Secured Financing = Financing in which the lending of money (extending of credit) is secured by a SI (or lien or mortgage) giving the lender a legally enforceable interest in certain property of the debtor.
The 2 types of secured financing both cover interests in property – but they cover different types
Real property secured financing – document by which you create the legally enforceable right in property is mortgage.
This is not uniform – different in every state.
Personal property secured financing – document by which you create it is a SA.
Covered by Art 9 of UCC
§1-201(b)(35): SI means an interest in personal property or fixtures which secures payment or performance of an obligation.”
Here is our focus
SI gives the secured creditor a leg up against other creditors in 2 ways:
Secured creditor v. Debtor
Process of Foreclosing for Unsecured Creditor:
When debtor doesn’t pay up creditor must sue the debtor and get a judgment
Wait statutory amount of time to give debtor opp to pay judgment (21 days in MI)
Get a judgment lien: Clerk of ct issues writ of execution – says creditor can seize debtor’s property that is not exempt. (MCLA 600.6023)
Sheriff levies (seizes) personal property first and only if insufficient can he go after real property
Act of seizing creates judgment lien = judicially created interest on behalf of creditor in debtor’s property.
Judgment creditor now transferred into judgment lien creditor – they have priority over other people with an interest without a judgment lien.
Sheriff sells property and gives whatever isn’t absorbed by the costs to the creditor and the excess back to the debtor.
Process of Foreclosing for Secured Creditor:
Self Help: If debtor defaults on a secured financing – the secured party is allowed (without going to ct or giving notice to creditor) to go and seize the collateral (as long as doesn’t breach the peace) and sell it and apply the proceeds to their debt. UCC 9-609
Can go after exempt property: State exemption statutes don’t apply to SIs – if debtor has granted a security interest in property they have waived exemptions.
AMONG DIFFERENT CREDITORS OF DEBTOR
Gives the creditor priority over other creditors of the debtor
Secured Creditor will get paid first
[i]Should always secure interest to be first to get paid when debtor defaults – which collateral to pick:
1st Choice: Debtors usually pay back loans using current income – prob won’t even be able to get loan if you don’t have enough to pay it back out of income. Assume you will be paid out of earnings, don’t expect or want to be paid out of the assets.
2nd Choice: Sale of debtor’s assets: Need to be able to reach assets at the time when debtor is in default
Inventory: Need SI that attaches to new inventory – not just inventory that exists today. But inventory may shrink at time you are trying to collect it – since debtor prob in default with those creditors as well.
To use inventory, but limit risk: Limit the amount of continuing loan to market value of what inventory is at that time. If debtor has shrinking inventory, then can shrink the loan proportionally.
Inventory might not be movable.
Accounts receivable: Good security – right to receive money – So only one step removed from money.
But AR are only as good as people paying them, so high accounts receivable may not be valueable. But they are like inventory – diminish and come back. So need to get SI not only on current accounts, but any future ones that are generated.
Equipment: Doesn’t disappear like inventory does –but isn’t worth as much now since it’s used
Can also limit risk in the same ways – could say you will loan 50% against eligible equipment
Leases: Leases can be valuable asset if it’s a valuable lease
Might be very valuable – but it’s a lease in a building, and that is real property not covered by Art 9. Are rates below or above market? Assignability?
Profits: No good – prob won’t have profits if they went into default.
Background Rules of Commercial Law
Derivation Principle: Party who has interest in property can transfer to another party only the interest that person has. Not any greater.
Applies to Personal Property: Hard to tell who true owner of personal property is if there isn’t a record of every transfer
Problem of ostensible/apparent ownership
So Art 9 sets up a public recording system for security interests in personal property.
MI’s race-notice statute/recording acts is an exception
Shelter Principle: If you take from a winner you are a winner.
§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.
§9-102(a)(30) “Purchaser” means a person that takes by purchase.
§9-102(a)(29) “Purchase” means taking by sale, lease, discount, negotiation, mortgage, pledge, lien, security interest, issue or reissue, gift, or any other voluntary transaction creating an interest in property.
Someone who takes a SI is a purchaser[ii] Applies to Personal Property[iii]:
9-317 should be read as implicitly authorizing transfer from someone whom qualified as the described buyer to take account of shelter rule
SCOPE OF ART 9
INCLUSIONS IN ART 9[iv] General Scope Provision
§ 9-109(a) Except as otherwise provided in (c) and (d) this article applies to:
(1) A transaction, regardless of its form, that creates a SI in personal property or fixtures by K
§1-201(b) GENERAL DEFINITION: SI means an interest in personal property or fixtures which secures payment or performance of an obligation.
Art 9 applies only to personal property with one exception:
§9-102(a)(41):Fixtures means goods that have become so related to particular real property that an interest in them arises under real property law
Ex: Mortgage on house includes fixtures that are attached to the house. So it’s real property in that way – but still covered by Art 9.
Art 9 only applies to SI created by consensual security interests
What would not be a consensual SI:
A judgment lien[v] Statutory things: mechanics liens, warehousemens liens, tax liens[vi] §9-102(a)(12): Contract, as distinguished from “agreement”, means the total legal obligation that results from the parties' agreement as determined by UCC as supplemented by any other applicable laws.
K doesn’t have to be written – but an agreement creating a SI generally has to be authenticated (signed or accepted in some way). Therefore, a security interest will usually be created by a written agreement.
A written agreement creating a SI is a SA:
§9-102(a)(73): Security agreement means an agreement that creates or provides for a SI.
Additional Inclusions[vii] An agricultural lien[viii] §9-102(a)(5): Agricultural lien means an interest in farm products
Which secures payment or performance of an obligation for:
Goods or services furnished in connection with a debtor's farming operation; or
Rent on real property leased by a debtor in connection with its farming operation
Which is created by statute in favor of a person that:
In the ordinary course of its business furnished goods or services to a debtor in connection with a debtor's farming operation; or
Leased real property to a debtor in connection with the debtor's farming operation; and[ix] Whose effectiveness does not depend on the person's possession of the personal property.
A sale of accounts, chattel paper, payment intangibles, or promissory notes[x] A consignment
True consignments are different from secured transaction[xi] Must distinguish traditional consignment transaction from 2 others in Art 2:
§2-326 These are NOT Consignments
Unless otherwise agreed, if delivered goods may be returned by the buyer, even though they conform to the contract, the transaction is
a “sale on approval” if the goods are delivered primarily for use and
a “sale or return” if the goods are delivered primarily for resale.
Goods held on approval are not subject to the claims of the buyer's creditors until acceptance; goods held on sale or return are subject to such claims while in the buyer's possession.
True consignment v. A-9 consignment:
Someone who owns goods (consignor) physically takes goods and delivers them to another party (consignee) who acts as retailer and sells the goods.
So consignee expects to resell the goods and presumably if consignee doesn’t sell the goods he can return them to original seller – that makes it look sort of like sale or return under Art 2.
Art 9 consignment provision – consignor should have to give public notice in order to protect their interest
This is a special Art 9 consignmentàdoesn’t mean every consignment falls within this def.
Merchant has to satisfy 3 conditions, and 3 others have to be met:
§9-102(a)(20) Consignment means a transaction, regardless of its form, in which a person delivers goods to a merchant for the purpose of sale and:
deals in goods of that kind under a name other than the name of the person making delivery (consignee must different name than consignor);
is not an auctioneer; and
is not generally known by its creditors to be substantially engaged in selling the goods of others;
with respect to each delivery, the aggregate value of the goods is $1,000 or more at the time of delivery;
the goods are not consumer goods immediately before delivery; and
the transaction does not create a SI that secures an obligation.
§9-102(a)(19) Consignee means a merchant to which goods are delivered in a consignment.
§9-102(a)(21) Consignor means a person that delivers goods to a consignee in a consignment.
Consignment Case: KING[xii] Under the REVISED ARTICLE 9, any consignment for consumer goods are not covered; BUT, Michigan has an unusual provision which protects the artist
Consumers goods are carved out of Art 9 consignments – they ARE NOT included
In re Haley & Steele[xiii] Remember – if it is an Art 9 Consignment, then must make a filing to protect yourself from other creditors.
Lease v. SI
Leases are excluded from Art 9[xiv] §1-203 how to distinguish a lease from a SI:
Whether a transaction in the form of a lease creates a lease or security interest is determined by the facts of each case.
Determinative Factors that create a SI:
A transaction in the form of a lease creates a SI if the consideration that the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease and is not subject to termination by the lessee
àaka, lesee has to pay the rent for the whole term, ie, cannot terminate lease early.
AND need at least 1 of the 4 below:
The original term of the lease is equal to or greater than th
ells that account to bank, but debtor continues to collect the account, and person who owes money has no idea it has been sold.
Line is difficult to draw – so drafters included true sales of these things in scope of Art 9 and treat it as sec trans.
[xi] àBut the form of a consignment may also be used to mask what is in substance, a secured transaction:
These are called consignments intended for security – and they are included in the scope of Art 9 under §9-109(a)(1) “a transaction, regardless of its form, that creates a security interest”
àBut even true consignment (that aren’t secured transactions really) – have the potential to mislead creditors of the consignee, so they fall under Art 9 too under §9-102(a)(20)
[xii] Is it an Article 9 consignment?
Trustee wins if the agreement is subject to Article 9 b/c Consignor would have to file a financing statement subject to filing provisions. If not subject to Article 9, they would get the property back.
Court’s focus à whether merchant was generally known by its creditors to be substantially engaged in selling goods of others
“Its creditors” – What is the universe of creditors that you look to? — Thought that the thrust of the statute was concerned w/ creditors that might be the most easily misled
“Generally known” – How many creditors have to know? — some unknown percentage of at least half of the creditors [only 5/17 know] “Substantially engaged”
Holding – NOT a consignment under Article 9
DECISION IS WRONG – court mistakenly called this a “sale on approval”
But this is incorrect – the buyer never intended to use the goods for their own purposes, they always intended to sell them
[xiii] F: Ind customers of art dealership delivered their own artwork from their homes for dealer to sell pursuant to consignment agreements which gave dealer right to keep artwork for periods of time and sell it. Also said art dealer would care for, insure and handle the artwork. Art dealership failed and artwork was seized by bank who was a secured creditor of dealership.
H: This is not Art 9 consignment b/c these are consumer consignors consigning their own art from their house. Ct says §2-326 (sale or return) does not apply to consumer consignments since that would be a back door to making consumer consignors comply with Art 9 – they would have to file fin statement and become secured party to get priority for those goods. Only thing applicable is CL Bailments– result would be that consumer consignors get the art back.
[xiv] but the general scope provision says a transaction “regardless of it’s form” is covered by Art 9; this means there could be a transaction that in form looks like a lease, but can still be a SI and be within scope of Art 9.
[xv] F: D had rental agreement with company for furniture. He made 3 payments then sold it saying he owned it and company only had a SI in it. Agreement had monthly payments, option of renewal, said lease can be terminated at end of term with the return of property, that company retained title to property. Also had purchase option.
H: D did have right to terminate it– it was month to month. If lessee can terminate at any time, leaving economic value in the leased goods = lease Lessee is only purchasing the goods if they exhaust the economic value of the goods.If he then didn’t terminate it and he has exhausted the economic life – it turns into a SI and he owns it.
[xvi] L leased equipment from B under agreement where L paid 5,000/piece of equipment/month for 3 month term – then would continue on month to month basis with option to buy. L says he bought the equipment while B says it was leased. L failed to make payments and B filed suit
H: 2 tests used to see whether consideration was nominal:
If a comparison of the option price with the market value of the equipment at the time the option is to be exercised shows that the lessee is acquiring the property at a substantially lower price, then the consideration is nominal.
Nominal if the terms of the option are such as to leave the lessee with no sensible alternative but to exercise the option.
Although L never exercised the option to purchase, if he had the consideration would have been nominal. If L made all his 5,000 payments for 19 months, then 100% of the price would have been paid and L would have only owed interest and sales tax. This means L would have had no other reas option but to buy equipment. So agreement was a SI.
Court got this wrong, it was clearly a lease