper from the clerk of the court to the sheriff telling the sheriff to go take the judgment debtor’s stuff and sell it and give the proceeds to the plaintiff (so you need all this before you get to exemptions)
o Vitale v. Hotel California, Inc. (p. 6)
· Problems / obstacles to executions and collecting judgments:
o Finding the stuff
o Fraudulent transfers – If the transferee is conspiring with the defendant, then the transferee has to give the money directly to the plaintiff (but if the transferee is an innocent buyer, harder to get the money/property back)
o Hard-to-sell junk
o Rival creditors
o Risk of liability – Such as accidentally taking property that belongs to a third-party (liability for conversion)
o Jurisdiction – May be out of the jurisdiction of the sheriff
o Exemption statutes – Some property is exempt from seizure or levy (varies from state to state)
· Events of default and Ways a creditor can protect themselves in the original contract for the loan
o Acceleration clause – If the debtor defaults on a payment, the entire balance will become due
§ Accelerates to the present all the amounts that are due
o Divisibility – If you are the creditor, and you sue for the dollar amount of the one payment that the debtor has missed, then you have to bring another lawsuit for each payment that is missed. So to fix this problem, creditors put in acceleration clauses.
o Collateral – Distinction between secured creditors and unsecured creditors
o Co-signor or guarantor – Have someone else personally obligated
o Contingent agreement – For example, if the debtor’s top manager is no longer the manager, then the debtor will be in default (this way the lender gets a say in picking the replacement manager)
o Other events of default – The creditor will often have a list of the events that will create a default
· Default judgments are very common (uncontested by the defendants)
o Reason: Defendants realize there is no defense and they recognize that they owe the debt
o These are called “collection cases”
o So, winning the judgment is the easy part, the real work is in collecting the judgment
o If you are a lawyer for a defendant, one way to make money is to assert a counter-claim
§ Such counter-claims may fall under the consumer protection statutes or lender liability law
o All 50 states have exemption statutes, but they vary in what property is exempt
o Must first have the writ of execution before you get to exemptions
· When you win the judgment in one state, you need to domesticate the judgment into the state where you want enforcement (Full Faith and Credit Law – You don’t have to re-litigate because the other states must recognize the judgment, but you still must ask them to recognize it)
· Secured creditors – Types of collateral:
o Goods (governed by Art. 9 of the UCC)
o Land (governed by non-uniformed state law, usually mortgage law that varies from state to state)
Assignment 2. Security and Foreclosure
· Lien – A charge against or an interest in property to secure payment of a debt or performance of an obligation (right to take someone else’s property)
o A lien is a relationship between particular property (the collateral) and a particular debt or obligation
o Security interest is a type of lien
o A lien is a very narrow property interest, which secures performance
· Foreclosure – The process by which the creditor compels application
· Security interest – Most common form of lien, is a right in property contingent in non-payment of debt
· The usefulness of property as collateral will ultimately depend on:
o (1) how much value the creditor can extract from it after default; and
o (2) how much leverage the creditor can derive from its ability to deprive the debtor of the property
· Distinction between purchase money security interest and non-purchase money security interest
o Purchase money – When the borrowed money is used by the borrower to buy the collateral
§ Ex: The borrower borrows the money to buy the house and the borrower gives the house as collateral (borrowing money for something that you also give as collateral)
o Non-purchase money – When the borrower borrows the money for something else and uses the house as collateral
· Mortgage = Security interest in real property
· Three kinds of liens:
o Judicial lien (granted by the court)
§ Execution – Usually tangible property only
§ Garnishment – Property held by third party or intangible property
§ Judgment – Usually real property only
o Statutory lien (granted by statute)
§ Tax lien
§ Mechanic’s lien – Contractors who work on real estate
o Consensual lien (granted by contract; given by the debtor’s consent)
§ Security interest – Personal property
§ Mortgage – Real property
· Exemption statutes – Don’t protect the debtor against secured creditors
· Interest rates on secured loans will almost always be lower than the interest rates on an unsecured loans
o The ease with which a debtor can grant security interests virtually assures that by the time a debtor is in serious financial difficulty, an unsecured creditor will have difficulty finding property to satisfy its debt.
B. Transactions Intended as Security
3. Sales of Accounts
· Accounts receivable are one type of intangible collateral
· Art. 9 refers to accounts receivable as “accounts”
· Account debtor – The person who owes an account
· Example: An auto parts manufacturer that is short of cash might solve its problem either of two ways. First, it might sell the accounts at a discount. “Factors” are businesses that specialize in buying accounts. If, for example, Auto Parts Corporation generates $1 million in accounts receivable each month and the accounts remain outstanding for an average of 120 days, Factor might buy those accounts for $950,000, and collect $1 million from them. Ignoring expenses, Auto Parts Corporation receives $950,000 at the time of the transaction instead of $1 million at the time the accounts are later collected. Auto Parts Corporation might achieve exactly the same thing by using the accounts as collateral to borrow $950,000 from a bank. If Auto Parts collects $1 million from the accounts, and pays $950,000 in principal and $50,000 of interest to the bank, the loan transaction has essentially the same effect as the sale transaction. Ignoring expenses, Auto Parts Corporation receives $950,000 at the time of the loan transaction instead of $1 million at the time the accounts are later collected.
o If Factor will bear the loss, the sale is a true sale.
o If, on the other hand, Auto Parts Corporation has agreed to pay any deficiency so that Factor still receives $1 million in total, the first transaction is merely a security interest disguised as a sale.
· Right of recourse – Contracts for sale of accounts frequently give the purchaser a “right of recourse” against the seller with respect to unpaid accounts. If the account debtor does not pay, the deal is that the seller will buy the account back for the initial sale price. The effect is to guarantee the “purchaser” the full face amount of the accounts. A sale of accounts with recourse is in substance a secured loan, but numerous courts have held otherwise.
o The transaction between the bank and the manufacturer is a sale, rather than a loan, because the bank is taking on the risk if the retailer does not pay
§ If you want to make it so that the bank is a lender, and not a buyer, you need to make it where the bank is not assuming any risk if the retailer doesn’t pay – Bank has a right of recourse against the manufacturer, so if the retailer doesn’t pay, the manufacturer has to buy back the account from the bank (so there is still an account sold to the bank, but the bank also gets from the manufacturer a promise that if
ession to the creditor so the creditor can hold a foreclosure sale
· Replevin – Any party entitled to possession of tangible personal property is entitled to the writ. The writ directs the sheriff to take possession of the property from the defendant and give it to the plaintiff.
o Issuance of the writ is usually conditioned on the creditor’s posting a bond to protect the debtor in the event that the debtor ultimately prevails in the replevin action
· Creditor has possession between breach and foreclosure
· Del’s Big Saver Foods, Inc. v. Carpenter Cook, Inc.
o The plaintiffs alleged they were deprived of their due process rights
o The defendants went to court, filed a complaint alleging that the plaintiffs had defaulted several times on the note, and the judge issued an order granting the defendant immediate possession of the collateral, and the lawyers went and took possession of the store – all of this happened in one day
o The court stated that the plaintiffs could not prevail on their claim that their due process rights were violated because the plaintiffs never requested a post-seizure hearing, so since they never requested a hearing, they cannot said they didn’t have the opportunity to be heard
C. The Article 9 Right to Self-Help Repossession
· Use of available judicial procedures is usually mandatory; however, the principal exception is that a creditor with an Article 9 security interest in tangible, personal property can bypass the courts and the sheriff and do its own work
· The right to self-help repossession is derived from UCC 9-609
· The courts generally hold that the duty to refrain from breach of the peace during repossession is nondelegable, making the secured creditors liable for the consequences of illegal repossessions by their independent contractors
· UCC 9-609(a)(2) gives the creditor the option to leave “equipment temporarily in the possession of the debtor but render it unusable.” – This is usually when the equipment is too large to move
· 9-609: Secured Party’s Right to Take Possession after Default.(a) [Possession; rending equipment unusable; disposition on debtor’s premises.] After default, a secured party: (1) may take possession of the collateral; and (2) without removal, may render equipment unusable and dispose of collateral on a debtor’s premises under Section 9-610(b) [Judicial and nonjudicial process.] A secured party may proceed under subsection (a): (1) pursuant to judicial process; or (2) without judicial process, if it proceeds without breach of the peace. = self-help repossession(c) [Assembly of collateral.] If so agreed, and in any event after default, a secured party may require the debtor to assemble the collateral and make it available to the secured party at a place to be designated by the secured party which is reasonably convenient to both parties.
D. The Limits of Self-Help: Breach of the Peace
· Most lawsuits involving creditor’s self-help repossession turn on what constitutes a breach of the peace
· Salisbury Livestock Co. v. Colorado Central Credit Union
o Colorado Central loaned money to Salisbury and the loans were secured by his vehicles. He defaulted on the loan, so Colorado Central sent a team of repossessors after the motor vehicles. The repossessors took some of the vehicles from a ranch owned by Salisbury Livestock Co. and they encountered no opposition when they took the vehicles around dawn.
o The issue is whether the entry to repossess was privileged either by the self-help statute or by consent.
o The court does not agree with Salisbury Livestock’s contention that a trespass without more is a breach of the peace. A trespass breaches the peace only if certain types of premises are invaded, or immediate violence is likely.
o The court says that confrontation or violence is not necessary to finding a breach of the peace. The possibility of immediate violence is sufficient
o The court says that a jury should hear the case because the location and setting of this entry to repossess is sufficiently distinct, and the privacy expectations of rural residents sufficiently different
· See examples on pages 47-49 for examples on situations when there has been a breach of the peace and when there has not been a breach of the peace