Secured Transactions
Aiello
Fall 2013
I. Overview
A. When a creditor extends credit to a borrower, the creditor wants to be sure of repayment. Sometimes, the creditor will demand nothing more than a promise to pay. These creditors are unsecured. They have not demanded any collateral in return for the credit extended and will not be protected should the borrower default on the debt.
B. However, if the creditor demands the party secure the debt with current or future collateral, the creditor may seize the property to satisfy the debt if the borrower defaults. If the creditor demands the borrower obtain a surety (guarantor, co-signer), the creditor may look to the surety for repayment of the debt.
C. The problem arises when more than one creditor is looking at the borrower/debtor’s property to satisfy his bills. The creditors compete with other claimants for the property (donees, buyers, bankruptcy trustee). Which claimant will have priority over another claimant for the property?
II. Fundamental Concepts
A. Debtor [§ 9-102(a)(28)]
1) A person having an interest, other than a security interest or other lien, in the collateral – whether or not the person is an obligor;
2) A seller of accounts, chattel paper, payment intangibles, or promissory notes; or
3) A consignee.
B. Lien
1) An interest in the debtor’s personal property given by the law to protect a creditor.
§ Consensual Lien: The debtor voluntarily grants an interest in his personal property
§ Mortgage: Consensual lien on real property.
§ Security interest: Consensual lien on personal property or fixtures (governed by A9)
§ Involuntary Liens
§ Judicial Lien: Lien arising from a judicial proceeding. (E.g.: Creditor’s judgment)
§ Statutory Lien: Lien imposed by a statute or common law in favor of certain creditors the law deems worthy of protection. [E.g.: Liens given to landlords, artisans repairing personal property (like a car or a mechanic’s lien for construction), innkeepers, federal tax lien]
C. Bankruptcy
1) May be a voluntary (debtor) or involuntary (creditor forces debtor into bankruptcy) petition filed
2) Date filed is important because it is the measuring moment for many of the bankruptcy sections
3) Trustee’s Obligations
§ Oversees distribution of the debtor’s assets:
§ Encumbered collateral
(a) Returned to secured creditor OR
(b) Sold and proceeds distributed to perfected secured creditors first
§ Unencumbered collateral
(a) Sold and proceeds used to pay expenses of bankruptcy proceeding, bankrupt’s employee’s wages, certain tax claims, certain other priority claims, general creditors
§ Advocates for and maximizes recovery for the unsecured creditors
4) Generally:
§ Bona fide purchaser (BFP) in the ordinary course of business are favored
§ Bankruptcy trustee is favored (because perfected lien creditor)
5) Perfected vs unperfected creditors
§ Perfected creditor: One who has an protected security interest in a piece of collateral that is superior to all other creditor’s or claimant’s interests in that collateral
§ Generally:
§ Unperfected creditors lose right to collateral
§ Perfected creditors will survive attack of:
(a) Bankruptcy trustee
(b) A non-BFP (creditor without a perfected security interest)
(c) Creditors whose security interests were perfected later in time
(d) Creditors with no security (general creditors – e.g.: corner grocer, family doctor)
D. Pre-Code Security Devices
1) Benedict v. Ratner (Secret lien case)
§ (NOT ON THE EXAM – Just shows us the holes the UCC needed to fill)
§ This is a pre-UCC case when no notice was required regarding collateral
§ Facts:
§ Hub Carpet sells carpet on credit (account receivable created). Hub assigned the accounts receivable to Ratner as collateral for loans made to Hub.
§ Hub adjudicated bankrupt in involuntary proceedings. Benedict (trustee) collected the book accounts of the company.
§ Ratner petitioned for payment of his account claiming he had an interest in the accounts receivable.
§ Benedict denied the petition as void under NY law because a fraudulent conveyance
(a) Conveyance of accounts receivable to one creditor not disclosed (no notice) so fraudulent against all other creditors.
(b) Secret lien not allowed because it harms other creditors
§ Secret because collateral that secretly belonged to the creditor (Ratner) was still in the possession of the debtor (Hub)
§ Ratner’s argument: Intangible property so how do you give notice. With tangible property (chair), I could take possession and control of the property, and show the world my collateral. How do I show my ownership and control with an intangible item (account receivable)?
2) UCC’s response was enact A9 which solved the secret lien problem by creating a nice efficient set of rules for providing notice.
§ §9-205 & Official Comment 2 (solving the secret lien problem)
(a) Creditor’s interest in the debtor’s property must be obvious so that no later creditors are deceived (typically by the filing of a notice called a financing statement).
§ Must let other creditors know of interests held by a secured creditor; if no notice, it is fraudulent to other creditors.
§ UCC gives priority to creditors who provide notice, and punishes those that are secretive.
3) Pledge (physical transfer of possession)
§ Debtor (pledgor) gives physical possession of the collateral to creditor (pledgee) until the debt is paid.
§ This provides notice to the other creditors which solves fraudulent transfer problem.
§ Possession then perfects the creditor’s interest in the collateral (even against the BK trustee)
§ Drawbacks/Limitations:
§ Can’t pledge an intangible. Only tangible objects can be pledged, and a business debtor may want to borrow money against intangible collateral (e.g.: an account receivable); and
§ For some types of collateral the debtor cannot give physical possession because it needs to keep the collateral to continue operations (e.g. machines used in manufacturing)
4) Chattel Mortgage (mortgage against personal property – e.g. furniture)
§ Puts world on notice of creditor’s interest by recording it in a designated place (recorder of deed)
§ Drawbacks/Limitations:
§ Where to file, what state’s law to adopt– no one unified system
(a) Person taking chattel mortgage is dealing with a different system in every state or even county
§ Chattel mortgage is something that can be moved – difficult to figure out where the collateral is at any given time to collect
5) Conditioned Sale
§ Seller holds title until buyer makes payment in full, then the title is transferred (analogous to a land contract). No such thing as a conditioned sale interest, always treated as a security interest
§ Problems with a Conditioned Sale:
§ Inequitable because buyer never acquires equity as a result of payments until the last payment is made. If the buyer misses the last payment and defaults, the creditor takes the collateral and the buyer receives nothing.
§ Putting others on notice is difficult. The buyer has physical possession, the seller still has title, and the other creditors of the buyer may think it can be used as collateral
6) Field Warehouse
§ A piece of paper is issued (warehouse receipt or bill of lading) that stands for title to the goods.
§ E.g.: Corn in a silo. Would not want to move the corn. But, title can transfer and party with title can take the title to the person who has the owns the silo to get the corn.
§ A way to pull of a pledge that is too big to be left in possession of the creditor.
§ A way for the debtor to store the goods in a warehouse (3rd party). The warehouse receipt is made out to the bearer of the goods, and the goods are not released without presentment of the receipt. Then if the bearer wants to use the goods as collateral, he pledges the warehouse receipt or bill of lading.
§ Problem: Only works for tangible, not intangible. Doesn’t work well for inventory or equipment, because debtor needs to keep these things.
III. The Scope of Article 9 (§ 9-109)
A. Covers what is and is not
or claims of an account debtor;
11) the creation or transfer of an interest in or lien on real property, including a lease or rents thereunder, except to the extent that provision is made for:
§ liens on real property in Sections 9-203 and 9-308; (Supporting Obligations)
§ fixtures in Section 9-334;
§ fixture filings in Sections 9-501, 9-502, 9-512, 9-516, and 9-519; and
§ security agreements covering personal and real property in Section 9-604;
12) an assignment of a claim arising in tort, other than a commercial tort claim, but Sections 9-315 and 9-322 apply with respect to proceeds and priorities in proceeds; or
13) an assignment of a deposit account in a consumer transaction, but Sections 9-315 and 9-322 apply with respect to proceeds and priorities in proceeds.
G. Exclusions from Article 9
1) [Extent to which article doesn’t apply] [§9-109(c)] – This article doesn’t apply to the extent that:
§ A statute, regulation, or treaty of the United States preempts this article;
§ Another statute of this State expressly governs the creation, perfection, priority, or enforcement of a security interest created by this State or a governmental unit of this State.
§ Note: A9 applies to the extent that:
(a) a federal statute does not preempt the UCC, OR
(b) another statute of the state governing perfection does not preempt the UCC
2) Problem 2
§ Assume that a state statute gives someone doing repairs a possessory artisan’s lien on the property repaired. Mr. Baker took his car into Mack’s garage for repair, but being strapped for cash, couldn’t pay the full bill, and Mack wouldn’t let him have the car back.
§ Is Mack’s artesian lien an Article 9 security interest?
§ Under 9-109, the Article applies to transactions that create a security interest in personal property by contract (consensual or voluntary). Here this is a mechanic’s lien or statutory lien created by statute. Thus, the lien is not a security interest because it was not voluntary – not created by contract. In addition, under 9-109(d)(2), the scope of A9 excludes a lien that is created by state statute for services. Here, Mack’s garage performed services (repairs) on Baker’s car. Therefore, the lien does not create a security interest in Baker’s car.
(a) Mack’s garage cares whether or not this is a security interest because they need to know what to do to perfect the lien. UCC rules or other rules? With statutory liens, he will beat out other perfected liens IF he retains possession.
§ If, prior to the repair work, Mr. Baker signed a statement giving Mack’s garage a right to possess the car if the bill wasn’t paid, does this agreement create a security interest under the Code?
§ Under 9-109(a)(1), a security interest is created through a voluntary contract. Here a signed statement gives rights to the car if bill is not paid. This contract transforms the lien into a security interest because it is created voluntarily or consensually.
§ Remember: Lien = involuntary; security interest = voluntary
§ Change facts: GM financed the car and they have a security interest. Who has priority – Mack’s or GM?
(a) Mack’s has priority if they keep possession of the car, otherwise no mechanic would ever work on the car. If a party adds value, even after another party perfected the interest, they have priority.
