PMSI

Question 1

TERMS

“Purchase-money obligation” definition

Answer 1

Purchase-money obligation means a loan or credit or other obligation incurred in order to purchase something (hence the name “purchase-money”).

Question 2

TERMS

“Purchase-money collateral” definition

Answer 2

This one is simpler. It generally means that the debtor/obligor gives its purchase-money obligation creditor a security interest in the very goods that it incurred the purchase-money obligation in order to buy.

Question 3

TYPES OF PMSIs

What are the two types of PMSIs

Answer 3

1. Obligation incurred for price of collateral (direct-financing sellers). This is referring to a direct-financing seller.
2. Obligation incurred for value given to enable acquisition of collateral (third-party lenders).

Question 4

TYPES OF PMSIs

Example of direct-financing seller PMSI

Answer 4

So, for example, say that Wayne buys (purchases) a washing machine from Paula’s World-of-Appliances. The seller Paula extends credit to Wayne in order to enable him to purchase the machine. Wayne’s obligation to Paula is a purchase-money obligation.

Question 5

TYPES OF PMSIs

Example of third-party lender PMSI

Answer 5

Now say that Wayne does not get credit from Paula, but instead goes to First Bank to get a loan to buy the washing machine. The loan is from a third-party lender, who gave value to Wayne to enable him to acquire (purchase) the washing machine. Assuming that Wayne in fact uses the loan money directly to buy the washing machine, Wayne’s obligation to First Bank is a purchase-money obligation.

Question 6

SPECIAL PMSI RULES

Cross Collateralization rule for PSMI in inventory

Answer 6

If the security interest is in inventory that is or was purchase-money collateral, [a security interest in goods is a PMSI] also to the extent that the security interest secures a purchase-money obligation incurred with respect to other inventory in which the secured party holds or held a purchase-money security interest.

Question 7

SPECIAL PMSI RULES

Cross Collateralization example

Answer 7

Here’s what’s happening. Say Donny Debtor borrows $10,000 from First Bank to purchase Inventory item #1, giving First Bank a security interest in Inventory item #1. This is a PMSI. Let’s say that, at the time, the parties include a clause—let’s call it a “cross-collateralization clause”—that says, basically, that all other inventory Donny owns or may own will also secure the $10,000 Inventory Item loan #1 amount (this is allowed—we’ll discuss it in more detail later). Later, Donny borrows $15,000 from First Bank to purchase Inventory Item #2, giving First Bank a security interest in Inventory item #2. This is also a PMSI. So, the $10,000 secured by Item #1 is PMSI, and the $15,000 secured by Item #2 is PMSI.
- Now, say that Donny sells Item #1, so he no longer has it anymore. And, further, say that Donny pays off the $15,000 Item #2 loan amount. What’s left is that Donny still has Item #2, and he still owes on the $10,000 loan for Item #1. Item #2 is still collateral for the $10,000 Item #1 loan, because of the cross-collateralization clause. Under 9–103(b)(1), the remaining security interest in Item #2 securing the $10,000 would not be PMSI because the $10,000 debt wasn’t incurred “with respect to” Item #2. But, under the clause of 9–103(b)(2), this remaining, mismatched loan and collateral are considered to be PMSI, since they were each originally part of a PMSI transaction, the items in question are inventory, and a cross-collateralization clause was included. This is an important benefit granted to inventory PMSI financings, since the nature of inventory is that it is bought and sold all the time, and so the actual inventory held by a debtor is constantly changing.