Secured Transactions

Question 1

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

Answer 1

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 2

How must the collateral be described in a financing statement?

Answer 2

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 3

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

Answer 3

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 4

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

Answer 4

The secured party is allowed to remove the accession from the other goods 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.

Question 5

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

Answer 5

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 6

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 6

A security interest in collateral attaches automatically to identifiable proceeds.

Question 7

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

Answer 7

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

Question 8

An after-acquired clause is not effective if the collateral is consumer goods, except in what circumstance?

Answer 8

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, or a commercial tort claim.

Question 9

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

Answer 9

(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 10

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

Answer 10

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 11

If a consignment is subject to Article 9, how are the consignor and the security interest in the consigned goods treated?

Answer 11

The consignor is treated as the secured party and the security interest in the consigned goods is treated as a PMSI in inventory.

Question 12

Where must a financing statement be filed?

Answer 12

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

Question 13

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

Answer 13

(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.

When these conditions coexist, the security interest has attached, unless there is an agreement to postpone the time of attachment.

Question 14

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 14

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 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

Question 15

When can a PMSI exist in goods?

Answer 15

(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 16

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

Answer 16

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

(1) The effectiveness of the lien depends on the lien holder’s 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 17

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

Answer 17

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 18

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

Answer 18

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 perfected before or within 20 days after the debtor receives possession of the collateral.

Question 19

Which of the following descriptions of collateral in a security agreement is 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 19

(3) “All of debtor’s assets”= super-generic and does not reasonably identify the collateral

(4) “All of debtor’s personal property” = super-generic and does not reasonably identify the collateral

NOTE: 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 20

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

Answer 20

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 21

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 21

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 seller who is in the business of selling goods of that kind;

(3) in good faith; and

(4) without knowledge 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 22

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

Answer 22

(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 23

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 23

(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 24

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 24

Courts are split on whether to imply after-acquired language, but the majority of courts have adopted a rebuttable presumption that after-acquired property is included.

Question 25

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

Answer 25

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

Question 26

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

Answer 26

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

EXAMPLE: 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 27

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

Answer 27

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 an authenticated demand prior to distribution of the proceeds; then

(4) Any surplus or remainder will be returned to the debtor.

Question 28

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 28

(1) A check or a promissory note = instrument

(2) A check along with a security agreement = chattel paper

(3) The right to be paid for a service rendered = accounts

(4) A savings account at a bank= deposit account

Question 29

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

Answer 29

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 30

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

Answer 30

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 31

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

Answer 31

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 32

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

Answer 32

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 33

Once there has been a default, how can the secured party take possession of the collateral?

Answer 33

A secured party is required to use judicial process (e.g., a replevin action) to obtain possession unless possession can be obtained without breach of the peace.

Question 34

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

Answer 34

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

Question 35

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

Answer 35

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 36

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

Answer 36

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 37

In order for a security interest in a fixture to have priority over an interest in the real property, what must happen?

Answer 37

For a security interest in fixtures to have priority over an interest in the related real property, the secured party must file a fixture filing before the real property interest is recorded.

Note: 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 filing or recording of a mortgage on the related real property.

Question 38

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

Answer 38

To properly classify 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 39

“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 39

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 40

When can perfection occur as it relates to attachment?

Answer 40

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

Question 41

What is the general priority rule when there are two or more perfected secured parties with rights in the same collateral?

Answer 41

When there are two or more perfected secured parties with rights in the same collateral, the first to file or perfect its security interest has priority.

Question 42

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

Answer 42

(1) Consumer goods

(2) Farm products

(3) Inventory

(4) Equipment

Question 43

“Breach of the peace,” is not defined by Article 9 and is left up to the courts. What self-help measures are typically deemed acceptable by courts?

Answer 43

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 44

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

Answer 44

The first to attach takes priority.

Question 45

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

Answer 45

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 46

Chattel paper consists of one or more records that evidence what two things?

Answer 46

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

Question 47

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

Answer 47

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 48

How can a security interest in a deposit account be perfected?

Answer 48

Only by control

Question 49

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

Answer 49

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 50

A security interest in ________ can be perfected only by possession unless it is received as __________ of a perfected security interest.

Answer 50

money; proceeds

Question 51

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

Answer 51

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 52

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

Answer 52

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 53

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

Answer 53

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 54

“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 54

(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 55

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 55

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 56

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 56

(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 57

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

Answer 57

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 58

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

Answer 58

(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 59

If a secured party holding a junior interest in a piece of collateral sells that collateral, what happens to the senior security interests in that collateral?

Answer 59

Senior, or superior, security interests survive the sale. In other words, the buyer or transferee takes the collateral subject to the senior security interest.