Você está na página 1de 140

INTRODUCTION The goal of the secured credit system: is to facilitate lending and, by doing so, to encourage desirable economic

activity. To the extent the system succeeds at doing this, is does so in two ways: A. Provides creditors with coercive remedy that doesnt destroy too much of the value of the collateral in the process. Provides creditors with coercive remedy that doesnt destroy too much of the value of the collateral in the process. The principle subsystems that work to provide this remedy are: Procedures for creating security interests Rules authorizing self-help repossession State remedies system Bankruptcy system B. Lets lenders know before they lend what priority or rights in the collateral they will have against third parties in the event of default Three subsystems at work: Public records systems Rules of priority Bankruptcy lien avoidance PART I: THE DEBTOR-CREDITOR RELATIONSHIP CHAPTER 1: CREDITORS REMEDIES UNDER STATE LAW I. REMEDIES OF UNSECURED CREDITORS UNDER STATE LAW (P3) A. Who is an Unsecured Creditor? (p3) Anyone owed a legal obligation that can be reduced to a $ judgment is a creditor of the owing party May be voluntary (loaning $) or involuntary (victim of accident is creditor to tortfeasor) Unsecured creditor = creditor whose debt is not backed up by security or collateral Judgment creditor = creditor who has obtained court judgment to establish liability B. How do Unsecured Creditors Compel Payment? (p4) Limits on power of creditor Self-help seizures of the debtors property are prohibited. Recovery of debt via fraud or other illegal methods usually produces counterclaim for debtor, may cause the creditor to face larceny charges, or may cause the debtor to incur liability for wrongful collection practices. Prohibited seizure of a debtors property will constitute the tort of conversion Conversion = wrongful exercise of dominion /control over anothers property inconsistent w/ rights Creditor can counterclaim for amount of unpaid debt, but conversion may be bigger than debt Unsecured creditor may only coerce payment of the debt through the judicial process specified by the state Process File lawsuit and obtain judgment Do discovery to ascertain assets held sheriff cannot act w/o proper information If you win, obtain writ of execution from court certifies ability to collect judgment Take writ to sheriff w/ instructions of what to seize and sheriff seizes it and conducts sale/auction.

Creditor pays costs of seizure, sale and auction, then distribution (auctioneer, lawyers, etc. paid first) Debtor can challenge auction method or claim exemptions under state law Vitale v. Hotel California (p5) Holdings: Successive Levies Under One Writ: Successive levies can be made under the same writ. It is the universal rule that further levies under one writ are authorized under the same writ before the return day if the initial levy does not satisfy the judgment is recognized universally. Reasonableness of Requested Levies: The plaintiff has an obligation not to request inordinately frequent and numerous levies. Amrecement : By a proceeding in amercement, a judgment creditor may hold a sheriff liable for failing to properly excuse against a judgment debtor. Other remedies Small claims court cheaper, faster, do writ yourself. Garnishment if third party owes $ to debtor, writ can compel third party to pay creditor directly C. Procedural and Practical Limitations on Collection (p13) Creditors cannot sue until debtor default; No legal remedy until debtor is in breach. Judgment creditors have the obligation to use discovery to locate assets sheriff will only act on clear info Judgment creditor can ask discovery questions about debtors assets under threat of contempt/perjury but remember debtor with $10,000 in cash in pockets. If the property seized turns out to be that of a third party, the judgment creditor may be liable for any damages caused to the third party. Wrongful exercise of dominion and control over the property of another = conversion. Even if the judgment creditor discovers the location of the assets, the assets may not remain stationary. Assets may be mobile, and even if discovered, can be moved before sheriffs office acts Debtor may sell assets and disperse cash in bona fide transactions Debtor may move out of state ($ judgment only enforceable in state where rendered) Debtor may continue to conduct business, losing or converting assets Debtor may repay other creditors before you, exercising preference Attachment: The debtor is fraudulently disposing of its property during the lawsuit, the creditor may have the right to an immediate attachment of whatever property the debtor still has. Exemption statutes prevent sheriff from seizing certain assets under a writ of execution Only available to individuals, not to corporations for vital goods, homestead, vehicle, % GI, etc. Only protects debtors against unsecured creditors Both state and federal law protects debtors wages. Federal statutes provide that a minimum of 75% of the debtors earnings from personal services will generally be exempt in all states. TX and PA exempt all earnings from personal service. Policy to protect basic means of subsistence and income to sustain life and basic property D. Is the Law Serious About Collecting Unsecured Debts (p17) Enforcement of civil judgments for money damages is often ineffective. Strict enforcement mechanisms for some things (child support, etc.), but not money judgments, wages, or most contract breaches. Criminal remedies are reserved for violations of rights we hold more dear than mere money obligations E. Problem Set 1 Problem 1.1: Jeff loans neighbor $1000 to buy furniture. Neighbor Lisa signs an IOU. Jeff wants to take furniture. Jeff may not simply enter Lisas backyard and reposes the furniture. Self-help seizures of property are prohibited and may constitute the tort of conversion. Jeff must first get a judgment against Lisa. To do so, he has to prove that he loaned Lisa the money. If he is successful in getting a judgment against Lisa, he must then get a writ of execution and take this writ to the sheriff so that the Sheriff, and not Jeff, may levy on Lisas furniture. This is likely

not worthwhile for Jeff because law firm costs are more than value of furniture. But because Jeff has union agreement for consultation, the lawyer can tell Jeff how to handle the issue in small claims court (less than small amounts like 2,500). Small claims court is an option in a jurisdiction with a streamlined process. The threat of a treble damage lawsuit is often enough to end matter. If small claims court is not an option, Jeffs options are really poor. To be an unsecured creditor is bad situation if debtor is unable to pay. Lots of people end up being unsecured creditors. If you go into bank to buy car, the bank is going to take security interest in car. But if business asks for 10 million, the bank will give it for unsecured credit (maybe to get business and working relationship). Problem 1.2: This is a story about some unsecured creditor who tricks the debtor into giving unsecured creditor valuable property. The creditor tricks the debtor to giving up lobster (under pretense it was going to Stephen King), but the lobster value is $11,000 short of full debt. I would tell him to try to repurchase the lobsters and return them to their owner. I would tell him that he could be in trouble for conversion if he does not return them and perhaps some form of criminal liability. I would then tell him that he should identify assets of his debtor and then get a writ against him for the amount to be executed by a sheriff, not self-help. The judges remedy was a civil remedy along with a criminal remedy. We want to avoid the criminal charges. How to avoid prosecution? You should bring prosecution for criminal charges first. There is a colorable case of fraud. So when debtor responds and brings criminal charges back at you, the prosecutor would probably not go forward with either charge. For public interests, prosecute both or none. Problem 1.3: This involves a loan in business situation. Benning gives $$ to day care center. Payment has been made and discovers that all kinds of things happen at day care center that makes loan precarious. They are not behind on payment to Benning. Look to loan agreement to see her options. She may try to negotiate for some security but she has no leverage to do it. If she is on better relations, she could exchange some credit for better security. The point of the problem is to show that unsecured creditors go down if debtor goes down. The debtor really runs the show once the money has been paid over. Problem 1.4: The daycare folds, and you have default judgment against owner. How does Benning get paid? Benning is a judgment creditor. She is going get a writ of execution and go to the Sheriff. She needs to know what assets she can levy on. These assets cannot be covered by state exemption statute or secured by another creditor. You can go to state records, personal property records. If you were not Benning the dentist, but rather the Telephone Company, you could go to a credit reporting service that would find a lot of this information for you. Benning wont be able to do that because service does not open to private people. Like Hotel California, the lawyer took deposition to discover assets. There is a problem here because depositions require hiring court reporter (very pricy). There is no incentive at all to come into depositions and show what is owned. He has every incentive to prolong deposition. As lawyer for Benning, tell her that its expensive. You may find that assets are not owned by daycare center. Problem 1.5: Assume that took deposition. WI exemption statute may apply to certain assets to allow debtor livelihood. Vehicle: 1,200 + unused car is exempt. Principle residence: exempt if less than 40 acres. Daycare Center Equipment: if daycare center is closed, its not currently being used, so its not exempt, but if it is used, then its exempt. Bank Account: only exempt up to 1,000. You need to get a writ of execution from the court to order bank to pay you as creditor. If debtor withdraws money before Sheriff serves writ, creditor is SOL. You can take a bathroom break during deposition and serve writ right away. Problem 1.6: Kinds of questions you want to ask in a deposition. The collection business requires some creative thought- last month rent, medical payments, etc. You can try to collect a lot of assets. Dont just look for cash assets. You could ask him whether anyone or any entity owed Knoff anything which could be considered of value. One of the questions you ask someone when youre searching for assets is, does anyone owe you money. If you suspect that there is something they are holding back, you would ask them more specific questions. You could ask him if he had any accounts receivable from the daycare. You could ask him if he has loaned money to anyone. Any outstanding legal judgments in his favor. Any security deposits he might have. Does he have any tax refunds or insurance come due for any loss. Really what we are getting at here is, do you have legal rights against anyone. Could ask about pre-payments in connection with insurance. Have you paid any bills for which you might be reimbursed by insurance. Have you been paid for all the day care equipment which you sold off.

II. SECURITY AND FORECLOSURE (2) A. The Nature of Security (p21) Security provides more protection than the unreliable methods discussed above for unsecured loans Lien = charge against interest in property to secure payment of debt (Bankruptcy Code 101) Lien is thus relationship b/w particular property (collateral) and particular debt or obligation Foreclosure = process by which creditor compels payment of debt by seizing ownership of collateral Security interest = any lien created by contract b/w debtor and creditor (UCC Article 9) Right in a property contingent on nonpayment of debt Security interest holders necessarily diminish effective collection rights of unsecured creditor Primary Types of Liens: Consensual Lien Security Interest Non-Consensual Liens Liens granted by statute, such as mechanics liens (statutory liens) and Liens obtained by unsecured creditors through judicial process (judicial liens). Anything recognized as property can be collateral Usually dictated by logic of transaction (car is collateral in car loan, home in mortgage) Usefulness of collateral depends on (1) how much value and (2) how much leverage SC can extrac Distribution of proceeds To UC: costs exemptions UCs debtor (remainder) To SC: costs secured creditors exemptions UCs debtor (remainder) Why would you ever become unsecured creditor? Higher rate of return Sometimes unwilling creditors judgment creditors Ignorance airline tickets, for example, are unsecured if airline goes broke Business practice constraints Intended as Security doctrine (p 23) UCC 9-109(a)(1): Art. 9 applies to any transaction (regardless of form) that creates security interest. It is the substance and not the form that governs what kind of transaction something is. It is the substance of what is going on, not the form that determines what the transaction is. Applies to both personal and real property transactions. If looks like secured transaction, doctrine frustrates attempt to circumvent the hassle of foreclosure. Basile v. Erhal Holding Corp. (p27) Holding: A deed conveying real property, although absolute on its face, will be considered to be a mortgage when the instrument is executed as security for a debt. Reasoning: No matter what documents say, if the substance of the transaction is that the creditor has an interest in the property only to secure the debt, no matter what the documents contain in them (even an absolute transfer), the transaction will be treated as the security interest, the debtor will still be the owner of the property and the creditor will have a security interest in the property to secure payment of the obligation. The court looks beyond the terms on the instrument to the real transaction; and when that is shown to be one of security, and not of sale, it will give effect to the actual contract of the parties. B. Foreclosure Procedure (p29) Foreclosure

Foreclosure: is a process that operates on the ownership of collateral. It transfers ownership form the debtor to the purchaser at the foreclosure sale and cuts off the debtors right to redeem the collateral. But the transfer of possession can occur before, during, or after foreclosure. Foreclosure v. possession of collateral Foreclosure = ownership transfer. Change of possession may occur before, during, or after foreclosure. Types of foreclosure (1) Judicial foreclosure (p29) Foreclosure process accomplished by the entry of a court order. Procedure for Judicial Foreclosure Creditor holding a mortgage or security interest typically files a civil action against the debtor. The complaint is served on the debtor and any subordinate lien holders, who then have a period of time (usually 20 days) in which to raise defenses. Rarely will the debtor have a defense that would preclude foreclosure altogether, but normally they can find a defect in the complaint to stall. Court wont enter final judgment of foreclosure until these issues are resolved. Typically, as part of the judgment, the court will set a date for the foreclosure sale. The statute typically requires that the sale be advertised beforehand by the person who will conduct it. On the date fixed for sale, the sheriff or clerk conducts an auction. Under the procedures of most jurisdictions, a foreclosure sale must be confirmed by the court. Ordinarily, the debtor remains in possession of the mortgaged premises until the sale is confirmed by the court. The purchaser is then entitled to possession. After the confirmation order has been entered and the time for appeal has expired, the sheriff or clerk disburses the sale proceeds. If the debtor wont surrender the premises, the purchaser is entitled to a writ of assistance (writ of possession) directing the sheriff to remove the debtor from the premises and put the purchaser in possession. If there are no other liens or interest in the collateral, the debtor can simply transfer the property to the creditor by means of a deed in lieu of foreclosure. It immediately extinguishes the mortgage and the underlying mortgage debt. Wisconsin Statutes Annotated (p32) Year long wait period between judgment of foreclosure and salefairly typical. Stems from equity of redemption If debtor cooperates, debtor can transfer property to creditor using deed in lieu of foreclosure mortgage and debt are both immediately extinguished. Creditors will sometimes pay debtors to transfer property, essentially purchasing debtors equity of redemption. (2) Power of sale foreclosure (p33) Security agreement gives creditor the right to sell the property in the event of default Each state has outlined procedure, including cure period and advertising requirements In deed of trust states, property is in hands of third-party agent who effects the sale Avoids messy litigation (unless debtor refuses to vacate but this is a separate legal issue) (3) UCC Foreclosure by Sale (p34) (easier than in real property) Article 9 governs disposition of collateral after default, 9-610(a) Upon default, secured party may sell, lease, license, etc. the collateral Sale or disposition itself forecloses debtors right to redeem the property Every aspect of the disposition of collateral must be commercially reasonable, 9-610(b) Effect of Disposition governed by UCC 9-617(a) A secured partys disposition of collateral after default: Transfers to the transferee for value all the debtors rights in the collateral Discharges the security interest under which the disposition is made

Discharges any subordinate security interests or other subordinate liens C. Problem Set 2 Problem 2.1: You have a security agreement taking a car, house, equipment, etc as security. What items can Benning reach through foreclosure of her security interest? State foreclosure exemptions dont apply to secured creditors who foreclose. Here the WI exemption statute does not apply because it applies only to liens that result from judicial procedure. There, the lien is created only once the property is actually seized. The entry of judgment does constitute a lien against most real property in almost all states, but not in respect to personal property, the sheriff has to seize it for there to be a lien. The minute Knoff enters into a security agreement, then a lien in the property exists and need not be established by judicial procedure. Therefore, because he has a security interest, he can reach all those items. The WI statute specifically preserves the mortgage from the homestead exemption. You cant use the exemption to defeat the banks claim from the mortgage or no one would ever give our mortgages to buy houses. Problem 2.2: Here Bonnie runs a used car lot and ends up repossessing a lot of cars. To ease her administrative burden, Bonnie plans to being leasing the cars rather than selling them. She wants to lease the cars for a per month figure giving the lessor the option to purchase at the end for $10. She would provide that on default, she has the right to terminate the lease and the right to buy. She thinks this way she can just reposes without having to foreclose under article 9. Is this correct? No. This lease is actually a sale with a right of repossession in the event of default as the equivalent of a security interest. UCC 1-201(37): whether a transaction is a lease of security interest depends on the facts of the case. There are a number of transactions in which the form of a lease is actually a security interest. In the second paragraph of the definition of security interest, a transaction that is a lease in form is treated as a security interest if the lessee cannot terminate the agreement. See if lessee has right of termination; if so, that takes us out of this paragraph. The second factor is that the lessee has an option of ownership for nominal consideration. This would mean that the rent payment is not really rent but rather an installment plan. The courts are concerned with the economics of the transaction. Maybe the substance of the transaction is actually a sale with a security interest. One of the most litigated issues is whether the transaction constituted a lease or sale. The problem is supposed to be simple; however, the lease terms are exactly the same as security agreement. You cannot get out of the foreclosure requirements by doing this. Typically, you will not have such an easy fact situation. You cannot get around giving public notice by calling your document a lease when it is really a security interest. Problem 2.3: The statues of the state in which you are practicing authorizes foreclosure against real property only by judicial process. You work for Enterprise State Bank who performs dozens of foreclosures at a time. You are now told to being foreclosure proceedings on Linda OHurley notifying her of her default.

A) Linda says she realizes they cannot afford the house, but states that the house is worth more than the balance
owed, but that the housing market is slow now and attempts to sell the house havent gone well. She wants to know if she can just turn the house over to the bank because they dont want to be sued or have a foreclosure on their record. If they go through the foreclosure procedure, OHurleys would get the amount over their defaulted loan. If the bank avoids foreclosure, the bank saves money, so maybe they can negotiate. The banks best option is to take the deed and maybe give up some money. What about the explanation issue? Any explanation may be construed as violating ABA Model Rules of Professional Conduct (see caption). There might be a legal problem with the fact that the bank doesnt represent the OHurley. The bank could tell her that they do not represent her or her interests. They get her to sign a paper saying she understands they do not represent her. That seems to be okay. Suppose the OHurleys have their own lawyer, what would a good lawyer tell them. Giving the bank a deed in lieu of foreclosure is giving the bank the excess money in the house and it is saving the bank the costs of going through the foreclosure process including the cost of delay. So youd advise them to negotiate with the bank for some money for the OHurleys to make it worthwhile for them. You as the banks lawyer know this and they dont actually have a lawyer, so what do you tell Mrs. OHurley. So youve told her youre not disinterested, you represent the bank, not her and that shes free to get her own lawyer. During representation the lawyer should not give advice to an unrepresented person other than the advice to attain counsel. Can you negotiate with her if she is unrepresented if you do all these things, yes, you cant force her to get counsel. What is she asks you to explain the drawn up deed to her, then you are giving her advice perhaps, and you arent allowed to do that. What is the obligation of a lawyer for a secured creditor with respect to dealing with a debtor not represented by counsel. You have no legal or fiduciary

obligation, but you want to be careful in dealings as to not expose your own client and sometimes that will mean not taking maximum advantage of people like the OHurleys.

B) What if the OHurleys execute the deed today, with an understanding that you will give it back to them if they
make up the bank payments within 60 days, but otherwise you will record it? This is really the equivalent of a security interest. See UCC 1-201(37) and Basile. The banks interest is contingent on nonpayment of the OHurleys. If deed is effective immediately, that would not be a security interest. The difference is between giving you a book (effective now as a gift), and I will give you my book tomorrow where there is no consideration. Problem 2.4: Mr. Mashimoto has an idea for a deed of trust, in event of default the creditor forecloses. If you include a power of sale within the transaction you can avoid a judicial foreclosure, which is expensive and time consuming procedure. Problem 2.5: There is another way to deal with collateral. Take a security interest in both real property and personal property. Judicial foreclosure takes a long time, but if you acquire enough company stock to control its actions you can expedite the foreclosure process by making the company consent to the transfer. The foreclosure of stock, unlike real property, occurs under Article 9 so this is done much more quickly. Two months, maybe, instead of six. You dont have to worry about statutory rights of redemption. The creditor gains stock of corporation and gets company to deed real estate. The creditor takes control of debtors corporation, but the debtor corporation is probably in default to others, and the secured creditor assumes the corporations other debt. If debtors corporation spill toxic stuff on land, the secured creditor is liable for the cleanup. But is some situations its worth thinking about. A secured creditor can deal with default situations in ways that are not most time consuming. Problem 2.6: How would you change the high cost and excessive litigation involved in judicial foreclosure? The issues in foreclosure cases usually involve efforts by debtors to prolong everything. Usually debtors think tomorrow will be better. Some issues of foreclosure involve overreaching by creditors too. The form most seriously considered involves trying to get state foreclosure procedures to mimic federal bankruptcy procedures, changing the debtors right to redeem, the statutory period, the actual sale of collateral. During the whole period, the debtor can stand by and do nothing. The efforts of reform try to make the redemption period run smaller. That is the time the debtor should raise defenses, creating less uncertainty. III. REPOSSESSION OF COLLATERAL (3) A. The Importance of Possession Pending Foreclosure (p37) Creditor has numerous reasons to want to possession of collateral pending foreclosure Debtor may have little incentive to preserve and maintain property about to be foreclosed Economic value enjoyed during period Prospective buyers may have limited or no access if debtor retains control, thereby, depressing sale price If a creditor can threaten immediate repossession he can exert considerable leverage upon the debtor, if the debtor can maintain control and threaten to draw our process, he can exert considerable pressure on the creditor. Security agreement can provide that the creditor has the right to possession immediately upon default B. The Right to Possession Pending Foreclosure REAL PROPERTY (p38) The Debtors Right to Possession During Foreclosure Mortgagees never become entitle to possession of mortgaged real property in their capacity as mortgagees. Debtor retains ownership and possession until right of redemption is foreclosed and sale is held. Purchaser at sale is entitled to dispossess debtor. Purchaser may have to sue for eviction of debtor. Appointment of a Receiver While a foreclosure case is pending, any interested party can apply for the appointment of a receiver to

preserve the value of the collateral. A foreclosing mortgage does not always succeed in winning the appointment of a receiver. Appointment of receiver is equitable remedy in sole discretion of the court Mortgagee must demonstrate necessity that foreclosure alone is not enough Rarely appointed for owner-occupied real estate or business-based commercial real estate Courts rarely appoint receivers unless the terms of the mortgage provides for such an appointment Many states have states have statutes governing the appointment of receivers in mortgage foreclosure cases listing factors of concern to the court. The receiver will be an officer of the court with fiduciary obligations to all who have an interest in the property Mortgagee doesnt receive CF directly, but benefits b/c receiver has fiduciary duty to maintain property Assignment of Rents: Entitles mortgagee to rents from property as additional security in case of default Because collecting the rents from mortgaged property that has been rented to third parties, like appointing a receiver, is functionally the equivalent to taking possession, some courts are reluctant to give effect to the assignment of rents clause. C. The Right to Possession Pending Foreclosure PERSONAL PROPERTY (p41) Secured Partys Right to Possession After Default - UCC 9-609 Secured Creditor w/ Art. 9 interest in personal property can self-help, but is liable if he/agent commits wrong After default, SC can automatically (1) take possession or (2) render collateral unusable May not breach the peace (9-609(b)(2)) With resistance, writ of replevin orders sheriff to take possession of property and give it to plaintiff Results from SC filing a civil action; SC must show at hearing hes likely to prevail in action Issuance normally contingent upon creditor posting a bond in case debtor ultimately prevails Dels Big Saver Foods v. Carpenter Cook (W.D. Wis. 1985, 6) Store is repossessed; Dels owners had no notice until repossession In creditor repossession or garnishment cases, the due process clause requires either: That the debtor be provided a hearing before his property is taken, or That the debtor be provided certain pre-seizure procedural safeguards, coupled with a prompt postdeprivation hearing before final judgments. In taking possession a secured party may proceed without judicial process if this can be done without breach of peace or may proceed by action. D. The Article 9 Right to Self-Help Repossession (p46) The right to self-help repossession is derived from U.C.C. 9-609 That section provides that after default a secured party ay take possession of the collateral. The courts generally hold the duty to refrain from breach of peace during repossession non-delegable, making the secured creditors liable for the consequences of illegal repossessions by their independent contractors Gives UCC 9-609(a)(2) gives the creditor the option to leave equipment temporarily in the possession of the debtor, but render it unusable. E. The Limits of Self-Help: Breach of the Peace (p47) UCC 9-609(b)(2) permits self-help repossession only if creditor can repossess w/o breach of peace 9-607: cannot be waived before default. See 9-624 for waiver after default. Salisbury Livestock Co. v. CO Central Credit Union (p48) Creditors repossessed vehicles by trespass on secluded area belonging to third party

Holding: jury should decide whether this was breach of peace, b/c reasonable jury might find so. Breach depends on: (1) potential for imminent violence and (2) nature of premises intruded upon A trespass isnt necessarily an automatic breach of peace. Depends upon the type of premises invaded or likelihood of immediate violence. Confrontation or violence is not necessary to finding a breach of the peace. The possibility of immediate violence is sufficient. Cases holding breach of peace (p50): Debtor consented w/ no confrontation b/c creditor brought police officer. Walker v. Walthall. Creditor returned to recalcitrant debtor w/ two intimidating men. Morris v. First National Bank. Creditor cut chained fence and left property unprotected to repossess. Walter Coal v. Heller. Cases holding no breach of peace (p51): Creditor stealthily took back truck at 2 a.m., frightening debtor. Wallace v. Chrysler Credit. Repo agents stood b/w debtor & car while they retrieved personal items. Williams v. Ford Credit. Repossession despite threat of violence from debtor. Wade v. Ford Motor Credit. Locksmith changed locks on doors to repossess collateral. Global Casting v. Daley-Hodkin. Repossession of rigs due to fraudulent misrepresentation but no threat of violence. K.B. Oil. Creditor allowed access to debtor facilities by friend and peacefully repossessed. Rainwater v. Rx. F. Self-Help Against Accounts (Receivables) as Collateral (p52) Debtors routinely borrow against accounts receivable as collateral: common repayment arrangements Creditor allows debtor to collect accounts, but must apply portion to loans Account debtors directly pay creditor Sometimes account debtors must deposit payments in PO box under control of creditor (lockbox) In the event of default, 9-607 and 9-406(a) provide self-help remedy 9-607: creditor who knows identity of ARs can send them written notices to pay creditor directly 9-406(a): forces account debtors to pay creditor once they receive notice that they are no longer supposed to pay his debtor as they had been. Marine Nat. Bank v. Airco (OK): creditor sued account debtor who had received notice to pay creditor but paid debtor instead. Account debtor was required to pay secured creditor sum that debtor owed creditor. Account debtor should have had relief from the debtor, but in this case the debtor was out of business. Account debtor was forced to pay debt twice. 9-404(a): gives the debtor the same defenses it had against the debtor against the creditor after it receives notification of assignment. AR may be hard to collect if AR debtor realizes that debtor is headed out of business. G. Policy behind allowing self-help for accounts Policy of self-help is to keep small loans out of court Also keeps market going by encouraging lots of small transactions H. Problem Set 3 Problem 3.1: J lends money to N. When N does not pay, J cannot just go take the lawn furniture (if unsecured creditor). He may find himself in front of criminal trial. The picture changes if J is secured creditor. He can selfhelp repossess if he does not breach the peace. Looking at cases, J probably wants to sneak onto the property and take furniture. The danger of confrontation is less at night. The debtor has less possibility of doing things that would increase chance of violations. In long run, maybe interest will not be served by taking furniture. The N may play load music at night. There are often good business reasons for not pushing ahead. But its also true that lenders lose more by trying to help debtor through period of financial troubles. Problem 3.2: Collection department and repossession policy. What are general guidelines for repo people. No matter what the circumstances say avoid confrontation, do not use force while attempting to repossess, leave the minute there is any sign of confrontation. Can you come back later once a confrontation has occurred? Wade v. Ford Motor Credit Co. says you can go back even if there was threat of breaking the peace the first time. Suppose

the debtor comes out and says what are you doing and the debtor says dont do that. Unless they order you to leave, you dont have to leave so long as they dont attempt to interfere or order you off the property you dont need to leave, see Williams and Rain-water. Sometimes if you put a provision in the security agreement that says you have the right to enter the debtors premises it makes it easier.

A) Assume no guard and no fence. If no one will start conflict or confront repo, then do it peacefully. If there is
potential for immediate violence, then dont repo. If all the people are doing is objecting, the repo people can still do it. But the threshold is objection +. You can always come back later. The case law seems to favor when the people do it at night. There is a greater possibility for violence when you are mistaken for a thief. B) Suppose there is a fence but no guard. Its probably ok.

C) There is a guard. The site is a little more secure. What if you say you have a court order but you are lying?
Cases differ. What about the ethics rules about professional misconduct? A lawyer may discuss the legal consequences of proposed course of conduct. What if you say you have a court order but you are lying? Cases differ. What about the ethics rules about professional misconduct? A lawyer may discuss the legal consequences of proposed course of conduct. Suppose you say that the debtor says it is okay to enter to the guard. You could discuss this with the client, you just cant encourage him or conduct in it yourself. See rule 1.2 of the ABA Model Rules of Professional Conduct.

D) D) A right granting Maretka the right to trespass when making repossessions. This would help make it easier to
repossess without Problem 3.3: What advice can we give the debtor to prevent repossession? Article 9-609, a secured creditor may proceed without judicial process if it proceeds without a breach of the peace, taking possession, rendering equipment unusable. The debtor is always going to win if both sides play it smart. Repo usually wins only against stupid debtors. Problem 3.4: If both the debtor and creditor have the best legal advice regarding self-help repossession follow it carefully, who wins? The debtor is always going to win if both sides play it smart. Repo usually wins only against stupid debtors. If both get good legal advice the debtor will likely prevail because self-help just isnt going to work against a well-informed debtor. Repossession people have their biggest clientele, consumers mostly. Commercial property repossession is much rarer. Problem 3.5: Deare has a bunch of A/R from its customers. It needs financing and uses its A/R to receive a loan from First Bank. Deare has requested that Firstbanks interest in the accounts not be made known to the account debtors because it might make them nervous. What are the risks of this arrangement. How might Deare cheat you? Is there any way you could discover this cheating without contacting Deares customers? First Bank not being able to talk to customer limits its ability to find out if customer will pay them or if the equipment is a good product (defenses, etc). Deare may cheat, so have customers send checks directly and compare against Deares deposits. Doing an audit is expensive, and each level involves an extra layer of defense. You want to make sure that if Deare defaults, the money will be in there. It is not useful to have security interest in the collateral and when you need it, the collateral has already been spent. You want a security interest to back the A/Rs. Deare would assign to bank an A/R + a security interest in the farm machinery (stock in trade of retail consumers). That is more typical. There are situations that bank finance transactions backed only by A/R, but not with farm equipment and cars. This is a much more complex transaction. We want to think about this 3 party transaction to realize that typically we have 2 loans- Bank to Dear to Customers. What is Bank security? There are two kinds: it has the stream of payments made by customer to Deare. That is the A/R. It is highly liquid and available form of return. This stream of payments accounts for the figures heavily. This is why Bank needs to know something about customers of Deare, how credit worthy they are. It is a lot easier to talk about customers if we know who they are. The stream of payments is one thing. But secondly, it wants a security interest in the underlying collateral. It is thinking about the farm equipment. Is it accurate to say that Bank has security interest in farm equipment when in the hands of the customers. If Deare is in default, but the customers of Deare are not in default of Deare, what can Bank foreclose? You cannot get at the farm equipment because the Banks interest is subject to non-payment by customers. But Deare has something of value, a security interest in the

10

farm machinery. If Deare is in default, Bank can go against Deare, foreclose on Deare, and steps into Deares shoes, and it is the secured creditor. Between Deare and Bank, they own all the sticks making up the property interest. Problem 3.6: A year after the proceeding problem, Firstbank is back, Deare ultimately defaulted on the loan, and four months ago Firstbank notified the account debtors to pay it directly.

A) Hornes Feed and Seed, one of Deares account debtors, claims that it paid Deare in full last month and refuses
to pay Firstbank. Does the person who owes the debtor money have to pay twice? They were told four months ago to pay the creditor, the paid the debtor one month ago. The person who owes the creditor must then pay twice. 9-406(a) says that once notified the debtor cannot continue paying the other debtor, but must pay the creditor. The account creditor may discharge its obligation by paying the assignee and may not discharge its obligation by paying the assignor. The secured party simply by telling the client you have to pay us, imposes an obligation on the client to pay a party with whom it has never dealt. One solution would be to have a interpleader to cut this off. 9-607(a) gives the creditor the debtors enforcement rights as against his debtors.

B) Another account debtor, Wilsons farming Goods, has refused to pay claiming that they received $42,000 in
equipment, they have warranty claims amounting to $19,000. What can Firstbank collect from Wilsons. 9404(a) gives the debtor the same defenses it had prior to receiving notification. Problem 3.7: You are trying to advise your client who to pay first when he is having cash flow problems. This is not illegal, looking at the rule of professional conduct, the delay isnt just for delay itself, it is to keep the work going and keep paying the employees, you can always find some reason for delay that sounds more in tune with public good. On the other hand it is very hard to tell where to draw the line. a) Bank has mortgage on business premises. You want to know whether they have to go through judicial foreclosure or not. If you have power of sale or transfer, those go quickly. Judicial foreclosures take time. Different foreclosure rules means different leverage for debtors/creditors. b) Loan is secured by trade fixtures and equipment. Citizens repossess the trade fixtures and equipment. c) The utility people have lots of leverage, and they can turn off the lights. d) With any unsecured creditors, you may need them in the future. Its expensive to foreclose; it cuts off future business. If the secured creditor has security in the collateral, they would probably hold off. You probably want to deal with the utility people first. Problem 3.8: what do you do by way of going ahead trying to get possession when debtor claims a defense? Dont go ahead. If you repossess and there is a defense, there is the risk of conversion. You could instead go through a judicial foreclosure proceeding where the debtor must go through defenses and litigate them if they have any (you dont have to go through the sheriff and get a writ of replevin). The debtor will have some problems with suing for conversion because if its a lemon, it isnt worth much as she claims, if it is valuable, then she has no defense. Problem 3.9: Give weekly code to start car. If not up to date, no code, and cannot drive the car. It is unclear whether this is ok. An article turned up in the newspaper and circulated among commercial law teachers. People are split. The disabling rules allow a creditor in event of default to disable equipment, a classification that does not relate to consumer goods. There is no provision that allows disabling of consumer goods. Its a question of how we will interpret the default provisions. If there is a mistake and the person has paid then there is a conversion for sure. You could also be in trouble if there is a malfunction and someone is hurt. IV. REAL ESTATE JUDICIAL SALE AND DEFICIENCY (4) A. Typically Sale Must be Held (p59) Even if the mortgage specifically provides for the secured creditor to become the owner of the collateral in the event of default and foreclosure, the public sale must still be held in many states. The equity maxim is that equity abhors forfeiture. If auction fetches higher value than debt, debt is repaid and excess equity remitted to debtor If auction fetches lower value, debtor can still be liable for deficiency B. Strict Foreclosure (p59) Strict foreclosure = assets arent sold; property held in satisfaction of debt Most states dont require that foreclosure conclude with a sale of the property, instead if the debtor

11

doesnt pay the full rice within the end of the statutory grace period, the debtors interest in the property is forfeited and the court confirms the title remains with the seller. The most common is the foreclosure of contract for deed, or installment land contract, which is a contract for the sale of real property that provides for payment of the purchase price in installments over many years, with the deed to be delivered only after the last installment is paid. If the purchaser does not pay timely, seller must foreclose through the court process. C. Foreclosure Sale Practice (p60) Nearly always the sales are conducted by a public official, usually the sheriff, the clerk of the court, or a court commissioner. The creditor who brings the foreclosure case is typically the highest bidder at the sale. Process dictated by state statute Auction in specified time and place Post auction: court must review circumstances of auction and confirm the sale Distribution Cover auction expenses pay creditor for outstanding debt remaining surplus goes to debtor If sale price doesnt cover debt, creditor may sue for deficiency Mortgage Debtors Right to Redeem Debtor has right to redeem pre-sale by paying full mortgage amount plus interest and attorneys fees This common law right to redeem is typically cut off as of the time of sale Additionally may have statutory right to redeem collateral after the sale D. Problems with Foreclosure Sale Procedure (p61) Inadequate Sale Price Debtor can bring suit to set aside sale for inadequate sale price, but probably wont have much success. Armstrong v. Csurilla (p62) Armstrong sells Csurilla gas station/house for $230K. Csurilla defaults; Armstrong buys it for $90K. Only two circumstances will invalidate a low repurchase: (1) Price is so low it shocks the conscience of court, (2) Circumstances are unconscionable Various factors, including poorly advertised sales, little opportunity to inspect property or get info on it, caveat emptor, and statutory redemption period, lead to low prices from foreclosure sales. Reasons why foreclosure sales fail to bring reasonable prices: Poor Advertising Method generally fixed by statute or the judgment of foreclosure Wisconsin Statutes Annotated 815.13 (p66) Notice of Sale of Realty

Notice of sale published for 3 weeks in 3 public places in city where sale will take place and city where property is located. Additionally, notice runs in a newspaper in the county for 6 weeks.
Difficulty/Impossibility of Inspection

Debtor generally retains possession of property. In mortgage, creditor generally has right to inspect property. Every other potential purchase has no right to inspect property except from adjacent public places. Buyers who want the property for their own use are unlikely to be willing to purchase without looking inside the building. Only professionals who plan to find a bargain and resell for a large profit are likely to be interested.
Title and Condition (Caveat Emptor) Caveat emptor rule applies to judicial sales Marino v. United Bank of IL (p69): superior lien existed on property. Laywer denied such lien, and purchaser bought property. No detrimental reliance complaint was allowed because of caveat

12

emptor. Horicon v. Kant Lumber (p 71): environmental liabilities dont nullify sale Hostile Situation Creditor and Auctioneer are unlikely to have much information, especially if debtor doesnt wish them to. Debtor can make life hard on the buyer by trying to prevent third parties from obtaining information about property. Bidders need to take into account the debtors ability to delay, litigate, and potential damage property. Buyers Statutory Right to Redeem Buyer may be unable to use/preserve property until statutory redemption period expires E. Antideficiency Statutes (p73) Statutes that prohibit the court from granting deficiency judgments in certain circumstances (to react to fact foreclosure sales rarely yield Most common statute: assumes property sold for fair market value and creditor can only get deficiency above that. California Code of Civil Procedure 580A., B., D. (p74) Deficiency Statutes

Deficiency limited to amount by which debt exceeds fair market value of sale. Do deficiency where loan was for purchase of domicile. No deficiency where property is sold under power of sale clause in mortgage.

F. Credit Bidding at Judicial Sales (p75) Creditor who forces the sale will usually bid on it. Lacks hurdles of other bidders: knowledge of auction, contractual right of entry, asset familiarity Creditors usually win: whatever creditor pays at auction will be paid right back post-expenses Credit bid: creditor can take shortcut of bidding on credit up to the amount of the debt Creditor always has incentive to bid full amount of debt, even if it exceeds FMV of property, b/c: Higher price minimizes chances that sale will be set aside for inadequacy of price Minimizes chances that debtor will exercise statutory right to redeem (at amount of sale price) After this sale, creditor is free to inspect property and sell to third party Therefore two-sale process: buyer at first sale (usually lien holder) gets property for amount of lien Resells it for price approaching market value, thus capturing debtors equity Where there are no anti-deficiency statutes, can also collect a deficiency judgment from the debtor G. Policy Arguments pro-deficiency Things that help creditors ultimately help availability of credit More likely to be sold at FMV w/ deficiency owner has more incentive to help market/preserve prop. Arguments anti-deficiency Form of insurance everyone should pay extra fifteen cents than one person shouldering deficiency Leave something for unsecured creditor (equity) Encourage low prices for redemption Reduces incentive to go into BR Avoid double profit for banks get deficiency plus re-selling at above purchase price There are a lot of moving parts here in determining bids Redemption/no redemption bank wants to keep price high so that owner cant redeem Unconscionable price bank wants to keep price high so that its not overruled as inequitable Deficiency/no deficiency bank wants to keep price low so that it captures equity and gets deficiency H. Problem Set 4

13

Problem 4.1: Bank has a judicial foreclosure sale. The balance owing on the mortgage is $53,231. The bank estimates that the house is worth $40-45,000. Under the law of the state, the bank will not be able to obtain a judgment for any deficiency remaining after the sale. The bank wants to know how much it should bid at the sale.

A) The bank is the only bidder present at the sale, for what amount should they buy the property? They
Should bid the full amount of their debt, $53,232. B) A third party bids $53,232, should the bank go higher? You should bid nothing and let them win.

C) A third party bids $44,000 get the place appraised. Is it worth more than that? Maybe bid up to have
the other match you. Think about who the third party bidder is. Is it a bonafide bid? It may indicate that the market value is more than you thought it was. If that bid is not bonafide, you may have to do it all over again. It is not a slam-dunk answer. Commercial is going to have to response by figuring it out. Problem 4.2: Give advice to a defaulting debtor who owes $53,000 on mortgage. The creditor can ask for a deficiency. A) FMV between $40-45,000: Her danger is that she cannot count on the bank to bid that amount. She should look out for potential bidders. She can stir things up a bit. Maybe the bidding price would put her in bankruptcy, so it does not matter. B) FMV $70,000: She has equity of 17 grand. Maybe it would be better to look for a bidder to give closer to $70,000; she cannot count on the bank to bid this amount. Maybe the bank would split the equity. Maybe she can raise money on a second mortgage. If she wants the full equity, she can try to sell the house herself. When you go to the realtor, you dont want to explain the desperate situation. If the potential buyer knows this is a distress sale, then that buyer may offer less than FMV. C) Sallies brother deals in real estate and has the ability to buy the house. He is willing to do so and allow Sallie to keep living in it. How does that change your answer. What if First City Bids its debt of 53,000 when the house has a market value of 40,000 to 45,000, I think you would not bid because youd be paying in excess of the houses FMV. In many cases she can redeem at the FMV and get the house back. So that is what Sally would want to do. So suppose first savings bids 20,000, what should Sally do then. She should let them buy and then redeem at 44,000, maybe she could redeem at 20,000. If first savings bids 20,000, my sale should be confirmed at 20,000 because that is FMV, then you are in a problem of interpretation on FMV that gets credited. The court would then have to decide what that was. What about the deficiency, she still has that problem so long as first savings goes in and gets a deficiency judgment. She can go into bankruptcy and get rid of the deficiency and gets to live in the house because of the homestead exemption. She could assign her right of redemption to her brother in law who can buy the house and she can continue to live in it. Why doesnt the brother in law pay of the mortgage before the sale and let Sally repay, what is the downside of doing that. Assume the house is worth 70,000. If first savings stops at 53,000 what do we do? Wed bid higher than that because bank just wants its money paid back they dont really want to try to resell the house and the like. Theyll be happy to have their judgment paid off. At that point, before the foreclosure sale takes place, they figure first savings is going to bid 53,000 and know first savings knows it is worth 70,000 and at that point suppose the brother says why dont I just pay them off. As Sallys lawyer what do you say? What will be the difference in the title to the house situation in the two scenarios. If brother buys at auction brother gets title, if brother pays off mortgage sally keeps title to house. Why might Sally be better off without title? She could have other creditors. If you want to buy and pay off mortgage you buy subject to any other liens because it never got to foreclosure. Problem 4.3: You are the buyer and see a house in foreclosure. What do you want to know about the house? Is it worth my time to get interested in this house? You want the value of the house to be more than mortgage, because bank will credit bid full amount. If house is worth 70, there is a possibility here. You dont assume anything about the condition of the house. The house may have serious problems. The more the sheriff talks, the more he is exposed to liability. Youd want to know about the redemption statutes or if there were other liens on the house because if you buy and there are other liens on the house youre stuck with them. You can

14

go to the various lien recording places and find everything (title search). Youd want to know the condition of the house. A secured lender buying at sale may get a court order that allows it to get the house tested, but you wont. Very chancy to buy at a foreclosure sale. But unless the home owner is cooperative there are lots of things you wont find out. The foreclosure sale discharges all liens subordinate to the foreclosing secured creditor. All junior liens end at foreclosure, all senior liens survive. See 9-617(a). Problem 4.4: American Insurance Company is creditor and debtor defaulted on loan. Four wealthy people guarantee the loan. The mortgage is 20 million and FMV is 18. What to bid? In theory bid low and go after guarantors for deficiency. But this strategy invites litigation. But why arent the wealthy guarantors at the sale. The Ins Co was going to bid 500,000 in FL where there is no statutory right of redemption. What happens turns up in b and c. The mystery bidder turns up and bids 20 million. Maybe he is in there to make sure that the guarantors are off the hook. Maybe the mystery bidder is a shell corporation with no assets. Its really hard to know what to do. You can let them get it. But if there is no cash, then you have to start all over again with another sale process. The Ins company has to make a judgment about the mystery bidder in a hurry. What if there are three bidders, .5, 12, and 25 million. A statute designed to protect creditors- giving property to second highest bidder if highest bidder unable to complete sale- might be used to creditors disadvantage. If cannot recover 8 million from guarantors you can always claim conspiracy. Problem 4.5: The bank is approached by a shopping center developer, who would like a $2.5 million standby commitment to enable her to bid on a shopping center that is to be sold at a judicial foreclosure sale. The developer thinks the value of the shopping center is $5.1 million. What do you want to know? What is the outstanding balance on the loan being foreclosed, if it is more than 2.5 million the mortgagee will bid up to the loan so you wont get it. If it is less you might have a chance. Concerned with lack of information. Marshak might have information if she is an insider, This is a situation where you are more likely to make a loan to an insider than an outsider. The big question is, weve assumed that the mortgage balance is below the value of the shopping center so why is the debtor unable to turn enough of the profit to pay the mortgagee, that is a warning signal. Reason the debt is not being serviced. Suppose you go ahead and lend her the money. What can she go wrong if she wins the bid? There could be a statutory right of redemption, if in fact the property is worth more the current owner might scare up enough cash with a partner to make it worthwhile to redeem. This is highly unusual in commercial sales. Make the mortgagor say that if the property is redeemed the debt will be paid out of the redemption price. V. ARTICLE 9 SALE AND DEFICIENCY (5) Serves same purpose as real estate judicial sales determine value of collateral and convert it to cash Like real property, foreclosure sale cant be waived or varied in initial contract pre-default, see 9-602(10) and 9-620, 9-610. A. Strict Foreclosure under Article 9 (9-620) (p80) Strict Foreclosure can occur when the debtor consents to the creditor retaining collateral in full or partial satisfaction of the debt after default has occurred, Debtor must give consent for creditor to accept collateral in full or partial satisfaction of obligation Silence to a proposal for retention of the collateral in full satisfaction of the debt sent by the creditor can count as consent 9-620(c)(2) Consent to Strict Foreclosure is subject to three conditions: There must be no objection from others holding liens against collateral 9-620(a)(2) If collateral is consumer goods, debtor can consent to strict foreclosure only after repossession 9620(a)(3) Strict foreclosure not permitted if debtor has paid 60% of cash price of consumer goods purchased on credit or 60% of the loan against other consumer goods 9-620(a)(4) and (e) B. Sale Procedure under Article 9 (9-610) (p81) 9-610 governs the procedure for sale of the collateral Important difference from real estate: Secured Creditor (not public official) conducts sale/distribution w/ broad latitude to determine the method and timing of the sale. Limits on an article 9 Sale

15

Duty to choose sale procedure that is commercially reasonable. 9-610(b) 9-627(a) governs whether conduct was commercially reasonable: Doesnt mean best possible price A disposition is commercially reasonable if: 9-627(b) In the usual manner on any recognized market At the price current in any recognized market at the time of the disposition; or Otherwise in conformity with reasonable commercial practices among dealers in the type of property that was the subject of disposition. 9-611(c)(1): Creditor must give debtor prior notice, unless perishable/recognized market 9-611(d) 9-623: Incorporates common law right to redeem Debtor must pay full amount of debt, including SCs attorney fees and expenses of sale No additional statutory right to redeem after disposition Debtors right to set aside a defective/irregular sale Debtors right to set aside a defective or irregular sale is more constricted under the U.C.C. then under most judicial sale procedures. After the sale, debtors may sue for two injuries: loss of equity (rare) larger-than-appropriate deficiency judgment The good faith purchaser at a U.C.C. sale can buy with the confidence that it will not lose its bargain because the sale is set aside, see 9-617 The USS standard for commercially reasonable is so vague, that the debtor can nearly always find something to complain about C. Problems with Article 9 Sales Procedure: Possible Objections (p83) (1) Failure to sell the collateral UCC 9-610(a): collateral may be sold, but not required except with respect to consumer goods 60% paid for 9-620(e) and (f) UCC 9-626(a): if delay in sale is commercially unreasonable, deficiency limited to amount owing if sale had been reasonable. (2) Requirement of Notice of Sale Secured party must send notice to debtor, guarantors, and some lien holders (UCC 9-611) FDIC v. Lanier (p84): Notice that bank would sell property in public or private sale within 10 days and maybe immediately was adequate for sale that didnt occur for 4 months. Burden to find out about details of sale is on debtor. (3) The Requirement of a Commercially Reasonable Sale 9-610(b): every aspect of a disposition (method, time, place, etc.) must be commercially reasonable Intentionally vague. Leaves it to discretion of creditor. Reasonableness depends on assets, case-bycase. Chavers v. Frazier (p 86) Commercial reasonableness of seized Lear jet depends on facts and circumstances of sale Holding: sale was not commercially reasonable $415K price tag compared to $700K market value One-month turnaround was unreasonable haste (6 months to 1 year needed) Brief advertisements in WSJ and one trade magazine were insufficient Creditor must make effort to maximize value of collateral before they dispose of it for too little Deficiency only for non-consumer transactions (consumer transactions go to court)(p90) If sale is commercially unreasonable (price<FMV) secured creditor can still recover deficiency for debt minus FMV Example: FMV is 12K, debt is 25K. Unreasonable sale yields 8K. Secured Creditor can recover

16

13K. SC must defeat rebuttable presumption that value of collateral was at least = to debt (9-626(a)(3)) Exception to this rule for consumer contracts. 9-626(b) no inference for consumer goods. Must go to court for all these. Majority of courts apply the above logic, yet some deny deficiency at all for commercially unreasonable sales. D. Policy Secured Creditor has no incentive to sell for high price, b/c Secured creditor will make up $ w/ deficiency In fact, creates incentive to lowball sale (selling asset for FMV later) & make up full deficiency after Uninformed debtors will fail to challenge deficiency on grounds of commercially unreasonable E. Problem Set 5 Problem 5.1: repossession of personal property. The balance on the loan is 10 grand. The FMV of car is 8 but it sales for 7 in a commercially reasonably sale. A) What is the proper amount that the court should reward as a deficiency? The deficiency is 3 grand. See 9-615(d) for calculation of surplus or deficiency, indicating that the deficiency is the difference between the sale price and the obligation owed.

B) How much should have to be paid to redeem the car? 10 grand. 9-623 to redeem a person must pay
for all obligations secured by the collateral and any reasonable expenses and attorneys fees. C) Should he redeem the car? He should redeem because its 10 grand total. 7 grand for the car and 3 for the deficiency. To buy another comparable car, he would owe a 3 grand deficiency first and then pay 8 grand for a car = 11,000.

D) What if a friend offers 8 grand but the bank sells it for 7 grand at a private auction where the friend
cannot go? UCC 9-627(b)(3): you can sale at a dealers auction. Just depends if this meets one of the statutory requirements for commercially reasonable under 9-627(b) or if not, then under 9-626 it might be commercially unreasonable and therefore entitle him to only the difference between Debt and FMV, or 2 grand. Problem 5.2: You are a creditor owed a debt of $57,345, plus interest to date of the sale for $3,541. The security agreement provides that the debtor will cover the creditors reasonable attorneys fees on default. Your attorneys fees are $3,650. Youve spent $1,500 preserving the collateral and $750 advertising the sale. Auto Parts sends you a letter saying they are owed 4,200 to be paid out of the proceeds of the sale. A) Assume the highest Bid is 47,316. That money is now in your possession. Who should you pay with it? How much is the deficiency? Autoparts is an unsecured creditor, they dont get anything. You didnt get a judgment so too bad. First, we are entitled to get repaid because we are the only secured creditor. The total debt is 57,345 plus 3,541 for a total of 60,886. Do attorneys fees get included in the expenses, only if it is included in the security agreement and here it was. All other expenses of the sale are always included. There are is a total sale expense of 6,250. So they are owed a grand total of 67,136. The highest bid is 47,136 so the deficiency is 20,000. B) If the highest bid is 75,000? Wed have 7,864 left over after paying off secured creditor. You have to give this to the debtor as opposed to the unsecured creditor because under the statute the surplus goes back to the debtor and if you send it to autoparts it is conversion. They do not have a lien or a secured interest against the inventory or equipment sold. If there is a surplus, the debtor gets the remaining amount before the unsecured creditor. If there is not enough money to pay for sale expenses and secured creditor, the secured creditor will get a deficiency judgment and the debtor will bear the sale expenses. But if the debtor does not pay the deficiency judgment, the creditor bears the cost of sale. If there is a surplus, the sale takes care of it. Problem 5.3: Does East Bank have to send notice to defaulting debtors of auction, where the debtor cannot participate anyways since only dealers are invited? If security agreement has a waiver, then maybe no notice

17

required. Under UCC 9-611(a)(2): the debtor can waive notification, if sale is under recognized market (under 9-611(d)). Dealer auction is not a recognized market under comments. But comments have not been enacted by legislature. Problem 5.4: Bank repossessed hull of helicopters, finding out that debtor has taken out engine and stuff. The debt is $345,000, leaving a hull with no resale value. The debt is personally guaranteed.

A) Can the creditor throw away the hull? 9-610(a) seems to give secured creditor a choice. A secured
creditor can sell collateral in present condition or following any commercially reasonable preparation. What is commercially reasonable? We would have to decide whether its commercially reasonable to reinstall old equipment or buy new stuff. But the comment is designed to make it clear that you DONT have a right to sell it in the present condition if you can make more on it by fixing it up.

B) What if Grizzly could have spent 245,000 to get 345,000? 9-626(a)(3): LOOK at this provision. It is
probably a drafting error. There is no deficiency judgment if the creditor could have spent 245,000 to get 345,000 (commercially reasonable). Again, what if guarantors hypothetically could prove that if creditors put in 245,000, they could have sold it for 345,000? If you look 9-626(a)(3), seems to reach an absurd result for determining deficiency amount. The secured party is entitled to 0 even though it would have had to spend 245 to realize 345. This is because expenses does not include the 245 under 9-623(a)(3)(B) if it is not actually spent on rebuilding helicopter. But if in reality, the creditor actually spent the 245, then that amount is real and counts as an expense under 9623(a)(3)(A) and is added to the deficiency limit. Note: proceeds means gross sales. Problem 5.5: The owner of a business wants to retire and sells store to a new party. The new party put down 50 grand and signed a promissory note for 277,000. The new party cannot run store. The old owner takes the store back and sent defaulting buyer a bill for 131 grand, which was the excess it owed after crediting him for the value of the store. Can the old owner sue for the deficiency without selling the store first? Under 9-626: if the secured party fails to prove that the collection disposition was conducted in accordance to the provisions of this part, the creditors deficiency is limited (reasonable sale provisions). Secured creditor says he is entitled to full amount of debt less value of what it was when took it back. The debtor may argue that 9-626 does not apply because there was no defective sale. The creditor just kept the property. Look to 9-617: good faith transfers. PART II: CREDITORS REMEDIES IN BANKRUPTCY BR changes debtor/creditor relationship b/c SC & UC must consider what happens if debtor goes into BR VI. BANKRUPTCY AND THE AUTOMATIC STAY (6) A. The Federal Bankruptcy System (p95) Compared to state collection systems that can take a long time, bankruptcy system provides quick, efficient resolution of debtors financial problems. To achieve this, the bankruptcy system offers permanent forgiveness of debt (referred to as discharge) or rescheduling of repayment (referred to as an extension or debt adjustment). Federal bankruptcy (supremacy) is always a possibility for state debtors; if the debtor is in financial difficulty, either the debtor or the creditors may be able to move the matter to a federal bankruptcy court to avoid the state court system. The Constitution gave Congress the power to establish uniform laws on the subject of bankruptcy throughout the United States. Under the Supremacy Doctrine, federal bankruptcy law supersedes state collection law. Creditors structure there relationships with debtors with bankruptcy in mind. B. Filing a Bankruptcy Case (p96) Process may be initiated by either debtor or creditor, though overwhelming majority are by debtor The debtor pays a filling fee and the forms are filled out with the court clerk of the bankruptcy court Upon receiving the forms, the bankruptcy clerk stamps with the date and time

18

Immediately upon receiving the forms: (1) a bankruptcy estate, which consists of all the property of the debtor, is automatically created. Bankr. Code 541(a) (2) a stay against any collection activities is automatically imposed. Bankr. Code 362(a) Chapter 7 Cases (Liquidation) Cases Bankr. Code 552(b) Chapter 7 debtor keeps property exempt under state law (Bankr. Code 552(d) lists federal bankruptcy exemptions that are an option for debtor instead of the exemptions under state law). In all Chapter 7 (liquidation) cases, a trustee is appointed to administer the estate. Bankr. Code 704 debtors assets are liquidated and distributed pro rata to general creditors. If debtor is an individual, all remaining debts are discharged. Bankr. Code 727(a)(1) If debtor is a corporation, then after discharge, corporate shell

remains w/ no assets but still owing all debts.


Chapters 11, 12, and 13 Cases Chapter 11 (business), 12 (family farm), and 13 (Individual) Reorganization Cases In all Chapter 11,12, and 13 reorganization and adjustment cases, the debtors are left in control of their own estates, to administer them in accord with bankruptcy law. Chapter 13 (individual reorganizations) Trustees are appointed in cases under Chapter 12 (reorganization only for owners of family farms) and 13 (reorganization only for individuals), but they do not take possession of the property of the estate. The debtor files a proposed budget, with a plan to devote all disposable income to the repayment of debt for a period of at least three years, Bankr. Code 1325(b) The plan must promise to pay creditors at least as much as they would have received in a Chapter 7 liquidation, Bankr. Code 1325(a)(5) The Chapter 13 trustee examines the budget and appears at the court hearing to consider the confirmation of the debtors plan, Bankr. Code 1302 The trustee receives the payments from the debtor and distributes them pro rata to the general creditors over the life of the plan. The plan lasts from three to five years, and the debtor is discharged from most remaining debt when the last payment is made, Bankr. Code 1328 Chapter 11 (typically business reorganizations) In a Chapter 11 (reorganization, typically a business) case the debtors management usually remains in possession of the property of the estate as a debtor in possession (DIP) and operates the business. If the court determines the DIP is not running estate effectively, it may order the appointment or election of a trustee to replace the management, Bankr. Code 1104(a). Similar to Chapter 13 readjustment but, the plan that the debtor in possession purposes can provide payment over any length of time, most pay in 5-7 years. The plan most promise creditors at least as much as they would have received in a Chapter 7 liquidation, Bankr. Code 1129(a)(7) C. Stopping Creditors Collection Activities (p99) Unsecured creditors (general creditors in bankruptcy parlance) Bankruptcy is now a collective proceeding all lumped together. Share pro rata in what $ is recovered Unsecured creditors can no longer disrupt debtors business or seize assets Can benefit unsecured creditors from some aspects of collective action, reduces collection costs, no creditors can move ahead of them by seizing assets Aggressive creditors tend to be worse off than they would have been under state collection law, under bankruptcy they have little leverage and the creditors claims may be discharged eliminating their right to collection. Bankruptcy courts take stay violations quite seriously

19

Hold deliberate violators in contempt of court and impose a fine sufficient to make them regret action In some circumstances, injured parties of a stay violation may sue for damages, Bankr. Code 362(h) Actions taken in violation of stay are either void or voidable Reasons for the stay Provides opportunity to taken an accurate account of all debtors assets Gives debtor breathing room Halts ongoing litigation in the state system Freezes RELATIVE rights of secured creditors and give general rights to ALL OTHER creditors Stay does not halt criminal actions against debtor Scope of the Automatic Stay Bankruptcy Code provides that stay is applicable to all entities against any act to collection prepetition debt. Protects the debtors personally as well as the property of the estate. Applies to both direction and indirect collection attempts. With respect to unsecured creditors, the automatic stay generally remains in effect until the conclusion of the bankruptcy case, Bankr. Code 362(c) D. Lifting the Stay for Secured Creditors (p101) BR only delays secured creditors rights, doesnt eradicate them. Secured creditors are eventually promised their collateral or to property or money of equivalent value. Gives neither secured or unsecured creditors right to full payment of outstanding debt, but at least gives secured creditors right to be paid at least the value of their collateral. Secured creditors are allowed to participate individually to protect collateral rather than forcing collective action on them (like what is forced on unsecured creditors) Lifting the stay (p102) (A) Lack of Adequate Protection 362(d)(1) Court must always lift the stay if debtor doesnt provide adequate protection against value erosion (361 definition, 362(d)(1)) Creditor must show asset deterioration w/o adequate protection (extra payment, lien, etc.) If no adequate protection against value erosion is given, game over stay is lifted Equity cushion above value of collateral will offset concerns about adequate protection (collateral that secures debt is worth significantly more than debt results in an equity cushion) Exactly how large an equity cushion must be to provide protection depends upon key circumstances including: The nature of the factors that might change the value of the collateral The volatility of the market in which the creditor might have to sell it The rate at which the secured debt is likely to increase in amount What constitutes adequate protection is decided by the court. Adequate protection may come in many forms: monthly payments, additional liens against other property (B) Even w/ adequate protection 362(d)(2) Even with adequate coverage, court may nevertheless lift the stay if: (1) There is no equity in the collateral that unsecured creditors might eventually realize (2) The collateral is not necessary to an effective reorganization While secured creditors are entitled to adequate protection against loss from a decline in value of their collateral, they are not entitled to protection against other losses resulting from the imposition of the automatic stay. A stay is automatically terminated unless, within 30 days after a secured creditor moves to lift it, the court enters an order continuing it in effect. Bankr. Code 362(e). This high priority is given because the value of the secured partys collateral may be at stake. In re Craddock-Terry Shoe Corp. (p105) Creditors seek to lift a stay to get access to depreciated collateral of customer mailing lists

20

362(d): Bankruptcy stay lifted either if: Showing of lack of adequate protection of property interest, or 362(d)(1) Showing of (1) no debtor equity and (2) no necessity to an effective reorganization 362(d)(2) Holding: Lists vital to reorganization, so stay is not lifted under 362(d)(2), but that doesnt mean that the debtor need not provide them with adequate protection nevertheless, 326(d)(1) E. Policy Moving to lift stay is more often tool to get leverage w/ debtors, especially if assets essential to business Stay applies to secured creditors to preserve value for unsecured creditors, except for causes in 362(d) This is equity point you can lift the stay when theres no equity interest, b/c nothing left for unsecured creditors In bankruptcy, aggressive creditors are not rewarded more than non-aggressive creditors, unlike under state collection procedures. F. Problem Set 6 Problem 6.1: CEO says a bunch of their clients are in bankruptcy. She wants to do serious collection efforts. What do you say? The automatic stay is the paradigm of the collective nature of bankruptcy against the individual orientation of state remedy law. Under state law the remedy goes against the swiftest creditor. Whatever unsecured creditor gets to the court first has the best chance of collecting his debts. The whole idea of bankruptcy is that the whole pool of unsecured creditors who sink or swim together. There is really nothing you can do here. You should just submit claim in bankruptcy court. The automatic stay prevents you from any effort to collect and probably even sending a statement would be a violation of an automatic stay, because the purpose of sending a statement is to induce payment. Under 362(a)(6): when under stay, cannot act to collect, assess, or recover. If do it, then may get fined or be held in contempt. Problem 6.2: You represent a bank that is trying to collect collateral that is the security for one of its loans through self-help repossession. You have a judgment and the sheriff is ready to levy on the goods, however, at that moment you learn the debtor has filed for bankruptcy. Can you go through with the repossession? No. You cannot go after debtor once in bankruptcy. But can the sheriff? No, the only applicable provision for government agency is under 362(b)(4) and that provision applies to things like environmental safety. Problem 6.3: The bank wants to foreclose after restaurant goes into bankruptcy. You cannot foreclose under 362(a)(3) because you cannot take possession. But you can ask the court to lift the stay if debtor has no equity and the property is not necessary to an effective reorganization, 363(d)(2). Even as a secured creditor, you cannot foreclose because there is an automatic stay. Automatic stays apply to both secured and unsecured creditors. You can move to have the say lifted. This will likely be granted because the debtor has no equity in the property and because they had already closed the business it was necessary for reorganization. Once the stay is lifted you can foreclose under state law. Problem 6.4: The bank wants to foreclose on a chapter 11 restaurant owing 210 grand. But the restaurant is worth about 600 grand. There is still adequate protection because there is a 390 grand cushion. Also, the property is necessary for effective reorganization, so the court probably wont lift the stay. If you start to loose your adequate protection you can go back into court. The longer the debtor stays in renegotiation the more likely the property value is to decline. Problem 6.5: You have a security interest in a yacht worth 350,000 on a loan of 175,000. The boat has no insurance and the owner goes into bankruptcy. What do you do? If the boat is destroyed by a storm, there would be total loss for the bank. So the equity cushion may not be meaningful. 362(d) There is a lot of equity here, so they might say there is a lack of necessity here. You might be able to get relief if the boat is destroyed by a storm, there would be total loss for the bank. So the equity cushion may not be meaningful. There is no adequate protection of its interest because the insurance is critical and if the hurricane comes along to destroy the boat the collateral is gone. Problem 6.6: You are helping out a debtor food processor. The company files for chapter 11.

21

A) The first irate creditor calls and says he wants his loan amount of 126 grand. Problem unsecured
creditor. So he is SOL, and has to wait along with the rest of the unsecured creditors. The unsecured creditor is not going to get any money, if any, until a plan is confirmed or the debtor is liquidated. Those are the two situations you may get some money. By and large if there is liquidation and there is no plan, unsecured creditors usually dont get anything.

B) The next creditor has a secured interest in equipment. However, the defaulting amount of 50 grand is
less than the value of the equipment (40 grand). They are not going to win under 363(d)(2) because property is crucial to reorganization. But under 363(d)(1), there is lack of adequate protection. The debt is 50 but the secured collateral is worth only 40 grand. Most courts say you dont get additional adequate protection from the date the debtor filed bankruptcy protection. You only get adequate protection from the time you took efforts to protect yourself, such as filing relief from stay. The secured creditor is going to move to lift the stay. If they win that will doom the reorganization plan if you lose that equipment, it is probably essential to the business however, there isnt adequate protection because the collateral is appraised at less than what the secured creditor is owed. The issue, adequate protection, when do you measure adequate protection from. Retroactivity rule, apply only when the motion for adequate protection is filed, it hasnt been filed yet, so no additional jurisdiction needs to be granted yet. However, that isnt the rule in all jurisdictions. Craddock Terry(sp), is a case with the minority rule. Under a jurisdiction with this case, wed have to provide as of this moment another 10,000 of additional collateral in order for them to be adequately protected. But even in a majority rules jurisdiction, if the motion is filed instantly, and we arent adequately protected, so measured form now you have no claim, it is valued at 40,000 and that is what your collateral is worth. The secured creditor is going to say what, adequate protection is what? Suppose there is a likelihood of decline in the collateral, you can demonstrate that now, are you entitled to additional protection. Yes! The real question for the court is which way does the 10,000 drop in the value of the collateral drop point. Does it point to the value of the collateral really heading south or has it hit rock bottom and it is going to go up. The parties are going to introduce evidence and fight over what happens to this kind of collateral in this kind of market. VII. THE TREATMENT OF SECURED CREDITORS IN BANKRUPTCY A. The Vocabulary of Bankruptcy Claims Debt a sum of money owing, determined under nonbankruptcy law, typically contract, tort or antitrust law. Discharge a discharged debt still exists, but creditor is permanently enjoined from collection, Bankr. Code 524(a)(2) But if lien of security interest hasnt been removed during bankruptcy, creditor can foreclose on it after Non-recourse debt discharged debt that cant be enforced against debtor, merely an artifact or legal metaphysics. (if, however, there is non-recourse debt and the lien is not removed during bankruptcy, it continues to encumber the collateral afterwards and the creditor can force a foreclosure after bankruptcy, but he cant then get any deficiency if the sale doesnt cover the debt.) Security interest in bankruptcy code, groups article 9 security interests together with real estate mortgages and deeds of trust under the term, Bankr. Code 101(51) Claim debt owed at the time the bankruptcy is filed under nonbankruptcy law, Bankr. Code 101(5) and (12). (debt can continue to increase during bankruptcy due to things like accrued interest, while the claim stays constant. If the stay is lifted or the bankruptcy case dismissed without a discharge for the debtor, creditor can seek the debt again and isnt limited by the claim.) Allowed only claims that are allowed are eligible to share in the distributions made in the bankruptcy case. Bankr. Code 502(b) contains a list of the kinds of claims that are not allowed. B. The Claims Process Summary How much creditors are paid from bankruptcy estate depends on: How much the various creditors are owed The creditors relative priorities in the estate

22

The available value from which to pay them System for Creditors to Establish Claims The creditor must file a one-page form called a proof of claim, describing the debt and stating that it remains outstanding, Bankr. Code 501(a) If one objects to the claim, then it is allowed, Bankr. Code 502(a) Under chapter 11, debtor files list of creditors and what is owedcreditor doesnt have to file anything unless something is incorrect, Bankr. Code 1111(a) Claims are accelerated due to bankruptcy if claim is disputed, quicker resolution than under state law, 502(b)(1) If the debtor outside bankruptcy had a legal defense to payment, the bankruptcy estate will have the same defense, Bankr. Code 558. Bankruptcy law gives some groups of unsecured creditors priority over others, see 507(a): (e.g. tax authorities and employees) C. Calculating the Amount of an UNSECURED Claim Amount of unsecured claim under bankruptcy is amount owed on debt at moment BR is filed, Bankr. Code 502(b) No accrual of interest or fees after that moment are owed, Bankr. Code 502(b)(2) Fees and costs are only added if contractually mandated, and if before declaration of bankruptcy. Bankr. Code 502(b)(1) Once value of all assets is apprised, they are distributed to creditors pro rata Most unsecured creditors get nothing in bankruptcy D. Calculating the Amount of a SECURED Claim: 9-506 The amount of the secured creditors claim begins with determining the amount owing under nonbankruptcy law at the time bankruptcy forms filed, Bankr. Code 502(b) The next step is to bifurcate the claim. The claim of a secured creditor can be a secured claim only to the extent of the value of the collateral. The remainder is an unsecured claim. Bankr. Code 506(a) Example of Bifurcated claim under 506(a) imagine 40K loan, but collateral only worth 35K The value of the collateral is a secured claim (35K of collateral is secured) The additional value of the loan is an unsecured claim (5K of collateral is unsecured) 506(b): On secured claim, creditor is entitled to post-petition interest, fees and costs IF: (1) Fees and costs are reasonable, and (2) Payment is contractually mandated by agreement (3) Interest, fees, etc. are only accruable to the extent that value of collateral exceeds value of claim Example: 40K loan, 50K collateral. Fees can be accrued up to 10K Example: 40K loan, 35K collateral. Fees cannot be accrued on either secured or unsecured portion. E. Selling the Collateral Chapter 7 Sale procedure trustee has broad leeway to maximize proceeds 541(a) trustee usually sells property subject to security interest, this is because the trustee ordinarily sells only the debtors equity in the property subject to a security interest because that is all the estate is entitled to under Bankr. Code 541(a) If boat is worth 50K and debt is 40K, and trustee sells boat for 10K, subject to lien of 40K: This terminates automatic stay bank now free to foreclose, Bankr. Code 362(c)(1) But foreclosure is probably unnecessary b/c buyer knew of attached lien and is prepared to pay it 554(a): if boat is worth 35K w/ 40K lien, trustee allowed to abandon property burdensome to estate (the debtors equity in the collateral is so inconsequential not worth bothering with) If debt has not been paid and property abandoned, stay is lifted and creditor can repossess Or, trustee can potentially (circumstantially) sell collateral free and clear of liens (363(f)) Whatever amount it fetches becomes security claim of bank, if less than value of claim If more than value of claim, full lien is paid off and excess remains w/ estate for general distribution

23

F. Who pays expenses of sale by trustee? 506(c): Trustee who has incurred reasonable disposition costs can recover them from SCs property But only if the secured creditor has benefited from the sale if SC would have had to pay those fees Court must analyze what would have happened if stay had been lifted and creditor sold on his own. Undersecured SC fees will be deducted, b/c would have had to pay fees out of collateral value Oversecured SC fees wont, b/c fees wouldve been taken out of extra equity above loan price G. Chapters 11 and 13 Reorganization Debtor typically seeks to hold on to property and seeks to reschedule/reduce payments of debt (can be accomplished only through confirmation of plan by bankruptcy court). Process: Court confirms Chapter 11 plan discharging old secured debts and substituting new ones, Bankr. Code 1141(d)(1)(A); the creditor must retain his lien, but now the lien only secures the new debt. The confirmation of plan to which creditor has not agreed is called cramdown Statutory requirements for cramdown (1325(a)(5)): (1) Debtor must surrender the collateral to the secured creditor in satisfaction of secured claim or (2) Debtor must distribute to the creditor, on account of the secured claim, property w/ value as of the effective date of the plan that is no less than the amount of the allowed secured claim. Therefore, although secured claim is paid in full, might not be immediate or in cash H. Valuing Future Payments B/c of TVM, value referred to in prong 2 must be NPV of future payments. But at what discount rate? In re E.I. Parks No. 1 Ltd. Partnership (Bankr. W.D. Ark. 1990) Creditor objects to debtors amended plan b/c plan didnt propose to pay market rate of interest Holding: appropriate discount rate must be determined in light of risks involved I. Problem Set 7 Problem 7.1: The creditor claim would be limited to 30 grand plus interest until the debtor filed bankruptcy. They get six months interests so 2,700 (30,000 x 18% x 6/12). The total before petition is 32,700. After the petition is filed, under 502(b)(2), it says you cannot get unmatured interest. Attorney fees can only be claimed if agreed upon before hand. Dataeserve could sue its prior counsel for failing to include an attorneys fees provision in the contract. There is almost always an agreement for pre-petition attorneys fees for both secured and unsecured creditors. Neither of them can collect these fees if they are not in the original contract. Interest for unsecured creditors stops being collectable at the minute the party files for bankruptcy. Problem 7.2: Every unsecured creditor gets 5%, (59,575/1,191,500) x 32,700 so our client get 1,635 and writes off the excess of 31,365, more than their original loan. That is what happens to unsecured creditors. Our client was probably lucky to get anything with 59,000 kicking around there. There is lots of temptation to jack up the attorney fees. Nobody will have a big enough stake to make a claim. Problem 7.3: Our client CI is a secured creditor, owed 340,000 plus 6 months of interest at 12%, secured by equipment worth 400,000. The debtor filed Chapter 11. A) Interest is 20,400 (340,00 x 12% x 6/12), for a total of 360,400. Can you get post-petition interest on a secured claim if is provided for in the plan and if the collateral is sufficient. B) If plan was confirmed today, you can add an additional 12%. You have 1% interest per month, 360,400 x 3% = 10,212. You would have to propose payments that have a discounted value of 371,212. The plan would have to promise payment on the effective date of plan with interest at a market rate. With this kind of collateral were talking about something in the neighborhood of a 5-10 month payout plan. The plan has got to propose a payment schedule that when discounted amounts to a present value of 371,212 dollars and add a market interest rate on top of that. You do post filing interest on the 360,400 (the claim at the filing date).

24

C) If the reorganization plan is not confirmed for another year, then what? You can keep piling on the interest of the year, but only up to the amount of the secured collateral, of 400,000. If the contract provided for collection expenses, and had prefiling collection expenses, that lowers your cushion even more. After your secured claim is capped at 400,000, you may end up with an unsecured claim as well. But the interest does not go past the 400,000 mark. After that, the debt goes up, but the claim is not allowed. As a secured creditor you want to push for approval of the plan. Another 28,788 in interest for 12 months so that brings you up to 400,000. The calculation of the payments that gets discounted Problem 7.4: The secured claim is capped at 325,000. The debt owed is 360,400. A) The claim is bifurcated under 506(a). The secured claim is 325,000, the remaining amount, 35,400, is unsecured. B) You dont get post petition interest on any claim because the collateral cannot handle it. The creditor becomes an unsecured creditor after that amount and cannot charge unmatured interest. The creditor could only get post petition interest if the collateral exceeded the debt. Since it does not, the creditor cannot charge post petition interest because it acts as an unsecured creditor. So they get the 325,000 + 10% of 35,400 for a total of 328,540. C) The claim will stay the same this year or next. You are going to close this up youll get the same, but youd rather have it this year than next year. Problem 7.5: Now assume same problem as above but the party is not secured. A) Her company is an unsecured creditor for 340,000 + 20,400 interest = 360,240. The scheme of payment under the bankruptcy code has some unsecured creditors getting payment before others. B) They get 10% of this so 36,024. Problem 7.6: You are appointed to act as TIB in chapter 7. Perez summer house is in estate. This is a summer house so it wont qualify for an exemption so they can go after it. You are appointed to act as TIB in chapter 7. Perez summer house is in estate. The house is encumbered by mortgage to first capital. The mortgage is 85,000, which includes interest accrued to date at the contract rate of 10% per annum. If sold after 6 months, the house will produce 100,000 6,000 (Real Estate Commission) 85,000 (Mortgage) 1,000 (interest for 6 months on mortgage i.e. 4,250) = 3,750. If the house is sold a year later, another 4,250 of mortgage interest is added because the bank has a secured interest in that collateral. Sometime between 6 months and one year, the trustee may want to look out for unsecured creditors, and abandon it. This way, the bank could get the mortgage on the house. It allows the bank to go ahead with its foreclosure procedure. 6000 com, 1000 costs, 85000 mtg, 4350 add int. = 96,250, might want to sell. If sell for 100,000, 3750 is left in trust for unsecured creditors. If it takes a year then the interest goes up by 4250 and your total is above 100000. Problem 7.7: the secured creditor gets its money and the unsecured get the rest pro rata. For the coin collection, the secured creditor gets the 26,000, but the rest is unsecured and they all get it pro rata. PART III: CREATION OF SECURITY INTERESTS VIII. FORMALITIES FOR ATTACHMENT (8) Secured interests are created by contract at the time of the loan, they obtain their status by contract with the debtor They are by definition consensual creditors A. A Prototypical Secured Transaction (p135) A agreement is reached between debtor and creditor and a financing statement if singed. The creditor then files the financing statement with the secretary of state in the UCC filing system Authenticating financing statements are not required for enforcing foreclosure only for perfecting the

25

interest, to let creditor have priority to collateral over other creditors, 9-203(b) B. Formalities for Article 9 Security Interests (p138) Three formalities to create enforceable security interest (UCC 9-203(b)) ATTACHMENT (1) Either SC possesses collateral or debtor authenticates security agreement w/ collateral description (2) value must have been given (3) debtor must have rights in the collateral Only when all 3 have been met does security interest attach to the collateral and become enforceable (1) Possession or Authenticated Security Agreement (p139) Article 9 ratifies two different kinds of security agreements, authenticated records, but also taking possession of goods pursuant to an oral agreement to create a security agreement. Lenders have devised ways to take possession without depriving debtor of use of collateral, called field warehousing. Written security agreements are much more common. They contain a description of the collateral, a description of the obligations secured, and provisions defining default, specifying the rights of the secured creditor on default, imposing other obligations. Authenticated a security agreement (9-203(b)) can mean one of three things: Oral contract when creditor is in possession of collateral Written, signed agreement when collateral is in possession of debtor Tangible medium record such as e-mail exchange or electronic agreement (9-102(a)(7)(b)) In re Ace Lumber Supply (p140) P claimed security interest in debtor, evidenced only by financing statement and telephone notes Two part test proposed by White and Summers (1) Does language of writing objectively indicate that parties intended to create interest? (2) Did parties actually intend to create that interest? Composite document rule: signature + clear intent + description of collateral = security interest Must be (1) cross-reference and (2) apparent and actual intent. Jurisdictions are split on the application of the composite doctrine. Yet hand-written phone notes, unlike prior cases, do not round out the requisite intent What about when 1 document has signature, and another expresses intent to create security agreement? Majority rule: so long as documents have internal connection, may be read together to include collateral of second agreement under signature of first agreement (see also Longtree, p. 145) Policy justification of requiring authenticated documents Preventing fraud Minimizing litigation Cautioning debtors: may enter into written agreements less lightly Channels transactions to good business practices Question: does description of collateral have to be in document at the time its authenticated, or can it be filled into an authenticated document later? This question has split the circuits (148) 9-203(b)(3)(A) doesnt specifically say that description has to be there at time of authentication (2) Value has been given (p148) Practically irrelevant requirement, b/c so broad that will almost always be met, see 1-201(44) for definition of value Even security interest in exchange for pre-existing debt counts as value exchanged (3) The debtor has rights in collateral (p149) Person cant grant security interest in someone elses property. Three subtexts: If debtor owns limited interest in property (such as lease), if he grants a security interest in the property, the security interest will generally attach only to the limited interest, UCC 9-203. Some owners who acquired prop. rights by fraud have the power to transfer to a bona fide purchasers ownership rights they themselves dont have. UCC 2-403

26

Security interest only becomes enforceable at time that debtor obtains collateral C. Formalities for Real Estate Mortgages (p150) Formalities for mortgages governed by state law: at minimum, require written/signed mortgage w/ witness D. Problem Set 8 Problem 8.1: One example, Promissory note for 50 grand that was signed by debtor, reciting that secured by collateral described in security agreement bearing same date. There is no description of the collateral. The third example, a lawyer cannot sign for debtor. What about composite document rule? Why does the financing statement not serve? It has a description of the collateral and although not signed it was executed by debtor. Do the documents stand alone or do you need to read the testimony? See 9-102(a)(7) for definition of authentication seeming to require signature or mark of some sort on the document. There may be something in there that will take you out of the composite document agreement. The rule says that debtor must authenticate the agreement (who cares if security did not sign). Problem 8.2: Was there a security agreement when the financing statement was filed in the Fishermans Pier example? One of the great advances for secured creditors was that they were allowed to file a financial statement before security agreement was filed. But the date of the financial statement is the date when notice was given to third parties. Also, there were some famous cases where there was a closing and the debtor rushed in to file, and in between that time, another person rushed in and got priority. The value is given with the first check or 38,000 not the promissory note. The bill of sale is the time in which the debtor had rights in collateral. You need to have value given for attachment to occur, see 9-203(b). Problem 8.3: You cannot have a security interest without a description of the collateral. 9-203(a). The description is later mailed and stapled to security agreement. Is this sufficient? 2 cases say yes and 2 cases say no (page 148). If Pablo is in bankruptcy then what? The bankruptcy court says you cannot create security agreement while in stay. 363(a)(4). Problem 8.4: After debtor goes into bankruptcy, you forgot to attach the description to the blank spot. The client sent it to you and you stuck it in your desk but forgot to staple it together. You cannot prove it after stay. What about the composite document doctrine? Its not signed by debtor but in some of these composite document doctrine the debtor does not sign everything. The composite document doctrine makes reference to each document internally. If we read the documents, they should refer to each other. If you know that the client will commit perjury, can you still withdraw without telling trustee? Client is willing to fix mistake and then lawyer will turn you in? Problem 8.5: Do you turn your ex client into the court? This is confidential information. Mr Meastre is not a present client; he is a former client. You need to keep confidences of former clients. What about 3.3? Maybe it wont be assisting fraud to keep silent, especially considering that there is an argument that the composite document rule covers this whole thing and it meets 9. MRPR: a lawyer is required to keep confidences of a former client. Does 3.3a2 required you to turn in a prior client (it clearly requires you to turn in a present client). Assisting does not mean aiding and abetting in the criminal law sense. IX. WHAT COLLATERAL AND OBLIGATIONS ARE COVERED? (9) The value of the security interest can be no greater than the value of the collateral covered by it Every security agreement contains a description of the collateral. Each also contains a description of the collateral. Most secured transactions will have at least two descriptions of the collateral: one in the security agreement that is the contract between the parties and one in the financing statement that will be filed in the public records. A. Interpreting Security Agreements (p155) In debtor/creditor suits, courts try to discern intent of parties as objectively expressed in written agreement Security agreements also bind third parties (9-201(a)) other creditors and purchasers of collateral Descriptions of collateral afforded Art. 9 definition meaning, not everyday meaning (e.g. accounts, equip.)

27

B. Sufficiency of Description: Article 9 Security Agreements (p157) Primary purpose of describing collateral in a security agreement is for identification what degree of precision is required? In re Shirel (Bankr. W.D. OK 2000, 157) Contract of adhesion purported to create security interest in all merchandise bought w/ credit card Court invalidates: since contract of adhesion, read in most unfavorable light to creditor 9-108(c): all debtors assets or personal property not specific enough to identify collateral All merchandise doesnt do work that 9-203 expected (notice/identification). Too broad. C. Describing After-Acquired Property (p160) After-acquired property (floating lien): collateral that debtor obtains on rolling basis (AR, inventory) Authorized by 9-204(a): extends valid collateral in security agreements to after-acquired property Stoumbos v. Kilimnik (p161) Kilimnik Description of equipment does not imply after-acquired property, although inventory does. Use of after-acquired is to allow security interest to float on collateral that constantly changes. Collateral is often the category rather than the individual items contained in it. After-acquired clauses become ineffective after filing bankruptcy 552(a). 552(a): after-acquired property clauses become ineffective upon filing of BR case D. Sufficiency of Description: Real Estate Mortgages (p163) Description of land must be sufficient to identify it; if ambiguous, parol evidence used to explain meaning Real estate law recognizes after-acquired title doctrine, but seldom used except for after affixed fixtures Permanent buildings and other structures permanently affixed to land (known as fixtures) become part of the real estate. They are automatically included in a description that refers only to the land. E. What Obligations are Secured? (p164) Virtually any obligation can be secured if the parties make their intentions clear 9-204(c): allows for security agreement in future advances. Security agreements can include dragnet clauses where every obligation of any kind that comes into existence in the future is secured, although some states disfavor them and will require strict proof that later advance was one that parties contemplated when they made the contract. Security agreements also generally include nonadvance provisions where attorneys fees and collection expenses are included in total debt. Dragnet clauses: pre-securitize any further monies advanced by creditor Valid for Art. 9 security agreements Can be included in real estate mortgages, w/ three limitations in SOME states: Strict proof that later advance was contemplated by parties at the time they executed the mortgage Recorded mortgage must indicate max. amount of indebtedness to be secured Real property cant secure obligations not reducible to money F. Problem Set 9 Problem 9.1: The farmer gives security interest in crops growing on farm in Osprey, County, about 14 miles from Tilanook and most of their farm equipment. With crops growing on land, you have to describe the land too. The land description seems ok. The farmers want to borrow more money from another lender but that lender wont go because the crops are already encumbered by first national. The security description is ambiguous. Suppose repayment is one year, then current crops may be the only crops encumbered. But if at the time the loan is taken out, and there is no current crops, maybe the security interest is for the future crops growing on the land, meaning that whatever grows on land becomes a security interest. This would apply to future crops. You want to know more details. What should the farmers do? Litigation takes time. They want a security interest in crops because crops means cash. Equipment sits in fields. What about the land itself? The land is probably encumbered already. They could always sue their lawyer. The lawyer that left them in this fix is a perfect target. With malpractice insurance,

28

if there is a plausible claim, the lawyers will settle and not fight it. The current crop might qualify as after acquired property under 9-204. Problem 9.2: What about the sheep the farmers raise on the property? Are the sheep equipment? Are they crops? They are valuable for their wool, meat, and milk. The wool is a crop in Websters dictionary. The security agreement says crops growing on farm. Maybe the sheep are on land and not on farm. What is the difference? An opinion letter leaves great potential for malpractice. You cannot give an opinion letter in absolute affirmation that the sheeps wool is not covered. There is a small risk but the odds are in their favor. Problem 9.3: The security agreement says all of debtors equipment, including replacement parts, additions, repairs, and accessories incorporated therein or affixed thereto. Without limitation the term equipment includes all items used in recording, etc. Does this include new equipment? Does the word additions sufficiently describe after acquired property? It might, but its not clear? This description comes out of a case, in which the court granted summary judgment against the secured creditor. It is an example of the court. You can define it at one level of generality such as equipment, etc (but cannot use all consumer goods under 9-108c), as long as it is not supergeneric under 9-108c, such as all assets or all property (to protect the mom and pop stores). If you want to include everything, you need to list the types of property, such as inventory, equipment, A/Rs, farm products, etc, and state after acquired property too (look at 9-108). You could create a standardized form and check off what does not apply. The purpose of this section was to protect the consumer. Problem 9.4: Walter takes an interest in everything the debtor purchases on their credit card. They cannot just describe interest in everything bought on credit card anymore. What should they do? Walter should outfit their ash register with a documentation database that will give a computerized security agreement at the point of sale. Problem 9.5: Someone wants to create a form taking an interest in everything of debtors, except for the few boxes that are checked off of items not covered. Is this possible. Likely not, would violate 9-108(c) Problem 9.6: As a matter of policy, why should a description saying all the debtors property be invalid? Because the drafters were worried debtors would not understand the exactly how much there were agreeing to. Problem 9.7: Client executed a security agreement in 1997 in accounts. The creditor is now claiming that accounts include the proceeds owing from the sale of real estate. Accounts did not include real estate proceeds in 97, but became accounts upon adoption of revised Article 9. Did the expansion in article 9 definitions of accounts expand the scope of First Banks security interest? If you use an Article 9 definition, you are stuck with an Article 9 category over time. You have to tell your client that he cannot ignore First Bank. There is no way to handle this problem without dealing with First Bank. According to 9-102(a)(2) account is a right to payment of a monetary obligation for property that has or is to be sold X. PROCEEDS, PRODUCTS, AND OTHER VALUE-TRACING CONCEPTS (10) A. Introduction (p 168) Collateral changes form (oil to plastic, inventory to accounts receivable, goods to cash) The form is usually unimportant to creditor; just value By giving its secured creditor an interest that floats from one item to another as the value is transferred, transformations in value become less threatening to the secured creditors Two ways to solve this problem of changing forms: Express the description of collateral in the agreement that covers all forms the value is likely to take and The creditors can employ value tracing concepts so that the security will fallow the value of the collateral. Value tracing concepts are employed as : proceeds, products, rents, profits, offspring. B. Proceeds (p169) Definition of Proceeds UCC 9-102(a)(64) gives broad definition of proceeds Proceeds includes:

29

Whatever is acquired upon the sale, lease, license, or exchange or other disposition of the collateral NOTE: gives rights into the entire value of the exchanged despite value that might me added from wholesale to retail. McLemore, Tustee v. Mid-South Agri-Chemical Corp. Held that a cash payment for not planting crops under a federal subsidy program was proceeds acquired from the disposition of crops. Whatever is collected on, or distributed on account of collateral Rights arising out of collateral Nobody has any idea what this means Can be used to give rights in anything connected in any way with the collateral. The value of collateral, claims arising out of the loss, nonconformity, or interference with the use of, defect or infringement of rights in, or damage to, the collateral Insurance payable by reason of the collateral, to the extent of the value of the collateral and to the extent it is payable to the debtor If proceeds become collateral 9-102(a)(12), then the proceeds of proceeds come under the security agreement. Value Tracing is the policy reason behind including proceeds. Rights to proceeds attaches automatically. UCC 9-203(f), 9-315(a)(2). Continuation of Security Interest in Proceeds CC 9-315(a) Disposition of Collateral: Continuation of Security Interest in Proceeds Security interest continues in collateral notwithstanding sale Unless secured party has authorized debtor to sell collateral free of security interest, security interest continues in the original collateral and the proceeds potential multiplication of value to SC! Combine this w/ 9-102(a)(12): security interest in new product that proceeds are used to buy! See also Keystone General (175) Limitations: SI only covers proceeds so long as they remain identifiable 9-315(a)(2) 9-315(b) comment 3: SCs collateral remaining in commingled bank account decided by equitable principles: in many states, lowest balance b/w deposit of collateral and time rule is applied In re Oriental Rug Warehouse Club (Bankr. D. Minn. 1997) Creditor repossesses rugs bought with proceeds from rugs that were collateral Burden is on creditor to track the proceeds when claiming interest in results of commingled funds Termination of Security Interest in Collateral After Authorized Disposition 9-315(a)(1) stipulates that a security interest does not continue after an authorized disposition 9-315(a)(1) gives effect to the authorization: They buyer takes free of the security interest and the secured creditor can look only to the debtor and the proceeds. Authorization can be explicit or implicit. If the creditor allows sale and later tries to enforce the provision, courts will deem the provision waived. (but these are mostly livestock cases and sales resulting in waiver are fairly continuous.) Continuation of Security Interest in Collateral After Unauthorized Sale In some financing statements, the parties contemplate that the debtor will sell the collateral only pursuant to further agreements. Even if the security agreement expressly prohibits sale of the collateral, the debtor has the power under 9-401 to transfer ownership to a buyer (the transfer will be a breach of the security agreement and perhaps even a crime) After a sale that a secured party has not authorized to be free of the security interest, the buyer will own the collateral subject to the security interest, see 9-315(a)(1). The buyer may or may not know of that interest. (9-320(a) serves to give buyers in the ordinary course of business some protection from the continuation of a security interest)

30

Can result in potential multiplication of the value of the security itnerest in favor of creditor. The rationale behind it is that the secured creditor needs additional protection when a sale occurs. The multiplication can sometimes be tremendous, 9102 (a)(12) and 9-315(a) Additionally, 9-315(a) doesnt say that the sale needs to be done by the debtor, that is the first buyer can then resell and this will also be considered proceeds. Implicit Waiver to Sell: If the creditor allows sales when the relationship is good and then when the relationship sours asks that the court enforce restrictions, the court may not since the creditor will be considered to have waived the conditions on sale by its course of dealing with the debtor and that the sale to the 3rd was therefore impliedly authorized. (but these are mostly livestock cases and sales resulting in waiver are fairly continuous.) Limitations on the Secured Creditors Ability to Trace Collateral Only identifiable proceeds are covered. UCC 9-315(a)(2) Commingled collateral is still identifiable Grain in a storage silo Cash in a bank account Lowest intermediate balance test amount collateral in the account will be equal to the lowest intermediate balance between the time the collateral was deposited and the time the rule is applied. In re Oriental Rug Warehouse Club, Inc Proceeds from the sale of collateral (oriental rugs) went into a bank account. Funds from account were used to buy new inventory. Held that if the creditor wanted new inventory to secure the old debt he should have required a separate bank account. [or presumably put in an after acquired clause.] 9-332(b) transferee of funds from a bank account takes free and clear unless he acts in collusion to defraud the secured party. C. Other Value-Tracing Concepts (p179) The definition of proceeds in 9-102(a)(64) may not encompass all states that value of a secured creditors collateral can assume. A secured party who wants to contract as nearly as possible for the value of its collateral, in whatever form it may take, will want to employ some additional value-tracing concepts. Product = something collateral produces (milk from cows, wool from sheep, etc.) Profit = money that collateral generates Rents = money paid for the temporary use of the collateral Offspring = refers to animals. i.e. calf Note they may also be proceeds since they arise out of the collateralbut nobody is sure. Become more important in bankruptcy where the definition of proceeds is narrower. 9-203(f): even if a description of collateral does not mention proceeds, their inclusion is implied Even though you get proceeds automatically, you dont get anything else automatically Why? You dont want to disincentivize improvements, production or value-maximization Especially undesirable in case of products b/c debtor has expended energy and resources: youre not only collateralizing products, but the extra value and expense. Should be contracted for. D. Non-Value-Tracing Concepts (p180) After-acquired property, replacements, additions and substitutions: are non-value tracing in that they can pick up property acquired by the debtor with value not derived from the pervious collateral. The distinction between after acquired property and proceeds can be a fine one. So include both. The value in the after-acquired collateral can come entirely from other sources. Why dont we just bar debtors from selling period? Blanket restraint on alienation is disfavored in property law Value-preservative: leaves it in discretion of party who knows most about maximizing collaterals value E. Problem Set 10 Problem 10.1: First Bank has secured interest in equipment, inventory, and accounts without mention proceeds, products, offspring, substitutions, additions, or replacements. Are they included? Even if the

31

security agreement makes no mention of proceeds a SI automatically covers them. 9-203 (f) and 9-315 (a), these sections also provide the right to the creditor the right to proceeds. What about the substitutions, offspring, etc.? To the extent that any of these items is not in the definition of proceeds then they are not covered by either Art 9 or the security agreement. If any of the inventory, equipment or accounts can fall within the definition of proceeds then they would be included. The careful secured creditor would include all of these concepts in the agreement just incase. 9-203(f) the attachment of a security interest in collateral gives the secured party the rights to proceeds provided by 9-315, and is also attachment of a security interest in a supporting obligation for the collateral. 9-315(a)(2), a security interest attaches to any identifiable proceeds of collateral. Any manufacturer selling to retailer does not expect that security interest will follow into car itself. Of course, it wants security interest in proceeds. Problem 10.2: What of the following are collateral of First Bank under secured interest in equipment, inventory, and accounts?

A) Money in the bank? No, it doesnt cover deposit accounts. Accounts is defined in 102(a)(2) and the
term means a right to payment of a monetary obligation, whether or not entered by performance. Account does not mean deposit account. The money in deposit account could, however, be proceeds from inventory sold or equipment sold. The most likely scenario is that they got paid on their A/R. Dont try and squeeze anything into these strict definitions when drafting a SA. 9-315 (b), a SI attaches to proceeds of collateral. Could apply the equitable methods to trace the money. You could apply the method referenced in Commentary 3 to this lowest intermediate balance rule, to identify and trace the money.

B) The parrot that Polly took in payment of an overdue account? The text suggest that after acquired
property is inferred when you take a security interest in inventory and accounts (since they are constantly changing). The parrot is covered b/c it is a proceed. The parrot falls under the definition of proceeds. 9-102(a)(64) proceeds whatever is acquired upon sale, lease, license, exchange, or other disposition of collateral, etc. It might also fall under (c) as a right arising out of the collateral. C) New computer to replace the old one? You would have to determine is how she got the new computer. If she traded it with the old computer or if she used the money from the sale of the old PC then it would be since it would be a proceed. Replacements are not mentioned in security agreement so you cant rely on the security agreement. We would have to distinguish here from after-acquired property which is not covered. What about equipment? Does after acquired property work for equipment too. The secured creditor is the enemy in the bankruptcy proceeding. D) Myna Bird? The person giving her the bird doesnt owe her something, it was a trade of services for the bird, not a monetary obligation. So the bird isnt an account since there is no monetary obligation, its a trade. The bird is not part of the business because its kept as a pet its not equipment or inventory. The bird doesnt arise out or collateral in any way either. Maybe you could argue that its proceeds, but the most likely is that even with a Court that focuses on the econ equivalence it would be very difficult to get it considered as collateral. Problem 10.3: What about security interest in race horse and proceeds, products, and profits. The horse wins 50 grand purse, is this 50k part of the collateral? Maybe the purse is a profit. You cannot get the purse in 102(a)(64) because you did not get the purse in disposition of the collateral. t is not an account since it doesnt fit in the definition. What about 102(a)(64)(c)? It could be rights arising out of collateral. Should also look at (42) General Intangible, which is the general things that dont fit into the other categories. (61) also refers and defines a payment intangible which may also define the payment made in the grand purse. Problem 10.4: J contracted to buy Toy Shop. Can inventory become A/R? The property that Joey is buying isnt A/R but anything bought from the proceeds of a sale of inventory could then be attached. Inventory could transform into an A/R, and then that money could come in and become furniture, equipment, fixtures, etc. The inventory is not a static concept and if the A/R are used to buy more inventory then its going to be seen as proceeds and then yes it would be encumbered. See 9-102 (48) for definition of inventory. The description in the security agreement is a starting point but that description does not limit the coverage. It gives the creditor

32

an interest in lots of other property. The concept of proceeds really overwhelms the description in the collateral, that is to say that applying the proceeds description many things could be covered. Another creditor may not know what is covered and what is not. Why even have a description of the collateral then? The idea of the description is that the proceeds have to arise out of somewhere. The fact is that a 3rd party cant rely on the description put into the security agreements to decide to lend extra money to the debtor since the collateral may extend far beyond the description put into the agreement. If the debtor has already given a security interest, it makes the job of a lawyer very difficult. We want to get rid of the inventory loan that B took out. Once this loan is paid off, the security interest will be gone. It goes with the debt. Problem 10.5: ELP loaned Golan money to buy copier (35 grand), Golan gets loan, and signs a security agreement. The security agreement list copier with serial number. The copier gets destroyed. Insurance is owed to the debtor, and the claim is now the proceeds, it is the collateral replacing the copier. (It is a payment intangible)

A) What is the collateral at this point if secured by insurance company? Under 9-102(a)(64)(e), proceeds
includes insurance proceeds of collateral. The proceeds would be the insurance payments made on the loss of collateral. This would fall also under the general category of payment intangibles. The check paid over before being deposited is collateral.

B) The insurance company paid proceeds to debtor since creditor was not a loss payee. Now what? What if
the debtor puts it in a bank account where he already has 5k? The lowest intermediate balance would be the 35k of the 40k now in the account, so the 35k would be the total SI. The proceeds are identifiable under the lowest intermediate balance method. It would be a mistake for ELP to be named loss payee. There are two ways for ELP to get protected: 1) have itself named loss payee, as their interest may appear. But if ELP is named as loss payee, and the debtor in applying for insurance has misstated certain facts, the insurance company can assert that defense to the creditor. 2) The secured creditor can make sure that it is named in standard mortgagee clause, and if named, you get first dibs, and you are not subject to insurance companys defenses. It has not cost anymore to get a standard mortgagee clause. The lawyer who lets the debtor get insurance but does not get the creditor a standard mortgagee clause is an idiot. Lawyers dont do it for some reason. The debtor deposits the check in bank account. The proceeds are commingled with debtors funds. We can trace it by using lowest intermediate balance rule up to extent of collateral value.

C) From the account suppose the debtor writes a check for 2k? Now what? The lowest intermediate balance
rule says you get the lowest amount in the account. The collateral is 35 grand. When Golan rights a check for 2,000, there is 38 grand left, so its enough to cover the 35,000 grand. The lowest intermediate balance says that the 2,000 that was paid out was paid from the extra 5 grand and not your 35,000 value. Those funds are paid from debtors funds first. Can you say that part of your SI is in the account and hence when a part of the account is used to get a lease for 2k, can you say that par of your SI is in the account and part of it in the lease? You will only get 35k, but can you have an interest in both? Does is have a SI in the whole account or only in the 35k? This a theoretical debate, that one could argue both ways. This is a gray line, the Prof doesnt know whether a Court would grant the creditor the right to an interest in the lease paid with the money from the account. The whole notion of a security interest on a deposit account came from trust law, which followed the money owed into the commingled account and regarded the beneficiary as having an interest of 35k in the account. The consequence of picking one or another theory answers the questions of what happens when Golan (debtor) writes a check out for 2k to rent another copier or writes a check to buy another copier. Can the creditor have a SI in the new or rented copier or can the creditor only have access to what is left in the bank account? This is a different way of looking at this problem, the intermediate balance theory is only applied when the creditor closes on the collateral, gets the actual money. The tendency has been to think of this issue in terms of the equitable principle, that is that the creditor doesnt have a SI in the new things bought with the money form the account. There has been a tendency only to give the creditor collateral on the account, but the Prof thinks the counter argument is quite good.

D) Then G writes a check to the IRS for 32,000, with 6 grand left in the account. Once the check is written,
the creditor is screwed and has only 6,000 claim on that account. The 38 grand was 3 grand debtor cash and 35 grand of secured creditor collateral left. Once the payment is made then the SI is only on the 6k

33

remaining in the account. You cant get the money back from the account. Can you get money back from the 2,000 creditor or the IRS? 9-332b, you cannot trace funds out of bank accounts to the transferee, unless the transferee acts in collusion with the debtor, violating the rights of a secured creditor. A transferee take free and clear of any lien. Problem 10.6: What if the debtor wrote a check to buy another copier? What is the collateral now? Is the new machine covered by the security agreement? The security agreement says copier but gives a serial number so the description wont cover it. Remember we dont have a right to after-acquired property in our account. You would need to trace the old machine, to insurance, to deposit in account, to new machine. There is 6k in account that is still proceeds of old collateral, this is the lowest intermediate balance. This is still proceeds. This new machine cost 32 grand and that 32k check comes form the account. But is this 32k check from our proceeds, from our money? Is this new machine collateral? There are several possibilities. 1) Following Gilmore theory, you could say that the secured creditor security interest is lost. The new copier is not entirely related to secured creditors old collateral interest. Since it is not entirely proceeds, its not proceeds at all. When our 29k is mingled with another 3k that is not ours in the check, they are no longer proceeds. 2) Since if you can trace most of the proceeds, say 29k worth, you can trace all the proceeds to the new copier. The collateral grew. But that happens in many types of situations. This is not unheard of in article 9. 3) You could argue that the doctrine of the lowest intermediate balance is there to protect the creditor and shouldnt be used to hurt the creditor. The creditor should be allowed to reject the idea of the lowest intermediate balance rule in order to follow some of the proceeds into the new machine. 4) You can identify the bank account and say that 29/32 of the copier is yours. The authors think that the last suggestion is bizarre. That there is no such proceed interest left in article 9. XI. TRACING COLLATERAL VALUE THROUGH BANKRUPTCY (11) A. Distinguishing Proceeds From After-Acquired Property (p183) Under article 9 proceeds are defined broadly in 9-102(a)(64) and permit secured creditors to trace the value of its collateral through concepts such as proceeds or products and also to pick up additional collateral by means of after-acquired property clauses. Bankr. Code 552 also permits the secured creditor to trace the value of its collateral during bankruptcy, but it is narrower than Article 9 in two respects: 552(a): once debtor is in BR, SC can no longer get additional collateral via after-acquired property clause 552(b): Value tracing limited to five concepts: proceeds, products, offspring, rents, profits Result: secured creditor can keep collateral value it had as of BR filing but cant acquire additional collateral value during bankruptcy. In effect, 552 permits a secured creditor to trace collateral value from one form to another, but does not permit the secured creditor to enhance its position by claiming assets that would have been available equally to all creditors (reflects idea that trustee is prohibited from favoring one creditor over another). In re Delbridge (Bankr. E.D. Mich. 1986, 185) Cow is collateralized; creditor seeks access to milk as product of cow. Farmer argues that milk is not product of cow, but of farmers expenses and labor 552(b) includes explicit language of applying the equities of the case. Holding: product belongs to SC in proportion of input to product farmer retains % value of own work In re Hotel Sierra Vista Ltd. Partnership (9th Cir. 1997, 189) Congress amended 552 to clarify that rents include hotel room revenues Court mandates that post-petition revenues be divided into rent and service revenue. Net revenues (post expenses) from rent are proceeds for SC; revenues from services not. Are all proceeds under the definition in article 9 proceeds in bankruptcy? 5th and 9th circuits have said yes

34

11th Circuit says no because that would give state law makers the ability to define terms in the federal bankruptcy statute If this rule prevails, the definition is probably that under article 9 at the time the bankruptcy code was adopted (the 1978 UCC definition of proceeds): Proceeds includes whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds. Insurance payable by reason of loss or damage to the collateral is proceeds, except to the extent that it is payable to a person other than a party to the security agreement. Thus, four views of what proceeds means: As defined in UCC 9-102(a) As defined under 1978 official text of article 9 Only that portion of proceeds attributable to the collateral under Delbridge test Only the net proceeds derived from use of collateral under Hotel Sierra Vista test B. Cash Collateral in Bankruptcy Remember that debtors in BR can use collateral to keep business going (363(c)(1) and (b)(1)) The same is true of cash collateral, see Bankr. Code 363(a) defining cash collateral as highly liquid collateral like cash, negotiable instruments. The only restraint in both cases is that debtor provide adequate protection to SC against loss/dimunition Yet in case of cash, that protection usually comes in form of lien against product of cash expenditure (like if cash is used to pay workers in factory, you could get a lien against some of the inventory produced by the workers) This is not really proceeds, although it mirrors the structure and logic (9-102(a)(64)) The difference is that it need not be lien on proceeds it can be protective lien on anything Bankr. Code requires notice/hearing to SC before trustee can use cash collateral (363(c)(2)) C. Problem Set 11 Problem 11.1: What about the racehorse example, winning a 50 grand purse, where the security agreement said proceeds and profits? The debtor filed bankruptcy now and the money is in a trust account. Is your claim stronger, weaker or unchanged? The horse won the purse. Its either proceeds or its not. If that security interest is good, and gets resolved in favor of secured creditor, one looks at bankruptcy code 552, and the dollar bills are proceeds of track promise, then the situation is unchanged, and the proceeds serve as collateral to secured creditor. So the claim would be unchanged in this case, since it really doesnt matter what the definition of proceeds is since the creditor had an interest in the winnings before the bankruptcy proceedings began. There is an interest in cash and the amount doesnt increase, grow or change during the proceedings. There is no change then. In problem 10.3 we had said that maybe it could be rights arising out of the collateral. If it is this category we could not get it now since bankruptcy limits the value tracing concepts to 5. Problem 11.2: Polly, from problem 10.2, filed bankruptcy but continued to run her business. A few days later, she worked for 28 straight hours repairing a dangerous leak at Golan Industries power plant and billed Golan at $65 an hour for a total of $1,820. When Polly receives the money, will it be subject to Firstbanks security interest? The security interest includes all equipment, accounts, and inventory. Does the later work, creating a new account, create a security interest for First Bank? Thats an after acquired property clause and in bankruptcy this cannot be taken by the creditor. The automatic stay interrupted this. The other argument is that this is just proceeds. The account arises out of her services and if it were services then this wouldnt be part of the Banks collateral. So if its services it cannot go to the bank. Suppose she uses inventory and equipment to produce this account receivable. i.e. she uses O rings and other materials. 9-102 (a) whatever is acquired on the disposition of collateral. You could also argue that the account is a right arising out of the collateral. Proceeds include accounts received upon the disposition of the inventory. There is nothing in there that says proceeds have to come entirely from the disposition. The court probably wont buy this argument. The court is likely to say that the equipment and value of inventory used up was negligible. Somewhere half way in between where some inventory was used would probably go half way. It is not at all clear that a court would say it was not proceeds. The proceeds cases have been pretty generous.

35

Most of the time the court will say that it is services and will refuse to address the issue, besides in this case the amount is so little. Maybe the court will apply some equitable remedy here as in the Delbridge case where the creditor is entitles to the same percentage of proceeds as its capital contribution. Problem 11.3: The copy machine caught on fire problem. After fire but before insurance, Golan filed for bankruptcy. Golan got the check for 35 grand, deposited it, and then started to write checks without prior consent or hearing. There is only 6k left in the account instead of 40k. What is the collateral in the bankruptcy case? The thing that is different is that under automatic stay provision, there is a chapter 11 reorganization, operating under bankruptcy rules, the debtor in possession was acting in possession, and the secured creditor had as proceeds 35 grand in bank account. The debtor violated the stay provision. You could ask for adequate protection and look around for anything that has value. Under 363, the debtor before it used that money was suppose to get permission of the court and it did not do so. The debtor used the money wrongfully because of a lack of permission. The trustee could probably void the transaction. There is an argument under 549, that the trustee could upset that transaction and forcing the third party transferee to give the money back on tendering the new copier. Problem 11.4: Security interest in Hotel Sierra Vista. What does the secured creditor get under Sierra Vista? You have to distinguish the revenues generated by room rental from services. If you do it that way, there is a loss. The cash collateral would be 0. Under Delbridge, there is no depreciation, so the cash collateral would be 0. Under 552, it applies to revenues and not net revenues, so all $510,000 from room revenues goes to cash collateral and proceeds. All authors of article 9 are trying to expand definition of proceeds. If you think reorganization should be carried out, then read net into revenues, but if read literally then read just revenues.

A) If the court follows Hotel Sierra Vista, what is the collateral? The collateral would be 0 since 520k-510k=
-10k, so there is a loss since here we distinguish the room revenues or rents from the services. The Court in Hotel Sierra Vista takes the net room revenues as what goes to debtor to be used to continue the life of the business. The Hotel could use the other 21k of profit made on the food and drinks.

B) If we follow Delbridge, then what? In Delbridge the Court applies a complicated formula to give something to
the creditor for the depreciation of the collateral by the use of it by the debtor and over time. In this case over the 17 day period the depreciation was 0 and hence if we apply the formula just as it was is Delbridge then the result is 0, (0/0 = 0). In Delbridge since we were dealing with a cow there was always a positive outlook since it was producing milk.The Prof thinks that the formula could be modified. In the numerator we could place the rental value of the collateral and that way we can more faithfully represent the contribution of the secured creditors capital to the amount of money coming in.

C) If the Court applies BC 552(b)(2) literally without applying equity? The cash collateral would be 510k, and
the debtor would have no cash with which to operate the business and hence it folds. If there is no equity adjustment then the debtor cannot continue to operate the business. In a way it is like the Art 9 definition of proceeds. Some courts are not reading this article literally b/c they dont want to believe that Congress wants to foreclose the businesses, but the Prof thinks that the lobbyists that rote this article may have pretended just that. Problem 11.5: You represent a client, Globus who is a secured creditor for 900k on an apartment building worth 700k. There is a managing company that wants to use cash proceeds of 10k monthly to pay off expenses and run the business. What can you do?

A) What is the secured claim? The secured claim is for 700,000, the value of the collateral. B) Can Globus accrue interest on that amount? No, they are in bankruptcy and the creditor is under
secured and hence interest doesnt operate since if they were to get interest it would be going to their unsecured claim. They would only get interest if they were over secured up to the amount of their collateral. Here, in this case, the creditor cannot accrue the interest not even in their unsecured portion, they just loose it for the purposes of the bankruptcy proceeding. Unless they come out of bankruptcy without a discharge then maybe you have something but this almost never happens.

36

C) The 10,000 rent is received after filing. Is that collateral? Yes, it is under 552b of BC. IT would be yes
for the Courts that read the article literally and no or perhaps for those courts who read it differently as discussed above. The statute does not say anything about net rents. So it probably means gross rents.

D) What about adequate protection? 363 of BC says that adequate protection needs to be given for the
creditors interest. In this case the adequate protection may have to be for the 200k (900-700= 200 unsecured). Pine Manor has no other assets so I dont know how they could provide protection. You would argue that you need adequate protection against apartment house and decline in value of rest of collateral, which is 10 grand a month. You should win on this argument because Pine Manor has no other property. Globus should lift the stay instantly. You go to 7 oclock hearing and oppose the motion. Every secured creditor who winds up to be under secured is in a bad situation but it happens for a number of reasons; the collateral changes etc. So here Globus has to go the hearing and try to get the automatic stay lifted. If the Court allows the cash to be used then Globus is going to be losing daily. XII. THE LEGAL LIMITS ON WHAT MAY BE COLLATERAL (DO NOT READ) PART IV: DEFAULT: THE GATEWAY TO REMEDIES XIII. DEFAULT, ACCELERATION, AND CURE UNDER STATE LAW (13) A. Default (p217) Under 9-601(a) creditors have access to remedies, if, and, only if, the debtor is in default. However, Article 9 does not define default or make any effort to say when a debtor is in it. Default = debtors failure to pay the debt when due or otherwise perform the agreement Both secured creditors and debtors are interested in precise definitions of default. If creditors exercise remedies before the debtor is in default they will be liable Security agreements nearly always define default expansively (reflects higher bargaining power of SC?) Failure to pay, breach of warranty, debtor dies/insolvent, misleading info, collateral lost/destroyed B. When is Payment Due? (219) Different types of loans Installment loans repayment in a series of payments at intervals If the debtor makes each payment by the due date and otherwise complies with the loan agreement, it will not be in default or subject to creditor remedies. Installment payments also provide a form of enforced budgeting that is absent in single payment loans. Single payment loans - lump sum due either on fixed date or on demand (bank can call loan at any time) Loan on a particular account receivable Rollovers loans made payable with no expectation that the loan will be continued if the account remains in good standing. Loans on demand lender can call the loan at any time. Lines of credit creditor agrees to lend up to a fixed amount of money as the debtor needs it A typical arrangement: Bank contracts to lend up to a fixed amount of money Lender borrows on the line as he needs it by writing a check on his bank account at the bank Bank covers any overdrafts up to the line of credit As the debtor receives revenues from its operations, it pays down its obligation on the line of credit. When are they due? Sometimes the contract specifies a due date during the debtors off season Many times the expectation is that a certain balance will be rolled over.

Debtors want default provisions defined as narrowly as possible to avoid them

37

C. Acceleration and Cure (p221) Acceleration Acceleration - by contractual provision, the creditor specifies that if the debtor fails goes into default in any way the entire outstanding balance of the loan will be due Creditor can then enforce the entire obligation in a single lawsuit. The practical effect of acceleration is often to eliminate the debtors ability to cure Cure - debtor pays the amount of the loan on which he is in arrears The debtor still, however, has the common law right to redeem by paying the entire balance after acceleration. Limits on the Enforceability of Acceleration Clauses The creditor has the right to accelerate only if it in good faith believes the prospect of payment or performance is impaired, insecurity clause, 1-208 JR Hale v. United New Mexico Bank (p223) Debtors failed to pay interest on revolver bank calls loan based on default and insecurity Company must prove bank lacked good faith belief that its prospect for repayment was impaired The Debtors Right to Cure A debtor usually has the right to cure a default by paying the amounts then due. If the debtor cures before the creditor accelerates, the necessary sum may be small. Once the creditor has accelerated, however, a debtor can usually redeem, but only by paying the entire amount of the accelerated debt. 9-623 governs the right to redeem. 9-623(a) Persons who may redeem - says a debtor, or any secondary obligor, or any other secured party or lienholder may redeem collateral 9-623(b) Requirements for Redemption to redeem, must tender fulfillment of all obligations secured by the collateral reasonable expenses and attorneys fees from 9-615(a)(1) 9-623(c) When redemption may occur may occur at any time before the secured party Has collected the collateral under 9-607 Has disposed of the collateral or entered into a contract for its disposition under 9-610 Has accepted collateral in full or partial satisfaction of the obligation it secures under 9622 Old Republic Insurance Co. v. Lee (p228) as a general rule of law, a mortgagor, prior to the election of a right to accelerate by the mortgage holder upon the occurrence of default, may tender the arrears due and thereby prevent the mortgage holder from exercising his option to accelerate. However, once the mortgage holder has exercised his option to accelerate, the right of the mortgagor to tender only the arrears is terminated. Some states provide for reinstatement by statute Allows debtor to cure and reinstate by payment of only the arrearages Generally apply only to home mortgages and consumer borrowers and a few other similar circumstances. D. The Enforceability of Payment Terms (p229) Debtors and creditors often agree to terns the debtor has no real hope of satisfying. Given the severe consequences of default, some courts have sought ways of softening those terms. Courts may be amenable to waiver or estoppel. Courts have split on whether or not creditors have obligations to debtors when they loan on demand 6th Circuit Lender Liability the obligation to act in good faith requires a period of notice to allow reasonable opportunity to seek alternative funding. KMC v. Irving Trust (6 Cir., 229): refused to enforce agreement allowing bank to call loan on small co., helped establish doctrine of lender liability.

38

7th Circuit Easterbrook not in the seventh circuit knowledge that literal enforcement means some mismatch between the parties expectations and the outcome does not imply a general duty of kindness... Kham and Nates Shoes v. First Bank of Whiting (7 Cir. 230) - Easterbrook Bank and debtor signed K enabling bank to refuse to extend more money at any time Debtor sues for lack of good faith when bank refuses to extend more cash Holding: Bank was only acting out language of K, and they are not at fault Some changes have been made to revised article 9 and revised article 1 reflecting these concepts of good faith, but they are unclear and revised article 1 has been adopted by only a few states, like TX and VA. 9-201(20): good faith = honesty in fact and observance of reasonable commercial standards of fair dealing, but this term applies only to good faith in article 9, not article 1 except in the states with article 1 revisions E. Procedures After Default (p233) Secured creditor has two choices Self help: call the loan, refuse to make more payments, repossess Or go through judicial process of foreclosure, getting judgment before taking irrevocable action Advantage to option 2 is that its more cautious before taking irreversible action; disadvantage is speed Replevin offers intermediate course: judicial action w/ immediate possession of collateral In a replevin action the secured creditor can move for an order granting it temporary possession of the collateral. F. Problem Set 13 Problem 13.1: Pat missed two payments of $434. She noticed her omission before bank gave notice of acceleration. She sent a check for overdue payments. The bank says that its a default and the secured creditor can accelerate the loan. The bank mailed the check back to her saying that they called the whole loan, requesting the balance. Does the bank have to give notice of acceleration? Look to the contract? Can the Bank get away with accelerating the loan? The agreement says at the parties option so when she missed the payment the loan didnt become do, the Bank had to accelerate. What about notice? The authors do not say anything, so assume there is no notice provision. Compare acceleration v. debtor tendering payment. So did she cure her default before the notice or before acceleration? So when was the debt accelerated and when was the tender made? Its a question of timing. If the bank had decided to accelerate before receiving the check then she may have not cured her default. The Prof. thinks that if the bank received the checks before the accelerated then this would be a good tender. When does the bank accelerate, when they put the notice in the mail? When the board records the decision in the minutes of the meeting? When is the tender made? When put into the mail box? Maybe just by raising these questions the Bank will want to negotiate to avoid a negative decision on the books of the bank. If they accelerate the books by making the entry that is pretty good evidence that accelerated before debtor tendered payment. She may have an estoppel claim. A) 9-623 (c) tells us when redemption can operate, and it is anytime before the debtor (1) Has collected the collateral under 9-607, (2) Has disposed of the collateral or entered into a contract for its disposition under 9-610, or (3) Has accepted collateral in full or partial satisfaction of the obligation it secures under 9-622, in which the creditor takes back the collateral. The comment to this article says that if the entire balance is due, if acceleration has occurred then the entire balance would have to be tendered. But when they get the check, why should bank send it back. Apply it to payment of principal. Is it a waiver of default to deposit the check? Its an intentional relinquishment of rights. The debtor must show some king of reasonable reliance to his detriment. Many banks return the checks in situations like this to avoid any possible claim that they waived default by the debtor. B) What would have been the effect if the Bank had accelerated the loan on their books before receiving the check? Many banks would not accept the check just to avoid the estoppel argument. Problem 13.2: You are asked advice by friend with temporary cash flow problem who cannot pay mortgage (monthly payment of $860). He missed the October 1 payment. He is worried about what happens next. The

39

default provision is set out in the example: default means an outstanding amount EXCEEDING one full payment which has remained unpaid for more than 10 days after the due date. Now, on Oct 1 we are one full payment late but not exceeding one full payment late. A) When does the debtor absolutely have to make the payment? Nov. 12 (10 days over due), after Nov. 12 we would be late exceeding one full payment. We have to be more than 10 days late. If he doesnt pay then the creditor can accelerate payment and foreclose on the mortgage. If interest was accruing on unpaid portion, then he is in default when interest accrues on October 12. The interest plus the unpaid amount would add up quickly and we would be overdue much sooner. Some states dont allow the accrual of interest by overdue payment by statute. If you are representing someone who is trying to hold off as long as possible you have to read these clauses carefully. The Prof. wonders that with a clause like this one if this more like a drafting error that the creditor has made since he is giving the debtor 2 months leeway. B) If under the Illinois Reinstatement act (p228) then the debtor would have 90 days after being served with a summons or publication in the foreclosure case during which he could try and reinstate the mortgage by paying all costs and expenses required by the mortgage. This is a big deal since it gives the debtor a big power, but its not costless, the debtor would have to come through will all the attorneys fees and others, which sometimes can run very high (10k for instance). Can the bank argue that the whole is due even though foreclosure did not go through. It is costly for the bank. Every state has a rule of responsibility that fees must be reasonable. A lawyer who enters that fee arrangement must be very careful. Problem 13.3: There is a provision in the loan agreement requiring that insurance be effective and notice be given annually to secured creditor and failure to give notice is an event of default. The Creditor knows that the debtor is a good debtor but the creditor needs money on the spot and he can recall this loan based on the fact that he has not provided insurance info. The contract has gone on for 2 years without providing insurance info. Can you recall the loan if the debtor has not provided the certificate of insurance? There is a general requirement of good faith. 9-102 defines good faith as honesty in fact and the observance of reasonable commercial standards of fair dealing. 9-102 definitions only apply to article 9 issues. As of this moment revised article 1 has only been passed in VA and TX. The present article 1 definition in every state except VA and TX only talks about honesty and fact. This is an easier standard to meet. There is a disconnect between article 1 and revised article 9. A court sympathetic to a debtor would have to follow the comment. Easterbrook (Case on p. 230) would say that the contract declares default and the secured creditor can take advantage of it. How about the secured creditor waiver by not asking proof of insurance (waiver by estoppel since it did not ask in the past)? Its hard to find a waiver by not acting within 23 days in Hale case (where the bank met with the debtor and remained silent). Problem 13.4: A debtor gets a line of credit with a bank and signed a note for 150k although she is only drawing 75k. The banks security agreement says payable on demand. The debtor is in no position if the demand note is called. What if the bank decides to execute the demand provision and calls the loan? If she cannot meet it instantly, the bank will follow it up with a writ of replevin and shut her down. Oral assurances? They are not worth anything. Oral assurances are certain to be followed up by a written agreement. If not written, the parole evidence rule will keep them out. You can call it an assurance or a prediction. What is she signs a note for 100k? When pushed came to shove she signed a demand note. Maybe she got a lower interest rate for signing a demand note. She could make the loan come due once a year instead of on demand. What about relying on her relationship with her loan officer? There is always turnover. She is only liable up to the amount that she took out. If she wants the money, she should sign the note. That is the way business is done. If she makes too much noise about it, she will go down as a trouble maker. Problem 13.5: The loan officer wants to give the debtor in financial trouble 30 days notice to find additional money to deal with financial problems instead of pulling the plug. They buy their inventory on credit, and as the loan officer looks at collateral they have, it looks like they will lose 50 grand. This is a long time customer, who has been a good debtor, so give him another 30 days. The debtor may deplete the inventory. Giving 30 days notice puts the bank at risk. When it looks bad enough, your initial instinct is that the bank would be better off if you pull the plug now. But watch out for Lender Liability. Problem 13.6: It looks like lender liability to tell another lender the financial problems that caused initial lender to call loan. It blocks attempt to refinance. It destroys business. If complaint looks good enough, then maybe initial bank would work with you. If you really think the threats are empty, but you still want to be careful. You should

40

still call the loan, but hold off on getting a writ of replevin. You probably will face liability for destroying the debtors business by proceeding without notice. Advising the client is pointing out all the risk. If you proceed by thinking you are in a 13.5 situation, but you are not really in a 13.6 situation. Recite the whole history of what happened. XIV. DEFAULT, ACCELERATION, AND CURE UNDER BANKRUPTCY LAW (14) A debtor who suffers from an acceleration can get better treatment under bankruptcy law than under most state law Bankruptcy protection of a debtor who has suffered an acceleration of installment debt occurs in two stages: In the first stage, which extends from filing of bankruptcy to confirmation, the automatic stay protects the debtor from foreclosure while the debtor attempts to formulate a plan In the second stage, confirmation of the debtors plan reverses the acceleration, the debtor cures its default, and the installment payments contract between the debtor and creditor is reinstated. A. Stage 1: Protection of the Defaulting Debtor Pending Reorganization (p239) Stay is automatically imposed and remains in effect until the case is closed or dismissed, see Bankr. Code 362(c) and (d). A debtor who provides adequate protection to its secured creditor typically will be permitted to use the collateral while the case remains pending, Bankr. Code 363(b)(2) and (c)(2). Debtor must still provide adequate protection: only protection against decline in the value of the interest in the collateral. Ch. 13 debtors will have to resume making payments no later than 45 days after petition for bankruptcy Ch. 11 debtors need not resume payments until a plan has been confirmed by the court (typically about one year) B. Stage 2: Reinstatement and Cure (p240) Modification Distinguished from Reinstatement and Cure Like reinstatement and cure, modification is accomplished through a plan that provides for it Modification allows the rewriting of the loan provided that: Minimum due under modification = the present value of the amount allowed under the secured claim using a market rate of interest. Ch. 11 allows payments to extend over any period that is fair and equitable, Bankr. Code 1129(b) (1) Ch. 13 only allows payments over the period of the plan (usually 3 years). The bankruptcy code prohibits the modification principal-home mortgages altogether except for home mortgages with only a few years left to run, Bankr. Code 1322(b)(2) Reinstatement = return to the original terms after cure. Reinstatement and Cure Under Chapter 11 The debtors rights to cure and reinstate under Chapter 11 are described in Bankr. Code 1124(2) Bankr. Code 1124(2 ) allows for resuming the obligation of the current loan if: The debtor cures any default occurring before or after the commencement of the bankruptcy (courts: lump sum at the effective date of the plan.) Future payments due as specified in original contract Creditor is compensated for damages incurred through reasonable reliance The plan does not otherwise alter the legal, equitable, or contractual rights of the secured creditor If conditions are met, plan may be imposed on the creditor. Why would the debtor choose reinstatement over modification? Modification is prohibited on mortgages against the principal residence of the debtor in both 11 and 13. Debtor may wish to preserve some favorable term in the original contract (such as favorable interest rate.)

41

Reinstatement and Cure Under Chapter 13 The debtors rights to cure and reinstate under Chapter 13 are described in Bankr. Code 1322(b)(5) Allows for resuming the obligations of the current loan if: Cure all defaults as in 11, but only within a reasonable time not lump sum. (cannot extend beyond the period of the plan). Future payments must remain due at the times scheduled in the original contract Compensation for damages will be required only if required under state law or provided for under the underlying agreement. Some states require interest on overdue arrearages, others do not The plan does not alter the legal, equitable, or contractual rights to which the holder is entitled. Ch. 13 debtors are more likely to use reinstatement rather than modification because modification can only last over the period of the plan (usually 3 yearstoo short for long-term obligations) When is it Too Late to File Bankruptcy to Reinstate and Cure? In re DeSeno (p244) says that modification but not reinstatement is available to debtor in possession (after foreclosure). Bankruptcy Reform Act (1994) says reinstatement available until the residence is sold at a foreclosure sale and modification has since been disallowed under 11 and 13 for primary residences The result is that a debtor in possession can reinstate but not modify mortgage on primary residence. Despite more favorable treatment in 11, debtors still choose 13 because it is less expensive: Chapter 11: $800 filing fee; $2,500 total (based on inexpensive fees) Chapter 13: $130 filing fee; $600 total Binding Lenders in the Absence of a Fixed Schedule for Repayment (Lines of Credit Payable on Demand) No right to cure under bankruptcy Such debtors are protected only through their ability to modify the claim or to use the respite of reorganization proceedings to find a willing substitute Nothing in the bankruptcy law requires a lender to make advances during or after bankruptcy, even if the lenders have contracted to make those advances C. Problem Set 14 Problem 14.1: What can the debtor do in bankruptcy to change position from 13.5? The debtor could stop bank in its tracks by filing chapter 11. If indeed Rebel is viable, and can give the bank adequate protection, it can keep operating. Sometimes the bank will just tell Rebel what it proposes to do and that he will file chapter 11. The bank will give same advice as Rebels lawyer. Problem 14.2: The bank will lend Teresa $150,000 according to two options. 1) lend at prime plus 2% on demand note; or 2) lend at prime plus 3.5 with a 30 days notice provision if not in default. What can Teresa do? She can either refinance or file chapter 11. Under bankruptcy, the automatic stay will keep her in position, and if she is viable, she can cram down a plan even if the bank does not like it. If she is viable, she can find another bank and refinance. And if thats realistic, the bank really should give her time. Suppose she is not really viable, the 30 days is not going to do her much good. If she is really not viable, she will not be able to find substitute financing. That interest is a lot to pay, given the alternatives from chapter 11. You are better off taking prime + 2%. Does the loan look any different from a line of credit of 150,000? You should pull full line of credit, and then file in chapter 11. However, there is a big upside in bargaining for an advanced notice with an agreement in the loan agreement that you can borrow full amount. You should pull it all out and file chapter 11. A) If you chose option 1 and the bank calls the loan the sheriff can show up with a writ of replevin right away, but chapter 11 eliminates the worry that youll go out of business the second the sheriff shows up. You can rewrite the loan over a longer period of time and you can stay in possession. 11-29(b) you can cram down the plan over the banks objection. There could be an advantage to option 2, the bank might call the loan instantly, here she has try to get new financing, but if shes in bad shape she wont be able to get refinancing.

42

Chapter 11 for two kinds of businesses, cash flow problem or capital problem, so they can find new sources of capital or deal with cash flow issues. B) IF notice when fully drawn then no difference from the answer in A. If we are thinking about January then think what teresa could do if the bank calls the loan. Why would a bank ever allow that to happen, look at Easterbrook case, that is exactly what happened, the debtor increased its loan substantially after the loan had been called. Once it has given notice, the bank must be open to draws or can be subject to a tremendous lender liability suit in that situation. If Teresa hasnt solved its finaces in 30 days and the sheriff comes she can file chapter 11 and use the 50,000 to keep going, so may be worth the extra interest you would pay to have an advance notice of a call of a loan. Problem 14.3: homeowner financing mortgage at 8%, and then goes into default, with a stream of letters from the lender, and then the lenders lawyer with increasing demands. Under chapter 11, if he cures, he has to pay lump sum from arrearage at effective day of plan. He would also have to make up post petition results, and the big chapter 11 filing fee. Suppose you advise him to go into chapter 13. He does not have to cure the default in a lump sum. He has to pay it over a period of the plan. The chapter 13 fees are not as big either. Under chapter 13, you have to file a plan within 15 days and pay 30 days after that initial 15 days. Also, they may be able to charge interest on the arrearage depending on non-bankruptcy state law. For this client, make sure he makes payments soon. b) What about a balloon payment after five years? She could reinstatement and cure. But she would have the balloon payment due in two years anyways. Reinstatement under chapter 13 works well with long-term mortgages. But you cannot get a planned confirmed under 13 unless she can proves that she can make the payments. Her only possibility is to find another source of financing and with her difficulties that is highly unlikely. Under part d), what if she moves out, and rents it out, using the rental payments to rent another house? If she moves out, its not her principle residence, and she can modify under chapter 11 and stretch the payments out over 20 to 30 years, paying a higher market interest rate. But she keeps the house. e) If Willard did not file but instead re-negotiated terms, paying a higher interest rate and 6 months to pay fixed arrearage, what is his best move? Dont file chapter 13 until the 6 grand is past due so that its not maintained under the plan but rather as arreara A) This is a typical situation, there were five letters the homeowner received before there was a declaration of default, banks dont like to declare a default, it is expensive for them so they try to keep the debtor making payments. He has a choice now that he has a choice between chapter 11 and 13. If you are in chapter 11 the homeowner doesnt have to make any payments until the plan is confirmed, but once the plan is confirmed he must pay the sum in areas at confirmation and post petition defaults and some attorneys fees. You cannot modify this mortgage. The one kind of mortgage you cant modify are the home mortgages for some crazy reason for some peoples belief that that will bring in more lenders. If he files under chapter 13 he has to resume regular mortgage payments and payments to cure default within 30 days of filing bankruptcy, yes you have to get started paying sooner, but you avoid the big fees of chapter 11 and most lawyers would push for chapter 13 instead of a chapter 11. (you can t modify a mortgage unless the last payment is due on the date on which the final payment of the plan is due, that is only the case in less than one percent or one percent, like less than three years to go on the mortgage, see 13-22(2) ). B) How much to pay to keep the house, chapter 13, 587.02 regular payments, and another series of payments to retire the arrearages in a reasonable time, whether there is interest on the arrearages will depend on the state law of the jurisdiction where he lives. You have to file a plan within 15 days and start making payments in 30 days, you have to start making payments soon. D) What happens if she moves out? If it is not her principal residence anymore, modification becomes possible. Under a literal reading of chapter 11 you can modify by stretching out payments over 20-30 years, youll end up paying a higher interest rate and a higher chapter 11 fee and attorneys fees but you can keep your house. If the interest rate drops under the literal reading of chapter 11, then they could get this lower interest rate perhaps. D) Could use 13-22 to cure and reinstate, but he cant use it to get out of the contract with the bank and go back to the old one, can wait on paying 6,000 so it goes to arrearage and then file a chapter 13 and ask to draw out, but he will pay the 11% he agreed to pay rather than the 8% he would have to pay if hed gone into bankruptcy six months sooner

43

Problem 14.4 a) they cannot modify their mortgage under chapter 13 so maybe they should not enter into bankruptcy and try to work something out with the bank beforehand. If they moved out they might be able to file a chapter 11 and have the payments extend over a longer-term. b) Cut their loses The only way they can keep it is to pay 71,000. They can file under chapter 7 give the condominium to the bank and discharge the 71,000 debt and buy the condo when the bank sells it for 23,000 or forget about it another condo for 23.500 and then they could, the noblemans could discuss with the bank options 2 and 3 and then work out a deal with the bank. Use the ability to walk away and stick the bank with a condo worth only 23,500 as some leverage to work a deal with the bank, the bank might decide to deal with the devil they know rather than the devil they dont know and taking a big hit. Theyve got some big leverage right now.

PART V: THE PROTOTYPICAL SECURED TRANSACTION


XV. THE PROTOTYPICAL SECURED TRANSACTION (15) A. Documents (p255) Security Agreement and Statement of Transaction Sets out terms of deal, defines default and remedies, describes collateral The security agreement includes the typical terms. names of parties description of the collateral promises by the debtor and creditor acceleration clause list of what constitutes default

parties signatures
Financing Statement For filing in UCC filing system of state gives public notice of security interest Personal Guarantee Proprietor of business signs personal guarantee of repayment Gives incentive to owner to minimize deficiency w/o it, less incentive to keep business going Also gives incentive to pay that one SC who has personal guarantee! Floorplan Agreement Agreement b/w inventory supplier and lending bank If bank must seize the collateral, the supplier will buy it back at full invoice price With this agreement in place, supplier can offer 100% financing to qualified dealers b/c bank puts up $ and if inventory supplier had to do financing itself it would still have to do that anyways The bank can supply the debtor more credit than it otherwise would do B. Bonnie is the guarantor. A creditor can get the money from the guarantor, who then has the rights to recover from the debtor. The guarantor has the rights of reimbursement, contribution, and subrogation (meaning that the guarantor can assert the rights of the bank) C. Why doesnt Bonnie borrow from the bank directly? All of the contractual complexities would be avoided, yet all of Bonnies assets could still be seized by the company However, the bank could only go after Bonnie personally. While this would include her shares in the company, the banks security interest would be subordinate to other creditors who have a security agreement with Bonnies Boat World directly. D. Process

44

When someone files a bank application for a loan, they are asked questions about finances, the bank will also get a credit report on the applicant from a credit service. Bank searches filing system to see what other secured creditors have liens on the applicants assets Once collateral is sold, proprietor immediately forwards invoice for amount of collateral to bank. If she doesnt, she could sell all collateral w/o bank ever knowing! Banks regulate this by sending floorcheckers every 30-45 days to keep track of collateral All items checked at once, b/c dishonest debtor could claim temporary absence and double-count E. Problem Set 15 Problem 15.1(a) The problem was identical to a real case. Allied Crude Vegetable leased the oil tanks of a refinery. They persuaded the creditor to operate a field warehouse on the premises, which was a wholly owned sub of American Express. They induced the major producers of salad oil to store their oil in those tanks. Allied acted as either (1) broker (agent for sale) or (2) purchaser for resale on its own account. The major figure in Allied had been prosecuted for fraud in an earlier point in his career. A number of his employees were hired by the creditor to operate the field warehouse. He stole blank receipts, presented them to the banks, and got huge loans from the banks. He managed to sell most of the vegetable oil supplied by the major companies and pocket the proceeds. The field warehouse employees, the suppliers and the banks secured creditors would check the collateral. How were they deceived? 1) The tanks only had a small amount of oil on the tops. 2) There was a glass cylinder that was pure vegetable and the rest was water. 3) The tanks were interconnected, so they would change the contents of the tanks as the checkers moved around. Allied had loans for more vegetable oil than could actually be produced through out the country. American Express was not a corporation (at the time). The individual stockholders were individually liable for the debts of American Express. It was formed under an ancient statute. They settled and could not take the risk that the corporate veil would be pierced. The major figure in Allied went to jail. Not interested in B because you go in and see that there are no boats. Problem 15.2 (a): What if Bonnie sells as many boats as possible and wires proceeds to Bahamas? How can you stop her? Requirement that the buyers bank send the money directly to the creditor. More checks by the inspector. Look for advertising of sales. Surprise inspections or requirement that the debtor keep the bank account at the creditors bank. Some creditors have too many debtors to monitor all of them. They rely on the initial credit check and do not perform random checks. (b) Debtor sells the boat and does not report the sale to the secured creditor. Look at the registration numbers on the boat. Look to see if the buyer has painted a name on the side of the boat. Check the sales ledger, but the debtor might keep two sets of books. Can demand all statements or origin, you have to surrender to get a certificate of title, so the seller would have to give it up to get the owners certificate of title for the buyer Problem 15.3 Personal guaranty of the debtor (p. 265). 9 out of 10 cases, you cannot collect on them, so how are they useful? Induces the owners to cooperate. The debtor will have an incentive to avoid or minimize the judgments that might be taken against them. The debtor will want to avoid the stigma of bankruptcy. Trade-off: May loose business to banks who are less risk-averse and dont require personal guaranties.

45

He is more likely to favor the creditor with personal guarantees over other creditors. A debt is not dischargeable in bankruptcy when there is fraud!!! Problem 15.4 Duetsche has a right to the boat, she has it by contract and by statute (9-609) when she is default. Deutsche will immediately try try (a): The bank declared BBW in default and demands surrender boats. The agreement for wholesale financing and the floorplan agreement give the secured creditor the power to repossess the boats at its discretion; notice is not required. 9-601(a) after default, a secured party may reduce a claim of judgment, foreclose, or otherwise enforce the claim, security interest, or agricultural lien by any available judicial procedure 9-609(a) a secured party has the right to possession of collateral after default. 9-609(b) The secured party may proceed without judicial process (i.e, self-help) if it proceeds without breaching the peace. (b): The debtor gives up the collateral without a fight: 9-608(a)(4) a secured party shall account to and pay debtor for any surplus, and the obligor is liable for any deficiency. The debtor might have to file for bankruptcy. She could be prosecuted under the Illinois statute: Ill Statute (p173) it is unlawful for a debtor to dispose of the collateral and willfully and wrongfully fail to pay the secured party the amount of proceeds due under the security agreement. Failure to pay within 10 day is prima facie evidence of a willful and wanton failure to pay. The bank could prosecute the debtor to send a message to its other customers. (c). Does the debtor have the power to keep the boats? How long? If the bank tries to repossess the boats, the debtor could create a breach of the peace. The secured creditor will be required to use judicial process. File a petition in chapter 11 automatic stay stops the replevin. The bank will have to get the stay lifted, which will take time and money. What is the point of doing all this? Can the debtor can use the threat to delay in chapter 11 to get them to agree not to prosecute her? Danger it that Deutsche could try to get her put in jail (fraud), you dont want to make them that mad. (d). Model Rules of Professional Conduct A lawyer shall not threaten criminal prosecution solely to gain advantage in a civil matter. In this problem, it is the other way around. The debtor wants the secured creditor to give up an advantage in the civil matter. Does it turn on whether in the first instance, the secured creditors lawyer has mentioned the violation of the criminal statute? Designed to prevent lawyer conduct that looks like extortion. If the lawyer does not go to the prosecutor, it looks suspicious. This has been a requirement of determining whether solely was met. If the secured creditor agrees not to prosecute it supports an inference that the purpose of threatening the criminal prosecution was to return the stolen money. The client can make the deal not to prosecute, but the clients lawyer cannot. Can the lawyer tell the client to threaten criminal prosecution? A lawyer cannot violate the rules through the actions of another. You are not supposed to unjustly delay, but has the lawyer delayed them, he has given them their boats in the deal. The initial refusal to turn over the boats doesnt violate article 9 because article 9 says self-help possession only if they can do so without breaching the peace. The ability to hold up a secured creditor, through chapter 11 and breach of peace, gives the debtor considerable leverage.

46

Problem 15.5 There is no consideration. Once it has given consideration it is done and the argument is gone. Thinks it is a waste of money to make that argument if the loan has been made and if it hasnt been made you wont be in court because the bank wont be a creditor. Problem 15.6 Bonnie consults you before signing each of the following deals, what is your advice? a) Thinks it means that the next 60 days the interest days is prime 1, over ninety probably means prime + 2.1, if it is late it is prime +5.5, some kind of add on

b)

9-109 (d)(11) could take priority over the interest in contract rights, lots of litigation over transfer of interest, if article 9 were to apply wouldnt be contract right but general intangible. Doesnt think they could get lease as general intangible, because the exclusion ought to control. No security interest in the rents, the rents arent proceeds of your collateral. It can become a separate item of collateral, it just doesnt follow from your interest in the lease. You can give someone a security interest in a deposit account, yes, but you cant give a creditor a security interest in lease and then by virtue of that have it extend to rents (???). What about the deposit account? Is a deposit account an account? Def. of accounts, right to payment of a monetary obligation, doesnt include deposit accounts, 9-102(a)(2). How might deposit accounts be included, if proceeds from collateral go into the deposit accounts, proceeds from things that are undeniably collateral go into account. Contract rights used to be an article 9 term, some has gone into definition of accounts and some into general intangible. Turns up in some peoples security agreements.Do general intangibles cover a bank account, dont think that it is sufficiently ambiguous to allowing officer to testify as to what it meant. c) Can they give a demonstration ride? Paragraph 5(b) of prototype agreement says you cant demonstrate without the written permission. Why is that? The value of the demonstrating boats goes down. Demonstration models get sold at a cheaper price. Under our agreement use as a demonstrator is an event of default giving Deutsche a right to call the loan.

d)

When there is a reposed boat, Shoreline says they will pay Deutsche the value of the boat, but whatever happens there is no deficiency for Deutsche because it gets paid in full by shoreline. Can it get a deficiency under 9-618? A secondary obligor, shoreline, acquires the rights and has the obligations after. The sale to shoreline by contract is a disposition and thus shoreline is in the position of a buyer and not a secured creditor. By contract shoreline has been done out of the ability to get a deficiency judgment. Comment 3, transfer to a recourse party, shoreline, can sometimes constitute a disposition that discharges a security interest. Prof. thinks that is wrong, because of 9-618 proposition of subrogation, there is a case called The French Lumber Case, said someone subrogated to position of former debtor, he thinks that once shoreline pays Deutsche finance, it is subrogated to Deutsches position by obligation of law and you dont have to worry about 9-618. Whatever is in paragraph 10 of Deutsche Bonnie agreement shouldnt bind shoreline. Shoreline more like a purchaser at auction or one who takes over debt. Takes over debt then should be on hook. ZONE II: THE CREDITOR/THIRD PARTY RELATIONSHIP PART VI: PERFECTION XVI. THE PERSONAL PROPERTY FILING SYSTEM (16) A. What is Priority? (p276) The law treats many of the contests over rights to collateral as questions of priority. Liens are relationship b/w debt and property that serves as collateral Remedy the attribute of a lien where if the debtor fails to pay the debt, the secured creditor can foreclose the lien, force a sale of the collateral, and have the proceeds of the sale applied to payment of the debt. Priority is relationship b/w liens and other liens against the same collateral Senior/prior lien has priority over (gets paid before) junior/subordinate lien

47

Each lien is a relationship between an obligation and an item of collateral; priority is the relationship between these relationships Peerless Packing Co. v. Malone & Hyde (p 278) There were 13 unsecured creditors of a grocery store; one took secured interest and got everything. Unjust enrichment claim denied. B. How do Creditors get Priority? (p280) In order to establish priority, creditor must perfect the lien The steps for perfection vary w/ type of lien, but usually take one of four general forms: Filing notice on public record system Taking possession of collateral Taking control of collateral by means of agreement to hold it Posting notice on the property itself Central to priority is that the chronological order in which claims are perfected determines pecking order The dates and times of perfection will determine the priority of the liens C. Theory of the Filing System (p281) Provides notice of which liens exist on which property through UCC-1 Financing Forms Filing is relatively easy and failure to file creates a significant risk that the creditors lien will be avoided in bankruptcy. D. The Multiplicity of Filing Systems State and federal governments have a boggling array of filing systems depending on type of collateral Each county in the US maintains a real estate recording system in which not only real estate mortgagees, but also Article 9 fixture filings are filed Often confusing, draws thin lines b/w different types If filed in wrong office, very little chance that it will be transferred or corrected In re Peregrine Entertainment (C.D. Cal. 1990, 284) Q: is security interest in copyright perfected by filing w/ the US Copyright Office or secretary of State? Holding: comprehensive scope of federal copyright law clearly meant to preempt state filings E. Methods and Costs of Searching Filing systems are often only accessible to employees; lawyer must order (exactly) over the counter Lenders tend to employ service companies to search files F. Policy: Why do we permit a debtor to give priority to one creditor over the other? In many filing offices, only employees may access records, although some allow members of the public to search Lawyers generally choose to go through a service company. Costs: Searching $50 per name is not unusual May have to search multiple names or variations of a name or both. Tack on the cost of the service company and you are talking about real money for smaller lenders And add on $1 per page for copies of records, overnight deliveries Filing Service company: $15 Filing Office: $5-$25 Costs can be reduced by dealing with the office often and knowing the procedures, having an account with the office, or even being able to access the records from a remote terminal. More advantages to large sophisticated lenders. Sometimes it is best to just file everywhere if you are uncertain what type of property you are dealing with, but the decision where to file requires an understanding of the law.Also probably cuts down on litigation

48

It also gives you some certainty in your rights G. Problem Set 16 Problem 16.1: Felicia (judgment creditor) wants to have sheriff levy on car (Honey), and you discover that there is a security interest on car given to Bernie. Felicias lien is not perfected since Sheriff does not have possession. Bernie is perfected, and Felicia is not. The debt is greater than the amount of the car. There is nothing left for Felicia. Between these two creditors, its the debtor who has decided who is going to give priority. If this occurred before 90 days of filing before bankruptcy, the TIB can upset security interest as voidable preference. Its up to Bernie to see if he can stay off bankruptcy for 90 days. The sheriff can still go ahead and levy. All Bernie has to do is notify the sheriff and say he has priority over Felicia, and the active sale is a conversion of Bernies rights.

A)

9-317(a)(2) is the disposition that refers to the competition b/w a lien creditor and a secured creditor. The secured creditor is not subordinate to the lien creditor if it perfects first. Bernie by going out and filing the financing statement and entering into a SA has perfected first. Felicias lien is not perfected since Sheriff does not have possession. Bernie is perfected, and Felicia is not. The debt is greater than the amount of the car. There is nothing left for Felicia. In most States an unsecured creditor obtains an execution lien by reducing its claim to judgment obtaining a writ of executing and having the sheriff levy on the assets. Under the law of most states the levy both creates the lien and perfects it by the Sheriffs possession. (p280). In this case the SI comes before and has priority.Bernie became a secured creditor long before after being a creditor. Did Bernie give value to get this SI? Are the past loans considered as value? 1-202 (44) defines value: the taking of property in satisfaction of or as a security for a preexisting claim. The debtor decided who would be the secured creditor. Both of these guys has a right to money from the debtor. The debtor decided who was going to win basically. Can he do this? Is there anything that cuts down on the debtors ability to do this? Bankruptcy Law prevents the debtor on the eve of bankruptcy from preferring one debtor over another. Bankruptcy law prevents the debtor to prefer one debtor, the law is in favor of equality of debtors, to share the assets of goods of the debtor on a pro rata basis. The preference period is of 90 days (this is why in the facts of the case it says just over 3 months ago), so in this case the preference laws dont work. If this occurred before 90 days of filing before bankruptcy, Felicia can upset security interest as voidable preference. Its up to Bernie to see if he can stay off bankruptcy for 90 days. The idea is that if you have a SI you are going to prevail over unsecured creditors is one of the great certainties of commercial law. B) The sheriff can still go ahead and levy. All Bernie has to do is notify the sheriff and say he has priority over Felicia, and the active sale is a conversion of Bernies rights. Could Felicia sell the car subject to Bernies priority? The junior creditor can sell the item subject to the senior creditors rights. 9-401 it can be transferred involuntarily. As a buyer of course you arent going to pay very much for the car or anything. In this case you have a 10k car with someone else who has a 12k priority in it. So the car isnt worth anything to anyone else, she couldnt sell. In some cases a Court wont let the junior creditor sell if the senior creditor objects. If in this case Bernie comes in and says he wants to conduct the sale and not let the junior sale conduct the sale, then the junior creditor should seize in his sale. The senior creditor has the right to exercise the first sale. Selling subject to the senior creditors priorities isnt per say a prejudicial circumstance to the senior creditor. The real problem for Bernie would come if the debtor was in default to the junior creditor alone and not to the senior creditor. This would be a problem since the junior creditor would have a right to foreclose. In this case Bernie could declare a default even though the payments are not in default to him. This is the reason behind a provision in the SA by which a default in subordinate liens is to be considered a default in the loan you are making.When there is an original disposition the proceeds are multiplied since the creditor has access to the collateral and the proceeds received form the sale.

49

Problem 16.2: This is a small claims problem. There is Sergio the street vendor, paying some money to a seller for a vender cart. Seller goes into business, but street vender finds out that seller previously gave a security interest in cart to financer. The financer is fully protected. Street vender is not a BOC of business. Sergio cannot sue seller because of bankruptcy stay. Under UCC, there is nothing you can do for Sergio. You could look to the footnote in Peerless Packing, talking about fraudulent conduct by secured creditor (GFC). Its not general finance companys fraud. Its sellers fraud. The GFC of this world are tuff guys in a tuff business. You can find something to give leverage. Problem 16.3: You are order UCC searches for collateral below in anticipation for lending against it. In what systems will you make the filings and conduct searches? a) Tools: look to state UCC system. The tools are equipment. b) Patent: file in both places- Patent and UCC system, Kazinsky is unclear in National Peregrine whether we have to file in Patent Office. c) Royalty on Copyright: probably in copyright office. You would want to double file because there is uncertainty. What about the proceeds from the copyright? You have to order 119 searches. Thats a lot of money. One of the purposes of the copyright office is to set up a filing system for searches. That makes it harder for searchers not easier, since it adds a multiplicity of places to look. d) Rare Automobiles Dealer: If not inventory then its equipment. There is lots of fraud with respect to motor vehicles. Trade Mark (American Originals): You might have to search/file in both UCC and Trademark Office for trademarks. Problem 16.4: Should you search or file first? File first because you may lose priority in the mean time. Plus, there may be someone ahead of you and it has not yet shown up in the records (the filing office has 2 days). What if there is a delay? There is no penalty against the filing officer. XVII. ARTICLE 9 FINANCING STATEMENTS (17) A. The Components of a Filing System (p294) A filing system has subsystems for: Adding new records Searching among the records Removing obsolete records Most systems are not searchable by text; easiest way is to search by filing # assigned to each document When financing statements are filed they are assigned a unique number referred to as a file number. A few kinds of filing systems index by a description of the collateral Real estate systems are by description of collateral Motor vehicle certificate of title system indexes by description of collateral Both the real estate and motor vehicle filing systems can index collateral because the collateral they govern has a stable identity It would be impractical to index by number for most collateral covered by article 9, so indexing by collateral is also impractical for the UCC index UCC files by the name of the debtor 9-519(c) requires that filing office index financing statements by debtors last name B. Search System (297) Some search systems have hard indexes that are reminiscent of searching the phone book, in other systems the search is conducted electronically The rules that determine what the program will consider equivalent are referred to as the search logic of the program. The financing statement is effective the moment the filing officer creates a record that bears the record and file number assigned to the filing statement, even though it may take a up to a few weeks, for the filing officer to make the index entry. C. Correct Names for Use on Financing Statements (p299) 9-506: Filing statement is effective despite minor errors or omissions, unless errors make it seriously

50

misleading 9-503: Name of debtor (p299) 9-503(a)(1): if debtor is registered organization, financing statement must have name indicated on that jurisdictions public record Corporations must have suffix that indicates corporate status Filing documents of incorporation w/ sec of state ensures no two corporations w/ same name 9-503(a)(4): For individual/partnership, FS must provide individual or organizational name of debtor But individuals can change their names so easily Plus, so many people have the same name And one debtor may be known by many different names to many different people 9-503(b) and (c): Trade name alone does not sufficiently provide the name of the debtor, but its inclusion on the financing statement along with the proper name doesnt invalidate the statement Trade name = name disassociated w/ incorporation name under which company does business Individual Names (p299) RULE: The correct name is the name by which the individual is generally known, for non-fraudulent purposes, in the community. This definition causes a number of problems With regard to individual names, the indexing system is built on sand. Courts are favoring longer more formal names over shorter more colloquial versions FILERS RULE: file in the full, formal name of the debtor SEARCHERS RULE: a searcher may still be required to make multiple searches to protect himself. Rules regarding name changes discussed in Ch. 23. Corporate Names (p300) Because corporations can only be formed through a charter or certificate of incorporation filed with the Secretary of State (or equivalent officer) in the state of incorporation, a corporation has only one correct name at any given time. Corporate names are generally required to designate themselves as such through suffix: Corp., Co., Inc., etc.. EXCEPTION: CA States will refuse to incorporate a second corporation with the same or confusingly similar nameno McDonalds Inc. and McDonalds Corporations, for example BUT two corporations can have the same name if incorporated in different states. Partnership Names (p301) RULE: The name of a partnership is that by which it is generally known in the community The name, may, but need not, include some indication that the entity is a partnership A person forms a partnership by filing papers with the secretary of state, the certificate will contain the name of the limited partnership Rules regarding name changes discussed in Ch. 23. Trade Names (p302) DEFINITION: name other than legal name by which a person or entity does business. RULE: Trade names are neither necessary nor sufficient to identify a debtor on a financing statement. UCC 9-503(b)-(c). The Entity Problem (p302) If looking to see if Harvard Law Schools property was encumbered, what name would you look under? The law school? The university? The trustees? 1-201(28) ends the definition of organization with the words or any other legal or commercial entity. The implication is that an entity might be a debtor for the purposes of article 9 even though it is not

51

a legal entity for any other purpose. D. Errors in the Debtors Names on Financing Statements (p303) If creditor fails to find security interests b/c of incorrect name, filing is ineffective (9-503(a) and 9-506(a)) But if the search is made under correct name & clerk indexed it incorrectly, filing is effective, 9-517 9-506(c): when the sufficiency of name is challenged, the proper question is not whether the creditor actually failed to find the record, but whether he hypothetically would have found the financing statement According to search logic of that office differs from state to state Transamerica Commercial Finance Corp. v. GE Capital (Bankr. S.D. Ind. 1990) Was financing statement filed by Transamerica sufficiently accurate to protect its security interest? Debtors name is Wardcorp, Inc. Financing statement listed debtor as Ward Corporation, Inc. Rule: error in debtors name is seriously misleading if it would prevent discovery of the FS 9-506(a) (excusing minor errors) may extend to address or secured creditors name, but not debtors name Holding: filing was ineffective to perfect the prior security interest Cases turn on courts opinion of whether error would have led reasonable searcher not to find financing statement E. Problem Set 17 Problem 17.1: Your client wants to lend against equipment, inventory, and A/Rs owned by McErny Leasing and Bob McErny. What will you ask for from Bob to conduct a UCC search under McErny Leasing and Bob McErny. Bob is the owner of the company. You want to know what kind of entity McErny Leasing is? Verify with Secretary of State. You are looking for something that looks like McErny Leasing Co. at a familiar address. How do you know that company owns collateral? You have to trace title from inventory and equipment to sources of sale. Suppose its not a corporation. Ask the filing officer to do a search in all variations of the name he is known in the community. McErny Leasing could be a trade name and that is no good to file. Ask Bob what his full name is? Its Robert Joseph McErny. If you file under the most formal name, and if that name is not used, its probably an ineffective filing. It all depends on the systems search logic. If you are in a system that does not show up variations, the question is how are you going to search all variations. The lender has to come up with a policy. Because if you start searching for all the variations, you start to run into big bucks. The bigger the loan, the more thorough the searching. Problem 17.2: Susan Alexander? John Phillip (Jack) Smith? Tessies Tire City? You want to know what entities these are before you go down to the filing office. Whats the transaction about? Is it a developer? Is it a consumer? You first want to know the address before you go to the filing office. There is a hard copy but its probably old, so you will probably request a computer search. You ask for Susan Alexander, and order all the financial statements, and see which ones match the address of your person. The problem is learning the search logic and dealing with it. States differ in procedure. Tessies Tire City is not a corporate name because it does not have an inc., co. corp., etc. Once you find that out the business name, search it, but also search with trade name to make sure (even though its probably ineffective). Problem 17.3: Which ones do you order? If there is a mistake in the middle name, its probably not a seriously misleading mistake, since it came up under our search. Because it turns up in the searching logic, it aint serious if the name that its under is ineffective. The Secretary of State office did us no favor by giving us all those names. Curse the Secretary of State. Problem 17.5: If filing office receives an original financing statement on Wednesday, when does it have to index it under 9-519(a) and (h) and 9-523? It has to index it by Friday, end of the second business day, 9519(h). What day would the last search go out that did not include reference to this financing statement? Under 9-523(c)(1), the filing office has to report/communicate on the record by the 3rd business day after received original. The information has to be current as of 3 business days. So on Friday, they dont have to report on information except from Tuesday. Overall, its 2 days to be recorded and 3 days to show up in a request. Because the filing office can do it at the end of the day on the second business day. This means that the request may not be current until 3 days after filing, and here that day is Monday.

52

Problem 17.6: You are going to search for security interest on Tang and on Argon. Who knows if you can be ready by end of closing day? They may follow state procedure. XVIII. ARTICLE 9 FINANCING STATEMENTS: OTHER INFORMATION (18) A. Introduction (p312) 9-521 contains a standard form for filing and amending financing statements; the secured party can use this form, its own form, or file a copy of the security agreement as a financing statement. 9-502(a): in order for financing statement to be effective, must contain: (1) Name of debtor (2) Name of secured creditor (3) Indication of collateral covered 520(a): requires filing officer to refuse FS unless it contains numbers 1 and 2 above and: (4) The mailing address of secured creditor (9-516(b)(4)) (5) The mailing address of the debtor (9-516(b)(5)(A)) (6) An indication of whether the debtor is an individual or a corporation (9-516(b)(5)(B)) If debtor is organization, UCC 9-516(b)(5)(C) also requires rejection if FS doesnt have: (7) Type of organization (corp., LLC, etc.) (8) Debtors jurisdiction of organization (9) Debtors organizational ID # This doesnt mean that filing officer should refuse filings w/ incorrect information (516) Comment 3 filing office is not required to even consider the accuracy of information provided Should only reject if the blanks arent filled in, not assess the validity of what is filled in 520(c): A filed FS satisfying (1)-(3) of 9-502(a) is effective, even if officer should have rejected it. B. Filing Office Errors in Acceptance or Rejection (p313) If a filing officer mistakenly accepts a filing that contains three items of 9-502(a) (name of debtor, name of secured party or his rep, indicates collateral covered), but should have been rejected under 9-520(a), filing is nonetheless effective. 9-520(c) Why? B/c little burden on searchers (they can still find interest w/ items 1-3) 9-516(d): If filing officer rejects an actually-correct filing statement, that statement will be effective for defeating lien creditors (lien-perfected) but not against purchaser-perfected searchers w/ reliance C. File Errors in Accepted Filing (p314) If a filer omits from the financing statement a piece of information required in 9-516(d), the filling officer can and should reject the filing, 9-520(a). However, the officers are not required to read the filings and are specifically instructed not to evaluate the accuracy of any information contained therein. (1) Information necessary only to qualify for perfected filing The items only items necessary to the sufficiency of a financing statement are the name of the debtor, the name of the secured creditor or his rep, and the collateral covered, ie those factors from 9-502(a). If the information furnished in response to any of the other requirements set forth in 9-516(b)(5). If erroneous, the fact that information has been filled in still qualifies for filing, but will be of limited effectiveness. Limited-effectiveness, wrongly rejected, and fully-effective filings are all perfected 9-338: Filings w/ incorrect 9-516(b)(5) information (items 4-9) will be effective against lien creditors, bankruptcy trustees, and others (lien-perfected), but not against purchasers who give value and act in reasonable reliance on the incorrect information (purchaser-perfected) Whether this applies to errors in address of secured party is unclear: 9-502 doesnt require address for sufficiency, but comment 5 to 9-516 excludes them from errors that merely invoke 9-338 How do you know when a purchaser might give value on reliance of info? E.g.: Wrong address that convinced him FS was for different debtor (2) Required information

53

The name of the debtor, the name of the secured creditor or his rep, and the collateral covered are necessary to the full effectiveness of financing statement Financing statement will be effective despite minor errors or omissions unless the errors or omissions make the financing statement seriously misleading 9-506(a) Whether or not seriously misleading depends on function of description E.g., name of SC on FS allows searcher to contact SC for authentication/information Collateral description must render collateral objectively determinable Grabowski v. Deere & Company (Bankr. S.D. Ill. 2002, 318) B of A files financing statement listing collateral as all equipment South Pointe Bank files financing statement listing collateral as three specific machines South Pointe claims that prior financing statement is ineffective for failure to describe collateral 9-504 gives huge leeway in description of collateral for financing statement Either by type or category under 9-108, or by saying all assets of the debtor Under this standard, B of A wins reasonable searcher had necessary info to make further inquiry Even more generous standard under Teel Construction (321) Security interest granted in collateral at certain address. That address didnt exist. Nonetheless, FS valid b/c searcher had enough info to inquire. D. Authorization to File a Financing Statement (p322) Before filing financing statement, secured creditor must obtain authorization from debtor in an authenticated record 9-509(a)(1) Simply authenticating the security agreement constitutes authorization 9-509(b) If person filing a financing statement is not authorized, the financing statement is ineffective. 9-510(a) 9-518 allows victim of bogus filing to file a correction statement that will show up on searches E. EW Summary Items (1)-(3) must be present for sufficiency If one is incorrect, FS is only ineffective if it is seriously misleading If incorrect on (4)-(9), effective against lien creditors, but not against SCs w/ reasonable reliance If wrongly rejected, effective against lien creditors, but not against SCs w/ reasonable reliance on absence F. Problem Set 18 Problem 18.1: You have a filing statement that has to be filed today. The debtor authorizes it but you dont know its organization number. Its not required to be effective, but the secretary of state by statute is required to reject it if it does not have the number. The filing office does not reject it if it is a wrong number. The effectiveness only goes to the debtor, creditor, and collateral description. There is no difference from leaving it blank or telling you to fill in a false number. From a substantive reason there is none. What happens if a busy body in the secretary of state office sends it back to you? The danger of doing nothing, and later some creditor is deceived, and you prove that you are perfected under the statute, that creditor is going to say that you should have done something. You are perfected, but you are perfected because you put false information. There could be an estoppel argument. The secretary of state office did something wrong. But they have sovereign immunity. What did the first creditor do wrong? You can claim a lack of good faith argument. You should not rely on fault of secretary of state mishap. A lawyer shall not make a material misrepresentation of fact to a third party. So are you violating that? The lawyer should later file an amended statement on Monday with the correct number. Therefore while you are lien perfected with the wrong number, you will lose to a secured creditor that relies on the misrepresentation and the fact that filing with an incorrect number got you by. The other author says 9-516 comment 3 doesnt say it is okay to do it all it does it not provide a penalty for filing with the wrong organizational number. What you are really saying is that you get to do the morally correct thing by violating a rule of professional ethics. A) In the context of the particular facts, giving the wrong organizational number is not a material misrepresentation if taken to mean what they do in 441. Doesnt article 9 set you up to do it. Maybe you could include in parenthesis that this is not the right number to save you from disciplinary action.

54

If you dont file with a false number and someone gets in before you then you could be on the hook for medical malpractice.

B) 9-516(d) a record communicating to the filing office with the fee which the filling officer refuses to
accept is effective except with respect to a person who gives reasonable value (a purchaser) with reliance on the absence. A secured creditor is a purchaser according to 1-201(32) and (33), but it is generally effective against the person you are probably most worried about, the trustee in bankruptcy.

C) 9-338 again talks about the purchaser who gives value in reasonable reliance on incorrect information.
What kind of reliance are you going to have on a false organization number. In the usual situation it is going to be perfectly obvious that the organizational number is wrong, especially if there were addresses, jurisdiction, and organization was there. Hard to see how someone is going to rely on organization number then. Problem 18.2: Being perfected at debtors bankruptcy is critical.

A) 9-516(b)(4) the filing officer should have rejected, but he didnt, so is it still effective? Yes under 9-520.
Is this a problem for a hypothetical searcher, is a searcher who wishes to find a secured party even without an address, sure. This is a federally chartered bank, a searcher wont have any difficulty at all in finding that bank, so the failure to put an address wouldnt make any difference to the searcher.

B) It has the correct name so it is effective, because they are required to accept the financing statement even
though it had the incorrect debtor address. The filing clerk is required to accept it anyways. Can the trustee avoid it? When it is lien perfected it applies to trustees in bankruptcy as well. Although, this one really does interfere with the operation of the system. How does article 9 deal with it? 9-338 it is effective, but it does have consequences, 9-338 limits the priority of the secured party in favor of a purchaser who gives value in reliance on the wrong information.

C) Assume that the filing officer has accepted it, 9-506(a) it is effective even if there are some minor errors
unless it is seriously misleading and here the trade name is so different from the actual name that, as much as searches are not conducted under the partys name an error in the name of the secured party will not be seriously misleading. That is what the comments say. (Using the debtors trade name is the a problem, but here using the secured creditors trade name so we dont have that kind of situation). If it made the secured creditor hard to find then perhaps it could be considered misleading. After all the name is required to be there for a purpose.

D) You can inquire of the stated secured party, but once she says it isnt her, the searcher cannot rely on the
name so there isnt going to be any estoppel relied there. But they you look at 9-506 comment 2 that says an error in the name of the secured party will not be misleading. If that is effective and it turns out that both Elizabeth Warren and Lynn LoPucki says I will pay you a little money and Ill be protected by your filing. Kaufman thinks it is seriously misleading and it is true that you dont search in the name of the secured party and at times you are entitled to rely on what you find there. Kaufman doesnt see why you cant rely on that at least to the extent of saying that it is seriously misleading. The financing statement must have the following correct information: Debtors name, secured partys name and description of the collateral. Unless they are minor errors that are not misleading. 9-502 are the three items that have to be right except for minor stuff. E) The description of the collateral is just wrong and aside from the problem with the financing statement, is there another problem? They listed what was at A and meant to cover what was at B and by the particularity of the description they have missed the collateral that they wanted to include. F) The filing officer should have rejected, but even though he took it, as a matter of article 9 it is defective. As a matter of policy how should this turn out, the searcher should have been put on notice that there was some kind of security interest in something the debtor owns and of what value is the description of the collateral in the financing statement? Suppose you find equipment and you want to know if you can levy on inventory or accounts receivable. Are you safe to levy on the inventory, the accounts receivable by

55

looking at the financing statement that says equipment and finding no other financing statements and no other liens. A security interest that starts in equipment can drift off into other items as proceeds. The authors suggest that there is a pretty good argument that that requirement ought to be offended. The people who defend it say that it ought to be a starting point. Problem 18.3: The other creditor has 5 financial statements stated at a particular addresses other than Trimble Ave. The landlord knows that the other location is new and not listed. Could Trimble Ave collateral be perfected? Maybe. What you going to do? You should levy on Trimble Ave. You are entitled to rely on apparent state of the record. You have not sold anything yet, so go ahead and levy. A) It doesnt seem that likely that Glacier is perfected. B) Reasonable chance you should go ahead and levy because it is reasonable to assume that Glacier is going to be unperfected. Problem 18.4: Glacier is supposed to have a security interest in Trimble Ave collateral but financial statement got screwed up. A lien creditor calls and asks you about it because he wants to levy. Do you lie? Some jurisdictions take lying seriously. The law may sanction it. You should say, let me find out, and Ill get back to you. Then go get one at that point before Smith levies. What about if you got a call from another bank, whose debtor SCI wants a loan and gives an application? Is there a difference is confidentiality arrangements between Glacier and debtor, when another bank calls and wants to know debtor status? Creditors by and large do not have confidentiality with debtors. Here a loan officer from another bank calls you, and you who are the first lender, and you have a negative pledge clause preventing giving a junior lien to yours, to finance new inventory, want to find out whats going on. On the other hand, you want to have a look at state law in jurisdiction, which has expanded privacy rights over the years. A) You might try to get off the phone as soon as possible. You dont have a duty to do the other persons work for them. You can then go get the debtor to approve of anything you need and get the security interest filed. It is the other parties mistake for calling you and putting you on notice that I am about to levy. You dont, however, want to be put in a position of making a flat out lie. B) Is there something there for you if youre honest. This is your debtor going to another bank for a loan. You want to find out Problem 18.5: typically department stores who take security agreements dont file financing statements, and with respect to consumer goods, they dont have to and there is automatic perfections. But you file a financing statement, and you may want to file one with high ticket items. If the consumer sales to another consumer, that second consumer will take free and clear of security interest, as long as there is no financing statement filed, as a consumer to consumer transaction under 9-320(b). You dont need explicit permission to file against a customer who has already executed a security agreement. That execution constitutes authorization. The debtor normally has to authorize an execution of a financial statement in writing. So if the financing agreement goes first, you need a writing. Also, use same description as that in security agreement because authorization in security agreement only covers property in the security agreement. A) The execution of a security agreement is the necessary authorization for the secured creditor to file a financing statement. B) What does the authorization consist of? You are authorized to file a financing statement based on security agreement so the collateral description ought to be the same or you might find that you didnt have permission. Problem 18.6: The issue here is that you had an early financing statement with only an oral authorization, and some later creditor files one, and the first filer subsequently executes a security agreement, that then constitutes the authorization. The authors think the first filer loses since there is no written authorization. Kaufman is doubtful that is the correct result because priority section states priority from date of filing. And here second bank is the first filer. Maybe filing means authorized filing. But it was authorized orally, and they were on record first, and the second filer should have seen that filing.

56

A) If he hasnt signed anything authorizing the filing then the first filer loses. Normally we have our second national bank on March 1, and Nations Bank on March 10. Normally the first filer wins, but here there was no authorization of filing, 9-322 the basic priority rule. Second Bank Filed first, why doesnt our client win, our authors say our client doesnt. The authors say that the only way to read filing is authorized cause you cant just go out and file against everyone and youd have priority if you later made a loan. Nations Bank should have searched the file, willing to read authorized but they got subsequent written authorization so the first in time Kaufman thinks should be prevail. Authors dont agree. XIX. EXCEPTIONS TO THE ARTICLE 9 FILING REQUIREMENT (19) Four ways to perfect a security interest By public record filing for most types of collateral By taking possession in many forms of collateral (money) By automatic perfection by operation of the law for some collateral (PMSIs in Consumer Goods) By notice to or through some person or organization that controls the collateral (deposit accounts) A. Collateral in the Possession of the Secured Party (p327) The Possession Gives Notice Theory OVERALL RULE: You need to know how to classify the collateral to know how to perfect it Possession by secured creditor is a perfection substitute for notice recording 9-310(b) and 9-313 9-313 Permits perfection by possession if the collateral is negotiable documents, goods, instruments, money, or tangible chattel paper Theory behind this rests on two assumptions: Lenders will want to see collateral before making loan Lenders understand that if collateral is in anothers possession, they should ask about security interest What is Possession Possession is not an observable fact, but in many situations depends ultimately on the legal right of the would be possessor A secured party can possess through an agent, 9-313 comment 3 Possession as a Means of Perfection Possession may take any of three roles in perfection It may be the sole means of perfection As with money as collateral 9-312(b)(3) or (as far as control goes, deposit accounts, 9-312(b) (1) It may be an alternative means of perfection to filing As with goods, instruments, tangible chattel paper, negotiable documents, and certificated securities; 9-312(a), 9-313(a) Notice that under 9-330(d) and 9-331(a), perfection by possession of the above (except for goods) trumps prior perfections by filing. It may be an ineffective means of perfection Security interests in accounts and general intangibles may be perfected only by filing or some other form of automatic perfection not by possession. 9-313(a) B. Collateral in the Control of the Secured Party (p332) Control of some kinds of collateral is a substitute for filing. Control of deposit accounts, electronic chattel paper, invest. property and letter of credit rights is a substitute for filing, 9-310(b)(8). A deposit account is the type of property generally referred to as a bank account.

57

9-104 indicates 3 ways SC can take control of a deposit account (1) Secured creditor is bank in which account in maintained If this is the case, no other form of public notice is necessary (2) Secured creditor, debtor and bank can authenticate a record instructing bank to comply with SCs instructions (3) Secured creditor can become banks customer by putting the account in name of secured party 9-104(b): Secured control is not abrogated by permitting debtor to retain right to direct funds in account This is possible because the control specified in 9-104 is potential control, not actual control Parties who wish to encumber deposit accounts without putting other creditors on notice could do so by agreement; 9-104(a)(2) does not require that the agreement be filed or made public in any way. C. Purchase-Money Security Interests in Consumer Goods (p333) 9-309(1): PMSIs in consumer goods automatically perfected (no filing needed) Purchase Money Security Interest 9-103(b)(1) a security interest is a PMSI to the extent that it is taken or retained by the seller of the collateral to secure all or part of the purchase price, or taken by a person who by making advances or incurring an obligation gives value to enable the debtor to acquire rights in or the use of collateral if such value is in fact used. Consumer goods: 9-102(a)(23) goods bought for personal, family or household purposes In re Lockovich (W.D. Pa. 1991, 335) Debtor bought boat with PMSI, but SC failed to perfect interest by filing. Is perfection automatic? Is this a consumer good for which PMSI creates automatic perfection, despite size and price? Yes. In interest of administrability and clarity, anything that is for personal use is consumer good What if goods are bought w/ one use in mind, then put to different use? 9-102 is ambiguous on this point cases support both sides (use at time of purchase v. actual use) D. Security Interests Not Governed by Article 9 or Another Filing Statute (p339) Security interests in a variety of types of collateral are excluded from the coverage of article 9. Excluded: security interests in: Wage claims 9-109(d)(3) Insurance policies and claims 9-109(d)(8) Real estate interests 9-109(d)(11) Non-commercial tort claims 9-109(d)(12) Bluxome Street Associates v. Firemans Fund Insurance (Cal. Ct. App. 1988, 339) Settlement for legal malpractice suit for payment of $600K Flynn and Stewart law firm claimed that they were first in line, b/c they filed financing statement. Holding: under 9-109, such interest in non-commercial tort suit is not governed by article 9. E. What Became of the Notice Requirement? (p341) These rules that allow for automatic perfection dont provide notice Lawmakers must not think that subsequent losses to these non-notified parties are worth avoiding F. Problem Set 19 Problem 19.1: Permissible ways to perfect question? A) Cash in the Register: the only way to perfect a security interest in actual physical money is by taking possession of it. 9-312(b)(3). Have an employee of yours run the machine. You can make the teller your employee. Is that enough if debtor still pays that person? The creditor has to pay the teller as an employee? B) Negotiable promissory notes: falls under instruments, in which perfect by filing or possession. Possession is better because if you have only perfected by filing, a purchaser (which includes another creditor) who takes possession will take priority over the prior filer. Filing is a weak protection because you can lose to another creditor. The concept of negotiable promissory notes is to make them as much like dollar bills as possible. C) Money debtor keeps in Deposit Account: 9-104: bank holding an account, second, an authenticated report signed by debtor and bank saying bank will comply with secured party instructions, and thirdly, the secured party becomes banks customer with respect to account which means secured party named account holder.

58

D) Stock: perfect by either filing or by taking possession of certificate, or having shares registered by GM in name of secured party. E) Obligations of customer to pay for merchandise evidenced by a promissory note and a security interest. Chattel paper, 9-102(11) it is something in writing that evidences a monetary obligation, a debt of the buyer of goods, and a security interest in the goods. Another example is just a plain old lease that is used as collateral (contains monetary obligation and an interest in goods themselves, the interest of the owner). You can perfect by possession or filing, 9-330(b) and (c) possession is favored over filing unless you work the number of filings by stamping each piece of chattel paper. Problem 19.2: K for Payment, promising certain installments plus interest? Instrument or Account. Account definition excludes instrument. Does it transfer? Kanards are filing using money for a contract for payment that theyve gotten from someone else for payment. In UCC terms, a contract for payment is what: is it an account, is it an instrument, or is it a general intangible. Youd have to see the document itself to try to figure out if it is an instrument. General intangible is any personal property other than an instrument. Suppose it isnt an instrument because it doesnt fit the article 3 definition of an instrument. Then what would it be? Then it could be an account. It cannot be both an account or an intangible. It has to be one or the other. If it is an account, you have to file to perfect. If it is an instrument, then you should probably possess. So what do you do? You want to do both because it isnt crystal clear which you should do. Problem 19.3: Instrument with another party holding possession. There are two creditors, one with both possession and a 60 grand first security interest. What does the second creditor do to perfect as a second secured interest. Maybe have a 4th party hold it in escrow. You should refinance that loan and add it to your 300 grand, and take possession of note. Problem 19.4: How to protect yourself against automatically perfected security interest. A) Mobile Home: may have a PMSI automatically perfected. Trace source of title. Find out where the money came from, relying some on the debtor at that point. You also worry about whether salesperson had it free and clear when sold it. Could this mobile home be a fixture on the land, permanently on the land? There may be a mortgage on the land, which gives the mortgagee an interest in that mobile home. B) Rare Book Collection: it could be PMSI. The library of congress could be holding the books for the secured creditor and does not have to tell you under 9-313(g)(2). C) Mercedes Benz Automobile: if in certificate of title state, almost certainly you can only comply with filing according to certificate of title rules. D) Diamonds: could be PMSI. E) Computer Equipment: located at office, which would tend to look like business not consumer, but the stock stuff makes it look like personal use. You may have an automatic security interest. Before you spend a lot of money, you should take a good look at the equipment. F) Checking account at Bank of West and in Ketterings name: You perfect by control. A secured creditor under 9-104 (private agreement between bank creditor and debtor) or a bank under 9-104. G) Almost anything can be consumer goods. The provision that makes things easy for takers of security interests in consumer goods makes it difficult for searchers. Problem 19.5: Borrow 100,000 using potential lawsuit winnings as collateral. Tort claim? How to perfect? What is this lawsuit about? Is it a breach of contract? If its a breach of contract, its not a tort claim, but rather its a general intangible (this a catch all category). How to perfect a general intangible? You have to file. But what if this is a tort claim? Then look to see if it is a commercial tort (where claimant is with an organization, or the claimant is an individual and the claim is in the course of persons business)? 9-109d12- commercial tort claims but not tort claims are in article 9. There is nothing talking about commercial tort claim specifically, so we file, because 9-310 says that unless otherwise provided, a financing statement must be filed to perfect all security interests. 9-108e says you cannot say just file by identifying commercial tort claim. You dont have to go into great detail, but you have to identify the nature of the claim. Problem 19.7: Sabine sells musical equipment to Jersey on credit with a security interest in equipment, but Sabine is going to be using equipment in business. They put it in separate room, sublease it to Sabine, and agree the its in Sabines possession. Bill (President of Jersey), as Sabines agent will control access to room, with this information printed on door. You can use an employee of the debtor to take possession under comment 3 of 9-313. But the

59

comment explains that debtor cannot qualify as agent for the secured party for purposes of the secured party taking possession. Although the separate room is to give notice and warn a creditor who levies on it not to waste their time, and they got a lien, but the problem is that the agent is the president. This is not like the field warehouse where the agent is an employee of the creditor. So this is a dual agency situation, and you picked somebody that is subordinate, or in fact, is the debtor. XX. THE LAND AND FIXTURES RECORDING SYSTEMS (20) Personal Property refers to anything capable of being owned, that is, all property except real property. Real property includes land, certain interests in land such as easements, and permanent structures on land Overlap and controversy occurs in regards to fixtures, a poorly-defined intermediate category A. Real Property Recording Systems (p345) Each state is divided into counties, and each county maintains a real estate recording system. Typically it is located in the county seat. Resemble personal property filing systems in that: If you took a mortgage to the recording office a clerk would take a small fee for recording and would immediately stamp the date and time of the recording on the face of the mortgage. The clerk would place your now-recorded mortgage in a basket for photocopying and indexing and later someone would add it to the appropriate place in the index and mail the original back to you Differ from personal property filing systems in that: Real estate system contains not only documents evidencing liens against real estate, but also deeds that show transfers of ownership. Enables users to determine who owns property as well as who has liens against it Bills of sale, the personal property equivalent of deeds, are not recorded in the personal property system It is more expensive to file in the real estate system. This system has both recording and transfer fees. The real estate recording system is not self-purging. Filings in the real estate system are permanent and do not have expiration times like UCC filings. The debtors name is relatively unimportant in the real estate system because the filing system records tracts of land and chains of title. A search with the wrong name would present no documents at all, including deeds. In most counties, real estate searches can be conducted not only by the names of the parties, but also by tract, the description of the property. Real estate records are duplicated by private firms across the United States. There is no uncertainty as to which filing system is correct for the real estate system. Land in one county must be filed in the real estate recording system for that county. Land touching multiple counties must be recorded in the recording system for all of the counties. B. What is Recorded (p347) Formalities for the creation of a mortgage A mortgage document Singed by the debtor and Perhaps Containing a description of the debt secured and the collateral securing it. Split authority as to whether a mortgage that omits entirely the amount of the debt or expresses it in general terms is valid General rule is that a description of the collateral is not too vague so long as it is possible to identify the property by a rule of construction or through evidence extrinsic to the mortgage The actual mortgage document is filed in the real estate system not just notice of the existence of a document. The advantage is that searchers can see the actual debt. The disadvantage is that additions or changes may require a new filing. Recording usually requires that the mortgage be signed in front of a witness and be acknowledged before a notary public or some official, who authenticates the debtors signature by affixing the officials own signature and seal.

60

C. Fixtures (p348) The law considers permanent buildings as part of the land on which they stand, unless they are specifically excluded. As such, the proper place to record a mortgage on these buildings is in the real estate filing system. A UCC filing is ineffective 9-109(d)(11) The above suggests that individual parts of permanent buildings must also be recorded in the real estate system. Some go so far as to suggest that machinery which is essential to a manufacturing plant would fall under the definition of a fixture even if the machinery is not permanently attached. What is a Fixture The UCC defers to real estate law, and designed around it. The UCC states that goods are fixtures when they have become so related to particular real property that an interest in them arises under real property law. 9-102(a)(41). What may be a fixture in one state might not be a fixture in another state. One idea is that for most courts intent is most clearly manifested by the firmness with which the goods are affixed to the real estate and the amount of sweat that removal would entail. How Does a Secured Creditor Perfect in Fixtures In many situations it will be impossible to predict whether the courts would consider particular property to be fixtures. Often this will lead to filings in both the real estate and personal property filing systems. Goods that are fixtures or may become fixtures may be used for a security interest under article 9 if allowed under the state real estate law, 9-334(b). In re Cliffs Ridge Skiing Corp. (Bankr. W.D. Mich. 1991 p350) A ski chairlift was classified as a fixture under a three-part test. Is the property annexed or attached to the realty Is the attached property adapted or applied to the use of the realty Is it intended that the property will be permanently attached to the realty Fixture filings are permissible in Michigan in both the real estate and UCC systems. Real estate mortgages, when filed, can also perfect security interests in future fixtures. In the case, three different entities were found to hold security interests in the chair lift. Security interests in fixtures may be perfected three ways 1) Mortgage filing in the county real estate office Under most if not all state law a mortgage creates an interest in fixtures and this interest is perfected when the mortgage is filed 2) Fixture filing under the UCC Must file a financing statement that meets the standard requirements of 9-310(a) and under 9502(a)(3) the financing statement must State that it covers collateral that are fixtures or are to become fixtures State it is to be recorded in the real estate filing system Contain a description of the real estate where the fixtures are located or are to be located, which is sufficient to give constructive notice If the debtor doesnt have an interest of record in the real estate, the owner of the record must be disclosed, 9-502(b)(4) 3) Filing an ordinary financing statement under the UCC Allows perfection of a security interest in goods that are fixtures, yet such a filing does not qualify as a fixture filing, UCC 9-501(a), but there is nothing in article 9 that says one must make a fixture filing to perfect in fixtures. UCC 9-501 doesnt require filing in the real estate records to prefect in fixtures, it merely requires filing in the real estate records by means of a fixture filing. However as shown in 33, this is of limited effect Perfecting in the Fixtures of a Transmitting Utility 9-501(b) allows for the filing of security interests in the fixtures of transmitting utilities to take place in

61

the office of the secretary of state. 9-102(a)(80) defines transmitting utility to include businesses such as radio and television stations that do not have lines or tracks running through numerous counties. This simplifies filings against railroads and power companies who have fixtures strewn across the country, and would have required filings in hundreds of counties. D. Personal Property Interests in Real Property (p356) If a person owns land in fee simple, their interest is in real property and a security interest in that interest must be recorded in the real estate system. If they form a corporation or a partnership, her interest, the stock or interest in the partnership, is personal property and is governed by article 9. Article 9 considers a mortgage to be a security interest in a note, personal property, and therefore covered by article 0=9. 9-109(b) provides that the application of article 9 to a security interest in a secured obligation (the mortgage note) is not affected by the fact that the note is secured by an interest (the mortgage) to which the article doesnt apply. The drafters extended coverage to mortgages by saying that attachment of a security interest to a right of payment secured by a security interest in real property (the note) is also attachment of a security interest in the mortgage, 9-302(g). E. Problem Set 20 Problem 20.1: This has to do with the Cliff Case. There are 3 creditors: FoA, Cliff Dev, and First National. There was not one unified priority scheme, and thus, equity answers the subordination question. FoA v. FN: FN wins; FoA v. CRD: FoA wins; CRD v. FN: CRD wins. If title of property is held in Pacific Interest partnership, the partnerships interest is personal property, and if you take interest in partnership interest, you file in UCC. a) How should SLP (lender) perfect in PIs (debtor) 1/3 interest in 160 tract of land known as Devils Valley? Trees all over the tract of land are realty. PI could be a tenant in common, or PI might have a beneficial interest. If PI owns the property, SI would have to go to the real estate system. If you have a beneficial interest it would be more like a general intangible and you would have to go to the U.C.C. system. Couldnt be a fixture. b) Pine trees growing on land. The authors try to show that the trees are crops grown for harvesting, so they dont seem to be part of the land. However, under 9-501(a)(1)(a) timber to be cut is filed in U.C.C., but this does not meet the definition because it does not have a contract for sale on it. 9-102(a)(44). Before trees are cut, they are goods. After cut, they are something different. If its not goods, it cannot be fixtures, and then maybe its not covered by article 9. Does it mean that it might not be covered by article 9? (d) If SLP perfects by recording mortgage against the second parcel, does it have to mention the trees? The problem with mentioning the trees is inclusio est exclusio est. If you describe one and you dont describe the others there is an argument that you didnt get the others. e) PI has a mortgage and note from another party. PI recorded in real estate office and original is now in PIs possession. SLP wants security interest in that mortgage and note. If SLP perfects by recording a mortgage, does the mortgage have to mention trees? No, the mortgage covers everything on land. You can put in the mortgage, including trees but not excluding other things. The note that evidences the promise to pay is physically incorporated into the purchase money mortgage. The mortgage follows the debt. Old adage: With a note representing an obligation to pay, a transfer in an interest in the note automatically transfers the underlying security. Under 9-203g, the secured creditor by perfecting the security in the promissory note perfects a security interest in the underlying mortgage. You perfect a security interest in the underlying mortgage by taking possession of the note. Theoretically, you dont have to file in the real estate records. But if you are really counting on real estate security, most careful lawyers will file in the real estate records, because someone searching the title in the real estate records and does not find it will be pissed off and their may be litigation. h) The fact that they call them store fixtures does not make them store fixtures. Ask whether there is an interest so related to realty that they are part of the property arising in real estate law. You should file in Secretary of States office if they turn out to be equipment; also, file in the real estate office in case they turn out to be fixtures.

62

Problem 20.2: The eccentric debtor gets a million by signing security agreement in manufacturing facility on a food stained napkin. The question is whether the security agreement sufficiently describes the collateral. If sufficient, the secured creditor can write up a filing statement and file it because the security agreement implies debtor authorization. If land is involved, is there sufficient description to record a mortgage on the land? In many jurisdictions, that would be so vague as to be barred. In some jurisdictions, they allow extrinsic evidence. In some jurisdictions you need a witness. You need a notary at the time the debtor signed, in her presence. If you dont have the proper witness and notary you cannot file it as a mortgage. But maybe you can start a foreclosure suit, which files a les depends, a notice of pending lawsuit, which gives notice of the mortgage, and there is at least an argument that this gives the equivalent of notice. Problem 20.3: Folds sells mobile homes; he has buyer execute a promissory note, security interest, and a standard UCC financing statement, describing the brand mobile home, serial number, and files it in the Secretary of State office. But here a buyer takes it home and the PSF (mortgagee of buyer) forecloses on mobile home. Is the mobile home a fixture? Maybe. Folds may have a PMSI. If this is not a fixture, then our client is home free. But if its a fixture, the client is perfected under article 9 because it did file under the UCC. But to take priority over mortgagee, it had to file as a fixture filing before mortgage under 9-334(e). But it will beat the trustee in bankruptcy under 9-334e3, which says that if client perfects by any method under article 9, it is to prevail over any interest obtained by legal or equitable proceeding. The TIB stands in the shoes of a lien creditor. This enables priority over estate. Folds should file in real estate records, as a fixture filing. What do they have to do in order to file in real estate records? Problem 20.4: There is a mortgage clause saying that borrower has to give lender any requested financing statements, including to successors. This is in here in case the bank forgets to do something in closing. A new buyer from FLEET may want additional documentation. They may want additional stuff that did not turn up in search. The costs are heavy. XXI. CHARACTERIZING COLLATERAL FOR THE PURPOSE OF PERFECTION (21) Article 9 makes several distinctions as to how and where the perfection of a security interest should be done. These distinctions can be placed in two main categories: 1) Those that relate to the place of filing (state, federal) and; 2) Those that relate to the method of perfection (possession, control, filing) A. Determining the Proper Place Determining the right place to file is going to depend on the classification of the collateral. Filling against a motor vehicle that is used as inventory is going to occur in the statewide filing system while if this motor vehicle is used as equipment a SI is perfected by notation on the certificate of title. Personal Property vs. Real Property Real-estate filing offices are the proper place to file when the collateral is real estate or a fixture. There are 3 factors in determining if something is a fixture: 1) The firmness with which the collateral is affixed to the real estate, 2) The intention of the parties as to whether the collateral is to become a permanent part of the real estate, and 3) The degree to which the collateral is essential to the proper functioning of the real estate. For example, a fixture filing can be made against fixtures but not against ordinary building materials incorporated into an improvement on the land so the filer needs to be to distinguish between the two. Inventory vs. Equipment Security interests in inventory and equipment are both filed in the same filing system. 9-501(a). Exception for motor vehicles. Normally security interests in motor vehicles are perfected by notation on the certificate of title, but when motor vehicles are inventory held for sale or lease and the holder is in the business of selling or leasing goods of that kind, perfection is achieved by filing. 9-311(d) and Comment 4.

63

Reasons for need to distinguish Where the debtor sells goods: buyers generally take free of a security interest in the inventory, but not a security interest in goods. Where the security agreement or financing statement specifically cover one but not the other Implicit in the definition of Inventory is that the debtor is in the business of selling and leasing goods of that kind, Comment 4 to 9-102. Goods held for lease are explicitly included in the definition of inventory. B. Determining the Proper Method of Perfection (p363) There are essentially five ways a security interest in personal property can be perfected: By filing By possession By control By giving notice to the stakeholder (on Non-UCC collateral such as tort actions) And by doing nothing (automatic perfection) Instrument vs. General Intangibles Omega Environmental Inc. v. Valley Bank, NA (p363) Instrument means a negotiable instrument as defined under 3-104 or any other writing which evidences a right to payment of money and is not itself a security agreement or lease and is of the type which is in the ordinary course of business transferred by delivery with any necessary endorsement or assignment The term general intangible was intended to cover types of personal property such as goodwill, copyrights and trademarks that are not usually represented by a particular document Rather than looking at the narrow form of a writing, a court should instead look to the realities of the marketplace. If there is evidence that the type of writing at issue is ordinarily transferred in the marketplace by delivery with the necessary endorsement, the requirement under the UCC is met. CDs are instruments under UCC, because although say nonnegotiable and nonassignable, is still a right to payment of money which is in the ordinary course of business transferred by delivery with any necessary endorsement or assignment. True Leases vs. Leases Intended as Security Art 9 applies to security interest in personal property but not to leases of personal property unless they are intended as security. A lease intended as security is a sort of security interest in disguise a lease not intended as security is referred to as true leases. If the length of a lease and the payment schedule under a security agreement happen to be for exactly the useful life of the property, there may be no functional difference between the two. *Tax Rules: If it is a true lease then under special tax rules there can be a deduction equal to the monthly payments of the lease. If it is a security interest then the deduction is for the annual depreciation and the interest instead. 9-505 allows the true lessor to file a financing statement when he is not sure it has achieved that status. It can file without the admission by the lessor that the transaction is a SI. 1-201(37) sets forth the distinction between true lease and leases intended as security interests Realty Paper Realty paper is a promissory note secured by a mortgage or deed of trust. In most cases this note is considered an instrument and hence perfection can be accomplished by taking possession of the note (9-313(a)) or by filing a financing statement (9-312(a)). Chattel Paper and Instruments vs. Accounts Chattel paper, instruments, and accounts- all involve a debt owed by a third party to the debtor. The debtor is using its right to that money as collateral to secure its own debt to the creditor. Chattel Paper

64

Chattel paper is when documentation evidences both a monetary obligation and a security interest in specific goods, a security interest in specific goods and software used in the goods, or a lease of a specific good; 9-102(a)(11) Perfection of Chattel paper can be accomplished by: filing; 9-312(a)(1) possession; 9-313(a). Note that purchasing chattel paper, with no knowledge of a prior security agreement is superior to filing; 9-330(b). Purchaser is broad enough to encompass both buyers and takers of security interests, including bank lenders; 1-201(32) and (33). Possession in realty paper or chattel paper is not necessary preferred to filing in all circumstances. If you perfect by filing and then stamp the individual conditional sales contracts or whatever other from you use to make up realty or chattel paper, that will have preference over the other creditor goes ahead and takes possession. The stamping of the paper gives notice to the creditor that comes along and takes possession (to perfect by possession and have priority they cant have had notice, they cant be aware of the previously perfected SI). Example: Purchasing a boat for $20,000 with no money down financing and a security interest in the boat. The $20,000 promissory note along with the security interest constitutes chattel paper. Instrument Instruments occurs when documentation evidences a right to the payment of a monetary obligation, is not itself a security agreement or lease, and is of a type that in ordinary course of business is transferred by delivery with any necessary endorsement or assignment; 9-102(a)(47) Perfection of Instruments can be accomplished by: Filing; 9-313(a) Possession; 9-313(a) Account Accounts are a right to payment of monetary obligation, not chattel paper, instrument, tort, or deposit account or general intangible (personal property other than accounts, chattel paper, commercial tort claims, deposit accounts, documents, goods, instruments, etc); 9-102(a)(2) and (42) Perfection only by filing Recourse vs. Without Recourse In many cases when there is a sale or lease of chattel paper to a 3rd party to get additional financing the question of who bears the risk of default form the original debtor is going to be determined by another term in the contract b/w the 3rd party and the creditor. The terms can allow for recourse or without recourse. Recourse means that the first creditor must buy back the chattel paper from the Bank and attempt to collect the debt itself. Once the original creditor buys back the chattel paper itll be in the same position that it had been if it had never gotten the additional loan by selling the chattel paper. Selling Chattel Paper and granting a security interest in it are in practical terms the same thing, 9109(a) C. Multiple Items of Collateral In re Leasing Consultants, Inc. (p368) Was the Bank required to file a financing statement against L with the secretary of state in NJ in order to perfect a SI? The court assumed that the agreements b/w L and P were true leases and not conditional sales agreements. The Court found that the Bank acquired a security interest in both the right to receive rental payments under the lease and in the reversionary interest in the underlying equipment. The Court held that the leases themselves were chattel paper and the SI was perfected by filing FS in NY but the machines itself constituted equipment located in NJ and hence for perfection purposes they would have to comply with NJ requirements. A potential creditor observing these machines should be entitled to believe that he could discover all non-possesory interest by consulting the files in the state where the equipment is located. The Bank did not file in NJ and hence did not perfect its SA on the machines.

65

The general consensus among courts is that filing with respect to leases is different with respect to conditional sales contracts in situations like this. So long as Art 9 requires a filing with respect to goods to be where the goods are located, the Bank by filing and taking possession of the chattel paper collateral was not perfected in the goods located in NJ. Revised Art 9 makes the location of the debtor critical but this we will see later this week. D. Problem Set 21: Problem 21.1: How should the secured party perfect the following security interests? a) Lessees interest under a lease in real property: a lease embodies a right to payment to lessor, also embodies a right of reversion like chattel paper. For lease to be chattel paper, the lease has to be a lease of goods. This is not a lease of goods, but rather real property, so it is not chattel paper. 9109(d)(11): article 9 does not apply to creation or transfer of real property including a lease. This is not an article 9 transaction, so record it in real estate office. So the answer here is to record the assignment in the real property record. The lease taken is chattel paper, any lease can be made into chattel paper, but in this case were dealing with real-estate and hence it escapes the scope of applicability of Art 9 and the filing need be done in the real property system.

b)

Wheat growing in farmer debtors field: Crops are goods under 9-104(a)(44). In some states, crops may be fixtures, but in either case, article 9 applies, and you should file a financing statement. You have to file in both places. The landowner shouldnt allow or give a mortgage if the only thing being financed is the fixture b/c they put a cloud on title. Can you perfect by a fixture filing in the real estate record? There is one court that has held wheat planted annually cannot be a fixture, because there is no intent of permanent connection to land.

c)

Franchise to operate a BK franchise: this is a general intangible 9-102 (42) and can only be perfected by filing in the secretary of states office.

d)

An electronic book entry certificate of deposit: you would think it was an instrument 9102(47), but this section tells us that it has to be in writing. 1-201 has a definition of writing printing and any reduction to a tangible form, what does that mean though? So the issue here is if an electronic records a tangible form. Additionally an instrument also requires that it be transferred in ordinary course of business and in this case we dont really know if the transfer of these types of entries are transferred as an ordinary course of business. It is probably a deposit account, that is an account maintained with a bank. This is a critical distinction. If it is an instrument, then you need to file or take possession, but if is a deposit account, you need to take control, by one of the three methods in 9-104, that is taking control. The problem with these cases is always to be thinking about the what ifs, the concept of control by itself is a vague concept. The Bank may issue a written certificate to replace the electronic certificate at the request of the debtor, the debtor then can give someone else a SI in the written certificate. Another creditor could even take possession in the written certificate and the collateral now is in the hands of someone else and there is a creditor with priority under 9-330(d). In most cases as a creditor you can ask the debtor to give you a written or paper version of your electronic entry. 9-105 allows the creation of electronic chattel paper as long as the creditor can maintain control over it and can create it and store it in a unique and identifiable manner. This section tells the creditor what he must fulfill to create it but one cannot be 100% sure how to create an electronic file that cannot be confused with copies. The best solution is simply to get the debtor to print out the certificate of deposit or whatever and then youre back with the regular paper filing.

e)

Software on a consumers debtors personal computer, including software written by the debtor. The issue is over whether it is goods. If the program is so embedded with goods that it goes with goods (anti-lock brake example), then it is goods (9-102(44)). So if it is not embedded in goods then its goods, but if it is not embedded then it is going to fall in the category of general intangibles, under 9-102(a)(42). So what is embedded then; is the operating system software embedded? You can take it off and replace it etc, so probably its not embedded. So the software on a PC is not embedded most likely so it is not a good. The anti-lock braking system in the car is a

66

computer program is probably embedded in the car, you cant take it out with the transfer of the car. If we can take it off and transfer it, then its a general intangible. If its a general intangible, you have to file to perfect it. But goods could be perfected in a whole variety of ways: filing, possession, Cert of Title on car, etc. *With debtors own software, software written by the debtor? In that case were talking about IP and copy write issues. Kazinsky has to register by filing in copyright office. One has to look at what the collateral really is before filing.

f)

With respect to the manuals to software: 9-102(75) defining software includes supporting stuff so this would also be a general intangible and hence perfection would be by filing. Problem 21.2: Why have separate systems? If you keep the real property and personal property divisions could you unite and make a single filing system for all personal property SI? Could you require a UCC filing for everything under one office? Prof thinks it would probably be a good idea. May place a greater burden on the debtor since the creditor could file against more of the debtors collateral more easily. The debtor would then find it hard to get extra or additional financing to try and re-finance the debt and pay up. No other bank would make loans. There could be issues trying to get the collateral from another creditor who has already perfected by taking possession. You would have to take it from another creditor. Farm products: filing is where crops are located but inventory is where the debtor is located. Instruments v. general intangibles and accounts: instruments by possession. Chattel paper v. accounts also makes things complicated. The ability to perfect by taking possession seems to be more certain today than dealing with the filing system. You could theoretically get rid of problems by having everyone file in the same manner. Problem 21.3: Is there someway to structure a transaction to create a lease out of what is really a sales transaction? If you run the same payment schedule for the whole life of the equipment you are going to end up having a secured transaction and not a lease. This is the problem of true leases v lease intended for security. The seller needs to assume some risk to take advantage of the full econ value of the property and to make sure that a Court will find that the deal was a lease and not a SI. The longer the lease and the closer the terms that the so called lease has similar to those of a sales contract the higher the risk of a Court finding that the lease was really a SI.Their solution is to require filing for all true leases. They want to say that you can turn a lease really intended as security into something that looks like a lease transaction by shortening the term and saying that you have to pay the reversionary interest. PART VII: MAINTAINING PERFECTION XXII. MAINTAINING PERFECTION THROUGH LAPSE AND BANKRUPTCY (22) A. Removing Filings from the Public Record How to Terminate Perfection (p375) Security filings arent literally removed new files are added to state that the old document is no longer in effect Nearly all real estate recording systems operate in this manner Satisfaction in real estate transactions When a real estate mortgage is paid, the mortgagee executes a document called the satisfaction of mortgage for recording. Both the mortgage and the satisfaction remain permanently in the recording system When someone wants to sell property with a mortgage to a new buyer who wants to take it free of the mortgage, a closing is held, where all the parties can simultaneously exchange documents. Because of the importance of satisfaction, statutes in most states provide for imposition of a penalty on a secured party who fails to give one to a debtor who has fully paid the mortgage debt. Release in real estate transactions Mortgages frequently encumber more than one parcel of real property. If such a mortgage has not been paid in full but the secured creditor is willing to release some of the property from the mortgage lien, the secured creditor accomplishes this by executing a release for recoding. Releases secured interest for a portion of mortgage debt

67

Most often in real estate developments for sales and subsequent mortgages of individual plots Absent a release provision in a mortgage, the mortgagee is under no obligation to release the collateral on partial payment of the mortgage, even if the debtor offers a paydown that will improve the lenders collateral-to-loan ratio. Article 9 Termination and release If debtor has paid the secured obligation and the secured party is not required by contract to lend more money, debtor can demand that secured party file a termination statement w/in 20 days 9-513(c)(1) If SC fails to do so, SC liable for actual damages and a civil penalty of $500 9-625(b) and (e)(4) Upon the filing of termination statement, FS to which it relates ceases to be effective 9-513(d) As under real estate law, the secured party is obligated to file a termination statement upon full payment of the secured debt, but is not obligated to file an amendment deleting collateral on partial payment unless the secured party has contracted to do so. Termination statement must identify file number of FS and declare it no longer effective 9-102(a)(79) Termination statement becomes part of financing statement to which it relates 9-102(a)(39) Thus, errors in termination statement are subject to seriously misleading test of 9-506 9-512 requires that an amendment identify initial financing statement by file number. Could wrong file # be a minor error that didnt render it seriously misleading? 2 possibilities: Although 5-609 wouldnt literally apply, courts would apply it by analogy Indexing error. Amendment effective regardless of whether searchers could find it: 9-517 B. Self-Clearing and Continuation in the Article 9 Filing System (p379) Article 9 filings are self-clearing lapse after 5 years FS lapses unless SC files continuation statement during the last 6 months of 5-year period. 9-515(a),(c) One year after lapse, filing officer can remove and destroy it. 9-552 Continuation system: rather than new filing, informs new filers of original date of security interest (run from the date of the original filing, not when the continuation statement is filed). UCC 9-515 distinguishes between a continuation statement and a later-filed financing statement, and the courts generally enforce the distinction with vengeance. Worthen Bank v. Hilyard Drilling Co. (8th Cir. 1988, 381) NBC fails to continue security interest in Hilyard AR instead files new financing statement Worthen files financing statement on same asset. B/c NBC didnt continue, Worthen has priority. Same result: In re Hays (384): New financing statement is not substitute for continuation statement Moreover, continuation statements filed too early are not valid 9-510(c), Lorain Music Co. (385) Upon lapse, security interest becomes unperfected and is deemed never to have been perfected as against a purchaser of the collateral. 9-515(c). This retroactive loss of priority is only against purchasers, or holders of security interests Doesnt apply to lien creditor or trustee in bankruptcy if was perfected when acquired lien or entered bankruptcy Comment 3, 9-515 C. Effect of Bankruptcy (p386) Even in debtor BR, SC must file continuation statements 9-515(c) This doesnt violate automatic stay Bankruptcy Code 362(b)(3) and 546(b)(1)(b) D. Problem Set 22 Problem 22.1: Financing statement filed on Dec 30, 2001, a continuation on July 7, 2006 - was that continuation filed properly? a) It was filed on time. You have to file it within 6 months of 5 years, and if you file it later or earlier, its ineffective. Lawyers sometimes neglect to have the conversation with the client on who is going to accept responsibility. File it between June 30 (or July 1) and December 30, 2006.

68

b) The next window if the statement filed on July 7, 2006. Does it run from July 7th or December 30th. It
runs from the 30th because the old statement is effective until Dec. 30th and the second is filed but doesnt run until the old statement expires, so it lasts until Dec. 30th 2011. c) There is no stay under 362(b)(3) to perfect on interest. Section 362(b)(3) refers you to 9-546(b)(1) which says you are protected as against the lien creditor in the intervening period. You can file the continuation after debtor files for bankruptcy. The bankruptcy dates do not change the dates. The continuation statement is an important document in any transaction that is ongoing. Problem 22.2: The lawyer makes a mistake. The layer discovers that a client sold a restaurant and took back a PMSI, which payments are suppose to go over 6 years, and the lawyer discovers that he did not file a continuation within the 5 years 6 month period. He will have to file a new financing statement. Will that be effective? Youll have to see if somebody else has also filed or see if there has been a judgment and levy. Suppose you find another financing statement. Under 9-509, a security agreement gives a debtor authorization in filing an initial financing statement and amendment (a continuation is not an amendment). There may be an agreement in the security agreement that says you can file a continuation or another financing statement. You are worried about any intervening interest in the last two months. The debtor now has the ability to lend money on the security because there is no longer a perfected security agreement. The second financing statement has no authorization because the security agreement only applies to the initial one. Whatever is decided should be memorialized in writing because the lawyer can always claim that Gomez was supposed to file a continuation. Before you call your malpractice insurer, what do you want to know? You want to know if you are able to file another financing statement. Do you have the authorization. What do you want to know, suppose you file and you think it is alright, what is it that you want to know. You are going to do a search to see who has intervening filings. Why not get authorization from the debtor? The debtor now has the ability to lend money on the security because there is no longer a perfected security agreement. There is another question regarding if you have to notify your client of this. Suppose you find out that there is someone who has a priority over you now, do you have to call your client? Can you say, why didnt you file a continuation statement Gomez? The continuation statement is supposed to occur in five years so then you didnt even know that he will be your client. You ought to clearly and in writing tell your client that perhaps it was the clients responsibility to file the continuation statement or secure council to do so. Problem 22.3: This involves a fight between two secured creditors, one with possession of the collateral when both filed, while the second filed first and the one with possession filed second. First in time under 9-322(a)(1), and under 9-308(c) if you perfect in different ways then both of them are continuous and you can tack them (if by another method). Possession method one and filing method two. The possession works to beat out the first filing creditor. You should always look to see if there is automatic perfection and possession, not just that no one else has yet to file. You ask the debtor where he got the goods from and ask the seller if he has a security interest, he doesnt have to tell you but this will signal red flags, how you check for automatic perfection. You can get an affidavit sworn to before a notary and dated as of the relevant date or pictures to prove you had possession of the assets at the date you claimed you perfected your interest. Problem 22.4: Real estate development. The developer is financed on entire holdings and then sales one lot, and the buyer does not want to buy the lot with anothers mortgage stuck to it. Courts will enforce mortgage as written. You are going to look at the terms of the mortgage, if there is a release term hurrah, if not, then you tell your client he is going to have to beg because the court is going to enforce the mortgage as written. The court is going to say to get a lot released you have to pay the entire 160,000 to get the lot released. You cant clear the title by merely paying 30,000. You could beg or try to get refinancing. Problem 22.5: There is a lender secured by forklifts and additions/replacements. The financing statement says all collateral. Now the debtor wants to borrow against a drill press, which is not covered by lenders SA. Debtor wants lender to file a release but lender wants it as leverage. There is nothing in article 9 requiring a release. If the financing statement is authorized, its completely effective. The debtor has to authorize the financing statement. So at that time, put releases in the statement. You can try to refinance. You can get the secured creditor to give a statement of current collateral, but the financing statement still allocates priority between secured creditors. There is a very broad financing statement that has been filed that covers equipment. Secured creditor hasnt made a loan against all the equipment of the debtor, it has only made a loan against some of the debtors equipment. The

69

financing statement is much broader than the actual equipment the creditor has a claim against. The debtor wants to get a release to so that it can take the portion of the financing statements coverage off. They cant do anything, they authorized the financing statement so it is just too bad. The new lender will not give a loan against the property that isnt in the other secured creditors security agreement because (in bankruptcy no problem because security agreement doesnt cover the equipment) if subsequently the original secured party lends some more money against the drill presses even though its security agreement will be second to us, its financing statement is prior to ours and it will have priority. Suppose the debtor promises us he wont give the original secured creditor an interest in the drill presses, if they break that agreement were stuck. Suppose the new lender goes to the old lender and gets an agreement from the old lender that it wont take a security interest in the drill presses. The moral is that representing a debtor this is the sort of problem that the debtor runs into that the debtor authorizes the filing of a too broad financing statement, when the statement describes assets by type rather than the particular assets covered. Problem 22.6: what happens if mortgagee tries to screw debtor? There are not a lot of options when closing is set. You can pay the ransom and sue for a refund after get satisfaction. You need the cooperation of the buyer. Under FL statute, you can get attorney fees. In some jurisdictions, you can ask for an emergency order. AZ. holds secured party liable for actual damages. What happens when your mortgagee holds you up and says you owe more money than you really do and you need to close. You could pay what they ask for and hope that theyll give you a satisfaction of mortgage by closing date and then sue for a refund. You will be met with a defense, but will you really sue for such a small amount. You could refuse to pay the money, let the sail fall through and sue Global. Is the loss of the deal avoidable damages under contract law because you could have sold and sued for a refund. Maybe the buyer would help out. Under FL statute, you can get attorney fees. In some jurisdictions, you can ask for an emergency order. AZ. holds secured party liable for actual damages. Complicate suit for a small recovery. NC allows money to be deposited with court and order execution of release once money with court. Problem 22.7: Under 9-513(c) the Suarezes would be entitled to a termination statement within 20 days of the payment of their debt, instead of the 30 or 60 provided for in the AZ and FL statute. If there is a shorter time period maybe you could get the buyers cooperation. Thinks that in a situation like this faced with the sellers problems will just want to wash their hands of it. XXIII. MAINTAINING PERFECTION THROUGH CHANGES OF NAME, IDENTITY & USE (23) A. Changes in Debtors Name (p391) 9-507(c) although a change in debtors name renders FS seriously misleading, remains effective for: collateral owned by the debtor at the time of the name change collateral acquired by the debtor in the first four months after the change For collateral acquired four months after change, FS not effective to perfect a security interest Effect of this rule: lenders who securitize property to be acquired must keep current. Financer of inventory who doesnt notice for a year may not longer have a security interest in any collateral Most security agreements require debtor to notify the secured party of a name change, but this doesnt stop certain debtors although they will have civil liability for breach of contract. Failure doesnt subject them to criminal prosecution. Changes in Name vs. Transfer to New Debtor Changes in name are covered by 9-507(c), transfer of collateral to a new debtor is covered by 9-507(a) 9-507(a) notes that a security interest is still effective if collateral is sold, exchanged, leased, licensed or otherwise disposed of and in which a security interest continues, even if the secured party knows of or consents to the disposition. B. Changes Affecting the Description of Collateral (p394) Type 1 changes: 9-507(b) even though a change in the use of collateral (going from inventory to equipment) renders a filed financing statement seriously misleading, remains effective Change in circumstance did not control the place of filing, but did make the collateral difficult for the searcher to identify as covered by the filing. Type 2 changes: 9-507(b) if collateral is changed into an item that itself requires a different type of

70

filing (like real estate, or certificate of title), UCC excuses the seriously misleading description of collateral, but likely not the failure to register the collateral in the new system. Change in circumstance is one that is sufficient to affect the method of perfection that would have been appropriate for the initial filing. C. Exchange of the Collateral (p394) On sale, exchange, collection, or other disposition of collateral, a security interest continues in the identifiable proceeds, UCC 9-102(a)(64) and 9-315(a)(2) The holder of a security interest will want: The security interest to be perfected in the proceeds and The perfection to be continuous from the creditors original filing Barter Transactions Barter is the exchange of one commodity for another in a transaction in which no cash is involved. 9-315(d)(1) govern perfection in a barter exchange, are different from the rules governing perfection in exchange for cash that is then used to purchase the commodity. Type 0 barter: if exchange is for a good that itself would be included under original financing statements description of collateral, new interest is already perfected even w/o a clause in the contract about proceeds. 9-203(f) This is because 9-502 allows the filing of a financing statement prior to the security agreement being made. Type 1 barter: if exchange is for property not covered by description in FS, but the filing office would be the same for new collateral, secured party remains perfected w/o a new filing. 9-315(d)(1). SC thus always in doubt about perfection unless he knows that debtor didnt swap for that collateral Type 2 barter: if exchange of collateral for non-cash proceeds, filing for which must happen in a different office, lender must re-file in that office to be perfected because doesnt qualify for 9-315(d)(1) exception. For continuous perfection, SC must file w/in 20 days of debtors receipt of item. 9-315(d)(3). The secured party doesnt need any additional authorization to rile a financing statement to perfect proceeds in collateral as far as UCC concerned, 9-509(b)(2) In re Seaway Express (9 Cir. 1990, 397) Secured loan on AR; AR is paid by grant of land. Not perfected b/c separate filing not made. Collateral to Cash Proceeds to Noncash Proceeds Provided it can trace its value, a creditors security interest will apply as proceeds of proceeds. 9102(a)(12) and (64) But is the interest still perfected? Type 0: (description broad enough to cover both) yes, still perfected 315(d)(3) Type 1: (description doesnt cover new collateral) not perfected unless creditor files new FS. Not continuous unless filed w/in 20 days of debtors receipt of new collateral 315(d)(3) Type 2 change (requires filing in new office) same 315(d)(3) Collateral to Cash Proceeds (no new property) 9-315(d)(2) secured parties have continuous, perpetual perfection in identifiable cash proceeds. Instead of relying on 9-315(d0(2) they could also perfect in deposit accounts as original collateral by taking control of the account under 9-314(a). D. Problem Set 23 Problem 23.1: HM is a compliance officer at Gbank. She is working with Bonnie, owner of Bonnie Boat World. GB finances BBW inventory under a financial statement that describes collateral as inventory, accounts, and chattel paper: a) Changes affecting description of SAME collateral: On routine inspection, HM found that B violated security agreement prohibiting use of inventory by keeping it at her house (using it personally). Did the interlude have any effect on GBs security interest? Under 9-507(b), even if change in circumstance makes

71

financial statement seriously misleading after initial filing, it is still effective if would file in the same office. Under 507(a), security interest follows to Bonnie (from BBW). But if personal equipment, GB now has to file under COT office for boats. Excuses seriously misleading description but not non-filing. But if its owned by the business, the business cannot use it as consumer goods. This is careless drafting under 9102a23-26, defining consumer stuff as used by individuals. How do you sort it all out? A careful lawyer would initially file it as equipment. It is probably equipment since the debtor is a business, but maybe its consumer goods, since the drafting is not clear. If consumer goods, dont worry about it. Change of use makes it misleading but the financial statement is effective under 9-507b. b) What happens when ownership of boat transferred from company to Bonnie? GB is still perfected. This is not a change of name (507c) but rather a transfer (507a) and the security interest follows. A transaction of this size would have paperwork. This is an unauthorized transaction, and financing statement is still good. c) BBW traded boat for forklift. Went from inventory to equipment. Barter transaction type 1, where same office, and under 315(d)(1) the secured party remains perfected without a new filing. This is the elephant rule. d) What if BBW bought the forklift with cash from the proceeds of a boat sale? No longer effective under 9-315(d)(3), which requires filing within 20 days for collateral to cash proceeds to noncash proceeds transasction. e) Bank should have, but was not listed as loss payee of former insurance policy does bank have a perfected interest in claim against former insurer? Insurance loss is proceeds under 9-102(a)(64), so 9109(d)(8) allows 9-315 to apply. Was security interest in original collateral perfected? If so, under 9-315c the proceeds are perfected. Assume yes, then perfect cash proceeds within 21 days by taking control. Under 9-315d, proceeds become unperfected unless comply with provisions. Before the insurance company pays out, is it identifiable cash proceeds? If the insurance company owes you money, its a general intangible. You perfect that in the same financing office. So you can comply with 9-315d1. Boats to Insurance is a 9-315d1 situation (barter in same office) and then its goes into identifiable cash proceeds (under 9-315d2 you are perfected), and finally, trace it to the deposit account where it is still identifiable cash proceeds and 9-315d2 protects you. What if another bank takes a second security interest in the boat for extra collateral? If the second bank becomes loss payee, then the first bank loses security interest in insurance proceeds. The insurance payable to the second bank would say that its payable to second bank and Bonnie consistent with their respective interests. So GB says that it is payable to debtor, so it has proceeds interest in it. The answer is that you have a proceeds interest but only to the extent of debtors interest in insurance. If second banks interest is greater than amount of collateral, then debtors interest is zero and so is GBs. Do secured parties as common practice always see if name is on insurance policy? No, there is lots of malpractice out there. The peculiar wording of proceeds interest was insufficiently appreciated. Many secured parties make sure their names on insurance policies. The reason insurance is handled differently in Article 9 comes out of pressure in insurance industry. There can be a proceeds interest unless someone other than debtor or secured party is named loss payee. That opens up possibility that someone else on insurance policy gets money. Problem 23.2: GB inventory loan to SW Appliance. 6 months ago debtor changed name to SW General. How to remain perfected. Under 9-507(c), with a debtor name change, the financing statement is effective to collateral already owned by debtor before change, and collateral acquired in first 4 months since name change. Also, a 9-507c Amendment to change name to keep continuous perfection has to be filed within that 4-month period. But the debtor has to authorize the amendment. Amendments are for adding new debtor or new collateral. Problem 23.3: What procedures to keep up with name changes? A) Check every 4 months minus a couple of days. You may want to make it a shorter time in a jurisdiction that is behind. B) What about continuation statements and new names? There is nothing in article 9 that says new name has to be on continuation statement. C) In the investigation of a loan applicant, how old a name change could be relevant? 5 years.

72

Problem 23.4: Lender wants to loan secured by substantially all debtors assets. There is only one financing statement filed by Suti, describing the collateral as lawn dogs manufactured by Suti. There are only $25,000 of lawn dogs on inspection. Is there anyway Sutis filing could cover more than the lawn dogs? Yes under 9-315d1, via collateral barter with collateral in same financing office. Type 1 exchange! Also, lawn dogs may cover other collateral fitting under lawn dogs (type 0 unlikely). Also, cash proceeds ok and cash proceeds to bank account, control of bank account sufficient. But cash proceeds to other collateral needs financing statement under 9-315d3, if new collateral does not fit lawn dog description. You want to know if there is outstanding debt and that if there is lots of debt of unsecured creditors. Problem 23.5: A bank lends 1 million taking security interest in equipment , inventory, and accounts, chattel paper, and bank accounts. The lender files a financing statement. One of the debtors assets is a bank account. Does lender have security interest in the bank account? Maybe. Control is exclusive if original collateral. But security interest follows/perfected to cash proceeds under 9-315d2. So, only if control if original or cash proceeds. Are they identifiable cash proceeds under 9-315d2? It does not matter how long the cash proceeds have been in the bank account. The time factor is not important. XXIV. MAINTAINING PERFECTION THROUGH RELOCATION OF DEBTOR/COLLATERAL (24) A. State-based Filing in a National Economy (p403) Art. 9 is adopted in 50 states; filing requirements in 9-301 to 9-307 take place in different state offices 9-301 9-307 govern perfection by possession, control and filing. B. Initial Perfection (p404) At the location of the debtor: 9-301(2): If interest is possessory, the local law of the jurisdiction the collateral is located in governs If the law of the state applies, 501(a)(2) will require filing in the statewide filing office 9-301(1): While debtor is located in state, local law governs perfection of non-possession security interest if the interest is non-possessory If the law of the state applies, 501(a)(2) will require filing in the statewide filing office 9-307: individual debtor is located at principle residence (living there, not permanently domiciled there) 9-307(e): registered organization that is organized under the law of a state is located in that state In other words, state of incorporation is state of perfected filing Policy: incorporation is matter of public record ease of notification For non-incorporated organizations: 9-307(b)(2) debtor is located in its place of business if it has only one such place If more than one place of business, nerve center test (406) At the location of the collateral 9-301(2): If interest is possessory, the local law of the jurisdiction the collateral is located in governs If the law of the state applies, 501(a)(2) will require filing in the statewide filing office Fixture filing: made in office of recording for real property to which fixture is attached 9-501(a)(1) So these filings must sometimes be made in states other than debtors state 3 properties governed by control rather than filing: deposit accounts, investment property, letters of credit C. Relocation of the Debtor (p408) When debtor changes state of principle residence, SC who filed in original state has four months to file in destination state 316(a)(2). If SC doesnt, security interest becomes unperfected . 316(b) This is retroactive with regard to purchasers for value including secured creditors, but not as against lien creditors, including trustees in bankruptcy. If corporation relocates/reincorporates by merger or sale of assets, 9-316(a)(3) gives SC one year to

73

perfect in new state If merges will be a matter of public record and easy to discover If sale of assets, will be more difficult to discover An unregistered organization can move from one state to another by changing the location of its chief executive office D. Notation Based Filing in a World Economy (p409) 9-301 applies among nations as well as states regarding a choice of law applicable to the secured transaction. 9-301(1) tells us that its the location of the debtor that governs perfection but 9-301(3) tells us that the law of priority is going to be governed by the jurisdiction of the collateral. This is what the wording of this means. If the corporation is registered in DE the creditor has to file in DE but the priority law will be that of where the collateral is located. To date there is no world wide filing system, and countries have various rules. One option would be to require filing where the collateral is located. This gives power over the form of filing to the country that has power over the collateral thereby assuring that security can be enforced and another option would be to require filing in the country of the debtors incorporation. The Unidroit Convention Relating to the Recognition and Enforcement of Security Interest in Mobile Equipment adopts neither of these, it just adds a new filing system for a specific type of collateral. E. Problem Set 24 Problem 24.1: William Shatner is the debtor. The collateral of the business is located in Tucson, AZ. Shatner lives in Kansas but will probably move to Missouri. He plans to move to Hawaii in a few years. His wife also works in the business. Who is the debtor? It is dependent on who owns the collateral, and it is not clearly specified in the problem. If William Shatner owns the collateral, he is an individual debtor under 9-307. An individual debtor is deemed to be located at the individuals principal residence. Where should the creditor file for Shatners principal residence? It is uncertain, so the creditor should file in all three places: Kansas he is currently living there, but you already know he is looking for a new place. Arizona his summer home. Missouri where he is looking of a house, and the creditor would want to be on file as soon as the debtor moves. Who is the debtor? Debtor is a defined term, a person having an interest, not a security interest, in the collateral whether or not the person is the obligor, 9-102. The collateral appears to be owned by Shatner Engineering, located in Tucson, AZ. So where do you file? 9-307(b) William Shatner, is he an individual or an organization. Lets assume he is an individual, where are we going to file? 9-307 tells you to file at the individuals principle residence. But where is Shatners principle residence? In the short term he intends to move to MO, why dont we file in MO? He does not have a residence in MO at the moment. In the long-term wants to move to HI, but he currently doesnt own anything there? He currently lives in KA, but he has no intention of staying there. AZ is where hes been the longest with a residence there. You file in KA because residence doesnt necessarily mean domicile so the intention not to remain may not stop KA from being the principal residence. File in AZ as well because he has a long-term attachment to there. You might also file in MO because he has an intent to live there, it probably isnt good now, but it might be in three months.

A) So what is Shatner Engineering? What would you call it? This is likely a sole proprietorship. A
debtor that is an organization and has only one place of business, does that apply. Is a sole proprietorship an organization. 9-307 comment 2: personal and business assets, it contemplates that an individual can be someone who owns business assets. 1-201(28) is the definition of the an organization found in the UCC. This tells us that it is two or more persons who have a joint account interest. So is Shatner an organization? So is he not a corporation because he isnt two or more people? Under the current notion if you keep reading it doesnt define an individual so Shatner Engineering could be something other than an individual. Subsection 28 suggests we have an organization here. What state does the debtor conduct the business from, AZ. But where is the chief executive officer or does it have more than one place of business. The real question is, is there more than one place of business. The nerve center is in MO during the academic year and AZ during the summer. His ex-wife receives a percentage of profits, sounds kinda

74

like a partnership doesnt it. Youd have to dig into that. What is the relevance of deciding shes a partners, then you know you have an organization. B) What names should we put on there? We are going to put William Shatner, Shatner Engineering, and Louise Godfrey (put them all on just to be sure). C) Nevada Corporation, why would you file in NV, all we know is that Shatner formed a NV corporation under Shatner Engineering Products Inc. You would want to know if the equipment, accounts and inventory belong to the corporation. How do you find that out? Youll have to ask the debtor all the stuff about how the accts. Arose and if there was a Merger there will be a public record of it. In the end if you cant assure yourself if this business youll file in another place. Could just file in NV instead of saving money. If there is a corporation in the picture, all these other things that youre worried about, youll start worrying about with respect to Shatner Engineering. What if Shatner Engineering Products, Inc. is a Nevada corporation? Before filing, make sure that the corporation owns the collateral that the creditor is taking a security interest in. How do you find out if the corporation owns the collateral? Look at invoices for the relevant equipment and inventory. Look at the invoices from the corporations debtors to see if they are in the name of Shatner Engineering Products, Inc. to determine if the accounts are owned by the corporation. If Shatner Engineering owns the collateral, file in Nevada, the place of incorporation. What if the business is unincorporated and Louise owns 1/3 interest as a tenant in common. In what state do you file? Which names should be listed? An organization is two or more persons having a joint or common interest. Thus, Louise and William Shatner, who share ownership in the business as tenants in common, are an organization. If the organization has more than one place of business, the proper place to perfect in the collateral is at the chief executive office. 9-307(b)(3). The creditor should file at both places of business (where Shatner and Louise are both located). Problem 24.2 How should Firstbank monitor the location of the debtors? Would the answer change if the loan were for $25 million instead of $225,000? Individual Debtors: Check the principal residence of the individual debtor in a time period that is less than every four months. When an individual debtor changes his or her state of principal residence, the secured creditor who filed in the original state has four months in which to file in the destination state. 9-316(a)(2). If the secured creditor does not file, the security interest becomes unperfected. 0-316(b). Registered Organization look at municipal records, tax records. Merger: Check the public records for merger documents in a time period that is less than every year. 9-316(a)(3) gives the secured creditor a year to discover the merger and perfect in a destination state. Sale of assets: Close monitoring b/c it may not show up in the public records. Unregistered Organization: Keep an eye on the office of the chief executive officer. Monitor Shatners involvement with the business, and if he cuts backs, retires, or withdraws, you might want to check on where the business is being run from. Who do you check who owns the collateral? Look at invoice documents from time to time. Problem 24.3: Global bank, the client, is lending $1.9 million to Tang Aluminum Products, Inc. to purchase the inventory, equipment, accounts and general intangibles of Argon, Inc. How should the lawyer conduct the UCC search? What inquiries should the lawyer make? Names to search? Filing systems? You want to know what other liens Argon had because Tang takes them subject to those liens. If Tang is not a registered organization youll have to worry about its place of business or its chief executive officers. Where is the first place youd go to verify what Tang has told you. The corporation division of the state to verify the names and the registration. Youd like to know if there has been a name change, because valid claims can exist in previous valid names that exist. Youd also like to know a change of identity through a merger. Youd also like to know if Argons in possession of its intangibles, youd like to know whether they own or lease them and if they own them,

75

you want to know how they got them. You want to know how they got them because if they just bought them they just bought them from some CA company, not a manufacturer, they might encumbered, they might have bought them subject to a security interest perfected by filing somewhere else. If you are really counting on these assets youre going to do some checking by asking for invoices and the like just to make sure they didnt buy them from some other company. Problem 24.4: Afghan law gives priority to the first security interest created and that country has no filing system. Firstbank loans $1 million to Afghan, Inc., an Afghanistan corporation whose headquarters and operations are in New York. Where if Firstbank required to file? Answer: File in New York. 9-307(c) 9-307(b) only applies if the debtor is located in a jurisdiction whose law generally requires information in a filing system. (9-307(b) applies b/c New York has a filing system). Under 9-307(b), the debtor has only one place of business (New York). What tells us that you file in the place of incorporation? E says a registered corporation that is created under the law of a state, Afghanistan is not a state. So e does not apply and were left with b. When you look at c, NY complies to Suppose Afganistan did have a filing system and the company had a place of business in Kabul where its chief executive officer was as well as in NY. C says that B applies only if a debtor residence, place of business, or chief executive officer has one of these systems. If Afganistan didnt have a registry system youd file in DC. Note in the prior problem it had only one place of business which is why you could file in NY. Problem 24.5 What would happen if: Delaware adopted a non-uniform amendment that excuses filing altogether, and all security interests are perfected without filing. Cherokee, Inc. a Delaware corporation whose assets and operations are located in NY grants a NY bank a security interest. The NY bank does not file a financing statement. A year later, Cherokee, Inc. files for Ch 11 bankruptcy in New York and wants to avoid the banks security interest as unperfected. Solution: If litigation occurs in New York, New York has adopted the official text of Article 9, which provides that perfection is determined by the local law of the jurisdiction in which the debtor is located. 9-301(1). Since the debtor is located in Delaware, Delaware law governs. And Delawares substantive law provides that security interests are perfected without filing. 9-307 was drafted to take care of this problem. E is controlling and he thinks the drafters blew it, all these except as otherwise provided really come home to roost. They shouldnt have done it there. If we got rid of filing a private market would grow up that would serve the interests of the major creditors many of whom rely on the private information market in addition to the public market already. The kind of credit information they get is very important to them, it is the financial situation of their debtors. That is what they are really relying on most. They might find it less expensive to rely solely on the private market system. It certainly wouldnt serve the interests of smaller creditors that a public filing system applies. XXV. MAINTAINING PERFECTION IN CERTIFICATE SYTEMS (25) Each of the 50 states maintains a certificate of title system for motor vehicles In all states the certificate of title system is physically separate from the UCC filing system. A widely adopted certificate of title act operates in almost all states; Uniform Motor Vehicles Certificate of Title an Anti-Theft Act (UMVCTA). For each motor vehicle in a system the Dept keeps a certificate that describes the vehicle and shows who owns it (The certificate contains the Vehicle ID Number or VIN). On the back of the certificate of title there is a form for transferring ownership of the vehicle. The face of the certificate is the proper place to record any security interest. The certificate of title is prima facie evidence of ownership but if ownership is with a person other than the person shown on the certificate there is no impediment to proof of that fact. The certificate has little importance in granting and perfecting SI in motor vehicles. A SI can be granted by any writing it need not be noted on the certificate of title to be valid.

76

In certificate of title systems, security interest are called liens and filing is called notation of the lien on the certificate of title. In the US almost all states transfer a motor vehicle by an annotation on the certificate of title. In Canada this doesnt operate like this, there a filing in personal property has to be done. Perfection of a security interest in a motor vehicle In the US, security interests are perfected by notation on the certificate of title in all but a few states The secured creditor must deliver to the Department (of motor vehicles) its application for notation of its lien on the certificate of title. Security interest need not be noted on title to be valid. Perfection is not accomplished by notation on either owners or Departments copy of certificate, but by application for such a notation. Advantages of certificate of title system: Title system contains title as well as lien information. Searchers in Art. 9 must determine from other sources the owner of collateral. In the certificate system as in real estate system the chain of title is on the public record, and a searcher can trace the debtors title back to its source. All collateral identified by two numbers: License plate number and VIN. This makes it easier to know if a SI has been filed against this particular collateral and doesnt give searchers the problems of the filing against the debtor. A searcher can look up one of these numbers since the collateral has a unique number assigned to it. Weakness of certificate of title system Unable to deal with the addition of parts to or the removal of parts from the whole. Additions to the boat, car or motor home are going to present inconveniences since the system was designed for items that were going to remain intact. A. Perfection in a Certificate of Title System (p420) Security interests in cars, motor homes or boats will be regulated by Art. 9 since its property subject to Art9 under 9-109(a),(c) and (d). However, 9-311(a)(2) and (3) provide that the filing of a financing statement otherwise required by this Article is not necessary or effective to perfect a security interest in property subject to [listed certificate of title statues of this state] or a certificate of title statute of another jurisdiction under the law of which indication of a security interest on the certificate is required as a condition of perfection. Perfection occurs at the moment when the filing officer receives the documents and the filing fee. The filing must include the existing certificate of title If the certificate is lost, stolen or destroyed the owner or legal representative of the owner is entitled to a replacement. Generally will accept both application for a new title and application for a lien on that title on the same day. Once made, the notation on the certificate of title relates back not just to the filing officers receipt of the application but to the time of creation of the security interest When the Dept issues a new Certificate of title noting the existence of the lien it mails the certificate to the secured party rather than to the debtor. The secured creditor is the only party that can request a duplicate of the certificate of title. Sometimes debtor can fraudulently register certificates of title with more than one state. They can register in FL and go to AZ and say that they lost the certificate and the Dept will give the debtor a new certificate clear of liens. Searches of the system can be requested by mail, or in most states, online. B. Accessions and Removals (p422) Just as personal property can be affixed to real property, creating a fixtures problem, one item of personal property can be affixed to another item of personal property creating an accessions problem. Accession problems present the most difficulty with regard to property covered by a certificate of title system The certificate issued in a certificate of title system implicitly assumes that the collateral is a whole and is mortgaged as such; the certificate of title is not designed to deal with the possibility of mortgages against particular parts of that whole. To give the accession-secured creditor priority would be to enable debtors to routinely defeat SI just by

77

affixing the collateral to a whole financed at some earlier time. Three Types of Accession Problems 1) That which is not sufficiently related to the whole to be considered part of it and therefore not an accession (spare tire); 2) That which is so integrated into the whole that it is part of the whole for financing purposes (mixer on the back of a cement truck); 3) Accessions, the property in b/w that is sufficiently integrated that is sufficiently affixed to be reached by a security interest in the whole, but not sufficiently integrated that it can no longer be subject of separate financing (tires on car). The accession-secured party can perfect its interest in the accession by filing in the Art 9 system but must do so before the property becomes affixed. 9-311(a)(2) provides that the filing of a financing statement is not effective to perfect a security interest in property subject to a certificate of title statute. 9-335(d) gives a security interest in the whole priority over a security interest in an accession to the whole, regardless of the order in which the two security interests were perfected and even though the security interest in the accession is attached and perfected before the accession was affixed and before the security interest in the whole was created. 9-335(e) bars the holder of a subordinate accessions interest from enforcing it, rendering it virtually worthless. 9-355 facilitates the financing of automobiles, aircraft, boats and other certificate of title property as wholes and makes accessions filing impossible. The biggest losers with this system are those who finance items not intended to be used as accessions, but that are. Under 9-335 any secured creditor whose non-certificate of title collateral is affixed to some other secured creditors certificate of title collateral effectively loses its interest. C. In What State Should A Motor Vehicle be Titled (p424) Manufacturers of motor vehicles assign a unique VIN number and issue a certificate of origin for each vehicle, which contains the make, model, and VIN of the vehicle. Vehicle Held as Inventory While a car is in inventory in the hands of a manufacturer or seller or dealer, the certificate of title statute does NOT apply (UMVCTA 2a2). Perfection of a security interest in the inventory of a car dealer is accomplished by filing a financing statement, 9-311(d), in the state where the dealer is incorporated (301(1) and 307(e)). Motor Vehicle Upon Sale Upon sale the dealer delivers the certificate or origin and that buyer makes application for the first certificate of title based on the certificate of origin, UMVCTA 4 Once the certificate of title is issues, liens against the motor vehicle can be perfected only by notation on the certificate of title, except while the vehicle is owned and used by the dealer Read literally UMVCTA 4 requires every owner of a vehicle which is in a state and for which no certificate of title has been issued by [this state] shall make applicationfor a certificate of title of the vehicle. In realty, vehicles of nonresidents must be registered when nonresidents acquire a regular place of abode or use the state for business for an amount of time specified by state statute. The fact that a certificate of title is issues from an improper state doesnt prevent it from being the proper place for a creditor to note the existence of a lien. Perfection can be lost when an owner obtains a second title, but in no case has a security interest in the automobile been upheld unperfected because the owner obtained a certificate of title from the wrong state, see UCC 9-303(a). Hoffman v. Associates Commercial Corp: The debtor registered a truck in Main instead of Connecticut (avoiding higher price registration and taxes). The Court noted that the owners failure to register in the required place is an infraction but does NOT unperfected a creditors otherwise valid perfected lien. D. Motor Vehicle Registration (p425) Each of the 50 states levies a license tax on automobiles.

78

Within some period after becoming a resident of a state or brining a car into the state as a nonresident, the owner is required to register the car in the state and a certificate of registration is issued. The registration in large part duplicates the function of the certificate of title system. However, liens cannot be perfected by notation on a certificate The registration systems purpose is to collect taxes and keep track of cars on the road Not every movement that requires registration requires titling in the destination state E. Maintaining Perfection on Interstate Movement of Collateral (p426) How It is Supposed to Work A creditor keeps the Certificate of Title in his possession. When the debtor moves he is going to requests the creditor to help out with the new registration in new state and sends the forms over. The creditor will file the forms and send the Dept in the new state the certificate asking a new one to be issued reflecting the creditors lien. The Dept then send the certificate still noting the lien to the creditor and the license plate to the debtor. Things That Can go Wrong : The new state issues a clean certificate not reflecting the lien that encumbers the car either by error or fraud. The Dept should have known b/c they had the certificate from the creditor so this is clearly an error. The Depts failure to include the liens on the new certificate rendered them unperfected. Creditor should notice that didnt receive new certificate and complain. Dept issues a new certificate without obtaining surrender of the old one. This may occur when the debtor says that his original certificate has been lost or destroyed. The result is that two certificates exist, each arguably covering the vehicle. 9-303(b) takes the position that when a subsequent certificate of title to property is issued by any state, prior certificates cease to cover the property. The law of the second state governs although the security interest perfected by the notation on the first certificate remains perfected permanently against a lien creditor or a trustee in bankruptcy, 9-316(d) Against a purchaser for value such as Art 9 Secured Creditor (Purchaser is a Secured creditor under Art 9 Definition) remains perfected for only 4 months after the issuance of the second certificate. If the debtor fails to perfect on new title during that period, he loses against a purchaser, whether the purchaser purchased before or after the end of the four month period, 9-316(e) UMVCTA 20c2a expresses a different view since it chooses to give validity to the certificate coming into the state, that is the first certificate. B/c the first certificate still exists the lien holder remains perfected even when a second certificate is issued. UMVCTA 26a authorizes the revocation of a certificate that was fraudulently procured or erroneously issued. This is going to be an important strategic solution to the problem. This will serve the first creditor is making sure his SI is valid and remains such. Movement of Good b/w Non-certificate and Certificate Jurisdictions Non-certificate to Non-certificate moves 9-316(a)(2) gives you four months to refile Certificate to non-certificate moves 9-303(a) tells us that the movements arent impediments to continued coverage. None of the two conditions which would render the security interest ineffective contained in 9303(b) have been met. The two circumstances where coverage ceases to be good Title ceases to be effective under the law of the issuing jurisdiction The goods become subsequently covered by a certificate of title issued by another jurisdiction

79

The good continue secured because 9-316(d) and (e) dont apply Non-Certificate to certificate moves Upon move, 9-301(1) makes the new state with a certificate of title requirement govern However, the filing remains effective pursuant to 9-316(a)(2) for 4 months. If the secured party doesnt perfect in the certificate of title state in 4 months, its interest will be defeated by a purchaser who buys or takes a security interest during or after the four month period, 9316(b) The secured partys interest will not be defeated by a lien creditor or trustee in bankruptcy during the 4 month period. F. Problem Set 25 Problem 25.1: a) First Bank lends 65 grand to Kahled to purchase a Jaguar. First Bank perfects by notation on WI title, putting it in safe deposit box. Kahled moves to AL. It borrows from Second Bank, perfecting on AL clean title (Kahled gets a new one in AL) and then Third Bank also perfects on the title in AL. Is First Bank still perfected? Here Kahled told the Dept of the second state that he lost his original certificate of title in order to get more loans on his car. Start at 9-316(d) and (e). Under d, the WI security interest remains perfected until it would have been perfected under that jurisdiction (forever, COT doesnt expire), that is four months later. But under e, d does not apply to purchasers for value, if not perfected on second COT within 4 months after second certificate issued. Remember a purchaser is a Secured creditor and here the second and third banks have become perfected. But 9-316 is a priority statute that allows First Bank security interest to remain perfected against lien creditor and trustee in bankruptcy, so First Bank remains perfected in bankruptcy. The bankruptcy code calls on state notions of perfection. By phrasing what happens in terms of perfection, the drafters have succeeded in allocating priority in bankruptcy. See page 428 of TB. The rule isnt a rule about perfection, its a rule about priority but the drafters have no choice but to phrase it as a rule of perfection since that is an area in which State Law can regulate while bankruptcy law and priority is a matter of Federal law. Suppose First Bank realized within 3 months and got it noted on AL certificate? First Bank fulfills 9-311(b). Under 9-316(d) the lien was noted on AL COT, First Bank has never become perfected, and d applies, and First Bank remains continuously perfected. There are situations where you can make a demand to get COT, but the subordinate lien holder needs to require mailing from lien holder in possession. UMVCTA 21c. This is a very common situation. People move all the time to new jurisdictions. All kinds of things happen when people move from one jurisdiction to another. It is common. How can First Bank persuade Second Bank to registering of their prior lien? First Bank can threaten to bring and action for fraud under 26 of UMVCTA and apply for a new certificate of title to be issues only showing First Banks lien. If First Bank does bring an action of this kind Second and Third Bank will most likely be subordinate lien holders, the AL Court will order the Dept to issue a new certificate showing the three liens in order of preference. Problem 25.2: Babs has a Nissan in MI where she lives. She titled it in MI and got financing from MI bank, has possession of COT with lien, and she moves to NY without telling the bank. She thinks shell be in NY for only a while so she thinks she doesnt have to register in NY or apply for a new certificate. a) Is MI bank still perfected after 4 months and for how long? Under 9-303(b) the car in NY is covered by MI COT, indefinitely, until earlier of new COT in another jurisdiction or MI law leaves unperfected. Registration is not a COT. Since she had not applied for a new COT the law of the old jurisdiction applies. There is nothing in MI law that is going to render the COT ineffective because of the move. Under UMVCTA 20 the same result will be reached. b) Suppose Babs registers the car in NY but NY Dept doesnt issue a new certificate of title just the plates? The MI COT is still valid and the Bank perfected. c) Suppose Babe has possession of MI COT and not the Bank. She gets a new COT from NY, turning into NY old certificate, falsely telling them that lien was satisfied? She resorts to fraudulent methods of getting a clean title. Is the Bank still perfected? UMVCTA 20(c)(2)(A)- There may be a strong argument that the old certificate is still

80

existing in any meaningful sense since then creditors looking at the MI title will be mislead. An NY Court interpreting UMVCTA law should say that the MI certificate ceases to be effective when the NY application is turned into the Dept. Assuming that there is nothing in MI law that says surrendering in another state makes the lien unperfected, there is still an a argument that the lien remains perfected if possessed by NY. A COT is like a bill of sale given to owner. So it is still perfected under subsection d, but you still have subsection e, protecting purchaser for value. But MI Bank still has argument against other lien holders and TIB. But under UMVCTA, if name of lien holder is shown on existing COT issued by that jurisdiction (MI), his security interest remains perfected in NY. This means that searcher cannot rely on COT. The thing is that here the UMVCTA and the UCC conflict on this particular point. Which controls? There is no clear answer, they are both state law so one has to try and put them together as best you can. d) Suppose Babs lies and says there is no liens on MI COT, which she lost a while ago and NY issues a new COT. Is the Bank perfected? The MI certificate is still perfected against lien holders and TIB but not against purchaser for value (secured creditor). 9-316e However, under section 26 of UMVCTA there is a way for MI to revoke COT due to fraud. This section does not say that if you get it revoked you perfect a security interest noted on it. The lien does not say anything about priority of second secured creditor against somebody in the position of MI bank. Maybe that will be dealt with under article 9-316. The ability to get the clean certificate revoked means what? If MI bank gets NY COT revoked, what happens to its security interest? Problem 25.3: What should MI bank do to perfect lien on COT of MI residents for automobiles? What if they move from MI to another state? The Bank plans to lend only to residents on cars that initially titled and were registered in MI, will make sure the Certificate carries a notation of the Banks lien and it will retain possession. They are vulnerable to second clean certificate and will loose out to buyers for value on the automobiles. You can monitor debtors but that probably would not work out. So know your debtor. There is a section in the UCC that says that except as otherwise provided in the UCC a SA remains effective b/w the parties if there is something else that is missing. The agreement itself is going to have some value. The plan of the Bank is a good plan and will hold up against trustees and lien holders. 1-201(32),(33) = defines purchasers as anyone who takes for sale, lease, lien, security interest, mortgage etc. So a secured creditor, a second creditor that comes a long is a purchaser and can be a purchaser for value. The Bank that puts up the money and takes a SI in the car is a purchaser. Problem 25.4: Shoreline Boats, with own credit corporation, wants to finance boats sold by its dealers in 23 states

A) They want to know how to perfect PMSI. If in COT statute state, then you have to file COT. 9-309 says a
PMSI interest for consumer goods is perfected upon attachment but 9-311b says that the property that is perfected by certificate or title system must be complied with and only perfection will occur if compliance is carried out (compliance with the certificate of title act). Under 9-303a, you can go to another state and get a COT in another state, allowing you to beat out a TIB or a lien holder under 9-303c but not a purchaser for value. If Shoreline isnt in a state where certificate of title operates then to perfect a PMSI you file if a boat is considered a consumer good. You will tell Shoreline that they should file b/c there may be boats that are not bought for the purposes of consumer goods. Normally you dont have to file a SI in consumer goods if you are dealing with high ticket items as collateral it is worthwhile to file a FS. If there is a filing then there will always be perfection in these goods.

B) How should Shoreline Boats protect itself against later movement or retitling of the boats? Suppose we go
from one pure Art 9 state to another pure Art 9 state = You have to file within the 4 month grace period (9-316a2) during which to discover the move from one jurisdiction to another. Suppose you move from a Art 9 state to a certificate of title state= The Bank would have a 4 month grace period to apply for a certificate of title Suppose you move from a Certificate of Title state to a Art 9 state= as long as that certificate of title is still good, it remains good, then Shoreline will remain perfected on the collateral. If a second lender wants to check the item to serve as collateral, he would have to check to see if the debtor has moved recently from one jurisdiction to another to see if there is a certificate of title outstanding. Certificates of title on trucks for example can be obtained in Maine no matter where you live. This is why you need to be careful, the boat in this case can be titled anywhere in the US and it will be effective. If the debtor moves from one certificate of title

81

state to another certificate state and the debtor doesnt ask for a new certificate in the new state the creditor will remain perfected on their certificate. If they go out and get a new one then the 4 month time frame operates. When Shoreline finances in a filing state what should Shoreline do? They perfect by filing in the state and then go to a state that allows titling of certificates of title and filing on the certificate of title to get additional protection. Problem 25.5: How to perfect on bulldozer, owned buy IL corp. and used in MI? Coldwell offices are in IL but bulldozer is in MI? We need to look at the two statues that conflict with one anther: 1. Under UMVCTA 5 tells us that a COT is optional and if you exercise the option and get a COT the perfection is not effective until the lien holder has complied with applicable law, that is with Art 9. The notation perfects although it is not going to be effective until the secured party complies with Art 9.2. Under article 9-311(a)(2), the filing of a FS is not necessary or effective when you must file on a COT. If you are perfected under a COT, filing isnt effective under Art 9. Hopefully Courts would find that the drafters of the UMVCTA meant to say that special mobile equipment is to be perfected under Art 9 and a gratuitous COT filing will help searchers. If Art 9 controls in this case then youd file where this organization is registered and file there. If its some other type of unregistered organization the you file in IL since thats where its main place of business is. In the end file in both places. Get a COT in case this isnt special mobile equipment and to prevent the debtor form getting a COT later at some point. 6 of UMVCTA could be used to find out if there has already been a certificate of title issues, you cant rely on the debtor telling you. The problem is that a COT could be outstanding in any jurisdiction in the US. PART VIII: PRIORITY

XXVI. THE CONCEPT OF PRIORITY: STATE LAW (26) To say that one creditor has priority over another is to say that if the value of the collateral is sufficient to pay only one of them, the law requires that the value be used to pay the one who has priority. A. Priority in Foreclosure Sales (p433) Two Basic Principles Govern Timing and Enforcement of Competing Liens 1) Absent an agreement to the contrary, any lien holder may foreclose while the debtor is in default to that lien holder Prior lien doesnt block exercise of rights under subordinate one; any creditor may act under default 2) No lien holder is compelled to foreclose Matter of discretion (can always give more time) General principles that Govern Most Judicial Foreclosure Sales (p434) Sale discharges from the collateral the lien under which the sale is held, and all subordinate liens, 9617(a). It does not discharge prior liens. The sale transfers the debtors interest in the collateral to the purchaser, subject to all prior liens, 9617(a) Holder of prior lien cannot enforce debt against the person who purchased at the foreclosure sale, because that person hasnt agreed to pay it, but he can enforce the lien on the purchaser by foreclosing. Proceeds: sale expenses payment of lien under which sale was held subordinate liens. 9-615(a) The remaining surplus, if any, is paid to the debtor, 9-615(d)(1). Unsecured creditors do not share in the distribution, their remedy is to levy on the debtor. Each debt is reduced by amount paid to lien holder from sale, but balance remains owing. The lien holder is then entitled to a judgment against the debtor for the deficiency, unless there is a statute providing otherwise, 9-615(d)(2). Example 1: house w/ first mortgage of 50K and second mortgage of 30K First mortgager forces the sale Mortgage sale will discharge both liens, if enough money to cover them Sheriff will first use proceeds to pay expenses of sale

82

Then will pay 50K, then 30K. Remainder goes to debtor (ignores claims of unsecured creditors) Example 2 Second mortgager forces sale Sale only discharges second mortgage lien purchaser will take it subject to first mortgage Sheriff will use first proceeds to pay expenses of sale, then next 30K to second holder Sheriff will pay remaining balance to debtor Bidder accepts property with 50K lien on house & is thus likely to pay 50K less than true value becaie the first mortgage holder can foreclose on the house still. B. Reconciling Inconsistent Priorities (p436) Inconsistent priorities are created by inconstant systems b/w, for example, Art. 9 and federal tax liens. Mortgages usually have priority over subsequent judgment liens because otherwise no one would make a mortgage loan to the debtor. Courts usually uphold mortgage liens priority over subsequent judgments even though a statute might call for the subordination of mortgages to judgment liens: Bank Leumi Trust v. Liggett (NY App. Div. 1985, 438) C. The Right to Possession Between Lien Holders (p440) Lien holders can foreclose at any time. What happens if two lien holders decide to foreclose at same time? General rule: junior lien holders surrender position to senior lien holders giving seniors the right of way. Grocers Supply Co. v. Intercity Investment Properties (Tex. Ct. App. 1990, 440) Grocers supply perfected a SI exceeding 600k to secure its inventory financing of The Grocery Store In and Cedric Wise. Intercity Investment obtained a judgment in the county court against The Grocery Store Inc. for 36k. Later that year the attorneys of Intercity levied writ of execution and sheriff took possession of the inventory of the store. A prior perfected creditor has a right to take possession of its collateral from an officer who has levied on the property at the direction of a judgment creditor. When senior and junior creditors clash, the senior creditor has the right of way. This is because to hold the contrary would make take away from the perfected security interest holder the right of repossession of the collateral (the secured party upon default by a debtor may recover possession of chattel by replevin from a sheriff who has taken possession). The Court found that Grocers Supply as a prior secured creditor has the right to take possession of the collateral with a superior right to that of Intercity a mere judgment creditor and that Grocers Supply could regain possession of the collateral from the constable who had levied on the property. Intercity is also condemned to pay for the damage and pay expenses of holding the property in warehouse. So the senior creditor here has the right of way.) Frierson v. United Farm Agency (8th Cir. 1988, 442) A senior creditor may not ignore a default by the debtor to the detriment of the junior creditors. The Senior Creditor cannot just sit on the SI and wait letting time go by although the debtor has clearly defaulted to the detriment of junior lien holders. 9-401 says that an unsecured creditor that has obtained a judgment against the debtor can levy on collateral encumbered by another creditors SI, it merely says that this will be governed by other applicable law. Sates may pass statutes that give judgment creditors priority. Reconciling Grocers Supply and Frierson 1.The right of the senior to possession is not the right to possession for the purpose of leaving the debtor in business and frustrating collection by junior lien holders. The senior lien holder must foreclose or stand aside so junior lien holder can do so. 2.The junior lien holder must surrender possession, but may continue with the sale. Under some states sale procedures, property can be sold even though it is not physically present. Negative Pledge Clause=The debtor agrees that it will not give a junior security interest to anyone else and it agrees that no one else will obtain any sort of lien on the collateral. In some cases, however, the senior creditor cant avoid another creditor attaching to the property Why would a senior SC ever permit a junior to foreclose? There is no answer, they shouldnt allow it, although in practice it does happen sometimes. Sometimes the senior creditor doesnt get notice or he is

83

inexperienced. As a senior the debtor is still going to owe you the money but now your security is in the hands of someone else, you dont know what his other person will do with the property. D. Problem Set 26 Problem 26.1: Junior mortgagee creditor has a debt of 10,000 on a property being sold at auction. The client is willing to pay up to 25,000. There is a senior mortgage of 17,000 that has not been disclosed. The costs of the sale are 200. Up to how much should she bid? She should not bid more than $8,000. She would have the property, but have a remainder of the senior mortgage of $17,000. Notice that a sale clears the mortgage or lien that is foreclosing, and any subordinate liens or mortgages. Senior mortgages, however, remain. In this the $8,000 bid would go to pay first the $200 cost of sale and goes to the sheriff. Then the $7,800 would go to the cover the $10,000 debt. There would be a deficiency judgment in the amount of $2,200 that would remain, but that is for the debtor to deal with and not the purchaser. See 9-617a. The foreclosing mortgagee is going to get the money out of the sale, the person that conducts the sale is going to get the money. So in this case Gotlieb who is foreclosing (we presume the junior mortgagee for 10k) will get 7,800. In this case if the property is worth 25k, you would only want to pay 8k since you have to pay off the 17k later to the senior creditor. The senior creditor has the right to foreclose to recuperate his loan. If the senior creditor knows the buyer in the auction then maybe he would be willing to let Gotlieb as a junior creditor sell off the property and reinstate the terms of the deal with the purchaser of the collateral replacing the debtor. If this were the case, most likely a deal would have been worked out earlier to avoid the foreclosure in the first place. The person who ends up bearing the expenses of the sale is the most junior lien holder, the one at the bottom of the collection rung is going to end up paying for the expenses. Problem 26.2: What about a 75k Rolls subject to two SI, one worth 60k first creditor and 30k second creditor. The sheriff seized the Rolls for a judgment creditor with a lien worth $8,000. The expenses of sale are $200. Neither creditor objects the sale. What do you expect the sale price to be offered? Here there is a car worth 75k with 90k worth of liens. This car isnt really worth anything. What you buy at a sale is the debtors equity in the collateral. In this case the car isnt worth anything. The foreclosing creditors are going to have to pay the sale expenses even if there is no bid, the sheriff doesnt work for free. So the foreclosing creditor has a credit bid has a bid for at least a couple hundred dollars. The execution creditor has to bid at least $200. What if you bid $0 or only the $200 to cover the expenses of a sale? If you take an outside bidder, whatever you purchase will be subject to security interests of $60,000 first, and $30,000 later. There is no equity there to an outside bidder. What if you bid $10? If no one else bids you get title and the car (subject to security interests). Then you just wait for one of the other secured creditors to come and foreclose. You still have the car until they foreclose. When they come to repossess you threaten violence, and you get the car for some more time. What about $200? This is the cost of sale. The executor is going to pay this out no matter what to pay the sheriff, so they might as well bid this much just in case so they get the car for a joy ride. You are going to have the use of this car for a while, at least for a couple of weeks or a month. There isnt a case for a conversion lawsuit in a case like this, yes you are forcing the creditors to spend money on lawyers but there is no way that this is conversion. They can take the car away from you, but they dont have a debt against you. They cannot come after you for any deficiency. There is a difference between buying property and assuming the mortgage, and buying subject to the mortgage. In the latter, you dont assume the debt. When you assume the mortgage you are agreeing to pay, but if you buy property subject to a SI then you are simply recognizing that the creditor can come after the car. As a bidder you would only buy the property if there were equity in it, if there were excess value in the property. When an unsecured creditor has gotten a judgment and is forcing the sale the thing for the secured creditors is to not allow the execution creditor to conduct the sale. If the execution creditor conducts the sale subject to the 2 SC, they should stop the execution creditors sale. The Senior secured creditor should jump in and ask the court to let him conduct the sale. Suppose the senior creditor in this case brings the sale. He is going to be willing to bid 60k credit bid. If you were the junior creditor you could bid 61k, pay off the senior creditor and then sell the car and get back 14k of your debt and then sue the debtor for the deficiency. If the senior creditor bids over his debt then the surplus goes to the second mortgage holder. If the senior creditor bids 65k then 5k (minus the sale costs) go to the junior lien holder. Problem 26.3: The debtor is current on his loan. You represent DHB, which has a first secured interest on mobile equipment for $27,000. The collateral is worth $40,000 at least, even is sold a judicial sale. DHB feels safe because

84

at an auction, the equipment will bring at least 40 grand. It becomes clear as you read through Art 9 that the secured creditor doesnt have to give notice. The creditor knows who his debtor and where the collateral is. If its consumer goods then the creditors arent entitled to notice. If its something thats not consumer goods then they are entitled to notice if its something that would come up on the FS on a search. (See 9-611). The issue is when the secured creditor gets notice only in certain circumstances. a)You have heard rumors what a junior lien creditor may be forcing a sale of the equipment? DHB should be concerned because the new buyer may not maintain the equipment. The new buyer does not keep up the insurance. This is why there are negative pledge clauses in agreement. If a subordinate creditor forces the sale, you dont know your debtor. Dont let someone else retain a lien on it. A negative pledge clause is an event of default. So the secured creditor can foreclose at that moment. Its not DHBs sale, so any money goes to subordinate creditor, DHB will get a SI in the collateral still even when it changes hands, the purchaser takes the property subject to SI. Most courts will let them step in and stop sale and conduct the sale themselves. DHB lien cannot be displaced, but remember it can be hurt if someone gets the property and tears it up. DHB also runs the additional risk that it wont be able to find the equipment because it is mobile. DHB might not even know about the sale. No notice is required under the U.C.C. It is set up that way because it hypothetically doesnt matter. b) What if DHB purchases to protect its position? If DHB knows there is a sale, it could bid at the sale. Remember the fact that DHB is in first position; they are buying into second position. You are paying in full dollars. You are just making that much of a bigger investment in the collateral. c) Can DHB prevent the sale? It cannot prevent the sale, but can take possession of the collateral. 9-401 is the relevant section if the junior lien holder is a judgment creditor and wed have to look at the state statute in this regard to see if the judgment creditor would have priority. If we assume that he is an article 9 secured creditor instead and forces sale then it cannot be prevented. D) Is DHB entitled to receive notice assuming the creditor is an Art 9 creditor? A judgment lien creditor does not have to give notice (unless it has received written notice from the other secured creditor that is has an interest in the collateral). A secured creditor has a limited obligation to search and make a limited effort to notify record holders who show up in the search. This is a courtesy of banks to banks. 9-611 and Comment 4. *So what could DHB do? The way to get ahead is for Diamond Head to foreclose before the lower creditor. You can demand possession. You could do a replevin, and you might get posted ahead (because replevin is faster). You could also self-help. If you foreclose, you are okay because the second interest will be discharged. There is a problem that you cant foreclose if the debtor is not in default. What you need to do is put in a couple of other clauses. The first is a cross default clause that says if you go into default on a loan with someone else you also go into default with me. The second says that no judgment liens will ever be placed against the collateral. But, if you dont have these in the contract you are in trouble. Problem 26.4: A Friend needs to borrow $10,000 from you. She will give a second against a house she bought for 120,000 subject to a first in amount of 80,000. The house is worth at least 90,000. a) Say the friend defaults on the 10k and you have to look to the house for repayment. What can you do? You can try to foreclose on the house. At an auction, in the worst case, if no one shows up to bid you should bid $10,000. To make a credit bid you dont have to be the senior party, you just have to be the foreclosing bidder. I am credit bidding, you arent bidding into the first position as in the above case. I am the legal owner of the house subject to an $80,000 mortgage worth at least 90,000 so in theory youd have the good to sell it and then pay the secured creditor. Would you really be willing to foreclose on your friends house? There is also risk in taking over the house and then trying to sell it again. You also run the risk that my buddy will tear up the house. If someone else bids more than 10k then you should let them take it since you will get your 10k and they will take the hose subject to the 80k senior creditors lien. b) Will that assure 10 grand recovery? Nope. c) What happens if your friend makes payment on your mortgage but defaults in payments under the first mortgage? Now you run the risk that the first creditor will foreclose. You also run the risk that they will bid $80,000 (or below). Because I have a second security interest I will end up with an unsecured deficiency of $10,000 and no

85

money. If you think that the property is worth 100k and the senior creditor has bid 80k maybe you could bid 90k, (80 for the senior and the other 10 as a credit bid) you are going to have to put up 80k in cash and pay the expenses. It doesnt look like a good deal. This is why second mortgage lending is for professionals with capital, here you, a friend are unlikely to have 80k in cash to get your 10k out. If your friend is about to default, what can you do? You can make a payment yourself and add it onto your mortgage (This is what is termed a wrap around mortgage). The second mortgagee is really extending a line of credit under a wrap around mortgage. d) Can you protect yourself against default in the first mortgage by a provision in your loan agreement? Maybe you could put in a clause that reads that when any term of the first mortgaged is breached you can foreclose. Problem 26.5: What exactly happened in Grocers Supply? A junior creditor took possession. It was decided the senior had a right to the inventory, so the sheriff made the junior return the stuff. The senior gets access to the property if he wants it. In Grocers Supply the senior wanted to foreclose. The junior then could have bid at the sale, or its also possible that a third party would have come in and bid high enough to pay them both off. Now we have a senior who is not foreclosing. He is just saying no and letting the Grocery Store continue running the business. The Junior creditor wants to foreclose and pressure the debtor but there is a senior credit and on the property and is in possession of the collateral. What can you do? We would argue to the court that a senior creditor also has a superior right of possession because he has priority. Junior would argue that if the senior doesnt choose to foreclose, he passes that right to the subordinates. The response is that as the senior should be able to control its own destiny. They are choosing to liquidate the inventory through normal sales in order to preserve value for everyone. The point is that then any debtor with a compliant senior secured creditor could frustrate all creditors. We have to solve who has the right of possession. Rather than doing the sale first do a lawsuit first. Go into court, explain the situation, and get a writ from the court saying you have a right to possess the property. That will put it on the table quickly and you will be able to make the determination. If you lose, you only lose court costs. In Court you would bring up the Frierson decision where the senior creditor was found to not be able to hold off from foreclosing for no reason. In Frierson says that the senior creditor has priority but the debtor cannot use the senior creditor to shield himself from foreclosure this way. -The problem is that Grocers and Frierson are from two different courts and are contradicting opinions. The ideal would be to get declaratory judgment in this case asking the Court whether the secured creditor can shield himself by letting the secured creditor remain in possession. The circumstances in Grocers are a little different, here the senior creditor has notice, etc. There are some people that still think that being a senior creditor means that you have control over the collateral and as such can let the debtor continue using the collateral. The senior can foreclose whenever it wants and doesnt have to do what the junior wants. Another possibility from page 443 is we might be able to have a sheriffs sale without taking possession of the property. Someone will buy at that sale, subject to the senior, and probably with an impending lawsuit. The advantage is the lawsuit occurs after, so you dont get dinged with the costs of possession. The problem is no one is really going to bid. When the collateral is something that can be divided up, such as inventory, the seizure of the collateral will only cover the amount of the debt. The order given to the sheriff in the writ says that he is to seize enough to satisfy the debt and not all the debtors inventory. Problem 26.6: Your client, Fidelity Mortgage, is a creditor in Alaska who lends money and takes SI in real property. You take a look at the agreements used by your client and notice that they say nothing regarding property taxes. In Alaska there is a provision that read: Property taxes, together with penalty and interest are a lien upon the property assessed and the lien is prior and paramount to all other liens or encumbrances against the property. If these taxes arent paid in 2 years the state forecloses the property tax lien and the property is sold to the highest bidder at auction. The proceeds are applied first to the tax authority and then to the liens. The clause in Alaska gives the State a super priority and is constitutional and exists in many states. A) If one of Fidelitys debtors fails to pay property taxes and the state forecloses what is the effect on your clients mortgage? The proceeds are paid after the tax authorities are paid and youd have a deficiency against the debtor for the remaining amount. B) If such a foreclosure is under way against one of your clients mortgages what can you do to protect the client? If the creditor pays the property taxes it ends the foreclosure, so you can do that and get the bank out of the way. Property taxes tend to be small so it shouldnt be too bad.

86

C) What suggestions do you have for reforming your clients standard form contract? Since the tax authorities give the debtor 2 years to pay you can place some clause that says that any failure to pay property taxes gives the creditor the right to foreclose on the property, it is an event of default. The creditor would have to come in and make the payments to the tax authority before theirs can foreclose. This way you can get the property sold before the state. The bank could create an escrow account to have the debtor pay the taxes and insurance on the house. The bank will require that these payments be made to an account in control of the mortgagee on a monthly basis. XXVII. PRIORITY IN BANKRUPTCY LAW (27) Security interests and liens survive the filing of a bankruptcy case except to the extent that Bankruptcy plans can reduce the amount of the lien to an amount equal to the value of the collateral as determined by the court and extend the time for payment During bankruptcy some kinds of liens can be avoided because they are unperfected or are preferences Similarity in the meaning of priority Priority means that when the value of collateral is sufficient to pay only one of two lien creditors, the law will seek to assure that they value is applied to payment of the one who has priority. In this sense, the meaning of priority doesnt change in bankruptcy. Differences in Meaning of Priority: Two basic principles in non-bankruptcy: 1) Any lien holder may foreclose while the debtor is in default to that lien holder. In bankruptcy, however, the automatic stay contradicts this principle. The secured creditor cannot foreclose until the stay is terminated; 362(a). Secured creditors can seek relief from the stay but there is no assurance that the Court will grant relief. 2) No lien holder is compelled to foreclose under non-bankruptcy law. In bankruptcy the trustee or debtor in possession can sell the secured creditors collateral free and clear of liens, effectively foreclosing the secured creditors lien on the trustees or debtors own time table. Three ways priority rights of secured creditors diminished in bankruptcy Through the trustee or debtor in possessions ability to sell the collateral free and clear of liens Through the trustee or debtor in possessions ability to grant leans senior to existing liens The shift in focus from the protection of more senior creditors to the protection of junior ones A. Bankruptcy Sale Procedure (p447) During bankruptcy, a trustee or debtor in possession can sell collateral As in foreclosure sales under state law, the collateral may be sold subject to the liens of senior creditors, Bankr Code 541(a) noting trustees interest is that of debtor Once the sale is complete, the collateral ceases to be property of the bankruptcy estate and the automatic stay expires, and, if the debt is in default, the secured creditor will be free to foreclose, Bankr. Code Bankr Code 362(c) As under state law, the purchaser only acquires the debtors equity Abandonment of Burdensome Property If the liens would exceed the value of the collateral, no one may be willing to buy the collateral. In this case the collateral is burdensome to the state and the trustee may abandon the collateral as it is considered burdensome to the estate; Bankr. Code 554. When abandonment occurs, the property is given back to the debtor, the automatic stay is terminated, and lien holders may foreclose, Bankr Code 362(c) Unlike state law, bankruptcy law provides an alternative procedure under which the trustee or DIP may choose to sell the collateral free and clear of liens; Bankr. Code 363(f). In this instance the collateral is sold much the same way as it would have been as if the senior creditor had foreclosed on the property and sold it free of all subordinate liens. In bankruptcy when this happens typically the full value of the collateral is received as the purchase price The liens are transferred from the sold collateral to the proceeds of the sale, with the ultimate effect that the proceeds are applied to the liens in the order of their priority. Deprives secured creditors control over timing of foreclosure In re Oneida Lake Development, Inc. (Bankr. NDNY 1990, p448) The debtor moves to have the Court permit the sale of all its real estate for 750k. The creditor WPV

87

was a judgment creditor and objected to the sale. As the date of the filing the real estate being sold was subject to $1.3 million in liens. WPV contends that the debtor doesnt comply with 363(f)(4) because the sale would not produce a full money satisfaction of its judgment and 363(f)(5) because there are no adverse proceedings against the preference it holds. Holding: There are some other decisions cited by the Court that say that the Court can allow the sale when the debtor is getting the best possible price for the collateral. Additionally WPV is a judgment holder whose judgment is subject to attack and the collateral is subject to quick depreciation which makes this a special circumstance. The Court allows the sale and the debtor has the right to sell collateral free and clear despite the secured creditors objection. Implications of the Oneida Lake Decision Any appreciation in the collateral will go to the purchaser and not the secured creditor had he sat on the collateral and not foreclosed. The ability to sell in bankruptcy protects the value in depreciating collateral for junior creditors. A weakness is that unsecured creditors who are unsure of the amount and priority of their lines may face a difficult problem in determining how to bid. (They may bid under 363(k)). Oneida Lake likely misinterpreted 363(f)(3) because under its interpretation any sale price would be sufficient for lien interests because they are defining the value of lien interests to be what the collateral can currently sell for. Just as in non-bankruptcy foreclosure sales, secured creditors are free to bid in the amounts of their liens, Bankr. Code 363(k). B. The Power to Grant Senior Liens (p452) In limited cases the trustee or DIP can borrow additional money from a postpetition lender secured by a lien prior to existing liens; bankr. Code 364(d). Before doing so the existing lien holders must be notified. If they object the following prerequisites must be shown: The estate is unable to borrow the money without granting a prior lien, and There is adequate protection of the interest of the secured creditor whose lien is being displaced. The theory is that post-petition financing is often essential to the successful operations of the business. If it is not forthcoming the business may fail and its future income lost. Secured creditors dont like this because typically they gain nothing, and the adequate protection the bankruptcy court dispenses is no guarantee against loss. If the collateral is later sold and there is not enough money to pay the secured party, it becomes an unsecured claim with some priority over other unsecured claims; 507(b). In re 495 Central Park Avenue Corp. (Bankr. SDNY 1992, p454) John Hancock Mutual Life took a SI in a building which later the debtor bought subject to the SI. The debtor defaults and Handcock accelerates trying to foreclose but is stayed. Then, during bankruptcy proceeding debtor needs money to renovate the building in order to enter a lease agreement with Leather Center. Holding: The goal of adequate protection is to safeguard the secured creditor from diminution in the value of its interest during the Ch11 reorganization. The property would be improved by the proposal renovations and that an increase in value will result so the value is sufficiently protected. The Court allows the debtor to obtain a senior priority and get another loan on the building. Aletha Dewsnup v. Louis L. Timm, et al. (502 US 410, 1992) The debtor in Dewsnup is trying to strip down the value of the SI to say that the secured claim is only worth 200k although the house that served as collateral and the loan were worth 1million. The debtor wants to only be burdened with a 200k debt when he comes out of bankruptcy. If the value of the house or collateral rises again the person who gains the value is going to be the debtor. The debtor claims that the creditor looses the value of his security interest above the value of collateral when he enters bankruptcy. 506 starts off by saying that a claim is a secured claim to the extent of the value of such creditors interest in the estates interest in such property. The Supreme Court in this case, makes a decision and considers that the lien of the secured creditor would not have been voided in this situation. When one looks at legislative history there is nothing to demonstrate that Congress wanted to change past law in favor of the debtor. The language in 506d to the extent that the lien secures a claim against the debtor, does not apply to cases under these

88

circumstances. The Court says that in this case the 1mill is secured and is a claim of the creditor. It is allowed in this case for the full 1mill and its secured (although in reality its only secured for 200k). None of the lien is voided by 506d. The time that is critical for the creditor is the moment of foreclosure, any increase in value b/w the time of institution of bankruptcy proceedings and the time of foreclosure has to go to the secured creditor and not the debtor. C. Protection of Subordinate Creditors (p459) Bankruptcy shifts the focus from the protection of more senior creditors to the protection of more junior ones to try and benefit everyone. This occurs in bankruptcy when: The senior lien holders are thought by the court to be adequately protected against loss, and The stay is likely to facilitate the collection efforts of subordinate creditors. Bankruptcy focuses its attention on creditors whose priority is sufficiently high that they nmay be able to be paid through an efficient and effective liquidation or reorganization, but not so high that they will be paid in any event. D. Problem Set 27 Problem 27.1: Junior mortgagee creditor has a debt of 10,000 on a property being sold at auction. The client is willing to pay up to 25,000. There is a senior mortgage of 17,000 that has not been disclosed. The costs of the sale are 200. Up to how much should she bid at a sale free and clear of liens in bankruptcy? Bid up to $25,000 to win. The sale is free and clear of liens so it wont be subject to a senior lien after the bankruptcy sale. The costs of sale will be paid for first. Then the rest will be distributed in order of priority on down to the general unsecured creditors. The buyer does not have to worry about costs of sale, they will be paid by the trustee. The bidding will probably begin by having each mortgagee credit bid on the property. In bankruptcy the person can simply bid on the property paying what the property is worth. Some would argue that under bankruptcy 363(f)(3) you can only sell if the aggregate value is greater than the value of the liens. The estate gets to determine the sale. One consequence is that if the estate can boost up the price, it lowers the residual claims that will persist against it. Given the estates interest, you can bet the estate will bring more money than at a sheriffs sale because they can advertise, they can fix stuff up, and the stuff will be sold free and clear. Furthermore, it doesnt have to sell on a particular day. The incentive is to maximize the price for the estate. What it takes away in value from the secured creditors is that they can no longer control the timing of the sale, and their interests cannot persist. Problem 27.2: You represent SSB that holds an 800k second security interest in railroad cars. In the depressed market the cart are worth about $1 million. The first SI is for about $1.1mill held by Citibank. SSB made the loan two years ago when the market was high and the collateral was worth $3mill. SSB thinks the market will come back around. The debtor who has the cars files for Ch 11 and proposes to sell free and clear of liens for current value. If sold for $1mill who will get what? Citibank will get $1mill and be unsecured for 100k. SSB will be unsecured for 800k. Citibank would argue that the true value of the collateral is worth more than 1mill, since it was purchased for 3mill. 363(f)3 tells us that in order to sell the sale must be able to satisfy all liens on the property. In this case that would mean the collateral has to sell for 1.9mill. Oneida Lake, however tells us that liens are valued by the value of the collateral and in this case Citibank is secured for 1mill since the collateral is now worth 1mill. Under Oneida Lake the secured status of SSB is $0 and there isnt much you can do about it under this holding. In this case the Citibank is secured for 1mill and SSB is unsecured for 800k and thats it. *What the debtor in the Aletha Dewsnup case is analogous to what the debtor is trying to do here in this case. What is different here is that in Dewsnup is that the trustee is going to abandon the property at some point. Here the debtor is trying to sell the collateral right now at this price. The question is whether these assets should be sold in bankruptcy proceedings and if it is sold then that will be the end for SSB. The debtor doesnt have any equity in the railroad cars. There is an argument made partly in Dewsnup that in these cases where the debtor is in deep then the property should be abandoned and the debtor barred from doing anything with it.

89

Why is the debtor proposing to sell the property here? If the sale goes on then the person likely to bid will be Citibank and SSB. Citibank would credit bid. People associated with the debtor though are the ones that know most about the value of these cars and will be in there bidding (others or the same industry and profession as the debtor). Can SSB do anything about it? SSB could bid more, but they will have to bid more than their credit bid. They will have to end up paying cash to Citibank which isnt a very good idea. There also may be some banking regulation regarding how long one of these two banks can hold onto. Maybe they cant keep them for 3 years waiting for the cars to increase in value. If the debtor could get away with stripping down the value of the debt to the value of the collateral then the debtor would be in great shape since he would only have about 1mill of debts to deal with. *The Court however should say that the trustee is going to abandon the property since there is no equity in the property and clearly the property is not needed for an effective reorganization. The car should be turned over to the secured creditors with their SI in the car attached. To abandon in this scenario would be the equivalent of having the collateral going out of the estate and then going straight into the hands of the creditors. Then the two banks could negotiate and reach an agreement to hold onto the car and wait for the market to go back up. Citibank has serious leverage here though since Citibank may ask SSB to buy them out if they are so sure the market is going to go back up. All of this depends of course on extending the theory of the Dewsnup decision. Some bankruptcy people think that this decision is terrible but its 13 years old and little attention has been given to it, the bankruptcy courts have discussed it little. *If the court however decides that Dewsnup doesnt apply and that Oneida Lake controls what do you do as SSB? You appeal the decision and at least you can delay the judgment and hopefully the market for the cars will go up while you get another decision. You may have to put up a bond when appealing but this would be to protect the estate from a downturn, but what sort of downturn can occur if the market of cars has hit rock bottom. Problem 27.3: Client owns a office complex under construction and the loans under the property total 5mill. It wants more money but the asset cannot support it, there are too many liens against the property. If we werent in bankruptcy: Asset is worth $2 million; American has first in amount $4 million; and Lien Creditors have mechanic lien in amount of $1 million. The asset would all go to American, they would only get half of what they wanted secured, and everyone else would be general unsecured In bankruptcy, asset is worth $2 million. If we spend another $1.5 million, then the asset will be worth $4 million. Outside of bankruptcy no one would come in and lend because they would be subject to American. In bankruptcy, under 364, a new lender can come in and lend and take first position, as follows. So the debtor would have to grant a new lender priority over American Bank and get the loan for 1.5mill. American bank will argue that adding 1.5mill will not increase the value of the offices to 2mill more. The argument on the other side is that the 500k cushion of equity is sufficient as decided in the Central Park Avenue Case. American may not want to lend more since the debtor has proven that he has failed once and why give him a second chance. Dev. Asset $4 million New Lender $1.5 million American $4 million Lien Creditors $1 million Distribution: New Lender $1.5 million American $2 million secured ($2 million unsecured) General Uns. $0.5 million If we look at the judgment in 495 Central Park Avenue Corp then its possible to think the judge may allow a senior loan on this shopping mall. The idea here is that under bankruptcy the debtor may be able to pursued the judge to grant an extra loan while granting a new and more senior SI. Problem 27.4: Refer to problem 26.4 where you loan friend 10 grand on house, where there is already a first mortgage. He defaults on the loan and now he owes another first secured creditor 80k and you 10k. The house is worth 120k but the housing market is slow. If a foreclosure sale is held, that is in nonbankruptcy law you are going to get hosed b/c your debt will get whipped out by the senior creditor. Because it is subject to the senior lien your

90

debt will be wiped out. The senior creditor will probably credit bid on the house and you will have a unsecured credit against your friend. In bankruptcy, he first mortgagee cant proceed to a sale b/c there is an automatic stay. Our client is a junior secured creditor but is secured b/c there is equity in the property. If someone wants to sell you are entitled to adequate protection under these circumstances. The bankruptcy proceeding may allow a restructuring so the both creditors get paid at some point down the line. The junior scured creditor is in a better situation in bankruptcy than under non-bankruptcy law. PART IX: COMPETITIONS FOR COLLATERAL XXVIII. LIEN CREDITORS AGAINST SECURED CREDITORS: THE BASICS (28) A. How Creditors become lien creditors (p463) Lien creditor: defined in 9-102(a)(52) any creditor who has acquired lien Five principle ways 1) Attachment: in most states, legal process to get sheriff to levy property pre-judgment Attachment is a legal process in which the plaintiff in litigation obtains a writ and delivers it to a sheriff, marshal, or other law enforcement officer, who then levies on the property of the debtor. The distinction between an attachment and an execution is that an attachment occurs before judgment is entered, while execution occurs after. 2) Execution: same legal process, after judgment 3) Garnishment: judgment creditor reaches debts owing from a third party to the debtor Garnishment is the process by which a judgment creditor in most states reaches debts owing from a third party to the debtor or property of the debtor in a third parties hands. Becomes a lien creditor at the moment the writ of garnishment is served on the third party 4) Recordation of judgment for $ damages: in real property registry or, more rarely, UCC filing system Recordation of a money judgment in a real property recording system creates and perfects a lien against all real property owned by the debtor within the county. Will also reach any such property that the debtor later acquires while the lien is in effect. 5) Trustee in Bankruptcy, has rights of hypothetical ideal lien creditor who obtained a lien on all property of the debtor on the date of the filing of a bankruptcy case B. Priority Among Lien Creditors (p465) Rules governing priority among lien creditors are found in state statutes to answer Q, you need the law Usually set up as first-come, first-serve on basis of one of four dates (in order of frequency): Date of levy when sheriff took possession Date of delivery of the writ by clerk of the court Date of service of writ of garnishment when its delivered to third party Date of recordation of judgment In competition between writes of execution: Majority rule gives priority to first to levy on the particular property Minority rule gives priority to the first to deliver their writ to the sheriff C. Priority Between Lien Creditors and Non-PMSI Secured Creditors (p467) 9-317(a)(2): SC is subordinate to lien creditor if person became lien creditor before the earliest of: SC perfecting security interest Attachment: SC filing financing statement and doing one of the conditions of 9-203(b)(3): Authenticating security agreement w/ description of collateral Gaining possession of collateral Gaining control over deposit accounts, chattel paper, investment property or letter-of credit rights This rule means that a secured creditor that has filed a financing statement, gotten an authenticated security agreement, but hasnt given value yet can have priority over a lien creditor. In majority of states execution creditor becomes lien creditor at levy; in minority on writ delivery to sheriff

91

D. Priority Between Lien Creditors and Mortgage Creditors (p468) Governed by real estate law. General rule: mortgage granted before judgment creditor becomes lien creditor has priority, even if judgment lien is perfected first E. Purchase Money Priority (p468) Priming: When a second-in-time creditor takes precedence over first-in-time 9-317(e): PMSI primes lien creditors interest only if PMSI comes into existence and attaches to collateral before the creditor obtains its lien against that collateral If PMSI attaches first, holder of PMSI has 20-day grace period to file financing statement and thereby defeat lien that came into existence b/w dates of attachment and perfection of PMSI Cost of system may surprise and confuse lien creditors, but overall cost is low b/c: No lien creditor is likely to advance additional funds based on deceptively clear record Lien creditors may choose to delay 20 days after acquisition of property and check title F. Problem Set 28 Problem 28.1: The local credit bureau reported the entry of a judgment of $125,000 in favor of Sheng Electronics, an unsecured creditor. The debtor also owes $50,000 (unsecured) to RFT. How can RFT get priority over Sheng? RFT can gain priority by perfecting a security interest before Sheng levies. Under 9-317(a) perfect a security interest prior to the levy for Shengs judgment, which will give RFT priority since it is complying with 9-203(b)(3) (A). You would have to get RFT to obtain and file a FS (with authorization), and a SA. Why would the debtor give RFT a security interest? RFT has been patient with the debtor and Sheng has already executed a judgment. Negotiate -- The debtor has leverage (the ability to give a secured interest to RFT and put RFT in a much better position). The debtor could use this leverage to obtain more credit, etc. from RFT. Well see later that under bankruptcy a trustee could upset the granting a SI in collateral within 90 days of the filing of bankruptcy. Grocer Supply -- RFT does not have to levy. RFT can say the debtor is in default and has a right to possession. Therefore if the sheriff levies in favor of Sheng, it must give the property to RFT. The secured creditor will hold off the lien creditor and assert its position to get the property back if there is a levy. Grocers Supply is not a long-term solution. The subsequent case (Friersan) says the secured creditor cant keep holding off lien creditors forever. The solution for the unsecured creditor who wants to levy is to get a declaratory judgment and not risk attorneys fees the second time around. -Under the Ohio statute, if RFT delivers a writ of execution to the sheriff on the same day as Sheng, the amount will be distributed pro rata (see statute on p466). The creditor needs a judgment in order to get a writ of execution. This is not likely to happen in one day even if the debtor cooperates. Problem 28.2: Phyllis loans Melinda $20,000, which is secured by a scaffolding and construction equipment. On March 7, Melinda signs a financing statement, security agreement, and promissory note, but Phyllis does not distribute the money, because she has ordered a search. Phyllis files the financing statement the same day and orders a search. On March 10, the sheriff levies on equipment pursuant to a writ of execution in favor of Star Plastering. On March 11, Phyllis receives the report. (a) As matters now stand, is Phyllis perfected? No, under 9-308(a) she has not met all the requirements of 9-310 through 9-316 since she has not given value. Under 9-203(b)(1) a security interest attaches against a debtor and third parties with respect to the collateral if value has been given. A SI hasnt even attached. If Phyllis has made a promise or commitment that she will disburse, then this would be considered as having been given value for purposes of attachment of a security interest. (b) If Phyllis makes the $20,000 loan despite the levy, will she have priority over Star in the equipment? Yes, if Phyllis gives value she will be perfected, under 9-317(a)(2)(B) it will also have a priority if it has filed a financing statement and the debtor has authenticated a security agreement describing the collateral under 9-203b3. You can file and get a security agreement before the levy, and give money after the levy and win. If you file according to a security agreement that is enough to get a toe hold. When you actually give value the security agreement goes

92

back to the date of the filing even if the levy has already occurred. The filing pursuant to a security agreement locks your date, these two things the filing of a FS and the signing of a SA allow you to have priority when you later give value. The policy for this is a way to make sure you are in first in line. You dont want to have to put dollars on the line to find out if you are first in line. Problem 28.3: National specializes in asset-based lending to small businesses that are in financial distress. All of Nationals loans are non-PMSI loans secured by personal tangible property. All are made in a state in which a creditor becomes a lien creditor only when the sheriff takes actual possession of the property. Nationals loan procedure: First, they file a financing statement, then search to make sure collateral is in hands of debtor, then disburse loan amount within two weeks. Can an execution creditor come ahead of National? Once they see the collateral in the debtors possession (a judgment creditor has not already levied), National is ok under 9-317(a)(2) (B) if debtor also authenticated a security agreement. It seems they dont have any problem, it looks like a good plan. Possible problem: Maybe there are loans over these goods are PMSI although their loans are not PMSI. Hence, goods purchased with a PMSI that have a 20-day grace period under 9-317(e) if a person files a financing statement with respect to a PMSI before or within 20 days after the debtor receives delivery of the collateral the SI takes priority over the rights of a buyer. Problem 28.4: What if National is in a state that adopts a statute like CAL, which creates a judgment creditor (and applies as a lien) by filing notice of the judgment with the Secretary of State? The situation does not change from Problem 28.3. The judgment should show up in the creditors search since the CAL statute says that the judgment becomes a lien on personal property when the JLC files a FS with the secretary of state. So in a search then it will show up before the loan is made. Problem 28.5: What if Nationals state adopts a statute like Ohio 2329.10 (in which no preference is given to writs delivered on the same day if amount is not sufficient, pro-rata distribution). *Hypo: On Nov. 1, the judgment creditor gives a writ. On Nov. 5, National files a financing statement. On Nov. 15, the sheriff levies. When did the judgment creditor become a lien creditor? -The statute says in all other cases the writ of execution first delivered to the officer shall be the first satisfied it does not say when the judgment creditor becomes a lien creditor with respect to Article 9. It only discusses priority between two levying creditors. Its uncertain, but the statute suggests that the judgment creditor becomes a lien creditor on Nov. 1 before the Sheriff takes possession. It takes the date on which the writ is taken to the Sheriff to grant the status of lien creditor. 9-313(3)(a) tells us that a lien creditor is going to have priority if he becomes one before the SC perfects. Another problem with these state statutes is how extensive is this lien going to be. Does it cover all the personal property of the debtor? So this is a problem in states like Ohio. If you are Nationals lawyer, you would suggest that National change its procedures to protect them from this possible upset of priority. Most sheriffs offices keep records with respect to delivery of documents, so National should add a search of the records of the county sheriff to be sure that nothing has been delivered. Kaufman: Not likely, but it is possible that under the law of Ohio, delivery of the writ to the sheriff in county 1 might establish priority with respect to county 2. The attorney would need to research case law, etc. In Ohio there are something like 70 counties so this evidently is a huge problem. So you would have to tell National that its uncertain and there is some minor risk involved here. Problem 28.6: Bonnie sold a boat to Edith for $35,000 -- $3,500 down and a promissory note for the rest. Bonnie ran an instant creditor check and missed the judgment against Edith for $22,000 unpaid alimony and child support, there was an unregistered Judgment against Edith from her husband. Edith signed a security agreement and financing statement. All these documents are sitting on Bonnies desk. Immediately after Edith takes possession of the boat she is followed to the marina and the sheriff levied on the boat in favor of Ediths ex-husband. Bonnies contract states that any levy on the boat constitutes a default. What can Bonnie do? If they are consumer goods then it is a Purchase Money Security Interest with a special set of rules in 9-317(e). There is automatic attachment and perfection when we are dealing with consumer goods. It was perfected when she signed the security agreement. If we have consumer goods, then we can ask for the boat back because we have a fully perfected security interest. She has to have a right to immediate possession and this will be if Edith is in default and the SA contains a provision that any levy constitutes default. So if she is in default then she can demand possession from the sheriff. 9-102(26) Consumer transactions are those there an individual buys something for personal or household purposes 9-309(1)SI perfects when it attaches when dealing with a SMSI in consumer goods. Citing Grocers Supply we would be

93

asking for it back based on the prior security interest. The judgment is interfering with the senior creditors ability to repossess. As between our right to repo and the judgment creditors right to foreclose, we have the stronger right (Remember that Grocers Supply isnt everywhere). 9-609 gives creditor right to possession, but this has to be keeping the seniors rights intact. *If they are not consumer goods, you are no longer automatically perfected. You need to file a FS. Once you have the sale go through, under 9-317(e), you have 20 days to file because it is a purchase money security interest. If you file within the 20 days then you are priming. Problem 28.7: Same facts as above EXCEPT Edith forgot to sign the security agreement, the space on the SA for the signature is blank. Edith (the buyer) is sitting in your clients office in BBW and is wiling to sign the SA at this very moment. Id rather BBW get the boat than my ex. (The sheriff has already levied). What do you tell them? It wont do any good to sign now. Now the date that you would go back to is still after the judgment levy and 9-317e would not be applicable. 9-317e tells us that it goes back to the time of attachment. It attaches when she signs the security agreement. We still tell her to sign and file now. But, we are still in big trouble because of the judgment levy. Ethical Issues: Bonnies lawyer cannot advise Edith. Bonnie can get Edith to sign as long as she does not represent the advice as coming from the lawyer. You are not tricking Edith into doing anything she is not supposed to do (i.e., signing the security agreement). Bonnie would be doing something perfectly lawful. Possible argument: There is a provision in the model code that says the lawyer cannot advise someone to do something the lawyer could not do themselves. In this case Bonnie would not be allowed to pass along her lawyers advice to Edith. But, The Model Rules are in effect, which contains a sentence that says it is not a violation to give legal advice to your client. The lawyer is required to explain the legal situation to Bonnie, the client that the security agreement is second in time. -Lopuckis advice: Bonnie has supplied value here, the ex husband has not, the fact that Bonnie get the boat back would be the equitable solution. Edith was supposed to sign it anyway. Bonnie should have Edith sign it and waive it around in the sheriffs face. See if the sheriff asks the right questions or not. Warren: There are witnesses. This is kind of shady since in reality you are backdating the SA, and as a SC she didnt do what she was supposed to do. You may even be exposing Bonnie to criminal prosecution for fraud. -Now suppose you were present when all this happened and Bonnie asks you what she can do? Bonnie can sue for malpractice and come out of this whole; you would have the obligation to advise Bonnie about her cause of action for malpractice. Problem 28.9 The debtor grants a real estate mortgage to M, who does not record. C levies on the real estate. As between M and C, who has priority? Generally, the unrecorded real estate mortgage prevails over the lien creditor since most states give priority to the first lien created. Justification for two different results: there is usually more of a reliance interest in the case of real estate, and they dont want to do anything to mess up a chain of title. The lending of the money was not given with getting a reliance of the collateral when we talk about a judgment creditor. XXIX. LIEN CREDITORS AGAINST SECURED CREDITORS: FUTURE ADVANCES (29) A. Priority of Future Advances: Personal Property (p472) 9-323(b): secured future advances have priority over lien creditor: In all cases for 45 days following the attachment of the lien Beyond 45 days if the secured party makes the advance w/o knowledge of the lien Beyond 45 days if the secured party is committed and entered commitment w/o knowledge of the lien B. Priority of Non-advances: Personal Property (p474) Security agreements provide that in the event of default the debtor will compensate secured creditors expenses of collection, including attny fees Do these non-advances qualify for priority over lien creditors under 9-323(b)? Uni Imports v. Exchange National Bank of Chicago (7 Cir. 1991, 474) Exchange National Bank (National) and Aparacor executed a SA. The two then executed a note wich incorporated future advances with a revolving line of credit. The note expired and National kept making advances to debtor. UNI obtains a $60,000 judgment against the debtor which is

94

registered. The Sheriff serves a writ on National to seize debtors assets. Past decisions though confirm that nonadvances do not constitute new security agreements under 9323(b). Rather, they relate back to the first date of perfection and share that status against judgment creditors. Although protecting nonadvances benefits revolving credit lenders and this presumably improves debtors chances of obtaining such loans it does so at the cost of squeezing out lien creditors. It would be unfair to permit after enlargement of the SI after the lien creditor has successfully levied on the property. Non-advances are not advances for the purposes of 9-323(b). Non-advances have priority when they relate to advances contracted to before knowledge (not sure about this) C. Priority of Future Advances and Nonadvances: Real Property (p479) The law governing real estate transaction is even more tolerant of future advances made after a lien creditor perfects an interest in the collateral. Shutze v. Credithrift of America (Miss. 1992, 479) General rule in real estate: future advances under mortgage agreement always trump lien creditors. In the real property system, the court gave a future advance priority over an earlier judgment even though the creditor was not obligated to make the advance. The second mortgage holders mortgage contained a so called drag net clause that contemplated future advances. Nothing obligated the second mortgage holder to make future advances. A judgment creditor obtains a judgment against the property and the debtor. After this the debtor refinances his second mortgage and obtains some more money added onto the original loan. The Court decides that future advances clauses are enforceable in this case. The creditor put this in his mortgage contract for all diligent searchers to see. The law should not and does not demand new title searches when a future advance is going to be made. Even under the UCC regime of would have rendered the same decision, but real estate is more expansive about this concept. Not every jurisdiction follows Shutze. Some only give priority to future advances that are obligatory while others (like in Shutze) also give priority to optional advances. This distinction b/w optional and obligatory advances is similar to the pursuant to commitment terms in the UCC system. Most jurisdictions follow this unitary theory; some only prioritize obligatory (not optional) advances If advances relate back in priority, so do non-advances (fees and interest) associated with them. When a purchaser (not a purchaser in the ordinary course of business) acquires collateral, they acquire it free of security interests from future advances under the earlier of 45 days or acquiring knowledge of the sale, 9-323(d). D. Problem Set 29 Problem 29.1:Real property and future advances. The mortgagor borrows $50,000 from the Mortgagee, and executes a note and mortgage that states that future advances can be made by the Mortgagee for $25,000 in the future. Mortgagee has no obligation to make the future advance. The mortgage states it secures interest at 10% and attorneys fees in a collection action. J obtains a judgment for $100,000 against mortgagor and records a lien on the real estate. Then Mortgagee loans an additional $25,000 with knowledge of the lien. Mortgagor defaults owing $10,000 interest and $5,000 attorneys fees. As between Mortgagee and J, who has priority in the real property? In real property according to the Shutze case the mortgagee will get $75,000 persuant to the mortgage agreement. (The Restatement 3rd of property also says this is what is going on this isnt to say there arent minority jurisdictions, but this is the majority view). The mortgagee gets nonadvance costs as well. Notice that for a mortgagee, knowledge doesnt matter. Involuntary third parties really cant wiggle their way in with judgment liens. *What is we were in a jurisdiction that distinguishes b/w optional and obligatory advances? If states start to recognize this distinction for personal property, where the statute doesnt speak to that, it would seem that it would be natural to introduce the same kind of distinction into real estate law. The states that do it in the personal property context will probably do it in the real estate. In this case the advance was optional the JLC would have priority over the second 25k and would have priority over a portion of the attorneys fees and interests related to the 25k.

95

Problem 29.2: Personal Property and future advances. Debtor borrows $50,000 from Secured Party and executes a note and a security agreement that state that future advances up to an additional $25,000 may be made by the Secured Party in the future. However, Secured Party has no obligation to make such advances. The security agreement also states that it secures interest at 10%. Secured Party perfects. Thereafter, J obtains a judgment of $100,000 against Debtor and becomes a lien creditor by levying on the collateral. Secured Party has actual knowledge of the lien. Sixty days after the levy, Secured Party lends and Debtor accepts an additional $25,000 advance. Debtor defaults on the loan owing the full balance and $10,000 in interest. Secured Party incurs $5,000 of attorneys fees that are recoverable against Debtor under the terms of the security agreement. As between Secured Party and J, who has priority in the personal property? First $50,000 goes to the secured party (both real estate and personal property). As for the $25,000 (optional advance made 60 days after with knowledge of the existence of a JLC), the secured lender wins if this were real estate, but when dealing with personal property and the UCC, the Judgment Lien Creditor wins according to 9323(b). This additional advance made by the secured party was made after 45 days of the JLC perfection and the secured party did not make a commitment prior to the JLC perfection, the secured party had no obligation to make advances. So there are three circumstances here; the SC had actual knowledge, had no commitment to make advances and the 45 days have passed now. Concerning the expenses (nonadvances, the interest and attorneys fees) when dealing with personal property they are split. All interest and fees attributed to the $50K get the same priority as the $50,000. Whatever is associated with the second advance gets that same position behind the judgment lien creditor. If this were real estate, the mortgagee would get them all. What about the nonadvances then? How do you distribute them? Maybe you can prorate them, etc. There is nothing in the state that tells us. Problem 29.3: A year ago, Carol lent $1,000 to her friend, Bob. Bob gave her a security interest in his new boat, and saw that the financing statement was duly filed. BCA recently recovered a judgment against Bob in the amount of $45,000. On March 1, they levied on the boat. It now sits in the Sheriffs compound. Now, Bob is back to ask Carol another favor. Bob wants an advance of $31,000. Bobs lawyer says the advance will protect the boat from judicial sale. He says even if they go through with the sale they wont get anything. Carol asks if this will work? What would happen if Carol did not make the additional loan? The sale will happen, but Carols 1,000 interest will continue. If the boat is worth $32,000, the sale will go as high as $31,000. What happens to the JL and Carols liens? What happens if the bidder only bids 10k? Then the lien will be paid off and the lien will be discharged. The JLC will get proceeds but they dont attach to the boat. We also have to worry about the costs of the sale. There is no credit bid on cost of sale. So here the JLC could bid $31,500. If someone comes along and purchases the boat at auction, there is a danger here that the SA contains a future advance clause b/c Carol could have made a future advance at some point b/w the bidding process. The purchaser of the boat would need to tell Carol about the purchase instantly, give her knowledge, so that would trump Carols ability to make future advances on the boat. This is the way that 9-323(d) reads, the earlier of 45 days or the time that the SC receives notice of the purchase. A buyer of goods takes free of SI to the extent that it secures advances made after the earlier of: 1. the time the SC acquires knowledge of the buyers purchase or 2. 45 days after the purchase. The SC should not be protected any further once they know that someone else has bought the collateral. *Under 9-317(a)(2) if the security agreement included a future advance clause, and Carol loaned additional money within 45 days Carol has priority over the lien creditor, under 9-323. Note: We dont know if the original agreement had a provision for future advances. If it was limited to the $1,000 loan without a dragnet clause or anything of the sort, then Carol would need a NEW security agreement since SI arise as a matter of contract. Here although there is a new SA Carol could use the same old FS but there would need to be a new SA. In order to get priority over the JLC it would have to be done after a SA contemplated advances. The new security agreement would be perfected too late and the Carol would not have priority over the judgment creditor. hats a future advance? Carols second advance could be considered a future advance but we and the UCC is referring to a future advance clause contained in a SA. The drafters of the UCC recognized the notion of the split SI after future advances are made, but only in certain circumstances in which the JLC could come before the SC. The drafters do this simply by giving us rules that tell us who wind certain contests. Problem 29.4: BCA is attempting to collect the $45,000 judgment against Bob. The value of the boat is assessed at $45,000. The sheriffs sale is set for March 29, just a few days from now. In preparation for the bidding and sale, you discover Carols financing statement. You dont want to bid higher than the value of Bobs equity in the boat.

96

But to know how much that is you need to know the amount secured by Carols interest. When you call Carol, she said she would have to consult her attorney before giving you the information. Carol has not called you back. a) How do you plan to get the information? The levying creditor wants to know how much to bid and what to tell others how much to bid. The levying creditor needs to know how much the loan is at the instance of sale, its not god enough to know that there is a 1k lien on the boat. Can you force Carol to give you the amount of the loan? Maybe if you are the execution creditor you can get her in Court to give the amount of the loan and immediately paying her off and having the court order her to remove the FS on the boat. The amount is not found on the financing statement. According to 9-210, the inquiry must be made by the DEBTOR. The response to an inquiry has to arrive within 2 weeks not enough time. I would also ask Bob. I assume they come into court with a paper saying $1,000 and future advances. We are still not safe because they can still make future advances. A judgment creditor could put Bob under oath and ask how much he owes, but this will not be at sometime before the foreclosure. But this does not help the bidder, b/c the financing statement and security agreement is outstanding and Carol could lend additional money right before the sale. Another option: You could string the sale out for 45 days, and then do the discovery. (b) If you cant get the information, what will be your bidding strategy at the sale? Should bid zero -- The bidder does not know how much the secured creditor is owed, and it should bid zero b/c it would buy subject to the security interest. Look to 9-323(d) the buyer of goods acquires free of the security interest to the extent it secures advances at the earlier of 1) the secured party has knowledge of the purchase; or 2) 45 days after the purchase. The secured party must have knowledge of the purchase. Typically, if the secured party gets knowledge that the boat will be sold on March 29. It will prevent the secured party from making an advance. Buying subject to the $1,000 security interest. So, you should bid $31,000. (Value of $32,000 - $1,000). What if Carol doesnt make the loan, and goes to the sheriff to demand possession under Grocers Supply? The lien creditor would use Freierson especially if Carol lets Bob use the boat. Problem for the lien creditor: provision in Article 9 that says the debtor can require Carol to supply the 3rd party with the details of the security agreement. The lien creditor cant get it on its own. The lien creditor would have to take Carol to court. Then, the lien creditor would pay off Carols 1,000 judgment. Problem 29.5: A creditor Sheng runs a search in preparation for a levy. There are three financings statements, each covering all the assets of the debtor Conda Copper, a company that is in financial difficulty. You doubt that anyone would have been stupid enough to lend money to Copper unsecured. The financing statements have been filed in the last few months. (a) What do you think is going on? Copper is wrapping herself in security agreements in order to ward of judgment creditors. Looks like Grocers Supply the debtor is friendly with a creditor in order to block a judgment creditor. It is better to be second in priority instead of a unsecured general creditor. (b) What should you do? Put the last two questions together with Grocers Supply. I have one debtor and one creditor who are in cahoots. You can say you are harming my stuff. Frierson limits Grocers Supply when they are both trying to repossess. The best thing to do is to put a future advance agreement in the original contract with your buddy. It allows the first secured lender to protect its position up front, and then come in at any point.Uniform Fraudulent Conveyance (and Transfer: two different Acts) Act: is aimed at transactions with the intent to hinder, delay or damage creditors. These are transfers normally given without fair consideration. Some of the law under these Acts is very obvious and other not so much, very subtle complex transactions. At the moment though there probably isnt much that our client can do. The facts say that 3months ago have passed since the reach back of the trustee in bankruptcy to upset transfers like this is normally 90 days. XXX. TRUSTEES IN BANKRUPTCY AGINST SECURED CREDITORS: THE STRONG ARM CLAUSE (30) Security interests generally retain their priority when the debtor goes into bankruptcy. That is not true however, as to unperfected security interests. Under Bankruptcy Code 544(a), sometimes referred to as the strong arm clause, a bankruptcy trustee or debtor in possession has the power to avoid most kinds of security interests that remain unperfected as of the time of filing of the bankruptcy case. Because perfection of a security interests is so likely to be challenged in bankruptcy, bankruptcy is often referred to as the acid test of the perfection of a security interest.

97

A. The Purpose of Bankruptcy Code 544(a) (p486) Bankr. Code 544(a) Seen as policy against secret liens It is seen as a policy against secret liens and reinforcing the requirements of Art 9 of having creditors give public notice of their security interest There are two reasons for this: It polices compliance with the filing requirements of Article 9 It serves a distributive function by insuring that secured creditors don't get benefits against unsecured creditors in bankruptcy that secured creditors couldn't get outside of bankruptcy. The interest is preserved for the benefit of the estate. If the trustee is successful in avoiding a security interest, the interest is preserved for the benefit of the estate, Bankr. Code 551. B. The Text of Bankruptcy Code 544(a) (p487) Probably the reason the drafters just didnt say that trustees can avoid unperfected security interests and liens is because the provision was intended to apply to a wide variety of statutory and judicial liens authorized under state laws. The drafters of the Bankruptcy Code decided to give the trustee the most powerful creditor rights possible, the ideal lien creditor, however, federal law leaves it to state law to determine what rights the ideal lien creditor has against others. 544(a) gives the trustee the power to avoid any transfer that could be avoided by one of the three hypothetical persons. 1) The Judicial Lien Creditor of 544(a)(1) The trustee can step into the shoes of a hypothetical creditor that extends credit to the debtor at the time of the commencement of the case, and that obtains, at such time and with respect to such credit, a judicial lien on all property which a creditor on a simple contract could have obtained such a judicial lien, 544(a)(1) They wanted to test perfection as of the filing of the bankruptcy case. When competing claim is a security interest, the applicable state law is 317(a0(2) and 9-323(b). Under it, ideal lien creditors defeat unperfected security interests for which no effective financing statement exists, but lose to other security interests. The Creditor with an Execution Returned Unsatisfied 544(a)(2) The trustee can choose to step into the shoes of a hypothetical creditor that extends credit to the debtor at the time of the commencement of the case, and obtains, at such time and with respect to such credit, an execution against the debtor at such time that is retuned unsatisfied at such time, 544(a)(2) Fixed some short coming in 544(a)(1) with regard to fraudulent transfers The Bona Fide Purchaser of Real Property 544(a)(3) The trustee can choose to step into the shoes of a hypothetical bona fide purchaser who bought and paid for the property (perfected such transfer) at the time of the commencement of the bankruptcy case, 544(a)(3). However, trustee must be one against whom applicable law permits such transfer to be perfected To put it another way, the trustee gets the rights of a bona fide purchaser only in circumstances where the competing transfer was capable of perfection. They allow a trustee to prevail only where The competing creditor was supposed to do something to perfect its lien and The competing creditor failed to do it Does not give trustee the rights of a hypothetical bona fide purchaser in a fight over fixtures In a case involving real estate, the trustee can use his or her rights as a hypothetical lien creditor or as a hypothetical bona fide purchaser. Midlantic National Bank v. Bridge (18 F.3d 195, p490) Midlantics Bank (MB) refinances a mortgage for 260k. The old mortgage is discharged, but the bank fails to record a new mortgage until after the bankruptcy proceeding is initiated. MB

98

argues that it retained an equitable lien on the property b/c under the doctrine of equitable subrogation they would be able to replace the new mortgage and replace the first. Holding: Under the NJ recording statute the bank did not have a good mortgage against anyone at time of bankruptcy. The court said they had an equitable lien but that such a lien would not be good against a bona fide purchaser under NJ case law. 544(a)3 gives the trustee the powers of a hypothetical bona fide purchaser and entitled the trustee to avoid the equitable lien of the unrecorded mortgage. Trustee in bankruptcy wins here. C. The Implementation of Bankruptcy Code 544(a) (p495) 544(a) makes certain transfers avoidable but it does not require the trustee to avoid them. The debtor in possession often has reason not to avoid transfer that it could avoid Exercise of Bankr. Code 544(a) Discretion by Chapter 7 Trustees Trustees are lawyers, professionals appointed by the US trustee to administer. They aren't paid if there is nothing in the estate but fully encumbered property, Bankr. Code 330 They aren't paid if there is nothing in the estate but fully encumbered property, i.e. they get paid ahead of all unsecureds but behind the secureds. When there are sufficient fund they get paid. In most (95%) of Ch7 cases all assets of the estate are encumbered though. If the trustee manages to avoid one or more security interests or liens against the property of the debtor, that property becomes the property of the estate, 541(a)(3) and (4) The proceeds of the sale are available to pay expenses of administration, including the fees of the trustee for administering the estate. Working in this incentive system makes trustees particularly vociferous advocates. Secured Creditors can File proofs of claim in Bankruptcy cases, but they are not required to do so. Dewsnup v. Timm the court held that unless someone sues them and serves them with process, secured creditors have the right to ignore their debtors bankruptcy. If the debtor ignores the bankruptcy and no one comes after them the debtors debt is discharged, but the secured creditor can still foreclose the lien. The trustee can bring an action under BC 544(a) whether or not the SC has filed a proof of claim in the Ch7. Under the 546(a) the trustee has up to 2 years from the time of his appointment to bring the action. Exercise of 544(a) Discretion by Chapter 11 Debtors in Possession Trustees are rarely appointed in chapter 11 cases If a debtor in possession is successful in challenging a secured creditors lien, the effect is to change the creditors status from secured to unsecured. They often do not want to avoid security interests: They may have granted the security interest in the first place in order to screw unsecured creditors. DIP is in the position of a fiduciary to the interest of the estate. If the DIB abuses his discretion by failing to bring or avoiding action that clearly should be brought some courts may permit the unsecured creditors committee to sue instead. Some may even remove the DIB and name a TIB. If chapter 11 is converted to a chapter 7 normally there is still enough time in the 2 year window under Bankr. Code 546(a) to avoid actions against secured parties who were not perfected at the time chapter 11 was filed. D. Recognition of Grace Periods Many states require public filings to perfect a lien and provide the creditor with a grace period within which to make the filing. An unperfected creditors at the time of bankruptcy can take advantage of relate back provisions that allow them to take action post-filing that would make them secured from some pre-filing event How is this possible? What about the automatic stay? Where is it in the code? 363(b)(3) creates an exception from the automatic stay for perfection allowed under 546(b) 546(b) says post-filing perfection is fine if it is perfection that would be good against any entity prior to

99

filing. This section makes the rights and powers of a trustee subject to any generally applicable law that permits perfection of an interest in property to be effective against an entity that acquires rights in such property before the date of perfection. E. Resistance to Bankruptcy Code 544(a) James White revising Art 9 Proposal to get rid of 9-317(a)(2) since it is unfair and creates waste: 1.Unfair- 9-201 makes even an unperfected SI king of the hilt. The fact that real estate law recognizes that unrecorded transferees over subsequent lien creditors suggests that at least some believe it to be the fairest outcome. 2.Waste- There are too many filings just to try and get priority over the TIB and no one else. Getting rid of this would eliminate a lot of litigation on the question of whether a particular SI is perfected or not. It would save money on filings and litigation and leave more money for the whole system to use (creditors, filing system, etc). Getting rid of this would eliminate a lot of litigation on the question of whether a particular SI is perfected or not. It would save money on filings and litigation and leave more money for the whole system to use (creditors, filing system, etc). The UCC made some changes to tone down the strictness of the perfecting requirements. 9-338 and 9520 allow SI perfected by the filling of incorrect FS to prevail over lien creditors and 9-515 allows SI that no longer are perfected b/c the FS has lapsed to prevail over a creditor that became a lien creditor while the SI was perfected. F. Trustees Rights Under 544(b) 544(b) Gives the trustee the power to avoid transfers that can be avoided by an actual unsecured creditor. This removes from the trustee the power to avoid security interests voidable under Article 9 b/c the creditor who can defeat an unperfected security interest is not an unsecured creditor. Only a lien creditor can defeat an unperfected security interest. In bankruptcy, a lien creditor is a secured creditor b/c the judgment is secured by the lien. This requirement can be end run, however, when a trustee is able to void a secured creditors interest and then step into the shoes of that creditor under 551 and use their interest for the benefit of the estate. As they are now an unsecured creditor the trustee can use 544(b) and exercise any rights in priority they had over other secured creditors before their interest was avoided by the trustee. G. Problem Set 30 Problem 30.1: Filed chapter 11 on April 15, and the case was converted to Ch 7 on October 15. Which security interests can the trustee avoid under 544(a)? (a) The secured party filed its financing statement on April 22. It can be avoided b/c the effective date of bankruptcy filing is April 15, and as of this date the secured party had not perfected. A lien creditor would have priority over an unperfected security interest. 348(a) the conversion of a bankruptcy case does not effect a change in the date of filing of the petition or commencement of the case. Bankruptcy Code 544(a) says that trustee can avoid it because he takes on the role of a lien creditor as of the date of the bankruptcy file on April 15, and as such it can avoid the unperfected security interest because he has priority over the un-perfected security interest at this point. 9-317(a)(2), if you become a lien creditor before it is perfected. 546(b)(1) the rights and powers of a trustee under 544 are subject to any general applicable law that permits perfection of an interest in property against any entity that acquires such rights as of the date of perfection. The facts here suggests we might have a PMSI with respect to collateral, they have 20 days to perfect. The attorney filed a financing statement on April 22nd, with respect to collateral acquired after 2 or after then the person might be okay. It doesnt violate an automatic stay in that case. Would filing a financing statement violate an automatic stay if the collateral were acquired prior to April 2nd. 362(a) (4) any act to create, perfect, or enforce any lien violates the automatic stay. 363(b)(3) filing of a petition does not operate as a stay of an act to perfect to the extent that such rights and powers are subject to such perfection under 546(b). So if you are within 20 days your alright, but with respect to property acquired 22 days before you might not be okay? The rest of 362(a)(3) unless the act is accomplished under the period set forth in 547(e)(2)(a) used to provide a 10 day grace period, but in the most recent change of the bankruptcy act they changed the 10 day period to

100

30 days. Go back 30 days from April 22, we might be okay on 30 day things. It is possible that you cant beat the purchase money under article 9 and that you havent violated the stay. (b) Same facts as (a), except the bank properly filed its financing statement on April 14, one day before the debtor filed under Ch 11. Not avoided under 544(a). It is a properly filed and perfected security agreement. NOTE: It may be a voidable preference under 547. Once youve gotten it on file, the trustee cant use 544(a), that is the meaning of 544(a). (c) The creditor listed the debtor as Gargantuan Industries and left off Inc. and it omitted all the information required by 9-516(b)(5). The security agreement still showed up in the search, but it is impossible to tell if the filing is against the debtor or a business using a trade name. The filing officer should have rejected the financing statement, but it was accepted. The trustee loses. Under 9-520(c), if the filing office accepts a financing statement that does not give the information required, the filing is fully effective. 9-520(c), comment 3. The trustee, therefore, cannot avoid it. Does the exception in 9-338 apply? 9-338 (Priority of Security Interest Perfected by Filing Financing Statement with Incorrect Information) the creditor is subordinated to a purchaser who buys in reasonable reliance on the incorrect info. No. Under 9-338, you have to make a negative inference. We dont have someone who is a purchaser or gave value. A trustee cannot fit into this description. (d) The creditor filed a financing statement 5 years prior to July 15, but failed to file a continuation statement. The financing statement lapsed on July 15, so it was effective on the date bankruptcy was filed on April 15. A lien creditor would not have prevailed if it levied on April 15. What happens when the financing statement ceases to be effective? 9-515(c) a security interest is unperfected upon lapse. If a security interest becomes unperfected upon lapse, it is deemed to never have been perfected ONLY against a purchaser of the collateral for value. See 9515(c), Comment 3, example 2. If you are thinking about filing for bankruptcy, you should wait until the financing statement lapses. It is all about reliance. The lien creditor did not rely on the filing system, so the lien creditor does not get an advantage. Even after the perfected secured creditor becomes unperfected it still has priority over someone who becomes a lien creditor when the it was perfected. (e) The lawyer forgets to fill in the description of the collateral on the security agreement. Two years later, the lawyer wants a subordinate lawyer, Grace to fill in the blank. Grace refuses, resigns from the firm, and tells the trustee. Another lawyer in the firm, Bennie fills in the blank. The lawyer and the client agree in writing that this expressed their original intention. What have Bennie and Grace done wrong? Bennie has violated the automatic stay of 362(a) criminal contempt of court, and he can go to jail. Bennie has also falsified documents to court and could be disbarred. Under the old version of the Model Rule 1.6, Grace is not allowed to breach confidence. Under the new version of Rule 1.6, Grace can breach confidentiality in order to prevent the financial harm to a 3rd party. Grace is an associate, so she wont have responsibility for what her colleague did unless she supervised him. In NY it is the intention to commit a crime, CA has a very restrictive notion to the exceptions of confidentiality and they dont encompass what Grace did here. (f) On April 6, nine days before the company filed for Ch 11, a bank financed the purchase of a company vehicle. The bank filed the certificate of title on April 25 after it learned of the bankruptcy. Did the bank violate the automatic stay? The bankruptcy code allows you to file within a window under 362(b)(3). Here, we are outside 10 days, but under 20 days. The DMV only gives you 10 days, as does 547(e)(2)(A). But, 546(b) gives you a bigger window subject to generally applicable law. Under 9-311(a) you dont need a financing statement because cars are done by certificate of title. Under 9-317 it is a PMSI (purchase money security interest) so you get 20 days. What about the fact that the DMV only gives you 10 days? Note that the DMV gives you 10 days to maintain your status not 10 days to file. You can file whenever you want. The question is whether you get the 20 days in PMSI or the 10 days from the DMV? You have to look at the comments. Look at comment 8 to 9-317. If it is filed within the 20 days you are okay. This comment is a wraparound. When article 9 was revised they wanted more time for PMSI and rather than asking all of the DMVs to change the amount of time, they put in this workaround. So the trustee loses. For purposes of bankruptcy, you still have 20 days to file.

101

Section 20(b) of the motor vehicle title act gives you a ten day grace period. Article 9-311(b) compliance with that is the equivalent of filing a financing statement, does that gives us an argument that 9-317(e) applies, that if someone files a PMSI within 20 days. He might make this argument. (g) One week before Gargantuan filed its bankruptcy petition, the Yarn Shop delivered a writ of execution to an Ohio sheriff along with instructions to levy on an automobile owed by Gargantuan. Two days after the petition is filed, the sheriff (who was unaware of the filing) levies on the car and takes possession of it. Can the TIB avoid the levy under 544(a)? The trustee will prevail if a hypothetical lien creditor that levied on the date of bankruptcy would prevail over the yarn shop. Under Ohio law, the yarn shop having delivered the writ of execution first would prevail over a hypothetical lien creditor who delivered a writ of execution and levied on the same day. So how do we regard the trustee, the trustee effectively delivers its writ to the sherrif on the day of the filing. The yarn shop has already delivered its writ. Is the reference in the bankruptcy code to non-code law to determine the rights of the hypothetical lien creditor, yes. The existence of a lien and priority are two different things according to Kaufman. Unless you have a security interest that priority doesnt do you any good. The argument for 546(b)(2) is that there is an inchoate lien here. The OH statute is a moderately common statute, and you can imagine that when a bankruptcy is occurring there are unsecured creditors outside scrambling to get liens. What else should we look at to solve the problem? Violated 362(a)(3) Automatic stay the sheriff levied after the filing of the petition in bankruptcy. 362(b)(3) is not applicable in this problem allows you to perfect a lien that you already have. This section does not apply b/c under Ohio law, you dont have a lien until the sheriff seizes the property. The priority dates from the writ of execution. There are two viewpoints authors and Kaufman. Authors: Based on state law: Ohio lien law (p466) priority between liens does not depend on day of levy BUT delivery of the writ to the sheriff. The bankruptcy petition comes between delivery of the writ and execution. The sheriff is permitted to finish the execution, and it relates back to the delivery of the writ. Kaufman: what about the provision of the Ohio lien law that says you have to levy to get a lien? The sheriff had not levied by the date of bankruptcy in this problem, regardless of when their priority relates. Problem 30.2: if you disperse the profits early, if you are dealing with PMSI, weve got 20 days after the debtor receives possession of the collateral and if we do that our client will have priority over trustees in bankruptcy and even with respect to certificates of title with 10 day provisions. 360(2)(b)(2)? gives us a 30 day window for file to beat the trustee in bankruptcy if it isnt a PMSI. Could be problem if doesnt get it on file within 30 days or if someone files ahead of us or that we wont always fill out the financing statements perfectly right and the filing office properly rejects them. The answer to the question is that there are enough risk one ought to change the procedure and not disburse the proceeds early, borrowers need the money and put on a lot of pressure to disburse the proceedings once the closing has taken place and sometimes it is hard to resist them. Problem 30.3: Debtor has $10 million in assets. $8 million of secured debt to Oriental bank. The debtor also has $20 million in unsecured debt. (a) The financing statement does not show up in a search under the debtors name. The DIP may avoid. 9-506(b) a financing statement is seriously misleading if it fails sufficiently to provide the name of the debtor 544(a) only says that the trustee in bankruptcy may avoid. So, Oriental is vulnerable but within limits it is up to the DIP to decide what it wants to do. (b) How much can Oriental get under chapter 11? It is entitled to what it would get in a chapter 7 liquidation. If the DIP does not avoid its security interest, it is entitled to the full $8 million. $8 million but since it is now unsecured debt, the creditor will probably not get the entire $8 million, but rather a pro-rata portion of the debt. (8/28 * $10 million = .29 cents on the dollar) (c) How much money are unsecured creditors entitled to receive? It turns on what the DIP does with Orientals security interest. Not avoided - $2 million is left.

102

(d)

Avoided 20/28 * $10 million = $.71 cents on the dollar, other unsecured creditors, 7.1 million 8/28 of the 20 million, .29 on the dollar, 2.9 million How much money are shareholders entitled to? None, there is $28 million in unsecured debt, and $10 million in assets. Absolute priority rule under bankruptcy.

(e) Proposal by the DIP -- $5 million for Oriental, $4 million for the unsecured creditors, and $1 million for the shareholders. Oriental: accept the $5 million if they think the DIP will avoid their security interest. Unsecured creditor: o If they think Oriental is a friendly creditor to the DIP and the DIP will not avoid Orientals security interest, they should accept the proposal. o If they think Orientals security interest will be avoided, they should not accept the plan. The unsecured creditors might be able to bring a lawsuit against Oriental to avoid its security interest. If the case against Oriental is open and shut, they dont have much of a defense. The position of the unsecured crediors is strong for getting permission to avoid it. But this does not happen very often. What has the DIP in possession accomplished if the proposal is accepted? o The shareholders have equity left in the company. Problem 30.4: If the property in Midlantic v. Bridge had been personal property rather than real estate, would that have changed the outcome? The trustee would only have the rights of a lien creditor under 544(a) with regards to personal property. Kaplan -- Lien creditor vs. lien creditor principles of equitable subrogation might edge out the trustee in bankruptcy. Should real estate and personal property be the same. An unrecorded mortgage is effective in most instances. You could do something like reduce the rights of real estate mortgages. Kaufman isnt so sure about repealing 544(a): we could have a rule that just protected creditors who actually relied on the situation as it was. Who actually looked at the files and were misled by either a mistake that was made by the filing officer or the filing party. The minute you have rules that turn on reliance, those rules do encourage lying. Filing is easy and it is easily proved in most cases, so Kaufman thinks there is a lot to be said for just leaving things as they are. XXXI. TRUSTEES IN BANKRUPTCY AGAINST SECURED CREDITORS: PREFERENCES (31) A. Priority Among Unsecured Creditors (p507) Priority Under State Law Basically the unsecured creditors jockey with one another and the debtor can prefer one creditor over another creditor by promoting them to the status of secured. The grant of a security interest to a previously unsecured creditor is valid and enforceable even if the creditor who receives the grant furnishes no new consideration, 9-203(b)(1) and 1-201(44)(b) Debtors have the right to pay one creditor in preference to another. Priority Under Bankruptcy Law The moment the debtor files for bankruptcy, the automatic stay bars unsecured creditors from further collection efforts. To the extent that general unsecured creditors are paid at all, they are paid pro rata, in proportion to their claims. Treats general unsecured creditors alike. Reconciling the State and Bankruptcy Policies State and Bankruptcy law have competing goals, it seems. Generally, bankruptcy respect state law, however there is the problem of debtors, on the eve of Bankruptcy, preferring their creditor friends. Solution: Bankruptcy looks back in the 90 days before filing and knocks out any attempts to promote creditors from unsecured to secured status. This period if the preference period. Bankr. Code 547 authorizes the trustee or debtor in

103

possession to avoid any transfer made during the preference period that would have the effect of preferring one unsecured creditor over others. B. What Security Interests Can be Avoided as Preferences? Generally Bankr. Code 547(b) states which transfers can be avoided as preferences, to be avoidable, a transfer must satisfy each part of that section. 547(b) starts off noting that only a transfer of interest of the debtor in property can be avoided as a preference As defined in 101 transfer is very broad and includes, every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with property or with an interest in property. The creation and perfection of a security interest is clearly a transfer under this definition. 547(b)(1) to or for the benefit of a creditor, and 547(b)(2), for or on account of an antecedent debt. Basically the transfer must have been to a party, who at the time of the receipt was already a creditor. Principal effect it to shelter from avoidance interests securing loans that were secured from the time they were made. To protect security agreements that came into effect right after the debt had been created and arguably, therefore, related to antecedent debt, congress adopted 547(c)(1) that prohibits avoidance of a transfer that was intended to be a contemporaneous exchange for new value and that was in fact a substantially contemporaneous exchange. 547(b)(3) the solvency test If a debtor is solvent at the time of the transfer, the transfer is not avoidable as a preference for that reason alone 547(f) arms trustee trying to set aside a transfer with a presumption of the debtors insolvency that extends 90 days before the filing. The creditor must affirmatively prove solvency to escape the application of this provision. 547(b)(4) preference period test To be avoidable the transfer must have occurred during the preference period The preference period is 90 days before bankruptcy and one year for insider creditors 547(b)(5) the improvements test To be avoidable, the transfer must have improve the creditors position That means the transfer must have enabled the creditor who received it to recover more than the creditor would have if the debtor had been liquidated under chapter 7 without making the transfer. When Does the Transfer of a Security Interest Occur? The precise moment of the transfer is important for two reasons The transfer can be avoided only if it occurs within the preference period Both state law and Bankr. Code 547 permit transfers of security interests that occur within certain grace periods to relate back to earlier dates. If the earlier date is at or about the time the transferee first became a creditor, the transfer is not longer for or on account of an antecedent debt and becomes unavoidable even though it occurred during the preference period. 547(e) basic rule that the transfer of a security interest is made when it is perfected 547(e)(1) refers to state law to determine when a security interest is perfected Real Property security interest is perfected when it is too late for a bona fide purchaser to acquire a superior interest Personal Property and Fixtures - security interest is perfected when it is too late for lien creditors to acquire a superior interest UCC 9-317(a)(2) and 9-323(b) tell us that it is too late for a lien creditor to acquire a superior interest when the security interest is perfected within the article 9 meaning or the term or the earlier time that a security agreement was signed and a financing statement filed.

104

Possible for perfection under bankruptcy when none exists under UCC for example, because no consideration has been given. 547(e)(3) states that for purposes of this section, a transfer is not made until the debtor has acquired rights in the property transferred. This means for things like after acquired property, transfer doesnt occur until the debtor actually has rights to the collateral rather than when the initial statement was filed as under article 9 The 547(c)(5) Exception for Accounts Receivable and Inventory The 547(e)(3) rule that the transfer of a security interest in after-acquire property is not made until the debtor has acquired rights in that property is potentially devastating to accounts and inventory lenders. Here most of the debtors collateral could have been acquired during the preference period and thus, according to 547(e)(3) would have been a transfer during the preference period. 547(c)(5) creates a safe harbor for security interests in accounts receivable and inventory. Treats accounts and inventory as a single pool. The basic gist is that you are safely secured up to the value of your inventory or accounts as of 90 days before filing, regardless of whether there are actually different widgets in place during the 90 day period. Because youre measuring aggregate changes in collateral over a period, you use the two point test of whether the receivables and inventory lender has improved its position. In re Ebbler give description of two-point test: First determine the amount of the loan outstanding 90 days prior to the filing and the value of the collateral on that day Next, make the same determination as of the date of filing the petition If there is a reduction during the 90 day period of the amount by which the initially existing debt exceeded the security, there is a preference. 547 makes only the extent of the preference voidable If the creditor is fully secured 90 days before filing the petition, then the creditor wil never to subject to a preference attack. Relation-Back Rules Determining when the transfer of a security interest was made is complicated by the existence of rules in both state and federal law that permit perfection, once made, to relate back to an earlier date Bankr. Code 547(e)(2) provides that if a secured creditor perfects its security interest within 30 days after the interest takes effect (that is, 30 days after attachment), the interest is deemed perfected as of the time it took effect between debtor and secured creditor. Debtor and secured creditor create a security interest that attaches on March 1, secured creditor perfects interest on March 10. Bankr. Code deems the transfer made on March 1. Bankr. Code 547(c)(3) exempts a purchase money security interest from preference avoidance provided that the secured creditor disburses the loan proceeds at or after the signing of the security agreement that perfects the interest within 30 days after the debtor receives possession of the collateral. Can a state extend or curtail grace periods for perfecting found within the bankruptcy code Fidelity Financial Services, Inc. v. Fink (522 US 221, p514) The broad statutory history of the preferences provisions persuasively suggest that congress intended 547(c)(3)(B) to establish a uniform federal perfection period immune to alternation by state laws permitting relation back. After this case, it no longer matters for purposes of preferences avoidance what grace period a state gives the holders of purchase-money security interests in which to perfect. C. When the Transfer Take Effect v. When the Transfer Occurs The transfer takes effect when the security interest attaches. The transfer essentially occurs at the time of perfection or the earlier authentication of a security agreement and filing of a financing statement, 547(e)(1), or if the interest is perfected within 30 days of attachment, the transfer is deemed to have occurred at the time of attachment under the relate-back provision of 547(e)(2).

105

D. Strategic Implications of Preference Avoidance (p515) Many debtors can choose when to file bankruptcy, so they can make preferential transfers and then wait until the preference period expires to transfer. Unsecured creditors will monitor filings to see if debtors are promoting some unsecured to secured status. This indicates financial troubles. Unsecured creditors may file for involuntary bankruptcy to insure that there is something in the estate. Savvy unsecured creditors will go to the creditor and threaten involuntary petition and demand that they be upgraded. E. Problem Set 31 Problem 31.1: Company filed Ch 11 bankruptcy on September 1. On December 30, the case was converted to Ch 7. A partner in the law firm was appointed trustee. Which transactions can be avoided as preferences? (a) On Aug. 15, Company borrowed $300,000 from Firstbank. They executed loan documents that day. They included security agreement and financing statements, both covering equipment owed by the Company. Firstbank filed the financing statement the following morning. Is Firstbanks security interest preferential? Not avoided. When did the transfer take effect? That is to say when did attachment occur. Aug. 15 b/c a security agreement was signed. When was the transfer made? Aug. 15 b/c the security agreement was filed within 30 days and wasnt for antecedent debt. Therefore, it is not for antecedent debt even though it was in the preference period. No antecedent debt the debt was created on the day the transfer was made. 547(b)(2) requires there be an antecedent debt. 547(e)(2) relation back for security interests perfected within 30 days after the interest takes effect between debtor and creditor. b) On February 7, Company borrowed $300,000 from Secondbank on an unsecured one-year note. On July 11, Company signed a security agreement that granted a Secondbank a security interest, and Secondbank immediately perfected. Avoided transfer for benefit of creditor on antecedent debt within 90 days of filing bankruptcy. The security interest will put the creditor in a better position. When does the transfer take effect? July 11. When was the transfer made? July 11. When was the debt created? Feb. 7. (antecedent debt). TIB is going to be able to avoid this one. (c) On Feb 7, Company borrowed $300,000 from Thirdbank on a secured one-year note. The financing statement was lost in the mail. Five months later, it was found by a postal employee. On July 11, the UCC filing office accepted the filing. Avoided not within the 30 day window. When is the transfer made? July 11 for antecedent debt. (d) On July 21, Company purchased a network and hardware from EMS. Company financed the purchase with a $30,000 note from Fourthbank. Company signed a promissory note, security agreement, and financing statement. Fourthbank issued the loan check on July 21. EMS delivered the network the following day. Fourthbank mailed the financing statement to the Secretary of State, and it was accepted for filing on July 30. Not avoided there is no preference b/c of 30 day window. What if this was filed on Aug. 2? PMSI 9-103(a)(1) purchase money collateral means goods or software that secures a purchase-money obligation incurred with respect to the collateral. 9-103(b) purchase money security interest in goods. 30 day window after debtor gets possession of the collateral under 547(c)(3). 547(e)(3) a transfer is not made until the debtor acquires rights in the property. The transfer is perfected within 30 days and so is not avoidable. (e) Would the result be different in (d) if Company had issued the check to the Company and the Company used other funds to purchase the network? Not a different result. It would no longer meet the definition of a PMSI, but it is still within the 30 day window of 547(e)(2). (f) On March 9, Company did not have the money to make its payroll. It borrowed $300,000 from the wife of the CEO. The financing statement was not filed until April 9 which would make it voidable. 101(31) defines insider and if the debtor is a corporation, it includes the relative of a GP, director, officer, or person in control of the

106

debtor.101(45) defines relative and it means an individual related by affinity or consanguinity within the 3 rd degree. 547(b)(4) gives a preference period for insiders of one year. Remember that the trustee loses the presumption of insolvency under 547(f). It was not contemporaneous under 547(c)(1) and does not meet the 30day window exception under 547(e)(2). So here it would be voidable since here we would consider this to be a deal with an insider so the one year term applies and this would be a transfer. Problem 31.2: Over a year ago, you filed suit against Company on behalf of your client. The suit is on an unsecured promissory note. The case was tried more than two months ago, and you won a verdict of $547,000. On the day after the verdict, four other creditors of the Company filed financing statements and recorded real estate mortgages against Company. Eleven days ago, the court entered judgment on your verdict. Yesterday, the judgment became final and you entered writs of execution and garnishment on Companys property. The Company is still selling motorcycles on its showroom. What is your next move? (1) Involuntary bankruptcy303(a) -- Threaten with involuntary bankruptcy. If the debtor has 12 or more creditors, it takes 3 creditors to file an involuntary petition. Watchdogs get no special reward only pro rata distribution, so this is not a good option. With all the other creditors hanging around you probably arent going get much money. 547(b) - avoid the other creditors security agreements filed the day after the judgment. (2) Threaten involuntary bankruptcy unless the Company gives you a security interest or money. But, if you get a security interest, and later they go into bankruptcy your security interest may be avoided while the others will be outside the preference period. It isnt a good idea to get the debtor to give you a SI since at anytime bankruptcy can be entered and then youll be in the preference period. (3) Best option: Go to the other creditors and bargain with them. Unless they cut you in on their preferential position, you will push the Company into bankruptcy and then theyll all be in the same boat. Problem 31.4 Security interest in inventory 547(c)(5). On June 1 balance of loan was $250,000 and value of inventory was $120,000. On Aug. 29, date of bankruptcy filing, the loan balance was $150,000 and the value of inventory was $70,000. Kaufman thinks that one could cram a conditional sales contract and chattel paper into the exception of 547(c)(5). Solution: This section creates what is called two point test under 547(c)(5) Within 90 days of filing (June 1) $130,000 difference between loan and value of inventory. (250120=130) Date of filing -- $80,000 difference between value of loan and value of inventory. (150-70=80) Preference of $50,000. So 50k will be voidable by the TIB. Here the SC has improved its position and so that 50k improvement represents a preference. The formula doesnt deal with the situation in which the SC is fully secured, it only comes into play when the debtor is under secured. HYPO: If you are oversecured on day one, there is no preference! Within 90 days of bankruptcy: (100 debt and 125 collateral) AND Date of bankruptcy: (100 debt and 200 collateral), there is NO preference! Kaufmans problem to illustrate 544(b) The Bank loan and creditors judgment are each in excess of the value of the equipment. Should the trustee abandon the equipment? 544(b) gives the trustee the power to avoid transfers that can be avoided by an actual unsecured creditor. This removes from the trustee the power to avoid security interests voidable under Article 9 b/c the creditor who can defeat an unperfected security interest is not an unsecured creditor. Only a lien creditor can defeat an unperfected security interest. In bankruptcy, a lien creditor is a secured creditor b/c the judgment is secured by the lien. 544 is useless with respect to secured creditors, except in this situation: What c With this Assignment, consider the following scenario: 7/1/05 7/2/05 7/10/05 9/15/05 Bank makes loan and takes a security interest in debtors equipment Judgment creditor of debtor levies on its equipment Bank files its financing statement Debtor files in bankruptcy

107

Avoided Under Strong Arm Statute? Trustee in bankruptcy cant attack the bank under 544(a) b/c the bank has perfected before bankruptcy. Under 544(a) the Bank wins over the trustee in bankruptcy. The trustee cant attack the banks security interest under 544(b), which only gives unsecured position. The trustee cant step into the shoes of the lien creditor here because under banrkruptcy law, lien creditors are considered to be secured creditors. The minute the judicial lien creditor gets its rights by levying it looses its status under the bankruptcy code as an unsecured lien. So for purposes of the bankruptcy code the judicial lien creditor is safe. The trustee cant go against the judicial lien creditor. If he hasnt levied then 9-317 doesnt give the creditor any rights. Avoided as Preference? The perfection is on account of an antecedent debt in literal terms but we have the 30-day window provided in 547(e) (2)(b), 30 days after the SI is perfected. The transfer is made at the time the transfer takes effect which means the giving of a SI. Transfer taking effect means when it attaches. The SI doesnt have to be perfected, all it has to do to transfer is attach. Here the SI attaches on 7/1 and is filed in the window of 30 days and hence IS NOT considered antecedent debt. Perfection depends on beating out the lien creditor. In order to get the relation back and the retroactive effect, it has to be perfected within 30 days of attachment. 547(e)(2)(A) is important. 547(e)(2)(A) gets you around the notion that the transfer is made for antecedent debt. This is why the trustee cant avoid the transfer under the true transfer avoidance. The SC can relate back to 7/1 since he has filed within the 30 days. The loan and the transfer are considered simultaneous. The Bank hasnt beat out the JLC until he files on the 7/10. If the bank had filed after 30 days then the FS may be considered for antecedent debt. The relation back only operates when you file within the 30 days. What about the judicial lien creditor? Can the trustee avoid the judicial lien creditor? There is a case of classic preference. The indebtedness of the judicial lien creditor must date to way back before the Banks since by the 7/2 he already has gotten a judgment and levied (his original loan must be much older). The JLC gets its interest in the property when it levies. Therefore, the judicial lien creditors interest can be avoided as a preference under 547(b). 551 any transfer voided or lien voided is preserved for the benefit of the estate. The trustee in effect steps into the shoes of the unperfected SC and enforces the SI for the benefit of the estate and indirectly the unsecured creditors. The trustee steps into the shoes of the lien creditor. The TIB has avoided the lien of the lien creditor, the trustee preserves that lien and by preserving it for the benefit of the estate it preserves the priority it enjoys over the bank. To the extent of the amount represented by the JLC the trustee is going to be able to exercise the right over the equipment and reduce the right of the bank to that of an unsecured creditor completely. The TIB thus achieves the result that was formally achieved by Moore v Bay using the rights of an actual creditor to defeat the secured creditor but measures by the amount of the priority of the avoided lien. The lien creditor can prime the bank for the amount of the judgment. The delay in filing allowed the lien creditor to get priority over the bank to the extent of the lien. Remember 9-317(a) judgment creditor has priority over the bank. The judgment creditor primes the bank b/c the bank is not perfected before or did not file before judgment creditor levied. Although 544 does not allow the TIB to use rights of lien creditor directly, through this end run, by using 9-317 and 551, the TIB can use the rights of an actual lien creditor against the security interest. The estate gets the amount the lien creditor can get. XXXII. SECURED CREDITORS AGAINST SECURED CREDITORS: THE BASICS (32) 9-322 governs priority among article 9 security interests. They do not apply to competitions between article 9 security interests and other kinds of liens except agricultural liens A. The Basic Rule: First to File or Perfect (p519) Basic rule: 9-322(a)(1) pure race statute Priority date of one secured creditor against another is the earlier of the date on which secured creditor filed or perfected. Rule allows a party to file before lending or agreeing to lend, searching the system, and then assuring itself no one could have perfected in the interim. SC not only has to check title for filing, but inspect property to ensure no perfection by possession The holder who gains priority first by filing or perfecting retains it so long as the holder remains

108

continuously filed or perfected, 9-322(a)(1) 9-322(a) assigns priority without reference to either creditors state of mind Doesnt matter if thought your lien was subordinate when filed if it isnt Doesnt matter if knew debtor wanted someone else to be senior. 9-325: exception to pure race for asset transfers Subordinates security interests perfected against a transferee to those perfected against a transferor. Example SC1 securitizes debtor 1 for equipment. SC2 securitizes debtor 2 for after-acquired property. SC2 files. Then, SC1 files and perfects. Debtor 1 sells asset to debtor 2 Even though SC2 filed first, SC1 (transferor SC) wins as long as it perfected before the sale This is because SC1 had a security interested perfected against the transferor prior to the sale which trumps the security interest SC2 has perfected against the transferee regardless of who perfected first. B. Priority of Future Advances (p521) Advances made by secured creditor to debtor have priority as of filing of financing statement provided that the financing statement cover the collateral, implicit in 9-322(a). Policy Reasons Financing statement is to put on notice, the second lender is on notice of the possibility of advances by a filed financing statement Less persuasive than under real estate law where a future advances clause must appear in the mortgage An important function is to relive the lender who will make future advances from the necessity to file and search in conjunction with each advance Ironically, many filed financing statements are just to reserve the date there is no security interest A single financing statement is adequate to perfect any number of security interests, to the limits of the description of the collateral in the financing statement. C. Priority in After-Acquired Property (p523) Article 9 permits the grant of a security interest in property that the debtor doesnt yet own. If there is an after acquired property provision and the debtor later acquires property that fits the description in the security agreement, the security interest attaches, 9-203(b). As against other article 9 secured creditors of the debtor, the after-acquired lenders priority dates from the time of its filing, 9-322(a)(1). Inventory secured financers are the most prevalent users of the after acquired property clause. D. Priority of Purchase-Money Security Interests (p525) PMSIs generally 9-324(a): PMSI in collateral other than inventory has priority over conflicting security interest in same collateral, if PMSI is perfected no later than 20 days after debtor receives possession of collateral. Example Feb 1: Bank files financing statement against equipment of Davis Industries July 1: vendor sells equipment to Davis w/ PMSI July 19: vendor perfects PMSI by filing financing statement Result: Vendor has priority. Because the 20 day grace period exists, anyone lending against non-inventory collateral in possession of the debtor must consider the possibility that The debtor obtained possession of the collateral in the past 20 days and The holder of more or more PMSIs in the collateral has yet to file a financing statement, but will do so before the end of the 20 days. Conflicts b/w PMSI secured creditors .

109

More than one creditor may have PMSI in collateral 9-324(g)(1) gives the sellers PMSI priority over the lenders PMSI. 9-324(g)(2) gives a lenders PMSI priority over anther lenders PMSI if that lender filed or perfected first under the rules of 9-322(a) (this could come as a surprise to the lender who thinks it has the 20 day grace period to create its priority) PMSIs in inventory 20-day grace period for filing PMSI in 9-324(a) does not apply to inventory If PMSI lenders against inventory could, like non-inventory counterpart, obtain priority by filing a financing statement 20 days after delivery, the debtor would have (and spend) double financing long before the inventory lender learned of the conflict. 9-324(b) permits PMSIs in inventory have priority in inventory only on these conditions: PMSI financier must perfect no later than the time the debtor receives possession of collateral PMSI SC gives advance notice to all secured inventory lenders of upcoming PMSI in inventory Basically searches files for other creditors and sends notice via certified mail or something Notice is good for five years, and then must be renewed E. Purchase-Money Priority in Proceeds (p528) Purchase-money priority under 9-324(a) extends to collateral or its proceeds Thus, PMSI holders have priority over proceeds of collateral, above competing security interest perfected by an earlier filing that named those proceeds as original collateral. EXCEPTION: PMSI in inventory only flows into chattel paper, instruments, and cash proceeds (not, for example, accounts). 9-324(b) F. Priority in Commingled Collateral (p529) Collateral is commingled when it is mixed with other property. Commingling of goods bought under PMSI If collateral becomes part of product or mass, security interest continues in product or mass. 9-336(c). If more than one security interest attaches to product or mass as result of commingling, interests rank equally & share pro-rata in proportion of cost of each partys contribution to total mass cost If identity of collateral is not lost: E.g., if security is a replacement part in a machine it is an accession and governed by 9-335 SCs perfected interest will have priority over later-perfected interests in the whole machine Yet 9-335(e): SC in whole w/ priority over accession SC can prevent removal from whole G. Problem Set 32 Problem 32.1: There is a debtor who gives several security interests in the same collateral, some lawn dogs, to different creditors on different dates. The security interests are the following: 8/1 Bank 1 filed a financing statement (but there is no commitment yet). 8/5 Bank 2 filed a financing statement and advanced funds to debtor 8/7 C-Dogs became a lien creditor by levying on the equipment and taking possession 8/10 Bank 1 approved the loan and disbursed the funds Who has priority in the equipment? Bank 1 vs. Bank 2 Bank 1 wins. 9-322(a)(1) -- Between the holders of two security interests in collateral, the first to FILE OR PERFECT has priority and here Bank 1 first filed the FS on Aug 1. Bank 2 vs. Lien Creditor Bank 2 wins. 9-317 -- Bank 2 perfected before the lien creditor filed as they had a SA and a FS. Bank 1 vs. Lien Creditor Lien Creditor wins. Bank 1 would need a security agreement and financing statement to beat Bank 1 under 9-317(a)(2)(b) since Bank 1 didnt have a SA by the time the lien creditor takes possession of the law dogs and UCC tells us that a FS and a SA has to exist. Lien creditor is superior to Bank 1. How do you divide up the collateral? Circular priority problem (Similar to Ski Ridge in assignment #20 where the court broke the circular priority where there was a subordination agreement. The Court allowed the junior creditor to

110

take the property.). There is no logical way to break out b/c there is inconsistency in the priority rules. The court faced with the problem must decide which party does public policy favor in the situation? The court will have to invent some solution here and favor one of the creditor. The problem is that there are Art 9 rules and common law rules regarding the priority of the lien creditor that clash here. It depends on if you are pro-secured creditor or not. Maybe the court will divide the payment after liquidation. If one were to follow the Art 9 rules then Bank1 would come first, Bank 2 second and lien creditor last. Problem 32.2: Double debtor problem. Centurion loaned money to Flight Analysis against flight simulation equipment, but it did not realize that First National Bank had previously filed a financing statement covering the same collateral. Centurion had a security interest in another company and a first FS (in Pilots Unlimited) describing the same collateral and after acquired property (last year sometime). Will Centurion be ahead of First National if Flight Analysis sold its equipment to Pilots Unlimited? Solution: No, Centurions security interest in the equipment sold to Pilots Unlimited will be subordinate to First Nationals security interest, even if Centurion filed against Pilots Unlimited before First National filed against Flight Analysis. Under 9-325 (a), a security interest created by a debtor (Pilots Unlimited) is subordinate to a security interest in the same collateral created by another person (Flight Analysis) if: a) debtor acquired the collateral subject to the security interest created by the other person; (Yes, First Nationals security interest clings to the equipment); b) the security interest created by the other person was perfected when the debtor acquired the collateral; and (Yes) c) there is no time when the security interest was unperfected. (Yes). 9-325 is deliberately designed to prevent pulling off the scheme to take advantage of an earlier filed financing statement and allege that the collateral would be covered under an after-acquired property clause. Additionally 9507 tells us that even when disposed of the FS remains effective against the collateral being sold. Under the old Article 9 this problem would come up, and people in the position of Centurion would look around and find an earlier financing statement even though the other deal was in the records. See Comment 3, 9-325. The idea is that the buyer that in this case is a fraudulent buyer would have the possibility of looking and searching before making the purchase to see if what they are buying is subject to a SI. HYPO: A Holding Corp owns Bank A and Bank B. A part of Bank As collateral goes to Bank B (inventory, accounts). According to 9-325 were still in the same situation. What happens though, if this inventory and the account receivables these now create after acquired inventory and account value. As a matter of law, the contracts that are inherent to the assets of one part of the business become binding on the other parts when the collateral moves. 9-203d and e tell us that the SA entered into by a corp is binding on the taker. In the case above the conditions of the SA b/w Bank A and the collateral is binding on the Bank B. 9-508 tells us that the FS naming an original debtor is effective to perfect the SI in collateral in which new the new debtor has or acquires rights in the FS that would have been effective. If the FS becomes seriously misleading theyll have 4 months to file a new one. So here there will be control on the after-acquired accounts and inventory. Bank A will have a SI over the after acquired inventory and accounts. Bank A will have these rights without tracing mechanism. Problem 32.3: ONB made a $7,500 loan to George and filed a financing statement that contained no provision regarding future advances. It indicated that the collateral was equipment. ONB has approved a $40,000 line of credit for George secured by the dry cleaning equipment in his shop. ONB knows it must prepare a new security agreement, but does it have to file a new financing statement? ONB does not need to file a new financing statement. The financing statement does not have anything to do with the amount outstanding. The security agreement defines the terms between the parties and a new SA needs to be made. This would be so even if it were another advance on the same thing the first loan was made. So, there has to be a second SA. It may even be dangerous to file a second FS since you open yourself to the argument that the 2nd FS refers to the second loan. A financing statement is good for any number of security agreements as long as they relate to the same description, the original FS serves the notice giving function. Since ONBs financing statement covers equipment all advances made by ONB have priority as of the filing of the first financing statement. 9-322(a)(1). Under 9-502(d) a financing statement may be filed before a security agreement is made or attaches The authors tell us this is so. This will of course be limited to the description of the collateral.

111

Problem 32.4: (a) Carol lent Bob $1,000 secured by his boat. A month later, BCA loans Bob $45,000 secured by his boat and other items. Bob fell behind on payments to BCA, and BCA repossessed the boat. Bob wants Carol to advance him $31,000 so BCA cant sell the boat or collect. Will this work? Yes. Under 9-322, the 31,000 advance has the same priority as the original $1,000 advance since both creditors are under Art 9 law and BCA has filed first. Possible problems: Fraudulent transfer hinder, delay, defraud creditors. There is a protection in the UFTA for recipients of transfers if they are in good faith and have given reasonably equivalent value. There is reasonably equivalent value b/c Carol advanced $31,000. But, is there a good reason for the advance? She made it to defeat a creditor who levied on the boat. What happens if the transfer is avoided? Carol has a lien for money that she gave, but the lien may be worthless in the face of the earlier seizure by the lien creditor. As Carols lawyer, you should discuss the reason for making the loan. Remember Grocers Supply, Carol can lend $31,000 and foreclose and that will knock out the subordinate security interest. See 4a2 and 8 of UFTA: a transfer made with actual intent to defraud or hinder any creditor of the debtor. (b) Assume that Carol had filed a financing statement against Bob before BCA repossessed, but Bob had not authorized a security agreement and Carol had not sent any money. Would the scheme work under these circumstances? Yes, the scheme would work even if Bob had not authorized a security agreement and Carol had not lent any money. See, Comment 4 to 9-322. When you have a secured creditor, all you need to do is get a subsequent security agreement. You dont even need a future advance clause. Comment 4 of 9-322 tells us jus this, the filing without a SA is going to act as a marker for your first position. Problem 32.5: How does a second creditor protect themselves from advances made by the prior secured creditor? Subordination agreement --9-339 - a person entitled to priority may effectively agree to subordinate its claim. Only the person entitled to priority may make such an agreement: a persons rights cannot be adversely affected by an agreement to which the person is not a party. The first secured creditor isnt likely to give a subordination agreement across the board. The first secured creditor may desist from making an advance in exchange for money from the second secured creditor. The first secured creditor may benefit from a fresh infusion of cash from the second secured creditor and this way may be able to have the debtor continue with the life of the corp and maybe pay back the loans. Problem 32.6: Harley is under pressure from Centurion to stop messing up. He had Centurion lend to Grumman 150 grand unsecured. However, he found out that FN has a security interest of 1.5 million in all Grummans assets (liquidation value less than 1.5 million). Harley ran a search. It does not turn up anything under the name of the debtor. Is the creditor safe can First National have an effective filing even though the search came back blank? (a) Is there any way that FN could have an effective financing statement that doesnt show up in the official search in the state in which Grumans business is located? (1) If the filing officer wrongfully rejects the financing statement, it is still effective. If the officer wrongfully rejected it then the original FS would have gone back to the filing office (2) They have moved within the last four months. 9-316(a) continuing perfection of security interest following change in governing law. A security interest perfected under the law of one jurisdiction remains perfected for a fixed period of time (four months or one year) even though the jurisdiction whose law governs perfection changes. If a secured party properly reperfects its security interest before it becomes unperfected under (a) it is continuously perfected. (3) The debtors principal residence is in another jurisdiction then the FS somewhere else will be effective. 506b (4) The filing officer made a mistake by misindexing it, the FS is effective, leaving the searcher at risk. (5) It could be a partnership with the financing statement under the name of one of the partners. (b) How can you find out if a financing statement exists without shooting yourself in the foot? Warrens answer: Search alternative names. If you can find the wrong filing, you 5know they made a mistake, and it is not enforceable against me. (c) What should you do? Harley offers to loan an additional $100,000, if Grumman secures all $250,000 (giving Centurion a possible first). The old $150,000 advance will remain vulnerable as a preference in

112

bankruptcy for 90 days, but the new $100,000 will not. What should Harley do? First, Harley could file a financing statement, and then call First National to see if they have a security interest in the debtors property. Harley cant file a financing statement unless they have authorization from the debtor. The debtor is unlikely to authorize unless the creditor agrees to lend money. Harley should carefully word the requirement for giving the debtor additional money. Second, wait four months for name and venue change windows to pass. Third, call FNB. Now you can tip your hand because you already have a security interest filed. Fourth, cut a deal between the two if FNB has a possible security agreement. Rather than litigate, have FNB and Harley sign a subordination agreement. Harley will not lend anything more than the $250,000 and that Harley wont be sued. -Here if Harley enters into a SA and has filed a FS it doesnt mean that Harleys Bank will give any money. The SA lays down the conditions that will apply when the Bank decides to give the money. The wording in the SA would have to say that this new loan will only be given if this loan is going to have priority. If FN has an effective FS it can withdraw the loan and if not the Centurion will have priority for 250k. -If there is a dispute b/w Centurion and FN then you can always agree on a subordination agreement and Centurion will be willing to forgo its priority for something in exchange. (d) What happens if you look under an incorrect spelling and find First Nationals filing? Ethical issue? 9-506 ineffective if seriously misleading. Finding it by accident doesnt cure the flaw. It didnt show up under the logic of the filing system. It is not effective. Ethical issue/Business judgment: The lawyer would not have an ethical issue. But, can Centurion take advantage of First Nationals mistake? It might adversely affect Centurions reputation and business ethics look at standard practices in the business community. Only $150,000 is at stake. Harley Davidson wants to file to protect his job, but the client is Centurion. The attorney should look out for the best interest of Centurion and not Harley whos an employee. Problem 32.7: Sara sells speakers to customers (who have inventory lenders). How can Sara get a first security interest in the speakers she sells to customers? 9-324(a) a PMSI has priority in goods OTHER than inventory. But this is inventory. 9-324(b) steps an inventory purchase money security interest must do to have priority: A)The purchase money financier must perfect no later than the time the debtor receives possession of the collateral. This would be done by perfecting a SA and filing a FS (although if this is consumer goods it would be automatically perfected, but we are selling to dealers). And; B)The purchase money financier must give advance notice to the inventory lender that it expects to acquire a PMSI in inventory. o It must search the system for all secured parties with a filing in inventory of the type if plans to sell. The lender should send notice by certified mail. Like a financing statement, the notice expires at the end of five years. The inventory lender must learn of the financing before disbursing against the collateral. The notification is going to say that Sally is taking a SI in the speakers. What is the inventory lenders position? They probably will not let the debtor give a PMSI in inventory. The debtor is double-financing and the creditor will probably have a provision in the SA that says that its an event of default if someone else gets priority on the collateral. The debtor is using the money from the inventory lender for some other purpose. What do you tell Sara, who sells the inventory? What is better than taking a purchase money security interest? Get paid out of the inventory financing cash on delivery or an arrangement that the inventory lender sends money straight to Sara. XXXIII. SECURED CREDITORS AGAINST SECURED CREDITORS: LAND AND FIXTURES (33) A. Mortgage Against Mortgage (p535) The rules governing priority among real estate mortgages are merely default rules that apply in the absence of an agreement among the parties. Normally mortgage contracts will contain their relevant position and so long as these agreements are consistent with one another they will themselves determine priority among the mortgages. NOTE: State real estate law is REALLY idiosyncratic. You must check the rule of the local jurisdiction Rules governing priority similar to those of article 9: Unperfected security interests in real property are binding on the debtor who grants them In general rule is that real estate mortgages rank in the order in which they are perfected

113

Timely recorded purchase money mortgages have priority over mortgages filed before them Mortgages can secure future advances (but a future advances provision must be included in the mortgage unlike UCC rule) It can reach after-acquired property but it will be subordinate to PMSI mortgage in the same property provided that the PMSI is recorded timely. Recording Statutes: The Rules of Priority Pure Race Statutes: He who records first wins, regardless of the intention or state of mind (knowledge of previous mortgage) Doesnt matter one bit that he is aware of other unrecorded mortgages out there already Pure Notice Statues: Order of recording is irrelevant. If you don't have notice of the previous mortgage at the time of conveyance you can prime it. However, you have constructive notice of all filed mortgages. Therefore, the person who files first will prevail, but not because he filed first, but because he gave constructive notice first Race-Notice Statutes: If the recipient of the second conveyance takes conveyance without notice and records first, he has priority over the first conveyance. NOTE: It is notice at time of conveyance that matters. Notice later does nothing it is a race to the recorder of deeds office. The notice portion of the notice-race statute is based on knowledge at the time of conveyance. Most common form of statute Who is a Good Faith Purchaser for Value Most recording statutes protect only good faith purchasers for value. These are considered to be those who give more than just nominal consideration (this is very different in the UCC). Those who grant mortgages in the hopes of forbearance on pre-existing debts without a binding contract of forbearance are not good faith purchasers for value. People who give too little value for a mortgage ARE good faith purchasers for value, e.g. A $20,000 mortgage for $15,000 of goods. Those who acquire liens against the collateral by proceedings are not purchasers. To be a purchaser, one must take in a voluntary transaction. Purchase Money Mortgages Most states recognize some kind of priority for purchase money mortgages B. Judgment Liens Against Mortgages (p540) In nearly all states, an unsecured creditor can obtain a lien against the debtors real property by suing the debtor, obtaining a judgment against the debtor and recording the judgment in the real estate recording system of the county where the real property is located. The judgment will constitute a lien against real property owned by the debtor at the time of the recording and real property the debtor later acquires. The recording of the judgment both creates and perfects the lien Normally, priority between a judgment lien and a mortgage depend on which was first created. Some states require that the mortgage be recorded before the lien judgment to trump it, NC Most states allow an unrecorded mortgage to trump a recorded lien if the mortgage was created before the judgment was recorded This is because these states only protect purchasers and lien creditors are not purchasers under the UCC definition. C. Construction Liens Against Construction Mortgages (p541) Mechanics Liens/Construction Liens are salutatory liens, liens that arise by operation of the law, to protect those who supply labor and material incorporated into the construction of a building. Protection comes in the form of a lien against the real property into which the labor and materials are incorporated.

114

A Prototypical Construction Financing Transaction Construction is financed by loans secured by the property to be built. The loan is paid out bit by bit in draws as certain portions of the building are completed. This way the financier isnt unsecured at any moment, as the cash is being put into the collateral immediately. Cash if given as a lump sum tends to disappear. The draws are used to pay laborers or subcontractors, all creating a chain of people dependent on the draws given by the bank. This keeps the bank from getting stuck with extending a bunch of cash for a building not yet built. Construction workers are hired with promises to pay when the building reaches the stage that allows a draw. It is the laborer and subcontractors who end up financing on credit the construction. The draws are held in trust for the laborers. Controls offered by construction lien law Normally require the money to be held in a trust to only be paid for proper payments. This means that nasty liability and even criminal sanctions attach to folks who misuse their draws. If the laborers are not paid they can file (generally with in 90 to 120 days) for a mechanic's lien or have a right on a claim of lien that is filed in real-estate recording system. Generally they take effect as of the date of the beginning of construction This means a mechanic's lien will generally kill a project because the bank will no longer pay out. (filing such a lien is almost universally a default condition in loan contracts). The filing of something like this puts everyone on notice that something has gone wrong and people stop working on credit. The threat gives contractor leverage with debtor. It also limits the effectiveness of the threat since the owner of the project can tell the creditor that it will screw itself over since the project will stop. If there is no payment the creditor must foreclose on the property as is. Who is Entitled to a Construction Lien Construction Liens are generally associate with the construction of a building, but the statutes of many states provide for liens in favor of virtually anyone who participates in the making of any improvement to real property. Priority in Construction Liens A lien for an alternation or repair, such as the installation of a new furnace to an existing building, takes priority as of the recording of the claim of lien. Liens that arise out of the construction of a building typically all take priority as of the same date, normally the date of the commencement of construction. Issues that arise: Erection/Construction or just Alteration? The construction lien goes back to time of construction, alteration simply to time of alteration When does construction actually start? (Date that mechanic lien could attach) When does construction get done? (Date from which the window to file for a lien begins running) In re Skyline Properties, Inc. (Bankr. Code WD PA 1992, p545) A mechanics lien for services which constitute alterations and repairs take effect and has priority as of the date the mechanics lien claim is filed. In the case of erection and constructions, the lien of a claim takes effect and has priority as of the date the visible commencement upon the ground work has begun. The concern in determining whether the work is erection and construction or alterations and repairs is whether a substantial change to the existing structure has occurred such that a third party, such as a bank, would be on notice that potential liens could exist. If there is a construction lender in the picture, the project is probably erection or construction. The construction lender will want its mortgage to have priority over any construction liens eventually field. Most direct way to do this is to record the construction mortgage before commencement of construction. Draws paid after creation and recording of the mortgage will be a future advance that will in nearly all circumstances have priority over liens arising out of the construction. Normally inspect site and take photographs before construction begins to prove that construction hasnt commenced.

115

Ketchum, Konkel, Barrett, Nickel & Austin v. Heritage Mountain Development Co. (Utah Ap. Ct. 1989, p 546) Heritage began planning and developing a ski resort in 1972. It secured the loan by executing a deed on the property in June 1983. in Sept 1983 Guaranty recorded a trust deed. At the time of the loan Guaranty knew that Heritage has undertaken extensive design and architectural work. The question was whether this off-site design work on the project gives Heritage a mechanics lien on the property with priority over Guaranty. The court decided NO. The liens take effect as of the time of the commencement to work on the ground for the structure. Commencement to do work means visible work with the presence of materials to give constructive notice to the other possible creditors. The staking work which was part of the work done by a surveyor was not sufficiently noticeable to give actual notice. D. Priority of Article 9 Fixture Filings (p549)

Priority of Fixture Filings You can get an interest in fixtures by filing in the real estate system. UCC 334. Often you can also get a security interest via mechanics lien, e.g a subcontractor installing hot water heaters can get a mechanics lien or a security interest in hot water heaters. The fixture filing will be more limited, it will only cover the actual fixture that the creditor has given and not anything more. i.e. the water heater. The problem here is that if another creditor holds a construction mortgage he has priority over the fixture lien holder and can prevent him from removing the fixtures from the property (UCC 9-604c). The mechanics lien attaches to the whole property. -The fixture filing may be later mechanics lien dates to time of construction. *Prior perfected mortgage beats fixture filing. The fixture filing creditor will always be subordinate to the mortgage holders rights or to the construction lien creditor. This is so unless one of the following exceptions are met: a) 9-334f, the creditor with priority gives consent to the fixture creditor to grant him priority in the particular fixtures. b)The mortgage gives debtor right to remove fixtures under the mortgage agreement c)The fixture filing is a PMSI in the goods affixed after the mortgage is in place and the fixture filing is made not later than 20 days after the goods become fixtures (9-344d). If the fixture creditor retains a PMSI in the fixtures before they are installed and files within 20 days after installation then they will have a PMSI.
E. Priority in Real Property Based on Personal Property Filings (p551) Article 9 security interest can exist in goods that are fixtures under real estate law. Article 9 authorizes the perfection of such interests by fixture filing in real estate recording system, UCC 9-102(a)(40), 9-501(a)(1)(B) and 9-502(b). The priority achieved by fixture filings is governed by UCC 9-334 Priority in Fixtures Incorporated During Construction A Construction Mortgage trumps a fixture filing made during construction if the mortgage is recorded first, 9334(h) If another creditor who holds a construction mortgage has priority over the fixture lien holder, he can prevent him from removing the fixtures from the property (UCC 9-604(c)). Priority in Fixtures Incorporated Without Construction The basic rule is that article 9 fixture filings and mortgages rank in the order in which they are recorded in the real estate system, 9-334(c) and 9-334(e)(1)

116

Generally, the nonpurchase-money fixture financier will be subordinate to whatever mortgages exist at the time of the fixture filing. If this results is unacceptable to the fixture financier, he may wish to seek the mortgagees consent to a security interest, UCC 9-334(f)(1) Two Exceptions to This General Rule: The fixture filing will have priority over the mortgages if the debtor has the right under the mortgages to remove the fixtures The fixture filing will have priority over the mortgages if the security interest is a PMSI in good affixed after the mortgage is in place and the fixture filing is made not later than 20 days after the goods become fixtures, 9-334(d) The fixture-secured party has the right to remove the fixture from the real property upon default if the security interest in the fixture priority has priority over the owners and encumbrancers of the real estate, 9-604(c). F. Priority in Real Property Based on Personal Property Filing There are two levels of perfection a secured party can achieve in fixtures Filing a fixture filing in the real estate records Filing a financing statement in the UCC filing system, UCC 9-501(a)(2) Effectiveness of Filing in the UCC for a Fixture The ordinary UCC filing is ineffective against a later mortgagee or a fixture filer who perfects by filing in the real estate recording system, UCC 9-334(e)(1) The filing is only effective over lien creditors and in particular, trustees in bankruptcy, 9-334(e)(3) and Comment 3 Effects of this treatment Functionally allows misfiling secured lenders to still be secured in bankruptcy and get priority over the trustee in bankruptcy. Justified by theory that JLCs never check anyways. Another important effect is that against certain kinds of property it is fully effective. fixtures are defined by state real-property law and some states define it very broadly to include machinery in a factory for instance. Here personal property filing can defeat mortgages and fixture filings later recorded in the real estate system thus allowing for an alternative way to perfect a fixture filing. When you are unsure you might want to file in both or search both depending on what youre trying to do G. Problem Set 33 Problem 33.1: 15 years ago Wanda recovered a $35,000 judgment against her exhusband, Marshall, for alimony. 5 years ago Wanda recorded the judgment in California (Marshall had no assets). On March 1 Marshall paid $100,000 to buy a house ($80,000 was a PMSI loan from Bank and $20,000 was savings). The bank on March 10 records its mortgage on the PMSI. As between Wanda and the bank, who will have priority in Marshalls home? Use California statute for PMSI and assume the recording statute is the same as NY 291 (both in assignment #33). Bank wins. Wanda created and perfected her lien first, but under California law the PMSI mortgagee has priority over all other liens created against the purchaser subject to the operation of the recording laws. Under the Recording Act (good faith purchaser exception), the failure to record is void against any person who subsequently purchases the same real property in good faith and for valuable consideration. The Bank is first and the recording act does not help the lien creditor (Wanda) b/c she did not purchase and she did not give valuable consideration for the lien (it is antecedent debt). When she recorded she didnt give valuable consideration and she didnt give it when she got the lien either (the consideration would have to flow to the debtor). So even though she was the first to perfect her lien on the property she looses out to the subsequent PMSI mortgagee. The statues provided in these states treat lien creditors as not reliable people (much like Art 9 treats them) and hence doesnt give them much. Problem 33.2 Add the following facts: Marshall borrowed $50,000 from Bank2 on March 8, and Bank2 recorded the same day (non purchase money). Bank 1 that although got the first mortgage only recorded on March 10. Now Marshall left to the Bahamas and has not been seen since. Who has priority Bank1 or Bank2? Bank 2 wins b/c it is one of the few people who fits within the exception to the NY/California notice-race statute. Bank 2 is a subsequent purchaser in good faith for value. Unlike the lien creditor this creditor, Bank 2, fits the requirements, so here we see the discrimination v. lien creditors. Who has priority Bank2 or Wanda (lien creditor)? Cal. Civ. Proc. Code (on pg.

117

464) tells us that a JLC is created under this section by recording it. Wanda wins b/c she is first in time. Bank 2 is not purchase money, so Wandas lien is first under the general rule first in time first in right. This result is an example of circular priority, just like yesterdays case. It doesnt take much to get a circular priority problem when you have the different treatment for the lien creditors. In these cases the judge decides based on facts, equity, etc. Problem 33.3: Mobile Home filed in UCC instead of fixture filing. Eighteen months before filing bankruptcy, George bought a mobile home on credit from Folds. Folds took a security interest in the mobile home, and filed a non-fixture financing statement. The state does not have a certificate of title system. Under its laws, the mobile home was a fixture even before Folds filed its financing statement. Can the TIB take priority over Folds? Folds is perfected even though he did not file a fixture filing. 9-501(a)(2) can file in the secretary of states office unless you want to file as a fixture filing for other purposes. This is the provision that allows this alternative filling that the authors were talking about. So you can perfect by not going into the real-estate office. Now concerning priority or the effect of that perfection we are talking about a different matter. What is the effect of the filing in the Article 9 system? BC 544(a)(3) -- TIB is a lien creditor and has rights and powers of a bonafide purchaser in debtors property, other than in fixtures. Here it isnt a problem of avoidance, but an issue of priority. If the TIB had priority then it could beat out the fixture creditor. 9-334(e)(3) and Comment 9 -A fixture filing in the UCC system will give the filer priority over lien creditors and the TIB, it allows you to beat out the TIB. (But if you want priority over real estate interests, you must do a fixture filing in a real-estate office). The way this section is drafted is that it starts telling us that the real-estate interest is going to win, but then it tells us that there can be an exception, and in this case when the conflict is a TIB (a lien obtained by legal proceedings) you can get priority be perfecting by any method permitted by this article. You can file in the regular records for a fixture and get some protection. But you cant file a fixture filing if it is not a fixture you wont receive any protection. File in both places if you are not sure if the property is a fixture. For most cases of fixtures, when youre trying to prevail over real-estate interests the critical sections are 9-334d and e2. d is the PMSI financier and is able to perfect before the collateral gets attached to the realty and then perfects by filing in the real-estate (20 day window). e on the other hand, deals with the situation of the party that becomes a real-estate mortgagee after the fixture is attached, and it says that the fixture secured party will if the fixture secured party has perfected before the interest of the encumbrancer is of record and if it has priority over any conflicting interest over a predecessor entitled by the encumbrancer or owner. In order to beat the subsequent mortgagee you have to beat the predecessor in title (the owner of the property). The only way to beat the owner of the property is if you are a PMSC under d. The idea is that if the owner has priority of the fixtured secured party, the owner has to be able to sell what it owns and hence is able to sell or mortgage the priority. The subsequent mortgagee will prevail under e by virtue of priority of the owner. e2 contemplates things where the fixture creditor should defeat the subsequent mortgagee since it is easily removable. Problem 33.4: Your client, Sound City, sold sound system to Jake and installed it two months ago during Jakes remodeling. It took 3 days to install. It is bolted to walls and control panels are built in. Jake was supposed to pay for the sound system as soon as it finished, but he is stalling. Sound City does not have promissory note or security agreement. a)What should the lawyer recommend? The elaborate work makes the sound system part of the real estate -->fixture. There are two options: (1) Construction lien: Sound City is entitled to a construction lien. They can record a construction lien in the real property records (aimed at whole property). An unsecured creditor can obtain a lien against the debtors real property by suing the debtor, obtaining a judgment against the debtor, and recording in the real estate recording system. Usually the creditor is going to have 90 days from the completion of construction to record this lien. With construction, your lien dates back to beginning of construction, but with alteration, it dates to day you file the lien. In this case its going to most likely be seen as an alteration. There is a possibility that an interior change can be construction if appearance or use of premise is changed. The problem is that given the holding in Skyline Properties a court is probably not going to consider this a new construction but just an alteration. If the claim of lien does not result in payment, the lienor must bring an action for judicial foreclosure. The statute of limitations for a construction lien is one year. At the end of the year, the lien expires and the debt becomes unsecured. The threat of filing the construction lien is probably enough to get the debtor to pay, its a threat since the owner of the property doesnt want a construction lien on the whole property.

118

(2)Fixture filing aimed at the sound system only. Need debtor to sign a security agreement and authorize filing of the financing statement. Why would the debtor do this? To avoid the filing of a construction lien. The fixture filing would only relate to the sound system, but the construction lien would encumber the whole property. The advantage to getting a SI on the sound system would allow you to foreclose on the property, you could remove the speakers. If the debtor goes into default and if you have priority in it you can remove the speakers. b) What if Jake stalled on paying for the sound system b/c he was in the process of refinancing the bar. The new lender, MB, recorded their mortgage before Sound System could do anything. Assuming that MB acted in good faith and without knowledge that Sound City had installed the system, where does this leave you? File a construction lien. If new construction, priority dates back from time of construction, but this would mean trying to convince a judge that your installation is equal to an act of construction. It will be ahead of mortgagee. If alteration, priority dates from time you file the lien. It will be subordinate to the mortgagee. In re Skyline Properties -- An interior change can be construction if the appearance or the use of the premises is changed. Its critical to know if we have something that counts as something that is considered construction or if its just an alteration. What about priority of security interests in fixtures? Under 9-334(d) the PMSI can get priority over the prior owner or prior mortgagee if you have perfected either before affixation or within 20 days of affixation (grace period). With respect to the subsequent encumbrancer, under 9-334(e) the encumbrancer may rely on the presence of the fixture. The secured fixture party only gets priority over subsequent encumbrancer if (1) it has priority over the owner and (2) perfected at the time of affixation. There is no 20 day grace period. (The subsequent party is entitled to rely on the presence of the fixture). Difference between (d) and (e). Absence of the 20 day grace period. When advising the PMSI creditor on fixtures? It is a mistake to tell the client they have a 20 day grace period to perfect. If there is any possibility that the owner will sell or mortgage the land before the financing statement is on file. For safety sake, they should always perfect before they attach fixtures to someone elses property. *Normally when you have a constructor working on your property and building a building for you, you are going to have the contractor put up two bond; 1) performance bond that guarantees the completion of the job and 2) a payment bond, a bond that will guarantee payment of the materialmen and actual laborers if the contractor does not. Problem 33.5: Assume Sound City installs a sound system on Dubs authority and Dub doesnt pay for it. In this case there is no remodeling or anything. Will Sound City be entitled to a construction lien? If so, is this an adequate remedy? Who is entitled to a construction lien? a)Under New York lien law, Sound City is a laborer who performs labor or furnishes materials for the improvement of real property with the consent of the owner (owner includes a lessee). A lien is on the land. The lien is typically for a year some states allow the laborer to re-file for another year. If Dubs is the only owner or a leasee for a number of years, then yes, Sound City can get a construction lien on the property, but it will date form the time of filing of the notice. Many states provide liens in favor of virtually anyone who participates in the making of any improvement to real property. Most statute of limitations last only a year, and in this case the payments are to be extended over 18 months. In NY youre able to file for payments to last over a year, so youd probably be ok. What is the priority of a construction lien? A lien for an alteration takes priority as of the recording of the claim of lien. Can Sound City rip out the sound system if Dubs does not pay? No, it is a lien on the land. How could Sound City get back the sound system? Security interest in the sound system and make a fixture filing. PMSI is much more effective than the construction lien. Under 9-334(e). -- Sound City should file BEFORE they affix the sound system to the property. There is no grace period with regard to the subsequent mortgagee who relies on the fixture when making the mortgage. Reasoning: if the owner gives a mortgage between time of affixation and recording, there is no grace period (under 9-334e), and fixture filer loses out to second encumbrancer. Under 9334d, its the prior owner, and under 9-334e, its the subsequent encumbrancer, and 9-334 makes the distinction with respect to grace period, eliminating it for the subsequent encumbrancer. You cant use 344d because the speakers are installed before youve taken the PMSI. The danger of using the grace period is that another creditor may come along and take your priority. To do a fixture filing, you do it under real estate law. In the fixture filing, you have to include on the financing statement the name of the record owner of the real estate. That is the whole purpose of putting it in a fixture filing connection to real estate. Since Dub does not know the owner of the real estate, you will have to search the real

119

property records to find the name of the true owner. 9-502(b)(4) -- The financing statement must provide the name of the record owner in the real property if the debtor does not have an interest of record in the real property. So if Dubs is the lessee then he isnt the owner of the real-estate. To record the fixture filing you only need the authorization of Dubs and not the owner because hes going to be the debtor. If you do all these things right then you can take out the equipment. b)Assume Sound City decides to make a fixture filing. Whose authorization does Sound City need? For example, if Dub has a long-term lease from Realty Partners, Ltd., do you have to contract with Realty Partners or can Sound City do the deal with Dubs signature alone? No, you dont need Realty Partners authorization b/c you are dealing with personal property, and Dub is the owner of the personal property. Sound City has the right to remove the fixtures if Dub defaulted b/c it filed a fixture filing in the real property records. If it does damage when removing, it may have to pay the owner of the real estate. 9-334(f), 9-604(d). The removal when causing damage has to be compensated for by the creditor. c)Does the analysis change if Sound City is installing a sound system in a new building that is under construction? The fixture filing will have priority over the construction mortgage only if it was made before the mortgage was recorded. 9-334(h). This is not going to happen, b/c the people undertaking the construction will have recorded when the construction began. If the construction mortgage has priority, the holder of construction mortgage can prevent removal of the fixtures. 9-604(c). The security interest is subordinate to the construction mortgage even if the security interest is a PMSI. 9-334(d). Even though Sound City cant remove the sound system, it may be better off with a subordinated security interest that runs with the land. What else could Sound City do? Go to the owner, the encumbrancer, and the construction mortgagee, and see if they will subordinate the sound system. The sound system might not be so integral to the whole building. (Ex: an elevator installation could not negotiate to subordinate b/c it is very critical to the overall building). Problem 33.6: Barney loans his brother money to purchase a condo. Barney has a mortgage but he does not record. In the interim, 2 mortgages and a judgment lien are recorded against the property. How can Barneys mortgage be worth something? Apply New York laws. Possibility from Chapter 34 -- Marshalling -- One of the mortgages covers other property. Allies mortgage Under New York law, the purchaser must be for value and in good faith. Allie might have had notice about Barneys prior mortgage. If the mortgage was for antecedent debt, it is probably not for value. Talbot Financial Services judgment recorded a year ago the mortgage attached before the judgment, but it was not perfected. The judgment creditor is not a purchaser for value in good faith. A judgment creditor is not a purchaser. In NY, the unrecorded mortgage on real estate defeats the subsequent judgment creditor with a creditor. (Some states turn this around). Weyrauch a purchase money mortgage has priority subject to the recording laws. Weyrauch is not a purchaser for value, and received the mortgage b/c of the after-acquired property clause (antecedent debt not new value). Barney should prevail over Weyrauch in most jurisdictions. Moral of the problem: Real estate law gives a lot more power to unrecorded mortgages than Article 9 does. It depends on the particular law of the particular jurisdiction. In a majority, Barney would win over all 3 interests. Notice-race statute based on knowledge at the time of recording. Purchase money mortgage has priority over all liens created against the purchaser, subject to the operation of the recording laws. Does it have to be recorded within a certain amount of time to qualify for this treatment? Problem 33.7: Barney loans his brother money to purchase a condo. Barney has a mortgage but he does not record. In the interim, 2 mortgages and a judgment lien are recorded against the property. How can Barneys mortgage be worth something? Apply New York laws. Possibility from Chapter 34 -- Marshalling -- One of the mortgages covers other property. Allies mortgage Under New York law, the purchaser must be for value and in good faith. Allie might have had notice about Barneys prior mortgage. If the mortgage was for antecedent debt, it is probably not for value.

120

Talbot Financial Services judgment recorded a year ago the mortgage attached before the judgment, but it was not perfected. The judgment creditor is not a purchaser for value in good faith. A judgment creditor is not a purchaser. In NY, the unrecorded mortgage on real estate defeats the subsequent judgment creditor with a creditor. (Some states turn this around). Weyrauch a purchase money mortgage has priority subject to the recording laws. Weyrauch is not a purchaser for value, and received the mortgage b/c of the after-acquired property clause (antecedent debt not new value). Barney should prevail over Weyrauch in most jurisdictions. Moral of the problem: Real estate law gives a lot more power to unrecorded mortgages than Article 9 does. It depends on the particular law of the particular jurisdiction. In a majority, Barney would win over all 3 interests. Notice-race statute based on knowledge at the time of recording. Purchase money mortgage has priority over all liens created against the purchaser, subject to the operation of the recording laws. Does it have to be recorded within a certain amount of time to qualify for this treatment? Two questions asked Kaufman. If the debtor purchases a car with a down payment and gives 2 months to pay price, which is financed by a bank, can the bank have a PMSI? Yes. The loan must be to enable the debtor to do this and the funds are so used. What use is the two point test, of course if the secured creditor improves its position within 90 days there is a preference, right? The secured creditor is fully secured at the beginning and end, but during the 90 day period the collateral dipped, but then recovered. Before the two point test, the trustee could say that the improvement from the dip back up was an improvement, but the acct. expense that would be necessary to trace the value of the collateral day by day through the period to then declare a preference. The idea was that you just take the snap-shot at the beginning and end and just forget about all the stuff in between. So the two point test really does have a bite, a saving the estate money kind of bite. Contests between buyers of collateral and the secured creditors of the collateral. 9-320 is fairly straight forward, one of the tricky pieces is in (a) the buyer in the ordinary course of business takes free of a security interest created by the buyers seller even if the security interested is perfected and the buyer knows of its existence. Scott yard sells at wholesale to dealers, in their arrangement to dealers, their dealers are prohibited from seller to other dealers, they can only sell to retailers. In the leading case, a dealer bought from another dealer and then sold at discount to consumers. The suit was brought was brought by Scott against the dealer. The argument should have been made to say that Scott gave the original dealer a general power of sale and its restrictions arent for purposes of article 9, if the sale was authorized instead then maybe the security interest could be kept in line. (a thief cant pass good title and the original owner can get the good back) If the words created by the seller do not appear in the statute, although I cant get good title to the boat, if it is the secured creditor who brings suit against me, I can defend on the ground that by buying from dealer I am a buyer in the ordinary course and took free from all security interests. To prevent that buyer cant buy free of owners title, but can buy free of security interest, put in the words created by the seller. Daniel Case When a buyer becomes a buyer is up for grabs. You can become a buyer pretty early in the transaction and even after the revision of 1-201(9) that the authors talk about on 603, the reference to article 2? would not change the result in the case. XXXIV. COMPETITIONS INVOLVING CROSS-COLLATERALIZATION AND MARSHALLING ASSETS (34) More than one item of collateral can secure a single debt. The formal term for this is CrossCollateralization To determine if a debt is cross-collateralized you only have to read the security agreement. Overview:

121

More than 1 piece of collateral can satisfy a single debt. D cross-collateralized? Ds dont like cross-collateral b/c all collateral can be confiscated if default on one (although most loans have cross-default clauses, i.e., default on one means all are automatically in default). Better for debtor not to have cross-collateralization (c-c) b/c, assuming 4 loans (D1 D4) secured by 4 sets of collateral (X1 X4), D1, D2, D3 and D4 would all need to be paid off to just get X2 back. But c-c usually means lower interest rate, so better Ds might be more willing to accept c-c provisions. Marshaling: C1=$100, C2 = $60 C1 C2

A B

$80 $80

If C1 seizes A first

C1 $100 C2 $60 Unsecured Surplus: $0

But, what happens when C1 goes after B first? C1=$100 C2=no $, but unsecured claim for $60

Unsecured Surplus = $60


How do you decide which asset(s) to go after? Relative liquidity. If C1 and C2 are direct competitors, take B so that C2 now has no SI. What about PMSIs? PMSIs: when Creditor holds PMSIs in a variety of collateral, the burden is on the holder to establish how much of each item is secured on a PMSI. If not clearly stated in K, then creditor LOSES PMSI STATUS. An after-acquired property clause will generally operate to void a PMSI. A. Cross-Collateralization Provisions in Security Agreements (p555) When a loan is secured by more than one item of collateral, we refer to the loan as cross-collateralized. Cross-collaterlization occurs almost any time an after-acquired property clause reaches an additional item of collateral. The ability of Junior Lien Creditors to limit a secured creditors choice as to which collateral under a cross-collateralization clause to foreclose on is called the doctrine of Marshalling of Assets. 9-504(2)(a)(2): If secured interest secures indebtedness, then unless otherwise agreed, secured party is entitled to deficiency from debtor.. B. The Secured Creditors Right to Choose Its Remedy (p557) Creditor secured by more than one piece of collateral generally has the right to choose when it will foreclose against each. Can strategically force a debtor into bankruptcy. In most circumstances the applicable rule permits the creditor to foreclose against part of the collateral without waiving or abandoning it rights against the rest. Debtor-Enforced Limits On the Secured Creditors Right to Choose a Remedy Although rare, some limits in favor of the debtor on a secured creditors right to choose the sequence in which it will proceed against particular collateral exist. A secured party might bring so many separate foreclosure actions against a debtor that the court would bar further actions as a nuisance. A few states have single-actions rules, like CA, which says there can be only one action to enforce payment on a debt secured by a mortgage on real property. A creditor in one of these states who forecloses against one parcel of real estate omitting another may find that it has lost the omitted parcel as collateral. These single action rules dont apply to personal property.

122

9-604(a)(1) specifically authorizes secured creditors to sever the foreclosure against personal property collateral from their foreclosure of the same security interest against real estate collateral, and foreclosure against one piece of personal property does not, in the ordinary course, bar later foreclosure against another. Release of Collateral All collateral is encumbered until debt is paid in full. Buyers in the ordinary course of business take free of a security interest, 9-320(a) The debtor can also pay his entire debt and insist that the secured creditor file a termination statement under 9-513(c) Sophisticated debtorss often insist on release clauses as part of initial loan agreement, i.e. release of one or more specific items of collateral upon payment of a specified portion of loan. Debtors do not need release clauses for collateral that is inventory. UCC 9-320(a) sets as a default rule: Sale of inventory automatically releases the property sold from any SI created by the seller. Can K around though with items expensive items like aircrafts, etc. C. Marshaling Assets (560) Marshalling as a Limit on the Secured Creditors Choice Marshalling is an equitable doctrine developed to limit the senior secured creditors choice of which collateral to pursue. When the doctrine applies, it requires that a creditor look for its recovery to the assets not encumbered by junior liens, so that the holders of the junior liens can recover from the only collateral available to them. In Re R.E. Derecktor of Rhode Island, Inc (Bankr. DRI 1993, p561) Derecktors ship building/ repair facility is in bankruptcy; borrowed $6.5MM from Port Authority to set up business in 1979, gave SI in current and after-acquired fixtures, furnishings, equipment, machinery, inventory and other tangible personal property. 2/92 D still owed $5MM. In 1987/88 Bank of New England (eventually FDIC) loans D $9MM to buy a dry-dock and gets a PMSI. Unsecured creditors claim that allowing marshalling here would be prejudicial. 3 Elements Must be Present to Apply Marshalling Doctrine: The existence of two creditors of the debtor (here FDIC and PA); The existence of two funds owned by debtor (here, 2+: sale of proceeds from Dry Dock III, the Assignment, INA settlement, etc.); and The ability of one creditor to satisfy its claim from either or both funds, while the other creditor can only look to one of the funds (FDIC can satisfy its claim from all debtors funds, while PA can only look to Dry Dock III and equipment, machinery, and inventory for payment PAs rights as a secured creditor are legally superior to unsecureds, so no equal footing. Thus, prejudice argument doesnt fly. Limitations on Marshalling: The doctrine of Marshalling can only be applied if the senior creditor is not prejudiced, Matter of Woolf Printing Corp Marshalling is only available when the courts think it should be Cant be used to compel foreclosure against homestead property. Marshalling cannot be used by one junior lienor where the effect would be to prevent recovery by another junior lienor (however, marshalling can definitely be used by a secured creditor to the detriment of unsecured creditors as in the case above.) Equitable Assignment as an Alternative to Marshaling Some courts will let the senior creditor recover from the most convenient collateral, then require that creditor to assign its interest in the remainder (including collateral never encumbered by junior lienors) to the junior lienors.

123

This is called an equitable assignment remedy and is illustrated in Janke v. Chace Can Unsecured Creditors Marshal? Typically no. But bankruptcy trustees can marshal where someone other than the debtor owns collateral. In Derecktor, assets were marshaled against unsecured creditors Marshalling merely shifts assets from one application to another (inherently a for/against situation) Marshaling Against Property Owned by Third Parties Common for creditor to take a security interest in property that doesnt belong to its debtor Ex: get security interest in corporation and in private property of the corporations president The courts are split on cases like this where a lienor seeks to compel marshalling against the assets of a third party. Most courts have the common debtor requirement: Marshalling must be between two or more creditors of the same debtor The funds or assets must be in the hands of that common debtor Other courts only require that marshalling be between two or more creditors of the same debtor Trustees in bankruptcy then would be able to force marshalling on third parties in these states only If the trustee cannot force marshalling on third parties then there is no situation in which the trustee can marshal D. The Effect of Cross-Collateralization on Purchase Money Status Historically, a security interest has been considered purchase money only to the extent that the collateral secures an obligation that is the purchase price of the collateral, but this can be difficult to determine. PMSI status can be easily lost as a result of cross-collateralization. 9-107. The secured creditor may not keep a separate account for its purchase money obligation Dual Status Rule: a security interest may be part purchase money and part nonpurchase money, 9103(f)(1) There is also the problem of aggregating collateral Some people think that 9-103 allows a security interest to be a PMSI even though crosscollateralized, provided that the entire purchase-money obligation arises on a single occasion Example, in one deal you agree to lend someone the money to buy two horses and take an interest in both horses as security Comment 4 to 9-103 seems to say that an inventory lender can have a PMSI in an item of inventory that secures an obligation that is not even arguably the purchase price of that item E. Problem Set 34 Problem 34.1: The creditor holds a second mortgage on a house. There is an outstanding first mortgage of $220,000. The house is worth not more than $200,000. (a) If no additional relevant facts come to light, how much do you expect to recover? Zero. The first secured creditor is entitled to the whole amount, and can sue for deficiency under 9-615(d)(2). (b) What additional facts might allow the creditor to recover by virtue of the second mortgage? Marshalling Has the first secured creditor cross-collateralized? If the secured creditor had two funds to satisfy the debt, he could resort to the fund that did not have a junior lienholder. *Elements for marshalling: (1) two creditors of the debtor (2) two funds owned by the debtor (3) ability of one creditor to satisfy claims with either or both of the funds, while the other creditor can look to only one fund. Limitations of marshalling: Cant force the creditor to foreclose on a homestead if the other alternative is a nonhomestead. Cant be less equitable to the senior lien holder. If the senior SC feels over secured in two loans made, he would have no incentive to C-c? since he may be forced to marshal.

124

Problem 34.2: When the debtor filed for bankruptcy, he owned only two non-exempt assets, an apartment building and a yacht. The apartment building had a first mortgage held by UCB for $450,000. The first security interest in the yacht was held by CE for $400,000. The $400,000 note was also secured by a second mortgage against the apartment building. The debtors lawyer, Hurst, held a second security interest in the yacht securing $25,000 in legal work done more than a year before the filing of bankruptcy. By consent of all the parties, the Chapter 7 trustee sold the two assets free and clear of liens and the liens transferred to the proceeds of the sale. Apt Building- 660k UCB-450 Yatch-250k (200k) Carp Eq- 400k Hurst 25k

(a) If Hurst requests that CE marshall assets: Apartment proceeds $660,000: $450,000 to UCB (remaining $210,000 to CE). Yacht proceeds $250,000: $190,000 to CE; $25,000 to Hurst; $35,000 to the estate (TIB). The TIB cant force marshalling b/c he is a representative of the unsecured creditors. The estate is left with a surviving amount. Under the rule, Hurste can compel that CE look to the Apt first. If you are in a jurisdiction that recognizes the TIB as a junior lien holder (the minority) then youre not going to be able to marshall. The TIB could theoretically go into court and ask for instructions (b) If the yacht sold for only $200,000. Apartment building sold for $660,000. Apartment proceeds: $450,000 to UCB; ($210,000 to CE). Yacht: $190,000 to CE and $10,000 to Hurst. Hurst is out $15,000 and is unsecured for that amount. There is nothing for the TIB. If you took the minority view that the TIB was a lien creditor. It does not help the trustee b/c all the other people have good junior liens. One junior lien creditor cant use marshalling in a situation where it would hurt another junior lien creditor who has a good lien. That is this problem. The theory of marshalling is that the person who has taken the time and gone out and gotten security should be able to get some money and disfavor the unsecured creditors. Problem 34.3: See the debtors secured property below: A judgment creditor obtained a $10,000 judgment 6 months ago and recorded, but the D has all property encumbered. Is it collectible? Farm -- $60,000 First mortgage National City Bank ($35,000 Balance) Second mortgage PCA ($44,000 Balance) Third (judgment) Millers lien against property ($10,000)

Machinery -- $55,000 First security interest PCA $44,000 Second interest SBA ($54,000 Balance) Home (exempt homestead property) -- $63,000 First Security interest -- SBA ($54,000 Balance) How can Miller get his money? Under normal circumstances: The house is worth $60,000. NCB would foreclose on the house to obtain its $35,000. The remaining $25,000 would go to PCA. Miller would be left with nothing. Issue: Double marshalling argument -- Can a junior lien creditor (Miller) use marshalling to force a senior creditor (PCA) to go after other collateral in such a way to force SBA to look to its collateral (homestead) in which it is senior? You cant use marshalling to force someone to go against a homestead, which is a protection of the homestead. The effect is that Miller is forcing SBA to go against the homestead. There is no rule that says SBA on its own cant decide to go against the homestead. If SBA wants to, they can go after the homestead. Issue: How do we persuade SBA to go against the homestead? Threaten litigation if SBA makes a move against the machinery, when it can get money out of the homestead. Threatening in pro of litigation, you will scare SBA into thinking that theyll waste a lot of time and money on a litigation instead of just going after the home. Or buy out SBA and foreclose against the homestead and pick up the excess of the machinery. This is a home free. Or buy out PCA (cheaper option), you get the excess $25,000 on the foreclosure of the farm which will pay off the difference between $25,000 and $44,000, which is $19,000. It will also pay off the judgment of $10,000. By buying out ether one of them then youll be in control of the mortgage and you can do whatever you want to foreclose. In

125

this case there is enough money for everyone, but there is a problem with the homestead b/c perhaps the senior doesnt want to close on someones home first. Kaufman: This is an unrealistic problem. All the efforts have been directed at getting SBA to foreclose on the homestead. On the facts, SBA will foreclose against the homestead on its own b/c the most PCA can get out of the farm is $25,000. PCA will have to get $19,000 from the machinery. It will leave SBA $36,000 from the machinery, and it will not swallow an $18,000 loss. SBA will levy on the home. HYPO: PCA is only owed $25,000. You might convince the judge that PCA is getting fully paid on the farm. SBA is getting fully paid from the machinery. An equitable assignment of $1,000 of PCAs interest in the machinery to Miller. It will allow Miller to collect something without hurting SBA and PCA. Problem 34.6: On October 1, Becky sells a robot to MW for $70,000. MW pays $20,000 in cash and signs a promissory note for the remaining $50,000. MW also signs a security agreement granting Becky a security interest in all equipment to secure all obligations owing from MW to Becky. The security agreement makes no mention of purchase money status and provides no rules for applying payments. The robot will be equipment in the hands of MW. This problem addresses the difference between equipment and then inventory. (a) Is Beckys security interest purchase money? If so, to what extent? 9-103(b) -- A security interest is purchase money only to the extent that the collateral secures an obligation that is the purchase price of the collateral. Yes, the goods are purchase money with respect to the security interest. If the goods are purchase money collateral, they are purchase money to the extent of $50,000. PM collateral are goods that secure the partial payment of an obligation. (b) On November 1, Becky sells a miniature submarine to MW for $60,000. MW pays $20,000 in cash and signs a promissory note for the remaining $40,000. The submarine will be equipment in the hands of MW. In what amount is the submarine encumbered? What is the amount of the debt that encumbers the sub? The submarine is equipment and is encumbered with $90,000 of debt. 40k of this debt is PM. This is the intro to the notion that with respect to a single item of collateral, there can be part of it that secures PMSI and another that doesnt. (c) The definition of PMSI, the debt secures a purchase money obligation with respect to that collateral. Since it is equipment, the second submarine is PMSI only to the extent of $40,000. (d) MW pays down $1,000. What is the $1,000 attributed to? 9-103(e) -- $1,000 is credited against the oldest obligation, the robot. Comment 7 tells us that is has to go to the oldest PMSI, so the PMSI goes to 39k. (e) What if the collateral were inventory? You add it all up and dont differentiate with PMSI. If it is inventory, the $90,000 purchase money security interest is against both items. In other words youd have a 90k SI in the submarine. 9-103(b)(2) -- To the extent that the security interest in the robot secures the price of the submarine, the security interest in the robot would be a purchase money security interest. Rationale: it is too difficult to try to match each loan with respect to each item when inventory is flowing in and out. The authors of the book tell us that its too complicated to try and differentiate. So it all gets added up with a total of 90 grand PMSI against both the sub and robot. This is a big advantage to the SC. Problem 34.7: On May 31, Bonnies Boat World purchases two Coyote Loaders for $90,000. Coyote takes a security interest for $50,000 for the purchase price. Bonnie borrows another $40,000 from Firstbank against the loaders, without mentioning Coyotes lien. Firstbank takes a security interest in the loaders, disburses the loan proceeds directly to Coyote, and perfects by filing a financing statement on June 1. Coyote perfects by filing a financing statement on June 2 and, and delivers the loaders to Bonnies on June 3. Bonnie uses the loaders as equipment. (a) Who has priority? Two parties have contributed to the purchase of the equipment the seller and the lender. Coyote Loaders b/c they are the seller under 9-324. Under 9-324(a) -- A perfected PMSI in goods other than inventory have priority over a conflicting security interest if perfected when the debtor receives possession of the collateral or within 20 days thereafter. 9-324(g) conflicting PMSI priority is granted to the PMSI created in favor of the seller over PMSI that secures enabling loans (lenders). Coyote is preferred as it handed over actual collateral, the loaders while the Bank only gave cash to buy the loaders. The UCC gives priority to the provider and not the long term financer. b)What should the losing party have done to avoid this unexpected setback? There is nothing the lender can do it might be able to get a subordination agreement from the seller. The manufacturer may be willing to do this so it can make a sale. It is unlikely that the seller would give it, but in the right circumstances it may be possible. The Bank is more likely to rely on the financial condition of the debtor than on the SI it is getting.

126

Problem 34.8: Deutsche Financial Services finances inventory, and then conducted a search, finding a financing statement filed by Firstbank covering inventory. Debtor tells DFS that FB only financing Bayliner brand. Does DFS need a subordination agreement even though DFS plans on only financing Shoreline boats? Suppose that Firstbank gives debtor $100 to help make down payment on a Shoreline boat. And the description in FBs security agreement is broad enough to cover a Shoreline boat. Firstbank will have a PMSI in the boat. The collateral is inventory, so the Firstbank security interest in Shoreline is PMSI to the extent that it secures any inventory. Firstbank is crosscollateralized, so it secures the entire Firstbank indebtedness. a)Who would have priority in the Shoreline boat? Firstbank has priority b/c it has lent money to make the payment and the debtor has used it to buy the boat so it has a PMSI. b) For how much is it PM? The collateral is inventory so firstbanks debt, the whole thing (not just the $100) is PM. c) These are both lender, who has priority over the other? 9324bc and g. First bank did not give notice to Duestche Bank under 9-324, but it did not have to b/c it was the first filer. Duetsche needs a financing statement with respect to financing the Shoreline boats. Otherwise, Firstbank could lend money and it will come first. If Duetsche Bank filed first, it would have priority. So here, First Bank filed first and has priority. d) If Duetsche bank have priority if they filed first? Yes. They would have priority if they had filed first. XXXV. SELLERS AGAINST SECURED CREDITORS (35) (DO NOT READ) XXXVI. BUYERS AGAINST SECURED CREDITORS (36) A. Introduction (p592) Secured creditors have two expectations about consequences of debtor selling collateral Debtors are allowed to sell collateral (9-401) Security doesnt interfere with the free alienability of property If they do sell collateral, secured creditor expects to be protected as to the value of its interest Lien on the proceeds, continuation of lien in collateral in buyers hand, payment of loan Buyers of consumer goods tend to except the goods to be unencumbered Buyers of real estate have different expectations; they know they much search the real estate records for liens Might say that the law subjects the buyers of homes to searching the records because there is a strong presumption they will know to do so B. Buyers of Real Property (p593) All purchasers of real property are expected to search public record They are therefore deemed to have constructive notice of recorded mortgage, and buy subject to them If the mortgage was created before the debtor sold the property to the buyer, the buyer usually takes subject to the mortgage If the mortgage is recorded before the debtor sells the property, its priority over the rights of the purchaser is pretty much absolute If an unrecorded mortgage will trump a purchaser differs from state to state, depends upon recording statute Can be race statute, notice-race statute , or notice statute C. Buyers of Personal Property (p594) General rule: buyers buy goods subject to encumbrances on record 9-201: security agreement is effective against [subsequent] purchasers 9-315(a): even w/o provision to this effect, security interest continues in collateral through sale EXCEPTIONS (1) The authorized disposition exception: 9-315(a)(1) Doesnt continue if secured party authorized the disposition free of the security interest Authorization need not be express courts have held that creditors aware of debtors selling collateral in violation of agreement had authorized the sales i.e. Cornbelt Livestock (595) Courts split on issue of whether authorizing sale of collateral on condition that proceeds go

127

right to creditor, and then having the debtor default on payment, counts as authorizing (2) The buyer in the ordinary course of business exception: 9-320(a) 1-201(9): the buy must be in ordinary course of sellers business, not buyers business 9-320(a) protects buyer in the ord. course of business even though he knows of security interest. Buyer can assume that security agreement permits sale until she learns otherwise (Comment 3) If buyer knows there is a violation of a security agreement in sale, cannot be considered a buyer in the ordinary course under 1-201(9) 9-320(a): buyer only takes collateral free of interest if security interest was created by seller Security interests created by sellers predecessors in title still encumber buyer When does buyer become a buyer? Daniel v. Bank of Hayward (Wis. 1988, 598) When does retail purchaser who makes down payment on car but doesnt take title become a buyer in the ordinary course of business under 9-320(a)? Sets buying for 9-320(a) exception as date that K identifies the collateral After this case, drafters of UCC changed 1-201(9) to set buying to when the buyer takes possession or has a right to recover the goods from the seller (2a) When goods are in hands of SC, 320(a) exception doesnt apply (9-320(e)) (3) The buyer not in the ordinary course of business exception: 9-323(d,e) and 9-317(b) Buyers who buy goods outside ordinary course of business have no exemption from search-and-file They take ownership subjected to perfected security interests, but not unperfected ones (4) The consumer-to-consumer sale exception: 9-320(b) Buyers of goods that are personal, family, or household consumer goods in the hands of both buyer and seller buy free of security interest. Only if the buyer buys: w/o knowledge of security interest for value primarily for buyers household, personal or family purposes before the filing of a financing statement covering the goods D. Problem Set 36 Problem 36.1:Davis Store sold a TV-VCR to Beavis on credit. Beavis paid no money down, but signed a security agreement, promissory note, and financing statement. Davis Store filed in the statewide UCC records. The security agreement provides that Beavis agrees not to sell the collateral. Beavis sold the TV-VCR to Butthead at a garage sale. Butthead did not know about the security agreement. Butthead paid by check. Can Davis repossess the TVVCR from Butthead? The transfer can take effect under 9-401(b). The security interest continues under 9-315(a). The security continues in the collateral and Beavis is not a ordinary seller in this type of collateral. The conditions of consumer to consumer exception of 9-320(b) are not met (because a financing statement has already been filed) so the property is still encumbered. Davis has filed a financing statement and the later consumer who buys will not have priority over the second consumer. But how you expect a consumer to know about the filing system and check? If its a high ticket item then maybe you would be willing to check it out. The bank doesnt have to pay. Butthead can go after Beavis for the $960 he paid. Problem 36.2: UCB has a security interest in inventory of Sound City. The security agreement authorized sales in the ordinary course of business, prohibited sales on credit, and required Sound City to deposit the proceeds in a designated account. Sound City filed for bankruptcy. The trustee abandoned the inventory. A deficiency remains owing on the loan. The following transactions took place before the filing of the petition: (a) A buyer purchases as stereo from Sound City. The buyer bought the stereo by paying a negotiable promissory note. Under 1-201(9) -- A buyer in the ordinary course may buy for cash, in exchange of other property, or on secured or unsecured credit. Here the buyer can buy on credit. In this case the buyer is buying in the ordinary course although he is buying on a credit sale. UCB cant get this stereo.

128

(b) The lawyer takes the sound system in payment for services. Under 1-201(9) a buyer in the ordinary course does not include a person that acquires goods for total or partial satisfaction of a money debt. An antecedent debt is value for Art9 purposes. At the end of this section though it says that partial satisfaction of a money debt is not going to be a buyer in the ordinary course of business. Problem 36.3: All Seasons RV sold to Eddy a motor home (Eddy owes 17 grand). Eddy sells to another dealer, Sun Rise (subject to All Seasons security interest created by Eddy). All seasons security interest survives b/c Eddy is a consumer. When Alicia buys from Sun Rise, Alicia is a buyer in the ordinary course but she only takes free of security interests created by Sun Rise. The security interest was created by Eddie here (the sellers seller). a) Alicia wants to sue to remove All Seasons lien from the car? Is her case any good? The consumer gets stuck by the created by its seller in 9-320. It is hard to make an authorized disposition b/c All Seasons is selling to a consumer. The SI is created by Eddy here (the sellers seller) and not by Alicia and hence the SI survives. Eddy is not a dealer in the ordinary course of business, Sun Rise took the RV under the condition that the SI would continue. If Sun Rise were a consumer what would happen? The buyer has knowledge and the certificate of title is the equivalent of filing a FS. b) What if the consumer buyer wants to see the certificate of title? Sun Rise will show the certificate of title it will show All Seasons lien. On the bank of the certificate there will be Eddys signature. It is signed by Eddie in blank, and the dealer is likely to say it will take care of it. If there had been a release of the lien by All Seasons when Eddy sold the RV to Sunrise, it would be in a separate document (theres no place on it on the certificate). Alicia, the ordinary consumer, does not know to ask for this separate document. The dealer would most likely say Im getting it for you. Asking to see the certificate wont solve Alicias problem. If this were a genuine transaction, and if she knew to ask, she would know that there would have to be some document from All Seasons releasing Eddy from the SI. But someone in the position of Alicia (a regular consumer) isnt going to know this. Dealers in situations like this dont get certificates of title in their own name. They will hold on to Eddys with the transfer of title on the certificate. Once Alicia buys the car, the dealer will send the certificate to the RMV to get them to issue a new certificate with Alicias name on it. Problem 36.4: A consumer wants to buy a reconditioned piano at the mall. The buyer wants representation at the closing. Does she have anything to fear? 9-320(a).This is just like the RV case, but you dont get certificates of title on pianos. If the person who originally owned the piano has a security interest, Alicia will take the piano subject to the security interest. Difficult to check the records ask for the bill of sale to find the name of the former owner. You would look at the filing system of the prior owners residence and every place the prior owner lived while he/she owned the piano (Comment 3 9-507). AND, there may have been a previous owner before that. Theres a risk of there existing an ongoing chain of past ownership. What do you tell Alicia? You cant eliminate all risks, you can only narrow the risk. Can the problem occur with new good as well? Yes, but it is pretty unusual. Ex: if American bought the inventory of another piano company going out of business American could take subject to the interests of the other piano company since it is not a BOC, it would have been a buyer in bulk and not in OC. Alicia would not take free of the other piano companys security interest. So there is no guarantee about anything, you can narrow the risk as much as possible but there is no real way to be 100% safe. Problem 36.6: After the Daniel v. Hayward Bank Case, the Bank comes to you for advice. They send someone form the bank to inspect the vehicles physically every once in a while. Now though the bank could have sold the cars way before. a) The lot could be full of vehicles but all paid to prepaying customers. Do you agree? If there is a vehicle on the lot, and a buyer has already bought the car, a bank cannot know anything by the presence of a vehicle on the lot. The bank can be fearful about the cars on the lots being bought previous to delivery. But buyers of cars like to take their cars right away, but the dealer may be servicing and getting the cars ready for delivery or something. Theoretically, there is a danger for the bank, but its no usual for this sort of thing to endanger a large part of the collateral. It will not be the case with respect to the hundreds of cars on the lot. b)Under Chrysler the Bank says that we controlled delivery of the MSO, now the buyer can just sue us for it. Is the Bank right? Under Daniel, the buyer did not title in the sence of having the certificate of titile. But this was true under Chrysler too, all you needed was an agreement. If the dealer agreed that the title passed even before getting the certificate of title, the SC was going to be in bad shape. If the agreement said something about the passage of

129

title occurring when the consumer bought the car, then there was trouble, title had passed. Title can pass from a seller to buyer as a matter of contract law without the certificate of title being in the hands of the buyer. (When you buy a car and drive away, it takes a couple of weeks for the certificate of title to get to you from the registry of motor vehicles but title has passed under any version of 9-320.) Even before the RMV gets around issuing the certificate of title, title in the legal sense has already passed over to the buyer. So holding on to the MSO wont do that much, although it may help prove that the dealer has been selling cars out of trust without the knowledge of the Bank. c)In the Daniels case the Court said that the Bank is in the business of lending money and has access to information on how to protect itself. What can you suggest? There are a couple of things the bank can do. (1) keep possession of the car (under 9-320(e), part a, BOC, and part b, consumer to consumer sales, dont work when secured party has possession). The Bank would have to establish their possession of the collateral (and use 9-320(e) to defeat 9320(a)). Is this a good idea? Yes, they can defeat the buyers this way. Secured party can prevail even when vehicles were actually delivered to the lot. -Can the dealer be an agent of possession for the creditor? This is hard to do. What the Bank can do is set up a field warehousing operation. The bank can still maintain possession under a field warehouse arrangement and put up a sign that constitutes notice, there is going to have to be an employee on your payroll to control access to the field warehouse. Cars in the field warehouse are in possession of the bank, the secured creditor of the dealer. Problem 36.7: The Bank asks you what you think about a new plan. The bills of lading for new vehicles will provide that from the moment of identification of a new vehicle to a dealers contract for sale until the vehicle actually arrives on the dealers lot, the manufacturer and the carriers will hold possession of the vehicles agents for the bank that finances the dealers inventory. That way the Bank says buyers like Daniel wont be entitled to vehicles on which they have made down payments before the vehicles show up on the lot. a) Is the Bank right? b) Is there anyway the Bank can use 9-320(e) to prevail even as to vehicles actually delivered to the dealers lot? c) What advice would you give to people like the Daniels who want a car custom-made for them, but are faced with the inevitable demand from the dealer for a substantial down payment? The Daniels could try and contract around this issue. You want to defeat the secured creditor of the dealer. The contract would have to say that the Daniels become a buyer when the car is identified in the contract, and hence the SI of the secured creditor didnt attach on the car b/c it belongs to you. You want to make the Daniels the buyers as soon as possible. The dealer is simply the agent for the Daniels and not acting as a buyer themselves. Another possibility here would be to do a search and find the dealers inventory lender and send the lender a notice that says that the Daniels are taking a PMSI in their own car. Then, you give the dealer money for value and then the Daniels would have to file to perfect. This is a weird way to get priority but theoretically it would work. The need to do things like this suggests that the addition of 9-320(e) to get rid of certain cases wasnt such a good idea. It causes a lot of trouble. Problem 36.8: Two Sherrock brothers, partners in Sherrock Toyota Dealerships, buy two cars from Dover motors and made an arrangement to pay for them by transfer of funds later this afternoon. They leave the cars at Dover motors. Dover is in financial difficulty. Is there a problem with leaving the vehicles on the lot? a) What happens if Dover sells the cars in the ordinary course of business? Article 2-403(2) Any entrusting of possession of goods to a merchant who deals in goods of that kind gives him power to transfer all rights of the entruster to a buyer in ordinary course of business. The innocent purchaser will not think they are buying someone elses car, and the purchaser under 2-403(2) will divest entruster of title. So this is dangerous since someone could come along and purchase the cars free of the SI. b)What happens if Dover files for bankruptcy and the brothers cars are entrusted to Dover, and the inventory lender claims the cars? A purchaser is a person who takes by purchase, which includes a lender. Does inventory lender fit the definition of buyer in the ordinary course? No, 1-201(9) -- A buyer in the ordinary course buys goods, the inventory lender only has a security interest. 2-403(2) doesnt protect the inventory lender. Overview: What is the brothers claim? The brothers will claim to be BOC who takes free of the security interest. A buyer in the ordinary course of business must take in good faith. In article 9, good faith means honesty in fact

130

and the observance of reasonable commercial standards of fair dealing. Article 2 (sale of goods) good faith means honesty in fact and the observance of reasonable commercial standards in the trade. In the automobile trade, the standard is not for the dealer to have possession of the cars, after someone has purchased. Note: UFTA makes it a rebuttable presumption that leaving the goods in the possession of the dealer is not in good faith. Authorized Disposition? There is no restriction in the inventory lending agreement about selling to dealers. So, we may not have to reach 9-320. Also, what about acquiescence? Often a debtor restricted from selling will sell in a situation where at least there is an argument about whether the security interest does not attach b/c acquiescing is equivalent to entrusting under 2-403(2). When the secured creditor finds out that X has bought the collateral, and the secured creditor does nothing about it, maybe its acquiescence. If the person buying (X) is a merchant (rather than a ordinary purchaser), some courts will say 2-403 applies because acquiescence is entrusting within the meaning of 2-403(2). The buyer in the ordinary course from X is protected. It is a funny use of entrusting b/c the secured creditor did not entrust the goods to merchant X. This is a way of protecting the consumer that buys from the merchant. There is a body of common law doctrine that says when a buyer leaves the seller in possession of goods, this is fraud. In some jurisdictions this used to be conclusive proof of fraud in others it was just indicative. A lot of this has disappeared but a lot of this turns up on particular cases to make it a problem to cause a sufficient amount of worry. So the best thing here would be to drive the cars immediately, or at least take them off the lot and park them on the street. HYPO: Taking your watch to the Swiss watchmaker for repair. The Swiss watchmaker sells watches, so the watch maker could sell in the ordinary course of business. The owner of the watch would loose to the bona fide purchaser. POLICY: Maybe not good policy -- two equally innocent parties. HYPO: A neighbor entrusts his snow blower with another neighbor. Can the neighbor sell the snow blower and have the power to transfer the rights to an owner in the ordinary course of business? No, the neighbor-owner will be able to get the snow blower back. The neighbor entrusted with the snow blower does not deal in goods of that kind, so he does not have the power to transfer title. XXXVII. STATUTORY LIEN CREDITORS AGAINST SECURED CREDITORS (37) (DO NOT READ) XXXVIII. COMPETITIONS INVOLVING FEDERAL TAX LIENS: THE BASICS (38) The US government is one of the principal competitors for debtors assets. The threat of criminal prosecution and large civil penalties normally make people pay taxes. The most common source of tax liens are payroll taxes that accumulate when a business begins to go under since these are to be deducted by the owner and operator of the business and paid to the IRS on a periodical basis. There is no immediate threat posed to the business by not paying these so they go unpaid for a while and see if the business can survive. A. The Creation and Perfection of Federal Tax Liens (p632) Creation IRC 6321 and 6322 govern the creation of a federal tax lien When the IRS determines a tax is owing, it assesses the tax by recording the amount on its records When it notifies the taxpayer of the assessment, the notice constitutes a demand described in IRC 6321 and the tax lien comes into existence and relates back to the date and time of assessment The lien attaches to all property and rights to property, whether real or personal, belonging to the tax payer, 6321 This unperfected tax lien is good against the debtor, but not against third parties who acquire liens against or purchase property Perfection Tax Lien Act doesnt use word perfection, but the word valid The federal tax lien is not valid until the IRS files notice of its lien, IRC 6323(a) IRC 6323 defers to state law in determining the manner in which the IRS must file notice

131

IRS 6323(h)(1) defines a security interest as existing only if it is perfected and only to the extent that the holder has parted with money or moneys worth, thus perfected security interests under UCC may not qualify under IRC Remedies for Enforcement FI the taxpayer doesnt pay the tax within ten days after notice, the IRS can levy on the taxpayers property IRS is not required to use the services of a sheriff or marshal IRS can levy in two ways Physically seize the property of the debtor Serve notice of levy on a bank at which the debtor has an account or on some third party who is in possession of debtors property State exemption laws dont apply against IRS The tax sale is subject to prior liens, and the buyer takes free of subordinate liens, which are discharged by the sale. Maintaining Perfection of a Tax Lien IRC 6323(g) the required refilling period for a Notice of Tax lien is the one-year period ending 30 days after the expiration of ten years after the date of assessment of the tax. If the IRS fails to refile during the required period the effect is that the lien lapses. IRS can refile after period, but assumes subordinate status. The federal lien act contains no analogous provision regarding name changes and sale of collateral. United States v. LMS Holding Co. (ND Okla 1993, p635) IRS filed a perfected Notice of Tax Lien against property owned by MAKO. Then MAKO sells this property to RMC with the IRS knowledge. IRS knew that debtor sold property subject to the tax lien, and the IRS did not file a new notice. Held: the IRS has an affirmative duty to refile Notices of Tax Lien that could not be discovered upon a search and the IRS knew of the change. If not, how could a reasonable inspection reveal that property owned by RMC is the subject of a federal tax lien that was filed originally against MAKO. The court decides what instances trigger refilling and how long the IRS should have to refile, not like Art 9 that gives the secured creditors 4 months or 1 year to react to the name change and refile. Under Art 9 the SC has the burden of finding out about the name change and filing. Here, in LMS Holding, the Court simply said that since the IRS knew about it, but not that it should have known. So the IRS doesnt have to go find out about the change. What happens if the debtor moves? In re Eschenbach (Bankr. ND Tex 2001, p637) The IRS filed a Notice in a county in Florida where the people had their residence. They then move to Texas where they later buy some more stuff worth about 2k. The IRS claims 5k in back taxes but the people say that they only owe 3k b/c thats all they had worth when they lived in Florida. The IRS has not filed in Texas. Holding: A federal tax lien attaches to any property owned by the delinquent at any time during the life of the lien. The lien attaches to the taxpayer wherever he roams after the notice has been duly filed in the county of residence. Once properly filed, it attaches to property no matter where it is located. The lien remains valid even if the debtor leaves the residence. 26 USC 6323(f)(2)(B). The IRC doesnt require filing every time the person leaves the county. So all personal property is captured by the lien filed in Florida. B. Competitions Involving Federal Tax Liens (p640) IRC 6323(a) provides that the tax lien shall not be valid as against any purchaser, holder of a security interest, mechanics lien, or judgment lien creditor until the IRS files a notice of tax lien. What must a competing interest do to be valid and prevail over the tax lien? The basic idea is that first in time first in right. The priority is going to rank according to when the IRS Notice became valid. Drafters of 6323 didnt include this provision because it is considered so basic Security Interests

132

A security interests exists only when (a) the property is in existence and the interest has become protected against a judgment lien under local law and (b) the holder has parted with the money or other value, the repayment of which is secured, 6323(h)(1) Advances made prior to tax lien notice would meet requirements for priority There is no security interest until the property is in existence. (similar to bankruptcy law). Must be protected against a hypothetical subsequent judgment lien and levy. So, you must be perfected. Must have parted with money or moneys worth. Commitment to make a loan or future advance meets the definition of moneys worth. No commitment -- the situation of the future advance that has not been made, and you have not committed yourself to make -- does not meet the definition of a security interest under the federal tax lien statute. With respect to Mortgages, a mortgage has priority with respect to advances already made when the mortgage is recorded. When it is not recorded in some circumstances, it might prevail of the tax lien. Purchaser Must acquire its status as a purchaser BEFORE the government files a tax lien. 6323(a). Purchaser is defined as a person who for adequate and full consideration in money or moneys worth acquires an interest valid under local law (state law) against a subsequent purchaser without actual notice of the interest, 6323(h)(2) A purchaser of real estate prevails over a federal tax lien if the purchaser records its deed before the IRS records its Notice. In some states a purchaser of real estate that goes into possession but does not record prevails over a later purchaser who doesnt have actual notice. Mayer-Dupree v. Internal Revenue Service (10th Cir. 1993, p641) A person purchased an automobile before the government recorded a notice of tax lien. The person did not file a certificate of title at any moment The IRS can seize the car b/c the person who bought the car is not purchaser since she did not record). The did not register the certificate of title and thus this rendered her vehicle invalid against a subsequent purchaser without notice. If local law requires filing or recording of transfers of a particular type of personal property, the filing or recording is likely to be the act that protects the transferee against a tax lien later filed against the transferor. If purchaser leaves goods with seller could lose to tax lien 2-401title to goods passes from the seller to the buyer in any manner and on any conditions explicitly agreed to b/w parties. 2-403(2) however is an important exception since it says that the purchaser who leaves the property purchased with a seller who deals in goods of the kind loses to a later buyer in the ordinary course of business. This purchaser could well lose to a later filed tax lien. Judgment Lien Creditor The Federal Tax Lien Act doesnt define judgment lien creditor or say when one comes into existence for purposes of 6323(a) United States v. McDermott (507 US 447, p642) The IRS assessed the McDermotts for due unpaid paid taxes on Dec 1986 (and filed the notice on Sept 1987). The Zions Bank obtained a judgment against the McDermotts and recorded it creating a judgment lien on all of their property and thereafter acquired property (July 1987). In Sept 1987 the McDermotts acquired title to certain real property in the County. There is an issue regarding the after-acquired property. Neither Bank nor the IRS were first to file as regards this property that was later acquired. The federal tax lien must be given priority here since the government cannot go through the luxury of declining to hold the taxpayer liable for his taxes. The Tax lien should win. Some More Exceptions Exceptions in 6323(b),(c),(d) an interest that arises subsequent may prevail over the tax lien 6323(b)(3) the purchaser will prevail over the tax lien (unless the purchaser knows of the lien). If you buy at a yard sale, 6323(b)(4) says that if you dont know about the tax lien and what you buy

133

in the yard sale is less than $1,000, you prevail against the tax lien. 6323(b)(8) attorneys lobby C. Problem Set 38 Problem 38.1: Priority between a lien creditor (law firm) and a filed tax lien when there are two real estate parcels that the debtor owned before the notice of tax lien was filed. May 5, 1994 judgment recorded for $250,000 August 23 IRS filed a tax lien for $953,000 December 24 IRS levied on 3 parcels of real property owned by the debtor December 27 debtor files for bankruptcy The three parcels are the only property of value in the debtors estate. Each is worth between $50,000 and $30,000: 1993 Debtor bought the Adams parcel June 1994 Debtor bought the Baker parcel Nov 1994 Inherited the Charlie parcel Who is entitled to that value? A judgment creditor does not have to levy against real property. 1993 Adams parcel and June 1994 Baker parcel go to the judgment creditor, first in time first in right. 6323(a) the federal tax lien had been recorded. Who prevails in the after-acquired property? When property is inherited, both the lien of the lien creditor and the lien of the tax lien attach at the same moment. After-acquired property (property acquired in Nov 1994): federal tax lien is given priority (if it has been recorded McDermott). Problem 38.2: Sally owes $14,923 in payroll taxes. She has received two notices of assessment, but has not yet received a notice of the filing of a tax lien. She has a message on the answering machine from the IRS office, before calling the IRS back she comes to her lawyer with the following questions: Does the IRS have a lien against her business, house (which is exempt from execution under state law), or birds? Yes, it has a lien against all her property upon notification of assessment! When the IRS notifies the taxpayer of its assessment, that notice constitutes demand in 6321 and the tax lien comes into existence and relates back to the date and time of assessment. There is an exemption section, but it is not included in the statute book. 6334 is much like the homestead exemptions on p16 of the textbook. The principal residence of the taxpayer is exempt unless if the district director or assistant district direct of the IRS personally approves the levy in writing OR the secretary finds that the collection of tax is in jeopardy. (very discretionary). The lien attaches to all property and rights to property, whether real or personal, belonging to the taxpayer. 6321. What can the IRS do? What are they likely to do? Sally has converted trust funds. She has committed a crime, but the IRS is not likely to go after her. The IRS just wants to get the taxes collected. The non-payment must stop. They will set up a schedule for the payment of taxes. If they file a notice of tax lien, they will put Sally out of business. And, then the chances for getting the taxes paid will be small. The IRS will probably not file a notice of tax lien. If the taxpayer does not pay within 10 days after notice and demand, the IRS can levy on the taxpayers property. (Notice is notice that a levy is forthcoming, not simply notice of a tax lien). The IRS can levy in two ways: IRS employees can levy and sell assets, or serve a notice of levy on a 3rd party (easier and less complicated). Sally wants to sell one of her birds to her friend George for $2,500 to raise money to keep the business going. If George pays her the $2,500 and she gives him possession of the bird, can the IRS take it back? Does it matter whether George knows about the unpaid payroll taxes? In order to prevail, George must acquire status as a purchaser before the government files notice of its tax lien 6323(a), 6323(h)(6). This is true even if George know of the troubles with the IRS and knows there is a lien outstanding, but no notice has been filed. George does not have to do anything to prevail over a subsequent purchaser in this case he cant file for title, security interest, etc. 6323(a) deosnt seem to specify a knowledge requirement. They are also paid for at value.

134

Sallys mom loans her money and takes a security interest in the birds. What does her mother have to do to prevail over a tax lien? A security interest exists only when (a) the property is in existence and the interest has become protected against a judgment lien under local law AND (b) the holder has parted with money or value. If they get a written security interest and financing statement on file BEFORE the notice of tax lien is filed, the secured creditor will be protected against the subsequent lien creditor. There is nothing in the definition that requires that the value be given at the time the security interest is given (contemporaneously). Here there is antecedent debt. The secured creditor must do as follows: (A) security interest must attach under 9-203(a), and security interest must be perfected by filing (9-310) or possession (9-313) AND (B) give the money to the debtor. Under 9-317, a secured creditor that is properly perfected will prevail over a lien creditor. Note: perfect by possession (non written security agreement). Had she taken possession of the bird at that time, she would likely have been fine. There is till time to file a financing statement if she doesnt perfect through possession. 6323 tells us that the trigger for the government is the filing of the tax lien notice. Is there priority if June perfects before the tax line file? Yes, because purchaser doesnt include security interst holder, but 6323 says wont be valid against a security interest holder, you get a security interest under 6323 def. saying that until you are what wed call for article 9 purposes perfected, you have no security interest for federal tax lien act purposes, there for this act, are no unperfected security interests. So here they are talking about 9-317 which fixes the time of priority of the secured creditor compared to other. Problem 38.3: Sally lives in Wyoming County, NY and her business is in neighboring Niagara County, NY. The only real estate she owns is a home in Wyoming County. Where should the IRS file a notice of a tax lien against Sally? (using NY lien law). Under 6321 the IRS tax lien reaches all property and rights to property, whether real or personal, belonging to the taxpayer. For Individual file in the individuals county of residence (Wyoming County). Sallys business is an individual proprietorship when searching the records, there is nothing on file in the Secretary of States office and nothing on file in the county of residence. Filing in the individuals county of residence will cover the sole proprietorship. Compare to article 9: filing in secretary of state. Moral: Tax liens are filed in county of residence. Although the tax lien encumbers her business assets nothing will be on file with the secretary of state. What if Sally did not run her business as a sole proprietorship, but her business was incorporated and the corporation owned the pretzel shop in Niagara County and Erie, PA, but owned no real property at either location. Sally ran her business from her office in the back of the Niagara County store. Under these circumstances, where should the IRS file Notice of Tax Lien? Assume NY and PA have identical statutes to the NY statute 240 reproduced in text. For Corporation in two states: Personal property file in the county where the property is situated. Personal property is deemed to be situated at the residence of the taxpayer at the time the notice of lien is filed. The residence of a corporation is deemed to be the place where the principal executive office is located. Where the corporation has personal property in NY and PA, the principal executive office is probably in NY (Sally ran the business in back of Niagara county store). The notice of tax lien is filed in NY. A searcher in PA will not find anything. If you are lending to a corporation on the strength of the corporations PA assets, you must find out more about the corporation b/c they might have assets in other states. 6323(f)(1)(a)(2) tells us you file in the place where the property is situated. 6323(f)(3)(b) see that it is at the tax payers residence, the residence of a corporation is where its principal executive office is located, here probably at the store in Niagra county. The PA assets are deemed to be located at NY store. Look to NY lien law statute, section (2)(a) says youd file with secretary of state in NY. Sally is probably personally liable for the unpaid payroll taxes, which means that the IRS should probably also file locally in Wyoming county at her residence. Problem 38.4: Transfer of property by debtors -- Dans only asset is a lunch wagon worth about $18,000. Dan grants a security interest in the wagon to Firstbank to secure a loan in the amount of $10,000. The IRS files a tax lien against Dan. Dan sells the wagon to a buyer who does not check the records and does not have actual knowledge of either encumbrance. Eighteen months later, the buyer files under chapter 7 and you are appointed as trustee. What do you do? LMS case requires the IRS (if they know of the property has been transferred by the debtor to a 3rd party) to re-file in a reasonable time. The courts read into the tax lien act a requirement on the IRS to re-file when it knows of a transfer of property. They imply that it must be done in a reasonable time. LMS might be good law but the circuit courts and SC have not ruled on the issue.

135

If the IRS new of the sale, then you are talking about the LMS case. If the IRS knows and didnt refile, it would lose to a hypothetical lien creditor says the court, therefore the trustee. If the IRS knew the trustee could use LMS to prevail. XXXIX. COMPETITIONS INVOLVING FEDERAL TAX LIENS: ADVANCED PROBLEMS (39) IRC 6323(b) has a number of exceptions to the first in time, first in right rule that cut against the government Tend to be protection of commerce A. The Strange Metaphysics of the Internal Revenue Code (p648) 6323(a) sets up a basic priority system b/w the filed federal tax lien and pre-existing SI. The general rule is that the FTL has priority if the IRS filed a Notice of Tax Lien before the SI comes into existence, otherwise the SI has priority over the FTL. 6323(h)(1) provides that a SI comes into existence when it is protected by local law against a subsequent judgment lien, but only to it only comes into existence to the extent that SC has parted with moneys worth. (9-317(a) when it has filed or perfected). The value requirement is different in the UCC and in the FTLA- value is given when the creditor part with anything under the UCC (9-203(b)(1)). But under FTLA it requires that the creditor have made the loan (6326(h)(1)). The security interest exists only to the extent the secured creditor has made the loan. B. 3 Principal Exceptions to Normal Priority 6323(B)- it contains a whole list of people and situations that can take before the IRS has filed a Tax Lien. The most important is (b)(3), a business man who sells, the purchaser is going to prevail unless it is done with the purpose of getting over the tax. It is the analogue provision of 9-320(a). 6323(d)- It protects secured lenders who make future advances for a 45 day period with respect to collateral that is in existence on the date of the tax lien filing. 6323(C)- is the provision of the Tax Lien Act to take account of the fact that a lot of commercial financing is in collateral that turns over frequently. So it is dealing with a type of collateral that is calls commercial financing security (defined in 6323(2)(c) as including paper ordinarily arising in commercial transactions (chattel paper and negotiable instruments), inventory, accounts receivables, and mortgages on real property that are sold on the secondary market). This provision says that the SC cannot make advances for 45 that will have priority over the TLC, unless the commercial lender or secured creditor had actual notice of the Tax Lien Filing. You can make future loan for 45 days unless you know the tax lien has been filed. It also protects irrespective of knowledge the acquisition of after-acquired property for 45 days. The theory is that after-acquired property is out of control. C. Protection of Those Who Lend After Tax Lien Filed (p650) The General Provision Regarding Future Advances, IRC 6323(d) Art 9 protects future advances when the creditors SI attaches and has perfected (given consideration to support a simple contract) although under the FTLA perhaps no security exits at all. In any case, when the advance is made, and if the Art 9 filing has been completed before the Notice of Tax Lien is given, when the loan is given, it would have priority over the FTL. 6323(d) gives it priority over the tax lien as long as the SI would be protected under local law against a JLC arising as of the time of tax lien filing out of an unsecured obligation. 9-323(b) gives a 45 day window protection that is the same as that provided in 6323(D) to allow the SC the full advantage against Tax Liens under the FTLA. Commercial Transactions Financing Agreements Floating Liens -- 6323(c) protects Article 9 floating liens that occur within 45 days of filing the tax lien. This 45 day period is in essence an opportunity for the lender to learn of the tax lien filing and react to it.

136

Both 6323 (c) and (d) give advances made by the lender within 45 days after the filing of the tax lien priority over the tax lien. *(c) Applies only with respect to commercial financing security collateral: accounts, inventory, chattel paper, and mortgage paper. (d) applies to all type of collateral involved. Extends to collateral acquired 45 days after tax lien filing and even in cases when the creditor learns of the tax lien filing. That is, after-acquired collateral. Choateness Doctrine: the FTLA is of the view that the SI exists only when the property is in existence, or when the debtor has acquired it. This view with also is reflected in the McDermott case. Texas Oil & Gas Corp v. USA The commercial lender must check the applicable records every 45 days or else seriously jeopardize his security under the varying degrees of rigor promulgates by the choateness doctrine. In addition the lender would most likely not have the entire 45-day period in which to act unless he were lucky enough to discover the tax lien filing almost immediately after it was filed. Real Property Construction or Improvement 6323(c) protects construction lenders against a tax lien filed during construction. The construction lender must have entered into a contract to finance the construction prior to the filing of the tax lien. Protection only extends to the real property improved. If a construction lenders priority is protected under local law against a judgment lien arising as of the time of tax lien filing, out of an unsecured obligation the protection extends to advances made after the construction lender knows about the tax lien. The rationale is that everyone will be better off by the continued financing of the construction including the IRS. Obligatory Disbursement Agreements 6323(c)(4) protects lenders who have agreed before the tax lien is filed to make disbursements that the lenders then make after the lien is filed. Obligatory disbursement agreement (not the same as commitment under Art 9)- a written agreement entered into by a person in the course of his trade or business to make a disbursement. The obligation to pay must be conditioned upon an event beyond the control of the obligor. Statutory Liens Are liens that arise against a specific property by operation of a statute. Statutes typically provide such liens for activities of a nature that they at least arguably tend to improve the value of the property against which the lien is granted. 6323(b) some statutory liens have priority over federal tax liens, even when those statutory liens arise after the federal tax lien is filed. Artisans liens in favor of those of make improvements to personal property and retain possession of the property as security for claims - 6323(b)(5) Real property and special assessment -- 6323(b)(6) Mechanics liens for improvements made to real property - 6323(b)(7) limited to debtors personal residence and contracts not in excess of $1,000. Attorneys lien - 6323(b)(8) for fees against a judgment or settlement amount obtained by the attorney on behalf of the client Purchase Money Security Interest PMSI has protection against an earlier-filed tax lien (although this wasnt included in the FTLA, it was read into it by the Courts). No provision in 6323(b), but the courts interpreted one and the IRS acquiesced. First Interstate Bank of Utah, NA v. Internal Revenue Service (10th Cir. 1991, p654) First Interstate Bank argues that is obtained a PMSI in account receivables when it advances funds to Olympus. Can a PMSI to First Interstate Bank peempt a tax lien previously asserted by the federal government? On revision, the Court analyzed PMSI. These are given priority b/c the creditor gives more money to increase the value of the estate and hence should be given priority. The requirements of a PMSI are the following:

137

The lender must have given value by making advances or incurring an obligation. The value must have been to enable the debtor to acquire rights in or the use of collateral and The value must have been in fact used. (it excludes antecedent debt) D. Nonadvances 6323(e) (p660) What are nonadvances? Interest, attorneys fees, and other expenses incurred by the secured creditor in protecting and recovering its collateral and collecting the amount of debt owing from the debtor. They grow off their own accord If the nonadvances are provided for in the security agreement and are reasonable, nonadvances under a security agreement are equal in priority to the first advance. They are to take priority over the tax lien since they will be added to the first SI taken on the property. They are added up and put on. Basically 6323(e) gives non-advances the same priority against tax liens as they enjoy against intervening secured interest, lien creditors, and trustees in bankruptcy. E. Problem Set 39 Problem 39.1 Aug 1- Bank 1 filed a financing statement (no commitment to make the loan). Aug 5 Bank 2 approved the loan, filed a financing statement, security agreement, advanced funds to debtor. Aug 7 IRS files notice of tax lien. Aug 10 Bank 1 signs security agreement. What is the priority between Bank 1 and the IRS? Does Bank 1 have a security interest as defined by the FTLA in 6323(h)? 6232(h) a security interest comes into existence when it is protected by local law against a subsequent judgment lien and parted with moneys worth. Bank 1 does not have a FLTA-defined security interest until it parts with money on Aug. 10, which is after the tax lien was filed (Aug 7). IRS has priority over Bank 1. The outcome would not change even if Bank 1 signed the security agreement on August 1 (unless it made a commitment to make the loan). What is the priority between Bank 2 and the IRS? Does Bank 2 have a security interest as defined by the FTLA in 6323(h)? 6323(h) a security interest comes into existence when it is protected by local law against a subsequent judgment lien and parted with moneys worth. Bank 2 has a signed security agreement, filed the financing statement, and made the loan. Bank 2 has a FLTA-defined security interest on Aug. 5, which is before the tax lien was filed (Aug 7). Bank 2 has priority over the IRS. What is the priority between Bank 1 and Bank 2? Priority between two secured creditors:9-323(a)(1) -- first to file or perfect. Bank 1 has priority b/c it filed on Aug 1 before Bank 2 filed or perfected (Aug 5). Who wins when there is circular priority? A court will do equity in the situation and decide looking at Article 9 and the tax lien act and determine which principles are strongest in this situation. Tempted to say Bank One is at the top of the heap, and the federal tax lien will be paid out of Bank ones priority. If anything is left over, Bank One can take. Then, Bank Two. Policy of 6323 the federal tax lien is effective against Bank 1 the minute the tax lien is filed. What could Bank 1 have done? Give a nominal amount ($100) on August 1. Wait for search to come back, and then advance the remaining amount (which will be within 45 days of the tax lien). Problem 39.2: The debtor operates a pet store. The IRS notifies the debtor that it will file a tax lien in the next few days. The debtor is concerned about the following situations: (a)Will the customers who buy pets from the stores inventory after the Notice is filed take free and clear of the IRS lien? 6323(b)(3) -- Personal property purchased at retail take free of filed tax lien: with respect to tangible personal property purchased at retail, as against a purchaser in the ordinary course of the seller's trade or business, unless at the time of such purchase such purchaser intends such purchase to (or knows such purchase will) hinder, evade, or defeat the collection of any tax under this title. **Ordinary consumer is protected against the tax lien.

138

(b) The debtor needs to install a new fish tank that will cost $5,000. The seller will provide 100% of the financing, and the debtor will make payments over the next five years. They will not be able to get the deal done before the lien is filed. The seller will file a financing statement, but probably wont search the public records. Purchase money security interest exception: There is no provision in 6323(b) for purchase money security interests. But, the courts have read one into the provision. (First Interstate Bank). The PMSI lender should prevail over the tax lien filed earlier in time. (c) The debtor is worried about his employees. If he pays them with money which the IRS has a lien, can the IRS take the money back? If the IRS levies the day before payday, where do the employees stand? Everyone assumes that the employees take free and clear, but it is hard to actually see this in the FTLA Politically, the IRS should not try to take the employees money. Once there is a levy, the employees would be stuck b/c the debtor cannot pay out of a deposit account that has been levied. (d) The business is financed with an inventory and accounts receivable loan from the Bank. The bank lends 65% of the cost of inventory as the Debtor (pet store) receives it. The security interest contains the usual provisions regarding future advances and after-acquired property. The debtor believes the bank will work with him. There is an outstanding $175,000 balance on the loan. If the business continues, the collateral will be worth that amount. If the business closes, the bank will only get $50,000 out of the collateral. Can the Bank work with the debtor without losing its priority over the tax lien? They can work something out with the bank, but only for 45 days. 6323(c) inventory and a/r within 45 day period. The bank is not going to be interested in working with the debtor beyond the 45day period. If inventory is sold after 45 days, it diminishes the banks collateral. The inventory lender could become a purchase money lender with respect to specific shipments of inventory (even after 45 days it would be protected). But, the lender has a problem b/c they cant let the debtor make sales on credit b/c the Interstate case says you cant have a PMSI in an account receivable (for purposes of the a/r). What about using segregated accounts? The bank has priority in all inventory and a/r as of today. If they are sold, you put the proceeds in a segregated bank account. Use the segregated bank account to buy new inventory, even acquired after the 45 day limit. Then put those proceeds in a segregated bank account. Kaufman does not know the answer to this situation, but it is risky but might work. The FLTA does not say anything about proceeds. The notion of protecting the revolving collateral and loans in 6323(c) implicitly carries a notion of protecting proceeds in the same way secured creditors are protected in bankruptcy and retain an interest in proceeds. Problem 39.3: The client does a substantial amount of inventory and accounts receivable financing. The client was recently burned in a situation where a tax lien was filed ,and 45 days went by without the client learning of it. The client continued to fund the loan and eventually lost nearly all remaining collateral to the tax lien. What can the client do to avoid recurrence of the problem in the future? Texas Oil and Gas case refers to the problem of searching every 45 days. It is very expensive and it takes a while for tax liens to show up in the records. Practical solution: People in this lending business, use credit bulletins that put out weekly newsletters. The newsletter lists all the tax liens that have been filed. The newsletter does the searching every week. Problem 39.4: Should a debtor worry about leaving items purchased at a store? She is a purchaser, and under IRC 6323(b)(3) purchasers are protected against even earlier-filed tax liens. If she walks out with the item, she does not have a problem. Is she right about leaving the piano at the piano dealer entrusted with dealer? She will not be protected against the earlier-filed taxed lien b/c she is not protected against the subsequent purchaser w/o knowledge. If another buyer purchases the piano when Alecia leaves, she loses. Alecia has entrusted the piano with a dealer in those goods. 9-403(b); 2-403(2). Problem 39.5: If Alecia buys a used sailboat. How will she know if there is a tax lien against the boat? 6323(b)(4) casual sales (household goods, personal effects, and other tangible personal property) the tax lien is not valid in casual sale for less than $1,000. The sailboat is bought for $3,000, so it is not a casual sale. The buyer should check the records (and not only for tax liens but also security agreements of the bank that filed a financing statement).

139

140

Você também pode gostar