Sunteți pe pagina 1din 105

Secured Transactions Outline- Kauffman 2003

Part One Debtor Creditor Relationship Chapter 1- Creditors Remedies Under State Law Assignment 1: Remedies of Unsecured Creditors Under State Law (p3) 1) Who Is an Unsecured Creditor? (p3) a) Unless a creditor contracts with the debtor for secured creditor status, or is granted it by statute, the creditor is unsecuredgeneral creditors, ordinary creditors. 2) How Do Unsecured Creditors Compel Payment? (p4) a) No self-help methods (tort of conversion, perhaps even larceny, or wrongful collection practices). b) Process: judgment writ of execution levy under writ of execution by sheriff (creditor must designate property for sheriff to execute against), pay expenses of collection. Or writ of garnishment on a third party. i) Vitale v. Hotel California, Inc (p5) (1) Creditor worked for bar and obtained judgment and writ of execution. Sheriff was hesitant to go, but went and made one levy obtaining little to offset judgment. Sheriff should have made successive levies under the writ but didnt. Amerce the Sheriff! 3) Limitations on Compelling Payment (p13) a) Creditor must discover and locate assets. Judgment creditor can ask discovery questions about debtors assets under threat of contempt/perjurybut remember debtor with $10,000 in cash in pockets. i) Debtor can use (even use up) assets until sheriff arrives, and debtor can prefer one creditor to another and dedicate all assets to one debt. b) Exemption statutes prevent seizing of statutorily protected property. i) Wisconsin Statutes Annotated 815.18 Property Exempt from Execution (p15) (1) (6)(a) no contractual waiver of exemption rights before judgment on claim. 815.20 Homestead Exemption (fairly typicalTexas has an unlimited homestead exemption) 4) Is the Law Serious About Collecting Unsecured Debts (p17) a) Enforcement of civil judgments for money damages is often ineffective. Strict enforcement mechanisms for some things (child support, etc.), but not money judgments, wages, or most contract breaches. Class notes: Fair debt collection practices: forbids starting or threatening a law suit w/out planning to go through with it. Threat letter is not worth much unless threatened is gullible. Small claims court handles about 90% debt collection, and mostly by large companies. Problem Set 1. Problem 1.1: Jeff loans neighbor $1000 to buy furniture. Neighbor Lisa signs an IOU. Jeff wants to take furniture. Jeff has to get a judgment. He has to prove that he loaned Lisa $$. He has to get a writ of execution and have Sheriff levy. It is not worth it for Jeff because law firm costs are more than value of furniture. But Jeff has union agreement for consultation. Lawyer can tell Jeff how to handle small claims court (less than small amounts like 2,500). Small claims court is an option in a jurisdiction with a streamlined process. The threat of a treble damage lawsuit is often enough to end matter. If small claims

Secured Transactions Outline- Kauffman 2003

court is not an option, Jeffs options are really poor. To be an unsecured creditor is bad situation if debtor is unable to pay. Lots of people end up being unsecured creditors. If you go into bank to buy car, the bank is going to take security interest in car. But if business asks for 10 million, the bank will give it for unsecured credit (maybe to get business and working relationship). Problem 1.2: This is a story about some unsecured creditor who tricks the debtor into giving unsecured creditor valuable property. The creditor tricks the debtor to giving up lobster (under pretense it was going to Stephen King), but the lobster value is $11,000 short of full debt. Debtor may bring criminal charges against creditor. Creditor was convicted and fined. When creditor comes to you and says he has this lobster and wants to sue for remaining amount, what advice do you give client? You tell him to return the lobster to avoid the fine. The judges remedy was a civil remedy along with a criminal remedy. We want to avoid the criminal charges. How to avoid prosecution? You should bring prosecution for criminal charges first. There is a colorable case of fraud. So when debtor responds and brings criminal charges back at you, the prosecutor would probably not go forward with either charge. For public interests, prosecute both or none. Problem 1.3: This involves a loan in business situation. Benning gives $$ to day care center. Payment has been made and discovers that all kinds of things happen at day care center that makes loan precarious. They are not behind on payment to Benning. Look to loan agreement to see her options. She may try to negotiate for some security but she has no leverage to do it. If she is on better relations, she could exchange some credit for better security. The point of the problem is to show that unsecured creditors go down if debtor goes down. The debtor really runs the show once the money has been paid over. Problem 1.4: The daycare folds, and you have default judgment against owner. How does Benning get paid? Benning is a judgment creditor. She is going get a writ of execution and go to the Sheriff. She needs to know what assets she can levy on. These assets cannot be covered by state exemption statute or secured by another creditor. You can go to state records, personal property records. If you were not Benning the dentist, but rather the Telephone Company, you could go to a credit reporting service that would find a lot of this information for you. Benning wont be able to do that because service does not open to private people. Like Hotel California, the lawyer took deposition to discover assets. There is a problem here because depositions require hiring court reporter (very pricy). There is no incentive at all to come into depositions and show what is owned. He has every incentive to prolong deposition. As lawyer for Benning, tell her that its expensive. You may find that assets are not owned by daycare center. Problem 1.5: Assume that took deposition. WI exemption statute may apply to certain assets to allow debtor livelihood. Vehicle: 1,200 + unused car is exempt. Principle residence: exempt if less than 40 acres. Daycare Center Equipment: if daycare center is closed, its not currently being used, so its not exempt, but if it is used, then its exempt. Bank Account: only exempt up to 1,000. You need to get a writ of execution from the court to order bank to pay you as creditor. If debtor withdraws money before Sheriff serves writ, creditor is SOL. You can take a bathroom break during deposition and serve writ right away. Problem 1.6: Kinds of questions you want to ask in a deposition. The collection business requires some creative thought- last month rent, medical payments, etc. You can try to collect a lot of assets. Dont just look for cash assets. Assignment 2: Security and Foreclosure 1) The Nature of Security (p21)

Secured Transactions Outline- Kauffman 2003

a) Lienmore effective set of collection rights. BC 101 def. of lien: charge against or an
interest in property [collateral] to secure payment of a debt or performance of an obligation. Foreclosure: creditor compels application of value of collateral to payment of debt.

b) Security Interest: lien created by contract. BC 101 (security agreement and security
interest). Nonconsensual liens: statutory liensgranted by statute (mechanics liens); and judicial liensobtained by unsecured creditors through judicial process. Security interest only has effect in event of default. i) The Invention of Security: A Pseudo History (p23) (1) Important ideasit is the substance of what is going on, not the form. If it acts like a security agreement, it is a security agreement. ii) Basile v. Erhal Holding Corp. (p27) (1) Settlement, though not cast as security agreement, provided that if debtor did not pay, creditor could take possession of propertycreated a security agreement. 2) Foreclosure Procedure (p29) a) Foreclosure: transfer of ownership; transfer of possession is differentcan happen before, concurrently, or after foreclosure. b) Judicial Foreclosure (p29) i) Foreclosure by entry of a court orderafter all technical delays, final foreclosure judgment is entered and ownership transfers. After foreclosure, if debtor will not surrender property, creditor gets writ of assistance or writ of possession, and sheriff takes possession of property to sell. (1) See Farm Credit of St. Paul v. Stedman (foreclosure judgment entered June 1984, but by refusing to leave and filing technical challenges, the Stedmans remained in the home for 5 years and six months after foreclosure). Property is sold (never transferred directly to creditor, although often purchased by creditor at sheriffs sale), and proceeds are applied to pay sheriffs expenses, then to the debt. Any excess is returned to debtor. If sale does not make enough to cover debt, creditor gets deficiency judgment and becomes unsecured for the difference.

c) Wisconsin Statutes Annotated (p32) i) Year long wait period between judgment of foreclosure and salefairly typical. Stems from
equity of redemption

ii) If debtor cooperates, debtor can transfer property to creditor using deed in lieu of foreclosure
mortgage and debt are both immediately extinguished. Creditors will sometimes pay debtors to transfer property, essentially purchasing debtors equity of redemption. d) Power of Sale Foreclosure (p35) i) A power of sale clause, used by about half of the states, allows secured creditors quicker and simpler method of foreclosure against real property. Mortgage is traditional form. Others states use deed of trustcollateral is held in trust by creditor or third party and can be sold by trustee in the event of default. Foreclosure is still necessary under power of sale, but doesnt need to be done through a law suitcan simply be recorded in public records; debtor has 90 days to cure (CA law). Debtor can still refuse to give up property, and then creditor has to sue. Debtor sometimes has wrongful sale remedies. e) U.C.C. Foreclosure by Sale

Secured Transactions Outline- Kauffman 2003

i) Foreclosure of personal property is much easier than of real property. Policy: loss of real
property tears at social fabric in a way that personal property does not.

ii) U.C.C. 9-601(a): creditor may foreclose by available judicial procedures. U.C.C. 9610(a): secured party may also sell, lease, license, or otherwise dispose of any or all of collateral. U.C.C. 9-623: sale or other disposition constitutes foreclosure of right to redeem. U.C.C. 9-617(a): disposition extinguishes secured creditors interest in collateral and transfers to purchaser all debtors rights in property. Problem Set 2. Problem 2.1: Same fact pattern with dentist and daycare center. But there is now a security agreement taking a car, house, equipment, etc as security. What items can Benning reach through foreclosure of her security interest? All of it! An unsecured creditor does not have a lien until the sheriff seizes the property. Only in a few states can a judgment alone give you a lien on the property. The sheriff has to establish control over the property. To establish control, you need someone there 24-7 until unsecured creditor can arrange for someone to deal with it. The secured creditor under the WI statute wins because the exemption statute trumps only Unsecured not Secured creditors, on the basis that the secured creditor made a contract on the loan. The exemption would defeat the whole purpose of secured credit and the banks lending rates. The interest rate is a factor of the collateral the banks has on the loan. This is a basic difference between secured and unsecured creditor. Problem 2.2: Instead of the problems of foreclosure, the lender would rather start leasing cars. You do not have to file a public document with a lease. All the lessor has to do is repossess the property. This lease is actually a sale with a right of repossession in the event of default as the equivalent of a security interest. UCC 1-201(37): whether a transaction is a lease of security interest depends on the facts of the case. There are a number of transactions in which the form of a lease is actually a security interest. In the second paragraph of the definition of security interest, a transaction that is a lease in form is treated as a security interest if the lessee cannot terminate the agreement. See if lessee has right of termination; if so, that takes us out of this paragraph. The second factor is that the lessee has an option of ownership for nominal consideration. This would mean that the rent payment is not really rent but rather an installment plan. The courts are concerned with the economics of the transaction. Maybe the substance of the transaction is actually a sale with a security interest. One of the most litigated issues is whether the transaction constituted a lease or sale. The problem is supposed to be simple; however, the lease terms are exactly the same as security agreement. You cannot get out of the foreclosure requirements by doing this. Typically, you will not have such an easy fact situation. You cannot get around giving public notice by calling your document a lease when it is really a security interest. Problem 2.3: a) OHurleys does not want a foreclosure on their record and offers to give a deed in lieu of foreclosure. If they go through the foreclosure procedure, OHurleys would get the amount over their defaulted loan. If the bank avoids foreclosure, the bank saves money, so maybe they can negotiate. The banks best option is to take the deed and maybe give up some money. What about the explanation issue? Any explanation may be construed as violating ABA Model Rules of Professional Conduct (see caption). b) OHurleys wanted to give a deed in lieu of foreclosure. Suppose that works out, and H will get deed back to them if they work out payment within 60 days. This is really the equivalent of a security interest. The banks interest is contingent on nonpayment of H. If deed is effective immediately, that would not be a security interest. The difference is between giving you a book (effective now as a gift), and I will give you my book tomorrow where there is no consideration. Problem 2.4: Mr Mashimoto has an idea for a deed of trust, in event of default the creditor forecloses. If you include a power of sale within the transaction you can avoid a judicial foreclosure, which is expensive and time consuming procedure.

Secured Transactions Outline- Kauffman 2003

Problem 2.5: There is another way to deal with collateral. Take a security interest in both real property and personal property. If there is default, foreclose on stock, not done according to judicial foreclosure. The creditor gains stock of corporation and gets company to deed real estate. The creditor takes control of debtor corporation, but the debtor corporation is probably in default to others, and the secured creditor assumes the corporations other debt. If debtor corporation spill toxic stuff on land, the secured creditor is liable for the cleanup. But is some situations its worth thinking about. A secured creditor can deal with default situations in ways that are not most time consuming. Problem 2.6: How would you change this? The issues in foreclosure cases usually involves efforts by debtors to prolong everything. Usually debtors think tomorrow will be better. Some issues of foreclosure involve overreaching by creditors too. The form most seriously considered involves trying to get state foreclosure procedures to mimic federal bankruptcy procedures, changing the debtors right to redeem, the statutory period, the actual sale of collateral. During the whole period, the debtor can stand by and do nothing. The efforts of reform try to make the redemption period run smaller. That is the time the debtor should raise defenses, creating less uncertainty. Assignment 3: Repossession of Collateral 1) The Importance of Possession Pending Foreclosure a) Who has possession of property during period of time between default and foreclosure of equity of redemption? Competing interests: Creditor wants property to preserve value of property by avoiding abuse or lack of upkeep, to benefit from value of property during the period, and to allow prospective purchaser to inspect and evaluate property. Debtor wants day in court before being dispossessed, to avoid giving creditor extra leverage by having power to dispossess debtor, and to retain leverage by having right to retain possession. b) Generally, security agreements provide that creditor gets possession in the case of defaults. However, courts may not enforce the provision, or there may be procedural steps needed for enforcement. Rules for real property and personal property differ. 2) The Right to Possession Pending ForeclosureReal Property a) The Debtors Right to Possession During Foreclosure i) Rule: mortgagees never become entitle to possession of mortgaged real property in their capacity as mortgagees. Debtor retains ownership and possession until right of redemption is foreclosed and sale is held. Purchaser at sale is entitled to dispossess debtor. Purchaser may have to sue for eviction of debtor. b) Appointment of a Receiver i) Receiver can be appointed to preserve value of property (rents in foreclosed apartment building are paid to a receiver and receiver maintains buildings, etc.). Receivers are generally only appointed if mortgages provide for them, but can be appointed if creditor can show that foreclosure alone is inadequate in preserving value. This almost never happens in family homestead situations. (1) California Code of Civil Procedure 564 (p40) (a) Appointment of receiver when it appears that property is in danger of being lost, removed, or materially injured (2) Illinois Mortgage Foreclosure Law (p40) (a) Receiver appointed when (i) mortgagee is authorized by mortgage terms, and (ii) reasonable probability that mortgagee will prevail on final hearing, except if mortgagor shows good cause.

Secured Transactions Outline- Kauffman 2003

c) Assignments of Rent i) If debtor will rent property, mortgage will likely include terms about assignment of rents directly to mortgagee as additional security. This acts much like having a receiver so some courts are reluctant to enforce the provision. Others enforce. 3) The Right to Possession Pending ForeclosurePersonal Property a) Unless otherwise agreed, U.C.C. 9-609 gives creditor right to possession immediately on default. i) Creditor can self-help repossess if no breach of peace. If debtor resists, then creditor must get court order and sheriffs help, generally through writ of replevin, which instructs sheriff to take possession of property from debtor and give it to creditor. Creditor files civil action, and then moves for immediate possession. Creditor must generally post a bond to protect debtor in event that debtor prevails. Debtor can regain possession by posting similar bond. Most debtors dont fight it, judgment is entered by default, and creditor takes possession and sells property completing the foreclosure under 9-610.

(1) Dels Big Saver Foods, Inc. v. Carpenter Cook, Inc. (p42) (a) Creditor initiated civil suit, demanded possession under 9-609, and judge issued
order that day granting immediate possession to collateral grocery store. The same day, the order was certified and creditor took possession of store. Debtor had no prior notice of creditors intended actions. Not a violation of due process because of procedural safeguards (bond and right to post-seizure hearing). 4) Article 9 Right to Self-Help Repossession a) 9-609: right to self-help repossession, as well as to typical judicial procedures. 9-609(a)(2) gives creditor option to leave equipment, but render it unusable. b) The Limits of Self-Help: Breach of the Peace i) 9-609(b)(2): Self-help repossession only without breach of peace.

ii) Salisbury Livestock Co. v. Colorado Central Credit Union (p48)


(1) Repossessors took collateral vehicles from outdoor area adjacent to house just after dawn. Does this constitute a breach of the peace? (a) Two primary factors in deciding if trespass rises to level of breach of the peace: potential for immediate violence, and nature of premises intruded upon. Jury looks to reasonableness in deciding if actions may have triggered breach of the peace. Some trespass is privileged in self-help repossession if it does not threaten breach of the peace. iii) Examples of cases holding breach of peace: (1) Creditor brought police and debtor verbally consented to possession. Sets bad precedent of involving police in self-help repossessions. In re Walker v. Walthall. (2) Debtor verbally refused to allow repossession. Repossessors returned month later, and son told them they shouldnt take collateral, but did nothing to stop them because he was afraid of being beaten. Debtor did enough to protest so that repossession constituted breach of peace. Morris v. First Natl Bank and Trust. (3) Repossessors cut chain to lock fence and repossessed bulldozer leaving all other equipment unsecured and unprotected. Cutting chain constituted b.o.p. Laurel Coal v. Walter Heller and Co.

Secured Transactions Outline- Kauffman 2003

iv) Examples of cases holding no breach of peace: (1) Repossessor followed debtor to daughters house and took car at 2:00 AM frightening (2)
debtor and daughter. Stealthy manner calculated to avoid breach of the peace. Wallace v. Chrysler. Wrecker used to repossess car in the middle of the night. Debtor hollered at them and they stopped. They took her personal items from the car and gave them to her. She did nothing else to stop the repossession. No breach of peace. Williams v. Ford Motor Credit. Debtor had threatened use of weapon to keep repossessors from taking the car in the past. Repossessors came again at night, and retrieved vehicle while debtor slept. Although there was potential for violence there was no breach. Wade v. Ford Motor Credit. Repossessor cut lock to retrieve collateral bus from property marked no trespassing. SA permitted creditor to enter any premises without liability for trespass. No breach of peace. Wombles Charters, Inc. v. Orix Credit Alliance. Repossessor fraudulently misrepresented to equipment dealer that debtor had given permission to repossess. No breach of peace because actions did not support a potential for immediate violence. K.B. Oil v. Ford Motor Credit. Debtor admitted creditor to her office, and creditor repossessed computer collateral over debtors objections. No breach of peace because creditor did not use force or threat of force. Court said that creditor only need permission to enter premises, not permission to take collateral. Rainwater v. Rx Medical Services.

(3) (4) (5) (6)

5) Self-Help Against Accounts as Collateral a) 9-102(a)(2): AP and AR constitute accounts. Creditors use different arrangements to secure accounts: i) creditor gives debtor freedom to collect and use accounts ii) creditor allows debtor to collect accounts, but requires that a portion be applied immediately to the loan. Future advances are often allowed under this structure. iii) Creditor arranges with debtor that account debtors pay secured creditor directly. iv) Account debtors pay directly to a post office box under the control of the secured creditor: a lockbox. This avoids letting account debtors know that the accounts are used as collateral. (1) 9-607 and 9-406(a) provide self-help remedy to party holding security interest in accounts: secured creditor who knows identity of account debtors can send them written notices to pay directly to the secured creditor. (a) Marine National Bank (p54): creditor sued account debtor who had received notice to pay creditor but paid debtor instead. Account debtor was required to pay secured creditor sum that debtor owed creditor. Account debtor should have had relief from the debtor, but in this case the debtor was out of business. Account debtor was forced to pay debt twice. Problem Set 3. Problem 3.1: J lends money to N. When N does not pay, J cannot just go take the lawn furniture (if unsecured creditor). He may find himself in front of criminal trial. The picture changes if J is secured creditor. He can self-help repossess if he does not breach the peace. Looking at cases, J probably wants to sneak onto the property and take furniture. The danger of confrontation is less at night. The debtor has less possibility of doing things that would increase chance of violations. In long run, maybe interest will not be served by taking furniture. The N may play load music at night. There are often good business reasons for not pushing ahead. But its also true that lenders lose more by trying to help debtor through period of financial troubles.

Secured Transactions Outline- Kauffman 2003

Problem 3.2: Collection department and repossession policy. What are general guidelines for repo people. A) Assume no guard and no fence. If no one will start conflict or confront repo, then do it peacefully. If there is potential for immediate violence, then dont repo. If all the people are doing is objecting, the repo people can still do it. But the threshold is objection +. You can always come back later. The case law seems to favor when the people do it at night. There is a greater possibility for violence when you are mistaken for a thief. B) Suppose there is a fence but no guard. Its probably ok. C) Site with a guard? The site is a little more secure. What if you say you have a court order but you are lying? Cases differ. What about the ethics rules about professional misconduct? A lawyer may discuss the legal consequences of proposed course of conduct. Problem 3.3: What advice can we give the debtor to prevent repossession? Article 9-609, a secured creditor may proceed without judicial process if it proceeds without a breach of the peace, taking possession, rendering equipment unusable. The debtor is always going to win if both sides play it smart. Repo usually wins only against stupid debtors. Problem 3.5: Deare has a bunch of A/R from its customers. It needs financing and uses its A/R to receive a loan from First Bank. We have two financing. Deare to Customer and Deare to First Bank (using A/R as collateral). First Bank not being able to talk to customer limits its ability to find out if customer will pay them or if the equipment is a good product (defenses, etc). Deare may cheat, so have customers send checks directly and compare against Deares deposits. Doing an audit is expensive, and each level involves an extra layer of defense. You want to make sure that if Deare defaults, the money will be in there. It is not useful to have security interest in the collateral and when you need it, the collateral has already been spent. You want a security interest to back the A/Rs. Deare would assign to bank an A/R + a security interest in the farm machinery (stock in trade of retail consumers). That is more typical. There are situations that bank finance transactions backed only by A/R, but not with farm equipment and cars. This is a much more complex transaction. We want to think about this 3 party transaction to realize that typically we have 2 loans- Bank to Dear to Customers. What is Bank security? There are two kinds: it has the stream of payments made by customer to Deare. That is the A/R. It is highly liquid and available form of return. This stream of payments accounts for the figures heavily. This is why Bank needs to know something about customers of Deare, how credit worthy they are. It is a lot easier to talk about customers if we know who they are. The stream of payments is one thing. But secondly, it wants a security interest in the underlying collateral. It is thinking about the farm equipment. Is it accurate to say that Bank has security interest in farm equipment when in the hands of the customers. If Deare is in default, but the customers of Deare are not in default of Deare, what can Bank foreclose? You cannot get at the farm equipment because the Banks interest is subject to non-payment by customers. But Deare has something of value, a security interest in the farm machinery. If Deare is in default, Bank can go against Deare, foreclose on Deare, and steps into Deares shoes, and it is the secured creditor. Between Deare and Bank, they own all the sticks making up the property interest. Problem 3.7: a) Bank has mortgage on business premises. You want to know whether they have to go through judicial foreclosure or not. If you have power of sale or transfer, those go quickly. Judicial foreclosures take time. Different foreclosure rules means different leverage for debtors/creditors. b) Loan is secured by trade fixtures and equipment. Citizens repossess the trade fixtures and equipment. c) The utility people have lots of leverage, and they can turn off the lights. With any unsecured creditors, you may need them in the future. Its expensive to foreclose; it cuts off future business. If the secured creditor has security in the collateral, they would probably hold off. You probably want to deal with the utility people first.

Secured Transactions Outline- Kauffman 2003

Problem 3.8: what do you do by way of going ahead trying to get possession when debtor claims a defense? Dont go ahead. If you repossess and there is a defense, there is the risk of conversion. Problem 3.9: Give weekly code to start car. If not up to date, no code, and cannot drive the car. It is unclear whether this is ok. An article turned up in the newspaper and circulated among commercial law teachers. People are split. The disabling rules allow a creditor in event of default to disable equipment, a classification that does not relate to consumer goods. There is no provision that allows disabling of consumer goods. Its a question of how we will interpret the default provisions. Assignment 4: Judicial Sale and Deficiency 1) Strict Foreclosure a) Foreclosure proceeding that doesnt involve a salemost common in contract for deed, of installment land contract: court confirms that title remains w/ seller when debtor doesnt pay according to contract. Not common, and usually only for real estate of small value. Debtor can lose substantial equity in property. This has prompted policy concerns and some statutory protections. 2) Foreclosure Sale Procedure a) Statutorily defined. Generally, court must review results of sale and confirm it. After confirmation, sale proceeds are disbursed first to expenses of sale, next to creditor towards debt owed, and w/ no other liens, surplus goes to debtor. If deficiency, court enters deficiency judgment, then deficiency becomes unsecured debt.

b) Mortgage debtor has right to redeem while foreclosure is in progress by paying full amount due,
including interest and attorneys fees. Common law right to redeem foreclosed at time of sale. However, most states provide statutory right to redeem collateral from buyer after sale. Debtor usually retains possession during statutory right to redeem. Statutory rights to redeem are transferable. Some courts hold that right to redeem from buyer is simply price paid at sale. Others make it price subject to liens causing sale (same price as common law redemption). c) Problems with Foreclosure Sale Procedure i) Debtor can bring suit to set aside sale for inadequate sale price, but probably wont have much success. (1) Armstrong v. Csurilla (p62) (a) Property sold and brought in significantly less than fair market value leaving debtors w/ huge deficiency. To set aside judicial sale, inadequacy of price must shock the conscience, or there must be circumstances which make it inequitable to confirm sale (court doesnt specify what these are). Because the price doesnt shock conscience and there was no impropriety in the sale itself, the sale is confirmed. (i) Various factors, including poorly advertised sales, little opportunity to inspect property or get info on it, caveat emptor, and statutory redemption period, lead to low prices from foreclosure sales. d) Advertising i) Method generally fixed by statute. (1) Wisconsin Statutes Annotated 815.13 (p66) Notice of Sale of Realty (a) Notice of sale published for 3 weeks in 3 public places in city where sale will take place and city where property is located. Additionally, notice runs in a newspaper in the county for 6 weeks.

Secured Transactions Outline- Kauffman 2003

e) Inspections i) Debtor generally retains possession of property. In mortgage, creditor generally has right to inspect property. Every other potential purchase has no right to inspect property except from adjacent public places. (1) Homebuyer Finds Remains of Owner (enough said) f) Title and Condition i) Caveat emptor still applies. Court will not make up for bidders ignorance. (1) Marino v. United Bank of Illinois, N.A. (a) Marino asked lawyer representing bank about other liens. Lawyer said that she thought there were no other liens. Marino bought and found out that there were other liens. Caveat emptor appliedno detrimental reliance claim. g) Hostile Situation i) Debtor can make life hard on the buyer by trying to prevent third parties from obtaining information about property. Bidders need to take into account the debtors ability to delay, litigate, and potential damage property. h) The Statutory Right to Redeem i) High bidder may have to wait months or maybe years for possession. Even if they get possession, they can be ousted if right of redemption is exercised. 3) Anti-deficiency Statutes a) In some states, the court cannot grant a deficiency or has limits placed on the deficiency it can grant. Most common statute: assumes property sold for fair market value and creditor can only get deficiency above that. i) California Code of Civil Procedure 580A., B., D. (p74) Deficiency Statutes (1) Deficiency limited to amount by which debt exceeds fair market value of sale. Do deficiency where loan was for purchase of domicile. No deficiency where property is sold under power of sale clause in mortgage. 4) Credit Bidding at Judicial Sales a) Creditor can buy property for all or part of secured debt. Creditor can then resale the property for real money, and, where there are no anti-deficiency statutes, collect a deficiency judgment from the debtor. A high credit bid minimizes the chances that the debtor will exercise right of redemption. Mortgage foreclosure process becomes a two-sale process whereby buyer at first sale captures debtors equity. 5) Judicial Sale Procedure: A Functional Analysis a) Judicial sale process was intended to value property but doesnt seem to do a great job of it. However, it motivates knowledgeable debtors to liquidate property before judicial sale and to negotiate with creditors. Problem 4.1: Bank has a judicial foreclosure sale. The $40,000 mortgage exceeds $45,000 FMV of house. Under state law, there is no deficiency judgment. Half the states dont allow deficiency judgments. Credit bid if only bidder. Let higher $53,000 bidder win. As for $44,000 bidder scenario, get the place appraised. Is it worth more than that? Maybe bid up to have the other match you. Think about who the third party bidder is. Is it a bonafide bid? It may indicate that the market value is more than you thought it was. If that bid is not bonafide, you may have to do it all over again. It is not a slam-dunk answer. Commercial is going to have to response by figuring it out.

10

Secured Transactions Outline- Kauffman 2003

Problem 4.2: Give advice to a defaulting debtor who owes $53,000 on mortgage, and the FMV of house is worth between $40,000 to $45,000. The secured creditor may ask for a deficiency. Her danger is that she cannot count on the bank to bid that amount. She should look out for potential bidders. She can stir things up a bit. Maybe the bidding price would put her in bankruptcy, so it does not matter. What about a $70,000 FMV? She has equity of 17 grand. Maybe it would be better to look for a bidder to give closer to $70,000; she cannot count on commercial. Maybe the bank would split the equity. Maybe she can raise money on a second mortgage. If she wants the full equity, she can try to sell the house herself. When you go to the realtor, you dont want to explain the desperate situation. If the potential buyer knows this is a distress sale, then that buyer may offer less than FMV. The mechanics of how sale is conducted becomes critical. You want the potential buyer to sign a purchaser and sale agreement before they find out about title. Assume her brother is ready to buy the house and let her live in it and its worth 40 to 45 grand. You can redeem, under a statutory right to redeem, and the redemption price is the amount of the debt plus attorneys fee, or in some jurisdictions, the reasonable value of the collateral. It is a disincentive for the bank to get the property for 30 grand, because if redemption is FMV of collateral, they have given the brother a great argument that the property is only worth 30. In all these real estate foreclosure cases, there is an incentive for the bank to bid to the outstanding amount. If they bought for 30 and go for a deficiency of 23, then she can argue its not equitable, or she files for bankruptcy, she lets brother buy it and live in it. If brother pays off mortgage, she owns it free and clear, but she may be in default with other creditors. The lesson is that there are lots of different ways to proceed, depending on the jurisdiction. Problem 4.3: You are the buyer and see a house in foreclosure. What do you want to know about the house? Is it worth my time to get interested in this house? You want the value of the house to be more than mortgage, because bank will credit bid full amount. If house is worth 70, there is a possibility here. You dont assume anything about the condition of the house. The house may have serious problems. The more the sheriff talks, the more he is exposed to liability. Problem 4.4: American Insurance Company is creditor and debtor defaulted on loan. Four wealthy people guarantee the loan. The mortgage is 20 million and FMV is 18. What to bid? In theory bid low and go after guarantors for deficiency. But this strategy invites litigation. But why arent the wealthy guarantors at the sale. The Ins Co was going to bid 500,000 in FL where there is no statutory right of redemption. What happens turns up in b and c. The mystery bidder turns up and bids 20 million. Maybe he is in there to make sure that the guarantors are off the hook. Maybe the mystery bidder is a shell corporation with no assets. Its really hard to know what to do. You can let them get it. But if there is no cash, then you have to start all over again with another sale process. The Ins company has to make a judgment about the mystery bidder in a hurry. What if there are three bidders, .5, 12, and 25 million. A statute designed to protect creditors- giving property to second highest bidder if highest bidder unable to complete sale- might be used to creditors disadvantage. If cannot recover 8 million from guarantors you can always claim conspiracy. Assignment 5: Article 9 Sale and Deficiency 9-602(10), 9-620: Cannot waive or vary requirement that collateral be offered for sale as part of personal property foreclosure. Cannot have clause that creditor will retain collateral in satisfaction of debt. 1) Strict Foreclosure Under Art. 9

11

Secured Transactions Outline- Kauffman 2003

a) 9-620: debtor can consent to creditor retaining collateral for full or partial satisfaction of debt
subject to restrictions: no objection from other lien holders (a)(2), consent to strict foreclosure of consumer goods only after repossession (a), and strict foreclosure is not permitted if debtor has paid 60 percent of debt. Again, debtor can waive even this right but with a writing. (a)(4) and 9-624(b). 2) Sale Procedure Under Art. 9 a) 9-610: Creditor, not public official, conducts sale of collateral in a commercially reasonable manner (b). b) 9-611(c)(1): debtor must be given notice of sale. c) 9-623: redemption by paying full amount of debt, attorneys fees, and expenses of salebut sale forecloses right to redeem. 3) Problems with Art. 9 Sale Procedure a) Failure to Sell the Collateral i) 9-610(a): secured party may sell collateral, but doesnt have to. ii) 9-620(f): narrow exception for some consumer goods. iii) 9-626(a): if secured creditors delay is commercially unreasonable, deficiency will be limited to what exceeds a commercially reasonable sale. b) The Requirement of Notice of Sale i) 9-611: notice is required ii) 9-617: failure to give notice does not invalidate sale, but may limit deficiency. iii) Federal Deposit Insurance Corp. v. Lanier (1) Notice that bank would sell property in public or private sale within 10 days and maybe immediately was adequate for sale that didnt occur for 4 months. (2) Burden to find out about details of sale is on debtor. c) The Requirement of a Commercially Reasonable Sale i) 9-610(b): every aspect of sale must be commercially reasonable. Vague to provide incentive for secured creditor to maximize value. (1) Chavers v. Frazier (a) 9-627(a): failure to get best price does not make sale commercially unreasonable. Close factual analysis of case ensuesin this case, sale was too hasty, not adequately advertised, and price wasnt reasonable. 4) Art. 9 Sale Procedure: A Functional Analysis a) Art. 9 tries to get market price for goods, but it only does where deficiency is going to be large, and really provides incentive to get double recovery by purchasing collateral for less than its value, getting deficiency and selling collateral at market value. 5) Class notes: a) 9-626 is there to figure out the deficiency when it is not commercially reasonable. W/ a consumer, the court decides what a reasonable price would have been under common law principles. 626(b). W/ commercial property, deficiency equals difference between amount owed and greater of 1) what was realized at sale, or 2) what would have been realized at commercially reasonable sale. 9-626(a)(3). b) 9-602: cant waive notice provision. c) 9-611(d): perishable collateral exception to notice requirement.

12

Secured Transactions Outline- Kauffman 2003

Problem Set 5. Problem 5.1: repossession of personal property. The balance on the loan is 10 grand. The FMV of car is 8 but it sales for 7 in a commercially reasonably sale. The deficiency is 3 grand. How much is redemption amount? 10 grand. He should redeem because its 10 grand total. To buy another comparable car, he would owe a 3 grand deficiency first and then pay 8 grand for a car = 11,000. What if a friend offers 8 grand but the bank sells it for 7 grand at a private auction where the friend cannot go? UCC 9627(b)(3): you can sale at a dealers auction. Problem 5.2: If there is a surplus, the debtor gets the remaining amount before the unsecured creditor. If there is not enough money to pay for sale expenses and secured creditor, the secured creditor will get a deficiency judgment and the debtor will bear the sale expenses. But if the debtor does not pay the deficiency judgment, the creditor bears the cost of sale. If there is a surplus, the sale takes care of it. Problem 5.3: Does East Bank have to send notice to defaulting debtors of auction, where the debtor cannot participate anyways since only dealers are invited? If security agreement has a waiver, then maybe no notice required. Under UCC 9-611(a)(2): the debtor can waive notification, if sale is under recognized market (under 9-611(d)). Dealer auction is not a recognized market under comments. But comments have not been enacted by legislature. Problem 5.4: bank repossessed hull of helicopters, finding out that debtor has taken out engine and stuff. The debt is 345,000, leaving a hull with no resale value. The debt is personally guaranteed. Can the creditor throw away the hull? 9-610(a) seems to give secured creditor a choice. A secured creditor can sell collateral in present condition or following any commercially reasonable preparation. What is commercially reasonable? We would have to decide whether its commercially reasonable to reinstall old equipment or buy new stuff. But the comment is designed to make it clear that you DONT have a right to sell it in the present condition if you can make more on it by fixing it up. What if Grizzly could have spent 245,000 to get 345,000? 9-626(a)(3): LOOK at this provision. It is probably a drafting error. There is no deficiency judgment if the creditor could have spent 245,000 to get 345,000 (commercially reasonable). Again, what if guarantors hypothetically could prove that if creditors put in 245,000, they could have sold it for 345,000? If you look 9-626(a)(3), seems to reach an absurd result for determining deficiency amount. The secured party is entitled to 0 even though it would have had to spend 245 to realize 345. This is because expenses does not include the 245 under 9-623(a)(3)(B) if it is not actually spent on rebuilding helicopter. But if in reality, the creditor actually spent the 245, then that amount is real and counts as an expense under 9-623(a)(3)(A) and is added to the deficiency limit. Note: proceeds means gross sales. Problem 5.5: The owner of a business wants to retire and sells store to a new party. The new party put down 50 grand and signed a promissory note for 277,000. The new party cannot run store. The old owner takes the store back and sent defaulting buyer a bill for 131 grand, which was the excess it owed after crediting him for the value of the store. Can the old owner sue for the deficiency without selling the store first? Under 9-626: if the secured party fails to prove that the collection disposition was conducted in accordance to the provisions of this part, the creditors deficiency is limited (reasonable sale provisions). Secured creditor says he is entitled to full amount of debt less value of what it was when took it back. The debtor may argue that 9-626 does not apply because there was no defective sale. The creditor just kept the property. Look to 9-617: good faith transfers.

13

Secured Transactions Outline- Kauffman 2003

Chapter 2. Creditors Remedies in Bankruptcy Assignment 6: Bankruptcy and the Automatic Stay 1) The Federal Bankruptcy System a) Compared to state collection systems that can take a long time, bankruptcy system provides quick, efficient resolution of debtors financial problems (anyone notice a bias here?). Bankruptcy offers permanent discharge of debt and/or extension and debt adjustment and creditors collect at least as much as they would w/ an uncooperative debtor. Bankruptcy supersedes state collection law (supremacy doctrine). Lending is structured in the shadow of bankruptcy. 2) Filing a Bankruptcy Case a) Bankruptcy chapters generally: Chapter 7 (liquidation); Chapter 11 (reorganization for businesses); Chapter 12 (reorganization for family farms); Chapter 13 (reorganization for individuals) i) 362 Automatic Stay against all collection activities at filing. ii) 541(a) Bankruptcy estate (all property of the debtor) created at filing. iii) Under Chapter 7, trustee administers estate. Under Chapters 11, 12, and 13, debtors remain in control of estate and administer according to bankruptcy law (in 12 and 13, trustee is appointed to assistin 11, DIP: debtor in possession). iv) 552(b) Chapter 7 debtor keeps property exempt under state law (552(d) lists federal bankruptcy exemptions that are an option for debtor). v) 704 debtors assets are liquidated and distributed pro rata to general creditors. If debtor is an individual, all remaining debts are discharged. vi) 727(a)(1) If debtor is a corporation, then after discharge, corporate shell remains w/ no assets but still owing all debts. vii) Under Chapters 11 and 13 debtor must promise creditors at least as much as they would receive under chapter 7. They then restructure payment plans according to various code sections and adjust debt. 3) Stopping Creditors Collection Activities a) General creditors have very few specific rights once debtor enters bankruptcythe process is streamlined, they participate collectively w/ other unsecureds and receive pro rata. Any violation of stay is void or voidable, and the violator may be liable for damages. 362(h). The stay freezes the relative rights of the creditors at the moment of the bankruptcy filing. The stay applies to all entities and any act to collect prepetition debt. 362(a). The stay does not halt criminal proceedings against debtor. 362(b)(1). Unsecured creditors generally cannot lift the stay. 362(c). b) Lifting the Automatic Stay i) Secured creditors have a right to get paid at least the value of the collateral. They can participate individually in bankruptcy case. ii) 362(d) grounds for lifting the stay: adequate protection (cushion of equity alone can provide adequate protection) or if collateral 1) has no equity for unsecureds, and 2) is not necessary for reorganization (these two reasons referred to as bankruptcy purposes). These are factual questions for the bankruptcy court. (1) In re Craddock-Terry Shoe Corp. (p105) (a) Customer lists necessary for effective reorganization, therefore automatic stay will not be lifted for that reason. They were concerned about adequate protection of lists,

14

Secured Transactions Outline- Kauffman 2003

so court order security interest in all other assets to protect value of lists (notice what this does to all other unsecureds that were looking to other assets for some payment its now tied up in SA w/ secured creditor). c) Strategic Uses of Stay Litigation i) Debtor and creditor end up negotiating solutions in the face of automatic stay. Problem Set 6. Problem 6.1: CEO says a bunch of their clients are in bankruptcy. She wants to do serious collection efforts. What do you say? Under 363a6: when under stay, cannot act to collect, assess, or recover. If do it, then may get fined or be held in contempt. Dont send notices. Problem 6.2: Kansas savings trying to collect from defaulting debtor secured by equipment. The debtor filed bankruptcy. You have a judgment. You cannot go after debtor once in bankruptcy. But can the sheriff? No, the only applicable provision for government agency is under 362b4 and that provision applies to things like environmental safety. Problem 6.3: The bank wants to foreclose after restaurant goes into bankruptcy. You cannot foreclose under 362a3 because you cannot take possession. But you can ask the court o lift the stay if debtor has no equity and the property is not necessary to an effective reorganization (363d2). Problem 6.4: the bank wants to foreclose on a chapter 11 restaurant owing 210 grand. But the restaurant is worth about 600 grand. There is still adequate protection because there is a 390 grand cushion. Also, the property is necessary for effective reorganization, so the court probably wont lift the stay. Problem 6.5: If the boat is destroyed by a storm, there would be total loss for the bank. So the equity cushion may not be meaningful. Problem 6.6: you are helping out a debtor food processor. The company files for chapter 11. a) The first irate creditor calls and says he wants his loan amount of 126 grand. Problem unsecured creditor. So he is SOL, and has to wait along with the rest of the unsecured creditors. b) The next creditor has a secured interest in equipment. However, the defaulting amount of 50 grand is less than the value of the equipment (40 grand). They are not going to win under 363d(2) because property is crucial to reorganization. But under 363d(1), there is lack of adequate protection. The debt is 50 but the secured collateral is worth only 40 grand. Most courts say you dont get additional adequate protection from the date the debtor filed bankruptcy protection. You only get adequate protection from the time you took efforts to protect yourself, such as filing relief from stay. Assignment 7: The Treatment of Secured Creditors in Bankruptcy 1) The Vocabulary of Bankruptcy Claims a) Debt: sum of money owing. b) Discharge: debt remains, but creditor enjoined from attempting to collect c) Nonrecourse: only collect value of sale of collateralno deficiency d) Security Interest (Art. 9): special collection rights of personal property e) Lien: special collection rights of unsecured that has levied against property f) Mortgage: credit consensually secured by an interest in real estate g) Deed of trust: different form than mortgage, but much the same effect

15

Secured Transactions Outline- Kauffman 2003

h) Security Interest (bankr and IRS): Art. 9 SIs, mortgages, and deeds of trust i) Allowed claims (or claims): governed by 502(b)(lists claims not allowed)
j) *Claims are not equal to debt owed in bankrsee p116 2) The Claims Process a) 502:amounts debtor owed each creditor under state law at time of filing b) 501: proof of claim describes debt and states that it is outstanding and if no one objects, then it is allowed under 502. i) Under chapter 11, debtor files list of creditors and what is owedcreditor doesnt have to file anything unless something is incorrect. c) 502(b)(1): claims against estate are accelerated. d) 502(c): disputed claims can be estimated if they threaten to delay process e) 558: bankr estate has defenses available to debtor had outside bankr. f) 507(a): some groups (e.g. tax authorities and employees) get priority over other unsecureds 3) Calculating the Amount of an Unsecured Claim a) 502(b): unsecured claim is amount owed under nonbankruptcy law at filing, plus legal fees and other fees included in contract. Unsecureds do not get interest (no unmatured interest 502(b) (2)). b) Payments on Unsecured Claims i) Empirical studies show that the vast majority of unsecureds dont get anything under bankruptcy (no assets left to be distributed). 4) Calculating the Amount of a Secured Claim a) 506(a): secured claim only to the extent of the value of the collateral; the rest is unsecured. Secured creditors total claim is calculated the same as unsecureds. 506(b) governs payment of postpetition interest and fees (only when costs are reasonable, provided for in the agreement, and when claim is oversecured ). 5) Selling the Collateral a) Trustee sells in the manner that he thinks will bring the greatest value to the estate. 541(a): trustee can only sell debtors equity in secured collateral. Sale terminates automatic stay for collateral 362(c)(1). 554: trustee can abandon property (terminates automatic stay). 363(f): trustee can sell collateral free and clear of liens in certain circumstances (see assignment 27). 6) Who Pays the Expenses of Sale by the Trustee? a) If trustees sale benefits creditor, then expenses of sale come out of purchase price. Benefit to creditor generally only happens when creditor is unsecuredif creditor is oversecured, they dont benefit particularly from having collateral leave the estate. 7) Chapters 11 and 13 Reorganizations a) 1141(d)(1)(A): confirmation of chapter 11 plan discharges old secured debts and payment schedules and substitutes new ones. b) 1129(b)(2)(A)(i)(I): plan must specify that creditor retains lien in bankruptcy c) Cramdown: confirmation of plan when creditor has not agreed. d) These provisions encourage negotiation b/t creditor and trustee. e) Valuing Future Payments i) Payments must have value, not just amount (time value of money).

16

Secured Transactions Outline- Kauffman 2003

(1) In re E.I. Parks No. 1 Ltd. Partnership (a) Court agreed w/ debtors calculation of interest ratenot coerced loan rate, but treasury bond rate plus a little bit for risk. Problem Set 7. Problem 7.1: The creditor claim would be limited to 30 grand plus interest until the debtor filed bankruptcy. The total before petition is 32,700. After the petition is filed, under 502b2, it says you cannot get unmatured interest. Attorney fees can only be claimed if agreed upon before hand. Problem 7.2: Every unsecured creditor gets 5%, and our client get around 1600 and writes off the excess of 30,000, more than their original loan. That is what happens to unsecured creditors. Our client was probably lucky to get anything with 59,000 kicking around there. There is lots of temptation to jack up the attorney fees. Nobody will have a big enough stake to make a claim. Problem 7.3: Our client CI is a secured creditor, owed 340,000 plus 6 months of interest at 12%, secured by equipment worth 400,000. The debtor filed Chapter 11. 6 months interest is 20,400. b) If plan was confirmed today, you can add an additional 12%. The debtor would have to propose payments with a value of 371,212. This figure is a present value figure, so the plan would probably not involve the payout of 371,212 today. The debtor would probably propose a payout structure of more over 5 years. You do post filing interest on the 360,400 (the claim at the filing date). c) If the reorganization plan is not confirmed for another year, then what? You can keep piling on the interest of the year, but only up to the amount of the secured collateral, of 400,000. If the contract provided for collection expenses, and had prefiling collection expenses, that lowers your cushion even more. After your secured claim is capped at 400,000, you may end up with an unsecured claim as well. But the interest does not go past the 400,000 mark. After that, the debt goes up, but the claim is not allowed. As a secured creditor you want to push for approval of the plan. Problem 7.4: The secured claim is capped at 325,000. The remaining amount is unsecured. You dont get post petition interest on any claim because the collateral cannot handle it. The creditor becomes an unsecured creditor after that amount and cannot charge unmatured interest. The creditor could only get post petition interest if the collateral exceeded the debt. Since it does not, the creditor cannot charge post petition interest because it acts as an unsecured creditor. Problem 7.5: Her company is an unsecured creditor for 340,000 + 20,400 interest = 360,240. The scheme of payment under the bankruptcy code has some unsecured creditors getting payment before others. b) 507 priorities. These are all priorities in the group of unsecured creditors. Secured creditors get paid first up to the value of their collateral in the estate. Problem 7.6: You are appointed to act as TIB in chapter 7. Perez summer house is in estate. The house is encumbered by mortgage to first capital. The mortgage is 85,000, which includes interest accrued to date at the contract rate of 10% per annum. If sold after 6 months, the house will produce 100,000 6,000 (Real Estate Commission) 85,000 (Mortgage) 1,000 (interest for 6 months on mortgage i.e. 4,250) = 3,750. If the house is sold a year later, another 4,250 of mortgage interest is added because the bank has a secured interest in that collateral. Sometime between 6 months and one year, the trustee may want to look out for unsecured creditors, and abandon it. This way, the bank could get the mortgage on the house. It allows the bank to go ahead with its foreclosure procedure. Problem 7.7: the secured creditor gets its money and the unsecured get the rest pro rata. For the coin collection, the secured creditor gets the 26,00, but the rest is unsecured and they all get it pro rata.

17

Secured Transactions Outline- Kauffman 2003

Chapter 3: Creation of Security Interests Assignment 8: Formalities for Attachment 1) A Prototypical Secured Transaction a) Creditor lends money or sells property and takes an interest in property. i) Fishermans Pier: A Prototypical Secured Transaction (1) A cute story about Pablo and his restaurant. Important: financing statement is not necessary for security interest to be enforceable against Pablo, but it is necessary for priority over other secured creditors.

2) Formalities for Article 9 Security Interests a) 9-203(a) and (b): attachment and enforceability of security interest happens when 1) either collateral in possession of secured creditor, or security agreement with description of collateral; 2) value given; 3) debtor has rights in collateral. b) Possession or Authenticated Security Agreement i) Security agreement w/out writing if possession (think pawnshop). Field warehousing allows creditors to maintain possession while allowing debtors to use it. Prototypical security agreement is based on a writing that contains description of collateral, provisions defining default, rights of creditor on default, obligations of debtorwhen debtor signs, 9-203(b)(3) (A) requirement of authentication is met. Also provisions for electronic security agreements 9-203(b)(3) (1) In re Ace Lumber Supply, Inc. (a) Composite documents rule where various documents can be read together to create security agreement. In this case, however, signed financing statement and unsigned notes that security interest was intended was not enough to be authenticated agreement, even when both parties agreed that they had intended to create a security interest. (b) Other courts have been more liberal w/ this (p145). (c) Reasons for the stringent requirement: (i) preventing fraud (ii) minimizing litigation (iii) cautioning debtors (iv) channeling transactions (v) discouraging secured credit (d) Compare w/ real property doctrine of equitable mortgages (basically unwritten mortgages); impliedly repudiated in 9-203(b)(3). (e) 9-203(b)(3)(A): deals w/ idea of fill-in-the-blank-later agreements c) Value Has Been Given i) 1-201(44): value defined so broadly that requirement is virtually always met. Assumed that creditor has to be the one to give value. Value under Art. 9 includes all contractual notions of consideration and, in addition, past consideration (allows change from unsecured to secured) d) The Debtor Has Rights in the Collateral i) 9-203(b)(2): you can only grant a security interest in your property. If you have a limited interest in property, security interest only attaches to limited interest (nemo dat non habet).

18

Secured Transactions Outline- Kauffman 2003

3) Formalities for Real Estate Mortgages a) Subject to peculiarities of the state. Generally more formalities than Art. 9. i) Ohio Revised Code Ann. (1) Mortgage signed in presence of witnesses and notarized and acknowledged judge or clerk or other public official. (2) Real estate is known for obsessive adherence to details of conveyances, although every once in a while a judge will do something equitable (e.g. oral mortgage enforced because of partial performance). 4) Class notes: Under composite document rule intent is necessary, but not sufficient. This moves away from contract lawcontract exists independent of writing. Problem Set 8. Problem 8.1: One example, Promissory note for 50 grand that was signed by debtor, reciting that secured by collateral described in security agreement bearing same date. There is no description of the collateral. The third example, a lawyer cannot sign for debtor. What about composite document rule? Why does the financing statement not serve? It has a description of the collateral and although not signed it was executed by debtor. Do the documents stand alone or do you need to read the testimony? 9-102(a) (7). There may be something in there that will take you out of the composite document agreement. The rule says that debtor must authenticate the agreement (who cares if security did not sign). Problem 8.2: Was there a security agreement when the financing statement was filed in the Fishermans Pier example? One of the great advances for secured creditors was that they were allowed to file a financial statement before security agreement was filed. But the date of the financial statement is the date when notice was given to third parties. Also, there were some famous cases where there was a closing and the debtor rushed in to file, and in between that time, another person rushed in and got priority. The value is given with the first check or 38,000 not the promissory note. The bill of sale is the time in which the debtor had rights in collateral. Problem 8.3: You cannot have a security interest without a description of the collateral. 9-203(a). The description is later mailed and stapled to security agreement. Is this sufficient? 2 cases say yes and 2 cases say no (page 148). If Pablo is in bankruptcy then what? The bankruptcy court says you cannot create security agreement while in stay. 363a4. Problem 8.4: After debtor goes into bankruptcy, you forgot to attach the description to the blank spot. The client sent it to you and you stuck it in your desk but forgot to staple it together. You cannot prove it after stay. What about the composite document doctrine? Its not signed by debtor but in some of these composite document doctrine the debtor does not sign everything. The composite document doctrine makes reference to each document internally. If we read the documents, they should refer to each other. If you know that the client will commit perjury, can you still withdraw without telling trustee? Client is willing to fix mistake and then lawyer will turn you in? Problem 8.5: Do you turn your ex client into the court? This is confidential information. Mr Meastre is not a present client; he is a former client. You need to keep confidences of former clients. What about 3.3? Maybe it wont be assisting fraud to keep silent, especially considering that there is an argument that the composite document rule covers this whole thing and it meets 9. MRPR: a lawyer is required to keep confidences of a former client. Does 3.3a2 required you to turn in a prior client (it clearly requires you to turn in a present client). Assisting does not mean aiding and abetting in the criminal law sense.

19

Secured Transactions Outline- Kauffman 2003

Assignment 9: What Collateral and Obligations Are Covered? 1) Interpreting Security Agreements 2) Debtor Against Creditor a) 9-102(a)(73): security interest is contract between creditor and debtor so general contract interpretation rules apply. See 9-201, 1-203, 1-205. 3) Creditor Against Third Party a) 9-201(a): contract between two parties binds third party as well. 4) Interpreting Descriptions of Collateral a) Court usually uses Art. 9 definitions of collateral when parties use them in security agreements. (e.g. SI in accounts may have been intended to cover bank accounts, but bank accounts are expressly excluded from accounts under 9-102(a)(2)). 5) Sufficiency of Description: Article 9 Security Agreements a) Description is primarily to enable interested parties to identify collateral. i) In re Shirel (1) Merchandise did not sufficiently describe an interest in a fridge. (2) 9-108(c): all debtors assets or equivalent does not sufficiently describe collateral. However, all inventory, equipment, and accounts, is ok. 6) Describing After-Acquired Property a) 9-204(a) allows security interest in after-acquired property (although descriptions can use other words and sometimes even be simply implied in description and be enforceable). i) Stoumbos v. Kilimnik (1) Description of equipment does not imply after-acquired property, although inventory does. (a) Use of after-acquired is to allow security interest to float on collateral that constantly changes. Collateral is often the category rather than the individual items contained in it. After-acquired clauses become ineffective after filing bankruptcy 552(a). 7) Sufficiency of Description: Real Estate Mortgages a) Similar to Art. 9 in purpose (identify collateral), although will often use references to maps or public records, and parole evidence is also often used. Not much use for after-acquired property clauses, although they are allowed. Mortgage typically applies to all current and future fixtures. 8) What Obligations Are Secured? a) 9-204(c): allows for security agreement in future advances. i) Security agreements can include dragnet clauses where every obligation of any kind that comes into existence in the future is secured, although some states disfavor them and will require strict proof that later advance was one that parties contemplated when they made the contract. ii) Security agreements also generally include nonadvance provisions where attorneys fees and collection expenses are included in total debt. 9) Class notes:

20

Secured Transactions Outline- Kauffman 2003

a) On an ambiguous security agreement, 2nd lender wont loan unless they are prepared to be second
in line.

b) 9-108(b): categories are acceptableuse to get all debtors property


Problem Set 9. Problem 9.1: The farmer gives security interest in crops growing on farm in Osprey, County, about 14 miles from Tilanook and most of their farm equipment. With crops growing on land, you have to describe the land too. The land description seems ok. The farmers want to borrow more money from another lender but that lender wont go because the crops are already encumbered by first national. The security description is ambiguous. Suppose repayment is one year, then current crops may be the only crops encumbered. But if at the time the loan is taken out, and there is no current crops, maybe the security interest is for the future crops growing on the land, meaning that whatever grows on land becomes a security interest. This would apply to future crops. You want to know more details. What should the farmers do? Litigation takes time. They want a security interest in crops because crops means cash. Equipment sits in fields. What about the land itself? The land is probably encumbered already. They could always sue their lawyer. The lawyer that left them in this fix is a perfect target. With malpractice insurance, if there is a plausible claim, the lawyers will settle and not fight it. Problem 9.2: What about the sheep the farmers raise on the property? Are the sheep equipment? Are they crops? They are valuable for their wool, meat, and milk. The wool is a crop in Websters dictionary. The security agreement says crops growing on farm. Maybe the sheep are on land and not on farm. What is the difference? An opinion letter leaves great potential for malpractice. You cannot give an opinion letter in absolute affirmation that the sheeps wool is not covered. There is a small risk but the odds are in their favor. Problem 9.3: The security agreement says all of debtors equipment, including replacement parts, additions, repairs, and accessories incorporated therein or affixed thereto. Without limitation the term equipment includes all items used in recording, etc. Does this include new equipment? Does the word additions sufficiently describe after acquired property? It might, but its not clear? This description comes out of a case, in which the court granted summary judgment against the secured creditor. It is an example of the court. You can define it at one level of generality such as equipment, etc (but cannot use all consumer goods under 9-108c), as long as it is not supergeneric under 9-108c, such as all assets or all property (to protect the mom and pop stores). If you want to include everything, you need to list the types of property, such as inventory, equipment, A/Rs, farm products, etc, and state after acquired property too (look at 9-108). You could create a standardized form and check off what does not apply. The purpose of this section was to protect the consumer. Problem 9.4: Walter should outfit their ash register with a documentation database that will give a computerized security agreement at the point of sale. Problem 9.7: client executed a security agreement in 1997 in accounts. The creditor is now claiming that accounts include the proceeds owing from the sale of real estate. Accounts did not include real estate proceeds in 97, but became accounts upon adoption of revised Article 9. Did the expansion in article 9 definitions of accounts expand the scope of First Banks security interest? If you use an Article 9 definition, you are stuck with an Article 9 category over time. You have to tell your client that he cannot ignore First Bank. There is no way to handle this problem without dealing with First Bank. ASSIGNMENT 10: PROCEEDS, PRODUCTS, AND OTHER VALUE-TRACING CONCEPTS

21

Secured Transactions Outline- Kauffman 2003

1) Proceeds a) UCC 9-102(a)(64) gives broad definition i) Proceeds includes: (1) Whatever is acquired upon the sale, lease, license, or exchange or other disposition of the collateral (a) NOTE: gives rights into the entire value of the exchanged despite value that might me added from wholesale to retail. (b) McLemore, Tustee v. Mid-South Agri-Chemical Corp. Held that a cash payment for not planting crops under a federal subsidy program was proceeds acquired from the disposition of crops. (2) Whatever is collected on, or distributed on account of collateral (3) Rights arising out of collateral (a) Nobody has any idea what this means (b) Can be used to give rights in anything connected in any way with the collateral. (4) The value of collateral, claims arising out of the loss, nonconformity, or interference with the use of, defect or infringement of rights in, or damage to, the collateral (a) Insurance payable by reason of the collateral, to the extent of the value of the collateral and to the extent it is payable to the debtor (5) If proceeds become collateral 9-102(a)(12), then the proceeds of proceeds come under the security agreement. ii) Value Tracing is the policy reason behind including proceeds. iii) Rights to proceeds attaches automatically. UCC 9-203(f), 9-315(a)(2). 2) BUT the security interest in the property continues notwithstanding sale unless authorized. UCC 9315(a)(1). a) NOTE the multiplication of value for the creditor contrary to the value tracing principle. b) Authorization can be explicit or implicit. i) If the creditor allows sale and later tries to enforce the provision, courts will deem the provision waived. (but these are mostly livestock cases and sales resulting in waiver are fairly continuous.) c) Lack of authorization to sell the collateral will require a closing if the debtor wants to sell, but will require that the debtor have at the time of closing the difference between the outstanding balance on the secured debt and the sale price. d) Many states have criminal statutes against the unauthorized sale of collateral e) UCC 9-401 agreement which prohibits transfer does not prevent transfer. i) The result is that the buyer may unwittingly take subject to the prior security agreement (But see buyers in the ordinary course of business in assignment 36) 3) Limitations on the Secured Creditors Ability to Trace Collateral a) Only identifiable proceeds are covered. UCC 9-315(a)(2) i) Commingled collateral is still identifiable (1) Grain in a storage silo (2) Cash in a bank account (a) Lowest intermediate balance test amount collateral in the account will be equal to the lowest intermediate balance between the time the collateral was deposited and the time the rule is applied. (i) In re Oriental Rug Warehouse Club, Inc Proceeds from the sale of collateral (oriental rugs) went into a bank account. Funds from account were used to buy new inventory. Held that if the creditor wanted new inventory to secure the old debt he should have required a separate bank account. [or presumably put in an after acquired clause.]

22

Secured Transactions Outline- Kauffman 2003

(3) UCC 9-332(b) transferee of funds from a bank account takes free and clear unless he acts in collusion to defraud the secured party. 4) Other Value-Tracing Concepts: Products, Profits, Rents, Offspring a) Profits are most often seen in the case of agriculture: wool is the product of sheep, milk the product of cows, etc. b) Note they may also be proceeds since they arise out of the collateralbut nobody is sure. c) Become more important in bankruptcy where the definition of proceeds is narrower. 5) Non-Value-Tracing Concepts: After-acquired Property, Replacements, Additions, Substitutions a) The distinction between after acquired property and proceeds can a fine one. So include both. 6) Class Notes: Unless it qualifies as a BP in OCB, the third party, although innocent, is liable for the collateral because of conversion. The tort of conversion does not require any kind of scienter. The innocent converter is liable for exercising dominion over anothers property and has to pay. a) Materials talk about two kinds of situations: value tracing kinds of ways of following collateral and non value tracing. This means that in the first category you have to be able to identify the additional, new collateral as something that the old collateral was used to generate. The old collateral was sold for money, trace those exact dollars from the old collateral into the new collateral. Its not enough to show that old collateral was disposed. The non-value tracing is not limited by value. It is best seen as after acquired property. It is new collateral not traced to old collateral. Problem Set 10. Problem 10.1: First Bank has secured interest in equipment, inventory, and accounts without mention proceeds, products, offspring, substitutions, additions, or replacements. 9-203(f) the attachment of a security interest in collateral gives the secured party the rights to proceeds provided by 9-315, and is also attachment of a security interest in a supporting obligation for the collateral. 9-315a2, a security interest attaches to any identifiable proceeds of collateral. Any manufacturer selling to retailer does not expect that security interest will follow into car itself. Of course, it wants security interest in proceeds. Problem 10.2: What of the following are collateral of FB under secured interest in equipment, inventory, and accounts? a) $ is now in Pollys bank account. Accounts is defined in 102(a)(2). The term means a right to payment of a monetary obligation, whether or not entered by performance. Account does not mean deposit account. The money in deposit account could, however, be proceeds from inventory sold or equipment sold. The most likely scenario is that they got paid on their A/R. b) The parrot that Polly took in payment of an overdue account. The text suggest that after acquired property is inferred when you take a security interest in inventory and accounts (since they are constantly changing). You should include the magic words of after acquired accounts. But in this case, the courts would probably infer intent. The parrot falls under the definition of proceeds. 9-102a64: proceeds whatever is acquired upon sale, lease, license, exchange, or other disposition of collateral, etc. c) New computer to replace the old one? She would have to use the proceeds to buy it. Replacements are not mentioned in security agreement. What about equipment? Does after acquired property work for equipment too (its seems like it is inferred to A/R and inventory but not equipment). The secured creditor is the enemy in the bankruptcy proceeding. The whole system is geared towards producing money for unsecured creditors. d) Myna Bird: is it not an account because a Myna Bird is not a monetary obligation. The bird is not part of the business because its kept as a pet its not equipment or inventory.

23

Secured Transactions Outline- Kauffman 2003

Problem 10.3: What about security interest in race horse and proceeds, products, and profits. The horse wins 50 grand purse. Maybe the purse is a profit. You cannot get the purse in 102(a)(64) because you did not get the purse in disposition of the collateral. What about 102(a)(64)(c)? It could be rights arising out of collateral. Problem 10.4: J contracted to buy Toy Shop. Can inventory become A/R? Inventory could transform into an A/R, and then that money could come in and become furniture, equipment, fixtures, etc. The description in the security agreement is a starting point but that description does not limit the coverage. It gives the creditor an interest in lots of other property. If the debtor has already given a security interest, it makes the job of a lawyer very difficult. We want to get rid of the inventory loan that B took out. Once this loan is paid off, the security interest will be gone. It goes with the debt. Problem 10.5: ELP loaned Golan money to buy copier (35 grand), Golan gets loan, and signs a security agreement. The security agreement list copier with serial number. The copier gets destroyed. Under 9102(a)(64)(e), proceeds includes insurance proceeds of collateral. a) the insurance company paid proceeds to debtor. It would be a mistake for ELP to be named loss payee. There are two ways for ELP to get protected: 1) have itself named loss payee, as their interest may appear. But if ELP is named as loss payee, and the debtor in applying for insurance has misstated certain facts, the insurance company can assert that defense to the creditor. 2) The secured creditor can make sure that it is named in standard mortgagee clause, and if named, you get first dibs, and you are not subject to insurance companys defenses. It has not cost anymore to get a standard mortgagee clause. The lawyer who lets the debtor get insurance but does not get the creditor a standard mortgagee clause is an idiot. Lawyers dont do it for some reason. The debtor deposits the check in bank account. The proceeds are commingled with debtors funds. We can trace it by using lowest intermediate balance rule: up to extent of collateral value, but the lowest intermediate balance rule says you get the lowest amount in the account. The collateral is 35 grand. When Golan rights a check for 2,000, there is 38 grand left, so its enough to cover the 35,000 grand. The lowest intermediate balance says that the 2,000 that was paid out was paid from the extra 5 grand and not your 35,000 value. Those funds are paid from debtors funds first. Then G writes a check to the IRS for 32000, with 6 grand left in the account. Once the check is written, the creditor is screwed and has only 6,000 claim on that account. The 38 grand was 3 grand debtor cash and 35 grand of secured creditor collateral left. Can you get money back from the 2,000 creditor or the IRS? 9-332b, you cannot trace funds out of bank accounts to the transferee, unless the transferee acts in collusion with the debtor, violating the rights of a secured creditor. A transferee take free and clear. Problem 10.6: What if the debtor wrote a check to buy another copier? What is the collateral now? Is the new machine covered by the security agreement? The security agreement says copier but gives a serial number. You trace the old machine, to insurance, to deposit in account, to new machine. There is 6 grand in account that is still proceeds of old collateral. This is still proceeds. This new machine cost 32 grand. Is this new machine collateral? There are several possibilities. 1) Following Gilmore theory, you could say that the secured creditor security interest is lost. The new copier is not entirely related to secured creditors old collateral interest. Since it is not entirely proceeds, its not proceeds at all. 2) Since if you can trace most of the proceeds, say 29 grand worth, you can trace all the proceeds to the new copier. The collateral grew. But that happens in many types of situations. This is not unheard of in article 9. OR 3) You can identify the bank account. 29/32 of the copier is yours. The authors think that the last suggestion is bizarre. That there is no such proceed interest left in article 9. ASSIGNMENT 11: TRACING COLLATERAL VALUE DURING BANKRUPTCY 1) Differences in bankruptcy under Bankruptcy Code 552 a) Interest proceeds, products, profits, rents and offspring will continue.

24

Secured Transactions Outline- Kauffman 2003

b) But interest in after-acquired property will not


Since the value of after acquired property cannot be traced to original collateral, allowing the security interest to attach would take value that could be distributed among the unsecureds at the benefit of the secured party. ii) It would also allow debtors to covert unencumbered collateral into collateral that would attach to a security interest thereby avoiding their obligations to other creditors. 2) Value tracing in reorganization cases: Courts have used their equity discretion under Bankruptcy Code 552(b) to apportion only part of the value of products to the creditor to allow for reorganization. a) Delbridge lender is entitled to the same percentage of the proceeds that his capital contribution represents to total inputs in production. (See formula on page 188) b) Hotel Sierra Vista (In the case of hotels) lender is entitled to the portion of the room rates that are attributable as rents from room occupancy, but not those attributable to services such as check-in, check-out, room cleaning, bell-hop, telephone, ice making, etc. 3) Are all proceeds under the definition in article 9 proceeds in bankruptcy? a) 5th and 9th circuits have said yes b) 11th Circuit says no because that would give state law makers the ability to define terms in the federal bankruptcy statute i) If this rule prevails, the definition is probably that under article 9 at the time the bankruptcy code was adopted: (1) Proceeds includes whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds. Insurance payable by reason of loss or damage to the collateral is proceeds, except to the extent that it is payable to a person other than a party to the security agreement. 4) 4 interpretations of proceeds under article 9 are possible: a) new article 9, b) 1978 article 9, c) Delbridge and d) Hotel Sierra Vista 5) Cash Collateral in Bankruptcy a) Review Adequate Protection b) Because cash collateral is liquid, Bank. Code 363(c)(2) requires notice to a secured creditor and the opportunity for a hearing before a trustee or a DIP may use cash collateral. i) Must arrange adequate protection ii) Immediate nature of the need to use cash collateral means such hearing happen over the phone at uncivilized hours. Problem Set 11. Problem 11.1: What about the racehorse example, winning a 50 grand purse, where the security agreement said proceeds and profits? The debtor filed bankruptcy. The horse won the purse. Does filing petition change situation? Its either proceeds or its not. If that security interest is good, and gets resolved in favor of secured creditor, one looks at bankruptcy act 552, and the dollar bills are proceeds of track promise, then the situation is unchanged, and the proceeds serve as collateral to secured creditor. Problem 11.2: the security interest includes all equipment, accounts, and inventory. Does the later work, creating a new account, create a security interest for First Bank? Thats an after acquired property clause, i)

25

Secured Transactions Outline- Kauffman 2003

and you cannot do that in bankruptcy. The other argument is that this is just proceeds. The account arises out of her services. Suppose she uses inventory and equipment to produce this account receivable. Then you can argue that the account is a right arising out of the collateral. Proceeds include accounts received upon the disposition of the inventory. There is nothing in there that says proceeds have to come entirely from the disposition. The court probably wont buy this argument. The court is likely to say that the equipment and value of inventory used up was negligible. Somewhere half way in between where some inventory was used would probably go half way. It is not at all clear that a court would say it was not proceeds. The proceeds cases have been pretty generous. Problem 11.3: The copy fire problem. After fire but before insurance, Golan filed for bankruptcy. Golan got the check for 35 grand, deposited it, and then started to write checks. The thing that is different is that under automatic stay provision, there is a chapter 11 reorganization, operating under bankruptcy rules, the debtor in possession was acting in possession, and the secured creditor had as proceeds 35 grand in bank account. Under 363, the debtor before it used that money was suppose to get permission of the court and it did not do so. The debtor used the money wrongfully because of a lack of permission. The creditor may be entitled to adequate protection here. The trustee could probably void the transaction. There is an argument under 549, that the trustee could upset that transaction and forcing the third party transferee to give the money back on tendering the new copier. Problem 11.4: Security interest in Hotel Sierra Vista. What does the secured creditor get under Sierra Vista? You have to distinguish the revenues generated by room rental from services. If you do it that way, there is a loss. The cash collateral would be 0. Under Delbridge, there is no depreciation, so the cash collateral would be 0. Under 552, it applies to revenues and not net revenues, so all $510,000 from room revenues goes to cash collateral and proceeds. All authors of article 9 are trying to expand definition of proceeds. If you think reorganization should be carried out, then read net into revenues, but if read literally then read just revenues. Problem 11.5: the secured claim is 700,000. The 10,000 rent is received after filing. Is that collateral? Yes, it is under 552b. The statute does not say anything about net rents. So it probably means gross rents. You would argue that you need adequate protection against apartment house and decline in value of rest of collateral, which is 10 grand a month. You should win on this argument because Pine Manor has no other property. Globus should lift the stay instantly. You go to 7 oclock hearing and oppose the motion. The one critical thing needed to allow reorganization to go forward is that Time Manor afford adequate protection. Chapter 4. Default: Gateway to Remedies ASSIGNMENT 13: DEFAULT, ACCELERATION, AND CURE UNDER STATE LAW 1) Default a) Both secured creditors and debtors are interested in precise definitions of default. i) If creditors exercise remedies before the debtor is in default they will be liable ii) Debtors want default provisions defined as narrowly as possible to avoid them 2) When is Payment Due? a) In an installment loan, payment is due in a series of scheduled payments b) In single payment loans the entire value of the loan is due on a particular day i) Loan on a particular account receivable ii) Rollovers loans made payable with no expectation that the loan will be continued if the account remains in good standing.

26

Secured Transactions Outline- Kauffman 2003

iii) Loans on demand lender can call the loan at any time.
c) Lines of Credit i) A typical arrangement: (1) Bank contracts to lend up to a fixed amount of money (2) Lender borrows on the line as he needs it by writing a check on his bank account at the bank (3) Bank covers any overdrafts up to the line of credit (4) As the debtor receives revenues from its operations, it pays down its obligation on the line of credit. ii) When are they due? (1) Sometimes the contract specifies a due date during the debtors off season (2) Many times the expectation is that a certain balance will be rolled over. 3) Acceleration and Cure a) Acceleration i) by contractual provision, the creditor specifies that if the debtor fails goes into default in any way the entire outstanding balance of the loan will be due b) Cure i) debtor pays the amount of the loan on which he is in arrears. Acceleration generally has the effect of eliminating the debtors ability to cure its default. c) Limits on the Enforceability of Acceleration Clauses i) A creditor can accelerate for any default no matter how small, even if the debtor is current on its payments ii) If a creditor accelerates because he feels the prospect of payment is impaired, he must demonstrate a good faith belief that repayment is impaired d) The Debtors Right to Cure i) GENERAL RULE: Once acceleration occurs a debtor may redeem only by paying the entire outstanding balance on the accelerated debt. ii) Some states provide for reinstatement by statute (1) Allows debtor to cure and reinstate by payment of only the arrearages (2) Generally apply only to home mortgages and consumer borrowers and a few other similar circumstances. 4) The Enforceability of Payment Terms a) Courts have split on whether or not creditors have obligations to debtors when they loan on demand i) 6th Circuit Lender Liability the obligation to act in good faith requires a period of notice to allow reasonable opportunity to seek alternative funding. ii) 7th Circuit Easterbrook not in the seventh circuit knowledge that literal enforcement means some mismatch between the parties expectations and the outcome does not imply a general duty of kindness... iii) Some changes have been made to revised article 9 and revised article 1 reflecting these concepts of good faith, but they are unclear and revised article 1 has yet to be adopted in any state. 5) Procedures After Default a) A secured creditor has a number of options available after default. The one he chooses will depend on what he knows about the debtor i) Self-help remedies: repossession or notification to account debtors (debtors of the debtors) (1) Creditor risks a lender liability action if debtor is not in default

27

Secured Transactions Outline- Kauffman 2003

ii) Foreclosure (1) Safer but is slow and the debtor may be selling off his assets iii) Replevin (1) Middle ground: heard much faster and though the debtor doesnt have to respond, often will to try and keep control of assetsallows creditor opportunity to evaluate defenses. Problem 13.1: Pat missed two payments of $434. She noticed her omission before bank gave notice of acceleration. She sent a check for overdue payments. The bank says that the K says its a default and the secured creditor can accelerate the loan. The bank mailed the check back to her saying that they called the whole loan, requesting the balance. Does the bank have to give notice of acceleration? Look to the K? The authors do not say anything, so assume there is no notice provision. Compare acceleration v. debtor tendering payment. When does tender payment happen? If they accelerate the books by making the entry that is pretty good evidence that accelerated before debtor tendered payment. But when they get the check, why should bank send it back. Apply it to payment of principal. Is it a waiver of default to deposit the check? Its an intentional relinquishment of rights. She may have an estoppel claim. The debtor must show some king of reasonable reliance to his detriment. Many banks return the checks in situations like this to avoid any possible claim that they waived default by the debtor. Problem 13.2: You are asked advice by friend with temporary cash flow problem who cannot pay mortgage (monthly payment of $860). He missed the October 1 payment. He is worried about what happens next. The default provision is set out in the example: default means an outstanding amount EXCEEDING one full payment which has remained unpaid for more than 10 days after the due date. When does the debtor absolutely have to make the payment? Nov. 12 (10 days over due). If interest was accruing on unpaid portion, then he is in default when interest accrues on October 12. Some states dont allow the accrual of interest by overdue payment by statute. They are talking about payments. When do you make payments? It requires a really close reading of what arguments are there for your client. Its either the bank or the debtor. With the IL reinstatement statute, the debtor could redeem within 90 days starting from the foreclosure notice. IL really helps out the debtor a lot in that situation. You have to pay the attorney fees due to the bank. The cost of foreclosure is steep. The charges for the whole proceeding oftentimes runs 10,000. Can the bank argue that the whole is due even though foreclosure did not go through. It is costly for the bank. Every state has a rules of responsibility that fees must be reasonable. A lawyer who enters that fee arrangement must be very careful. Problem 11.3: there is a provision in the loan agreement requiring that insurance be effective and notice be given annually to secured creditor and failure to give notice is an event of default. Can you recall the loan? There is a general requirement of good faith. 9-102 defines good faith as honesty in fact and the observance of reasonable commercial standards of fair dealing. 9-102 definitions only apply to article 9 issues. As of this moment article 9 has only been passed in VA and TX. The present article 1 definition in every state except VA and TX only talks about honesty and fact. This is an easier standard to meet. There is a disconnect between article 1 and revised article 9. A court sympathetic to a debtor would have to follow the comment. Easterbrook would say that the K declares default and the secured creditor can take advantage of it. How about the secured creditor waiver by not asking proof of insurance (waiver by estoppel since it did not ask in the past)? Its hard to find a waiver by not acting within 23 days in Hale case (where the bank met with the debtor and remained silent). Problem 13.4: A debtor gets a line of credit with a bank and signed a demand note. The debtor is in no position if the demand note is called. What if the bank decides to execute the demand provision and calls the loan? If she cannot meet it instantly, the bank will follow it up with a writ of replevin and shut her down. Oral assurances? They are not worth anything. Oral assurances are certain to be followed up by a written agreement. If not written, the PE rule will keep them out. You can call it an assurance or a

28

Secured Transactions Outline- Kauffman 2003

prediction. When pushed came to shove she signed a demand note. Maybe she got a lower interest rate for signing a demand note. She could make the loan come due once a year instead of on demand. What about relying on her relationship with her loan officer? There is always turnover. She is only liable up to the amount that she took out. If she wants the money, she should sign the note. That is the way business is done. If she makes too much noise about it, she will go down as a trouble maker. Problem 13.5: The loan officer wants to give the debtor in financial trouble 30 days notice to find additional money to deal with financial problems instead of pulling the plug. They buy their inventory on credit, and as the loan officer looks at collateral they have, it looks like they will lose 50 grand. This is a long time customer, who has been a good debtor, so give him another 30 days. The debtor may deplete the inventory. Giving 30 days notice puts the bank at risk. When it looks bad enough, your initial instinct is that the bank would be better off if you pull the plug now. But watch out for Lender Liability. Problem 13.6: It looks like lender liability to tell another lender the financial problems that caused initial lender to call loan. It blocks attempt to refinance. It destroys business. If complaint looks good enough, then maybe initial bank would work with you. If you really think the threats are empty, but you still want to be careful. You should still call the loan, but hold off on getting a writ of replevin. You probably will face liability for destroying the debtors business by proceeding without notice. Advising the client is pointing out all the risk. If you proceed by thinking you are in a 13.5 situation, but you are not really in a 13.6 situation. Recite the whole history of what happened. ASSIGNMENT 14: DEFAULT, ACCELERATION AND CURE UNDER BANKRUPTCY LAW 1) Stage 1: Protection of the Defaulting Debtor Pending Reorganization a) Stay is automatically imposed and remains in effect until a plan is confirmed. b) Debtor must still provide adequate protection: only protection against decline in the value of the interest in the collateral. c) Ch. 13 debtors will have to resume making payments no later than 45 days after petition for bankruptcy d) Ch. 11 debtors need not resume payments until a plan has been confirmed by the court 2) Stage 2: Reinstatement and Cure a) Modification Distinguished from Reinstatement and Cure i) modification allows the rewriting of the loan provided that: (1) minimum due under modification = the present value of the amount allowed under the secured claim using a market rate of interest. (2) Ch. 11 allows payments to extend over any period that is fair and reasonable (3) Ch. 13 only allows payments over the period of the plan (usually 3 years). ii) Reinstatement = return to the original terms after cure. b) Reinstatement and Cure Under Chapter 11 i) allows for resuming the obligation of the current loan if: (1) the debtor cures any default occurring before or after the commencement of the bankruptcy (courts: lump sum at the effective date of the plan.) (2) future payments due as specified in original contract (3) creditor is compensated for damages incurred through reasonable reliance (4) the plan does not otherwise alter the legal equitable or contractual rights of the secured creditor a. If conditions are met, plan may be imposed on the creditor. ii) Why would the debtor choose reinstatement over modification? (1) Modification is prohibited on mortgages against the principal residence of the debtor in both 11 and 13.

29

Secured Transactions Outline- Kauffman 2003

(2) Debtor may wish to preserve some favorable term in the original contract (such as favorable interest rate.) c) Reinstatement and Cure Under Chapter 13 i) allows for resuming the obligations of the current loan if: (1) cure all defaults as in 11, but only within a reasonable time not lump sum. (cannot extend beyond the period of the plan). (2) Future payments must remain due at the times scheduled in the original contract (3) Compensation for damages will be required only if required under state law. Some states require interest on overdue arrearages, others do not (4) The plan does not alter the legal, equitable, or contractual rights to which the holder is entitled. ii) Ch. 13 debtors are more likely to use reinstatement rather than modification because modification can only last over the period of the plan (usually 3 yearstoo short for longterm obligations) d) When is it Too Late to File Bankruptcy to Reinstate and Cure? i) DeSeno says that modification but not reinstatement is available to debtor in possession (after foreclosure). ii) Bankruptcy Reform Act (1994) says reinstatement available until the residence is sold at a foreclosure sale and modification has since been disallowed under 11 and 13 for primary residences iii) The result is that a debtor in possession can reinstate but not modify mortgage on primary residence. e) Despite more favorable treatment in 11, debtors still choose 13 because it is less expensive: i) Chapter 11: $800 filing fee; $2,500 total (based on inexpensive fees) ii) Chapter 13: $130 filing fee; $600 total 3) Binding Lenders in the Absence of a Fixed Schedule for Repayment (Lines of Credit Payable on Demand) a) No right to cure under bankruptcy Problem Set 14: Problem 14.1: What can the debtor do in bankruptcy to change position from 13.5? The debtor could stop bank in its tracks by filing chapter 11. If indeed Rebel is viable, and can give the bank adequate protection, it can keep operating. Sometimes the bank will just tell Rebel what it proposes to do and that he will file chapter 11. The bank will give same advice as Rebels lawyer. Problem 14.2: the bank will lend Teresa $150,000 according to two options. 1) lend at prime plus 2% on demand note; or 2) lend at prime plus 3.5 with a 30 days notice provision if not in default. What can Teresa do? She can either refinance or file chapter 11. Under bankruptcy, the automatic stay will keep her in position, and if she is viable, she can cram down a plan even if the bank does not like it. If she is viable, she can find another bank and refinance. And if thats realistic, the bank really should give her time. Suppose she is not really viable, the 30 days is not going to do her much good. If she is really not viable, she will not be able to find substitute financing. That interest is a lot to pay, given the alternatives from chapter 11. You are better off taking prime + 2%. Does the loan look any different from a line of credit of 150,000? You should pull full line of credit, and then file in chapter 11. However, there is a big upside in bargaining for an advanced notice with an agreement in the loan agreement that you can borrow full amount. You should pull it all out and file chapter 11. Problem 14.3: homeowner financing mortgage at 8%, and then goes into default, with a stream of letters from the lender, and then the lenders lawyer with increasing demands. Under chapter 11, if he cures, he

30

Secured Transactions Outline- Kauffman 2003

has to pay lump sum from arrearage at effective day of plan. He would also have to make up post petition results, and the big chapter 11 filing fee. Suppose you advise him to go into chapter 13. He does not have to cure the default in a lump sum. He has to pay it over a period of the plan. The chapter 13 fees are not as big either. Under chapter 13, you have to file a plan within 15 days and pay 30 days after that initial 15 days. Also, they may be able to charge interest on the arrearage depending on non-bankruptcy state law. For this client, make sure he makes payments soon. b) What about a balloon payment after five years? She could reinstatement and cure. But she would have the balloon payment due in two years anyways. Reinstatement under chapter 13 works well with long-term mortgages. But you cannot get a planned confirmed under 13 unless she can proves that she can make the payments. Her only possibility is to find another source of financing and with her difficulties that is highly unlikely. Under part d), what if she moves out, and rents it out, using the rental payments to rent another house? If she moves out, its not her principle residence, and she can modify under chapter 11 and stretch the payments out over 20 to 30 years, paying a higher market interest rate. But she keeps the house. e) If Willard did not file but instead re-negotiated terms, paying a higher interest rate and 6 months to pay fixed arrearage, what is his best move? Dont file chapter 13 until the 6 grand is past due so that its not maintained under the plan but rather as arrearage. Chapter 5. The Prototypical Secured Transaction Assignment 15: The Prototypical Secured Transaction 1) Bonnies Boat World borrows money from ITT Commercial Finance in order to fund its inventory. There are a few things to note about the security agreement. a) The security agreement includes the typical terms. i) names of parties ii) description of the collateral iii) promises by the debtor and creditor iv) acceleration clause v) list of what constitutes default vi) parties signatures 2) Bonnie is the guarantor. a) A creditor can get the money from the guarantor, who then has the rights to recover from the debtor. b) The guarantor has the rights of reimbursement, contribution, and subrogation (meaning that the guarantor can assert the rights of the bank) 3) Why doesnt Bonnie borrow from the bank directly? a) All of the contractual complexities would be avoided, yet all of Bonnies assets could still be seized by the company. i) However, the bank could only go after Bonnie personally. While this would include her shares in the company, the banks security interest would be subordinate to other creditors who have a security agreement with Bonnies Boat World directly. 4) The casebook stresses that the terms in the security agreement seem to be unfair to Bonnie. a) Banks have strict contract terms rather than offering a complete menu of terms with different prices. b) For one thing, banks would not want to lend to anyone who would agree to a huge interest rate. This is a sign that the borrower has no intention of re-paying the loan. Usury laws also prevent banks from charging ridiculous rates.

31

Secured Transactions Outline- Kauffman 2003

5) Field warehousing a) The debtor is typically willing to offer as collateral items debtor needs for its business (inventory, equipment). b) If the creditor is worried about leaving the debtor in possession, the creditor will let the debtor continue to use the collateral to produce the funds to repay, but the secured creditor will establish tight controls (more than inspection checks). c) The secured creditor establishes a physical warehouse on the debtors premises. Under lock and key The secured creditor requires that the inventory be deposited in the locked portion of the premises, which is under the control of an employee of the field warehouse company. It was a way of preventing the debtor from disposing of the collateral without paying the loan out of the proceeds of the sale. i) It is an expensive way of monitoring, and it had some flaws. (1) Main flaw: The operation of the field warehouse required knowledge of debtors trade and business. The secured creditor would hire an employee of the debtor and take the employee off the debtors books. If the employees loyalty was to the debtor, the monitoring was ineffective. Problem 15.1(a) The problem was identical to a real case. Allied Crude Vegetable leased the oil tanks of a refinery. They persuaded the creditor to operate a field warehouse on the premises, which was a wholly owned sub of American Express. They induced the major producers of salad oil to store their oil in those tanks. Allied acted as either (1) broker (agent for sale) or (2) purchaser for resale on its own account. The major figure in Allied had been prosecuted for fraud in an earlier point in his career. A number of his employees were hired by the creditor to operate the field warehouse. He stole blank receipts, presented them to the banks, and got huge loans from the banks. He managed to sell most of the vegetable oil supplied by the major companies and pocket the proceeds. The field warehouse employees, the suppliers and the banks secured creditors would check the collateral. How were they deceived? 1) The tanks only had a small amount of oil on the tops. 2) There was a glass cylinder that was pure vegetable and the rest was water. 3) The tanks were interconnected, so they would change the contents of the tanks as the checkers moved around. Allied had loans for more vegetable oil than could actually be produced through out the country. American Express was not a corporation (at the time). The individual stockholders were individually liable for the debts of American Express. It was formed under an ancient statute. They settled and could not take the risk that the corporate veil would be pierced. The major figure in Allied went to jail. Problem 15.2(a): What if Bonnie sells as many boats as possible and wires proceeds to Bahamas? How can you stop her? Requirement that the buyers bank send the money directly to the creditor. More checks by the inspector. Look for advertising of sales.

32

Secured Transactions Outline- Kauffman 2003

Surprise inspections or requirement that the debtor keep the bank account at the creditors bank. Some creditors have too many debtors to monitor all of them. They rely on the initial credit check and do not perform random checks.

15.2(b) Debtor sells the boat and does not report the sale to the secured creditor. Look at the registration numbers on the boat. Look to see if the buyer has painted a name on the side of the boat. Check the sales ledger, but the debtor might keep two sets of books. 15.3 Personal guaranty of the debtor (p. 265). 9 out of 10 cases, you cannot collect on them, so how are they useful? Induces the owners to cooperate. The debtor will have an incentive to avoid or minimize the judgments that might be taken against them. The debtor will want to avoid the stigma of bankruptcy. Trade-off: May loose business to banks who are less risk-averse and dont require personal guaranties. Problem 15.4 (a): The bank declared BBW in default and demands surrender boats. The agreement for wholesale financing and the floorplan agreement give the secured creditor the power to repossess the boats at its discretion; notice is not required. 9-601(a) after default, a secured party may reduce a claim of judgment, foreclose, or otherwise enforce the claim, security interest, or agricultural lien by any available judicial procedure 9-609(a) a secured party has the right to possession of collateral after default. 9-609(b) The secured party may proceed without judicial process (i.e, self-help) if it proceeds without breaching the peace. Problem 15.4(b): The debtor gives up the collateral without a fight: 9-608(a)(4) a secured party shall account to and pay debtor for any surplus, and the obligor is liable for any deficiency. The debtor might have to file for bankruptcy. She could be prosecuted under the Illinois statute: Ill Statute (p173) it is unlawful for a debtor to dispose of the collateral and willfully and wrongfully fail to pay the secured party the amount of proceeds due under the security agreement. Failure to pay within 10 day is prima facie evidence of a willful and wanton failure to pay. The bank could prosecute the debtor to send a message to its other customers. Problem 15.4(c). Does the debtor have the power to keep the boats? How long? If the bank tries to repossess the boats, the debtor could create a breach of the peace. The secured creditor will be required to use judicial process. File a petition in chapter 11 automatic stay stops the replevin. The bank will have to get the stay lifted, which will take time and money. What is the point of doing all this? Can the debtor can use the threat to delay in chapter 11 to get them to agree not to prosecute her? Problem 15.4(d). Model Rules of Professional Conduct

33

Secured Transactions Outline- Kauffman 2003

A lawyer shall not threaten criminal prosecution solely to gain advantage in a civil matter. In this problem, it is the other way around. The debtor wants the secured creditor to give up an advantage in the civil matter. Does it turn on whether in the first instance, the secured creditors lawyer has mentioned the violation of the criminal statute? Designed to prevent lawyer conduct that looks like extortion. If the lawyer does not go to the prosecutor, it looks suspicious. This has been a requirement of determining whether solely was met. If the secured creditor agrees not to prosecute it supports an inference that the purpose of threatening the criminal prosecution was to return the stolen money. The client can make the deal not to prosecute, but the clients lawyer cannot. Can the lawyer tell the client to threaten criminal prosecution? A lawyer cannot violate the rules through the actions of another.

Problem 15(d): Shoreline has agreed to buy repossessed boats for full amount due. What about Shoreline? If Shoreline has to pay Dbank more than the boats are now worth, and Shoreline sells them, can they get a deficiency judgment against Bonny? You need to know about subrogation doctrine. Trent Lumber Company: Trent financed products through WARE, and then went to a second finance company to get more funds, and then Associates, which paid off WARE, and took a note from Trent Lumber and took a security interest from Trent, but did not take an assignment from WARE of its security agreement, and then on the record, it did not proceed to the priority position of WARE over the second lender. When the case gets in the court, Associates could have taken an assignment and gotten priority, but the court bails out Associates, and says that by paying off the debt to WARE, by equitable law, the doctrine of subrogation, Associates succeeds to the position of WARE and has priority over the second lender. Thats the equitable doctrine of subrogation. Since Dbank could go after Bonny for deficiency, and Dbank is paid off in full under agreement by Shoreline, do the subrogation analysis. Look at 9-615d. Under 9-618, the secondary obligor gets rights after it receives assignment, transfer or subrogation from secured party. Shoreline, being a secondary obligor, is not in disposition of the collateral. Under article 9-618, the drafters makes it very difficult to get a deficiency judgment against Bonny. Subrogation does not save Shoreline.

34

Secured Transactions Outline- Kauffman 2003

Part Two: The Creditor-Third Party Relationship Chapter 6. Perfection ASSIGNMENT 16: THE PERSONAL PROPERTY FILING SYSTEMS 1) Priority a) Establishes a relationship between creditors vis a vis collateral. b) If creditor A has priority over creditor B, on default and foreclosure, A gets the entire value of his outstanding debt before B gets a penny. 2) How Do Creditors Get Priority? a) GENERAL RULE: liens rank in the chronological order in which they are perfected. A lien may be perfected by: i) Filing ii) Possession iii) Control iv) Posting notice on the property b) Policy: i) Notice to other creditors who are thinking of lending on the collateral 3) The Theory of the Filing System a) Filing system allows those with a security interest in property to leave a message giving notice to other creditors b) Problems: i) Sophisticated lenders will know about it while the unsophisticated will not ii) Knowledge of its existence is not enoughmust know the rules iii) Searching is difficult and expensive and adverse consequences only arise if the debtor lies on the loan applicationresult = disincentive to file. 4) The Multiplicity of Filing Systems a) Each county can have a variety of recording systems: i) UCC ii) Real estate recording system iii) Property tax lien recording system iv) Local tax lien recording system v) Money judgment recording systems b) In addition there are federal recording systems i) Copyright Office ii) Office of Patent and Trademarks 5) Methods and Costs of Searching a) Methods: i) In many filing offices, only employees may access records, although some allow members of the public to search. ii) Lawyers generally choose to go through a service company. b) Costs: i) Searching (1) $50 per name is not unusual (2) May have to search multiple names or variations of a name or both. (3) Tack on the cost of the service company and you are talking about real money for smaller lenders (4) And add on $1 per page for copies of records, overnight deliveries ii) Filing (1) Service company: $15

35

Secured Transactions Outline- Kauffman 2003

(2) Filing Office: $5-$25 iii) Costs can be reduced by dealing with the office often and knowing the procedures, having an account with the office, or even being able to access the records from a remote terminal. (1) More advantages to large sophisticated lenders. c) Sometimes it is best to just file everywhere if you are uncertain what type of property you are dealing with, but the decision where to file requires an understanding of the law. Problem 16.1: Felicia (judgment creditor) wants to have sheriff levy on car (Honey), and you discover that there is a security interest on car given to Bernie. Felicias lien is not perfected since Sheriff does not have possession. Bernie is perfected, and Felicia is not. The debt is greater than the amount of the car. There is nothing left for Felicia. Between these two creditors, its the debtor who has decided who is going to give priority. If this occurred before 90 days of filing before bankruptcy, the TIB can upset security interest as voidable preference. Its up to Bernie to see if he can stay off bankruptcy for 90 days. The sheriff can still go ahead and levy. All Bernie has to do is notify the sheriff and say he has priority over Felicia, and the active sale is a conversion of Bernies rights. Problem 16.2: This is a small claims problem. There is Sergio the street vendor, paying some money to a seller for a vender cart. Seller goes into business, but street vender finds out that seller previously gave a security interest in cart to financer. The financer is fully protected. Street vender is not a BOC of business. Sergio cannot sue seller because of bankruptcy stay. Under UCC, there is nothing you can do for Sergio. You could look to the footnote in Peerless Packing, talking about fraudulent conduct by secured creditor (GFC). Its not general finance companys fraud. Its sellers fraud. The GFC of this world are tuff guys in a tuff business. You can find something to give leverage. Problem 16.3: You are order UCC searches for collateral below in anticipation for lending against it. In what systems will you make the filings and conduct searches? a) Tools: look to state UCC system. The tools are equipment. b) Patent: file in both places- Patent and UCC system, Kazinsky is unclear in National Peregrine whether we have to file in Patent Office. c) Royalty on Copyright: probably in copyright office. You would want to double file because there is uncertainty. What about the proceeds from the copyright? You have to order 119 searches. Thats a lot of money. One of the purposes of the copyright office is to set up a filing system for searches. That makes it harder for searchers not easier, since it adds a multiplicity of places to look. d) Rare Automobiles Dealer: If not inventory then its equipment. There is lots of fraud with respect to motor vehicles. Trade Mark (American Originals): You might have to search/file in both UCC and Trademark Office for trademarks. Problem 16.4: Should you search or file first? File first because you may lose priority in the mean time. Plus, there may be someone ahead of you and it has not yet shown up in the records (the filing office has 2 days). What if there is a delay? There is no penalty against the filing officer. ASSIGNMENT 17: ARTICLE 9 FINANCING STATEMENTS: THE DEBTORS NAME 1) The Components of a Filing System a) Financing Statements i) Paper records which are filed at the filing office (1) Methods of storage whether paper, microfilm, microfiche, or digital imaging do not allow for searching the content of the financing statement (2) In order to find a particular financing statement, you must have the file number assigned to it by the clerk upon filing

36

Secured Transactions Outline- Kauffman 2003

b) The Index i) What the typical searcher knows is not the file number, but the name of the debtor, so the filing office maintains an index of the financing statements by the debtors name. (1) Index must also include the file number and generally the address of the debtoruseful for distinguishing your debtor from those with the same or similar names. (2) Other information in the index might include description of collateral, the name and address of the creditor and the date of filing ii) Not all filing systems are by name. Some filing systems are by description of collateral such as a real estate recording system by tract or an automobile recording system by VIN or by registration numbers.) iii) Today nearly all indexes are computerized to facilitate searching c) Search Systems i) In a system of million of alphabetized names it is easy for some to get lost due to misspelling by the filer, or data entry error by the filing clerk (1) Search logic can be programmed to pick up some but not all of these errors (2) The search logic may or may not be disclosed and no two search logics will be the same ii) Some systems will permit public searching while others will require the search be done by filing clerks (1) The quality of the results will very with the experience of the person conducting it iii) Not all financing statements may have made it into the index yet. Those which are still being processes are collectively known as the basket. 2) Correct Names for Use of Financing Statements a) UCC 9-506(a): a financing statement substantially complying with the requirementsis effective, even if it includes minor errors or omissions, unless the errors or omissions make the financing statement seriously misleading. b) Individual Names i) RULE: The correct name is the name by which the individual is generally known, for nonfraudulent purposes, in the community. (1) This definition causes a number of problems (2) With regard to individual names, the indexing system is built on sand. ii) Courts are favoring longer more formal names over shorter more colloquial versions (1) FILERS RULE: file in the full, formal name of the debtor (2) SEARCHERS RULE: a searcher may still be required to make multiple searches to protect himself. iii) Rules regarding name changes discussed in Ch. 23. c) Corporate Names i) Because corporations can only be formed through a charter or certificate of incorporation filed with the Secretary of State (or equivalent officer) in the state of incorporation, a corporation has only one correct name at any given time. (1) Corporate names are generally required to designate themselves as such through suffix: Corp., Co., Inc., etc.. (a) EXCEPTION: CA (b) States will refuse to incorporate a second corporation with the same or confusingly similar nameno McDonalds Inc. and McDonalds Corporations, for example (i) BUT two corporations can have the same name if incorporated in different states. d) Partnership Names i) RULE: The name of a partnership is that by which it is generally known in the community ii) Rules regarding name changes discussed in Ch. 23. e) Trade Names i) DEFINITION: name other than legal name by which a person or entity does business.

37

Secured Transactions Outline- Kauffman 2003

ii) RULE: Trade names are neither necessary nor sufficient to identify a debtor on a financing
statement. UCC 9-503(b)-(c). f) The Entity Problem i) If looking to see if Harvard Law Schools property was encumbered, what name would you look under? The law school? The university? The trustees? ii) 1-201(28) ends the definition of organization with the words or any other legal or commercial entity. (1) The implication is that an entity might be a debtor for the purposes of article 9 even though it is not a legal entity for any other purpose. 3) Errors in the Debtors Names on Financing Statements i) A lender who lends pursuant to a search under an incorrect name will nevertheless be subordinate to a lender who filed prior to them. ii) 9-503(a), 9-506(a), (c): A financing statement filed under an incorrect name is ineffective. iii) . 9-517: A financing statement that was misfiled by the filing officer is nevertheless effective (1) Searcher may have a cause of action against the filing officer if the state has waived sovereign immunity. iv) 9-502(a): Any future secured creditor or lien holder may gain priority by demonstrating that a prior filing was insufficient because it did not provide the name of the debtor. (1) 9-506(c): the test when the sufficiency of the name is challenged is not whether the financing statement was actually found but whether it would have been found in a search by a trustee, lien creditor or future secured creditor. v) 9-506: If the financing statement was not found in a search under the debtors correct name, using the filing offices standard search logic, the name was seriously misleading. Problem Set 17: Problem 17.1: Your client wants to lend against equipment, inventory, and A/Rs owned by McErny Leasing and Bob McErny. What will you ask for from Bob to conduct a UCC search under McErny Leasing and Bob McErny. Bob is the owner of the company. You want to know what kind of entity McErny Leasing is? Verify with Secretary of State. You are looking for something that looks like McErny Leasing Co. at a familiar address. How do you know that company owns collateral? You have to trace title from inventory and equipment to sources of sale. Suppose its not a corporation. Ask the filing officer to do a search in all variations of the name he is known in the community. McErny Leasing could be a trade name and that is no good to file. Ask Bob what his full name is? Its Robert Joseph McErny. If you file under the most formal name, and if that name is not used, its probably an ineffective filing. It all depends on the systems search logic. If you are in a system that does not show up variations, the question is how are you going to search all variations. The lender has to come up with a policy. Because if you start searching for all the variations, you start to run into big bucks. The bigger the loan, the more thorough the searching. Problem 17.2: Susan Alexander? John Phillip (Jack) Smith? Tessies Tire City? You want to know what entities these are before you go down to the filing office. Whats the transaction about? Is it a developer? Is it a consumer? You first want to know the address before you go to the filing office. There is a hard copy but its probably old, so you will probably request a computer search. You ask for Susan Alexander, and order all the financial statements, and see which ones match the address of your person. The problem is learning the search logic and dealing with it. States differ in procedure. Tessies Tire City is not a corporate name because it does not have an inc., co. corp., etc. Once you find that out the business name, search it, but also search with trade name to make sure (even though its probably ineffective).

38

Secured Transactions Outline- Kauffman 2003

Problem 17.3: Which ones do you order? If there is a mistake in the middle name, its probably not a seriously misleading mistake, since it came up under our search. Because it turns up in the searching logic, it aint serious if the name that its under is ineffective. The Secretary of State office did us no favor by giving us all those names. Curse the Secretary of State. Problem 17.5: If filing office receives an original financing statement on Wednesday, when does it have to index it under 9-519a,h and 9-523? It has to index it by Friday, end of the second business day. What day would the last search go out that did not include reference to this financing statement? Under 9523c1, the filing office has to report/communicate on the record by the 3rd business day after received original. The information has to be current as of 3 business days. So on Friday, they dont have to report on information except from Tuesday. Overall, its 2 days to be recorded and 3 days to show up in a request. Because the filing office can do it at the end of the day on the second business day. This means that the request may not be current until 3 days after filing, and here that day is Monday. Problem 17.6: You are going to search for security interest on Tang and on Argon. Who knows if you can be ready by end of closing day? They may follow state procedure. ASSIGNMENT 18: ARTICLE 9 FINANCING STATEMENTS: OTHER INFORMATION 1) Introduction a) Most file in hard copy on an official form (contained in 9-521) but the form is not required. Some file the security agreement itself. 2) Required Information on Financing Statements and the Result of Erroneous Information UCC 9-502(a) 2. Secured Creditors Name 3. Description of Collateral If it is accepted it is nevertheless ineffective. Required Information 1. Debtors Name If it is blank? Clerk should reject the filing. If it is wrong? Minor errors are only fatal if they are seriously misleading. 9506(a) Secured Creditors trade name is only fatal if seriously misleading Clerk should reject the filing If it is accepted it will be effective against all but a purchaser who reasonably relies 9520(c); 9-338 Clerk should reject the filing

9-516(b)(5) (A) 9-516(b)(4)

4. Debtors Address 5. Secured Creditors Address 6. Type of Debtor (indiv. or corp.)

Errors are only fatal if they are seriously misleading

9-516(b)(5) (B)

If the debtor

7. Type of organization (LLC,

Errors are only fatal if

39

Secured Transactions Outline- Kauffman 2003

is an org. 9-516(b)(5) (C) also requires:

corp.) 8. Jurisdiction of Origin 9. Organizational Identification # If it is accepted it will be effective against all but a purchaser who reasonably relies. 9520(c); 9-338

they are seriously misleading

3) Additional Rules: a) The filing clerk should not consider the accuracy of any piece of information, but should reject only if it is left blank. Comment to 9-516 b) If the filing office wrongfully rejects a filing, the filing is still effective against lien creditors. 9516(d) c) Unlike in a security agreement, all assets is a sufficient description of collateral. Grabowski v. Deere & Company . i) If the description of the collateral provides an incorrect address, the statement may still be effective. Teel Construction, Inc. v. Lipper, Inc. (noexistent address in the description of collateral put the searcher on notice.) 4) Authorization to File a Financing Statement a) Old article 9 only required that the financing statement be signed by the debtor, but prisoners, tax protesters and supporters of the Republic of Texas figured out how easy it was to reek havoc with the system. b) NEW PROCEDURES i) Must have permission in an authenticated document. 9-509(a)(1) (1) Signing a security agreement automatically gives the creditor permission to file a financing statement. 9-509(b) (2) If the financing statement is not authorized, it is ineffective. 9-510(a). ii) The victim of a bogus financing statement may file a correction statement. 9-518 c) Filing of a correction statement helps give notice to potential lenders, but title to the collateral is still clouded. (1) Real estate system attempts to remedy this problem by requiring that the mortgage be witnessed and acknowledged. Problem Set 18. Problem 18.1: You have a filing statement that has to be filed today. The debtor authorizes it but you dont know its organization number. Its not required to be effective, but the secretary of state by statute is required to reject it if it does not have the number. The filing office does not reject it if it is a wrong number. The effectiveness only goes to the debtor, creditor, and collateral description. There is no difference from leaving it blank or telling you to fill in a false number. From a substantive reason there is none. What happens if a busy body in the secretary of state office sends it back to you? The danger of doing nothing, and later some creditor is deceived, and you prove that you are perfected under the statute, that creditor is going to say that you should have done something. You are perfected, but you are perfected because you put false information. There could be an estoppel argument. The secretary of state office did something wrong. But they have sovereign immunity. What did the first creditor do wrong? You can claim a lack of good faith argument. You should not rely on fault of secretary of state mishap. Problem 18.2: Being perfected at debtors bankruptcy is critical.

40

Secured Transactions Outline- Kauffman 2003

a) The irregularity is complete absence of address of secured party? If accepted, its effective under 9-520. b) What about incorrect address of debtor. The filing office is required to accept filing, even though it is potentially misleading. The lien creditor is not protected because the lien creditor does not give value in reliance on security interest. c) Secured Creditors Trade name? This makes it seriously misleading. Its not a trade name. You put absolutely the wrong name in there. d) What about Elizabeth Warren? Its not defective. You are on notice after you call Warren and she says she knows nothing about it. e) Irregularity in description of collateral as Pizza Ovens at 621 State Street, Madison, WI. This is probably seriously misleading since the particular collateral in security agreement have been at 514 East Washington, Madison, WI. The debtor operates at both locations. A searcher looking for one address may ignore financial statements showing up at other addresses. An irregularity like this prevents it from being perfected. f) What about no description of collateral? If there is no indication of collateral, the basic building block of the financing statement is not there, its defective. The TIB can avoid it if its not mentioned at all in the financing statement. Problem 18.3: The other creditor has 5 financial statements stated at a particular addresses other than Trimble Ave. The landlord knows that the other location is new and not listed. Could Trimble Ave collateral be perfected? Maybe. What you going to do? You should levy on Trimble Ave. You are entitled to rely on apparent state of the record. You have not sold anything yet, so go ahead and levy. Problem 18.4: Glacier is suppose to have a security interest in Trimble Ave collateral but financial statement got screwed up. A lien creditor calls and asks you about it because he wants to levy. Do you lie? Some jurisdictions take lying seriously. The law may sanction it. You should say, let me find out, and Ill get back to you. Then go get one at that point before Smith levies. What about if you got a call from another bank, whose debtor SCI wants a loan and gives an application? Is there a difference is confidentiality arrangements between Glacier and debtor, when another bank calls and wants to know debtor status? Creditors by and large do not have confidentiality with debtors. Here a loan officer from another bank calls you, and you who are the first lender, and you have a negative pledge clause preventing giving a junior lien to yours, to finance new inventory, want to find out whats going on. On the other hand, you want to have a look at state law in jurisdiction, which has expanded privacy rights over the years. Problem 18.5: typically department stores who take security agreements dont file financing statements, and with respect to consumer goods, they dont have to and there is automatic perfections. But you file a financing statement, and you may want to file one with high ticket items. If the consumer sales to another consumer, that second consumer will take free and clear of security interest, as long as there is no financing statement filed, as a consumer to consumer transaction under 9-320(b). You dont need explicit permission to file against a customer who has already executed a security agreement. That execution constitutes authorization. The debtor normally has to authorize an execution of a financial statement in writing. So if the financing agreement goes first, you need a writing. Also, use same description as that in security agreement because authorization in security agreement only covers property in the security agreement. Problem 18.6: the issue here is that you had an early financing statement with only an oral authorization, and some later creditor files one, and the first filer subsequently executes a security agreement, that then constitutes the authorization. The authors think the first filer loses since there is no written authorization. Kaufman is doubtful that is the correct result because priority section states priority from date of filing.

41

Secured Transactions Outline- Kauffman 2003

And here second bank is the first filer. Maybe filing means authorized filing. But it was authorized orally, and they were on record first, and the second filer should have seen that filing. Assignment 19: Exceptions to the Article 9 Filing Requirement

1) Three ways to perfect other than filing


a) Possession (i.e. money) b) Automatic perfection by operation of law (i.e. PMSIs) c) Notice to or through some person or organization that controls the collateral (i.e. deposit accounts) 2) Possession a) Both Article 9 and real estate recognize possession of some types of collateral as a substitute for public notice filing i) Article 9 (1) 9-310(b)(6) refers you to 9-313 (2) 9-313 Permits perfection by possession if the collateral is negotiable documents, goods, instruments, money, or tangible chattel paper b) Assumptions (Possession-Gives-Notice Theory): i) Persons who lend against these types of collateral will look at the collateral before disbursing money. ii) Looking at the collateral in possession of a secured party will alert the searcher to the possible existence of a security interest. (1) -Favors sophisticated parties who engage in these transactions repeatedly, at the expense of people who stumble occasionally into a system in which everybody knows things that they do not. iii) 9-313 comment 3 allows a secured party to possess collateral through an agent. This is the case of a gas station with one employee on the premises. The employee is the agent, but the owner oil company retains possession (even though its name might not appear anywhere on the premises). c) Possession as a means of perfection i) -Possession may take any of three roles in perfection (1) It may be the sole means of perfection (a) As with money as collateral 9-312(b)(3) (2) It may be an alternative means of perfection to filing (a) As with goods, instruments, tangible chattel paper, negotiable documents, and certificated securities; 9-312(a), 9-313(a) (3) -Notice that under 9-330(d) and 9-331(a), perfection by possession of the above (except for goods) trumps prior perfections by filing. (4) It may be an ineffective means of perfection (a) Security interests in accounts and general intangibles may be perfected only by filing or some other form of automatic perfection not by possession. 9-313(a) d) Policy considerations: i) Perfection by possession imposes an additional burden on the searcher ii) Perfection only by possession of money encourages the free negotiability of it without the need to conduct an article 9 search. Money can always be spent free and clear.

42

Secured Transactions Outline- Kauffman 2003

3) Deposit Accounts (as an example of collateral in the control of the secured party) a) Generally referred to as a bank account 9-102(a)(29) b) 9-104 indicates three ways a secured party may take control of a deposit account i) The secured party may be the bank where the account is maintained ii) The debtor, the secured party, and the bank can authenticate a record instructing the bank to comply with the secured partys instructions iii) The account may be put in the name of the secured creditor thereby making the secured creditor the banks customer (1) -Notice that control is potential, not actual. The secured party may choose to control the account, but until then the debtor can use the account freely. 9-104(b) 4) Purchase-Money Security Interests in Consumer Goods (PMSIs) Automatic Perfection a) 9-309(1) creates and exception to the filing requirement for most purchase money security interests in consumer goods. b) Definition from old article 9: A security interest is a purchase-money security interest to the extent that it is (a) taken or retained by the seller of collateral to secure all or part of its purchase price; or (b) taken by a person who by making advances or incurring an obligation gives value to enable the debtor to acquire rights in or the sue of collateral if such value is in fact so used. i) Essentially, a PMSI is created in two situations: (1) a consumer buys a good on credit from a vendor, and the vendor takes a security interest in the good (2) a consumer gets a loan from a third party to purchase a good from a vendor, and the third party takes a security interest in the good.

c) PMSIs are automatically perfected only in consumer goods. In other situations they must be
perfected through the standard system. See 9-102(a)(23) for the definition of consumer goods. d) Policy: i) -Automatic perfection takes place for consumer goods because they are typically of small value, and the expense to search the UCC system would be too great. ii) Gallatin National Bank v. Lockovich 124 B.R. 660 (W.D. Pa. 1991) a $32,500 boat counts as a consumer goods for which a PMSI can be automatically created. 5) Security interests not governed by Art. 9 or another filing statute i) Types of collateral excluded from Art. 9 coverage, 9-104 (1) Wage claims, 9-104(d) (2) Insurance policies and claims, 9-104(g) (3) Real estate interests, 9-104(j) (4) Tort claims, 9-104(k) (5) Most kinds of bank accounts, 9-104(l) 6) Class Notes: a) Possession by escrow holder: gives notice but does it give control to the secured party? The escrow holder is the agent for both parties. If party is agent of debtor, he cannot serve as agent of creditor for taking possession. But the code wants to allow an escrow to take possession even though he is an agent for both sides. Even though secured party did not gain type of control over collateral as we would like to see, we will allow it in that context. b) PMSI #2: not the seller that finances but a lender who takes a security interest in the goods. There is a requirement that the loan be used to purchase the goods. What if the lender loans 20 grand to buy a new car, and it disperses the loan directly to the buyers bank account, and the buyer buys a car. That makes for an accounting problem. If you want favored status of PMSI

43

Secured Transactions Outline- Kauffman 2003

creditor, your loan actually has to go to the new collateral, so disperse the funds directly to the new seller. Only if the jurisdiction has adopted some limits on the dollar amount, there is no limit to the PMSI collateral value. If the consumer buys some goods from another consumer, the buyer can take free if the secured creditor has not filed a financing statement under 9-320(b). Problem Set 19: Problem 19.1: Permissible ways to perfect question? - Cash in the Register: the only way to perfect a SI in actual physical money is by taking possession of it. 9-312b3. Have an employee of yours run the machine. You can make the teller your employee. Is that enough if debtor still pays that person? The creditor has to pay the teller as an employee? - Negotiable promissory notes: falls under instruments, in which perfect by filing or possession. Possession is better because if you have only perfected by filing, a purchaser (which includes another creditor) who takes possession will take priority over the prior filer. Filing is a weak protection because you can lose to another creditor. The concept of negotiable promissory notes is to make them as much like dollar bills as possible. - Money debtor keeps in Deposit Account: 9-104: bank holding an account, second, an authenticated report signed by debtor and bank saying bank will comply with secured party instructions, and thirdly, the secured party becomes banks customer with respect to account which means secured party named account holder. - Stock: perfect by either filing or by taking possession of certificate, or having shares registered by GM in name of secured party. Problem 19.2: K for Payment, promising certain installments plus interest? Instrument or Account. Account definition excludes instrument. Does it transfer? If yes, then instrument, but if not, then account. If account, then you can perfect by filing. If instrument, then you can either file or possess to perfect. So overall just do both. Problem 19.3: Instrument with another party holding possession. There are two creditors, one with both possession and a 60 grand first security interest. What does the second creditor do to perfect as a second secured interest. Maybe have a 4th party hold it in escrow. You should refinance that loan and add it to your 300 grand, and take possession of note. Problem 19.4: How to protect yourself against automatically perfected security interest. - Mobile Home: may have a PMSI automatically perfected. Trace source of title. Find out where the money came from, relying some on the debtor at that point. You also worry about whether salesperson had it free and clear when sold it. Could this mobile home be a fixture on the land, permanently on the land? There may be a mortgage on the land, which gives the mortgagee an interest in that mobile home. - Rare Book Collection: it could be PMSI. The library of congress could be holding the books for the secured creditor and does not have to tell you under 9-313g2. - Mercedes Benz Automobile: if in COT state, almost certainly you can only comply with filing according to COT rules. - Diamonds: could be PMSI. - Computer Equipment: located at office, which would tend to look like business not consumer, but the stock stuff makes it look like personal use. You may have an automatic security interest. Before you spend a lot of money, you should take a good look at the equipment. - Checking account at Bank of West and in Ketterings name: You perfect by control. A secured creditor under 9-104 (private agreement between bank creditor and debtor) or a bank under 9104.

44

Secured Transactions Outline- Kauffman 2003

Almost anything can be consumer goods. The provision that makes things easy for takers of security interests in consumer goods makes it difficult for searchers.

Problem 19.5: Borrow 100,000 using potential lawsuit winnings as collateral. Tort claim? How to perfect? What is this lawsuit about? Is it a breach of contract? If its a breach of contract, its not a tort claim, but rather its a general intangible (this a catch all category). How to perfect a general intangible? You have to file. But what if this is a tort claim? Then look to see if it is a commercial tort (where claimant is with an organization, or the claimant is an individual and the claim is in the course of persons business)? 9-109d12- commercial tort claims but not tort claims are in article 9. There is nothing talking about commercial tort claim specifically, so we file, because 9-310 says that unless otherwise provided, a financing statement must be filed to perfect all security interests. 9-108e says you cannot say just file by identifying commercial tort claim. You dont have to go into great detail, but you have to identify the nature of the claim. Problem 19.7: Sabine sells musical equipment to Jersey on credit with a SI in equipment, but Sabine is going to be using equipment in business. They put it in separate room, sublease it to Sabine, and agree the its in Sabines possession. Bill (President of Jersey), as Sabines agent will control access to room, with this information printed on door. You can use an employee of the debtor to take possession under comment 3 of 9-313. But the comment explains that debtor cannot qualify as agent for the secured party for purposes of the secured party taking possession. Although the separate room is to give notice and warn a creditor who levies on it not to waste their time, and they got a lien, but the problem is that the agent is the president. This is not like the field warehouse where the agent is an employee of the creditor. So this is a dual agency situation, and you picked somebody that is subordinate, or in fact, is the debtor. Assignment 20: The Land and Fixtures Recording Systems 1) Real Property recording systems a) Each state is divided into counties, and each county maintains a real estate recording system. Typically it is located in the county seat. 2) Differences between real property and personal property recording systems: a) Real estate system contains not only documents evidencing liens against real estate, but also deeds that show transfers of ownership. Bills of sale, the personal property equivalent of deeds, are not recorded in the personal property system i) It is more expensive to file in the real estate system. This system has both recording and transfer fees.

ii) The real estate recording system is not self-purging. Filings in the real estate system are permanent and do not have expiration times like UCC filings. iii) The debtors name is relatively unimportant in the real estate system because the filing system records tracts of land and chains of title. A search with the wrong name would present no documents at all, including deeds. iv) Real estate records are duplicated by private firms across the United States. v) There is no uncertainty as to which filing system is correct for the real estate system. Land in one county must be filed in the real estate recording system for that county. Land touching multiple counties must be recorded in the recording system for all of the counties.

45

Secured Transactions Outline- Kauffman 2003

vi) The actual mortgage document is filed in the real estate system not just notice of the existence of a document. The advantage is that searchers can see the actual debt. The disadvantage is that additions or changes may require a new filing. 3) Fixtures a) The law considers permanent buildings as part of the land on which they stand, unless they are specifically excluded. As such, the proper place to record a mortgage on these buildings is in the real estate filing system. A UCC filing is ineffective 9-109(d)(11). b) The above suggests that individual parts of permanent buildings must also be recorded in the real estate system. Some go so far as to suggest that machinery which is essential to a manufacturing plant would fall under the definition of a fixture even if the machinery is not permanently attached. c) The UCC defers to the state law system for the definition of fixtures. The UCC states that goods are fixtures when they have become so related to particular real property that an interest in them arises under real property law. 9-102(a)(41). What may be a fixture in one state might not be a fixture in another state.

d) -In many situations it will be impossible to predict whether the courts would consider particular
property to be fixtures. Often this will lead to filings in both the real estate and personal property filing systems. Goods that are fixtures or may become fixtures may be used for a security interest under article 9, section 9-334(a). Where permitted by state law, security interests in fixtures may also be perfected under the real estate recording system.

e) In re Cliffs Ridge Skiing Corp. 123 B.R. 753 (Bankr. W.D. Mich. 1991) A ski chairlift was
classified as a fixture under a three-part test. Fixture filings are permissible in Michigan in both the real estate and UCC systems. Real estate mortgages, when filed, can also perfect security interests in future fixtures. In the case, three different entities were found to hold security interests in the chair lift. 4) Security interests in fixtures may be perfected three ways a) Mortgage filing in the county real estate office b) Fixture filing under the UCC i) Must file a financing statement that meets the standard requirements of 9-310(a) and (1) under 9-502(a)(3) the financing statement must (a) -state that it covers collateral that are fixtures or are to become fixtures (b) -state it is to be recorded in the real estate filing system (c) -contain a description of the real estate where the fixtures are located which is sufficient to give constructive notice ii) Ordinary financing statement filing in the UCC. This does not qualify as a fixture filing under 9-501(a) and is of limited effect (see assignment 33). 5) Perfecting in the Fixtures of a Transmitting Utility a) 9-501(b) allows for the filing of security interests in the fixtures of transmitting utilities to take place in the office of the secretary of state. This simplifies filings against railroads and power companies who have fixtures strewn across the country, and would have required filings in hundreds of counties.

46

Secured Transactions Outline- Kauffman 2003

Problem 20.1: This has to do with the Cliff Case. There are 3 creditors: FoA, Cliff Dev, and First National. There was not one unified priority scheme, and thus, equity answers the subordination question. FoA v. FN: FN wins; FoA v. CRD: FoA wins; CRD v. FN: CRD wins. If title of property is held in Pacific Interest partnership, the partnerships interest is personal property, and if you take interest in partnership interest, you file in UCC. a) How should SLP (lender) perfect in PIs (debtor) 1/3 interest in 160 tract of land known as Devils Valley? Trees all over the tract of land are realty. PI could be a tenant in common, or PI might have a beneficial interest. If PI owns the property, SI would have to go to the real estate system. If you have a beneficial interest it would be more like a general intangible and you would have to go to the U.C.C. system. Couldnt be a fixture. b) Pine trees growing on land. The authors try to show that the trees are crops grown for harvesting, so they dont seem to be part of the land. However, under 9-501(a)(1)(a) timber to be cut is filed in U.C.C., but this does not meet the definition because it does not have a contract for sale on it. 9-102(a)(44). Before trees are cut, they are goods. After cut, they are something different. If its not goods, it cannot be fixtures, and then maybe its not covered by article 9. Does it mean that it might not be covered by article 9? (d) If SLP perfects by recording mortgage against the second parcel, does it have to mention the trees? The problem with mentioning the trees is inclusio est exclusio est. If you describe one and you dont describe the others there is an argument that you didnt get the others. e) PI has a mortgage and note from another party. PI recorded in real estate office and original is now in PIs possession. SLP wants security interest in that mortgage and note. If SLP perfects by recording a mortgage, does the mortgage have to mention trees? No, the mortgage covers everything on land. You can put in the mortgage, including trees but not excluding other things. The note that evidences the promise to pay is physically incorporated into the purchase money mortgage. The mortgage follows the debt. Old adage: With a note representing an obligation to pay, a transfer in an interest in the note automatically transfers the underlying security. Under 9-203g, the secured creditor by perfecting the security in the promissory note perfects a security interest in the underlying mortgage. You perfect a security interest in the underlying mortgage by taking possession of the note. Theoretically, you dont have to file in the real estate records. But if you are really counting on real estate security, most careful lawyers will file in the real estate records, because someone searching the title in the real estate records and does not find it will be pissed off and their may be litigation. h) The fact that they call them store fixtures does not make them store fixtures. Ask whether there is an interest so related to realty that they are part of the property arising in real estate law. You should file in Secretary of States office if they turn out to be equipment; also, file in the real estate office in case they turn out to be fixtures. Problem 20.2: The eccentric debtor gets a million by signing security agreement in manufacturing facility on a food stained napkin. The question is whether the security agreement sufficiently describes the collateral. If sufficient, the secured creditor can write up a filing statement and file it because the security agreement implies debtor authorization. If land is involved, is there sufficient description to record a mortgage on the land? In many jurisdictions, that would be so vague as to be barred. In some jurisdictions, they allow extrinsic evidence. In some jurisdictions you need a witness. You need a notary at the time the debtor signed, in her presence. If you dont have the proper witness and notary you cannot file it as a mortgage. But maybe you can start a foreclosure suit, which files a les pendends, a notice of pending lawsuit, which gives notice of the mortgage, and there is at least an argument that this gives the equivalent of notice.

47

Secured Transactions Outline- Kauffman 2003

Problem 20.3: Folds sells mobile homes; he has buyer execute a promissory note, security interest, and a standard UCC financing statement, describing the brand mobile home, serial number, and files it in the Secretary of State office. But here a buyer takes it home and the PSF (mortgagee of buyer) forecloses on mobile home. Is the mobile home a fixture? Maybe. Folds may have a PMSI. If this is not a fixture, then our client is home free. But if its a fixture, the client is perfected under article 9 because it did file under the UCC. But to take priority over mortgagee, it had to file as a fixture filing before mortgage under 9-334e. But it will beat the trustee in bankruptcy under 9-334e3, which says that if client perfects by any method under article 9, it is to prevail over any interest obtained by legal or equitable proceeding. The TIB stands in the shoes of a lien creditor. This enables priority over estate. Folds should file in real estate records, as a fixture filing. What do they have to do in order to file in real estate records? Problem 20.4: There is a mortgage clause saying that borrower has to give lender any requested financing statements, including to successors. This is in here in case the bank forgets to do something in closing. A new buyer from FLEET may want additional documentation. They may want additional stuff that did not turn up in search. The costs are heavy. Assignment 21: Characterizing Collateral for the Purpose of Perfection 1) Chattel paper, instruments, and accounts all involve a debt owed by a third party to the debtor. The debtor is using its right to that money as collateral to secure its own debt to the creditor.

2) Chattel Paper when documentation evidences both a monetary obligation and a security interest in
specific goods, a security interest in specific goods and software used in the goods, or a lease of a specific good; 9-102(a)(11) a) -Perfection i) By filing; 9-312(a)(1) ii) By possession; 9-313(a). Note that purchasing chattel paper, with no knowledge of a prior security agreement is superior to filing; 9-330(b). Purchaser is broad enough to encompass both buyers and takers of security interests, including bank lenders; 1-201(32) and (33). (1) -Example: (a) Purchasing a boat for $20,000 with no money down financing and a security interest in the boat. The $20,000 promissory note along with the security interest constitutes chattel paper.

3) Instrument when documentation evidences a right to the payment of a monetary obligation, is not
itself a security agreement or lease, and is of a type that in ordinary course of business is transferred by delivery with any necessary endorsement or assignment; 9-102(a)(47) a) Perfection i) By filing; 9-313(a) ii) By possession; p-313(a)

4) Account (a right to payment of monetary obligation, not chattel paper, instrument, tort, or deposit
account) or general intangible (personal property other than accounts, chattel paper, commercial tort claims, deposit accounts, documents, goods, instruments, etc); 9-102(a)(2) and (42) i) Perfection (1) By filing Problem Set 21:

48

Secured Transactions Outline- Kauffman 2003

Problem 21.1: How should the secured party perfect the following security interests? a) Lessees interest under a lease in real property: a lease embodies a right to payment to lessor, also embodies a right of reversion like chattel paper. For lease to be chattel paper, the lease has to be a lease of goods. This is not a lease of goods, but rather real property, so it is not chattel paper. 9-109d11: article 9 does not apply to creation or transfer of real property including a lease. This is not an article 9 transaction, so record it in real estate office. b) Wheat growing in farmer debtors field: Crops are goods under 9-104(a)(44). In some states, crops may be fixtures, but in either case, article 9 applies, and you should file a financing statement. Can you perfect by a fixture filing in the real estate record? There is one court that has held wheat planted annually cannot be a fixture, because there is no intent of permanent connection to land. c) Franchise to operate a BK franchise: general intangible, only be perfected by filing. d) An electronic book entry certificate of deposit: you would think it was an instrument (but it has to be in writing). It probably is not an instrument because it probably cannot be transferred in ordinary course of business. It probably is a deposit account. This is a critical distinction. If an instrument, then file or possession, but if deposit account, you need to take control, by one of the three methods in 9-104. e) Software on a consumers debtors personal computer, including software written by the debtor. The issue is over whether it is goods. If the program is so embedded with goods that it goes with goods (anti-lock brake example), then it is goods. Otherwise, they are general intangibles, under 9-102(a)(42). If we can take it off and transfer it, then its a general intangible. If its a general intangible, you have to file to perfect it. But goods could be perfected in a whole variety of ways: filing, possession, Cert of Title on car. With debtors own software, Kazinsky has to register by filing in copyright office. With respect to last one, manual to software: 9-102(75) defining software includes supporting stuff. Problem 21.2: Multi-state farming problem; why have separate systems? Farm products: filing is where crops are located but inventory is where the debtor is located. Instruments v. general intangibles and accounts: instruments by possession.

Problem 21.3: true leases v lease intended for security. Their solution is to require filing for all true leases. They want to say that you can turn a lease really intended as security into something that looks like a lease transaction by shortening the term and saying that you have to pay the reversionary interest. Its not nominal consideration but you achieved the economic equivalent of a secured transaction and structured it in lease form. Chapter 7: Maintaining Perfection Assignment 22: Maintaining Perfection Through Lapse and Bankruptcy p. 375 1) Removal of filings a) Real Property System (simpler) i) When a mortgage is paid the mortgagee executes a document called a satisfaction of mortgage for recording. This document is maintained permanently in the recording system.

49

Secured Transactions Outline- Kauffman 2003

ii) Most states impose a penalty on a secured party who fails to give a satisfaction to the debtor who has fully paid a mortgage debt. (1) AZ. holds secured party liable for actual damages, and an additional $1,000 after 60 days (2) FL. Provides only for attorney fees and costs iii) Sometimes a secured party will release portions of a real property from a mortgage lien. This is usually only done subject to contract. This is customary for situations like housing developments. 2) Article 9 Termination and Release a) A debtor may demand the secured party file a termination statement within 20 days of satisfaction, provided that the contract does not provide for further loans; 9-513(c)(1). When a termination statement is filed, the financing statement to which it relates becomes ineffective; 9513(d). b) A termination statement must identify the financing statement to which it relates by its file number. Further, it must state the financing statement is no longer effective; 9-102(a)(79). The termination statement becomes part of the financing statement; 9-102(a)(39) c) If the secured party does not file a termination statement, it becomes liable for actual damages and a civil penalty of $500; 9-625(b) and (e)(4). d) A secured party may choose to release some collateral from the coverage of a financing statement by filing an amended financing statement; 9-512(a). As with the real estate system, this typically happens only by contract. 3) -Article 9 self-clearing and continuation a) Financing statements lapse after 5 years unless a continuation statement is filed during the last 6 months of the 5-year period; 9-515(a) and (c). Upon lapse the security interest becomes unperfected and is deemed never to have been perfected as against a purchaser of collateral for value; 9-515(c). i) The loss of priority does not apply in favor of a lien creditor or trustee in bankruptcy who filed while the financing statement was valid; comment 3 to 9-515. Note that a continuation does not violate the automatic stay of bankruptcy; 362(b)(3). b) This system is known as self-clearing because old financing statements automatically lapse. The filing office may remove the financing records from the office and destroy them 1 year after lapse; 9-522(a). c) U.C.C. 519(h) requires filings to be indexed within two days of receipt. 9-522(a) probably requires records to be kept of 1 year to ensure that if the filing office is not able to meet the 2-day demand of 519(h) the office will catch-up before purging records. i) Worthen Bank & Trust Co., N.A. v. Hilyard Drilling Co. 804 F.2d 596 (8th Cir. 1988) When a security interest lapses, the next oldest security interest takes priority. Filing a new financing statement is not sufficient to count as a continuation of a prior financing statement. d) Continuation statements filed after the lapse of a financing statement are ineffective; 9-510(c). The same is true of continuation statements filed too early. Problem 22.1: Financing statement filed on Dec 30, 2001, a continuation on July 7, 2006 - was that continuation filed properly? It was filed on time. You have to file it within 6 months of 5 years, and if you file it later or earlier, its ineffective. Lawyers sometimes neglect to have the conversation with the client on who is going to accept responsibility. File it between June 30 (or July 1) and December 30. There is no stay under 362(b)(3) to perfect on interest. You can file the continuation after debtor files for bankruptcy. The bankruptcy dates do not change the dates. The continuation statement is an important document in any transaction that is ongoing.

50

Secured Transactions Outline- Kauffman 2003

Problem 22.2: The lawyer makes a mistake. The layer discovers that a client sold a restaurant and took back a PMSI, which payments are suppose to go over 6 years, and the lawyer discovers that he did not file a continuation within the 5 years 6 month period. He will have to file a new financing statement. Will that be effective? Youll have to see if somebody else has also filed or see if there has been a judgment and levy. Suppose you find another financing statement. Under 9-509, a security agreement gives a debtor authorization in filing an initial financing statement and amendment (a continuation is not an amendment). There may be an agreement in the security agreement that says you can file a continuation or another financing statement. You are worried about any intervening interest in the last two months. The debtor now has the ability to lend money on the security because there is no longer a perfected security agreement. The second financing statement has no authorization because the security agreement only applies to the initial one. Whatever is decided should be memorialized in writing because the lawyer can always claim that Gomez was supposed to file a continuation. Problem 22.3: This involves a fight between two secured creditors, one with possession of the collateral when both filed, while the second filed first and the one with possession filed second. First in time under 9-322(a)(1), and under 9-308(c) if you perfect in different ways then both of them are continuous and you can tack them (if by another method). Possession method one and filing method two. The possession works to beat out the first filing creditor. Problem 22.4: Real estate development. The developer is financed on entire holdings and then sales one lot, and the buyer does not want to buy the lot with anothers mortgage stuck to it. Courts will enforce mortgage as written. Problem 22.5: There is a lender secured by forklifts and additions/replacements. The financing statement says all collateral. Now the debtor wants to borrow against a drill press, which is not covered by lenders SA. Debtor wants lender to file a release but lender wants it as leverage. There is nothing in article 9 requiring a release. If the financing statement is authorized, its completely effective. The debtor has to authorize the financing statement. So at that time, put releases in the statement. You can try to refinance. You can get the secured creditor to give a statement of current collateral, but the financing statement still allocates priority between secured creditors. Problem 22.6: what happens if mortgagee tries to screw debtor? There are not a lot of options when closing is set. You can pay the ransom and sue for a refund after get satisfaction. You need the cooperation of the buyer. Under FL statute, you can get attorney fees. In some jurisdictions, you can ask for an emergency order. Assignment 23: Maintaining Perfection Through Changes of Name, Identity, and Use p. 390 1) Changes in the Debtors Name a) Individuals, corporations and other entities can change their names i) Notice that corporate name changes are a matter of public record and can be discovered by: (1) Insisting that the debtor prove its incorporation under the laws of some state or country (2) Searching the records of that state or country for changes of the debtors name, and (3) Having discovered that the debtor had a previous name, running a search in the old name as well as the new name b) Lenders should be cognizant of changes by their debtors to things like names on checks and letterhead c) It is more difficult to track the name changes of individuals

51

Secured Transactions Outline- Kauffman 2003

i)

9-507(c): A change in the debtors name renders a filed financing statement seriously misleading, but the statement remains effective with regard to: (1) Collateral owned by the debtor at the time of the name change, and (2) Collateral acquired by the debtor in the first four months after the change ii) The financing statement is ineffective for collateral acquired more than four months after a name change (1) -Under this rule a secured party that financed the purchase of a specific boat need not be concerned with a name change. An inventory financer for a boat store would need to be very watchful for name changes. (2) *Our system places most of the burden on the secured party to monitor debtor name changes. Other than contractual provisions, there is nothing in the system that penalizes a debtor for failing to report a name change. 2) -Differentiating transfers of collateral a) Transfers of collateral are governed by 9-507(a), and are different than debtor name changes. i) e.g.: If Teresa borrows money against the equipment of her business, and later incorporates the business under the name of Teresa, Inc. it is not a change of name. It is a new entity with equipment that will be transferred to it from Teresa. 9-507(a) governs this type of transaction. The financing statement filed against Teresa would be effective against the collateral in the hands of Teresa, Inc. 3) Changes Affecting the Description of Collateral a) There are two types of changes to collateral: i) Type 1 changes: a change in circumstances that did not control the place of filing but that does make the collateral difficult for the searcher to identify as covered by the filing. (1) e.g. Collateral is pulled out of inventory for use as equipment (2) Even though the change in circumstances might make the financing statement seriously misleading, the financing statement remains effective; 9-507(b) b) Type 2 changes: a change in circumstances that is sufficient to affect the method of perfection that would have been appropriate for the initial filing. i) e.g. a security interest in lumber that is inventory, and the lumber is used to build a building that becomes a fixture. ii) 9-507(b) excuses the now-seriously-misleading description, but does not excuse the failure to make a fixture filing. 4) Exchange of Collateral a) Three types of barter transactions i) Type 0: the proceeds received by the debtor fall within the description of collateral in the already-filed financing statement (1) The security interest attaches to the new item as proceeds even without a statement to that effect in the security agreement 9-203(f) (a) e.g. Swapping a Coyote Loader for a Caterpillar Loader with a financing statement that just says loader in the description

ii) Type 1: an exchange of collateral for non-cash proceeds where those proceeds are property
not covered by the description in the financing statement but are property in which a security interest could be perfected by filing in the office where the secured creditors financing statement is already on file. (1) The secured party remains perfected without a new filing under 9-315(d)(1).

52

Secured Transactions Outline- Kauffman 2003

(a) e.g. an exchange of inventory for a circus elephant that will not be inventory. This is
the elephant rule. (2) *Any time a debtor has swapped collateral, the financing statement may encumber property not described in it. Unless the searcher knows that the debtor did not acquire the collateral in question in a swap transaction, the searcher cannot rely on the description of collateral in any financing statement.

iii) Type 2: an exchange of collateral for non-cash proceeds of a type in which filing is required
in a filing office other than the one in which the original collateral was perfected by filing. (1) The secured party becomes unperfected. It does not get the 9-315(d)(1) exception, and it must re-file in the appropriate system to remain perfected. To be continuously perfected from the original date, the secured party must make the new filing within 20 days from the time the debtor received the proceeds; 9-315(d)(3). (a) e.g. trading inventory for real property. In order to remain perfected, the secured party must re-file in the real estate filing system. (2) Type 2 transactions require much more vigilance on the part of the secured creditor, and less on the part of the searcher. (3) The secured party does not need additional authority to file the new financing statement under 9-509(b)(2). Otherwise debtors could refuse to give permission and the security interest would vanish. (a) National Bank of Alaska v. Erickson (In re Seaway Express Corp.) 912 F.2d 1125 (9th Cir. 1990) Where an exchange of a debt on an account for real property occurs, and a holder of a security interest in the account does not file a new financing statement in the real property system, the previously secured creditor becomes unsecured. 5) Collateral to Cash Proceeds to Noncash Proceeds (exchanging something for money and then buying something else) a) Provided it can trace the proceeds, the creditors security interest will reach the new property; 9102(a)(12) and (64). b) Type 0: The original filing remains effective to cover goods of the same description; 9-315(d)(3) c) Type 1: The exchange results in collateral that is no longer covered by the original description in the filing statement. The secured party has 20 days to file a new financing statement to remain continuously perfected 9-315(d)(3) d) Type 2: These are treated like type 1 changes, except that the new filing is required in a new office within 20 days; 9-315(d)(3). 6) Collateral to Cash Proceeds (No new property) a) Secured parties are granted continuous, perpetual perfection in identifiable cash proceeds; 9315(d)(2). i) e.g. An elephant, subject to a security interest, is sold for cash. The cash is placed in a bank account. The bank account is cash proceeds, and there is a security interest on the account under 9-102(a)(9). (1) The secured party may wish to take control of the account under 9-314 to avoid reliance on cash proceeds. (a) Control may be established in three ways (i) The secured party is the bank with which the deposit account is maintained (ii) The debtor, secured party, and the bank have agreed in an authenticated record that the bank will honor instructions from the secured party; or (iii) The account is in the name of the secured party

53

Secured Transactions Outline- Kauffman 2003

1. Notice the debtor may still write checks on the account even though it is in control of the secured party. 2. *The authors complain that they are unsure how this type of control fulfills the notice function of perfection in 9-342, which provides that the bank need not even confirm the existence of the agreement to an inquiring searcher. 7) *For problems dealing with this section, start by asking what changed. Look to see if it is a change in ownership or use, and what the consequences are. Problem Set 23: Problem 23.1: HM is a compliance officer at Gbank. She is working with Bonnie, owner of Bonnie Boat World. GB finances BBW inventory under a financial statement that describes collateral as inventory, accounts, and chattel paper: a) Changes affecting description of SAME collateral: On routine inspection, HM found that B violated security agreement prohibiting use of inventory by keeping it at her house (using it personally). Did the interlude have any effect on GBs security interest? Under 9-507b, even if change in circumstance makes financial statement seriously misleading after initial filing, it is still effective if would file in the same office. Under 507a, security interest follows to Bonnie (from BBW). But if personal equipment, GB now has to file under COT office for boats. Excuses seriously misleading description but not non-filing. But if its owned by the business, the business cannot use it as consumer goods. This is careless drafting under 9-102a23-26, defining consumer stuff as used by individuals. How do you sort it all out? A careful lawyer would initially file it as equipment. It is probably equipment since the debtor is a business, but maybe its consumer goods, since the drafting is not clear. If consumer goods, dont worry about it. Change of use makes it misleading but the financial statement is effective under 9-507b. b) What happens when ownership of boat transferred from company to Bonnie? GB is still perfected. This is not a change of name (507c) but rather a transfer (507a) and the security interest follows. A transaction of this size would have paperwork. This is an unauthorized transaction, and financing statement is still good. c) BBW traded boat for forklift. Went from inventory to equipment. Barter transaction type 1, where same office, and under 315(d)(1) the secured party remains perfected without a new filing. This is the elephant rule. d) What if BBW bought the forklift with cash from the proceeds of a boat sale? No longer effective under 9-315(d)(3), which requires filing within 20 days for collateral to cash proceeds to noncash proceeds transasction. e) Bank should have, but was not listed as loss payee of former insurance policy does bank have a perfected interest in claim against former insurer? Insurance loss is proceeds under 9-102a64, so 9-109d8 allows 9-315 to apply. Was security interest in original collateral perfected? If so, under 9-315c the proceeds are perfected. Assume yes, then perfect cash proceeds within 21 days by taking control. Under 9-315d, proceeds become unperfected unless comply with provisions. Before the insurance company pays out, is it identifiable cash proceeds? If the insurance company owes you money, its a general intangible. You perfect that in the same financing office. So you can comply with 9-315d1. Boats to Insurance is a 9-315d1 situation (barter in same office) and then its goes into identifiable cash proceeds (under 9-315d2 you are perfected),

54

Secured Transactions Outline- Kauffman 2003

and finally, trace it to the deposit account where it is still identifiable cash proceeds and 9-315d2 protects you. What if another bank takes a second security interest in the boat for extra collateral? If the second bank becomes loss payee, then the first bank loses security interest in insurance proceeds. The insurance payable to the second bank would say that its payable to second bank and Bonnie consistent with their respective interests. So GB says that it is payable to debtor, so it has proceeds interest in it. The answer is that you have a proceeds interest but only to the extent of debtors interest in insurance. If second banks interest is greater than amount of collateral, then debtors interest is zero and so is GBs. Do secured parties as common practice always see if name is on insurance policy? No, there is lots of malpractice out there. The peculiar wording of proceeds interest was insufficiently appreciated. Many secured parties make sure their names on insurance policies. The reason insurance is handled differently in Article 9 comes out of pressure in insurance industry. There can be a proceeds interest unless someone other than debtor or secured party is named loss payee. That opens up possibility that someone else on insurance policy gets money. Problem 23.2: GB inventory loan to SW Appliance. 6 months ago debtor changed name to SW General. How to remain perfected. Under 9-507c, with a debtor name change, the financing statement is effective to collateral already owned by debtor before change, and collateral acquired in first 4 months since name change. Also, a 9-507c Amendment to change name to keep continuous perfection has to be filed within that 4-month period. But the debtor has to authorize the amendment. Amendments are for adding new debtor or new collateral. Problem 23.3: What procedures to keep up with name changes? A) Check every 4 months minus a couple of days. You may want to make it a shorter time in a jurisdiction that is behind. B) What about continuation statements and new names? There is nothing in article 9 that says new name has to be on continuation statement. C) In the investigation of a loan applicant, how old a name change could be relevant? 5 years. Problem 23.4: Lender wants to loan secured by substantially all debtors assets. There is only one financing statement filed by Suti, describing the collateral as lawn dogs manufactured by Suti. There are only $25,000 of lawn dogs on inspection. Is there anyway Sutis filing could cover more than the lawn dogs? Yes under 9-315d1, via collateral barter with collateral in same financing office. Type 1 exchange! Also, lawn dogs may cover other collateral fitting under lawn dogs (type 0 unlikely). Also, cash proceeds ok and cash proceeds to bank account, control of bank account sufficient. But cash proceeds to other collateral needs financing statement under 9-315d3, if new collateral does not fit lawn dog description. You want to know if there is outstanding debt and that if there is lots of debt of unsecured creditors. Problem 23.5: A bank lends 1 million taking security interest in equipment , inventory, and accounts, chattel paper, and bank accounts. The lender files a financing statement. One of the debtors assets is a bank account. Does lender have security interest in the bank account? Maybe. Control is exclusive if original collateral. But security interest follows/perfected to cash proceeds under 9-315d2. So, only if control if original or cash proceeds. Are they identifiable cash proceeds under 9-315d2? It does not matter how long the cash proceeds have been in the bank account. The time factor is not important. Assignment 24: Maintaining Perfection Through Relocation of Debtor or Collateral p. 403

55

Secured Transactions Outline- Kauffman 2003

1) State-based Filing in a National Economy a) The rules that specify where to file and search are found in 9-301 to 9-307 2) Initial perfection a) 9-301(1) when a debtor is located in a state, the local law of that state governs perfection of a nonpossessory security interest b) 9-301(2) for a possessory security interest, the law is that of the jurisdiction where the collateral is located c) 9-307 provides additional provisions specifying the locations of particular kinds of debtors. An individual debtor is deemed located at the individuals principal residence. d) 9-307(b)(2) Some organization are not incorporated (general partnerships, etc). This section deems these debtors to be located at their place of business if it has only one, and 9-307(b)(3) deems such a debtor located at its chief executive office (use a nerve center test to determine) if it has more than one place of business. i) 9-307(a) defines a place of business to mean a place where a debtor conducts its affairs e) 9-307(e) provides that a registered organization (corporation, etc) that is organized under the law of a state is located in that state. i) e.g. A Delaware corporation is located in the state of Delaware even if it has no offices there. ii) This way debtors, creditors, and searchers dont need to worry about where the corporate headquarters is, or where collateral is located. The state of incorporation is a matter of public record and is easily ascertainable. This also reduced a dramatic number of filing errors because the secretary of state could match incorporation records along with filing records. 3) At the location of the collateral a) Fixture filings are to be made in the office designated for the filing or recording of a mortgage on real property 9-501(a)(1). Filings on real property are made in the county where the real property is located. b) Deposit accounts, investment property, and letters of credit are perfected by control of the collateral, rather than by filing a financing statement; 9-314. 9-304 to 9-306 specify the law applicable to the perfection and priority of security interest in these. 4) Relocation of the debtor a) An individual debtor may own multiple homes or change places of residence. The debtors principle residence is determined by the debtors intention. This can be difficult to discern.

i) When a debtor changes his/her state of principal residence, a secured creditor has four
months in which to file in the destination state; 9-316(a)(2). If the secured creditor does not, the security interest becomes unperfected 9-316(b). (1) Security agreements usually require the debtor to inform the creditor of a change in principal residence. Debtors often fail to do this. b) If a corporation moves (either by means of reincorporation by merger or sale of assets) the secured creditor has one year to perfect in the destination state; 9-316(a)(3) 5) Nation-based filing in a world economy a) To date there is no world wide filing system, and countries have various rules. b) One option would be to require filing where the collateral is located. This gives power over the form of filing to the country that has power over the collateral thereby assuring that security can be enforced c) Another option would be to require filing in the country of the debtors incorporation.

56

Secured Transactions Outline- Kauffman 2003

Problem Set 24. Problem 24.1: William Shatner is the debtor. The collateral of the business is located in Tucson, AZ. Shatner lives in Kansas but will probably move to Missouri. He plans to move to Hawaii in a few years. His wife also works in the business. Who is the debtor? It is dependent on who owns the collateral, and it is not clearly specified in the problem. If William Shatner owns the collateral, he is an individual debtor under 9-307. An individual debtor is deemed to be located at the individuals principal residence. Where should the creditor file for Shatners principal residence? It is uncertain, so the creditor should file in all three places: Kansas he is currently living there, but you already know he is looking for a new place. Arizona his summer home. Missouri where he is looking of a house, and the creditor would want to be on file as soon as the debtor moves. If Shatner, as an organization, owns the collateral: 1-201(25) -- Organization means a person other than an individual. Shatner is an organization if he is running a business. File at the chief executive office. 9307(b)(3). What if Shatner Engineering owns the collateral? Is the business a corporation, LP, LLC, service corp., or professional association? Registered organization under 9-102(a)(70)? 9-307(e) for a registered organization is organized under the law of the state is located in that state, file in the place of incorporation. What if the business is not incorporated (general pship, association, etc.)? 9-307(b)(2) -- The debtor is deemed to be located at the place of business if it has one. Place of business means the place where a debtor conducts its affairs. 9-307(b)(3) debtor is located at the chief executive office if it has more than one place of business. This is an undefined term in the revised Article 9. Nerve center the organization is located in the place it is managed regardless of the location of its operations. (Problem: what if the records are kept on-line? Is the nerve center a server? ). Arguable that Shatners office is the chief executive office or nerve center since he makes all the big decisions. (b) What names should you file under? William Shatner Shatner Engineering (as an organization and name of partnership), and Louise Godfrey (on the theory that there might be a partnership w/o a name). What if Shatner Engineering Products, Inc. is a Nevada corporation? Before filing, make sure that the corporation owns the collateral that the creditor is taking a security interest in. How do you find out if the corporation owns the collateral? Look at invoices for the relevant equipment and inventory. Look at the invoices from the corporations debtors to see if they are in the name of Shatner Engineering Products, Inc. to determine if the accounts are owned by the corporation. If Shatner Engineering owns the collateral, file in Nevada, the place of incorporation. What if the business is unincorporated and Louise owns 1/3 interest as a tenant in common. In what state do you file? Which names should be listed? (Ask Kaufman). An organization is two or more persons having a joint or common interest. Thus, Louise and William Shatner, who share ownership in the business as tenants in common, are an organization. If the organization has more than one place of business, the proper place to perfect in the collateral is at the chief executive office. 9-307(b)(3). The creditor should file at both places of business (where Shatner and Louise are both located). Problem 24.2 How should Firstbank monitor the location of the debtors? Would the answer change if the loan were for $25 million instead of $225,000?

57

Secured Transactions Outline- Kauffman 2003

Individual Debtors: Check the principal residence of the individual debtor in a time period that is less than every four months. When an individual debtor changes his or her state of principal residence, the secured creditor who filed in the original state has four months in which to file in the destination state. 9316(a)(2). If the secured creditor does not file, the security interest becomes unperfected. 0-316(b). Registered Organization look at municipal records, tax records. Merger: Check the public records for merger documents in a time period that is less than every year. 9-316(a)(3) gives the secured creditor a year to discover the merger and perfect in a destination state. Sale of assets: Close monitoring b/c it may not show up in the public records. 9-316(a)(3) gives the secured creditor a year to discover the merger and perfect in a destination state. Unregistered Organization: Keep an eye on the office of the chief executive officer. Monitor Shatners involvement with the business, and if he cuts backs, retires, or withdraws, you might want to check on where the business is being run from. Who do you check who owns the collateral? Look at invoice documents from time to time. Problem 24.3: Global bank, the client, is lending $1.9 million to Tang Aluminum Products, Inc. to purchase the inventory, equipment, accounts and general intangibles of Argon, Inc. How should the lawyer conduct the UCC search? What inquiries should the lawyer make? Names to search? Filing systems? Where is Argon incorporated? Check corporate records. Is Tang a registered organization? File in place of organization. Is Tang an unregistered organization? File in chief executive office. What is the concern with respect to the Argon assets? Make sure the assets are not subject to other security agreements. Get records of where the assets are located and how they obtained the assets (trace the title of the assets, use invoices). Has either merged or bought assets from a different company? Name change? A valid filing may exist under the old name. A filing under the old name is good against all assets owned before the name change. Look at bank statements, ask the debtor, internet search, trade journals. Were they another business before they incorporated? Have they purchased/bartered items that might be subject to security interest under another debtors name? 9-507(a) a filed financing statement remains effective with respect to collateral that is sold, exchanged, leased, etc. Collateral can be owned by a person other than the debtor against whom the financing statement was filed. The secured party remains perfected even if the secured party did not correct the public record.

Problem 24.4: Afghan law gives priority to the first security interest created and that country has no filing system. Firstbank loans $1 million to Afghan, Inc., an Afghanistan corporation whose headquarters and operations are in New York. Where if Firstbank required to file? Answer: File in New York. 9-307(c) 9-307(b) only applies if the debtor is located in a jurisdiction whose law generally requires information in a filing system. (9-307(b) applies b/c New York has a filing system).

58

Secured Transactions Outline- Kauffman 2003

Under 9-307(b), the debtor has only one place of business (New York).

Problem 24.5 What would happen if: Delaware adopted a non-uniform amendment that excuses filing altogether, and all security interests are perfected without filing. Cherokee, Inc. a Delaware corporation whose assets and operations are located in NY grants a NY bank a security interest. The NY bank does not file a financing statement. A year later, Cherokee, Inc. files for Ch 11 bankruptcy in New York and wants to avoid the banks security interest as unperfected. Solution: If litigation occurs in New York, New York has adopted the official text of Article 9, which provides that perfection is determined by the local law of the jurisdiction in which the debtor is located. 9301(1). Since the debtor is located in Delaware, Delaware law governs. And Delawares substantive law provides that security interests are perfected without filing. Assignment 25: Certificates of Title

1) In certificate of title systems, security interest are called liens and filing is called notation of the lien
on the certificate of title. a) To perfect, secured creditor must deliver to the Department (motor vehicles) its application for notation of its lien on certificate of title. i) Security interest need not be noted on title to be valid. Perfection is not accomplished by notation on either owners or Departments copy of certificate, but by application for such a notation. 2) Advantages of certificate of title system: a) title system contains title as well as lien information i) Art. 9 must determine from other sources the owner of collateral b) All collateral identified by two numbers i) License plate ii) VIN 3) 9-311(a)(2) and (3) provide that the filing of a financing statement otherwise required by this Article is not necessary or effective to perfect a security interest in property subject to [listed certificate of title statues of this state.] 4) Departments will accept both the application for a new title and the application for lien at the same time 5) Notation on the certificate relates back to the time of creation of the security interest. 6) Vehicles of nonresidents must be registered when nonresidents acquire a regular place of abode or use the state for business for an amount of time specified by state statute. Problem Set 25 Problem 25.1: FB lends 65 grand to Kahled to purchase a Jaguar. FB perfects by notation on WI title, putting it in safe deposit box. Kahled moves to AL. It borrows from Second Bank, perfecting on AL clean title (Kahled gets a new one in AL). Is FB still perfected? Start at 9-316(d) and (e). Under d, the WI security interest remains perfected until it would have been perfected under that jurisdiction (forever COT dont expire). But under e, d does not apply to purchasers for value, if not perfected on

59

Secured Transactions Outline- Kauffman 2003

second COT within 4 months after second certificate issued. But 9-316 is a priority statute that allows FB security interest to remain perfected against lien creditor and TIB. The bankruptcy code calls on state notions of perfection. By phrasing what happens in terms of perfection, the drafters have succeeded in allocating priority in bankruptcy. Suppose FB realized within 3 months and got it noted on AL certificate? Because under 9-316d the lien was noted on AL COT, FB has never become perfected, and d applies, and FB remains continuously perfected. There are situations where you can make a demand to get COT, but the subordinate lien holder needs to require mailing from lienholder in possession. UMVCTA 21c. This is a very common situation. People move all the time to new jurisdictions. All kinds of things happen when people move from one jurisdiction to another. It is common. Problem 25.2: A Nissan in MI, titled in MI, got financing from MI bank, has possession of COT with lien, and she moves to NY without telling bank. Is MI bank still perfected? Under 9-303(b) the car in NY is covered by MI COT, indefinitely, until earlier of new COT in another jurisdiction or MI law leaves unperfected. Registration is not a COT. Suppose has possession of MI COT; she gets a new COT from NY, turning into NY old certificate, falsely telling them that lien was satisfied? Assuming that there is nothing in MI law that says surrendering in another state makes the lien unperfected, there is still an argument that the lien remains perfected if possessed by NY. Indeed if COT is torn up in NY, all the records still exists in MI. A COT is like a bill of sale given to owner. So it is still perfected under subsection d, but you still have subsection e, protecting purchaser for value. But MI Bank still has argument against other lienholders and TIB. But under UMVCTA, if name of lienholder is shown on existing COT issued by that jurisdiction (MI), his security interest remains perfected in NY. This means that searcher cannot rely on COT. Suppose Babs lies and says there is no liens on MI COT, which she lost a while ago. The MI certificate is still perfected against lienholders and TIB but not against purchaser for value (secured creditor). However, under section 26 of UMVCTA there is a way for MI to revoke COT due to fraud. This section does not say that if you get it revoked you perfect a security interest noted on it. The lien does not say anything about priority of second secured creditor against somebody in the position of MI bank. Maybe that will be dealt with under article 9-316. The ability to get the clean certificate revoked means what? If MI bank gets NY COT revoked, what happens to its security interest? Problem 25.3: what should MI bank do to perfect lien on COT of MI residents for automobiles? They are vulnerable to second clean certificate. You can monitor debtors but that probably would not work out. So know your debtor. Problem 25.4: Shoreline Boats, with own credit corporation, finances boats sold by its dealers. They want to know how to perfect PMSI. If in COT statute state, then you have to file COT. 9-309 says a PMSI interest for consumer goods is perfected upon attachment. Under 9-303a, you can go to another state and get a COT in another state, allowing you to beat out a TIB or a lienholder under 9-303c but not a purchaser for value. Problem 25.5: How to perfect on bulldozer, owned buy IL corp. and used in MI? Coldwell offices are in IL but bulldozer is in MI? Under UMVCTA 5, look to article 9 to see how to perfect. Under article 9311a2, you perfect by noting it in COT. The lien is noted on COT because it applied 9-311a2. You can read the Uniform Act to say that it required perfection under article 9, but article 9 says perfection is not effective under article 9, and have to do it according to Uniform Act. The more likely reading is to read

60

Secured Transactions Outline- Kauffman 2003

Uniform Act to say that its left to article 9. Read them both generously and rely on optional 5 of Uniform Act. Chapter 8. Priority Assignment 26: The Concept of Priority: State Law p. 433 1) Priority in foreclosure a) Two basic principles: i) Any lien holder may foreclose while the debtor is in default to that lien holder ii) No lien holder is compelled to foreclose 2) Basic principles governing judicial and foreclosure sales: a) The sale discharges from the collateral the lien under which the sale is held and all subordinate liens (but not prior liens) 9-617(a). b) The sale transfers the debtors interest in the collateral to the purchaser subject to all prior liens; 9-617(a) c) Proceeds of sale are applied first to the expense of sale, then to payment of the lien under which the sale was held, then to payment of subordinate lines in the order of their priority; 9-615(a) d) The debt underlying each lien is reduced by the amount paid to the lien holder from the sale, but the balance remains owing. The lien holder is entitled to a judgment against the debtor for the deficiency unless there is a statute providing otherwise; 9-615(d)(2) e) After the foreclosing and subordinate lien holders have been paid, if there is money left over it is returned to the debtor (ignoring the claims of any unsecured creditors). 3) If a purchaser does not pay a prior lien, the purchaser does not become liable on the debt to the lien holder the debtor remains liable. The debtor, however, is unlikely to pay a debt owed on someone elses property (the purchasers). The prior lien holder will have to foreclose on the property now owned by the purchaser. Typically, however, purchasers pay the prior liens. 4) Reconciling Inconsistent Priorities a) The rules above are only typical rules. Some states have different rules such as a foreclosure sale discharges all liens with payment to the first lien holder and on down the line (even if the first lien holder wasnt the foreclosing lien holder). p. 436 b) All jurisdictions have one thing in common: Those creditors who liens are discharged by the sale share in the proceeds of sale in the order in which their liens have priority. i) Mortgages typically have priority over subsequent judgment liens because when a debtor has a judgment line against his or her property, no one will make a mortgage loan to the debtor. 5) The Right to Possession Between Lien Holders a) The Grocers Supply Co. v. Intercity Investment Properties, Inc. (Tex. Ct. App. 1990) A prior perfected creditor has a right to take possession of its collateral from an officer who has levied on the property at the direction of a judgment creditor. When senior and junior creditors clash, the senior creditor has the right of way. b) Frierson v. United Farm Agency, Inc. (8th Cir. 1988) A senior may not ignore a default by the debtor to the detriment of the junior creditors c) Two ways to reconcile Grocers Supply and Frierson

61

Secured Transactions Outline- Kauffman 2003

i)

The right of the senior to possession is not the right to possession for the purpose of leaving the debtor in business and frustrating collection by junior lien holders. The senior lien holder must foreclose or stand aside so junior lien holder can do so. ii) The junior lien holder must surrender possession, but may continue with the sale (1) *Policy implications (2) The senior creditor will want possession to avoid a situation where the collaterals value is compromised (3) The junior creditor had a debt that it is owed, and the debtor has defaulted (4) If the business can keep the collateral it is possible that more value can be created for everyone (5) The senior really is first in time, so it should also be first in right to decide what happens with the collateral (6) The senior creditor doesnt have to be notified of the sale is this right? (7) How much fencing capacity should a senior creditor have? Does it matter if the value of the collateral is more or less than the value of all debts owed? Problem Set 26. Problem 26.1: Junior mortgagee creditor with debt of 10,000. The client is willing to pay up to 25,000. There is a senior mortgage of 17,000. She should bid up to $8,000. She would have the property, but have a remainder of the senior mortgage of $17,000. Notice that a sale clears the mortgage or lien that is foreclosing, and any subordinate liens or mortgages. Senior mortgages, however, remain. In this the $8,000 bid would go to pay first the $200 cost of sale. Then the $7,800 would go to the cover the $10,000 debt. There would be a deficiency judgment in the amount of $2,200 that would remain, but that is for the debtor to deal with and not the purchaser. See 9-617a. Problem 26.2: What about a 75 grand Rolls subject to a 60 grand first and 30 grand second. The sheriff seized the Rolls for a judgment creditor with a lien worth $8,000. The expenses of sale are $200. What if you bid $0? If you take an outside bidder, whatever you purchase will be subject to security interests of $60,000 first, and $30,000 later. There is no equity there to an outside bidder. What if you bid $10? If no one else bids you get title and the car (subject to security interests). Then you just wait for one of the other secured creditors to come and foreclose. You still have the car until they foreclose. When they come to repossess you threaten violence, and you get the car for some more time. What about $200? This is the cost of sale. The executor is going to pay this out no matter what to pay the sheriff, so they might as well bid this much just in case so they get the car for a joy ride. They can take the car away from you, but they dont have a debt against you. They cannot come after you for any deficiency. There is a difference between buying property and assuming the mortgage, and buying subject to the mortgage. In the latter, you dont assume the debt. Problem 26.3: the debtor is current. You represent DHB, which has a first secured interest on mobile equipment for $27,000. The collateral is worth $40,000. DHB feels safe because at an auction, the equipment will bring at least 40 grand. What about if a lien creditor forces a sale of the equipment? DHB should be concerned because the new buyer may not maintain the equipment. The new buyer does not keep up the insurance. This is why there are negative pledge clauses in agreement. If a subordinate creditor forces the sale, you dont know your debtor. Dont let someone else retain a lien on it. A negative pledge clause is an event of default. So the secured creditor can foreclose at that moment. Its not their sale, so any money goes to subordinate creditor. Most courts will let them step in and stop sale and conduct the sale themselves. DHB lien cannot be displaced, but remember it can be hurt if someone gets the property and tears it up. DHB also runs the additional risk that I wont be able to find the equipment because it is mobile. DHB might not even know about the sale. No notice is required under the U.C.C. It is set up that way because it hypothetically doesnt matter.

62

Secured Transactions Outline- Kauffman 2003

What if DHB purchases to protect its position? If DHB knows there is a sale, it could bid at the sale. Remember the fact that DHB is in first position; they are buying into second position. You are paying in full dollars. You are just making that much of a bigger investment in the collateral. Can DHB prevent the sale? It cannot prevent the sale, but can take possession of the collateral. Assume an article 9 secured creditor instead forces sale. Is DHB entitled to receive notice? A judgment lien creditor does not have to give notice. A secured creditor has a limited obligation to search and make a limited effort to notify record holders who show up in the search. This is a courtesy of banks to banks. 9-611 and Comment 4. So what could DHB do? The way to get ahead is for Diamond Head to foreclose before the lower creditor. You can demand possession. You could do a replevin, and you might get posted ahead (because replevin is faster). You could also self-help. If you foreclose, you are okay because the second interest will be discharged. There is a problem that you cant foreclose if the debtor is not in default. What you need to do is put in a couple of other clauses. The first is a cross default clause that says if you go into default on a loan with someone else you also go into default with me. The second says that no judgment liens will ever be placed against the collateral. But, if you dont have these in the contract you are in trouble. Problem 26.4: A Friend needs to borrow $10,000 from you. She will give a second against a house she bought for 120,000 subject to a first in amount of 80,000. The house is worth at least 90,000. Say the friend defaults on the 10 grand. Try to foreclose on the house. At auction, in the worst case, if no one shows up to bid should bid $10,000. I am credit bidding. I am the legal owner of the house subject to an $80,000 mortgage worth at least 90,000. Would you really be willing to foreclose on your friends house? There is also risk in taking over the house and then trying to sell it again. You also run the risk that my buddy will tear up the house.Will that assure 10 grand recovery? Nope. What if friend defaults on the first but pays you? Now you run the risk that the first creditor will foreclose. You also run the risk that they will bid $80,000 (or below). Because I have a second security interest I will end up with an unsecured deficiency of $10,000 and no money. Problem 26.5: What exactly happened in Grocers Supply? A junior creditor took possession. It was decided the senior had a right to the inventory, so the sheriff made the junior return the stuff. The senior gets access to the property if he wants it. In Grocers Supply the senior wanted to foreclose. The junior then could have bid at the sale, or its also possible that a third party would have come in and bid high enough to pay them both off. Now we have a senior who is not foreclosing. He is just saying no. We would argue to the court that a senior creditor also has a superior right of possession because he has priority. Junior would argue that if the senior doesnt choose to foreclose, he passes that right to the subordinates. The response is that as the senior should be able to control its own destiny. They are choosing to liquidate the inventory through normal sales in order to preserve value for everyone.. One possibility from page 443 is we might be able to have a sheriffs sale without taking possession of the property. Someone will buy at that sale, subject to the senior, and probably with an impending lawsuit. The advantage is the lawsuit occurs after, so you dont get dinged with the costs of possession. The problem is no one is really going to bid.

63

Secured Transactions Outline- Kauffman 2003

We have to solve who has the right of possession. Rather than doing the sale first do a lawsuit first. Go into court, explain the situation, and get a writ from the court saying you have a right to possess the property. That will put it on the table quickly and you will be able to make the determination. If you lose, you only lose court costs. Assignment 27: The Concept of Priority: Bankruptcy Law 1) Although bankruptcy is similar to nonbankruptcy periods in that priority still exists and is not destroyed, to some degree bankruptcy violates the two general rules of priority mentioned above. a) Two basic principles in nonbankruptcy: i) Any lien holder may foreclose while the debtor is in default to that lien holder (1) -In bankruptcy, however, the automatic stay contradicts this principle. The secured creditor cannot foreclose until the stay is terminated; 362(a) ii) No lien holder is compelled to foreclose (1) In bankruptcy the trustee or debtor in possession can sell the secured creditors collateral free and clear of liens, effectively foreclosing the secured creditors lien on the trustees or debtors own time table. (2) Bankruptcy focuses less on priority and more on creating value for all creditors. The bankruptcy system holds secured creditors in place for the benefit of junior secured creditors, general unsecured creditors, and the debtor. 2) Three ways in which the priority rights of secured creditors are diminished in bankruptcy a) The trustee or debtor in possessions ability to sell collateral. i) Sale options in bankruptcy (1) As in foreclosure, the collateral may be sold subject to the liens of senior creditors. In this case the automatic stay expires, and the secured creditor becomes free to foreclose; 362(c). (2) If the liens would exceed the value of the collateral, no one may be willing to buy the collateral. In this case the collateral is burdensome to the state and the trustee may abandon the collateral; 554. When abandonment occurs, the property is given back to the debtor, the automatic stay is terminated, and lien holders may foreclose. (3) The trustee or DIP may choose to sell the collateral free and clear of liens; 363(f). In this instance the collateral is sold much the same way as it would have been as if the senior creditor had foreclosed on the property and sold it free of all subordinate liens. In bankruptcy when this happens typically the full value of the collateral is received and the proceeds are distributed among the lien holders based on priority. The difference is the secured creditors are at the mercy of the trustee or DIP for timing (a) In re Oneida Lake Development, Inc. (Bankr. N.D.N.Y. 1990) A defaulting debtor in bankruptcy won the right to sell collateral free and clear despite the secured creditors objection. It is noteworthy because the collateral had been very valuable, but sold for only a nominal amount which was judged to be the best possible value. (b) *The ability to sell in bankruptcy protects the value in depreciating collateral for junior creditors. (c) *A weakness is that unsecured creditors who are unsure of the amount and priority of their lines may face a difficult problem in determining how to bid. (They may bid under 363(k)). 3) The trustee or debtor in possessions ability to grant liens senior to existing liens

64

Secured Transactions Outline- Kauffman 2003

a) In limited cases the trustee or DIP can borrow additional money from a postpetition lender
secured by a lien prior to existing liens; 364(d). In order for this to happen the existing lien holders must be notified. If they object the following prerequisites must be shown: i) The estate is unable to borrow the money without granting a prior lien, and ii) There is adequate protection of the interest of the secured creditor whose lien is being displaced. (1) *The theory is that postpetition financing is often essential to the successful operations of the business. If it is not forthcoming the business may fail and its future income lost. (i) *Secured creditors dont like this because typically they gain nothing, and the adequate protection the bankruptcy court dispenses is no guarantee against loss. If the collateral is later sold and there is not enough money to pay the secured party, it becomes an unsecured claim with some priority over other unsecured claims; 507(b). (b) In re 495 Central Park Avenue Corp. (Bankr. S.D.N.Y. 1992) A debtor was able to borrow money, displacing an existing mortgage, to improve the collateral. The loan was thought of as an investment that would create greater value in the collateral. 4) The shift in focus from the protection of more senior creditors to the protection of more junior ones a) This occurs in bankruptcy when i) The senior lien holders are thought by the court to be adequately protected against loss, and ii) The stay is likely to facilitate the collection efforts of subordinate creditors. Problem Set 27. Problem 27.1: refer to problem 26.1. Junior mortgagee creditor with debt of 10,000. The client is willing to pay up to 25,000. There is a senior mortgage of 17,000. Bid up to $25,000 to win. The sale is free and clear of liens so it wont be subject to a senior lien after the bankruptcy sale. The costs of sale will be paid for first. Then the rest will be distributed in order of priority on down to the general unsecured creditors. The buyer does not have to worry about costs of sale. Some would argue that under bankruptcy 363(f)(3) you can only sell if the aggregate value is greater than the value of the liens. The estate gets to determine the sale. One consequence is that if the estate can boost up the price, it lowers the residual claims that will persist against it. Given the estates interest, you can bet the estate will bring more money than at a sheriffs sale because they can advertise, they can fix stuff up, and the stuff will be sold free and clear. Furthermore, it doesnt have to sell on a particular day. The incentive is to maximize the price for the estate. What it takes away in value from the secured creditors is that they can no longer control the timing of the sale, and their interests cannot persist. Problem 27.3: Client wants more money but the asset cannot support it. Liens against the property. If we werent in bankruptcy: Asset is worth $2 million; American has first in amount $4 million; and Lien Creditors have mechanic lien in amount of $1 million. The asset would all go to American, they would only get half of what they wanted secured, and everyone else would be general unsecured In bankruptcy, asset is worth $2 million. If we spend another $1.5 million, then the asset will be worth $4 million. Outside of bankruptcy no one would come in and lend because they would be subject to American. In bankruptcy, under 364, a new lender can come in and lend and take first position, as follows, Dev. Asset New Lender American Lien Creditors $4 million $1.5 million $4 million $1 million

65

Secured Transactions Outline- Kauffman 2003

Distribution: New Lender American General Uns.

$1.5 million $2 million secured ($2 million unsecured) $0.5 million

The reason American only gets $2 million is that the creditors become set at their value at the time of bankruptcy. Outside bankruptcy no one has any incentive to risk because they will be subject to American. Problem 27.4: refer to problem 26.4 where you loan friend 10 grand on house, where there is already a first mortgage. If a foreclosure sale is held, you are going to get hosed. Because it is subject to the senior lien your debt will be wiped out. In bankruptcy, there will not be a sheriffs sale. That is the worst thing that could have happened. Instead the trustee is going to be the seller. The trustee is likely to market the house and get the best price available. If the house is really worth $120,000 the trustee will get it or something close to it. Who benefits? The junior secured creditors who otherwise would not have received anything on their debt. Chapter 9: Competitions for Collateral Assignment 28: Lien Creditors Against Secured Creditors: The Basics 1) How Creditors Become Lien Creditors a) The prototypical lien creditor is an unsecured creditor who: i) Won a judgment against the debtor; ii) Obtained a writ of execution, and then iii) Obtained a lien by levying on specific property of the debtor

b) In most jurisdictions, attachment is the legal process in which the plaintiff in litigation obtains a
writ and delivers it to a sheriff, who in turn levies on the property of the debtor. The distinction between attachment and execution is that an attachment occurs before judgment is entered, while execution occurs afterward. Property seized pursuant to attachment is not immediately sold; it is held be the sheriff pending the outcome of the litigation.

c) Garnishment is the process by which a judgment creditor in most states reaches debts owing from
a third party to the debtor or property of the debtor that is in the hands of a third party.

d) Recordation of a money judgment in the real estate system creates and perfects a lien against all
real property owned by the debtor within the county. In a growing minority of states a judgment creditor may also record and perfect a lien by filing in the U.C.C. recording system. i) -e.g. California Civil Procedure Code p. 464 e) A trustee in bankruptcy or DIP has the rights of an hypothetical ideal lien creditor; 544(a) 2) Priority Among Lien Creditors a) Priority among lien creditors is generally found in state statutes, and is on a first come, first served basis. The laws generally award priority as of one of four dates (in order of most to least common): i) Date of levy

66

Secured Transactions Outline- Kauffman 2003

ii) Date of delivery of the writ iii) Date of service of a writ of garnishment iv) Date of recordation of judgment (in the large majority of states, this rule gives liens only in real estate) (1) In a competition between writs of execution, the majority rule gives priority to the first to levy on the particular property. (2) The minority rule gives priority based on the dates the writs of execution were delivered to the sheriff (e.g. Ohio p. 466) 3) Priority Between Lien Creditors and Secured Creditors a) Priority between a lien creditor and a non-PMSI Article 9 secured creditor depends on whether the lien creditor becomes a lien creditor (9-317(a)(2)) before the secured party does one of two things: i) Perfects its security interest, or ii) Files a financing statement and complies with one of the conditions of 9-203(b)(3) (security agreement, possession, or control) b) Typically the battle is not over when the secured creditor perfected, but rather if the secured creditor ever perfected. The lien creditor will try to find some sort of deficiency in the secured creditors filing. 4) Priority Between Lien Creditors and Mortgage Creditors a) This is governed by real estate law i) Generally priority is given to the first lien created, and then reverses the result only if the failure to perfect offends the states recording statute. (1) Typically states do not afford JLCs against real property the opportunity to record in the system. The result is that a mortgage granted before the judgment creditor became a lien creditor by recording its judgment has priority over the judgment lien, even though the judgment lien was the first lien perfected. 5) Purchase-Money Priority a) Purchase-money security interests (PMSIs) may prime prior secured lenders. They are an exception to the first in time principle i) PMSIs v. lien creditors (1) A PMSI can prime a lien creditors interest only if the PMSI comes into existence and attaches to the collateral before the creditor obtains its lien against that collateral. If the PMSI attaches first, the holder of the PMSI has a 20-day grace period in which it can perfect and thereby defeat a lien that came into existence between the dates of attachment and perfection of the PMSI; 9-317(e). (a) e.g. a debtor buys a boat on credit, a lien creditor then levies on the boat. The lien creditor will win unless the secured creditor perfects within 20 days of the sale. (b) *The 20-day grace period is to facilitate sales of personal property on secured credit. The seller may give immediate delivery to the buyer without first filing a financing statement. 6) PMSI: can take priority over lien creditors in some situations. You take a PMSI in the collateral, and you have 20 days to file, and then it relates back to PMSI date. This encourages sales of goods. The sales would be discouraged if the PMS creditor could not give possession to buyer until filed financing statement. The buyer would be annoyed. The lesson for the creditor, going to the Sheriff with a writ of execution, if you instruct the Sheriff to levy on new goods, there may be a PMSI out there to defeat your levy.

67

Secured Transactions Outline- Kauffman 2003

Problem Set 28. Problem 28.1: The local credit bureau reported the entry of a judgment of $125,000 in favor of Sheng Electronics, an unsecured creditor. The debtor also owes $50,000 (unsecured) to RFT. How can RFT get priority over Sheng? RFT can gain priority by perfecting a security interest before Sheng levies. Under 9-317(a) perfect a security interest prior to the levy for Shengs judgment, which will give RFT priority. Why would the debtor give RFT a security interest? RFT has been patient with the debtor and Sheng has already executed a judgment. Negotiate -- The debtor has leverage (the ability to give a secured interest to RFT and put RFT in a much better position). The debtor could use this leverage to obtain more credit, etc. from RFT. Grocer Supply -- RFT does not have to levy. RFT can say the debtor is in default and has a right to possession. Therefore if the sheriff levies in favor of Sheng, it must give the property to RFT. (The secured creditor will hold off the lien creditor and assert its position to get the property back if there is a levy). Grocers Supply is not a long-term solution. The subsequent case says the secured creditor cant keep holding off lien creditors forever. The solution for the unsecured creditor who wants to levy is to get a declaratory judgment and not risk attorneys fees the second time around. Under the Ohio statute, if RFT delivers a writ of execution to the sheriff on the same day as Sheng, the amount will be distributed pro rata (see statute on p466). The creditor needs a judgment in order to get a writ of execution. This is not likely to happen in one day. Problem 28.2: Phyllis loans Melinda $20,000, which is secured by a scaffolding and construction equipment. On March 7, Melinda signs a financing statement, security agreement, and promissory note, but Phyllis does not distribute the money. Phyllis files the financing statement the same day and orders a search. On March 10, the sheriff levies on equipment pursuant to a writ of execution in favor of Star Plastering. On March 11, Phyllis receives the report. (a) As matters now stand, is Phyllis perfected? No, under 9-308(a) she has not met all the requirements of 9-310 through 9-316. She has not given value. Under 9-203(b)(1) a security interest attaches against a debtor and third parties with respect to the collateral if value has been given. If Phyllis has made a promise that she will disburse, this is value for purposes of attachment of a security interest. (b) If Phyllis makes the $20,000 loan despite the levy, will she have priority over Star in the equipment? Yes, if Phyllis gives value she will be perfected, under 9-317(a)(2)(B) it will also have a priority if it has filed a financing statement and the debtor has authenticated a security agreement describing the collateral under 9-203b3. You can file and get a security agreement before the levy, and give money after the levy and win. If you file according to a security agreement that is enough to get a toe hold. When you actually give value the security agreement goes back to the date of the filing even if the levy has already occurred. The filing pursuant to a security agreement locks your date. The policy for this is a way to make sure you are in first in line. You dont want to have to put dollars on the line to find out if you are first in line. Problem 28.3: National specializes in asset-based lending to small businesses that are in financial distress. All of Nationals loans are non-PMSI loans secured by personal tangible property. All are made in a state in which a creditor becomes a lien creditor only when the sheriff takes actual possession of the property. Nationals loan procedure: First, they file a financing statement, then search to make sure collateral is in hands of debtor, then disburse loan amount within two weeks. Can an execution creditor come ahead of National? Once they see the collateral in the debtors possession (a judgment creditor has not already levied), National is ok under 9-317(a)(2)(B) if debtor also authenticated a security agreement. Possible problem: goods purchased with a PMSI that have a 20-day grace period.

68

Secured Transactions Outline- Kauffman 2003

Problem 28.4: What if National is in a state that adopts a statute, which creates a judgment creditor (and applies as a lien) by filing notice of the judgment with the Secretary of State? The situation does not change from Problem 28.3. The judgment should show up in the creditors search. Problem 28.5: What if Nationals state adopts a statute like Ohio 2329.10 (in which no preference is given to writs delivered on the same day if amount is not sufficient, pro-rata distribution). Hypo: On Nov. 1, the judgment creditor gives a writ. On Nov. 5, National files a financing statement. On Nov. 13, the sheriff levies. When did the judgment creditor become a lien creditor? The statute says in all other cases the writ of execution first delivered to the officer shall be the first satisfied it does not say when the judgment creditor becomes a lien creditor with respect to Article 9. It only discusses priority between two levying creditors. Its uncertain, but the statute suggests that the judgment creditor becomes a lien creditor on Nov. 1. If you are Nationals lawyer, you would suggest that National change its procedures. Most sheriffs offices keep records with respect to delivery of documents, so National should add a search of the records of the county sheriff to be sure that nothing has been delivered. Kaufman: Not likely, but it is possible that under the law of Ohio, delivery of the writ to the sheriff in county 1 might establish priority with respect to county 2. The attorney would need to research case law, etc. Problem 28.6: Bonnie sold a boat to Edith for $35,000 -- $3,500 down and a promissory note for the rest. Bonnie ran an instant creditor check and missed the judgment against Edith for $22,000 unpaid alimony and child support. Edith signed a security agreement and financing statement. Immediately after Edith takes possession of the boat, the sheriff levied on the boat in favor of Ediths ex-husband. Bonnies contract states that any levy on the boat constitutes a default. What can Bonnie do? If they are consumer goods then it is a Purchase Money Security Interest with a special set of rules in 9-317. There is automatic perfection. It was perfected when she signed the security agreement. If we have consumer goods, then we can ask for the boat back because we have a fully perfected security interest. Citing Grocers Supply we would be asking for it back based on the prior security interest. The judgment is interfering with the senior creditors ability to repossess. As between our right to repo and the judgment creditors right to foreclose, we have the stronger right (Remember that Grocers Supply isnt everywhere). If they are not consumer goods, you are no longer automatically perfected. You need to file. Once you file, under 9-317(e), you have 20 days to file because it is a purchase money security interest (just not in consumer goods). If you file within the 20 days then you are priming. Problem 28.7: Same facts as above EXCEPT Edith forgot to sign the security agreement. (The sheriff has already levied). Edith will sign the security agreement b/c she does not want her former husband to get the boat. It wont do any good to sign now. Now the date that you would go back to is still after the judgment levy. 9-317e tells us that it goes back to the time of attachment. It attaches when she signs the security agreement. We still tell her to sign and file now. But, we are still in big trouble because of the judgment levy. Lopuckis advice: sign it anyway and waive it around in the sheriffs face. See if the sheriff asks the right questions or not. Warren: There are witnesses. This is kind of shady. Ethical Issues: Bonnies lawyer cannot advise Edith. Bonnie can get Edith to sign as long as she does not represent the advice as coming from the lawyer. You are not tricking Edith into doing anything she is not supposed to do (i.e., signing the security agreement). Bonnie would be doing something perfectly lawful. Possible argument: There is a provision in the model code that says the lawyer cannot advise someone to do something the lawyer could not do themselves. In this case Bonnie would not be allowed to pass along her lawyers advice to Edith. But, The Model Rules are in effect, which contains a sentence that says it is not a violation to give legal advice to your client. ***The lawyer is required to explain the legal situation to Bonnie, the client that the security agreement is second in time.

69

Secured Transactions Outline- Kauffman 2003

Problem 28.9 The debtor grants a real estate mortgage to M, who does not record. C levies on the real estate. As between M and C, who has priority? Generally, the unrecorded real estate mortgage prevails over the lien creditor. Justification for two different results: there is usually more of a reliance interest in the case of real estate, and they dont want to do anything to mess up a chain of title. Assume the same facts, except that the collateral is personal property and Article 9 governs. As between M and C, who has priority? The judgment lien creditor wins. It reverses. Policy Rationale: There is a justice argument that secured creditors always make. They say I should beat the judgment lien creditor because I planned ahead (but they screwed up) and gave value. It is a reliance argument. The judgment lien creditor never looked in the filing system. Secured creditors look, and JLCs dont look. The real estate system gave it to the secured creditors. The U.C.C. gave it to the judgment lien creditors. Assignment 29: Lien Creditors Against Secured Creditors: Future Advances p. 472 1) Priority of Future Advances: Personal Property a) Exceptions for future advances: i) Secured inventory lenders, construction financiers, etcoften make additional loan advances to their borrowers. 9-323(b) gives future advances priority over lien creditors provided the creditor making the advance does not have knowledge of the lien. (1) *This allows secured lenders to only have to make one search before lending, and not requiring them to make additional searches, which would be costly, every time they want to lend more money. ii) Every secured advance made within 45 days after a levy is entitled to priority over the lien, even if the secured creditor making the advance knows of the liens existence; 9-323(b) (1) *This period was given to beat out IRS tax liens, it only follows that the period allows the secured creditor to beat out other lien creditors. iii) Every advance made pursuant to commitment entered into without knowledge of the lien is similarly protected; 9-323(b)(2) (1) This is to say that even if the secured creditor knew about the levy at the time of the advance, if there was no knowledge of the lien at the time of the commitment to make a future advance, then the advance is secured. (2) *Secured lenders argue this provision is necessary to provide businesses with the financing they need to remain in business. 2) Priority of Nonadvances: Personal Property a) Nonadvances are things akin to attorneys fees and collection costs that are arranged for in a security agreement. The debtor agrees to pay these nonadvances. b) Uni Imports, Inc. v. Exchange National Bank of Chicago (7th Cir. 1991) Nonadvances do not constitute new security agreements under 9-323(b). Rather, they relate back to the first date of perfection and share that status against judgment creditors. i) *The case for nonadvances can be stronger than the case for the priority of future advances. The secured creditor often has no way of paying attorneys fees, etcregardless of how diligent the secured creditor is. As such, the secured creditor should be able to protect itself. (1) *The response is that nonadvance payments do not enlarge the pie like future advances, so they should not be entitled to special priority over lien creditors. The payments simply eat up what is available for lien creditors. 3) Priority of Future Advances and Nonadvances: Real Property a) The real estate system is even more tolerant of future advances

70

Secured Transactions Outline- Kauffman 2003

b) *In personal property a lien creditor actually levies on the property. In the real property system, a lien creditor files in the country recording system. This is less notice the debtor wont find out about the recording until it tries to transfer its property. It is understandable that the real estate system is more lax regarding future advances. c) Shutze v. Credithrift of America, Inc. (Miss. 1992) In the real property system, the court gave a future advance priority over an earlier judgment even though the creditor was not obligated to make the advance. i) Not every jurisdiction follows Shutze. Some only give priority to future advances that are obligatory while others (like in Shutze) also give priority to optional advances Problem Set 29. Problem 29.1: Real property and future advances. The mortgagor borrows $50,000 from the Mortgagee, and executes a note and mortgage that states that future advances can be made by the Mortgagee for $25,000 in the future. Mortgagee has no obligation to make the future advance. The mortgage states it secures interest at 10% and attorneys fees in a collection action. J obtains a judgment for $100,000 against mortgagor and records a lien on the real estate. Then Mortgagee loans an additional $25,000 with knowledge of the lien. Mortgagor defaults owing $10,000 interest and $5,000 attorneys fees. As between Mortgagee and J, who has priority in the real property? If the property is sold, what is the priority? Mortgagee will get the first $50,000. The Shutze case says the mortgagee also get the next $25,000 (The Restatement 3rd of property also says this is what is going on this isnt to say there arent minority jurisdictions, but this is the majority view). The mortgagee gets nonadvance costs as well. Notice that for a mortgagee, knowledge doesnt matter. Involuntary third parties really cant wiggle their way in with judgment liens. Problem 29.2: Personal Property and future advances. Debtor borrows $50,000 from Secured Party and executes a note and a security agreement that state that future advances up to an additional $25,000 may be made by the Secured Party in the future. However, Secured Party has no obligation to make such advances. The security agreement also states that it secures interest at 10%. Secured Party perfects. Thereafter, J obtains a judgment of $100,000 against Debtor and becomes a lien creditor by levying on the collateral. Secured Party has actual knowledge of the lien. Sixty days after the levy, Secured Party lends and Debtor accepts an additional $25,000 advance. Debtor defaults on the loan owing the full balance and $10,000 in interest. Secured Party incurs $5,000 of attorneys fees that are recoverable against Debtor under the terms of the security agreement. As between Secured Party and J, who has priority in the personal property? First $50,000 goes to the secured party (both real estate and personalty). As for The $25,000 (optional advance made 60 days after with knowledge), the secured lender wins if real estate. But here, personalty, the Judgment Lien Creditor wins according to 9-323(b) because it was a non-commitment more than 45 days after the lien. Expenses (non-advances): interest and attorneys fees. If real estate, the mortgagee got them. But if personalty they are split. All interest and fees attributed to the $50K get the same priority as the $50,000. Whatever is associated with the second advance gets that same position behind the judgment lien creditor. Problem 29.3: A year ago, Carol lent $1,000 to her friend, Bob. Bob gave her a security interest in his new boat, and saw that the financing statement was duly filed. BCA recently recovered a judgment against Bob in the amount of $45,000. On March 1, they levied on the boat. It now sits in the Sheriffs compound. Now, Bob is back to ask Carol another favor. Bob wants an advance of $31,000. Bobs lawyer says the advance will protect the boat from judicial sale. He says even if they go through with the sale they wont get anything. Carol asks if this will work. What would happen if Carol did not make the loan? The sale will happen, but Carols 1,000 interest will continue. If the boat is worth $32,000, the sale

71

Secured Transactions Outline- Kauffman 2003

will go as high as $31,000. Distribution: the JLC will get $31,000. What happens if Carol agrees to make the loan (assuming the original agreement has a provision for future advances)? Still sell the boat. It will now sell for $0. The JLC will get $0. Under 9-317(a)(2) if the security agreement included a future advance clause, and Carol loaned additional money within 45 days Carol has priority over the lien creditor, under 9-323. Note: We dont know if the original agreement had a provision for future advances. If it was limited to the $1,000 loan, Carol would need a NEW security agreement. The new security agreement would be perfected too late. It would not have priority over the judgment creditor. Problem 29.4: BCA is attempting to collect the $45,000 judgment against Bob. The value of the boat is assessed at $45,000. The sheriffs sale is set for March 29, just a few days from now. In preparation for the bidding and sale, you discover Carols financing statement. You dont want to bid higher than the value of Bobs equity in the boat. But to know how much that is you need to know the amount secured by Carols interest. When you call Carol, she said she would have to consult her attorney before giving you the information. Carol has not called you back. (a) How do you plan to get the information? The amount is not found on the financing statement. According to 9-210, the inquiry must be made by the DEBTOR. The response to an inquiry has to arrive within 2 weeks not enough time. The good news is that we are a judgment lien creditor, so we are permitted to discovery. We would run into court and ask Carol the value of the loans. I would also ask Bob. I assume they come into court with a paper saying $1,000 and future advances. We are still not safe because they can still make future advances. A judgment creditor could put Bob under oath and ask how much he owes, but this will not be at sometime before the foreclosure. But this does not help the bidder, b/c the financing statement and security agreement is outstanding and Carol could lend additional money right before the sale. Another option: You could string the sale out for 45 days, and then do the discovery. (b) If you cant get the information, what will be your bidding strategy at the sale? Should bid zero -- The bidder does not know how much the secured creditor is owed, and it should bid zero b/c it would buy subject to the security interest. Look to 9-323(d) the buyer of goods acquires free of the security interest to the extent it secures advances at the earlier of 1) the secured party has knowledge of the purchase; or 2) 45 days after the purchase. The secured party must have knowledge of the purchase. Typically, if the secured party gets knowledge that the boat will be sold on March 29. It will prevent the secured party from making an advance. Buying subject to the $1,000 security interest. So, you should bid $31,000. (Value of $32,000 - $1,000). What if Carol doesnt make the loan, and goes to the sheriff to demand possession under Grocers Supply? The lien creditor would use Freyerson especially if Carol lets Bob use the boat. Problem for the lien creditor: provision in Article 9 that says the debtor can require Carol to supply the 3rd party with the details of the security agreement. The lien creditor cant get it on its own. The lien creditor would have to take Carol to court. Then, the lien creditor would pay off Carols 1,000 judgment. Problem 29.5: A creditor Sheng runs a search in preparation for a levy. There are three financings statements, each covering all the assets of the debtor Conda Copper, a company that is in financial difficulty. You doubt that anyone would have been stupid enough to lend money to Copper unsecured. The financing statements have been filed in the last few months. (a) What do you think is going on? Copper is wrapping herself in security agreements in order to ward of judgment creditors. Looks like Grocers Supply the debtor is friendly with a creditor in order to block a judgment creditor. It is better to be second in priority instead of a unsecured general creditor.

72

Secured Transactions Outline- Kauffman 2003

(b) What should you do? Put the last two questions together with Grocers Supply. I have one debtor and one creditor who are in cahoots. You can say you are harming my stuff. Frierson limits Grocers Supply when they are both trying to repossess. The best thing to do is to put a future advance agreement in the original contract with your buddy. It allows the first secured lender to protect its position up front, and then come in at any point. Assignment 30: Trustees-in-Bankruptcy v. Secured Creditors: The Joys of Strong Arming

1) The Purposes of Bankruptcy Code 544(a): This lets TIBs demote unperfected secured creditors to
the status of unsecured creditors in bankruptcy. There are two reasons for this: a) It polices compliance with the filing requirements of Article 9 b) It serves a distributive function by insuring that secured creditors don't get benefits against unsecureds in bankruptcy that secureds couldn't get outside of bankruptcy. 2) The Text of Bankruptcy Code 544(a): a) The text of the provision says that the TIB has the same rights as: i) A JLC who extends credit and levies at the time of bankruptcy ii) A creditor with execution returned unsatisfied: Ignore it. iii) A Bona fide purchaser of real property who could perfect against the debtor (1) This is trying to get a state recording statutes where you might have a race/notice, pure notice, or pure race statutes. (2) Midlantic National Bank v. Bridge (a) Facts: A bank refinances a mortgage. The old mortgage is discharged, but the bank fails to record until after bankruptcy. (b) Legal Stuff: Under the NJ recording statute the bank did not have a good mortgage against anyone at time of bankruptcy. However, the bank trotted out a theory of equitable mortgage, etc. The court said they had an equitable lien but that such a lien would not be good against a bona fide purchaser under NJ case law. Ergo TIB wins.

3) Implementing the Strong Arm Provision: The strong-arm provision is not self-executing; the TIB
or DIB must file a lawsuit in the bankruptcy court to demote the unperfected secureds. a) Chapter 7 TIB (1) TIBs are lawyers and they aren't paid if there is nothing in the estate but fully encumbered property, i.e. they get paid ahead of all unsecureds but behind the secureds. b) DIP in Chapter 11 i) DIPs tend to be the management of the corporation in Ch. 11. They often do not want to avoid security interests: (1) They may have granted the security interest in the first place in order to screw unsecured creditors.

4) Grace Periods: Bottom line is that unperfected creditors at the time of bankruptcy can take
advantage of relate back provisions that allow them to take action post-filing that would make them secured from some pre-filing event, e.g. PMSI filings. a) How is this possible? What about the automatic stay? Where is it in the code? i) 363(b)(3) creates an exception from the automatic stay for perfection allowed under 546(b) ii) 546(b) says post-filing perfection is fine if it is perfection that would be good against any entity prior to filing. Problem Set 30

73

Secured Transactions Outline- Kauffman 2003

You are employed as an attorney for the trustee in the Chapter 7 bankruptcy of Gargantuan, Industries. Gargantuan filed under chapter 11 on April 15, and the case was converted to chapter 7 on October 15. The trustee wants to know which of the following can she shed under Bankruptcy Code 544(a)? Problem 30.1: Filed chapter 11 on April 15, and the case was converted to Ch 7 on October 15. Which security interests can the trustee avoid under 544(a)? (a) The secured party filed its financing statement on April 22. It can be avoided b/c the effective date of bankruptcy filing is April 15, and as of this date the secured party had not perfected. A lien creditor would have priority over an unperfected security interest. 348(a) the conversion of a bankruptcy case does not effect a change in the date of filing of the petition or commencement of the case. (b) Same facts as (a), except the bank properly filed its financing statement on April 14, one day before the debtor filed under Ch 11. Not avoided under 544(a). It is a properly filed and perfected security agreement. NOTE: It may be a voidable preference under 547. (c) The creditor listed the debtor as Gargantuan Industries and left off Inc. and it omitted all the information required by 9-516(b)(5). The security agreement still showed up in the search, but it is impossible to tell if the filing is against the debtor or a business using a trade name. The filing officer should have rejected the financing statement, but it was accepted. The trustee loses. Under 9-520(c), if the filing office accepts a financing statement that does not give the information required, the filing is fully effective. 9-520(c), comment 3. Does the exception in 9-338 apply? 9-338 (Priority of Security Interest Perfected by Filing Financing Statement with Incorrect Information) the creditor is subordinated to a purchaser who buys in reasonable reliance on the incorrect info. No. Under 9-338, you have to make a negative inference. We dont have someone who is a purchaser or gave value. A trustee cannot fit into this description. (d) The creditor filed a financing statement 5 years prior to July 15, but failed to file a continuation statement. The financing statement lapsed on July 15, so it was effective on the date bankruptcy was filed on April 15. A lien creditor would not have prevailed if it levied on April 15. What happens when the financing statement ceases to be effective? 9-515(c) a security interest is unperfected upon lapse. If a security interest becomes unperfected upon lapse, it is deemed to never have been perfected ONLY against a purchaser of the collateral for value. See 9-515(c), Comment 3, example 2. If you are thinking about filing for bankruptcy, you should wait until the financing statement lapses. It is all about reliance. The lien creditor did not rely on the filing system, so the lien creditor does not get an advantage. (e) The lawyer forgets to fill in the description of the collateral on the security agreement. Two years later, the lawyer wants a subordinate lawyer, Grace to fill in the blank. Grace refuses, resigns from the firm, and tells the trustee. Another lawyer in the firm, Bennie fills in the blank. The lawyer and the client agree in writing that this expressed their original intention. What have Bennie and Grace done wrong? Bennie has violated the automatic stay of 362(a) criminal contempt of court, and he can go to jail. Bennie has also falsified documents to court and could be disbarred. Under the old version of the Model Rule 1.6, Grace is not allowed to breach confidence. Under the new version of Rule 1.6, Grace can breach confidentiality in order to prevent the financial harm to a 3rd party. Grace is an associate, so she wont have responsibility for what her colleague did unless she supervised him. (f) On April 6, nine days before the company filed for Ch 11, a bank financed the purchase of a company vehicle. The bank filed the certificate of title on April 25 after it learned of the bankruptcy. Did the bank violate the automatic stay? The bankruptcy code allows you to file within a window under 362(b)(3). Here, we are outside 10 days, but under 20 days. The DMV only gives you 10 days, as does 547(e)(2)

74

Secured Transactions Outline- Kauffman 2003

(A). But, 546(b) gives you a bigger window subject to generally applicable law. Under 9-311(a) you dont need a financing statement because cars are done by certificate of title. Under 9-317 it is a PMSI (purchase money security interest) so you get 20 days. What about the fact that the DMV only gives you 10 days? Note that the DMV gives you 10 days to maintain your status not 10 days to file. You can file whenever you want. The question is whether you get the 20 days in PMSI or the 10 days from the DMV? You have to look at the comments. Look at comment 8 to 9-317. If it is filed within the 20 days you are okay. This comment is a wraparound. When article 9 was revised they wanted more time for PMSI and rather than asking all of the DMVs to change the amount of time, they put in this workaround. So the trustee loses. For purposes of bankruptcy, you still have 20 days to file. (g) One week before Gargantuan filed its bankruptcy petition, the Yarn Shop delivered a writ of execution to an Ohio sheriff along with instructions to levy on an automobile owed by Gargantuan. Two days after the petition is filed, the sheriff (who was unaware of the filing) levies on the car and takes possession of it. Can the TIB avoid the levy under 544(a)? The trustee will prevail if a hypothetical lien creditor that levied on the date of bankruptcy would prevail over the yarn shop. Under Ohio law, the yarn shop having delivered the writ of execution first would prevail over a hypothetical lien creditor who delivered a writ of execution and levied on the same day. What else should we look at to solve the problem? Violated 362(a)(3) Automatic stay the sheriff levied after the filing of the petition in bankruptcy. 362(b)(3) is not applicable in this problem allows you to perfect a lien that you already have. This section does not apply b/c under Ohio law, you dont have a lien until the sheriff seizes the property. The priority dates from the writ of execution. There are two viewpoints authors and Kaufman. Authors: Based on state law: Ohio lien law (p466) priority between liens does not depend on day of levy BUT delivery of the writ to the sheriff. The bankruptcy petition comes between delivery of the writ and execution. The sheriff is permitted to finish the execution, and it relates back to the delivery of the writ. Kaufman: what about the provision of the Ohio lien law that says you have to levy to get a lien? The sheriff had not levied by the date of bankruptcy in this problem, regardless of when their priority relates. Problem 30.3: Debtor has $10 million in assets. $8 million of secured debt to Oriental bank. The debtor also has $20 million in unsecured debt. (a) The financing statement does not show up in a search under the debtors name. The DIP may avoid. 9-506(b) a financing statement is seriously misleading if it fails sufficiently to provide the name of the debtor 544(a) only says that the trustee in bankruptcy may avoid. So, Oriental is vulnerable but within limits it is up to the DIP to decide what it wants to do. (b) How much can Oriental get under chapter 11? It is entitled to what it would get in a chapter 7 liquidation. If the DIP does not avoid its security interest, it is entitled to the full $8 million. $8 million but since it is now unsecured debt, the creditor will probably not get the entire $8 million, but rather a pro-rata portion of the debt. (8/28 * $10 million = .29 cents on the dollar) (c) How much money are unsecured creditors entitled to receive? It turns on what the DIP does with Orientals security interest.

75

Secured Transactions Outline- Kauffman 2003

Not avoided - $2 million is left. Avoided 20/28 * $10 million = $.71 cents on the dollar

(d) How much money are shareholders entitled to? None, there is $28 million in unsecured debt, and $10 million in assets. (e) Proposal by the DIP -- $5 million for Oriental, $4 million for the unsecureds, and $1 million for the shareholders.

Oriental: accept the $5 million if they think the DIP will avoid their security interest. Unsecureds: o If they think Oriental is a friendly creditor to the DIP and the DIP will not avoid Orientals security interest, they should accept the proposal. o If they think Orientals security interest will be avoided, they should not accept the plan. The unsecureds might be able to bring a lawsuit against Oriental to avoid its security interest. If the case against Oriental is open and shut, they dont have much of a defense. The position of the unsecureds is strong for getting permission to avoid it. But this does not happen very often. What has the DIP in possession accomplished if the proposal is accepted? o The shareholders have equity left in the company.

Problem 30.4: If the property in Midlantic v. Bridge had been personal property rather than real estate, would that have changed the outcome? The trustee would only have the rights of a lien creditor under 544(a) with regards to personal property. Kaplan -- Lien creditor vs. lien creditor principles of equitable subrogation might edge out the trustee in bankruptcy. Assignment 31: TIBs v. Secureds: The Joy of Voidable Preferences 1) Priority Among Unsecured Creditors a) Under State Law: Basically the unsecureds jockey with one another and the debtor can prefer one creditor over another creditor by promoting them to the status of secured. b) Under Bankruptcy Law: Unsecureds are one big family. c) Ahg! No! Conflict!: State and Bankruptcy law have competing goals, it seems. Generally, bankruptcy respect state law, however there is the problem of debtors, on the eve of Bankruptcy, preferring their creditor friends. i) Solution: Bankruptcy looks back in the 90 days before filing and knocks out any attempts to promote creditors from unsecured to secured status. 2) What Security Interests Can be Avoided as Preferential? a) Bankrupcty Code 547(b) sets out the basic rule. The transfer must: i) Must be a transfer of property. (b) ii) For benefit of a creditor, (b)(1), or (b)(2) on account of antecedent debt (1) NOTE: This excludes new loans secured by new security interests. iii) Must be made when the debtor is insolvent. (b)(3). (1) The idea is that if the debtor is solvent then he has cash to pay off all of his creditors and we don't care if he is giving security interests, etc. (2) The debtor is presumed to be insolvent in the 90 days before filing. 547(f). iv) Be made in the preference period.

76

Secured Transactions Outline- Kauffman 2003

(1) For most creditors this is 90 days. (2) For insiders the preference period is 1 year
(a) For insiders outside of the 90 day presumption period, the avoider must actually prove insolvency. v) That improves the position of the creditor. (b)(5) (1) The Improvement Test: imagine two otherwise identical chapter 7 liquidations, one in which the creditor had the benefit of the preference and one in which the creditor did not have the benefit. If the creditor gets more in such a liquidation because of the preference it is voidable. b) When Does the Transfer of a Security Interest Occur? Basic Rule: Transfer occurs at the moment of perfection. 547(e) i) Perfection is defined understate law by imagining a hypothetical challenger to the security interest. Thus it is perfected when: (1) When a bona fide purchaser couldn't beat interest (real property). (2) When a JLC couldn't beat interest (personalty and fixtures). (a) Example: Under an after acquired property clause the interest in after acquired property is not created until it is actually acquired, rather than when the initial statement was filed void away! (see pg. 511) ii) Exceptions for Accounts Receivable and Inventory. 547(c) (1) Since accounts and inventory are constantly turning over, voidable preferences could mean that these creditors would always be unsecured in bankruptcy. (2) Fear not! under (c)(5) this is resolved by treating accounts and inventory as a single pool. The basic gist is that you are safely secured up to the value of your inventory or accounts as of 90 days before filing, regardless of whether there are actually different widgets in place during the 90 day period. iii) Relation Back Rules (1) The problem of creating secured loans during the 90 day period: How simultaneous need we be? If you sign a note and then five minutes later you file the financing statement, is the security interest voidable as give on account of an antecedent debt? (a) NO (surprise). You have a ten-day relation back period. 547(e)(2). (b) You also get 20 days for PMSIs. 547(c)(3) (c) Fidelity Financial Services v. Fink (US sup ct. 1998) (i) Issue: Which provisions prevail, ie can states change the length of the look back by statute? (ii) Held: Nope! The length of the look back is governed by federal not state law. Perfecting outside of the federal look back means it is on account of an antecedent debt. Daho! 3) Strategic Implications of Preference Avoidance a) Debtors who want to give preferences to some creditors will wait for 90 days in order to be outside the limits. b) Unsecured creditors will monitor filings to see if debtors are promoting some unsecured to secured status. This indicates financial troubles. Unsecureds may file for involuntary bankruptcy to insure that there is something in the estate. c) Savy unsecureds will go to the creditor and threaten involuntary petition and demand that they be upgraded.

4) Assignment 31 Class Notes: a) Kaufman wants us to understand a critical point. There are two concepts in 547, when the transfer takes effect and when it is made. i) The transfer takes effect in case of security interest, when the security agreement is 77

Secured Transactions Outline- Kauffman 2003

signed. This can take effect without perfection. ii) But the critical thing for 547 is when the transfer is made. Its made upon perfection, unless it relates back. If it is perfected within 10 days, and financing statement filed on day 9, the transfer is made on day 1. If it is perfected on day 11, the transfer is made on day 11. (1) The critical thing about transfer being made on day 11 is that it may push into 90 day preference period and also make the transfer for antecedent indebtedness. If transfer made on day 11, it secures an agreement made on day 1, and that is antecedent debt. Under 547c3, you have 20 days with PMSI. (2) But, under 547c1, you cannot avoid contemporaneous exchanges. b) Another thing. Suppose a payment is made to an unsecured creditor within the preference period of half its indebtedness. At time paid 50%, debtor could pay all 50%, so no preference. It went to SC, who said BS because that creditor will be paid a dividend. Unless debtor pays all unsecured 100%, then it is a preference.
Problem Set 31 Problem 31.1: Company filed Ch 11 bankruptcy on September 1. On December 30, the case was converted to Ch 7. A partner in the law firm was appointed trustee. Which transactions can be avoided as preferences? (a) On Aug. 15, Company borrowed $300,000 from Firstbank. They executed loan documents that day. They included security agreement and financing statements, both covering equipment owed by the Company. Firstbank filed the financing statement the following morning. Is Firstbanks security interest preferential? Not avoided. When did the transfer take effect? Aug. 15 b/c a security agreement was signed. When was the transfer made? Aug. 15 b/c the security agreement was filed within 10 days. Therefore, it is not for antecedent debt even though it was in the preference period. No antecedent debt the debt was created on the day the transfer was made. 547(e)(2) relation back for security interests perfected within 10 days after the interest takes effect between debtor and creditor. (b) On February 7, Company borrowed $300,000 from Secondbank on an unsecured one year note. On July 11, Company signed a security agreement that granted a Secondbank a security interest, and Secondbank immediately perfected. Avoided transfer for benefit of creditor on antecedent debt within 90 days of filing bankruptcy. The security interest will put the creditor in a better position. When does the transfer take effect? July 11. When was the transfer made? July 11. When was the debt created? Feb. 7. (antecedent debt) (c) On Feb 7, Company borrowed $300,000 from Thirdbank on a secured one year note. The financing statement was lost in the mail. Five months later, it was found by a postal employee. On July 11, the UCC filing office accepted the filing. Avoided not within the 10 day window. When is the transfer made? July 11 for antecedent debt. (d) On July 21, Company purchased a network and hardware from EMS. Company financed the purchase with a $30,000 note from Fourthbank. Company signed a promissory note, security agreement, and financing statement. Fourthbank issued the loan check on July 21. EMS delivered the network the following day. Fourthbank mailed the financing statement to the Secretary of State, and it was accepted for filing on July 30. Not avoided there is no preference b/c of 10 day window. What if this was filed on Aug. 2? PMSI 9-103(a)(1) purchase money collateral means goods or software that secures a purchase-money obligation incurred with respect to the collateral. 9-103(b) purchase money security

78

Secured Transactions Outline- Kauffman 2003

interest in goods. 20 day window after debtor gets possession of the collateral under 547(c)(3). 547(e) (3) a transfer is not made until the debtor acquires rights in the property. (e) Would the result be different in (d) if Company had issued the check to the Company and the Company used other funds to purchase the network? Not a different result. It would no longer meet the definition of a PMSI, but it is still within the 10 day window of 547(e)(2). (f) On March 9, Company did not have the money to make its payroll. It borrowed $300,000 from the wife of the CEO. The financing statement was not filed until April 9. Voidable. 101(31) insider if the debtor is a corporation, it includes the relative of a GP, director, officer, or person in control of the debtor.101(45) relative means individual related by affinity or consanguinity within the 3rd degree. 547(b)(4) preference period for insiders is one year. But, the trustee loses the presumption of insolvency under 547(f). It was not contemporaneous under 547(c)(1) and does not meet the 10-day window exception under 547(e)(2). Problem 31.2: Over a year ago, you filed suit against Company on behalf of your client. The suit is on an unsecured promissory note. The case was tried more than two months ago, and you won a verdict of $547,000. On the day after the verdict, four other creditors of the Company filed financing statements and recorded real estate mortgages against Company. Eleven days ago, the court entered judgment on your verdict. Yesterday, the judgment became final and you entered writs of execution and garnishment on Companys property. The Company is still selling motorcycles on its showroom. What is your next move? (1) Involuntary bankruptcy303(a) -- Threaten with involuntary bankruptcy. If the debtor has 12 or more creditors, it takes 3 creditors to file an involuntary petition. Watchdogs get no special reward only pro rata distribution, so this is not a good option. 547(b) - avoid the other creditors security agreements filed the day after the judgment. (2) Threaten involuntary bankruptcy unless the Company gives you a security interest or money. But, if you get a security interest, and later they go into bankruptcy your security interest may be avoided while the others will be outside the preference period. (3) Best option: Go to the other creditors and bargain with them. Unless they cut you in on their preferential position, you will push the Company into bankruptcy. Problem 31.3 Security interest in inventory. On June 1 balance of loan was $250,000 and value of inventory was $120,000. On Aug. 29, date of bankruptcy filing, the loan balance was $150,000 and the value of inventory was $70,000. Solution: Two point test under 547(c)(5) Within 90 days of filing (June 1) $130,000 difference between loan and value of inventory. (2) Date of filing -- $80,000 difference between value of loan and value of inventory. Preference of $50,000. HYPO: If you are oversecured on day one, there is no preference!

Within 90 days of bankruptcy: (100 debt and 125 collateral) AND Date of bankruptcy: (100 debt and 200 collateral), there is NO preference!

79

Secured Transactions Outline- Kauffman 2003

Kaufmans problem to illustrate 544(b) 544(b) gives the trustee the power to avoid transfers that can be avoided by an actual unsecured creditor. This removes from the trustee the power to avoid security interests voidable under

Article 9 b/c the creditor who can defeat an unperfected security interest is not an unsecured creditor. Only a lien creditor can defeat an unperfected security interest. In bankruptcy, a lien creditor is a secured creditor b/c the judgment is secured by the lien.
544 is useless with respect to secured creditors, except in this situation: 7/1 Bank loan and Security Interest in equipment 7/2 Judgment creditor levies on equipment 7/10 Bank files security interest (within 10 days) 9/15 Company files bankruptcy What can the TIB avoid? Trustee in bankruptcy cant attack the bank under 544(a) b/c the bank has perfected before bankruptcy. No 547 preference b/c the bank perfected within 10 days. TIB cant attack the banks security interest under 544(b), which only gives unsecured position. AVOIDED -- THE JUDGMENT CREDITOR has acquired a lien within the preference period that it did not have before. It is vulnerable under 547. It is a transfer, which includes involuntary transactions. 551 any transfer voided or lien voided is preserved for the benefit of the estate. The trustee steps into the shoes of the lien creditor. The lien creditor can prime the bank for the amount of the judgment. The delay in filing allowed the lien creditor to get priority over the bank to the extent of the lien. o Remember 9-317(a) judgment creditor has priority over the bank. The judgment creditor primes the bank b/c the bank is not perfected before or did not file before judgment creditor levied.

Although 544 does not allow the TIB to use rights of lien creditor directly, through this end run, by using 9-317 and 551, the TIB can use the rights of an actual lien creditor against the security interest. The estate gets the amount the lien creditor can get.
Assignment 32: Secured Creditors vs. Secured Creditors: The Battle Begins! 1) The Basic Rule: First to File or Perfect a) The basic rule is set out in UCC 9-322(a)(1) under the rule the first filer wins even if they don't perfect until after the second filer! e.g. Bank 1 files at T1, Bank 2 lends and files at T2 (perfects), and Bank 1 lends (and thus perfects) at T3, Bank 1 wins! i) Why have this system? (1) It protects the filing system by letting folks file, wait for the basket to clear and to be secure in their perfection. See comment 5 to UCC 9-322. (2) BUT: Someone might also be perfected but unfiled at the moment of filing, thus the filer must check for possession and the like. (a) If the creditor inspects after filing there is the chance that someone was perfected by time of filing by possession and has relinquished possession but filed and thus has continuous perfection. VERY RARE. b) Exception for Transfers, UCC 9-325

80

Secured Transactions Outline- Kauffman 2003

HYPO: Bank1 perfects against Debtor1's widget at T1. Bank2 perfects an after acquired property clause against Debtor 2 at T0. At T2 Debtor1 transfers the widget to Debtor2 without any release of Bank1's security interest. Between Bank1 and Bank2 who wins? ii) THE ANSWER: Bank1 wins. Under UCC 9-322 Bank2 perfected first and so should win. However, under UCC 9-325 Bank1 wins because it was perfected in the widget prior to transfer. 2) Priority for Future Advances a) HYPO: At T1, Bank1 files financing statement against widget1. At T2, Bank2 perfects against widget1. At T3 Bank1 perfects by taking security interest and making advance against widget1, with a future advance clause in its security agreement. As between Bank2 and Bank1's loan who wins in the fight for priority on widget1? b) ANSWER: Bank1 wins. It was first to file or perfect. Later advances secured by the same collateral relate back to the original perfection in the collateral and beat out Bank2. c) Why do we do this? i) Searchers are on notice. (1) Under real estate law they are probably on notice as to future advance clause. (2) BUT: under UCC the security interest with the future advance clause is not filed and the financing statement will not contain the future advance clause. ii) Relieves lenders of having to search each time they make a loan. iii) Promotes serial monogamy between lenders and borrowers. 3) Priority in After Acquired Property a) HYPO: At T1, Bank1 files against Debtor's widget (although debtor has no widgets). At T2, Bank 2 files against Debtor's widget. At T3, Bank2 loans money. At T4, Bank1 loans money. At T4, debtor actually buys a widget. Who wins the widget priority between Bank1 and Bank2? b) ANSWER: Bank1! c) This was Article 9's big innovation. Makes inventory financing practical. Otherwise bank would have to constantly be filing financing statements to stay perfected. 4) Priority of Purchase Money Security Interests a) Basic Rule i) Under UCC 9-324(a) a purchase money security interest triumphs if it is perfected within 20 days of when the debtor receives possession. ii) HYPO: Bank1 perfects against debtors equipment at T1. At T2 debtor purchases and takes possession of new equipment financed by a PMSI by Dealer. At T2 + 20 days, Dealer files against Debtor's equipment. Between Bank1 and Dealer, Dealer wins! iii) Why have this thing? (1) The PMSI lender could get it anyway by simply running the transaction through a strawman. (2) This allows dealers to sell on PMSI credit without searching, e.g. It isn't practical for best buy to run to the Sec of State's office on every sale of a PC. (3) Protects the debtor from an over reaching first creditor, who could in effect shut down any sales. b) PMSI in Inventory i) UCC 9-324(a) does not apply to PMSI in goods that become inventory in the hands of the purchaser. (1) Why? The idea is that generally inventory will be financed by inventory lenders not by PMSI. ii) A PMSI is still possible if: (1) Seller files before goods are in possession of Debtor (2) Seller notifies the inventory lender iii) Bottom line: Inventory lenders don't need to continually search inventory and wait twenty days before disbursing money. Facilitates quick inventory lending.

i)

81

Secured Transactions Outline- Kauffman 2003

5) Purchase Money Proceeds a) Basic Rule: The priority of PMSI creditor continues even if the original collateral is converted into something else subject to a security agreement. b) This flow through only applies to cash, instruments, and chattel paper (NOT ACCOUNTs). The purpose of this is to facilitate account financing. Without it, most inventory PMSI security interests would be converted to accounts and the PMSI would prime the account financer. 6) Priority in Commingled Collateral a) Basic Rule: When something is commingled, perfection continues in the new item. i) HYPO: A has a perfected security interest in nitrate. The nitrate is combined with something else to make fertilizer. B perfects in the fertilizer. A has priority to B. b) Accession: Perfection in objects that are incorporated into other objects remains, but a secured creditor in the new object can keep the first secured creditor from removing the original object. It is easier with an example. i) HYPO: At T1, I perfect in a machine part. At T2, you incorporate the machine part into a machine. At T3, your cousin perfects against the machine. I have priority over your cousin as to my part, but your cousin can keep me from yanking it out of the machine.

7) Class Notes: The first to file or perfect has priority. PMSI carries through to proceeds. Inventory is treated differently. To get PM priority, you have to give notice to other people who have financing statements covering the inventory, in order to prevent debtor engaging in double financing. A would be PM financer has to search the files before to find out if there is anything on file regarding the inventory. The text also points out that the PM priority of the inventory financer carries through to identifiable cash proceeds and chattel paper (because subsequent chattel paper financer has priority) but it does not carry over to accounts. Inventory and accounts are both favored kinds of financing in Article 9. The financing of accounts, involves financing of collateral, when the collateral is closest to be turned into cash. Between inventory and accounts financing, the priority is determined by who files first.
Problem Set 32 Problem 32.1: 8/1 Bank 1 filed a financing statement (but there is no commitment). 8/5 Bank 2 filed a financing statement and advanced funds to debtor 8/7 C-Dogs became a lien creditor by levying on the equipment 8/10 Bank 1 approved the loan and disbursed the funds Who has priority in the equipment? Bank 1 vs. Bank Bank 1 wins. 9-322(a)(1) -- Between the holders of two security interests in collateral, the first to FILE OR PERFECT has priority.

Bank 2 vs. Lien Creditor Bank 2 wins. 9-317 -- Bank 2 perfected before the lien creditor filed.
Bank 1 vs. Lien Creditor Lien Creditor wins. Bank 1 would need a security agreement and financing statement to beat Bank 1 under 9-317a2b. Lien creditor is superior to Bank 1.

82

Secured Transactions Outline- Kauffman 2003

How do you divide up the collateral? Circular priority problem (similar to Ski Ridge in assignment #20). There is no logical way to break out b/c there is inconsistency in the priority rules. The court faced with the problem must decide which party does public policy favor in the situation? The court makes it up as they go along. There is no principled answer. It depends on if you are pro-secured creditor or not. Problem 32.2: Double debtor problem. Centurion loaned money to Flight Analysis against flight simulation equipment, but it did not realize that First National Bank had previously filed a financing statement covering the same collateral. Centurion had a security interest in another company (Pilots Unlimited) describing the same collateral and after acquired property (last year sometime). Will Centurion be ahead of First National if Flight Analysis sold its equipment to Pilots Unlimited?

Solution: No, Centurions security interest in the equipment sold to Pilots Unlimited will be subordinate to First Nationals security interest, even if Centurion filed against Pilots Unlimited before First National filed against Flight Analysis. Under 9-325 (a), a security interest created by a
debtor (Pilots Unlimited) is subordinate to a security interest in the same collateral created by another person (Flight Analysis) if: (1) debtor acquired the collateral subject to the security interest created by the other person; (Yes, First Nationals security interest clings to the equipment); (2) the security interest created by the other person was perfected when the debtor acquired the collateral; and (Yes) (3) there is no time when the security interest was unperfected. (Yes). 9-325 is deliberately designed to prevent pulling off the scheme to take advantage of an earlier filed financing statement. Under the old Article 9 this problem would come up, and people in the position of Centurion would look around and find an earlier financing statement even though the other deal was in the records. See Comment 3, 9-325. 9-507 a financing statement remains effective with respect to collateral that is sold, exchanged, leased, licensed, or otherwise disposed of. Problem 32.3: ONB made a $7,500 loan to George and filed a financing statement that contained no provision regarding future advances. It indicated that the collateral was equipment. ONB has approved a $40,000 line of credit for George secured by the dry cleaning equipment in his shop. ONB knows it must prepare a new security agreement, but does it have to file a new financing statement? ONB does not need to file a new financing statement. The financing statement does not have anything to do with the amount outstanding. The security agreement defines the terms between the parties. A financing statement is good for any number of security agreements as long as they relate to the same description. Since ONBs financing statement covers equipment all advances made by ONB have priority as of the filing of the first financing statement. 9-322(a)(1). Under 9-502(d) a financing statement may be filed before a security agreement is made or attaches Problem 32.4: See below! (a) Carol lent Bob $1,000 secured by his boat. A month later, BCA loans Bob $45,000 secured by his boat and other items. Bob fell behind on payments to BCA, and BCA repossessed the boat. Bob wants Carol to advance him $31,000 so BCA cant sell the boat or collect. Will this work? Yes. Under 9-322, the 31,000 advance has the same priority as the original $1,000 advance. Possible problems: Fraudulent transfer hinder, delay, defraud creditors. There is a protection in the UFTA for recipients of transfers if they are in good faith and have given reasonably equivalent value. There is reasonably equivalent value b/c Carol advanced $31,000. But, is there a good reason for the advance? She made it to defeat a creditor who levied on the boat. What happens if the transfer is avoided?

83

Secured Transactions Outline- Kauffman 2003

Carol has a lien for money that she gave, but the lien may be worthless in the face of the earlier seizure by the lien creditor. As Carols lawyer, you should discuss the reason for making the loan. Remember Grocers Supply, Carol can lend $31,000 and foreclose and that will knock out the subordinate security interest. (b) Assume that Carol had filed a financing statement against Bob before BCA repossessed, but Bob had not authorized a security agreement and Carol had not sent any money. Would the scheme work under these circumstances? Yes, the scheme would work even if Bob had not authorized a security agreement and Carol had not lent any money. See, Comment 4 to 9-322. When you have a secured creditor, all you need to do is get a subsequent security agreement. You dont even need a future advance clause. Problem 32.5: How does a second creditor protect themselves from advances made by the prior secured creditor? Subordination agreement --9-339 -- a person entitled to priority may effectively agree to subordinate its claim. Only the person entitled to priority may make such an agreement: a persons rights cannot be adversely affected by an agreement to which the person is not a party. The first secured creditor isnt likely to give a subordination agreement across the board. The first secured creditor may desist from making an advance in exchange for money from the second secured creditor. The first secured creditor may benefit from a fresh infusion of cash from the second secured creditor. Problem 32.6: Harley is under pressure from Centurion to stop messing up. He had Centurion lend to Grumman 150 grand unsecured. However, he found out that FN has a security interest of 1.5 million in all Grummans assets (liquidation value less than 1.5 million). Harley ran a search. It does not turn up anything under the name of the debtor. Is the creditor safe can First National have an effective filing even though the search came back blank? (a) Is there any way that FN could have an effective financing statement that doesnt show up in the official search in the state in which Grumans business is located? (1) If the filing officer wrongfully rejects the financing statement, it is still effective. (2) They have moved within the last four months. i. 9-316(a) continuing perfection of security interest following change in governing law. A security interest perfected under the law of one jurisdiction remains perfected for a fixed period of time (four months or one year) even though the jurisdiction whose law governs perfection changes. If a secured party properly re-perfects its security interest before it becomes unperfected under (a) it is continuously perfected. (3) The debtors principal residence is in another jurisdiction. (4) The filing officer made a mistake, leaving the searcher at risk. (5) It could be a partnership with the financing statement under the name of one of the partners. (b) How can you find out if a financing statement exists without shooting yourself in the foot? Warrens answer: Search alternative names. If you can find the wrong filing, you know they made a mistake, and it is not enforceable against me.

(c) Harley offers to loan an additional $100,000, if Grumman secures all $250,000 (giving Centurion
a possible first). The old $150,000 advance will remain vulnerable as a preference in bankruptcy for 90 days, but the new $100,000 will not. What should Harley do? First, Harley could file a financing statement, and then call First National to see if they have a security interest in the debtors property. Harley cant file a financing statement unless they have authorization from the debtor. The debtor is unlikely to authorize unless the creditor agrees to lend money. Harley should carefully word the requirement for giving the debtor additional money. Second, wait four

84

Secured Transactions Outline- Kauffman 2003

months for name and venue change windows to pass. Third, call FNB. Now you can tip your hand because you already have a security interest filed. Fourth, cut a deal between the two if FNB has a possible security agreement. Rather than litigate, have FNB and Harley sign a subordination agreement. Harley will not lend anything more than the $250,000 and that Harley wont be sued. (d) What happens if you look under an incorrect spelling and find First Nationals filing? Ethical issue? 9-506 ineffective if seriously misleading. Finding it by accident doesnt cure the flaw. It didnt show up under the logic of the filing system. It is not effective. Ethical issue/Business judgment: The lawyer would not have an ethical issue. But, can Centurion take advantage of First Nationals mistake? It might adversely affect Centurions reputation and business ethics look at standard practices in the business community. Only $150,000 is at stake. Harley Davidson wants to file to protect his job, but the client is Centurion. The attorney should look out for the best interest of Centurion. Problem 32.7: Sara sells speakers to customers (who have inventory lenders). How can Sara get a first security interest in the speakers she sells to customers? 9-324(a) a PMSI has priority in goods OTHER than inventory. But this is inventory. 9-324(b) steps an inventory purchase money security interest must do to have priority: The purchase money financier must perfect no later than the time the debtor receives possession of the collateral, and The purchase money financier must give advance notice to the inventory lender that it expects to acquire a PMSI in inventory. It must search the system for all secured parties with a filing in inventory of the type if plans to sell. The lender should send notice by certified mail. Like a financing statement, the notice expires at the end of five years. The inventory lender must learn of the financing before disbursing against the collateral. What is the inventory lenders position? They probably will not let the debtor give a PMSI in inventory. The debtor is double-financing. The debtor is using the money from the inventory lender for some other purpose. What do you tell Sara, who sells the inventory? What is better than taking a purchase money security interest? Get paid out of the inventory financing cash on delivery or an arrangement that the inventory lender sends money straight to Sara. Possible problems for Sara? The security agreement may prohibit liens against inventory other than the lien of the inventory lender. Therefore, the notification pursuant to 9-324(a) will only notify the inventory lender that the debtor is about to go into default. The debtor may refuse to grant a PMSI interest to suppliers. Assignment 33: Secured Creditors v. Secured Credits: Land and Fixtures

1) NOTE: State real estate law is REALLY idiosyncratic. You must check the rule of the local
jurisdiction.

2) Mortgage v. Mortgage: The basic rule is that perfected mortgages beat unperfected mortgages and
timely perfected purchase money mortgages get priority. a) Recording Statutes: i) Pure Race Statutes: He who records first wins!

85

Secured Transactions Outline- Kauffman 2003

ii) Pure Notice Statues: Order of recording is irrelevant. If you don't have notice of the previous
mortgage you can prime it. However, you have constructive notice of all filed mortgages.

iii) Race-Notice Statutes: He who files first wins, unless at the time of the conveyance that
creates the second mortgage the lender has notice of the first mortgage. (1) NOTE: It is notice at time of conveyance that matters. Notice later does nothing it is a race to the recorder of deeds office. (2) Most common form of statute b) Who is a Good Faith Purchaser for Value? i) Most recording statutes protect only good faith purchasers for value. (1) Those who grant mortgages in the hopes of forebearance on pre-existing debts without a binding contract of forebearance are not good faith purchasers for value. (2) People who give too little value for a mortgage ARE good faith purchasers for value, e.g. A $20,000 mortgage for $15,000 of goods. c) Purchase Money Mortgages i) Some states give them special treatment a la UCC PMSIs. ii) Some states don't 3) Judgement Liens Against Mortgages. a) You can record a judgment in the real estate office and you get a lien against the property. b) Unless the recording statute changes things, the lien is perfected at time of filing against later, subordinate liens. c) Many state recording statutes change this outcome: i) These states protect only purchasers, i.e. an unrecorded mortgage beats out a recorded judgment. 4) Construction Liens aka Mechanics Liens a) Mechanics liens are used by contractors not mechanics. b) Background i) Construction is financed by loans secured by the property to be built. (1) The loan is paid out bit by bit in draws as certain portions of the building are completed. (2) The draws are used to pay laborers. (3) This keeps the bank from getting stuck with extending a bunch of cash for a building not yet built. ii) Construction workers are hired with promises to pay when the building reaches the stage that allows a draw. iii) The draws are held in trust for the laborers (1) This means that nasty liability and even criminal sanctions attach to folks who misuse their draws. iv) If the laborers are not paid they can file (generally with in 90 to 120 days) for a mechanic's lien. Generally they take effect as of the date of the beginning of construction (1) This means a mechanic's lien will generally kill a project because the bank will not longer pay out. (filing such a lien is almost universally a default condition in loan contracts). (2) The threat gives contractor leverage with debtor. (3) It also limits the effectiveness of the threat. v) Issues that arise: (1) Erection/Construction or just Alteration? The construction lien goes back to time of construction, alteration simply to time of alteration. (2) When does construction actually start? (Date that mechanic lien could attach) (3) When does construction get done? (Date from which the window to file for a lien begins running)

86

Secured Transactions Outline- Kauffman 2003

5) Priority of Fixture Filings a) You can get an interest in fixtures by filing in the real estate system. UCC 334. Often you can also get a security interest via mechanics lien, e.g a subcontractor installing hot water heaters can get a mechanics lien or a security interest in hot water heaters. i) The fixture filing will be more limited the mechanics lien attaches to the whole property. ii) The fixture filing may be later mechanics lien dates to time of construction. b) Prior perfected mortgage beats fixture filing, unless: see 9-334! i) The mortgage gives debtor right to remove fixtures. ii) The fixture filing is a PMSI. 6) Priority in Real Property Based on Personal Property Filing a) If you file a fixture filing in the UCC system rather than the real estate system you can still be perfected. UCC 9-501(a)(2) i) This filing will only be good against a JLC ii) Functionally allows misfiling secured lenders to still be secured in bankruptcy.

(1) Justified by theory that JLCs never check anyways.


Problem Set 33 Problem 33.1: 15 years ago Wanda recovered a $35,000 judgment against her ex, Marshall, for alimony. 5 years ago Wanda recorded the judgment in California (Marshall had no assets). March 1 Marshall paid $100,000 to buy a house ($80,000 was a PMSI loan from Bank and $20,000 was savings). March 10 bank recorded its mortgage.

As between Wanda and the bank, who will have priority in Marshalls home? Use California statute for PMSI and assume the recording statute is the same as NY 291 (both in assignment #33). Bank wins. Wanda created and perfected her lien first, but under California law the PMSI
mortgagee has priority over all other liens created against the purchaser subject to the operation of the recording laws. Under the Recording Act (good faith purchaser exception), the failure to record is void against any person who subsequently purchases the same real property in good faith and for valuable consideration. The Bank is first and the recording act does not help the lien creditor (Wanda) b/c she did not purchase and she did not give valuable consideration for the lien (it is antecedent debt). Problem 33.2 Add the following facts: Marshall borrowed $50,000 from Bank2 on March 8, and Bank2 recorded the same day (non purchase money). (a) Who has priority Bank1 or Bank2? Bank 2 wins b/c it is one of the few people who fits within the exception to the NY/California notice-race statute. Bank 2 is a subsequent purchaser in good faith for value. (b) Who has priority Bank2 or Wanda (lien creditor)? Wanda wins b/c she is first in time. Bank 2 is not purchase money, so Wandas lien is first under the general rule first in time first in right. This result is an example of circular priority judge decides based on facts, equity, etc.

Problem 33.3: Mobile Home filed in UCC instead of fixture filing. Eighteen months before filing bankruptcy, George bought a mobile home on credit from Folds. Folds took a security interest in the mobile home, and filed a non-fixture financing statement. The state does not have a certificate of title system. Under its laws, the mobile home was a fixture even before Folds filed its financing statement. Can the TIB take priority over Folds? Folds is perfected even though he did not file a fixture filing. 9-501(a)(2) can file in the secretary of states office unless
you want to file as a fixture filing for other purposes.

87

Secured Transactions Outline- Kauffman 2003

What is the effect of the filing in the Article 9 system? 544(a)(3) -- TIB is a lien creditor and has rights of a bonafide purchaser in debtors property, other than in fixtures. 9-334(e)(3) and Comment 9 -- A fixture filing in the UCC system will give the filer priority over lien creditors and the TIB. (But if you want priority over real estate interests, you must do a fixture filing). You can file in the regular records for a fixture and get some protection. But you cant file a fixture filing if it is not a fixture you wont receive any protection. File in both places if you are not sure if the property is a fixture. Problem 33.4: Your client, Sound City, sold sound system to Jake and installed it two months ago during Jakes remodeling. It took 3 days to install. It is bolted to walls and control panels are built in. Jake was supposed to pay for the sound system as soon as it finished, but he is stalling. Sound City does not have promissory note or security agreement. What should the lawyer recommend? The elaborate work makes the sound system part of the real estate -->fixture. There are two options: (1) Construction lien: Sound City is entitled to a construction lien. They can record a construction lien in the real property records (aimed at whole property). An unsecured creditor can obtain a lien against the debtors real property by suing the debtor, obtaining a judgment against the debtor, and recording in the real estate recording system. With construction, your lien dates back to beginning of construction,

but with alteration, it dates to day you file the lien. There is a possibility that an interior change can be construction if appearance or use of premise is changed. Must file a construction lien within
90-120 days of completion of work. If the claim of lien does not result in payment, the lienor must bring an action for judicial foreclosure. The statute of limitations for a construction lien is one year. At the end of the year, the lien expires and the debt becomes unsecured.

(2) Fixture filing aimed at the sound system only. Need debtor to sign a security agreement and authorize filing of the financing statement. Why would the debtor do this? To avoid the filing of a construction lien. The fixture filing would only relate to the sound system, but the construction lien would encumber the whole property. What if Jake stalled on paying for the sound system b/c he was in the process of refinancing the bar. The new lender, MB, recorded their mortgage before Sound System could do anything. Assuming that MB acted in good faith and without knowledge that Sound City had installed the system, where does this leave you? File a construction lien. If new construction, priority dates back from time of construction. It will be ahead of mortgagee. If alteration, priority dates from time you file the lien. It will be subordinate to the mortgagee. In re Skyline Properties -- An interior change can be construction if the appearance or the use of the premises is changed.
What about priority of security interests in fixtures? Under 9-334(d) the PMSI can get priority over the prior owner or prior mortgagee if you have perfected either before affixation or within 20 days of affixation (grace period). With respect to the subsequent encumbrancer, under 9-334(e) the encumbrancer may rely on the presence of the fixture. The secured fixture party only gets priority over subsequent encumbrancer if (1) it has priority over the owner and (2) perfected at the time of affixation. There is no 20 day grace period. (The subsequent party is entitled to rely on the presence of the fixture). Difference between (d) and (e). Absence of the 20 day grace period. When advising the PMSI creditor on fixtures? It is a mistake to tell the client they have a 20 day grace period to perfect. If there is any possibility that the owner will sell or mortgage the land before the financing statement is on file. For safety sake, they should always perfect before they attach fixtures to someone elses property.

88

Secured Transactions Outline- Kauffman 2003

Problem 33.5: Assume Sound City installs a sound system on Dubs authority and Dub doesnt pay for it. Will Sound City be entitled to a construction lien? If so, is this an adequate remedy? Who is entitled to a construction lien? Under New York lien law, Sound City is a laborer who performs labor or furnishes materials for the improvement of real property with the consent of the owner (owner includes a lessee). A lien is on the land. The lien is typically for a year some states allow the laborer to re-file for another year. Many states provide liens in favor of virtually anyone who participates in the making of any improvement to real property. What is the priority of a construction lien? A lien for an alteration takes priority as of the recording of the claim of lien. Can Sound City rip out the sound system if Dubs does not pay? No, it is a lien on the land. How could Sound City get back the sound system? Security interest in the sound system and make a fixture filing. PMSI is much more effective than the construction lien. Under 9-334(e). -- Sound City should file BEFORE they affix the sound system to the property. There is no grace period with regard to the subsequent mortgagee who relies on the fixture when making the mortgage. Reasoning: if the owner gives a mortgage between time of affixation and recording, there is no grace period (under 9-334e), and fixture filer loses out to second encumbrancer. Under 9-334d, its the prior owner, and under 9-334e, its the subsequent encumbrancer, and 9-334 makes the distinction with respect to grace period, eliminating it for the subsequent encumbrancer. To do a fixture filing, you do it under real estate law. In the fixture filing, you have to include on the financing statement the name of the record owner of the real estate. That is the whole purpose of putting it in a fixture filing connection to real estate. Since Dub does not know the owner of the real estate, you will have to search the real property records to find the name of the true owner. 9-502(b)(4) -- The financing statement must provide the name of the record owner in the real property if the debtor does not have an interest of record in the real property. Assume Sound City decides to make a fixture filing. Whose authorization does Sound City need? For example, if Dub has a long-term lease from Realty Partners, Ltd., do you have to contract with Realty Partners or can Sound City do the deal with Dubs signature alone? No, you dont need Realty Partners authorization b/c you are dealing with personal property, and Dub is the owner of the personal property. Sound City has the right to remove the fixtures if Dub defaulted b/c it filed a fixture filing in the real property records. If it does damage when removing, it may have to pay the owner of the real estate. 9334(f), 9-604(c). Does the analysis change if Sound City is installing a sound system in a new building that is under construction? The fixture filing will have priority over the construction mortgage only if it was made before the mortgage was recorded. 9-334(h). If the construction mortgage has priority, the holder of construction mortgage can prevent removal of the fixtures. 9-604(c). The security interest is subordinate to the construction mortgage even if the security interest is a PMSI. 9-334(d). Even though Sound City cant remove the sound system, it may be better off with a subordinated security interest that runs with the land. What else could Sound City do? Go to the owner, the encumbrancer, and the construction mortgagee, and see if they will subordinate the sound system. The sound system might not be so integral to the whole building. (Ex: an elevator installation could not negotiate to subordinate b/c it is very critical to the overall building). Problem 33.6: Barney loans his brother money to purchase a condo. Barney has a mortgage but he does not record. In the interim, 2 mortgages and a judgment lien are recorded against the property. How can

89

Secured Transactions Outline- Kauffman 2003

Barneys mortgage be worth something? Apply New York laws. Possibility from Chapter 34 -Marshalling -- One of the mortgages covers other property. Allies mortgage Under New York law, the purchaser must be for value and in good faith. Allie might have had notice about Barneys prior mortgage. If the mortgage was for antecedent debt, it is probably not for value. Talbot Financial Services judgment recorded a year ago the mortgage attached before the judgment, but it was not perfected. The judgment creditor is not a purchaser for value in good faith. A judgment creditor is not a purchaser. In NY, the unrecorded mortgage on real estate defeats the subsequent judgment creditor with a creditor. (Some states turn this around). Weyrauch a purchase money mortgage has priority subject to the recording laws. Weyrauch is not a purchaser for value, and received the mortgage b/c of the after-acquired property clause (antecedent debt not new value). Barney should prevail over Weyrauch in most jurisdictions. Moral of the problem: Real estate law gives a lot more power to unrecorded mortgages than Article 9 does. It depends on the particular law of the particular jurisdiction. In a majority, Barney would win over all 3 interests. Notice-race statute based on knowledge at the time of recording. Purchase money mortgage has priority over all liens created against the purchaser, subject to the operation of the recording laws. Does it have to be recorded within a certain amount of time to qualify for this treatment? Assignment 34: COMPETITIONS INVOLVING CROSS-COLLATERALIZATION AND ASSET MARSHALING
Overview: More than 1 piece of collateral can satisfy a single debt. D cross-collateralized? Ds dont like crosscollateral b/c all collateral can be confiscated if default on one (although most loans have cross-default clauses, i.e., default on one means all are automatically in default). Better for debtor not to have cross-collateralization (c-

c) b/c, assuming 4 loans (D1 D4) secured by 4 sets of collateral (X1 X4), D1, D2, D3 and D4 would all need to be paid off to just get X2 back. But c-c usually means lower interest rate, so better Ds might be more willing to accept c-c provisions. Marshaling: C1=$100, C2 = $60 C1 A C2 B $80 $80

If C1 seizes A first

C1 $100 C2 $60 Unsecured Surplus: $0

But, what happens when C1 goes after B first? C1=$100 C2=no $, but unsecured claim for $60 Unsecured Surplus = $60 How do you decide which asset(s) to go after? Relative liquidity. If C1 and C2 are direct competitors, take B so that C2 now has no SI.

90

Secured Transactions Outline- Kauffman 2003

What about PMSIs? PMSIs: when Creditor holds PMSIs in a variety of collateral, the burden is on the holder to establish how much of each item is secured on a PMSI. If not clearly stated in K, then creditor LOSES PMSI STATUS. An after-acquired property clause will generally operate to void a PMSI. 1) CROSS-COLLATERALIZATION PROVISIONS IN SECURITY AGREEMENTS a) 9-504(2)(a)(2): If secured interest secures indebtedness, then unless otherwise agreed, secured party is entitled to deficiency from debtor. b) Occurs almost any time an after-acquired property clause reaches an additional item of collateral. 2) THE SECURED CRS RIGHT TO CHOOSE ITS REMEDY a) Creditor secured by more than one piece of collateral generally has the right to choose when it will foreclose against each. Can strategically force a debtor into bankruptcy. b) Single-Action rules limited to items of real property, i.e, can only seize one item of real property; adopted in some states incl. CA. i) 9-501(4): IF Sec. Ag. covers both real and personal property, SP may either: proceed for ONLY personal property under Article IX; or real property and personal property under state real property law. c) Release of Collateral i) All collateral is encumbered until debt is paid in full. ii) Sophisticated debtorss often insist on release clauses as part of initial loan agreement, i.e. release of one or more specific items of collateral upon payment of a specified portion of loan. Ds do not need release clauses for collateral that is inventory. 9-307(1) default rule: Sale of inventory automatically releases the property sold from any SI created by the seller. (Can K around though with items expensive items like aircrafts, etc.) 3) MARSHALING ASSETS a) Creditors election to proceed against one item of collateral rather than another can determine the fate of other unpaid Creditors. See 9-504(4), and (1). b) Marshaling as a Limit on the Secured Creditors Choice i) Marshalling Equitable doctrine developed to limit the senior secured creditors choice of which collateral to pursue. When it applies, it requires the creditor to look for its recovery in that/those asset(s) not encumbered by junior liens (this enabling junior lienholders the ability to recover the only assets available to them). (1) Cant be used to compel foreclosure against homestead property. (2) Cant be applied if senior creditor is prejudiced. ii) In Re R.E. Derecktor of Rhode Island, Inc. (1) Derecktors ship building/ repair facility is in bankruptcy; borrowed $6.5MM from Port Authority to set up business in 1979, gave SI in current and after-acquired fixtures, furnishings, equipment, machinery, inventory and other tangible personal property. 2/92 D still owed $5MM. In 1987/88 Bank of New England (eventually FDIC) loans D $9MM to buy a dry-dock and gets a PMSI. Unsecured creditors claim that allowing marshalling here would be prejudicial. (a) 3 Required Elements: (i) The existence of 2 creditors of D (here FDIC and PA); (ii) 2 funds owned by debtor (here, 2+: sale of proceeds from Dry Dock III, the Assignment, INA settlement, etc.); and (iii) Ability of one creditor to satisfy its claim from either or both funds, while the other creditor can only look to one of the funds (FDIC can satisfy its claim from

91

Secured Transactions Outline- Kauffman 2003

all debtors funds, while PA can only look to Dry Dock III and equipment, machinery, and inventory for payment). (b) PAs rights as a secured creditor are legally superior to unsecureds, so no equal footing. Thus, prejudice argument doesnt fly. 4) Equitable Assignment as an Alternative to Marshaling a) Some courts will let the senior creditor recover from the most convenient collateral, then require that creditor to assign its interest in the remainder (including collateral never encumbered by junior lienors) to the junior lienors. 5) Can Unsecureds Marshal? a) Typically no. But bankruptcy trustees can marshal where someone other than the debtor owns collateral. b) In Derecktor, assets were marshalled against unsecureds. c) Marshalling merely shifts assets from one application to another (inherently a for/against situation) 6) Marshaling Against Property Owned by Third Parties a) Common for CR to take a SI in property that doesnt belong to the Common Debtor Requirement: Most courts require marshalling to be between two or more CRs of the same D and all relevant funds and assets must be in the hands of that common debtor. b) (Other Courts just require 1st part, and allow junior lienors to marshall against assets held by 3rd Ps). 7) THE EFFECT OF CROSS-COLLATERALIZATION ON PURCHASE MONEY STATUS a) PMSI status can be easily lost as a result of cross-collateralization. 9-107. i) Southtrust Bank of Alabama v. Borg-Warner Acceptance Corp. (1) Court places on secured creditor the obligation to trace its $ into particular items of collateral and keep the account. (2) BWACs exercise of future advances and after-acquired property clauses in its Sec. Ag. w/ debtors destroyed its PMSI status. (BWAC does maintain a secured interest in goods, just loses its priority status as a PMSI lender). (3) W/o some guidelines, legislative or contractual, the courts should not be required to distill from a mass of transactions the extent to which a security interest is purchase money. (4) How do you allocate against the assets? Whats the relationship between Warner Acceptance Co and the Ds here? Warner was financing all inventory purchases over time. Provision: Prior, present, and future indebtedness. (5) Why is it important for Warner to get a PMSI? Genl first-in-time rule, PMSI exception. (a) Every month D pays certain % of each invoice. (b) PMSI is valuable to break up bank; ensures maximum value.

8) Class Notes: This deals with an important situation, namely marshaling, a remedy that comes out of Old English system of equity law. Its a strong remedy in some jurisdictions. The idea is simple. a) A senior creditor, with priority in a piece of real property, may wipe out interest of junior creditor, but that senior creditor can look elsewhere, the junior lien creditor can force the senior creditor to look to another piece of property. It can take advantage of the breadth of the security interest of the senior creditor. b) The text points out that there are situations where marshaling cannot be used. 92

Secured Transactions Outline- Kauffman 2003

i) For one, the TIB as the representatives cannot use it. However, there are a minority of bankruptcy courts that allow it to use its status to compel marshaling.
Problem Set 34 Problem 34.1: The creditor holds a second mortgage on a house. Outstanding frist mortgage of $220,000. The house is worth not more than $200,000. (a) If no additional relevant facts come to light, how much do you expect to recover? Zero. The first secured creditor is entitled to the whole amount, and can sue for deficiency under 9-615(d)(2) (b) What additional facts might allow the creditor to recover by virtue of the second mortgage? Marshalling Has the first secured creditor has cross-collateralized? If the secured creditor had two funds to satisfy the debt, he could resort to the fund that did not have a junior lienholder. Elements for marshalling: (1) two creditors of the debtor (2) two funds owned by the debtor (3) ability of one creditor to satisfy claims with either or both of the funds, while the other creditor can look to only one fund. Limitations of marshalling: Cant force the creditor to foreclose on a homestead if the other alternative is a non-homestead. Cant be less equitable to the senior lien holder. Problem 34.2: When the debtor filed for bankruptcy, he owned only two non-exempt assets, an apartment building and a yacht. The apartment building had a first mortgage held by UCB for $450,000. The first security interest in the yacht was held by CE for $400,000. The $400,000 note was also secured by a second mortgage against the apartment building. The debtors lawyer, Hurst, held a second security interest in the yacht securing $25,000 in legal work done more than a year before the filing of bankruptcy. By consent of all the parties, the Chapter 7 trustee sold the two assets free and clear of liens and the liens transferred to the proceeds of the sale. (a) If Hurst requests that CE marshall assets: Apartment proceeds $660,000: $450,000 to UCB (remaining $210,000 to CE). Yacht proceeds $250,000: $190,000 to CE; $25,000 to Hurst; $35,000 to the estate (TIB). The TIB cant force marshalling b/c he is a representative of the unsecured creditors. (b) If the yacht sold for only $200,000. Apartment building sold for $660,000. Apartment proceeds: $450,000 to UCB; ($210,000 to CE). Yacht: $190,000 to CE and $10,000 to Hurst. Hurst is out $15,000. Nothing to the TIB. If you took the minority view that the TIB was a lien creditor. It does not help the trustee b/c all the other people have good junior liens. One junior lien creditor cant use marshalling in a situation where it would hurt another junior lien creditor who has a good lien. That is this problem. Problem 34.3: See the debtors secured property below: A judgment creditor obtained a $10,000 judgment 6 months ago. Is it collectible? Farm -- $60,000 First mortgage National City Bank ($35,000 Balance) Second mortgage PCA ($44,000 Balance) Third (judgment) Millers lien against property ($10,000) Machinery -- $55,000 First security interest PCA $44,000 Second interest SBA ($54,000 Balance) Home (exempt homestead property) -- $63,000 First Security interest -- SBA ($54,000 Balance)

93

Secured Transactions Outline- Kauffman 2003

How can Miller get his money? Under normal circumstances: The house is worth $60,000. NCB would foreclose on the house to obtain its $35,000. The remaining $25,000 would go to PCA. Miller would be left with nothing. Issue: Double marshalling argument -- Can a junior lien creditor (Miller) use marshalling to force a senior creditor (PCA) to go after other collateral in such a way to force SBA to look to its collateral (homestead) in which it is senior? You cant use marshalling to force someone to go against a homestead, which is a protection of the homestead. The effect is that Miller is forcing SBA to go against the homestead. There is no rule that says SBA on its own cant decide to go against the homestead. Issue: How do we persuade SBA to go against the homestead? Threaten litigation if SBA makes a move against the machinery, when it can get money out of the homestead. Or buy out SBA and foreclose against the homestead and pick up the excess of the machinery. This is a home free. Or buy out PCA (cheaper option), you get the excess $25,000 on the foreclosure of the farm which will pay off the difference between $25,000 and $44,000, which is $19,000. It will also pay off the judgment of $10,000. Or persuade PCA to take only $15,000 from the farm b/c it will not get paid in full from the farm and will have to foreclose on the machinery anyway. Kaufman: This is an unrealistic problem. All the efforts have been directed at getting SBA to foreclose on the homestead. On the facts, SBA will foreclose against the homestead on its own b/c the most PCA can get out of the farm is $25,000. PCA will have to get $19,000 from the machinery. It will leave SBA $36,000 from the machinery, and it will not swallow an $18,000 loss. SBA will levy on the home. HYPO: PCA is only owed $25,000. You might convince the judge that PCA is getting fully paid on the farm. SBA is getting fully paid from the machinery. An equitable assignment of $1,000 of PCAs interest in the machinery to Miller. It will allow Miller to collect something without hurting SBA and PCA. Problem 34.6: On October 1, Becky sells a robot to MW for $70,000. MW pays $20,000 in cash and signs a promissory note for the remaining $50,000. MW also signs a security agreement granting Becky a security interest in all equipment to secure all obligations owing from MW to Becky. The security agreement makes no mention of purchase money status and provides no rules for applying payments. The robot will be equipment in the hands of MW. This problem addresses the difference between equipment and then inventory. (a) Is Beckys security interest purchase money? If so, to what extent? 9-103(b) -- A security interest is purchase money only to the extent that the collateral secures an obligation that is the purchase price of the collateral. Yes, the goods are purchase money with respect to the security interest. If the goods are purchase money collateral, they are purchase money to the extent of $50,000. (b) On November 1, Becky sells a miniature submarine to MW for $60,000. MW pays $20,000 in cash and signs a promissory note for the remaining $40,000. The submarine will be equipment in the hands of MW. In what amount is the submarine encumbered? The submarine is equipment and is encumbered with $90,000 of debt. (c) The definition of PMSI, the debt secures a purchase money obligation with respect to that collateral. Since it is equipment, the second submarine is PMSI only to the extent of $40,000. (d) MW pays down $1,000. What is the $1,000 attributed to? 9-103(e) -- $1,000 is credited against the oldest obligation, the robot.

94

Secured Transactions Outline- Kauffman 2003

(e) What if the collateral were inventory? You add it all up and dont differentiate with PMSI. If it is inventory, the $90,000 purchase money security interest is against both items. 9-103(b)(2) -- To the extent that the security interest in the robot secures the price of the submarine, the security interest in the robot would be a purchase money security interest. Rationale: it is too difficult to try to match each loan with respect to each item when inventory is flowing in and out. So it all gets added up with a total of 90 grand PMSI against both the sub and robot. Problem 34.7: On May 31, Bonnies Boat World purchases two Coyote Loaders for $90,000. Coyote takes a security interest for $50,000 for the purchase price. Bonnie borrows another $40,000 from Firstbank against the loaders, without mentioning Coyotes lien. Firstbank takes a security interest in the loaders, disburses the loan proceeds directly to Coyote, and perfects by filing a financing statement on June 1. Coyote perfects by filing a financing statement on June 2 and, and delivers the loaders to Bonnies on June 3. Bonnie uses the loaders as equipment. (a) Who has priority? Two parties have contributed to the purchase of the equipment the seller and the lender. Coyote Loaders b/c they are the seller under 9-324. Under 9-324(a) -- A perfected PMSI in goods other than inventory have priority over a conflicting security interest if perfected when the debtor receives possession of the collateral or within 20 days thereafter. 9-324(g) conflicting PMSI priority is granted to the PMSI created in favor of the seller over PMSI that secures enabling loans (lenders). (b) What should the losing party have done to avoid this unexpected setback? There is nothing the lender can do it might be able to get a subordination agreement from the seller. But it is unlikely that the seller would give it. Problem 34.8: Deutsche Financial Services finances inventory, and then conducted a search, finding a financing statement filed by Firstbank covering inventory. Debtor tells DFS that FB only financing Bayliner brand. Does DFS need a subordination agreement even though DFS plans on only financing Shoreline boats? Suppose that Firstbank gives debtor $100 to help make down payment on a Shoreline boat. And the description in FBs security agreement is broad enough to cover a Shoreline boat. Firstbank will have a PMSI in the boat. The collateral is inventory, so the Firstbank security interest in Shoreline is PMSI to the extent that it secures any inventory. Firstbank is cross-collateralized, so it secures the entire Firstbank indebtedness. Who would have priority in the Shoreline boat? Firstbank has priority. It did not give notice to Duestche Bank under 9-324, but it did not have to b/c it was the first filer. Duetsche needs a financing statement with respect to financing the Shoreline boats. Otherwise, Firstbank could lend money and it will come first. If Duetsche Bank filed first, it would have priority. Assignment 36: Buyers v. Secured Creditors 1) General Principles: a) Security does not effect alienability. You can sell a car with a lien on it. It will probably sell cheaper, but you can alienate it. See UCC 9-401 b) Secured creditors expect to be secured in value, e.g. Proceeds etc. c) Some purchasers expect to get good title without searching, e.g. Buying an appliance at the mall. 2) Buyers of Real Property a) General rule is that mortgage created first beats out buyer. i) Recording statutes can reverse this. b) Buyers are always expected to search. 3) Buyers of Personal Property a) General Rule: Purchase subject to security interest. UCC 9-315(a) b) Authorized disposition: Secured creditors can authorize owners to sell property free of security interest.

95

Secured Transactions Outline- Kauffman 2003

i) Regardless of whether buyer searched and found security interest ii) Courts will sometimes imply consent, as when a secured knows that an owner is making a sale in violation of security agreement and does nothing. (1) Courts are split (2) Revised article 9 left the split in place. c) Buyer's in the Ordinary Course of Business. UCC 9-320(a). BOC take free of security interests i) Ordinary course of the seller's business ii) Regardless of buyers knowledge, ie even if she knows there was a security interest. iii) Only free of interests created by the seller. If it is encumbered by interests created by someone else the seller's seller? -- then buyer takes subject to those interests. iv) Doesn't apply to farm products v) When is a buyer a buyer? (1) Daniel v. Bank of Hayward (a) Facts: A car dealership has a loan secured by inventory. It sells a car to a customer who makes a down payment, but title is not delivered. (b) Issue: Is car free of secured lenders security interest? (c) Holding: The buyer becomes a buyer when the car is identified to the contract even if payment is not complete and title has not passed. d) Buyers not in the ordinary course of business don't get an exception. e) Consumer to Consumer Sales: i) Under 9-320(b), a buyer in consumer to consumer sales takes free of security interest, even if perfected, if the buyer buys: (1) Without knowledge of the security interest; (2) For value; (3) For personal use; and (4) Before the filing of a financing statement covering the goods.

4) Class Notes: we see that security interest continue, and can go to both proceeds and collateral. a) Authorized disposition effect. i) Clearly if the secured creditor authorizes the sale, it does not continue in the collateral, but goes to the proceeds. This is the case of secured inventory financing, under 9-315. In some way, the secured party conditions the permission to the inventory debtor to sell based on the debtor doing something with those proceeds in way of payment: dont sale to low, deposit the cash, etc. There are lots of cases that deal with the affect of those restrictions on the ability of the buyers to take free and clear.
Problem Set 36

Problem 36.1: Davis Store sold a TV-VCR to Beavis on credit. Beavis paid no money down, but signed a security agreement, promissory note, and financing statement. Davis Store filed in the statewide UCC records. The security agreement provides that Beavis agrees not to sell the collateral. Beavis sold the TV-VCR to Butthead at a garage sale. Butthead did not know about the security agreement. Butthead paid by check. Can Davis repossess the TV-VCR from Butthead? The transfer can take effect under 9-401(b). The security interest continues under 9315(a). The conditions of consumer to consumer exception of 9-320(b) are not met (because a financing statement has already been filed) so the property is still encumbered. 96

Secured Transactions Outline- Kauffman 2003

Problem 36.2: UCB has a security interest in inventory of Sound City. The security agreement authorized sales in the ordinary course of business, prohibited sales on credit, and required Sound City to deposit the proceeds in a designated account. Sound City filed for bankruptcy. The trustee abandoned the inventory. A deficiency remains owing on the loan. The following transactions took place before the filing of the petition:

(a) A buyer purchases as stereo from Sound City. The buyer bought the stereo by paying a negotiable
promissory note. Under 1-201(9) -- A buyer in the ordinary course may buy for cash, in exchange of other property, or on secured or unsecured credit.

(b) The lawyer takes the sound system in payment for services. Under 1-201(9) a buyer in the
ordinary course does not include a person that acquires goods for total or partial satisfaction of a money debt. Problem 36.3: All Seasons RV sold to Eddy a motor home (Eddy owes 17 grand). Eddy sells to another dealer, Sun Rise (subject to All Seasons security interest created by Eddy). All seasons security interest survives b/c Eddy is a consumer. When Alicia buys from Sun Rise, Alicia is a buyer in the ordinary course but she only takes free of security interests created by Sun Rise. The security interest was created by Eddie here (the sellers seller). The consumer gets stuck by the created by its seller in 9-320. It is hard to make an authorized disposition b/c All Seasons is selling to a consumer? B. What if the consumer buyer wants to see the certificate of title? Sun Rise will show the certificate of title it will show All Seasons lien. It is signed by Eddie in blank, and the dealer is likely to say it will take care of it. If there had been a release of the lien by All Seasons when Eddy sold the RV to Sunrise, it would be in a separate document. Alicia, the ordinary consumer, does not know to ask for this separate document. The dealer would most likely say Im getting it for you. Problem 36.4: A consumer wants to buy a reconditioned piano at the mall. The buyer wants representation at the closing. Does she have anything to fear? This is just like the RV case, but you

dont get certificates of title on pianos. If the person who originally owned the piano has a security interest, Alicia will take the piano subject to the security interest. Difficult to check the
records ask for the bill of sale to find the name of the former owner. You would look at the filing system of the prior owners residence and every place the prior owner lived while he/she owned the piano. AND, there may have been a previous owner before that. What do you tell Alicia? You cant eliminate all risks. Can the problem occur with new good as well? Yes, but it is pretty unusual. Ex: if American bought the inventory of another piano company going out of business American could take subject to the interests of the other piano company since it is not a BOC. Alicia would not take free of the other piano companys security interest. Problem 36.6: Inventory on the lot Daniel case. (a) If there is a vehicle on the lot, and a buyer has already bought the car, a bank cannot know anything by the presence of a vehicle on the lot. But buyers of cars like to take their cars right away. It will not be the case with respect to the hundreds of cars on the lot. (b) Does the buyer need to title; they can just sue for the MSO. Under Daniel, the buyer did not title. But this was true under Chrysler too, all you needed was an agreement. Title can pass from a seller to buyer as a matter of contract law without the certificate of title being in the hands of the buyer. (When you buy a car and drive away, it takes a couple of weeks for the certificate of title

97

Secured Transactions Outline- Kauffman 2003

to get to you from the registry of motor vehicles but title has passed under any version of 9320.) (c) Is there any way for the bank to protect itself? There are a couple of things the bank can do. (1) keep possession of the car (under 9-320(e), part a, BOC, and part b, consumer to consumer sales, dont work when secured party has possession). Secured party can prevail even when vehicles were actually delivered to the lot -- The bank can still maintain possession under a field warehouse arrangement and put up a sign that constitutes notice cars in the field warehouse are in possession of the bank, the secured creditor of the dealer. Problem 36.8: Two Sherrock brothers, partners in Sherrock Toyota Dealerships, buy two cars from Dover motors and made an arrangement to pay for them by transfer of funds later this afternoon. They leave the cars at Dover motors. Dover is in financial difficulty. Is there a problem with leaving the vehicles on the lot? What happens if Dover sells the cars in the ordinary course of business? Article 2-403(2) Any

entrusting of possession of goods to a merchant who deals in goods of that kind gives him power to transfer all rights of the entruster to a buyer in ordinary course of business.. The innocent purchaser will not think they are buying someone elses car, and the a
purchaser under 2-403(2) will divest entruster of title. What happens if Dover files for bankruptcy and the brothers cars are entrusted to Dover, and the inventory lender claims the cars? A purchaser is a person who takes by purchase, which includes a lender. Does inventory lender fit the definition of buyer in the ordinary course? No, 1-201(9) -- A buyer in the ordinary course buys goods, the inventory lender only has a security interest. Overview: What is the brothers claim? The brothers will claim to be BOC who takes free of the security interest. A buyer in the ordinary course of business must take in good faith. In article 9, good faith means honesty in fact and the observance of reasonable commercial standards of fair dealing. Article 2 (sale of goods) good faith means honesty in fact and the observance of reasonable commercial standards in the trade. In the automobile trade, the standard is not for the dealer to have possession of the cars, after someone has purchased. Note: UFTA makes it a rebuttable presumption that leaving the goods in the possession of the dealer is not in good faith. Authorized Disposition? There is no restriction in the inventory lending agreement about selling to dealers. So, we may not have to reach 9-320. Also, what about acquiescence? Often a debtor restricted from selling will sell in a situation where at least there is an argument about whether the security interest does not attach b/c acquiescing is equivalent to entrusting under 2-403(2). When the secured creditor finds out that X has bought the collateral, and the secured creditor does nothing about it, maybe its acquiescence. If the person buying (X) is a merchant (rather than a ordinary purchaser), some courts will say 2-403 applies because acquiescence is entrusting within the meaning of 2-403(2). The buyer in the ordinary course from X is protected. It is a funny use of entrusting b/c the secured creditor did not entrust the goods to merchant X. This is a way of protecting the consumer that buys from the merchant. HYPO: Taking your watch to the Swiss watchmaker for repair. The Swiss watchmaker sells watches, so the watch maker could sell in the ordinary course of business. The owner of the watch would loose to the bona fide purchaser. POLICY: Maybe not good policy -- two equally innocent parties. HYPO: A neighbor entrusts his snow blower with another neighbor. Can the neighbor sell the snow blower and have the power to transfer the rights to an owner in the ordinary course of business? No, the

98

Secured Transactions Outline- Kauffman 2003

neighbor-owner will be able to get the snow blower back. The neighbor entrusted with the snow blower does not deal in goods of that kind, so he does not have the power to transfer title.

Assignment 38 - Federal Tax Liens: The Basics


1) Federal Tax Lien a) All encompassing. b) When the tax is assessed, the lien comes into being. c) 6231(2) and (3) the federal tax lien does not become valid against 3rd parties (secured creditors, purchasers) until a notice of the lien has been filed under 6323. 2) Maintaining a Perfection in a Tax Lien a) 6323(g) the required refilling period for a Notice of Tax lien is the one-year period ending 30 days after the expiration of ten years after the date of assessment of the tax. 3) What happens if the debtors name changes or the property subject to the lien is sold? a) LMS Holding Company (IRS knew that debtor sold property subject to the tax lien, and the IRS did not file a new notice) i) Held: the IRS has an affirmative duty to refile Notices of Tax Lien that could not be discovered upon a search and the IRS knew of the change. ii) The court decides what instances trigger refilling and how long the IRS should have to refile. 4) What happens if the debtor moves? (In re Eschenback) a) A federal tax lien attaches to any property owned by the delinquent at any time during the life of the lien. b) Once properly filed, it attaches to property no matter where it is located. The lien remains valid even if the debtor leaves the residence. 26 USC 6323(f)(2)(B).

5) Competing Interests What must a competing interest do to be valid and prevail over the tax lien? a) Security Interest vs. Tax Lien-- 6323(h)
i) A security interests exists only when (a) the property is in existence and the interest has become protected against a judgment lien under local law and (b) the holder has parted with the money or other value, the repayment of which is secured. (1) There is no security interest until the property is in existence. (similar to bankruptcy law). (2) Must be protected against a hypothetical subsequent judgment lien and levy. So, you must be perfected. (3) Must have parted with money or moneys worth. (a) Commitment to make a loan or future advance meets the definition of moneys worth. (b) No commitment -- the situation of the future advance that has not been made, and you have not committed yourself to make -- does not meet the definition of a security interest under the federal tax lien statute.

b) Purchaser v. Tax Lien must acquire its status as a purchaser BEFORE the government files a
tax lien. 6323(a). i) Purchaser is defined as a person who for adequate and full consideration in money or moneys worth acquires an interest valid under local law (state law) against a subsequent purchaser without actual notice of the interest.

99

Secured Transactions Outline- Kauffman 2003

(1) If local law requires the filing or recording of transfers of particular personal property, the filing or recording is likely to protect the transferee against a tax lien filed later against the transferor. ii) Ex: in some states, a real estate purchaser would have to file a deed iii) Mayer Dupree person purchased an automobile before the government recorded a notice of tax lien. The person did not file a certificate of title. The IRS can seize the car b/c the person who bought the car is not purchaser since she did not record). c) Judgment Lien Creditor v. Tax Lien d) Exceptions in 6323(b),(c),(d) an interest that arises subsequent may prevail over the tax lien. i) Personal property retailer ex: file a tax lien against Best Buy. If you buy TV from Best Buy as a purchaser, under 6323(b)(3) the purchaser will prevail over the tax lien (unless the purchaser knows of the lien). ii) If you buy at a yard sale, 6323(b)(4) says that if you dont know about the tax lien and what you buy in the yard sale is less than $1,000, you prevail against the tax lien. iii) 6323(b)(8) attorneys lobby Problem Set 38 Problem 38.1: Priority between a lien creditor (law firm) and a filed tax lien when there are two real estate parcels that the debtor owned before the notice of tax lien was filed. May 5, 1994 judgment recorded for $250,000 August 23 IRS filed a tax lien for $953,000 December 24 IRS levied on 3 parcels of real property owned by the debtor December 27 debtor files for bankruptcy The three parcels are the only property of value in the debtors estate. Each is worth between $50,000 and $30,000: 1993 Debtor bought the Adams parcel June 1994 Debtor bought the Baker parcel Nov 1994 Inherited the Charlie parcel Who is entitled to that value? A judgment creditor does not have to levy against real property. 1993 Adams parcel and June 1994 Baker parcel go to the judgment creditor, first in time first in right. 6323(a) the federal tax lien had been recorded. Who prevails in the after-acquired property? When property is inherited, both the lien of the lien creditor and the lien of the tax lien attach at the same moment. After-acquired property (property acquired in Nov 1994): federal tax lien is given priority (if it has been recorded McDermott). Problem 38.2: Sally owes $14,923 in payroll taxes. She has received two notices of assessment, but has not yet received a notice of the filing of a tax lien. She has a message on the answering machine from the IRS office, before calling the IRS back she comes to her lawyer with the following questions: Does the IRS have a lien against her business, house (which is exempt from execution under state law), or birds? Yes, it has a lien against all her property upon notification of assessment! When the IRS notifies the taxpayer of its assessment, that notice constitutes demand in 6321 and the tax lien comes into existence and relates back to the date and time of assessment.There is an exemption section, but it is not included in the statute book. 6334 is much like the homestead exemptions on p16 of the textbook.

100

Secured Transactions Outline- Kauffman 2003

The principal residence of the taxpayer is exempt unless if the district director or assistant district direct of the IRS personally approves the levy in writing OR the secretary finds that the collection of tax is in jeopardy. (very discretionary). The lien attaches to all property and rights to property, whether real or personal, belonging to the taxpayer. 6321. What can the IRS do? What are they likely to do? Sally has converted trust funds. She has committed a crime, but the IRS is not likely to go after her. The IRS just wants to get the taxes collected. The nonpayment must stop. They will set up a schedule for the payment of taxes. If they file a notice of tax lien, they will put Sally out of business. And, then the chances for getting the taxes paid will be small. The IRS will probably not file a notice of tax lien. If the taxpayer does not pay within 10 days after notice and demand, the IRS can levy on the taxpayers property. (Notice is notice that a levy is forthcoming, not simply notice of a tax lien). The IRS can levy in two ways: IRS employees can levy and sell assets, or serve a notice of levy on a 3rd party (easier and less complicated). Sally wants to sell one of her birds to her friend George for $2,500 to raise money to keep the business going. If George pays her the $2,500 and she gives him possession of the bird, can the IRS take it back? Does it matter whether George knows about the unpaid payroll taxes? In order to prevail, George must acquire status as a purchaser before the government files notice of its tax lien 6323(a), 6323(h)(6). This is true even if George know of the troubles with the IRS and knows there is a lien outstanding, but no notice has been filed. George does not have to do anything to prevail over a subsequent purchaser in this case he cant file for title, security interest, etc. Sallys mom loans her money and takes a security interest in the birds. What does her mother have to do to prevail over a tax lien? A security interest exists only when (a) the property is in existence and the interest has become protected against a judgment lien under local law AND (b) the holder has parted with money or value. If they get a written security interest and financing statement on file BEFORE the notice of tax lien is filed, the secured creditor will be protected against the subsequent lien creditor. There is nothing in the definition that requires that the value be given at the time the security interest is given (contemporaneously). Here there is antecedent debt. The secured creditor must do as follows: (A) security interest must attach under 9-203(a), and security interest must be perfected by filing (9-310) or possession (9-313) AND (B) give the money to the debtor. Under 9-317, a secured creditor that is properly perfected will prevail over a lien creditor. Note: perfect by possession (non written security agreement). Problem 38.3: Sally lives in Wyoming County, NY and her business is in neighboring Niagara County, NY. The only real estate she owns is a home in Wyoming County. Where should the IRS file a notice of a tax lien against Sally? (using NY lien law). Under 6321 the IRS tax lien reaches all property and rights to property, whether real or personal, belonging to the taxpayer. For Individual file in the individuals county of residence (Wyoming County). Sallys business is an individual proprietorship when searching the records, there is nothing on file in the Secretary of States office and nothing on file in the county of residence. Filing in the individuals county of residence will cover the sole proprietorship. Compare to article 9: filing in secretary of state. Moral: Tax liens are filed in county of residence. What if Sally did not run her business as a sole proprietorship, but her business was incorporated and the corporation owned the pretzel shop in Niagara County and Erie, PA, but owned no real property at either location. Sally ran her business from her office in the back of the Niagara County store. Under these circumstances, where should the IRS file Notice of Tax Lien? Assume NY and PA have identical statutes to the NY statute 240 reproduced in text. For Corporation in two states: Personal property file in the county where the property is situated. Personal property is deemed to be situated at the residence

101

Secured Transactions Outline- Kauffman 2003

of the taxpayer at the time the notice of lien is filed. The residence of a corporation is deemed to be the place where the principal executive office is located. Where the corporation has personal property in NY and PA, the principal executive office is probably in NY (Sally ran the business in back of Niagara county store). The notice of tax lien is filed in NY. A searcher in PA will not find anything. If you are lending to a corporation on the strength of the corporations PA assets, you must find out more about the corporation b/c they might have assets in other states.

Problem 38.4: Transfer of property by debtors -- Dans only asset is a lunch wagon worth about $18,000. Dan grants a security interest in the wagon to Firstbank to secure a loan in the amount of $10,000. The IRS files a tax lien against Dan. Dan sells the wagon to a buyer who does not check the records and does not have actual knowledge of either encumbrance. Eighteen months later, the buyer files under chapter 7 and you are appointed as trustee. What do you do? LMS case requires the IRS (if they know of the property has been transferred by the debtor to a 3rd party) to re-file in a reasonable time. The courts read into the tax lien act a requirement on the IRS to
re-file when it knows of a transfer of property. They imply that it must be done in a reasonable time. LMS might be good law but the circuit courts and SC have not ruled on the issue. Assignment 39: Federal Tax Liens: Advanced Problems

1) Class Note Summary: a) Under 6323(d), a secured creditor can make additional loans under future advance clause for a period of 45 days, and come ahead of the IRS tax lien. i) 6323(d) with respect to any kind of collateral, in which a secured party has a security
interest at the filing of the tax lien, for a period of 45 days after that the secured creditor can make additional loans (1) If they dont know about the existence of the tax lien. The secured creditor will come ahead of the tax lien with respect to the debt incurred in the 45 day period. (2) Rationale: When you have a future advance lender who is disbursing to the debtor on a regular basis, the business would be killed if they had to check the tax lien filing every time they disbursed.

b) Also, the secured creditor would have to win with respect to advances over an article 9 lien creditor. There is a 45-day period where the secured lender wins over lien creditor even though it knows of the existence of the lien of the lien creditor. It has absolute priority for advances within 45 days. The purpose was not to defeat lien creditor but rather to defeat the IRS under the tax lien act. c) 6323(c) protects after-acquired property within 45 days. Refers to commercial lending in
situations where there is a constant flow of money to the debtor and changing collateral.

i) This defines collateral as commercial financing security for chattel paper, accounts receivable, mortgages on real property, and inventory. d) Part c is different from part d because the secured lenders take priority even if know of tax lien on after acquired property. The secured creditor has no choice, the inventory is sold and new inventory comes in. Unlike above, the secured creditor has no choice to cut off.
e) Note: How different from Article 9? i) Under Article 9, a security interest may be attached and perfected if the secured creditor has given consideration sufficient to support a simple contract. ii) Under FTLA, a security interest exists only to the extent that the secured creditor has parted with money (made the loan).

102

Secured Transactions Outline- Kauffman 2003

2) Protection of Those Who Lend After the Tax Lien is Filed: a) Commercial Transaction Financing Agreements
i) Floating Liens -- 6323(c) protects Article 9 floating liens that occur within 45 days of filing the tax lien. ii) Applies only with respect to commercial financing security: accounts, inventory, chattel paper, and mortgage paper. iii) Extends to collateral acquired 45 days after tax lien filing. b) Real Property Construction or Improvement Financing i) 6323(c) protects construction lenders against a tax lien filed during construction. ii) The construction lender must have entered into a contract to finance the construction prior to the filing of the tax lien. iii) Protection only extends to the real property improved. iv) If a construction lenders priority is protected under local law against a judgment lien arising as of the time of tax lien filing, out of an unsecured obligation the protection extends to advances made after the construction lender knows about the tax lien.

c) Obligatory Disbursement Agreement - 6323(c)(4) d) Statutory Liens - 6323(b) some statutory liens have priority over federal tax liens, even when
those statutory liens arise after the federal tax lien is filed. i) Artisans liens in favor of those of make improvements to personal property and retain possession of the property as security for claims - 6323(b)(5) ii) Real property and special assessment-- 6323(b)(6) iii) Mechanics liens for improvements made to real property - 6323(b)(7) limited to debtors personal residence and contracts not in excess of $1,000. iv) Attorneys lien - 6323(b)(8) for fees against a judgment or settlement amount obtained by the attorney on behalf of the client. e) Purchase Money Security Interests i) PMSI has protection against an earlier-filed tax lien. ii) No provision in 6323(b), but the courts interpreted one and the IRS acquiesced. iii) First Interstate Bank v. IRS f) Nonadvances - 6323(e) i) What are nonadvances? Interest, attorneys fees, and other expenses incurred by the secured creditor in protecting and recovering its collateral and collecting the amount of debt owing from the debtor. ii) If the nonadvances are provided for in the security agreement and are reasonable, nonadvances under a security agreement are equal in priority to the first advance. Problem Set 39 Problem 39.1 Aug 1- Bank 1 filed a financing statement (no commitment to make the loan). Aug 5 Bank 2 approved the loan, filed a financing statement, security agreement, advanced funds to debtor. Aug 7 IRS files notice of tax lien. Aug 10 Bank 1 signs security agreement.

103

Secured Transactions Outline- Kauffman 2003

What is the priority between Bank 1 and the IRS? Does Bank 1 have a security interest as defined by the FTLA in 6323(h)? 6232(h) a security interest comes into existence when it is protected by local law against a subsequent judgment lien and parted with moneys worth. Bank 1 does not have a FLTA-defined security interest until it parts with money on Aug. 10,
which is after the tax lien was filed (Aug 7). IRS has priority over Bank 1. The outcome would not change even if Bank 1 signed the security agreement on August 1 (unless it made a commitment to make the loan).

What is the priority between Bank 2 and the IRS? Does Bank 2 have a security interest as defined by the FTLA in 6323(h)? 6323(h) a security interest comes into existence when it is protected by local law against a subsequent judgment lien and parted with moneys worth. Bank 2 has a signed security agreement, filed the financing statement, and made the loan.
Bank 2 has a FLTA-defined security interest on Aug. 5, which is before the tax lien was filed (Aug 7). Bank 2 has priority over the IRS.

What is the priority between Bank 1 and Bank 2? Priority between two secured creditors:9-323(a)(1) -- first to file or perfect. Bank 1 has priority b/c it filed on Aug 1 before
Bank 2 filed or perfected (Aug 5). Who wins when there is circular priority? A court will do equity in the situation and decide looking at Article 9 and the tax lien act and determine which principles are strongest in this situation. Tempted to say Bank One is at the top of the heap, and the federal tax lien will be paid out of Bank ones priority. If anything is left over, Bank One can take. Then, Bank Two. Policy of 6323 the federal tax lien is effective against Bank 1 the minute the tax lien is filed. What could Bank 1 have done? Give a nominal amount ($100) on August 1. Wait for search to come back, and then advance the remaining amount (which will be within 45 days of the tax lien). Problem 39.2: The debtor operates a pet store. The IRS notifies the debtor that it will file a tax lien in the next few days. The debtor is concerned about the following situations: (a)Will the customers who buy pets from the stores inventory after the Notice is filed take free and clear of the IRS lien? 6323(b)(3) -- Personal property purchased at retail take free of filed tax lien: with respect to tangible personal property purchased at retail, as against a purchaser in the ordinary course of the seller's trade or business, unless at the time of such purchase such purchaser intends such purchase to (or knows such purchase will) hinder, evade, or defeat the collection of any tax under this title. **Ordinary consumer is protected against the tax lien. (b) The debtor needs to install a new fish tank that will cost $5,000. The seller will provide 100% of the financing, and the debtor will make payments over the next five years. They will not be able to get the deal done before the lien is filed. The seller will file a financing statement, but probably wont search the public records. Purchase money security interest exception: There is no provision in 6323(b) for purchase money security interests. But, the courts have read one into the provision. (First Interstate Bank). The PMSI lender should prevail over the tax lien filed earlier in time. (c) The debtor is worried about his employees. If he pays them with money which the IRS has a lien, can the IRS take the money back? If the IRS levies the day before payday, where do the employees stand? Everyone assumes that the employees take free and clear, but it is hard to actually see this in the FTLA Politically, the IRS should not try to take the employees money. Once there is a levy, the employees would be stuck b/c the debtor cannot pay out of a deposit account that has been levied.

104

Secured Transactions Outline- Kauffman 2003

(d) The business is financed with an inventory and accounts receivable loan from the Bank. The bank lends 65% of the cost of inventory as the Debtor (pet store) receives it. The security interest contains the usual provisions regarding future advances and after-acquired property. The debtor believes the bank will work with him. There is an outstanding $175,000 balance on the loan. If the business continues, the collateral will be worth that amount. If the business closes, the bank will only get $50,000 out of the collateral. Can the Bank work with the debtor without losing its priority over the tax lien? They can work something out with the bank, but only for 45 days. 6323(c) inventory and a/r within 45 day period. The bank is not going to be interested in working with the debtor beyond the 45day period. If inventory is sold after 45 days, it diminishes the banks collateral. The inventory lender could become a purchase money lender with respect to specific shipments of inventory (even after 45 days it would be protected). But, the lender has a problem b/c they cant let the debtor make sales on credit b/c the Interstate case says you cant have a PMSI in an account receivable (for purposes of the a/r). What about using segregated accounts? The bank has priority in all inventory and a/r as of today. If they are sold, you put the proceeds in a segregated bank account. Use the segregated bank account to buy new inventory, even acquired after the 45 day limit. Then put those proceeds in a segregated bank account. Kaufman does not know the answer to this situation, but it is risky but might work. The FLTA does not say anything about proceeds. The notion of protecting the revolving collateral and loans in 6323(c) implicitly carries a notion of protecting proceeds in the same way secured creditors are protected in bankruptcy and retain an interest in proceeds. Problem 39.3: The client does a substantial amount of inventory and accounts receivable financing. The client was recently burned in a situation where a tax lien was filed ,and 45 days went by without the client learning of it. The client continued to fund the loan and eventually lost nearly all remaining collateral to the tax lien. What can the client do to avoid recurrence of the problem in the future? Texas Oil and Gas case refers to the problem of searching every 45 days. It is very expensive and it takes a while for tax liens to show up in the records. Practical solution: People in this lending business, use credit bulletins that put out weekly newsletters. The newsletter lists all the tax liens that have been filed. The newsletter does the searching every week. Problem 39.4: Should a debtor worry about leaving items purchased at a store? She is a purchaser, and under IRC 6323(b)(3) purchasers are protected against even earlier-filed tax liens. If she walks out with the item, she does not have a problem. Is she right about leaving the piano at the piano dealer entrusted with dealer? She will not be protected against the earlier-filed taxed lien b/c she is not protected against the subsequent purchaser w/o knowledge. If another buyer purchases the piano when Alecia leaves, she loses. Alecia has entrusted the piano with a dealer in those goods. 9-403(b); 2-403(2). Problem 39.5: If Alecia buys a used sailboat. How will she know if there is a tax lien against the boat? 6323(b)(4) casual sales (household goods, personal effects, and other tangible personal property) the tax lien is not valid in casual sale for less than $1,000. The sailboat is bought for $3,000, so it is not a casual sale. The buyer should check the records (and not only for tax liens but also security agreements of the bank that filed a financing statement). Finally Dont with This Outline.

105

S-ar putea să vă placă și