Secured Transactions

Question 1

What are the four classes of tangible collateral (goods)?

Answer 1

(1) Consumer goods;
(2) Farm products;
(3) Inventory; and
(4) Equipment.

Question 2

The characterization of collateral can affect the validity of a security interest, the way in which a security interest can be perfected, and the rights of a third party in the collateral. Please classify the following collateral:

(1) A check or a promissory note;
(2) A check along with a security agreement;
(3) The right to be paid for a service rendered;
(4) A savings account at a bank

Answer 2

(1) Instrument;
(2) Chattel paper;
(3) Accounts;
(4) Deposit Account

Question 3

When distinguishing between types of collateral, what is the difference between “accounts” and “deposit accounts”?

Answer 3

Accounts include the right to payment for property sold, leased, licensed, or for services rendered. Also included are rights to payment under insurance policies, amounts owing on credit cards, as well as a company’s accounts receivable.

Deposit accounts include savings, passbook, time, or demand accounts maintained with a bank.

Question 4

What happens when parties leave out after-acquired language in situations that suggest they intended to include it (e.g., when the collateral is inventory or accounts)?

Answer 4

General rule: If there is no reference to after-acquired property, the security interest attaches only to the collateral that exists at the time that the security agreement is executed.
Exception: In most states, if the security agreement describes inventory or accounts, there is a rebuttable presumption that the description includes after-acquired inventory and accounts.

Question 5

Which of the following descriptions of collateral in a security agreement are inadequate for purposes of attachment? Why?

(1) “All of debtor’s equipment”
(2) “All of debtor’s inventory”
(3) “All of debtor’s assets”
(4) “All of debtor’s personal property”

Answer 5

(3) and (4) are inadequate descriptions because they are super-generic and do not reasonably identify the collateral. (Note that super-generic descriptions in a financing statement are adequate for perfecting a security interest. The security agreement for attachment purposes must be more specific.)

Question 6

Consignments may fall within Article 9 in order to facilitate public notice. These consignments carry the risk that a consignee’s lenders may be misled into thinking that consigned inventory is actually owned by the consignee rather than the consignor. If a consignment is subject to Article 9, how are the consignor and the security interest in the consigned goods treated?

Answer 6

The consignor is treated as the secured party and must perfect its security interest in the consigned inventory, and the security interest in the consigned goods is treated as a PMSI in inventory. (In other words, a consignor will have PMSI super-priority in consigned goods if the consignor perfects by filing before the consignee receives possession of the items, and the consignor properly notifies any secured parties with conflicting security interests in consignee’s inventory.)

Question 7

In order for a consignment to be subject to Article 9, what 4 requirements must be met?

Answer 7

(1) A consignor must deliver goods to a merchant (consignee) to sell;
(2) The merchant (consignee) must deal in goods of that kind, not operate under the name of the consignor, not be generally known by its creditors to be substantially engaged in the business of selling goods of others, and not be an auctioneer;
(3) The value of the goods must be at least $1,000 in each delivery; and
(4) The goods must not be consumer goods immediately before delivery.

Question 8

A PMSI may exist only with respect to two types of collateral. What are they?

Answer 8

A security interest qualifies as a PMSI only if the collateral is goods (including fixtures) or software.

Question 9

A new security agreement is not necessary when a debtor buys additional collateral if the original security agreement includes what?

Answer 9

Because a security interest only attaches to the collateral described in the security agreement, an after-acquired property clause should be included in the original security agreement if a creditor wants to have a security interest in property acquired by the debtor after the agreement is authenticated. Typical language includes, “all of the debtor’s existing and after-acquired [collateral]” or “all of the [collateral] now owned or hereafter acquired”.

Question 10

Under what circumstances does a buyer of goods take free of an unperfected security interest?

Answer 10

A buyer, other than a secured party, of collateral that is goods, takes free of an unperfected security interest in the same collateral if the buyer:

i) Gives value; and
ii) Receives delivery of the collateral;
iii) Without knowledge of the existing security interest.

Question 11

What is the most common method of perfection, and what is this method’s objective?

Answer 11

Filing is the most common method of perfection. By filing a financing statement, the secured party is giving notice that he/she has an interest in the debtor’s personal property. (The actual security agreement between the parties does not have to be filed. Perfection by filing assumes that a third party will investigate any details of a security agreement.)

Question 12

An after-acquired clause is not effective if the collateral is consumer goods, unless ______?

Answer 12

An after-acquired clause is not effective if the collateral is consumer goods, unless the debtor acquires them within 10 days after the secured party gives value.

Question 13

Even if parties label their transaction as a lease in the hopes of avoiding Article 9 rules, their transaction will be governed by Article 9 if one of the following four conditions is present:

Answer 13

(1) The original lease term is equal to (or greater than) the good’s remaining economic life;
(2) The lessee is bound to renew the lease for the good’s remaining economic life (or is bound to become the owner of the goods);
(3) The lessee has the option to renew the lease for the good’s remaining economic life for nominal or no additional consideration; or
(4) The lessee has the option to become the owner of the goods upon completion of the lease for nominal or no additional consideration.

(In essence, the economic reality in all of these situations is that there is a sale to the lessee with a security interest retained by the lessor. Thus, the lessor is a secured party and cannot avoid filing by labeling the transaction as a lease. The lessor would need to file or otherwise perfect his/her interest in the goods.)

Question 14

What happens to perfection when (1) a debtor moves to another state, or (2) the collateral is transferred to a person in another state who takes the collateral subject to the security interest?

Answer 14

(1) If a debtor moves to another state, a perfected security interest will remain perfected for four months after the move (unless the financing statement lapses earlier). This four month grace period also covers collateral the debtor acquires after the debtor moves. To remain continuously perfected, the secured party must re-file in the new state within the four-month window.
(2) If the collateral is transferred to a new debtor out of state, the secured party has one year to file a new financing statement listing the new debtor.

Question 15

How and when does tangible collateral (goods) get classified, and does this method apply to other types of collateral?

Answer 15

To properly classify tangible collateral (goods), look to the debtor’s principal use when the security interest attaches.
Unlike tangible goods, classification of other types of collateral does not turn on the manner in which the debtor uses the property.

Question 16

Proceeds are whatever results when collateral is sold, leased, licensed, exchanged or otherwise disposed of. If a security interest was attached to collateral, how does the security interest then attach to the proceeds of that original collateral upon its sale or disposition?

Answer 16

A security interest in collateral attaches automatically to identifiable proceeds.

Question 17

“Goods” encompasses anything that is moveable at the time that a security interest attaches. Also included in “goods” that are technically not moveable. Give 5 examples of these non-moveable goods.

Answer 17

(1) Fixtures
(2) Standing timber
(3) Unborn animals
(4) Growing or unharvested crops (including crops grown on trees, vines, or bushes)
(5) Manufactured homes

Question 18

When can a PMSI exist in goods?

Answer 18

(1) The value given (e.g., a loan) allows the debtor to acquire the goods or software; or
(2) The goods or software acquired is the collateral that secures the loan (e.g., goods bought on credit)

Question 19

Upon default, what happens when a secured party has priority in a fixture?

Answer 19

The secured party may remove the fixture from the real estate but will be liable for the cost of repairing any physical damage to the real estate, but not for any reduction in the value of the real property due to the removal.

Question 20

How must the collateral be described in a financing statement?

Answer 20

The financing statement must contain a description of the collateral that sufficiently indicates the collateral (such as one that meets the requirements for creation of an enforceable security agreement).

When the security interest covers all of the debtor’s assets or personal property, the description can contain a broad statement to that effect.

Question 21

Chattel paper is a record (paper or electronic) with what two components?

Answer 21

It is a record that evidences both (1) a monetary obligation and (2) a security interest in specific goods (security agreement) or a lease of specific goods.

Question 22

For a security interest to be enforceable against a debtor (i.e., attachment), what three conditions must be met?

Answer 22

(1) Value has been given by the secured party;
(2) The debtor has rights in the collateral; and
(3) The debtor has authenticated a security agreement describing the collateral, or the secured party has possession or control of the collateral.

Question 23

The general rule is that unless the secured party authorizes the sale free and clear of its security interest, a buyer takes subject to a perfected security interest. This is not the case for a buyer in the ordinary course of business who can take free of the security interest, even if the buyer knows of its existence. Explain what it means to be a buyer in the ordinary course of business.

Answer 23

A buyer in the ordinary course of business (BOCB) is a person who:

(1) buys goods (not farm products) in the ordinary course of business;
(2) from a merchant who is in the business of selling goods of that kind;
(3) in good faith; and
(4) without actual notice that the sale violates the rights of another in the same goods.

Note: A buyer cannot receive BOCB status if the merchant is a pawnbroker.

Question 24

What is the difference between accessions and commingled goods? What happens to security interests that are attached to those types of goods?

Answer 24

Accessions are goods that are physically united with other goods so that the identity of the original goods is not lost (e.g., a framed piece of art). The security interest in the accession continues in the accession.

Commingled goods are goods that are physically united with other goods to the point that their identity is lost (e.g., eggs being used to make a cake). The security interest in the good does not continue, but it will attach to the larger product.

Question 25

At a minimum, what information must a financing statement contain?

Answer 25

A financing statement must contain the following information:

i) The debtor’s name;
ii) The name of the secured party or a representative of the secured party; and
iii) The collateral covered by the financing statement.

Question 26

A security interest in ________ can be perfected only by possession.

Answer 26

money

Question 27

Does the buyer of collateral subject to a perfected security interest take the collateral free and clear, or subject to the security interest?

Answer 27

A buyer of collateral subject to a perfected security interest generally takes the collateral subject to that interest, unless the secured party has authorized its sale free of the security interest.

Question 28

A security interest in proceeds enjoys temporary perfection (20 days) and may continue to be perfected indefinitely under what three circumstances?

Answer 28

(1) If the original financing statement is broad enough to encompass the proceeds or the secured party amends the financing statement within 20 days;
(2) If the proceeds are identifiable cash proceeds and the security interest in the original collateral was perfected (note that cash proceeds includes checks and deposit accounts); or
(3) If the same office rule applies

Question 29

What is the buyer in the ordinary course of business (BOCB) exception and who qualifies as a BOCB?

Answer 29

A BOCB takes free of a security interest created by the buyer’s seller, even if the security interest is perfected and the buyer knows of its existence.

A BOCB is a person who:

i) Buys goods (other than farm products);
ii) In the ordinary course;
iii) From a seller who is in the business of selling goods of that kind;
iv) In good faith; and
v) Without knowledge that the sale violates the rights of another in the same goods.

Question 30

If attachment is the process by which a security interest in a piece of collateral becomes enforceable against a debtor, then why is it important to perfect?

Answer 30

Perfection is generally necessary for the secured party to have rights in the collateral that are superior to any rights claimed by third parties. The focus is to protect the secured party from subsequent buyers of the collateral, lien creditors, etc. who may claim an interest in the same collateral. While perfection has no relevance to the secured party’s rights against the debtor, it stakes the secured party’s claim so that the secured party might have priority over a later party.

Question 31

As between a perfected secured creditor and a statutory lien claimant, who has priority in a dispute over the same collateral?

Answer 31

A statutory lien claimant has priority over a perfected secured creditor provided:

(1) The lienholder has possession the goods; and
(2) The lien secures payment or performance of an obligation for services or materials furnished in the ordinary course of the person’s business (e.g., a mechanic’s lien).

Question 32

Typically, a secured party must give authenticated notice of disposition to a variety of parties. When is notice not required?

Answer 32

A secured party is not required to send a notice of disposition when:

(1) The collateral is perishable or threatens to decline speedily in value;
(2) The collateral is customarily sold on a recognized market; or
(3) Notice is waived by an authenticated agreement after default.

Question 33

Where must a financing statement be filed?

Answer 33

Generally, the financing statement must be filed with the Secretary of State (“central filing”) of the state of the debtor’s location.

Question 34

A security interest in a ________ can be perfected only by control.

Answer 34

deposit account

Question 35

Under what circumstances does the same office rule extend temporary perfection?

Answer 35

Under the same office rule, temporary perfection in proceeds may continue indefinitely if:

(1) A filed financing statement covers the original collateral;
(2) The proceeds are collateral in which a security interest may be perfected by filing in the same office as the original financing statement; and
(3) The proceeds are not acquired with cash proceeds.

(E.g., Lender filed a financing statement covering candle inventory. The candles are sold on credit to Boutique generating an account (which is the proceeds of the inventory). Those proceeds and the original inventory would be perfected by filing in the same office, and the account was not acquired with cash proceeds. Lender is perfected in the account without having to file a new financing statement.)

Question 36

When can perfection occur as it relates to attachment?

Answer 36

Perfection can happen after attachment or at the same time - but not before.

Question 37

Who has priority in a car radio that had been installed in a vehicle that was perfected under a certificate-of-title statute?

Answer 37

A security interest in an accession is usually subject to general priority rules. However, a security interest in an accession is subordinate to a security interest in the whole collateral if that collateral was perfected under a certificate-of-title statute. Here, the radio was installed in a vehicle that was perfected under a certificate-of-title statute. Therefore, the security interest in the car radio is subordinate to the holder of the lien noted on the title certificate of the vehicle.

Question 38

As between a secured party and a judicial lien creditor, who has priority?

Answer 38

A judicial lien creditor takes the collateral subject to an existing perfected security interest but generally has priority over an unperfected security interest.

Question 39

A PMSI in what type of goods automatically perfects upon attachment?

Answer 39

A PMSI in consumer goods automatically perfects upon attachment. (A PMSI in other types of goods (e.g., inventory, equipment) or automobiles does not automatically perfect.)

Question 40

Does a perfected security interest have priority over an earlier created but unperfected security interest in the same collateral?

Answer 40

Yes, the perfected security interest has priority of over an earlier created but unperfected security interest in the same collateral.

Question 41

A PMSI in fixtures has priority over a prior interest in the real property with which they are associated when what two things occur?

Answer 41

(1) The debtor has an interest in the real property (owner) or is in possession (lessee); and
(2) The security interest is perfected by a fixture filing before the goods become fixtures or within 20 days thereafter.

Question 42

Explain the “garage sale” exception to the general rule that unless the secured party authorizes the sale free and clear of its security interest, a buyer takes subject to a perfected security interest.
Is there an exception to this exception?

Answer 42

A buyer of consumer goods will take free of a security interest even if it is perfected, if the buyer buys consumer goods for value, from a consumer seller, it’s for his own personal, family, or household use, and it’s without knowledge of the security interest.

However, if the party holding a PMSI in consumer goods filed a financing statement covering those goods before the consumer to consumer purchase occurred, then the secured party’s security interest will be good against the consumer buyer. (Recall that a PMSI in consumer goods is automatically perfected and filing is not required. By filing regardless of automatic perfection, the secured party protects his priority in the event of a consumer to consumer purchase of the covered goods.)

Question 43

The general rule for a perfected security interest versus another perfected security interest in the same collateral is that the first to file or perfect has priority. In essence, this rule rewards the earlier _________.

Answer 43

Filer.

In essence, this rule rewards the first to file - even if the other party was first to attach or first to perfect. In other words, if both parties perfected by filing, the first party to file wins whether or not perfection was actually complete when the filing took place. Furthermore, if two parties perfected at the same time, but one party perfected by filing and the other party perfected using another means (control or possession), the party that perfected by filing wins.

Question 44

Once there has been a default, the secured party can repossess the collateral in what two ways?

Answer 44

(1) By use of judicial process (e.g., replevin action); or

(2) Self-help repossession

Question 45

(1) What is the general rule for a security interest in fixtures versus a real property interest to which it is associated?
(2) In order for a security interest in a fixture to have priority over an interest in the real property, what must happen?

Answer 45

(1) The general rule is that a security interest in fixtures is subordinate to a conflicting interest of an owner of the related real property (other than the debtor).
(2) For a security interest in fixtures to have priority over an interest in real property, the secured party must file a fixture filing before the real property interest is recorded. (A fixture filing is a financing statement covering goods that are or are to become fixtures.) It must be filed in the office designated for the recording of a mortgage on the related real property (i.e., local real property records).

Question 46

If a secured party holding a subordinate security interest in a piece of collateral reposseses and sells that collateral, what happens to the senior, or superior, security interests in that collateral?

Answer 46

Senior, or superior, security interests survive the sale. In other words, the superior security interest continues in the collateral in the hands of whoever bought, leased, or licensed it in the foreclosure sale (buyer or transferee takes it subject to the senior security interest).

Question 47

How do you determine priority when there is an unperfected security interest versus another unperfected security interest in the same collateral?

Answer 47

The first to attach takes priority.

Question 48

Self-help repossession cannot “breach the peace,” which is not defined by Article 9 and is left up to the courts. What self-help measures are typically deemed acceptable by courts?

Answer 48

A trespass with respect to the collateral itself (e.g., entering a car or other vehicle), or the debtor’s land (e.g., seizing a car from the debtor’s driveway [but not the garage or residence]) are generally deemed acceptable means of self-help repossession that do not breach the peace.

Question 49

What is the priority rule for a PMSI in goods (other than inventory or livestock)?

Answer 49

This PMSI will prevail over all other security interests in the same collateral, even if those other security interests were previously perfected (e.g., an existing after-acquired equipment clause by a lender), so long as the security interest is perfects before or within 20 days after the debtor receives possession of the collateral.

Question 50

What is the priority rule for a lender with a PMSI versus a seller with a PMSI?

Answer 50

The seller PMSI beats the lender PMSI. (In other words, the seller of collateral has priority over the lender whose loan enabled the purchase of the collateral.)

Question 51

What is the rule regarding construction mortgages and subsequent security interests in fixtures?

Answer 51

A construction mortgage has priority over any subsequent security interest in fixtures, including PMSIs in fixtures, if it is recorded before the goods become fixtures, and it covers only those goods that become fixtures before completion of the construction.

Question 52

“Default” is not defined by Article 9. Typically, parties to a security agreement agree to what circumstances give rise to a default. In the absence of such an agreement, what event gives rise to a default?

Answer 52

In the absence of an agreement between the parties, the only event of default will be the failure of the obligor to make timely payments to the secured party.

Question 53

Upon default, what happens when a secured party has priority in an accession?

Answer 53

The secured party with priority in the accession is allowed to remove the accession from the other goods (i.e., if the security interest in the accession has priority over the claims of every person having an interest in the whole). A secured party that removes an accession from other goods must reimburse the holder of a security interest or the owner of the whole for physical injury to the whole or other goods.

Note: A security interest in a car radio is subordinate to a security interest in the car perfected by notation of the security interest on the title to the car.

Question 54

What remedy is available to a secured party of large equipment that makes repossession difficult?

Answer 54

Equipment that is hard to repossess can be rendered unusable in lieu of repossession. This is usually followed by disposal (e.g., sale) on the debtor’s premises.

Question 55

What is the consumer buyer exception and who qualifies as a consumer buyer?

Answer 55

A consumer buyer of consumer goods takes free of a security interest, even if perfected, unless prior to the purchase, the secured party filed a financing statement covering the goods.

A consumer buyer is a person who:

i) Buys consumer goods for value;
ii) For his own personal, family, or household use;
iii) From a consumer seller; and
iv) Without knowledge of the security interest.

This is often referred to as the “garage sale” rule, because that type of sale would qualify.

Question 56

What is the priority rule for a PMSI in inventory or livestock?

Answer 56

This PMSI will have priority over all other security interest in the same inventory or livestock if the secured party:

(1) Perfects before the inventory or livestock is delivered to the debtor; and
(2) Sends an authenticated notification of the PMSI to other secured parties.

Question 57

Once a default has occurred, what are the secured party’s options?

Answer 57

The secured party may:

(1) Seek possession of tangible collateral (repossess) and either sell or retain it in satisfaction of the obligation owed;
(2) Initiate a judicial action to obtain a judgment against the debtor or obligor; or
(3) Pursue other courses of action to which the debtor and secured party have agreed.

Question 58

All aspects of the disposition of collateral must be conducted in a commercially reasonable manner. When is a disposition considered commercially reasonable?

Answer 58

A disposition is commercially reasonable when the collateral is:

(1) Sold in the usual manner in a recognized market that has standardized prices for fungible goods;
(2) Sold at the price current in a recognized market; or
(3) Disposed of in conformity with reasonable commercial practices among dealers in that type of collateral.

Question 59

If a secured party sells collateral, cash proceeds of a disposition are distributed in what order?

Answer 59

Cash proceeds of a disposition are distributed in the following order:

(1) Pay reasonable expenses for collection and enforcement (e.g., reasonable attorney’s fees); then
(2) Pay off the debt to the foreclosing secured party; then
(3) Pay subordinate security interests, provided the subordinated party makes a formal demand prior to distribution of the proceeds; then
(4) Any surplus or remainder will be returned to the debtor.