Commercial Law Outline

Background/Basic Points
Secured credit, by enabling lenders to take security interests in debtors property,
reduces their risk of not being paid and thereby increases the volume of credit
available.
Various levels of lending:
o Unsecured credit given based on borrowers projected cash flow and
general creditworthiness
unsecured creditors face risk that borrowers might take-on addtl
debt, even secured debt, or borrowers financial position might
deteriorate.
can protect against this, at least partially, by having
covenants in loan agreement
covenants can achieve the same effects as a security interest
by requiring borrower to not encumber or transfer certain
assets
o Secured-credit asset based loans. Assets can include inventory,
accounts-receiveable (A/R), equipment, intellectual property, etc.
o Purchase money secured credit prime example, car loan, most often seen
in consumer lending?
o Perhaps most important difference is tx of lenders when borrowers
become insolvent
Rights of Unsecured Creditors (p3)
Gen rule: before judgment or its equivalent, an unsecured creditor has no rights at
law or in equity in the property of his debtor.
o Seller vs Debtor: Seller must first sue Debtor, obtain money judgment,
then take steps necessary to authorize sheriff to seize Debtors assets
o Seller vs. Other unsecured Creditors and Trustee: whoever wins race to
courthouse gets assets before bankruptcy. After bankruptcy, proceeds (if
any) distributed pro rata among unsecured creditors, assuming no
unsecured creditor has transformed himself into secured creditor by
obtaining lien at least 90 days before bankruptcy filing.
Rights of Secured Creditors (p5)
Lien a property right in debtors property. Most often consensual, it becomes a
security interest.
Creating security interest under Article 9 is quite easy. Agreement must be
written (but electronic copies fine) and authenticated by debtor. It has then
attached, that is, the security interest has become enforceable against debtor w/
respect to collateral, 9-203(a).

Seller vs Debtor: Seller can seize collateral upon default w/ no need for court
intervention
Seller vs. Other unsecured Creditors and Trustee: under 9-201(a), a secured
creditors has rights to collateral that trump purchasers of collateral, or other
creditors.
o Secured claims trump unsecured claims unless specific Art 9 provisions
provide otherwise.
o 9-317(a)(2)(A) says security interest must be perfected before it trumps
other claims. If unsecured debtor acquires lien creditor status before
security interest is perfected, security interest becomes subordinate to lien
creditor.
Equitable Remedies Against Secured Creditors (p9) Knox v Phoenix Leasing
Inc. (Cal Ct of App 1994)
o Majority Rule: Can secured creditor who seized defaulted debtors
property be subject to restitution for value of goods furnished to debtor by
third party? No, absent exceptional circumstances.
Outlier cases, Producer Cotton Oil v Amstar (Cal) and Duggan
(CO), only allowed restitution when creditor was entitled to
proceeds of crops or livestock and third-party provided harvesting
services or feed, respectively, to debtor w/ understanding of
creditor. B/c feed or harvest preserved (or increased the value of)
the perishable collateral, third-party allowed to recover under
unjust enrichment claim against secured creditor
Exception restricted to cases where:
secured creditor would provide service 3rd party provided
anyway as part of its duty to provide reasonable care in
the custody and preservation of collateral in his
possession, 9-207(1), or
where creditors fraud was used to obtain 3rd party services,
1-103, principles of law and equity... shall supplement
[UCC] provisions.
Policy reasons behind majority rule:
secured creditors should not have to monitor debtors
business so closely
plus, secured creditor would have affirmative duty of
warning potential unsecured creditors
unsecured creditors put on notice by system of public
filings that they are at risk

Policy Issues Is Secured Credit Efficient or Fair? (p6)

Art 9 makes it simple for secured creditors to take security interest in all debtors
assets, present or future, to exclusion of all other creditors.
Pro Secured Credit

o Since unsecured creditors know ahead of time their claim might be

eclipsed by secured creditors, they will demand more for their increased
risk. Therefore no arguments for one rule over another can be made on
fairness grounds.
o Secured credit can be obtained more cheaply b/c it involves less risk
But increases risk for unsecured creditors
o Three types of efficiency arguments:
Cost - Secured credit can be obtained more cheaply b/c it involves
less risk
But increases risk for unsecured creditors
total cost to debtor probably unchanged
Bonding by giving security interest in certain assets to creditor,
debtor can ensure creditors and debtors interests are aligned.
Signaling allows borrowers to signal that they plan to pay back
since it will be costly to borrower if default occurs.
o Or inefficient just redistributes risk from secured party to unsecured
creditors; especially if done post-hoc or w/o consent of unsecured,
involuntary creditor, LoPucki calls this redistribution theft.
Anti Secured Credit
o But not all unsecured creditors agree to subordinate status voluntarily (e.g.
tort victims). Debtor can make himself judgment proof by granting
security interests in all property.
o Assumes all unsecured creditors are sophisticated parties acting w/o
coercion. Not always true.
One possible reform: subordinate security interests to involuntary
creditors. Secured creditors can take out insurance against such an
event to prevent losses. Debtors costs would be increased.

Definitions - 9-102 (p20)

debtor, 9-102(a)(28), and obligor, 9-102(a)(59)
o usually the same person, but the obligor is the person owing the debt while
the debtor is the person whose property is subject to the creditors security
interest
secured party, 9-102(a)(72) creditor in whose favor the security interest is
created
security agreement, 9-102(a)(73) agreement that creates the security interest.
Medium can be tangible or electronic.
security interest, 9-201(b)(35) interest in property that secures payment of debt.
Also applies to security interests created by specific transactions, e.g.,
consignments and sales of accounts, covered by UCC 9.
collateral, 9-102(a)(12) property subject to the security interest. Can be
tangible goods, 9-102(a)(44), like inventory, (a)(48), farm products, (a)(34),
equipment, (a)(33), or intangible like accounts.

financing statement, 9-102(a)(39) record, tangible or electronic, that secured

party files in public records, usually states filing office.
attachment, 9-203(a) security interest attaches to collateral when it becomes
enforceable against debtor. Usually occurs when debtor & secured party have
entered into security agreement and secured party has given value to debtor, either
by making loan or selling property on credit to debtor.
perfection, 9-308(b) security interest is usually perfected when it has attached
and secured party has filed financing statement or taken possession of collateral.
Sometimes security interest is perfected automatically. Perfection establishes
secured partys priority w/ respect to 3rd parties.
proceeds, 9-102(a)(64) property acquired by debtor upon sale, lease, licenseor
other disposition of collateral. If retail debtor sells inventory collateral in
exchange for cash or check, these are cash proceeds, 9-102(a)(9). Or retail debtor
may sell in exchange for obligation to pay which may be an account, 9-102(a)(2),
a promissory note, 9-102(a)(65), etc. Security interest in inventory carries over to
the proceeds, 9-315(a)(2).
record, 9-102(a)(69) information stored in tangible or intangible form so long as
it is retrievable in perceivable form.

Attachment (p22)

Security Interest
o SI attaches to collateral when it becomes enforceable against the debtor 203(a)
o SI is enforceable against debtor and 3rd parties w/ respect to collateral only
if: -- 203(b)
value has been given
debtor has rights in collateral or power to transfer rights
one of the following conditions is met:
debtor has authenticated a security agreement that provides
a description of the collateral - 203(b)(3)(A) (most
common)
o security agreement becomes authenticated when
debtor signs it 9-102(a)(7)
o writing not needed, only a record 102(a)(69)
in electronic form, debtor authenticates by
identifying itself and manifesting acceptance
of terms of agreement (p23)
o collateral description is sufficient if it reasonably
identifies what is described and does not need to
be specific. 9-108.
can describe specifically, by category,
quantity, etc.

but all the debtors assets or all the

debtors personal property not sufficient. 9108(c)
for security agreement, but this
generic/broad descrip is ok for fin
stmt. 9-504(2).
sufficient defined in Comment 2
collateral is in possession of secured party - 203(b)(3)(B)
collateral is deposit accounts, electronic chattel paper,
investment property, letter-of-credit rights, etc., and secured
party has control - 203(b)(3)(D)
o Composite Document Rule
In re Bollinger (3rd Cir 1980) (p24) rejects formal rule requiring
grant or other such language before finding presence of security
agreement, and instead allows financing stmt signed by both
parties, a written promissory note, and letters between both sides
evidencing an intent to create a security interest in the collateral to
suffice as a security agreement. IOW, a security agreement can be
found through the use of multiple documents, hence the composite
document rule.
Pro-secured creditor argument: lets just be realistic
Pro-bankrupcty trustee argument: Sec Cred are in
incredibly strong positions; insisting on minimal formal
reqts doesnt seem to be too much to req in exchange for
such benefits.
o After-Acquired Collateral (p37)
Security agreements may create or provide for a security interest
in after-acquired collateral. 9-204(a)
but not in consumer goods or commercial tort claims. 9204(b)
When security agreement is silent on after-acquired collateral,
court may read such a clause into agreement. UCC rules are silent
on issue. 9-108, Comment 3
Majority Rule: After-acquired clauses are presumed when
inventory and/or accounts-receivable are collateral, subject to
rebuttal evidence that parties intended otherwise. In re Filtercorp
(9th Cir 1998) (p39). Rationale: both inventory and A/Rs are
cyclical by nature.
Rebuttal evidence can include specific list of inventory
evidencing intent to limit reach of inventory as collateral.
In re Filtercorp (p41)
Minority Rule: express language reqd. Rationale: bright
line rule. Better notice to 3rd parties.
o Proceeds & Supporting Obligations (p42)

Gen Rule: security interest in collateral automatically attaches to

identifiable proceeds. 9-203(f), 9-315(a)(2).
Proceeds defined expansively. 9-102(a)(64). Includes dividends
of collateral, insurance proceeds.
Proceeds of proceeds (i.e. 2nd generation proceeds and inventory)
also included since def of collateral, 9-102(a)(12)(A), makes final
generation proceeds & transforms all prev proceeds into collateral.
Supporting obligations, 9-102(a)(77), tx in same way as proceeds
since Sec interest attaches automatically.
o Rights in Collateral (p45)
no need for debtor to have full ownership; even if debtor only has
some of the rights in the bundle of ownership rights, those rights
can be collateral. 9-203, Comment 6. Even the power to transfer
rights is sufficient enough for collateral. Id.
Swets Motor Sales v. Pruisner (p46) holding that financing co,
Chrysler Fin, took security interest in vehicles purchased by D
from Swets even though Ds check to Swets later bounced. Issue
was whether D had given value as reqd by 9-203(b). UCC
provides that purchaser of goods acquires all title that transferor
had or had power to transfer... even if delivery was in exchange for
check later dishonored. 2-403.

Perfection (p51)

Attachment elevates secured creditors over unsecured creditors so long as the

debtor is not in bankruptcy. Once in bankruptcy, however, secured and unsecured
creditors are in the same boat unless the secured creditor has perfected their
interest.
Perfection can be achieved in a variety of ways:
o Automatic perfection upon attachment. 9-309
o Possession of collateral. 9-313(a)
o Perfection by Control (most often of deposits). 9-312(b)(1) & 8-106,
Comment 1-7. (p100)
can apply to:
deposit accounts (9-104)
o control of deposit accounts can be achieved in 3
ways: 9-104(a)(1)-(3)
when SP is depository bank at which acct is
held
when debtor, SP, and depository bank agree
in authenticated record that bank will
comply with SPs instructions

when SP becomes banks customer w/

regard to deposit acct.
electronic chattel paper (9-105)
investment property (9-106), and
letter of credit rights (9-107).
in case of 1) deposit accounts as original collateral or 2) letter of
credit rights other than as supporting obligations, control is the
only possible means of perfection. 9-312(b)
reqts for control differ for each type of collateral.
control of ltr of credit right reqs issuer of ltr of credit to
consent to assignment of proceeds of ltr of credit. 9-107.
control of a certificated security, a subset of investment
property, reqs control as provided in 8-106 (i.e. delivery
and indorsement of security). 9-106(a).

o Compliance with other law (e.g. security interests in automobiles)

o Perfection by Filing 9-310.
Security interests in accounts and payment intangibles can only be
perfected by filing
Notice filing and central filing were two central goals in Art 9
system. Allows filing party to establish priority in debtors
collateral, and provides info to searching party about pre-existing
security interests in such property.
Sufficiency of Filing Statements, 9-502
Filing stmt is sufficient only if it provides, 9-502(a)
o name of debtor
o name or name of rep of secured party
o indicates collateral covered by fin stmt
However, filing stmts are effectively reqd to include
address of debtor and secured party, and type and state of
formation if debtor is an org, since sample form, 521(a),
has space for this info and state filing offices allowed to
reject fin stmts w/o this info, 9-516(b)(5). Stmts rejected
for his reason are considered not filed. 9-520(a).
o However, if a filing ofc accepts the fin stmt that
lacks such info, the filing stmt is considered valid.
9-516(a).
Filing of Financing Stmt has to be Authorized by Debtor
Fin Stmt has to be authorized by debtor in authenticated
record. 9-509(a).
o signed/authenticated security agreement (SA)
suffices to authorize fin stmt covering collateral in
SA. 9-509(b)

Fin stmt w/o authorization is not effective. 9-510(a).

Debtor damaged by unauthorized fin stmt can sue for
damages and $500 penalty. 9-625(b), (e)(3). Debtor has
right to demand termination stmt from secured party (filer)
that must be sent w/i 20 days of receipt of demand letter. 9513(c)(4).
Indication of Collateral in Filed Fin Stmt (p64)
Original Collateral
o Indication of collateral in fin stmt sufficient if it
provides either a description of collateral pursuant
to 9-108 or indication that fin stmt covers all assets
or personal property. 9-504(a) and (b), respectively.
Descriptions by category, type, computation,
etc. all suffice. 9-108(b)(3).
Descriptions of collateral covered allowed to
be much broader in fin stmt vs SA b/c fin
stmt puts 3rd parties on notice (and has no
effect on debtor if collateral not covered by
SA) while SA actually gives creditor
security interest in collateral mentioned
Addtlly broad descriptions in fin
stmts allow creditors to have easy to
extend floating liens
Proceeds
o Perfected security interest in collateral
automatically continues in proceeds, whether or not
proceeds are mentioned in fin stmt. 9-315(c).
o Security interest covers proceeds until fin stmt
lapses or is terminated, 9-315(e), only if:
1) proceeds are collateral in which sec
interest may be perfected by filing in ofc in
which fin stmt is filed, and
proceeds are not acquired w/ cash proceeds.
9-315(d)(1).
o Sec interest in cash proceeds continues indefinitely
as long as they can be identified. 9-315(d)(2)
o If debtor uses cash proceeds to buy new collateral,
sec interest continues for 21 days unless fin stmt
indicates type of collateral covered. 9-315(d)(3),
and Comment 5.
Name of Debtor (p67)
Name on fin stmt sufficient for individual debtor if name is
given. 9-503(a)(4)(A).

If debtor is general partnership, by giving name of

partnership, not partners. Id. and 1-201(b)(25) (defining
organization broadly).
o But, if partnership has no formal name, by giving
names of partners. 9-503(a)(4)(B).
If debtor is registered org, by giving name of organization
indicated in the public records of the debtors organizing
jurisdiction. 9-503(a)(1).
o Registered org, def in 9-102(a)(70), includes
corps, LLC, LPs, but not gen partnerships.
Minor Errors Rule (p68)
Fin stmt w/ minor errors ok, unless errors make fin stmt
seriously misleading. 9-506(a).
But, if correct name isnt given, fin stmt is per se
misleading. 9-506(b).
o But, if searcher using correct name and filing ofcs
std search logic would have turned up fin stmt in
question, then erroneous name provided does not
make fin stmt seriously misleading. 9-506(c).
o Post-Filing Changes (p83) SPs generally protected; AB2I, burden falls
on innocent searchers
Fin stmt still effective if debtor sells, exchanges, etc., collateral,
and even if SP knows of or consents to the disposition. 9-507(a).
Sec Parties (SP) security interest in collateral continues even if
debtor sells, exchanges, etc., collateral, and even if SP knows of or
consents to the disposition. 9-315(a).
But, security interest in collateral may become unperfected
(i.e. fin stmt becomes ineffective) if new debtor is located
in another jurisdiction. 9-316.
o If orig debtor moves to new jurisdiction, SP has
four months to file new fin stmt. 9-316(a)(2).
o If collateral is transferred to diff debtor in another
jurisdiction, SP has one year. 9-316(a)(3).
If debtor just changes name, SPs fin stmt remains effective for
four months, and if extended/amended before the end of 4 mos, for
however long afterwards. But if 4 mos go by w/ no amendment,
fin stmt loses effectiveness w/ regard to newly acquired collateral.
9-507(c), and Comment 4.
If new holder of collateral qualifies as new debtor, 9-102(a)(56),
by becoming bound to a sec agreement prev entered into by
another person, 9-203(d), then fin stmt remains effective against
all collateral covered by the sec agreement, not just collateral prev
held by original debtor. 9-508(a).
But, if fin stmt becomes seriously misleading b/c of name
change, then fin stmt not effective against newly acquired

collateral of new debtor acquired after 4 mos. grace period.

9-508(b).
When two debtors merge, both of which had pre-existing SAs w/
diff creditors, see 9-326 to resolve conflict.
When two debtors merge, and original debtor has pre-existing SA,
but new debtor has creditor that perfected by means other than
filing, see 9-326. Most often creditor of original debtor is
subordinated.

Filing System (p88)

o Central place of filing adopted by states Secy of State. 9-501(a)(2).
o Initial filing stmt effective for five years, 9-515(a), unless continued, 9515(c).
Model form at 9-521. Person entitled to file only w/ debtors
authorization, 9-509(a), but debtors authentication of security
agmt is presumed authorization to file fin stmt. 9-509(a).
o Amendments/continuation model form at 9-521(b).
If amendment adds collateral or addtl debtor, authorization is
needed.
Continuation effective for addtl five years past earlier fin stmts
expiration (i.e. no penalty for filing continuation early). 9-515(e).
But, continuation can only be filed w/i 6 mos of expiration
date. 9-515(d).
Other amendments dont continue. 9-512(b).
o Termination stmts when debt is paid in full, debtor can demand that w/i
20 days SP either send debtor a termination stmt that debtor may file, or
SP has to file a term stmt himself. 9-513(c).
But, consumers have right to have termination stmt filed w/o their
request w/i 1 month of full payment of debt. 9-513(a), (b).
o Assignments of security interest -- If SP1 assigns interest to another SP2,
fin stmt amendment can be filed pursuant to 9-514. But even if
new/amend fin stmt isnt filed, sec interest persists b/c all other parties still
have notice. 9-310(c).
o Filing becomes effective when fin stmt is presented to filing office along
w/ approp. fee or filing office accepts the record. 9-516(a).
o If filing office makes indexing mistake (making it impossible for searcher
to find), SP is not held responsible. Filing is still effective. 9-517
o If and only if fin stmts violate conditions imposed in 9-516(b) can they be
rejected by state filing offices. 9-520(a).
If filing office wrongly rejects the fin stmt, it is still effective
except against a purchaser of the collateral that gives value in
reasonable reliance upon absence of record from files. 9-516(d).
If filing office wrongly accepts fin stmt, it is effective unless it also
violates 9-502(a). 9-520(c).

If state filing office makes error, state tort law determines whether,
and to what extent (if any), they can be held liable. (p94-95).

Security Interests in Consumer Goods (p102)

o Most consumer transactions governed by state consumer protection laws.
See 9-201(b).
o Purchase money security interests in consumer goods automatically
perfected at attachment, w/ no filing req. 9-309(1).
exception justified on grounds that 1) transactions are freq small,
and cost of filing is prob prohibitive, 2) consumer transactions are
so numerous they would unduly burden filing system & 3) parties
to consumer transactions are less likely to search records.
But, this doesnt apply to vehicles, boats, etc. Perfection in these
items most often accomplished by listing security interest on title.
9-311.
Plus, credit cards are most often used and result in unsecured
purchases.
o Filing is necessary, however, to perfect nonpurchase money security
interest in consumer goods, and
o filing reqd for priority in consumer-to-consumer sales under 9-320(b).

Priority Chap 3 (p117)

Art 9, Part 3, Subpart 3 (i.e. 9-317 thru 9-339) deal w/ establishing various
creditors rights to property vis a vis the debtor and other debtors and lien holders
First to File Rule
o Gen Rule: when parties have conflicting claims to the same collateral,
whoever filed or perfected first has the superior claim. 9-317(a), 9-322(a).
Difference between filing submitting an effective fin stmt to
filing office and having it accepted and perfection having an
attached security interest in property attach and either having an
effective fin stmt filed, or having perfection occur by some other
method (automatic in case of purchase money interest, by
possession of collateral, etc.)
B/c most security interests are perfected by filing, rule is most
often referred to as first to file.
o Future Advances (p119) Sec agreements frequently have both afteracquired property clauses and future advances clauses. After-acquired
property clauses establish security interests in property acquired by debtor
in the future, while future advances clauses use existing collateral of
debtor to secure future advances made by creditor. Security agreements
can have both. Future advance clause that applies sec agmt to all future
loans is referred to as a dragnet clause.

Gen Rule: If SP1 has filed fin stmt earlier than SP2s fin stmt, SP1
has priority even if SP2 ends up advancing money earlier than SP1,
so long as both parties advanced money after they filed fin stmts.
In addition, if SP1 files fin stmt and lends $ to Debtor on April 1,
SP2 does the same on April 2, and SP1 lends addtl $$ on May 1,
SP1 has priority over SP2 in the amt of the sum of April 1 and May
1 loans so long as security agreement had future advances clause.
See 9-322(a), Comment 4.
When future advances are made are generally irrelevant for
purposes of priority since most often a fin stmt has been
filed. 9-322(a) & 9-323, Comment 3.
Leads to Financing Stmt as an Umbrella (p122)
o B/c fin stmts are good for five years, and can be contd so long as debt
exists, and fin stmts can cover all personal property of the debtor, the
first-to-file creditor can effectively lock up the rights to all of the debtors
property in the event of bankruptcy, preventing anyone else from
recovering anything. Simultaneously, no other creditors may appear since
the first locked up rights to all the debtors collateral.
o Three possible ways for junior creditors to get out from under senior
creditor(s):
Purchase money security interests (PMSIs)
Senior creditor agrees to subordinate its security interest, at least in
part, to junior creditor
Law is very accommodating to subordination agreements.
9-339. Subordination agreements are also effective in
bankruptcy. BC 510.
Junior creditor buys out senior creditor
Prob better for junior creditor to take assignment of Sr
creditors security interest, rather than having Sr creditor
file termination stmt, and junior creditor filing new fin stmt
of his own. 9-310(c) and Comment 4.
Purchase Money Priority (p129) an exception to First to File general rule
o Purchase money security interest (PMSI) has priority over conflicting
security interests in same collateral (other than inventory or livestock) if
PMSI is perfected when debtor receives possession of collateral or w/i 20
days thereafter. 9-324(a).
PMSI allowed in inventory only under some circumstances. 9324(b).
Even though debtor might have possession of property for more
than 20 days, if property doesnt become collateral until some
later point, 20-day safe harbor period to file fin stmt starts at the
point where possessor of property becomes debtor and property
becomes collateral. See Brodie Hotel Supply v U.S. (p130), 9-324,
Comment 3.

o Purchase money obligation def as one incurred (i) as all or part of the price
of collateral (seller sells goods to buyers and takes sec interest to secure
the unpaid price) or (ii) for value given to enable debtor to acquire rights
in or use of collateral if the value is in fact so used (lender lends money
used to purchase goods). 9-103(a)(2).
Purchase money obligation includes all costs of acquisition, not
just purchase price. 9-103, Comment 3.
But, PMSI limited to goods and software. 9-103(a)(1).
If property has already been acquired, creditor cannot obtain PMSI
after the fact. See Prob #1, p134.
Creditors money has to enable the purchase under 103(a)(2).
Diff. tracing rules, FIFO or LIFO, might be used. Banks can avoid
this situation by making out checks to debtor/seller jointly.
In cases of conflicting PMSIs, the sellers PMSI is normally given
priority over the lenders. See 9-324(g).
Transformation Rule Rejected in Favor of Dual Status Rule (p136)
o Gen Rule: Dual status rule; Just b/c loan secured by purchase money
collateral is consolidated w/ another loan, 9-103(f)(3), or if collateral
secures more than purchase money obligation, 9-103(f)(2), or conversely,
because PMSI is secured by more than purchase money collateral, 9103(f)(1), PMSI does not lose its status as PMSI. 9-103(f)
Old rule holding that PMSI disappeared when loan was
consolidated w/ others, or when collateral secured more than just
amt of purchase money obligation is rejected by 9-103(f).
But, Gen rule does not apply to consumer transactions. 9-103(h).
PMSIs in Inventory Req Purchase Money S/P to Notify (p138)
o PM secured party req to send authenticated notification to holder of
conflicting security interest in order to secure higher priority. 9-324(b)(2).
Notice is good for five years. 9-324(b)(3).
Conflicting security interest holder must receive notice before
debtor receives possession of inventory. 9-324(b)(3).
o PMSI must be perfected when debtor receives inventory. 9-324, Comment
4.
o PMSIs in inventory do not normally continue to proceeds. 9-324(b).
PMSIs limited to cash proceeds received on or before delivery of the
inventory to the buyer (i.e. cash down payments). Effectively deprives
purchase money creditors of usual proceeds from credit sales of inventory,
accounts, etc. In bankruptcy, inventory-PMSI holders can get down
payments made on inventory, and whatever is left of inventory, but general
inventory SIer gets priority to the rest.
o PSMIers get priority in identifiable cash proceeds (so long as they are
received on or before delivery of inventory to a buyer), chattel paper or
instruments constituting proceeds, and in proceeds of chattel paper. 9324(b).
o 9-103(e) outlines how payments are to be allocated.

o Contemporary practice is for original lender to have a negative covenant

declaring the existence or creation of any other security interests in the
Borrowers current or future-acquired property to be a condition of
default, causing immediate acceleration of total amt due. (p145).
o Not all PMSI rules are followed in consumer goods context. 9-103(h).
(p145)
Lien Creditors (p146)
o Gen Rule: Unperfected security interest is subordinate to lien holders. 9317(a)(2). Bankruptcy trustees are lien holders from the date the petition
was filed. 9-102(a)(52)(C).
Gen Rule means that S/P who perfects by filing after bankruptcy
filing is normally out of luck. However, if value wasnt advanced
by the date the bankruptcy petition was filed, the security interest
hasnt attached, and S/P is fine. See 9-317, Comment 4.
Exception to gen rule to create parity between first and
subsequent advances according to prior existing sec agrmts
o Future Advances so long as advances are made w/i 45 days of the lien
arising, S/P is okay. 9-323(b). If S/P didnt have knowledge of the lien,
S/P is covered even after 45 days has lapsed since lien was filed. 9-323(b)
(1), (2).
Buyers & Lessees (p148)
o Buyers and lessees of non-inventory goods take subject to perfected
security interests. 9-317(b).
Buyers of non-inventory goods determined by looking at whether
you are a buyer in the ordinary course of business. See Art 1.
This, in turn, is accomplished by determining whether selling these
goods is in the normal course of business by seller. If seller
normally sells this stuff, the buyer is in ordinary course of
business.
Interest continues in goods sold or leased and in any identifiable
proceeds. 9-315(a).
o Buyers and lessees of inventory take free of security interests
Gen Rule: Buyers in ordinary course of business takes free of a
security interest created by buyers seller. 9-320(a). Similar rule
for lessees. 9-321(b).
BUT, pre-existing secured interest can persist so long as
they were created prior in the ownership chain to buyers
seller, screwing over the unwitting, ultimate consumers
Buyer in ordinary course of business is def in such a way
that a person only becomes a buyer when they take
possession of goods or has a right to recover the goods
from seller under Art 2. See 1-201(9).
o Dual-Debtor problem (p153)
Descrip of problem: D1 grants SP1 a security interest in bus equip
and SP1 files fin stmt. D1 subsequently sells equip to D2, not a

buyer in ordinary course of business, and D2 takes equip subject to

SP1s security interest. But prior to initial SP1 fin stmt, SP2 had
filed fin stmt asserting rights in all equip owned by D2, then and in
the future. Chronologically SP2s fin stmt was filed earlier, but
common sense says SP1s rights shouldnt just be obliterated.
9-325(a) resolves conflict in SP1s favor. Debtors grant of
security interest is subordinate to security interest in same
collateral if:
debtor takes subject to prior security interest by other
debtor
that prior security interest was perfected at time Debtor
acquired collateral, and
no period where security interest was unperfected.
Comment 3 and 6 to 9-325 suggest that the reasoning behind 9-325
could be extended to fit situations that dont meet the exact, formal
reqts of 9-325(a)(1)-(3).
Rights to Payment (p160)
o Rights to payment: accounts receivable, payment intangibles, chattel paper
and instruments. Often referred to as receivables.
o Chattel paper, 9-102, Comment 5b, a monetary obligation w/ a security
interest in or a lease of specific goods if obligation and security interest or
lease are evidenced by a record(s). Installment sales contracts and leases
of goods are prime examples. Chattel paper can be tangible or electronic,
9-102(a)(78) and 9-102(a)(31), respectively.
o General intangible, 9-102(a)(42), a residual category meaning personal
property other than accounts, chattel paper, etc., including payment
intangibles and software, rights in software, copyrights, trademarks,
patents, etc.
o Payment intangible, 9-102(a)(61), subset of general intangibles under
which account debtors principal obligation is a monetary obligation.
Prime example is bank loan.
o Promissory note, 9-102(a)(65), an instrument that evidences a promise to
pay money. Def excludes checks and CDs.
Accounts & General Intangibles (p181)
o Priority in Proceeds
Gen Rules:
Accounts and gen intangibles can be perfected only by
filing, 9-310(a).
Priority between conflicting sec interests in accounts and
gen intangibles is determined by first-to-file rule of 9322(a).
Purchase money security interests can be created only in
goods and software, and not in accounts. 9-103 and 9-324,
Comment 2.

Gen Rule: If debtor sells collateral (covered by perfected SA) and

proceeds are accounts (not covered by SA), debtor has perfected
security interest in accounts dating back to original fin stmt. 9315(c),(d)(1).
BUT, if direct proceeds from sale of collateral are cash
proceeds, debtor generally has only 20 days to file new fin
stmt to continue perfected sec interest in new collateral
purchased w/ cash proceeds, unless new collateral is also
covered by orig fil stmt. 9-315(d)(1)(C) and Comment 5.
For ex., filed fin stmt covers only inventory. Debtor sells
inventory for cash and then purchases equip. Sec interest
in equip not perfected automatically. Diff result if orig fin
stmt covered both inventory and equip.
o One exception to need to file fin stmt for accounts is when they are truly
isolated instances or parties would never think of filing. 9-309.
9-309(2) lays out significant percentage test, to which case law
adds a casual or isolated instance prong. See In re Tri-County
Materials, Inc. (p183). 9-309, Comment 4 backs this dual prong
test.
Chattel Paper & Instruments (p186)
o Chattel paper is basically a record of both a monetary obligation and
security interest in specific goods or lease of goods. Traditionally,
accounts were not seen as pledgeable, but chattel paper was seen as
pledgeable b/c possession of that record was seen as evidence of the right
to collect payment. In effect, the record of the obligation to pay is merged
into that instrument the holder of the record is the one and only obligor.
chattel paper, def in 9-102(a)(11), can include leases, but excludes
charters of vessels or rights to payment of credit or charge cards.
o Another exception to first-to-file rule: Disputes over chattel paper
generally involve a Creditor floor planning a dealers inventory with a
filed fin stmt covering inventory. Dealer subsequently sells/leases
inventory in exchange for chattel paper, and sells chattel paper to Fin Co.
Creditor claims sec interest in chattel paper merely as proceeds of
inventory, while Fin Co holds possession. Fin Co wins if Fin Co
purchased chattel paper, 9-330(a):
in good faith and in the ordinary course of purchasers
business
purchaser gives new value, and
takes possession of chattel paper (or obtains control), and
chattel paper itself doesnt indicate that it has been assigned
to someone else.
If creditor claims sec interest in chattel paper other than merely as
proceeds, purchaser still wins if, 9-330(b):
purchaser gives new value,
takes possession (or control) in good faith,

in the ordinary course of purchasers business, and

w/o knowledge that purchase violates rights of SP
Creditor better off if they impose controls on Dealers handling of
cash proceeds in Dealers possession.
Merely as proceeds only qualifies for other than merely as
proceeds if original SP has stamped/legended actual chattel paper
so that Fin would have to know upon seeing it. 9-330, Comment 5.
o Instruments, def in 9-102(a)(47) as basically rights to payment, including
negotiable instruments, 3-104(a), (b).
Treated similar to chattel paper per 3-330(d). Main difference is:
purchaser of instrument only has to give value, not new
value as in case of chattel paper.
Req of good faith, 9-330(d), does not necessitate inquiry. 9-331,
Comment 5.
Some conflict between 9-330(d) and 9-331(a) for negotiable
instrument??? (see bot p194)
Deposit Accounts (p196)
o Deposit Accounts includes everything from checking & saving accts to
trust accts; excludes CDs. 9-102(a)(29).
o Art 9 excludes consumers from pledging deposit accts as original
collateral. 9-109(d)(13).
to get around, just transfer money into money mkt acct or CD
o Attachment, 9-203(b)(3)(D), perfection, 9-312(b)(1), and priority, 9-327,
over deposit accounts all depend on control (9-104)
o Control over deposit accounts, 9-104. SP has control, 9-104(a), if:
(1) SP is bank w/ which dep acct is maintained
(2) debtor, SP, and bank have agreed in authenticated record that
bank will comply w/ SPs instructions re: disposition of acct w/o
further consent by debtor
(3) SP becomes banks customer w/ respect to dep acct (acct put in
SPs name)
o Control is sole method of perfection for sec interests in deposit accts as
original collateral. See 9-312(b) and 9-104, Comment 2.
o Priority: Sec interests in Dep Accts as Proceeds of Other Collateral (p200)
When two SPs w/ dueling security interests assert claims in
debtors deposit acct and one has control (i.e. the bank), then the
one w/ control wins. 9-327.
Even if bank does not have sec interest in acct, bank can
still prob exercise right to set-off or recoupment against
secured creditor w/ regards to $$ in deposit account. 9-340.
Even if SP obtains 104(a)(2) control, bank still wins under 327(a)
(3). Only 104(a)(3) control (where SP gets account put into its
name) suffices to defeat Banks priority. Even a later arising sec
interest by Bank triumphs. See Comment 4e to 9-101.

In addition, Bank can refuse to enter into agreement

described by 104(a)(2).
Only way for SP to protect itself vis a vis Bank is 104(a)(3)
control, or subordination agrmt w/ Bank, 9-339.
In bankruptcy, unless SP has control over deposit acct, SP loses b/c
control is only way to perfect sec interests in deposit accts. So
subordination agrmt w/ Bank only protects in non-bankruptcy
situations.
Cash Proceeds (p205)
o Priority: A person who receives money or funds from a deposit account
takes free of a security interest unless the transferee acts in collusion w/
the debtor in violating the rights of the SP. 9-332(a), (b).
Collusion std described in Restatement of Torts 876, per 9-332,
Comment 4. Collusion occurs when person either:
commits tort in concert w/ another, or
knows that anothers act is a breach of duty and gives
substantial assistance to the violator and in doing so
breaches his own duty to the victim.
o Lowest Intermediate Balance Rule: to the extent cash proceeds are
mingled w/ other non-proceeds, cash proceeds remain identifiable to the
extent that the SP identifies the proceeds by a method of tracing, including
app of equitable principles, that is permitted under law other than this
article... 9-315(b)(2)
most pre-Revision cases used Lowest Intermediate Balance (LIB)
rule. 9-315, Comment 3 approves.
LIB rule leaves SP with rights only to extent of the lowest acct
balance over the period in question. If acct goes to zero or
negative bal, the SP is shit out of luck.
Creditor should use a lockbox account, see p222 (bot), to avoid
the possibility of co-mingled proceeds.

DEFAULT & ENFORCEMENT Chap 4 (p247)

Default
o Upon default, a secured creditor is entitled to take possession of tangible
collateral and sell them in order to satisfy the secured debt. Similarly, the
SP is allowed to collect directly from account debtors where chattel paper
or accounts were the collateral.
o Once a person/entity has declared bankruptcy, all creditor action is
automatically stayed.
o Default is not def w/i Art 9, leaving most to agree that default is whatever
the security agreement says it is. See Gilmore (p248).
Most often, total debt due is accelerated once any default has
occurred.

But if Sec Agmt is silent on the issue, creditor can only

dispose of collateral up to amt of overdue installments. 9610(a).
o Excess amts must be returned to debtor. 9-615(a)
(2), (d)(1).
o Insecurity clauses if SA gives creditor right to accelerate at will or
when it deems itself insecure, creditor is only allowed to do so if the
creditor believes in good faith that prospect of payment or performance
is impaired. 1-309.
Good faith honesty in fact and observance of reasonable
commercial stds of fair dealing. 1-201(b)(20).
Burden of proving lack of good faith is on debtor.
o Waiver & Estoppel (p260)
If SP hasnt insisted on debtors compliance w/ deal terms, SPs
behavior can be interpreted in two ways.
1) Debtors behavior could be part of a course of dealing,
understood as an element of parties agreement. 1-303(a),
(d).
2) SPs conduct could constitute a waiver of debtors
default.
o Moe v John Deere Co. (p260) Ct holds that John
Deeres repeated willingness to accept late
payments constituted a waiver which could only
have been cured by sending a letter insisting on
strict compliance w/ terms in future.
Ct held that even though non-waiver
clause was in K
Enforcement (p266)
o SPs can sue debtors in court, obtain a judgment and therefore attack all of
the debtors property, not just the collateral.
o Repossession: Extra-Judicial actions
Sale or other disposition of collateral. 9-610.
Repossession: SP has right to repossess collateral upon
debtors default w/o judicial assistance. 9-609.
o But, SP can only do so if done w/o breach of the
peace. 9-609(b)(2).
What constitutes breach of peace?
Traditionally, risk of violence is key
factor, but sometimes even that interpreted
favorably to SP. See Williams v Ford Motor
Credit Co. (p272)
o If breach of peaces does happen, SP is liable to
debtor for any loss suffered as a result. 9-625(b).

Commercially reasonable sale at either public or private

sale, 9-610, and apply proceeds to satisfaction of debt w/
surplus going to debtor.

Collection of rights to payment.

proceed in commercially reasonable manner under 9-607 to
collect amt owed by notifying account debtor to make
payment to SP.
If debtor consents in manner prescribed under 9-620, SP can accept
collateral as partial or full consideration of amt owed to SP.
o Repossession: Judicial Action
SP can respossess by judicial action. 9-609(b)(1).
SP can also reduce its claim to judgment, levy on the collateral,
and execute on its judgment by a judicial sale pursuant to 9-601(a).
Sale conducted by judicial officials in accordance w/ state
law.
Reqts of a commercially reasonable disposition dont
apply, and whether a SP may bid is governed by state law.
9-601, Comment 8.
Judicial sales may be costly, and no guarantee that those
costs can be recovered.
Also, if property damaged while being seized by marshalls,
SP is immunized from those damage claims. 9-604(d).
o Disposition of Collateral (p280)
Art 9, Part 6 allows sale of collateral at private sales (held to ex
post commercial reasonableness std) in effort to avoid limiting
sales to colluding bidders on courthouse steps. 9-610(b), 9-609(b),
9-627(b).
Notification before Disposition
If SP decides to foreclose by extra-judicial sale, SP shall
send... a reasonable authenticated notification of
disposition to debtor, any secondary obligor (e.g.
guarantor). 9-611(b), (c).
o Though notice must be sent, no proof of receipt
necessary
o oral notice does not suffice (see authenticated)
9-613 prescribes contents of notification in non-consumer
cases. 9-614 for consumer cases.
o date and time and place of sale must be listed.
o method of disposition (public, private)
if public, SP may bid. 9-610(c).
Public described in 9-610, Comment 7.
If private, SP may only bid if collateral is
customarily sold on recognized mkt. 9-

610(c). Stocks on NYSE okay, cars per

Blue Book not. 9-610, Comment 9.
o 9-613 gives commercial creditors more leeway if
they omit any info listed in 9-613(1). In addition,
minor errors ok. 9-613(3)(B).
Commercial SPs are given safe harbor if they send notice
at least 10 days before earliest disposition. 9-612(b).
Doesnt apply to consumer cases.
Notification of disposition can be waived by agreement
authenticated after default. 9-624.
Equitable Doctrine of Marshalling, 1-103(b). (p287)
If two creditors have security interest in one piece of
collateral, and one creditor also has security interest in
another piece of collateral, court can req creditor w/ two
security interests to proceed against piece of collateral with
only one security interest first. See Meyer v. US. Only
allowed when one SP wouldnt be inconvenienced or
harmed by this reqt.
Commercially Reasonable Disposition (p288)
SP may sell, lease, license, or otherwise dispose of
collateral in present condition or following any
commercially reasonable prep or processing. 9-610(a).
o But, collateral must be prepped if selling in present
condition would be commercially unreasonable. 9610, Comment 4.
Every aspect of disposition must be commercially
reasonable. Public or private proceedings, more than 1 K,
as a unit or in parcels all okay if commercially
reasonable. 9-610(b).
o But, public sales not always commercially
reasonable. See Farmers Bank v Hubbard (p299),
9-610(b).
Commercially reasonable def in 9-627. Safe harbor, 9627(b)(3), if disposition is made in conformity w/
reasonable commercial practices among dealers in the type
of property subject to disposition.
o Correct procedure in sale more important that final
price achieved. If price low, still ok so long as
commercially reasonable procedures were followed.
9-627(a).
o General Electric Capital Corp. v Stelmach
Construction Co. (p289) excellent example of
many steps savvy creditor took to protect itself
against later claims of commercial
unreasonableness. Advertised sale, listed each item

of collateral individually, contacted potential buyers

directly, allowed pre-auction inspection, etc.
Some duties/rights not waivable. 9-602.
o But, parties can agree on stds to measure
compliance w/ those rights/duties. 9-603. If SA sets
out stds/def of commercial reasonableness, then
compliance w/ SA is strong evidence of commercial
reasonableness. See Ford Motor Credit Co. v.
Solway (p302).
o Liability for Deficiency (p296)
If SP doesnt recover full amt owed after sale of collateral, SP may
elect to sue for deficiency judgment, though doing so might be
expensive and debtors assets might already be encumbered.
Obligor is liable for any deficiency, and debtor is entitled to any
surplus. 9-615(d).
But, if underlying transaction is sale of accounts, chattel
paper, promissory notes, etc., debtor is not entitled to
surplus and obligor is not liable for any deficiency. 9615(e).
If SP doesnt comply w/ disposition reqts, what is debtors
remedy?
Rebuttable presumption rule says baseline assumption is
the correct procedures wouldve resulted in sale equal to
debt, and SP has burden (and ability) to prove otherwise. 9623(a)(3), (4), Comment 3.
Consumer Transactions Cts free to adopt their own rules re: SPs
non-compliance w/ disposition remedies in cases where debtor is
consumer. 9-626(a).
o Acceptance of Collateral in Satisfaction of Debt (p305)
SP must get debtors authenticated consent. 9-620(a)(1), (c).
but, if SP sends an unconditional proposal accepting
collateral in full satisfaction of debt, and SP does not
receive notification of objection authenticated by debtor w/i
20 days after proposal is sent, consent is presumed. 9620(c)(2)(A-C).
o Good faith still reqd; if SP tries to obtain consent
via silence by accepting collateral worth $1mil in
exchange for $100K debt, Ct will probably
intervene. 9-620, Comment 11; Gilmore, p306.
Acceptance of collateral in partial satisfaction of debt must be
expressly agreed to by debtor. Silence not acceptable. 9-620(c)
(1).
Acceptance of collateral in partial satisfaction of consumer debt
not allowed. 9-620(g).

Acceptance of chattel paper, accounts, etc., for full satisfaction

considered a sale of such instruments to SP where formalities
reqd by 9-309 are considered automatically fulfilled. 9-620,
Comment 10.
9-628 immunizes SP from liability to unknown persons. See also
9-605.
Constructive possession - whereby SP holds onto collateral for
several months - does not suffice to remove need for explicit
acceptance by both SP and debtor. 9-620(b).
o Effect of Disposition or Acceptance on 3rd Parties (p309)
If 3rd party (good-faith transferee) takes collateral after auction,
transferee takes all debtors rights in property, and free and clear of
any debtors claims. 9-617(a), (b).
Junior Security Interests/Liens
Buyers at foreclosure auctions also buy free and clear of
any security interests or liens junior to that being
foreclosed. 9-617(a)(3).
Any junior creditor w/ fin stmt on file covering collateral
seized, or who has notified SP1 before sale of a claim on
that collateral must be notified by SP1. 9-611(c)(3). SP1
given notification safe harbor if 9-611(e)s notice
provisions complied with.
Surplus only reqd to be shared w/ junior secured party if
junior SP sends authenticated demand for proceeds to
ranking SP. 9-615(a)(3)(A).
Junior creditors entitled to recover from SP1 for their errors
in accordance w/ 9-625(b), (c).
Senior SPs acceptance of collateral wipes out all rights of
junior lienors and other subordinate interests. 9-622(a).
o Junior parties can object to proposal to accept w/i
timelines laid out in 9-620(d). Senior SPs must
send notification of proposal to junior parties. 9621(a).
o Collection of Rights to Payment (p311)
If collateral is chattel paper, accounts, etc., security agreement and
Art 9 both will allow SP to collect from account obligor directly.
9-607(a)(1).
If collateral is chattel paper, accounts, etc., no reqt that SP notify
debtor before SP collects directly from account obligors. If SP
doesnt want to collect directly, SP may sell accounts. 9-610.
Again, debtor is not entitled to surplus and SP is not entitled to
deficiency when accounts, chattel paper, etc., are sold. 9-608(b).
When are accounts, chattel paper, etc., sold outright
compared to sale of accounts that secure an obligation? 9109, Comment 4 leaves test to Cts.

o See Majors Furniture Mart v Castle Credit Corp.

(p313), holding that despite Sec Agmts explicit
reference to sales of accounts, nature of
transaction and nature of recourse was more akin to
financing transaction vs. outright sale.
Big point of analysis was risk allocation.
B/c Majors retained almost all risk,
transaction was seen more as fin than sale.
In addition, SPs returns on accounts, fixed
or related to assets performance, can be
determinative.
o Question is important b/c if debtor sold accounts
outright to SP, then debtor is not due any surplus
collected from account debtors. Conversely, if SP
retained a security interest in accounts in exchange
for giving loan/money, then relationship is more a
secured loan, and debtor is due any surplus
collected from accounts by SP.

Leases & Consignments Chap 5 (p323)

Leases
o Difference between leases and purchase money secured transactions are
tough to discern. But, Art 9 does not cover leases. See Art 2A instead.
Difference: in a lease situation, the lessor has a residual interest in
property and is entitled to get property back when term of lease is
over. In secured transaction, when debtor pays its debt, security
interest ends and former debtor owns property outright.
Even though lessee can appear to own property, no need to
notify 3rd parties (filing), and creditors are prior to lessors
interest in property. See 2A-307(1); 2A-301, Comment 2.
o Why do people lease v. retain security interest? Tax and accounting
treatments vary significantly.
o Lease w/ Option to Purchase or Renew (p325)
Key factors to differentiate between lease/security interest: 1-203.
If lessee cannot terminate lease, and 1 of 4 factors in 1203(b) is present = automatically becomes security interest.
Otherwise, consider facts of the case.
In re: Zaleha (p325) for thorough discussion of pertinent
factors.
o In deciding whether option to purchase is for
nominal amount, important to consider that fact
when the contract was signed, not at the time the
option can be exercised. In re: Zaleha (p329)
o Open-End Lease (p344)

Open-end leases: relationship between lessor/lessee does not end,

instead includes sale of [vehicle] and adjustment between two
parties based on sales price.
Key point in equip and consumer leasing business is terminal rent
adjustment clauses (TRAC)
In re Tulsa Port Warehouse Co. (p344)
Lessor regains possession of car at end of lease, sells it at
wholesale auction, and lessee is entitled to
surplus/responsible for deficit depending on price obtained
at auction.
o B/c lessee seems to be bearing both upside &
downside risks of equity, Ct leans towards security
interest
Addtl factors: lessee was reqd to obtain ins, pay sales tax,
licenses, registration, etc., pay for maintenance & repairs
Ct concludes arrangement in sale w/ GMAC retaining
security interest, not a lease. Therefore GMAC becomes
unsecured creditor in bankruptcy b/c no fin stmt was filed.
Cts still divided on question of whether open-end lease is really
just a security interest since lessees bear the upside/downside risk.
Consignments (p349)
o Consignments where a wholesaler/mfg retains all title and interest in
goods, but gives store possession of them to sell. When/if sold, title
passes from wholesaler/mfg to buyer directly. If not sold, goods returned
to wholesaler/mfg. Allowed/incentivized stores to stock new and/or risky
merchandise w/o having to outlay any of their own precious capital.
o Art 9 covers consignments meeting def in 9-102(a)(20). Must meet all
conditions of following test:
person/dealer delivers goods to merchant for purpose of sale, and
for purpose of sale does not exclude goods that need to
be processed, milled, etc., further or incorporated w/ other
materials in order to constitute final product. 9-102,
Comment 14. But if processor is simply processing goods
and delivering them to someone pre-selected by owner,
then not consignment. Id.
merchant deals in goods of that kind under a name other than that
of person/dealer,
in goods of that kind so long as components are regular
parts of consignees business, no problem. For ex., seller of
window frames held to be dealer of wood preservative
since it was regular component. In re Georgetown Steel
Co. (p357).
is not an auctioneer, and
is not generally known by its creditors to be substantially engaged
in selling the goods of others.

o
o
o

aggregate value of goods must be > $1000 at time of delivery

goods are not consumer goods immediately before delivery, and
transaction does not create security interest that secures obligation.
If transaction falls w/i 9-102(a)(20) def, its covered by Art 9. 9-109(a)(4).
If transaction does create a security interest, then its merely inventory
financing. 9-109, Comment 6.
Traditionally, if consignee (store) had to pay dealer/mfg regardless of
whether item was sold or not, then arrangement was considered to have
created security interest, thus violating 102(a)(20)(D)s condition
making it just plain old inventory fin and not a consignment
TAKE-AWAY: File fin stmt even if its consignment.
Other pertinent diff:
Consignment that meets def of 9-102(a)(20) isnt restricted
to recovery rules of Part 6. Consignments that create
security interest that secures obligation, 9-102(a)(2)(D),
are.

Security Interests in Bankruptcy Chap 9 (p461)

INTRO/BACKGROUND
o Chapter 7 bankruptcy most simple method, referred to as liquidation.
o Chap 13 bankruptcy reorganization
avail to individuals who owe:
less than $300K + in unsecured debt and less than $900K
+ in secured debt. BC 109(e).
debtor can be discharged from bankruptcy w/o losing nonexempt
property
debtor reqd to create plan where debtor pays, in whole or part,
some or all debt over a period of time (most often 5 yrs).
creditors paid from earnings, although some assets may be
liquidated.
Plan doesnt need to be approved by creditors, only bankruptcy
court. If approved, creditors are bound. BC 1327(a).
creditor can object, however.
if plan doesnt provide for full payment of debts, all
projected disposable income must be accounted for. BC
1325(b)(1).
o Chap 11 bankruptcy mostly business reorg (though can be used by
individuals)
debtor normally allowed to retain assets & continue to operate
business
normally debtor discharged only after plan approved the various
classes of creditors and stockholders
acceptance by class accomplished by vote of members in
class in specified majorities.

sometimes plan can be approved w/o every classes approval

plan normally provides that creditors be paid (maybe not
full amt) from debtors assets and post-discharge earnings.
if plan is accepted, pre-bankruptcy debts discharged
o Petition in Bankruptcy & the Automatic Stay (p464)
voluntary bankruptcy started w/ debtor filing a petition in
bankruptcy court. BC 301.
This filing acts as automatic stay against most acts against debtors
property. BC 362(a). Filing stays:
start or continuation of judicial proceedings against debtor
to recover pre-bankruptcy claims
enforcement of pre-bankruptcy judgment
any act to obtain possession of property
any act to create, perfect or enforce any lien against
property of estate
But creditor can get some relief under BC 362(d) in some
cases.
o Trustee in Bankruptcy (p465)
Chap 7 bankrutpcy estate administered by trustee (either an
individual or corp). BC 321
Duties of trustee listed in BC 704.
principal duties include: collecting property of estate,
reducing it to money (i.e. selling it), and applying proceeds
to payment of expenses of bankruptcy and claims of
creditors
collecting property can include recovering property
transferred in pre-bankruptcy transaction deals. These
avoidance powers are most important aspects of
bankruptcy.
trustee may also investigate and oppose improper claims
Trustee is fiduciary, but is primarily tasked w/ securing
biggest payout for unsecured creditors
Chap 12 or 13 trustee different from Chap 7
mostly collect earnings from debtor that are source of
payments under re-org plan
Chap 11 normally doesnt involve trustee, instead debtor continues
as debtor in possession. BC 1107(a), 1108.
o Claims in Bankruptcy (p466)
Chap 7 Secured Claims
Proof of claim normally filed by creditor written stmt
setting out creditors claim. BC 501.
Creditor def in BC 101(10).

Claim only paid if allowed, which simply means that its

recog by Ct as valid in amt claimed. BC 502 governs
allowance and disallowance
To the extent a debtor has a secured claim not covered by
value of collateral, part of claim not covered becomes
unsecured. BC 506(a)(1). Value determined by bankruptcy
court.
Chap 7 Unsecured Claims (p466)
After disposing of property in satisfaction of secured
claims, remainder get distrib to unsecured creditors.
o Priority among remaining claims outlined in BC
726.
o First priority is domestic support obligations, BC
101(14A), second is admin expenses, BC 503, and
then come addtl categories in BC 507(a)(3)-(10).
o Finally, distrib to remaining unsecured creditors
according to pro rata share.
BC 507 also applies to Chap 11-13 cases.
Chap 7 Discharge
Individuals normally receive discharge from prebankruptcy debts. BC 727(b).
o Some claims may not be discharged. BC 727(a).
Non-dischargable debts listed in BC 523(a).
SECURED CLAIMS IN BANKRUPTCY (p467)
o Upon debtors bankruptcy filing, secured party becomes holder of
secured claim. BC 506(a)(1).
o Secured claims take off the top (i.e. first). BC 725.
AVOIDANCE POWERS OF TRUSTEE (p492)
o Trustee not only succeeds to the assets of the debtor, BC 541(a)(1), but
also has power to reach back and nullify pre-petition transfers subject to
some infirmity. BC 541(a)(3).
Strong arm clause allows trustee to set aside unperfected security
interests in their entirety. BC 544(a).
BC 546(b) allows perfection after bankruptcy to defeat
rights of trustee when Art 9 gives retroactive effect to
perfection.
o If purchase money security interest attaches before
bankruptcy, and Art 9 allows retroactive fin stmt to
be filed, e.g. 9-317(e), then creditor also protected.
(??? Really??? See problems, p493)
Where creditor files fin stmt before bankruptcy, but
security interest doesnt actually attach until after
bankruptcy filing, creditor ok. 9-317(a)(2)(B), BC 544(a).

Preferences: If insolvent debtor pays unsecured creditor in

preference to other creditors w/i 90 days of bankruptcy, payment
may be recovered by trustee. BC 547.
Five elements of a voidable preference BC 547(b). Trustee
may avoid any transfer of an interest of debtor in property
transfers include creation of a lien. BC
101(54). So long as w/i 90 days of
bankruptcy declaration, lien can be nullified
by trustee. If transfer was cash, equiv amt
can be recovered. BC 541(a)(3).
o 1) to or for benefit of a creditor
if guarantor of debt is forced to pay debtors
debt, creditor receiving guarantors payment
cannot be attacked since debtors property
was not involved (estate isnt any smaller as
a result of guarantors payment).
if debtor pays creditor on debt guaranteed by
Guarantor, then trustee can attack either
creditor or guarantor if w/i 90 day window.
(p500).
o 2) for or on acct of antecedent debt owed by debtor
before such transfer was made. But BC 547(c) lists
exceptions:
if bank advances funds to debtor and w/i
short period debtor grants security interest to
bank to secure debt, then transfer is
substantially contemporaneous w/
advance, and immune from attack. BC
547(c)(1).
except if creditors intent to obtain
security interest is not
contemporaneous (i.e. it only arises
later). See Natl City Bank v
Hotchkiss (p502)
Money advanced by creditor to purchase
new property exempt from avoidance. BC
547(c)(3). Creditor allowed 30 days to
perfect; transfer then took place when
property transferred, not perfection. BC
547(e)(2).
payments in ordinary course of business
or according to ordinary business terms,
BC 547(c)(2), are exempt from avoidance.
if payment method changes, may no
longer be in ordinary course

late payments not ordinary, unless

late payments were normally
accepted in prior history.
floating liens: transfers involving account
receivables, inventory, or proceeds of
either, not avoidable. BC 547(c)(5). If this
provision didnt exist, some question as to
when perfection happened w/ these goods
would arise.
creditor (s/p) is in as good a position
as hell ever be 90 days before
bankruptcy; s/p can be worse off, but
cant be better off
if commodity prices increase, and
that makes s/p better off, fine, but
even if more oil, gold, etc., is
accumulated as collateral, it cant put
s/p in better position than he was 90
days before filing. (?? Check this
against class notes and answers to
problems on p509).
Delayed perfection (diff from delayed
attachment, see above) okay so long as w/i
30 days. BC 547(e)(2)
o 3) made while debtor was insolvent
presumption is that debtor was insolvent 90
days before filing. BC 547(f).
o 4) made on or w/i 90 days before filing of petition,
or between 90 days and 1yr before filing of petition
if creditor was insider, and
insider def in BC 101(31), but not limited
to those listed (p499).
o 5) that enables such creditor to receive more than
such creditor would receive if: case was under Chap
7, transfer had not been made, and creditor received
payment of debt to the extent provided by Chp 7
law.
KEY POINT: So if creditor has perfected
correctly, transfer is only avoidable if
secured party is under, or not, collateralized.
If SP has security interest in collateral worth
more than payment made, then its not
avoidable b/c under bankruptcy, SP
wouldve had rights to that amt anyway.

If debtors property had two liens on it and otherwise

superior lien is avoidable in bankruptcy, second lienholder
does not benefit. Instead, avoidance always operates to
benefit estate. BC 551.

If insolvent debtor transfers property to another w/o receiving

reasonably equivalent value in exchange w/i 2 years of bankruptcy,
trustee can recover property even if no fraud was involved. BC
548.
Subrogation of Trustee - BC 544(b).
If trustee can find one actual unsecured creditor at time of
bankruptcy against whom the debtors transfer is voidable,
the trustee can set aside the entire transfer for the benefit of
the whole estate. BC 541(a)(3), 550(a).
Principle, known as void against one, void against all,
codified in BC 544(a) and BC 550(a).
If one unsecured creditor relied upon lack of fin stmt in
making loan to Debtor, and thereafter secured party files fin
stmt (late), then normally perfected security interest
trumps. But, if debtor has filed for bankruptcy, then b/c
perfected security interest is void against creditor who
relied upon lack of fin stmt, perfected security interest if
void against all unsecured creditors. See problems p.494.

Negotiability and Holders in Due Course Chap 11 (p600)

Two fundamental idea behind negotiable instruments:

o Good faith purchase -- if a stranger purchased the bill for value, in good
faith, and in the ordinary course of business, he held it free both of
underlying K defenses and of outstanding equities of ownership.
o Merger doctrine -- the piece of paper on which the bill was written should
be treated as if it, the paper, was itself the claim or debt which it
evidenced.
Definitions:
o Note, or promissory note promise to pay another person, the payee. 3104(e). A note is a negotiable instrument if it complies w/ reqts of 3104(a), unconditional promise to pay $$ to a bearer or order. TWO
PARTY TRANSACTION.
o Draft an order by a drawer, 3-103(a)(5), to a drawee, 3-103(a)(4), to pay
a payee, 3-104(e). A check is the most common form of a draft. 3-104(f).
Person signing the check is the drawer and bank on which check is drawn
in drawee. THREE PARTY TRANSACTION.
o Holder in most cases, holder is possessor of an instrument that is either
payable to that person or indorsed to that person. But possessor of bearer
instrument is holder. Person must be holder before they can be holder in
due course. 1-201(b)(21).

Merger Doctrine (p604)

o Negotiation
Basic rule on enforcement: Person entitled to enforce (PETE) an
instrument means 1) the holder of the instrument, 2) a nonholder in
possession of the instrument who has rights of a holder, or 3)
person not in possession of the instrument who is entitled to
enforce instrument pursuant to 3-309 (lost instrument) or 3-418(d)
(dishonored instrument). A person may be a PETE even though
the person is not the owner of the instrument or is in wrongful
possession of the instrument.
Note payable to bearer: A note is issued by a maker when it is first
delivered. 3-105(a), 3-103(a)(5).
When person receives delivery from maker, she becomes
bearer of note as well as its holder. 1-201(5), (21). Right
of possessor to receive payment is based on fact that person
is holder, not on her ownership. 3-301.
If original payee loses bearer note, and Finder takes
possession, Finder becomes holder (but not owner) and
thereby has right to enforce bearer note. 3-301. Transfer of
possession alone, voluntary or not, is described as
negotiation of bearer note. 3-201(a).
Note payable to order: note payable, for ex., to order of Rachel.
3-109(b).
Upon delivery, Rachel becomes holder b/c shes in
possession and she is person identified in note as payee. 1201(21).
Negotiation of note payable to order requires not only
possession, but also indorsement by holder. 3-201(b).
Indorsement, described in 3-204(a), can be made for
several purposes:
o negotiation,
o restricting payment of instrument
o incurring indorsers liability on the instrument
o Signature is indorsement unless it is clear by
placement, accompanying words, etc., that signature
is on instrument for alternate purpose. 3-204(a).
o Special indorsement, 3-205(a), makes instrument
payable only to specific person, and normally
consists of Pay to Johnson before holders
signature.
o blank indorsement, 3-205(b) & 3-109(c), transforms
note from payable to order to bearer note.
o Transfer (p605)
Right to enforce instrument normally obtained via negotiation, but
right to enforce can be obtained w/o negotiation sometimes.

If payee of note transfers note to another w/ intent to serve as

payment, a transfer of the note has taken place. 3-203(a).
Reqs delivery, a voluntary transfer of possession, 1-201(b)
(15), and intent to give transferee right to enforce.
With transfer, possessor of note can then become PETE under 3301(ii), b/c possessor gains rights of a holder. 3-203(b)
Plus PETE has specifically enforceable right to have prev
holder indorse the note so that PETE also becomes holder.
3-203(c).
o Discharge (p607)
Tradtl rule held that only payments to holder of the note
discharged the obligation to pay the note
Corrollary was that if discharge was only obtained if correct person
was paid.
MODERN RULE: 3-602.
Payment to person formerly entitled to payment suffices
only if party obliged to pay has not received adequate
notification that note has been transferred and that payment
is to be made to most recent transferee. 3-602(b).
o Adequate notification) signed by transferor or
transferee, 2) reasonably identifies transferred note,
and 3) provides address at which future payments
should be made.
o Upon request, transferee of note shall provide
reasonable proof that note was transferred. Until
that time, person can continue paying old holder of
note.
Holder in Due Course: Freedom from Claims & Defenses (p610)
o A holder in due course (3-302) takes free of some defenses of the obligor
(3-305(b)) as well as claims of ownership (3-306).
o Claims of Ownership (p611)
Holders in due course take free of ownership claims. 3-306. In
comments, claims is construed extremely broadly, basically
immunizing holder-in-due-course from claims by previous or
original owners of instrument.
o Ordinary defenses (p612) per 3-305(b), rights of holders in due course to
enforce instrument limited only by real defenses listed in 3-305(a)(1).
holders in due course cannot be limited by ordinary defenses, 3305(a)(2), or claims in recoupment, 3-305(a)(3).
Ordinary defenses, 3-305(a)(2), listed in first paragraph of
Comment 2.
mostly: fraud, misrepresentation, and mistake in issuance
o Real defenses (p612) See 3-305, Comment 1, most real defenses
involve some kind of public policy concern of state (illegality, infancy,
duress, etc.)

o Claims in Recoupment, 305(a)(3) only available against non-holders in

due course
Formal Reqts of Negotiable Instruments (p613)
o Most important elements of negotiable instrument, 3-104(a), establish a
bright line test, and include:
only an order, a written instruction to pay money signed by the
person giving the instruction, 3-103(a)(6) or promise, a written
undertaking to pay money signed by person undertaking to pay, 3103(a)(9), qualify as negotiable instrument
negotiable instrument is always a signed writing that
promises or orders payment of money
negotiable instruments can be notes or drafts
o draft = order, 3-104(e)
checks are most common forms of draft, 3104(f)
o note = promise, 3-104(e)
CDs are considered notes, 3-104(j).
order or promise must be payable to order or bearer, 3-109
order or promise to pay must be unconditional, def in 3-106
order or promise to pay must be payable on demand or at a definite
time, 3-108.
order or promise to pay must be fixed amt of money, w/ or w/o
interest, 3-112, or other charges, 3-104(a).
Reqts for Holder in Due Course (p622)
o two reqd elements per 3-302
o instrument when issued or negotiated to holder isnt obviously forged or
fake, and
o holder took instrument
1) for value (p661)
only a holder who takes an instrument for value can be
holder in due course. 3-302(a)(2)(i)
value def in 3-303(a).
If only partial, ratable value given, sometimes only partial,
ratable amt is recoverable. 3-302, Comment 6, Case #5.
Banks are a special case. To determine whether they have
given value to a customer who deposited a check w/
them, see 4-210 and 4-211 which complement (and DO
NOT replace) 3-303.
o Whether bank has given value for the check is
determined under 4-211, which state that bank has
given value to the extent it has a security interest in
the check
Bowling Green v. State Street Bank & Trust
(p668) -- security interest is any security

interest, not just those mentioned in 4-210.

So bank w/ floating lien on all depositors
property acquired security interest in
depositors check (and therefore value, and
therefore became holder in due course) as
soon as it took possession of check. See
also 4-205.
o 4-210 states rules for determining when a banks
security interest arises.
if check is deposited and resulting credit is
withdrawn or applied. 4-210(a)(1).
applied = if bank reduces some other
debt or applies it to prev overdraft
if check is deposited and customer is given
right to make withdrawal. 4-210(a)(2).
if bank makes a loan or cash payment based
on check. 4-210(a)(3).
Determine whether bank has given credit
using FIFO rule. 4-210(b).
o This security interest is in addition to banks
common law bankers lien. 4-210, Comment 1.
2) in good faith,
good faith = honesty in fact and observance of reasonable
commercial standards of fair dealing. 1-201(b)(20)
3) w/o notice that instrument is overdue or has been dishonored or
that there is an uncured default w/ respect to payment of another
instrument issued as part of same series,
person has notice if person, 1-202(a):
o has actual knowledge,
o has received a notice or notification of it, or
o from all facts and circumstances known to person at
time in question, has reason to know that it exists.
4) w/o notice that instrument contains unauthorized signature or
has been altered,
5) w/o notice of any claim to instrument per 3-306, and
6) w/o notice that any party has defense or claim in recoupment per
3-305(a).

Liability of Parties to Negotiable Instruments Chap 12 (p675)

Obligations of parties are set out in four sections:

o Makers obligation, 3-412 (applies to notes which are 2-party transactions)
Maker is person primarily obliged to pay promissory note.
maker is person who signs or is identified in a note as
person undertaking to pay. 3-103(a)(5)

issuer of a note... is obliged to pay instrument (i) according

to its terms at time it was issued. 3-412.
issue is the first delivery of an instrument by the maker or
drawer, whether to a holder or non-holder, for purpose of
giving rights on the instrument to any person. 3-105(a)
If multiple parties sign the note, they can be jointly and
severally liable. 3-116(a). If one person pays the entire
note, that person can go after other signatory-issuers. 3116(b).
o Acceptors obligation, 3-413 (applies to drafts, i.e., 3-party transactions)
Drawee is not liable on instrument until drawee accepts it. 3-408.
Acceptance is the drawees signed agreement, on the draft, to pay a
draft as presented. 3-409(a).
A drawee that accepts a draft becomes known as an acceptor, and
is obliged to holder to pay the draft. 3-413.
Gen rule: drafts that doesnt specify time of payment are payable
on demand. 3-108(a). Most common example of demand draft is
check.
Time draft doesnt contemplate immediate payment but
instead says something like Pay to the order of Jane sixty
days after presentment. If time draft is accepted by
drawee, drawee becomes liable to pay, but only after stated
time period has passed. Normally, date of acceptance of
time draft is included along w/ signature of drawee
indicating acceptance, 3-409(a), (c), but not reqd.
Another example of accepted draft is certified check. Basically,
drawer obtains drawees assurance of payment before delivering to
payee. Banks signature is called certification, but is identical to
acceptance. 3-409(d).
Payee can also obtain banks (drawee) consent to pay
check, but not immediately, by asking that check be
certified. Bank can do this as courtesy, but is not reqd to
do so. 3-409(d). And refusal to certify is not dishonor. Id.
Once check has been accepted, drawers obligation to pay is
discharged. 3-414(c). Obligation to pay rests solely on acceptor.
o Drawers obligation, 3-414, (applies to drafts, i.e., 3-party transactions)
Drawer is obligated to pay draft until it is accepted by drawee, 3414(a), even if draft was never issued.
Drawers obligation ends upon drawees acceptance, 3-414(c),
regardless of when or by whom acceptance is obtained.
Presentment is when PETE demands payment, or acceptance, from
drawee. 3-501.
3-501(b) governs place, time and manner of presentment.

Drawee does not have obligation on draft to payee, so payee

cannot force payment and payee has no cause of action against
drawee. 3-408.
Drawer might have action against drawee for wrongful
dishonor, see 4-402, but holder of draft has no cause of
action against drawee.
Dishonor has occurred if payee presents check to drawee, but
drawee refuses to pay in timely manner. 3-502.
Dishonor of ordinary checks and drafts is governed by 3502(b), (e).
Drawer of draft other than check can disclaim liability by writing
without recourse after signature. 3-414(e).
o Indorsers obligation, 3-415
Indorser of instrument has obligation to pay instrument if
dishonored. 3-415(a).
Indorser can escape liability by printing without recourse
after signature. 3-415(b).
Indorser who has paid instrument can go after prior
indorsers. 3-145(a).
Conversely, if draft is accepted by bank after indorsement,
indorsers liability is discharged. 3-415(d).
If acceptor is non-bank, or indorsement made after acceptance,
indorser still potentially liable.
Drafts (i.e. checks)
Dishonor of instrument triggers indorsers liability. 3415(a). Dishonor normally requires presentment by payee
and failure to pay by drawee. 3-502(b).
Obligation of indorser to pay unaccepted instrument is
discharged in two situations:
o First, if draft is check and check is not presented w/i
30 days of indorsement, indorser is discharged. 3415(e).
o Second, discharge can occur as result of failure to
give timely notice of dishonor to indorser. 3-415(c),
3-503(a).
Timely notice of dishonor normally 30 days
for non-banks. 3-503(c).
Delay excused in some cases. 3-504(c).
Normally w/ checks, liability of indorser is of limited importance
since depository bank can just revoke provisional credit or
otherwise get refund from depositor. 4-214(a).
o Accomodation partys obligation (i.e. Guarantor)
3-419 accommodation party (i.e. guarantor) can sue the real
maker for the whole amount

if you want to make sure youre an accommodation party,

make sure to write that under your signature. Otherwise,
you might be deemed a co-maker, and you can only recover
a pro-rata share of what youve paid.
If accomodation party is an individual, accomodator (i.e.
guarantor) succeeds to all rights that payee had against maker of
note, if maker has forced accomodator to pay. 3-419(f).
Once maker of note has paid it, maker cannot demand
contribution by accomodator if accomodator did not
benefit. 3-419(f).
If accomodation party is an organization, accomodator has same
rights even if accomodator is related party (i.e. sole stockholder, or
corps president).
person asserting accomodator status has burden of proof
and whether person is accomodator is question of fact. 3419, Comment 3.
Liability of Transferor (p681)
o Just like a law finds that a seller of goods has provided certain implied
warranties, a seller of an instrument provides warranties outlined in 3416. Warranties regarding authenticity of instrument (a)(2),(3) and
instruments enforceability (a)(1),(4),(5):
all signatures are authentic and authorized. 3-146(a)(2)
instrument has not been altered. 3-416(a)(3).
transferor is PETE, 3-416(a)(1)
right to enforce is not subject to defenses that can be asserted
against transferor, 3-416(a)(4)
no knowledge of payors bankruptcy or insolvency proceedings, 3416(a)(5).
o Most of time, warranties are of limited use since transferor is often
indorser (and therefore personally liable). If indorsement made w/o
recourse, however, transferor warranties can be important. Transfer
warranties, however, can also be disclaimed by without warranties
legend. 3-416, Comment 5.
Cashiers and Tellers Checks (p682)
o Cashiers check always issued by a bank and in form of ordinary check
except that drawer and drawee are same bank (i.e. Bank A orders itself to
pay $xx.)
in this case liability of drawer is same as liability of maker, 3-412.
o Tellers check difference is that tellers check is typically drawn on
another bank (i.e. a small bank maintains acct at large, national bank.)
Issuer is obliged to pay check as drawer of check, 3-414(b).
Drawee bank still has no obligation to payee. 3-408.
o If uncertified check is taken for underlying obligation, obligation is
suspended until dishonor of check or check is paid or certified. 3-310(b)
(1).

o If certified check is taken, action can only be taken against bank, 3-310(a),
and if bank has failed, holder is insured by FDIC to $100K.
o Certification of check is considered same as payment, so no stopping
payment on certified checks. 4-303(a)(1).
Same result for tellers checks, but analysis a little diff under 4-403
and Comment 4.
Cashiers check is different still b/c no instruction by another
person can be made since bank is issuer/maker and drawee.
Wrongful refusal or delay by bank in paying either tellers or
cashiers check puts them in very bad position. 3-411.
But obligated bank can succeed in some limited situations.
3-411(c).
o Lost cashiers, tellers or certified checks under 3-312.
See 3-312 and especially Comment 4.

Payment Systems: Checks and Credit Cards - Chap 13 (p718)

Definitions:
o depository bank first bank to take an item, even if its also payor bank,
unless item is presented for immediate payment over the counter. 4105(2)
o payor bank bank that is drawee of draft. 4-105(3).
only payor bank can pay the check. Every other bank is buying
the check, but not paying it.
even for payor bank there is difference between settling check and
paying check.
BUT, under 4-107, each branch of a bank, or even separate office
of a bank, can (not must) be treated as a different bank for
purposes of computing midnight deadline.
o intermediary bank bank to which item is tranferred in course of
collection, except depository or payor bank. 4-105(4).
o collecting bank bank handling an item for collection, except payor bank
4-105(5)
o presenting bank bank presenting an item, except payor bank. 4-105(6)
o only payor
Check Collection
o Collection process consists of moving check from depository bank to its
presentation to payor bank.
o Returning process operates in reverse going from payor bank to
depository bank.
o Midnight Rule: To avoid liability for check, payor bank must return
dishonored check to depository bank by midnight deadline which is
midnight of next day after check is received. 4-104(a)(10).
o When has bank on which check is drawn (i.e. the payor bank) paid the
check under Art 4?

if payee takes check to drawee bank and asks for cash over the
counter, drawee can pay full amt in cash, and check is paid. 4215(a)(1).
If depository bank = payor bank.
If payees depository bank is same as drafts issuer bank,
when depository bank credits payees account, it is
normally a provisional settlement. 4-104(a)(11), 4-213(a)
(2)(iii).
bank has time-limited right to revoke payees credit. 4301(a).
bank can revoke credit by returning check to payee and to
debit payees account (revoke provisional settlement) in
amt of check.
If bank fails to do this, it has paid the check, b/c right to
revoke settlement no longer exists. 4-215(a)(3), 4-301(a).
payee has right to withdraw money/provisional credit at
opening of banks second banking day following receipt of
item. 4-215(e)(2).
If depository bank is not same as payor bank.
depository bank = collecting bank. 4-105(5).
if depository bank doesnt go directly to payor bank, it will
negotiate check to intermediary bank, which in turn is
collecting bank. 4-105(4).
Payor bank may refuse payment of check by returning it to
presenting bank, and revoking provisional settlement (i.e.
credit) to presenting bank. 4-301(a).
In turn, presenting bank and each collecting bank returns
the check to bank from which it received check, and
recovers provisional payment. 4-214(a). Same authority
allows depository bank to collect provisional credit from
payee/holder.
If payor bank misses midnight deadline, 4-104(a)(10), by
not returning, settling, or paying check, or sending notice of
dishonor, payor bank becomes liable for it. 4-302(a). By
missing the midnight deadline, payor bank has made final
payment on check. 4-215(a)(3).
o Delay by collecting or payor bank is excused if
caused by interruption of communication facilities,
suspension of payment by another bank, war,
emergency conditions, etc. 4-109(b).
Blake v Woodford Bank & Trust (p722) lays
out exacting standard when examining
banks excuses for missing deadline.
o In addition, liability of payor bank is subject to
defenses based on breach of presentment warranty,

4-208, or proof that person seeking enforcement of

liability intended to defraud payor bank. 4-302(b).
o Branches of banks can be considered separate banks
for purposes of midnight deadline. 4-107.
Payee who has deposited money in depository bank has
right to withdraw money originally provisionally credited
when settlement has become final and depository bank has
had reasonable amt of time to receive returned check, but
has not. 4-215(e)(1).
o Right of Collecting Bank to Revoke Settlement on Dishonored Check
(p749)
Depository bank is reqd to either send customer the returned
check or give notice of checks dishonor to customer by its
midnight deadline. 4-214(a).
Even if bank misses deadline, it can still revoke settlement,
but depository bank becomes liable to customer for any
loss resulting from delay. 4-214(a).
At moment of final payment, all previously provisional
settlements that occurred along the way become instantaneously
finalized. The payor bank becomes liable for amt of check, 4302(a), and collecting/depository banks lose ability to revoke
provisional settlement, 4-215(d), 4-214(a).
o Check Encoding (p752)
Bank who electronically encodes check erroneously is liable for
mistake, 4-209, in the amt of loss suffered as breach of this
warranty, plus expenses and loss of interest incurred as a result of
breach.

Fraud, Forgery & Alteration - Chap 15 (p855)

A person is not liable on their check unless they signed it. 3-401(a). So if a Thief
steals As check and forges As signature, A is not liable. Instead, Art 3 treats the
check as Thiefs. 3-403(a) (an unauthorized signature is ineffective except as the
signature of the unauthorized signer...)
o Checks like this are referred to as forged checks.
o Rights of a holder can be acquired by someone who acquires a forged
check.
o If Payor Bank pays on forged check, Customer/drafter cannot be held
liable since check is not properly payable since it was not authorized by
the customer. 4-401(a). Payor Bank bears risk of loss.
A different situation involves a valid check made out to Payee, but subsequently
stolen by Thief who forges Payees indorsement and obtains payment for check
from Payor Bank.
o This check bears a forged indorsement, but is not a forged check since
drawers signature is legitimate.

o Since Thiefs signature as Payees indorsement is ineffective, 3-403(a) and

3-401, Thief cannot negotiate the check, and no subsequent party can
obtain rights of holder unless some other provision of Art 3 applies.
Remember, negotiation of draft requires both possession and
indorsement by holder. 3-201(b).
o General Rule: Terms of check req Payor Bank to pay Payee, but since
Payee did not get paid, Payor Bank did not comply with the order of the
check. Therefore it has no right of reimbursement from Customer/drawer.
BUT, two provisions, 3-406(a) and 4-406, allow Payor Bank to
shift loss to Customer/drawer.
3-406 -- A person who fails to exercise ordinary care that
substantially contributes to an alteration of an instrument or
making of a forged signature on an instrument is precluded from
asserting [liability] against a person who, in good faith, pays the
instrument or takes for value or collection. 3-406(a).
If both parties failed to excerise ordinary care, the loss can
be apportioned between them. 3-406(b).
The burden of proving failure to exercise ordinary car is on
the party claiming it (i.e. the asserting party). 3-406(c).ef
Ordinary care defined in 3-103(a)(9).
Substantially contributes discussed in Thompson Maple
Products v Citizens National Bank (p856) and in 3-406,
Comments 2 and 3.
If drawer of fraudulent checks is time-barred from pursuing
claim against depository bank, 4-406, then 3-406 does not
create an affirmative cause of action against depository
bank. Halifax Corp. v. Wachovia Bank (p862).
4-406 If a bank sends an account stmt or cancelled checks to
drawer/customer, the drawer/customer must exercise reasonable
promptness in discovering unauthorized payments and reporting
those unauthorized payments to bank. 4-406(c). 4-406 only
applies to forged checks, not forged indorsements, whereas 3-406
applies to both.
If drawer/customer fails to discover or report fraud, then
customer is precluded against asserting any defrauders
conduct against bank that occurred more than 30 days after
which drawer/customer should have discovered the fraud.
4-406(d).
o But, if bank also failed to exercise ordinary care,
then the loss can be allocated. 4-406(e).
sight review of checks not reqd for banks to
exercise ordinary care. 4-406, Comment 4.
Ordinary care can be defined w/ reference to
size of bank, and type of check processor it
is. Even though many other banks might

have more stringent procedures in place,

bank can benefit if similarly situated banks
have similarly lackadaiscal procedures in
place. Espresso Roma Corp v. Bank of
America (p872)
Cts divided as to whether 1 yr absolute bar
applies if Bank acted in bad faith. (p875)
o But, if fraud goes more than 1 year undiscovered,
then bank cannot be held responsible for any
fraudulent checks paid more than 1 yr before fraud
was finally detected. 4-406(f).
Summary of 4-406 customer has duty to examine stmts w/i
reasonable amt of time (30 days) to discover fraud. If more than
30 days elapses, customer can only recover if bank also failed to
exercise ordinary care. If more than 1 year elapses, customer cant
recover payments made more than 1 year before fraud was finally
detected by customer.
Right of Payor Bank to Recover Mistaken Payment of Check (p883)
o Principle categories of mistake are:
forged checks
checks bearing forged indorsements
altered checks
checks on which drawer has stopped payment
checks drawn on account w/ insufficient funds
o Forged Checks Gen Rule: drawee can recover amt of draft from person to
whom or for whose benefit payment was made, or in the case of
acceptance, may revoke acceptance. 3-418(a). But, drawee cannot get
back mistaken payment from person who took instrument in good faith
and for value, or who in good faith changed position in reliance on
payment or acceptance. 3-418(c). In essence, 3-418(c) eviscerates the rule
stated in 3-418(a), so most times payor bank cannot recover money
mistakenly paid for forged check.
Might still be able to recover under 3-416(a)(2).
o Forged Indorsements
Under 417(a)(1), 4-208(a)(1), the policy of finality adopted in
forged check cases is not adopted in cases of forged indorsements.
Instead, person who accepted forged indorsement, and anyone who
transferred check after the forgery, can be held ultimately liable.
o Remotely Created Checks
Most often obtained by telemarketers who ask for and receive a the
routing and bank account number off of a persons check. They
then create a check remotely and deposit it at their bank.
Remotely created consumer item is a check that does not bear a
handwritten signature purporting to be the signature of the drawer.
3-103(a)(16).

Telemarketer warrants to depository bank that check is authorized

by person on whom check is drawn. 3-416(a)(6).
Telemarketer and depository bank warrant same to payor bank. 3417(a)(4).
o Overdrafts (p887)
A check drawn on an account w/ insufficient funds is properly
payable and the drawers account can be charged. 4-401(a).
3-418(b) gives the payor bank a limited right of restitution
from the person receiving payment, but 3-418(c)
immunizes holders who took the draft in good faith and for
value, or who in good faith changed position in reliance on
payment or acceptance.
Conversion Actions Re: Checks Bearing Forged Indorsement (p887)
o Action by Payee
An instrument is converted (stolen) if it is taken by transfer, other
than negotiation, from a non-PETE, or a bank makes or obtains
payment for a non-PETE. 3-420(a).
Anyone, including depository bank, that takes a draft after a forged
indorsement is a converter, as is a drawee bank that pays the
instrument.
A payee or other holder from whom instrument was taken can sue
either depository bank, 3-420(c), or drawee bank, even if neither
party was aware of forgery.
In situation where check is stolen from payee by payees employee
there are three theoretical options for payee, w/ last being best:
go after drawer under 3-309, but takes long, might require
payee to post bond, and there might be many drawers.
o 3-310 says drawers obligation suspended once
payee receives payment, but payment not
received since person receiving payment is not
PETE, 3-602(a).
go after payor banks under 3-420(a). but there might be
many payor banks located everywhere. Thief was not a
PETE since no negotiation took place, so no bank after
Thief could be a PETE
go after one depository bank under 3-420(a) -- most
efficient see Liability of Depository Bankk as Agent fro
Collection (p890)
o Delivery of Check to Payee (p890)
Payee does not take possession of draft until payee receives it, so
check stolen before it is delivered to payee leaves payee w/ no
actions in conversion b/c 3-420 implies that check must be taken
from payee. 3-420, Comment 1. Art 3 does not define delivery.
State courts have to wrestle w/ definition.
o Unauthorized Indorsement (p891)

Check payable to 2 persons may be indorsed by either, unless it is

made payable to them not alternatively. 3-110(d), 3-403(b).
If check is ambiguous, default assumption is either. 3-110(d).
o Forgery by Entrusted Employee of Payee (p892) burden shifted to
employer
If an employer entrusted an employee w/ responsibility w/ respect
to instrument and the employee or a person acting in concert w/
employee makes a fraudulent indorsement of the instrument, the
indorsement is effective as the indorsement of the person to whom
the instrument is payable if it is made in the name of that person.
3-405(b). See Comment 3 for case examples.
Fictitious Payees (p904) again, burden is shifted to employer
o A person who makes out a check to a fictitious payee, or who makes out a
check to a real, existent payee but w/ no intent to actually deliver it to
payee, then in both cases the person in possession of the check (most often
a trusted employee) is deemed a holder, 3-404(b)(i), and an indorsement
in name of the payee is effective as the actual indorsement, 3-404(b)(ii), so
that the depository bank that takes the check is taking it from a PETE, so
long as the depository bank takes the instrument in good faith and for
value, 3-404(b)(ii).
But the depository bank can be held partially liable if they failed to
exercise ordinary care. 3-404(d).
o By making indorsement valid, the check becomes properly payable under
4-401.
o Most of the time, this provision leaves the drawer (most often employer)
bearing the loss.
Payroll Padding (p909)
o If signature of the issuer of an instrument is made by automated means,
the payee of the instrument is determined by the intent of the person who
supplied the name of the payee, whether it was authorized or not. 3110(b).
3-110(a), (b) operate in conjunction w/ 3-404(b) making the person
fraudulently writing the checks the rightful holder, thereby forcing
the Corp to bear the loss.
If more than two people sign the checks, and the signers intend to
pay someone different, either intended payee suffices. 3-110(a).
But if person (e.g. Treasurer) signing the checks doesnt participate
in the fraud, which is instead perpetrated by another worker
(Payroll Clerk), the Payroll Clerks fraudulent indorsement of the
checks leaves loss w/ Depository Bank since 3-110(a) applies to
signers intent and Payroll Clerk didnt sign. If automated system,
and Payroll Clerk inputs the data and no further signing is needed,
the Payroll Clerk becomes signer, and opposite result reached (loss
stays w/ Corp).

But 3-405(a)(2)(ii) might apply in this case, returning loss

to Corp.
Allocation of Loss By Contract (p910)
o To certain extent, Banks can contract around their liability for fake
signatures and the like. 4-103(a). But they cant contract out of liability
for their lack of ordinary care or good faith. 4-103(a). See Jefferson
Parish School Board v First Commerce Corp. (p910) (where Bank agrees
to honor all checks issued by school board, and contracts to only check
that signature resembles that on file.)