Fall 2013
WestBrook – Secured Credit
Introduction and Overview
Article 9 v. Bankruptcy Code
– Focused on default
– Valid security interest and what happens to them in bankruptcy
– Different political constituencies but they have to fit together (they are at war because both seek to control the management of financial distress
What is the problem with statutory construction?
– How do we understand an approach to application of ambiguous statutes?
Transactional Analysis
– Judge level legal analysis
o Fixed Set of Facts
– Litigators analysis
o Not bound by the record
o Creates the record by working through hypotheticals
o More complex analysis
– Transactional analysis
o Looking forward to possible sets of facts
o Creation of facts
o Highest Level of Analysis
Law is about duties or obligations
– When violated, there is default
o This is the heart of commercial law
Defaults are specific or general
– Specific – Refusal to honor one’s obligation
– General – Default on all obligations; inability to pay
3 Parts of Default System
– Judgment Enforcement (Specific Default)
– Bankruptcy (Collective Response to General Default)
– Secured Credit (Covers both)
Priority Questions – Important and Complicated
– Interest given to more than one creditor
– Key point is transparency
o How does this avoid priority issues?
o One can’t be defrauded if information is available at the start of the deal
– Markets work better with more information
o Efficiency is increased
Definition of terms in UCC
– 1.201(35)
o Defines Security Interest
– Article 2 (Sales Article)
o Liens arise under sale
§ Liens are not always a security interest
§ Security interest is always a lien but voluntary
– Article 4 (The Bank Wins!)
– Article 5 (Letters of Credit)
– Article 7 (Bills of Laden; Receipts)
– Article 8 (Securities)
o Securities and Security Interests are different
o These are stocks and bonds
o How does it interact with Article 9
– Bankruptcy Code – Emphatically Federal Law (Exclusive Federal Jurisdiction even when state law is involved [like the UCC])
o Chapter 7 (Liquidation; Sell Out)
o Chapter 11 or 13 (Pay Out)
o Chapter 15 (International)
Negotiable Interests – Collateral
– [the order of] under Article 3
o “Magic Words”
o Passes without most defenses including “I already paid” and warranty defenses
– “Real defenses” apply
o Like forgery
– Secured parties prefer negotiability
o It is expressly prohibited by the FTC in consumer transactions
Enforcement of Debt Obligations
1. Under State Law
a. Unsecured Creditors on a Treasure Hunt: Enforcement of Judgments against the Debtor’s Property
i. “Execution” and Priorities Among “Executing” Creditors
1. Collection Process of a Unsecured Creditor:
a. Judgment for the creditor: The claim becomes indisputable by the debtor, but does not give the creditor any interest or priority. At this point, the creditor is a “judgment creditor.”
b. Granting of a writ: A court order that orders the sheriff or marshal to go look for non-exempt property of the judgment debtor and execute the collections process
c. Executing on the writ: The sheriff goes looking for debtor property and levies upon the property
i. To levy the property:
1. Ordinarily, the sheriff will take physical possession, transport it, and lock it in the courthouse
2. If the property cannot be immediately seized, the sheriff may tag it with a notice of seizure
ii. Upon the levy, the creditor becomes a “judgment lien creditor” (often “lien creditor” for short)
iii. Sheriff then files a “return” which describes process to the court
d. Public sale: Sheriff advertises the property for a public sale and sells to the highest bidder.
i. Proceeds are paid to the creditor until paid in full. Any leftover will be paid back to the debtor.
ii. If funds are insufficient, the sheriff will be commanded to look for more debtor property to seize
2. Priority between unsecured creditors
a. General Rule: “First in time, first in right” –first creditor to levy on a particular piece of property will have the right to be paid in full from the proceeds of the sale of that property before any other creditor gets any of the proceeds
b. In the majority of states, the issuance of the writ to the sheriff determines the priority date, but some states base it on the levy date
c. Most states require that the creditor take the property in order to become a judgment lien creditor
3. In the Matter of the General Assignment for the Benefit of Creditors of Hiawatha Do It Yourself, Inc. (M75)
a. Facts: Two judgment lien creditors choose not to sell the assets, but allowed Hiawatha to continue to operate. After they had both levied the assets, the US filed a tax notice.
i. Judgment doesn’t give interest in the debtor’s property, but the levy does
ii. Filed tax claim is the equivalent of judgment execution of all the debtor’s property
b. Holding: Whitlock gets first priority, Anchor gets second, and US has third; but the US get the inventory because the law gives the US a continuing levy on the inventory
i. Lien must become choate, or perfected, in order to have interest in the property (in minority state that doesn’t require the creditor to take the property in order to be a judgment lien creditor)
1. Levy is effective when perfected (choate) when identity of lienor, property subject to lien, and amount of the lien are established
ii. Exception for inventory (“stock in trade” because it is not specific or constant so the property subject to lien is not established
1. Common law couldn’t deal with after acquired property
2. Therefore, in order to seize, the creditor must immediately take
a. Otherwise secret lien
4. Credit Bureau of Broken Bow v. John V. Moninger (M78)
a. Facts: Bureau gets default judgment against debtor. The debtor subsequently renewed a prior note with Bank with the intention to secure the note. Bureau gets a writ of execution and the debtor’s truck is levied, but the Sheriff does not take possession and is told of the Bank’s interest. After the levying, Bank and debtor execute and file a security agreement.
b. Holding: Bureau has prior rights to the proceeds over the Bank.
i. Bureau became lien creditor with levy because Nebraska doesn’t require possession to have a valid levy
ii. Sheriff’s knowledge of the Bank’s interest is not imputed on Bureau so Bureau has priority under 9-317 because it is w/o knowledge
1. Sheriff is not an agent of the Bank, a third party
c. Who gets priority – Judgment Creditor v. Perfected Lien Creditor
i. In some states, the priority date relates back as the key date after the writ is executed (MAJORITY)
ii. In some states, the levy date is the key date (MINORITY)
5. Problem Set I (M84)
a. Question 1: RHA is financial trouble and owes 3 judgment creditors $10k each. AM obtained judgment on 11/1. BC got judgment on 11/10 and delivered writ to sheriff on 11/15. CP got judgment on 11/20, delivered writ on 11/22, got execution on 11/25. Sale gets $15k.
i. Some states allow a pro forma levy at the courthouse later for this writ which is required in the relation back system. If possible, BC should execute a pro forma levy on the goods that CP had already gotten execution on.
ii. If BC can get a pro forma levy, then the distribution will depend on the state
1. Most states base on the date of delivery of writ to sheriff (relation back), if this is the case, BC will get $10k and CP will get $5k.
2. Some states base the “first in time” on date of levy. In this case, BC will get $5k and CP will get $10k
iii. If BC doesn’t get a levy, CP will get $10,000 and the excess money goes back to RHA.
b. Question 2: SBC has 5 judgment creditors, but only one was executed. Each judgment is for $5k. The sheriff executed on HK’s fi fa by going to SBC and announcing that he was seizing the entire inventory. SBC convinces HK to forebear on seizing the inventory. Afterwards SBC granted SSB a SI in all inventory for a $10k loan which was properly perfected. SBC then fails. The sale of inventory will net $12k.
i. If in a levy as date state, 10k to SSB, 2K to SBC
1. No other creditor has perfected their claim
2. HK can try to levy the shoes after SSB has seized it
ii. Common law will likely not allow interest in inventory, so the bank would have the only valid interest (bank has right under Article 9)
ii. Garnishment
1. Used to attach debts owed to the debtor for the benefit of the debtor’s judgment creditor. The property being seized here is the debt. Common form of garnishment is to the debtor’s wages, bank account, and third party possession of debtor goods.
2. Garnishment process
a. Writ of garnishment:
i. Set of questions to determine if the garnishee owes money to or has any property of the debtor
ii. Command to the third-party garnishee to withhold payment or return of the debtor’s property
b. Garnishment: Either the seizure of the property from the garnishee or the transfer of debts. Treated as an ancillary lawsuit, so if the third party contests the garnishment a trial can be held.
i. Judgment debtor receives notice of the garnishment and may also participate
ii. Garnishee may assert defenses to garnishment such as claiming that he owns the property or that the debt had been released or satisfied. Most often it will be that the garnishee has superior rights to the property.
3. Some states allow for the entire judgment to be rendered against a garnishee who fails to answer the writ within the time specified (Webb v. Erickson [M90])
4. Webb v. Erickson (M90)
a. Facts: Judgment creditor got a judgment against Bates for the amount owed by Erickson. Another lawsuit for enforce garnishment against Bates from his employer.
b. Holding: Set aside the judgment against Bates
i. More liberality should be shown in setting aside a judgment against a defaulting garnishee
ii. Bates acted with excusable neglect due to his personal circumstances
iii. Lack of notice of the default judgment
5. Problem Set II (M105; uses Texas Rules on M103-104)
a. Question A: FC gets $3,000 judgment on 2/1 and delivered writ of garnishment to sheriff on the same date. Bank has an offset of $10. On 2/5 debtor deposits $2,500, and on 2/9 bank is served the writ.
i. Bank gets $10, and FC gets $2,490
ii. Bank usually gets offset no matter what time the offset is executed
iii. According the TX law, the bank needs to answer based on the amount it holds on the day that it is served
b. Question B: Same as question A, but debtor wrote a $500 check on 2/9 and bank accidently paid the check on 2/10. Still unknowing,
10 cmt. 7]
b. In a public sale, the secured creditor has the right to buy the collateral and the debtor is entitled to notification of the time and place of a public disposition [9-610 cmt. 7]
c. In a private sale, the secured party cannot normally buy the collateral and the debtor is entitled to notification of the time after which a private disposition is to be made [9-610 cmt. 7]
3. Under most circumstances, the creditor must give the debtor and any secondary obligor notice under 9-611(b)-(c) of the time and place of sale.
a. Gives the debtor the opportunity to his right of redemption under 9-623 or the debtor can attend the sale or notify other potential buyers
b. Notice doesn’t apply if collateral is perishable or threatens to decline speedily in value or is of a type customary sold on a recognized market [9-611(d)]
c. The notice must be reasonable time before the sale. In a non-consumer transaction, 10 days is reasonable. [9-612]
d. Contents of the notice: Consumer-Goods transactions [9-614] and Non-Consumer-Goods transactions [9-613]
iii. The secured party can also in some circumstances simply keep the collateral and give up further remedy. [9-620(a)]
2. Problem 127 (B299): DJ is in charge of repo for CM. CM charged DJ to repo 4 cars without notice. CM would be required to give notice if the security agreement required it, but otherwise 9-609 does not require notice to the debtor that he is in default (otherwise the system wouldn’t work).
a. Even if the creditor ends up breaking into the car, no breach of the peace has occurred unless the debtor notices. [Giles v. First Credit Services]. If the creditor is stopped by intervention of the debtor, but then tries again, it would be a jury question to determine if it is a breach of peace.
i. Some courts say breaking a window is breach of the peace; some say it is not
ii. Physical resistance is breach of the peace
1. You then need to get a court order and come back with the sheriff
b. If the creditor uses a law-enforcement officer without judicial process, courts have held this to be a failure to comply with 9-609.
i. Not even off-duty cops are allowed
c. The debtor may not waive the obligation of the creditor to repossess without breach of the peace [9-602(6)], so a breaking-and-entering (removing of padlock) is still a breach of the peace even if the creditor was contractually allowed to enter the debtor’s property.
i. Some courts may find a difference where there is no damage or for time of day
d. Courts differ on whether the use of trickery should be allowed.
i. It is not breach of the peace in majority jurisdictions
3. Problem 131 (B300): WS gave AND a SI in accounts receivable and chattel paper. WS missed payments, so AND notified WS’s customers that payments should be made directly to AND.
a. The creditor can notify an account debtor to make payment for the benefit of the secured party if the method of collection contemplated by the security agreement was direct or indirect. [9-607 cmt. 2]
i. Accounts receivable type accounts are different from other types of accounts because AND doesn’t have to sell later to get money
ii. This often happens pre-default.
iii. Customer can ask for proof of assignment [9-406(a) & (c)]
1. Allows assigning and discharge of debt
b. However if WS closes, whether the customers still have to pay AND depend on when they receive notification of the assignment.
i. The rights of an assignee are subject to the terms of the agreement between the assignor and the account debtor and any other defense or claim which accrues before the account debtor receives a notification of the assignment. [9-404(a)]
1. Account Debtor, not original loan debtor (customer that owes money to account receivables; see 9-102 definition)
a. Customer has claim against WS for breach of K
1. Assignor is WS, Assignee is AND, Account Debtor is the Customer
b. Defense against WS is good against the assignee [9-404(a)]
1. POLICY: Meant to protect consumers similar to the reasoning behind no negotiable instruments in consumer transactions
ii. 9-403 preserves any other rule of law that protects consumers from waiving their rights to assert their defenses against assignees of their obligation.
