Chapter 21: "Secured Transactions"

Question 1

The Terminology of Secured Transactions

secured party
debtor
security interest
security agreement
collateral
financing statement

Answer 1

A secured party is any creditor who has a security interest in the debtor’s collateral. This creditor can be a seller, a lender, a cosigner, or even a buyer of accounts or chattel paper [UCC 9-102(a)(72)].

A debtor is the party who owes payment or other performance of a secured obligation [UCC 9-102(a)(28)].

A security interest is the interest in the collateral (such as personal property, fixtures, or accounts) that secures payment or performance of an obligation [UCC 1-201(37)].

A security agreement is an agreement that creates or provides for a security interest [UCC 9-102(a)(73)].

Collateral is the subject of the security interest [UCC 9-102(a)(12)].

A financing statement—referred to as the UCC-1 form—is the instrument normally filed to give public notice to third parties of the secured party’s security interest [UCC 9-102(a)(39)].

Question 2

Three requirements must be met for a creditor to have an enforceable security interest:

Answer 2

Unless the creditor has possession of the collateral, there must be a written or authenticated security agreement that clearly describes the collateral subject to the security interest and is signed or authenticated by the debtor.

The secured party must give the debtor something of value.

The debtor must have rights in the collateral.

Question 3

Authentication

Answer 3

To sign a record, or with the intent to sign a record, to execute or to adopt an electronic sound, symbol, or the like to link with the record. A record is retrievable information inscribed on a tangible medium or stored in an electronic or other medium.

Question 4

The state in which a financing statement should be filed depends on the debtor’s location, not the location of the collateral [UCC 9-301]. The debtor’s location is determined as follows [UCC 9-307]:

Answer 4

For an individual debtor, it is the state of the debtor’s principal residence.

For an organization registered with the state, such as a corporation, it is the state in which the organization is registered. Thus, if a debtor is incorporated in Delaware and has its chief executive office in New York, a secured party would file the financing statement in Delaware because that is where the debtor’s business is registered.

For all other entities, it is the state in which the business is located or, if the debtor has more than one office, the place from which the debtor manages its business operations and affairs.

Question 5

pledge

Answer 5

A common law security device (retained in Article 9 of the Uniform Commercial Code) in which personal property is turned over to a creditor as security for the payment of a debt and retained by the creditor until the debt is paid.

Question 6

purchase-money security interest (PMSI)

Answer 6

A security interest that arises when a seller or lender extends credit for part or all of the purchase price of goods purchased by a buyer.

Question 7

Exceptions to the General Priority Rules

Buyers in the Ordinary Course of Business

Answer 7

Buyers in the Ordinary Course of Business

Under the UCC, a person who buys “in the ordinary course of business” takes the goods free from any security interest created by the seller even if the security interest is perfected and the buyer knows of its existence [UCC 9-320(a)]. In other words, a buyer in the ordinary course will have priority even if a previously perfected security interest exists as to the goods. The rationale for this rule is obvious: if buyers could not obtain the goods free and clear of any security interest the merchant had created, for example, in inventory, the free flow of goods in the marketplace would be hindered.

Example 21.13
Dubbs Auto grants a security interest in its inventory to Heartland Bank for a $300,000 line of credit. Heartland perfects its security interest by filing financing statements with the appropriate state offices. Dubbs uses $9,000 of its credit to buy two used trucks and delivers the certificates of title, which designate Dubbs as the owner, to Heartland. Later, Dubbs sells one of the trucks to Shea Murdoch and another to Michael Laxton. National City Bank finances both purchases. New certificates of title designate the buyers as the owners and Heartland as the “first lienholder,” but Heartland receives none of the funds from the sales. If Heartland sues National City, claiming that its security interest in the vehicles takes priority, it will lose. Because Murdoch and Laxton are buyers in the ordinary course of business, Heartland’s security interest in the motor vehicles was extinguished when the vehicles were sold to them.

Question 8

Effective Time Duration of Perfection

Answer 8

A financing statement is effective for five years from the date of filing [UCC 9-515]. If a continuation statement is filed within six months prior to the expiration date, the effectiveness of the original statement is continued for another five years. The continuation period starts with the expiration date of the first five-year period [UCC 9-515(d), (e)]. The effectiveness of the statement can be continued in the same manner indefinitely. Any attempt to file a continuation statement outside the six-month window will render the continuation ineffective, and the perfection will lapse at the end of the five-year period.

Question 9

Proceeds

Answer 9

Under Article 9 of the Uniform Commercial Code, whatever is received when the collateral is sold or otherwise disposed of, such as by exchange.

Question 10

After-acquired property

Answer 10

Property of the debtor that is acquired after the execution of a security agreement.

Question 11

cross-collateralization

Answer 11

The use of an asset that is not the subject of a loan to collateralize that loan.

Question 12

floating lien

Answer 12

A security interest in proceeds, after-acquired property, or property purchased under a line of credit (or all three); a security interest in collateral that is retained even when the collateral changes in character, classification, or location.

Question 13

The article of the UCC that governs secured transactions is ___

Answer 13

9

Question 14

ne concern that a creditor rarely has is:

a. will the debtor have enough in the bank to continue in business?	
b. can the debt be satisfied by the possession and sale of the collateral?	
c. will the creditor have priority over other creditors?

Answer 14

a. will the debtor have enough in the bank to continue in business?

Question 15

Juanita wishes to borrow cash from Kenneth and offers him a security interest in her neighbor’s diamond ring, which she will most certainly receive when her neighbor dies. Regarding Juanita’s proposal, which of the following statements is true?

Juanita must not give Kenneth something of value in a security interest.

Kenneth cannot take a security interest in the ring, because Juanita does not have legal rights to it.

Kenneth must have the ring in his possession or have a written agreement from Juanita describing the ring in order to have a security interest in it.

Answer 15

Kenneth cannot take a security interest in the ring, because Juanita does not have legal rights to it.

Question 16

Gill loans Sully funds to purchase a new ski boat and they agree that Gill will have a security interest in that boat until Sully repays the loan. They need to file a financing statement under the name of

Gill
Sully

Answer 16

Sully

Question 17

The most common means of perfection is by filing a financing statement with the office of the appropriate government official.

a. True
b. False

Answer 17

a. True

Question 18

A financing statement is effective after the date of filing for ___ years

Answer 18

five

Question 19

The state in which a financing statement should be filed depends is NOT the location of the collateral.

a. True
b. False

Answer 19

a. True

Question 20

Changes in the Debtor’s Name

Answer 20

If the debtor’s name changes, the financing statement remains effective for collateral the debtor acquired before or within FOUR months after the name change.

Question 21

Exceptions to the General Priority Rules

PMSI in Goods Other than Inventory and Livestock

Answer 21

An important exception to the first-in-time rule involves certain types of collateral, such as equipment, that is not inventory (or livestock) and in which one of the secured parties has a perfected PMSI [UCC 9-324(a)].

Example 21.14
Piper Sandoval borrows funds from West Bank, signing a security agreement in which she puts up all of her present and after-acquired equipment as security. On May 1, West Bank perfects this security interest (which is not a PMSI). On July 1, Sandoval purchases a new piece of equipment from Zylex Company on credit, signing a security agreement. The delivery date for the new equipment is August 1.

Zylex thus has a PMSI in the new equipment (which is not part of its inventory), but the PMSI is not in consumer goods and thus is not automatically perfected. If Sandoval defaults on her payments to both West Bank and Zylex, which of them has priority with regard to the new piece of equipment? Generally, West Bank would have priority because its interest perfected first in time. In this situation, however, as long as Zylex perfected its PMSI in the new equipment within twenty days after Sandoval took possession on August 1, Zylex has priority.

Question 22

Exceptions to the General Priority Rules

PMSI in Inventory

Answer 22

Another important exception to the first-in-time rule has to do with security interests in inventory. A perfected PMSI in inventory has priority over a conflicting security interest in the same inventory. To maintain this priority, the holder of the PMSI must notify the holder of the conflicting security interest on or before the time the debtor takes possession of the inventory [UCC 9-324(b)].

Example 21.15
On May 1, SNS Electronics borrows funds from Key Bank. SNS signs a security agreement that puts up all of its present inventory and any after-acquired inventory as collateral. Key Bank perfects its interest (not a PMSI) on that date. On June 10, SNS buys new inventory from Martin, Inc., a manufacturer, to use for its Fourth of July sale. SNS makes a down payment for the new inventory and signs a security agreement giving Martin a PMSI in the new inventory as collateral for the remaining debt. Martin delivers the inventory to SNS on June 28, but SNS’s Fourth of July sale is a disaster, and most of its inventory remains unsold. In August, SNS defaults on its payments to both Key Bank and Martin.

Does Key Bank or Martin have priority with respect to the new inventory delivered to SNS on June 28? If Martin has not perfected its security interest by June 28, Key Bank’s after-acquired collateral clause has priority because it was the first to be perfected (on May 1). If, however, Martin has perfected and gives proper notice of its security interest to Key Bank before SNS takes possession of the goods on June 28, Martin has priority.

Question 23

The classifications in which collateral is generally divided are _____ and ____

Answer 23

tangible and intangible

Question 24

Sung buys a refrigerator from Appliance Depot with a down payment, and the store creates a PMSI in the refrigerator so that she can pay it off over time. For Appliance Depot to have the PMSI perfected, it must:

a. file with the appropriate agency under Sung.	
b. do nothing, as PMSIs are automatically perfected.	
c. keep possession of the refrigerator until she has paid off half the cost.

Answer 24

b. do nothing, as PMSIs are automatically perfected.

Check My Work Feedback
When a seller of consumer goods extends credit for the purchase to a person buying for household purposes, a PMSI is created. PMSIs are automatically perfected and no financing statement filing is necessary, except in two special situations.

Question 25

Exceptions to Automatic Perfection. There are two exceptions to the rule of automatic perfection for PMSIs:

Answer 25

Certain types of security interests that are subject to other federal or state laws may require additional steps to be perfected [UCC 9-311]. Many jurisdictions, for instance, have certificate-of-title statutes that establish perfection requirements for security interests in certain goods, including automobiles, trailers, boats, mobile homes, and farm tractors.

Example 21.7
Martin Sedek purchases a boat at a Florida dealership. Florida has a certificate-of-title statute. Sedek obtains financing for his purchase through General Credit Corporation. General Credit Corporation will need to file a certificate of title with the appropriate state official to perfect the PMSI.

PMSIs in nonconsumer goods, such as a business’s inventory or livestock, are not automatically perfected [UCC 9-324]. These types of PMSIs will be discussed later in this chapter in the context of priorities.