Secured Transactions

Question 1

secured transactions

Answer 1

debt secured by collateral

generally involve credit transactions. a debtor buys something from a creditor or secured party on credit. the creditor wants to be able to rely on something other than the debtors promise too ensure payment. a security interest or collateral is that something

Question 2

security interest

Answer 2

right of creditor to repossess upon default

a security interest is a limited right in specific personal property (the collateral) of the debtor that allows the creditor to take the property (commonly referred to as repossessing) if the debtor fails to fulfill the credit obligation

Question 3

effective between creditor and debtor upon attachment

Answer 3

a security interest is effective between the parties as soon as certain steps are taken to attach the interest. once the interest attaches, if the debtor defaults the creditor has some right to take the collateral to satisfy the debt

Question 4

effective against third parties upon perfection

Answer 4

attachment does not provide the creditor with rights against third parties who might also have an interest in the collateral. to gain rights of third parties, a creditor must take aded steps to perfect the security interest

Question 5

perfection basically

Answer 5

serves as a ford of notice that the creditor has a security interest in the collateral , and because of this notice, gives the creditor rights in the collateral superior to certain third parties

Question 6

scope of article 9

Answer 6

article 9, with certain exceptions, applies to most contractual security interests in personal property of fixtures (personal property so attached to real property so as to become part of the real property) and outright sales of AR

Question 7

exceptions to article 9

Answer 7

does not apply to security interest in land (i.e. mortgages), wage claims, and statutory liens

Question 8

purchase money security interests (PMSI)

Answer 8

there is a special type of security interest, PMSI, that has priority over all other types of security interests in the same collateral, if the PMSI is properly perfected

Question 9

a PMSI arises when

Answer 9

a creditor sells the collateral to the debtor on credit, retaining a security interest for the purchase price or

the creditor advances funds used by the debtor to purchase the collateral

Question 10

types of collateral

Answer 10

collateral is the property subject to a security interest. under article 9, there are 4 broad categories of collateral: goods, intangible, and semi-intangible collateral, investment property and proceeds

it is important to know the type of collateral you are dealing with because certain rules (e.g. how to perfect, where to perfect, and priority) depend on the type of collateral involved

Question 11

goods include

Answer 11

consumer goods - goods used for personal, family or household purpose

inventory - goods held for sale or lease or goods used up quickly in business, such as raw materials used in manufacturing, goods to be furnished under a service contract, and work in progress

equipment - goods that do not fit into another category, including durable goods used or bought for use primarily in business

**nature of goods determined by how the debtor uses them

Question 12

intangible collateral accounts

Answer 12

an account is any right to payment for goods, services, real property, or use of credit card, not evidenced by an instrument or chattel paper

Question 13

investment property

Answer 13

investment property includes stock, bonds, mutual funds, and brokerage accounts containing such items. although most investment property could be described as intangibles, the code deals with the separately

Question 14

proceeds

Answer 14

proceeds include whatever is received upon the sale, exchange, collection, or other disposition of collateral. proceeds differ from other types of collateral in that they constitute any collateral that has changed in form from a previous category.

Question 15

duties of secured party

Answer 15

a secured party has a duty to file or send the debtor a termination statement when the debt is paid, confirm for the debtor the unpaid amount left on the secured debt, and to use reasonable care to preserve any collateral in the secured party’s possession

Question 16

attachment

Answer 16

a security interest is not enforceable unless it has attached to the collateral

Question 17

3 requisites for attachment

Answer 17

the parties must have an agreement creating the security interest evidenced by either: an authenticated record of the security agreement or the creditors taking possession or control of the collateral

value must be given by the secured party in exchange for the security interest and

the debtor must have rights in the collateral (usually outright ownership, but it could be something less, such as possessory right under a rental agreement)

these three elements must coexist for the security interest to attach. attachment will be effective when all 3 requisites are satisfied

Question 18

what is an authenticated record

Answer 18

article 9 was revised to embrace the use of computers in obtaining security interests. before the revision, security agreements had to be in writing and signed by the debtor. as revised, article 9 requires an authenticated record

a. a record includes not only old-fashioned written security agreements, but also intangible records such as computer files
b. a record can be authenticated by a written signature or by any electronic mark made with the intent to identify the authenticating person and adopt the agreement

Question 19

what is control

Answer 19

a security interest in investment property, non consumer deposit accounts and electronic chattel paper may be evidenced by control. generally, a creditor has control over an item if the creditor has power to make or prevent dispositions of the collateral.

Question 20

property in which debtor acquires interest in future (after acquired property)

Answer 20

after acquired property - permissible - a secured party will sometimes want to obtain a security interest not only in a debtors present property, but also in property that the debtor will obtain in the future. this is permissible

most often used with inventory and equipment - after acquired property clauses are most often used with inventory and equipment. the security interest attaches to the property as soon as the debtor acquires an interest in the property

Question 21

perfection of the security interest

Answer 21

attachment established the secured partys rights to the collateral vis-a-vis the debtor. however, other parties may also have rights in the collateral. to acquire the maximum priority in the collateral over most such third parties, the secured party must also perfect.

Question 22

5 methods of perfection

Answer 22

filing
taking possession of the collateral
control
automatic perfection
temporary perfection

Question 23

timing of perfection

Answer 23

a security interest is not enforceable against any party until it has attached to the collateral. thus, perfection of a security interest cannot be completed until it has attached

in some circumstances, however, a party may complete all of the other steps necessary for perfection before the security interest has attached. in such a case, the security interest will become perfected at the time it attaches

Question 24

perfection by filing

Answer 24

a security interest may be perfected as to all kinds of collateral except deposit accounts and money by filing a financing statement

Question 25

documents to be filed

Answer 25

the code simply requires notice filing - it does not require a filing of a copy of the security agreement. notice is given by the filing of a financing statement, which contains the following elements

1. the name and mailing address of the debtor and secured party
2. an indication of the collateral covered by the financing statement
3. if the financing statement covers collateral related to real property, a description of that real property

note carefully that a general description of the type of collateral is sufficient in the financing statement. a description of particular collateral is not necessary

Question 26

debtor must authorize filing

Answer 26

the debtor must authorize the filing of a financing statement in an authenticated record. a debtor will be deemed to have authorized the filing if the debtor authenticates a security agreement covering the collateral that is covered by the financing statement

Question 27

place of filing

Answer 27

generally, financing statements are filed centrally, with the secretary of state

Question 28

period for which filing is effective

Answer 28

5 years and it can be renewed

a financing statement is effective for 5 years. a financing statement can be renewed for an additional five year period by filing a continuation statement

Question 29

perfection by taking possession

Answer 29

a secured party may perfect a security interest in most types of collateral simply by taking possession of the collateral. this is similar to when a pawn shop takes an item in exchange for a loan of money. the property owner can redeem the pledged item by paying back the amount borrowed

Question 30

collateral that cannot be pledged

Answer 30

intangible property

a security interest in accounts, deposit accounts, nonnegotiable documents or general intangibles cannot be perfected by possession, even if they collateral is tangibly represented

Question 31

rights and duties of secured party in possession

Answer 31

the secured party must use reasonable care in storing and preserving the collateral, but may charge the debtor for any reasonable expenses incurred in preservation of the collateral, including the cost of insurance

Question 32

perfection by control

Answer 32

security interests in investment property may be perfected by control. basically, a secured party (or other purchases) has control of an item of investment property when the secured party has taken whatever steps are necessary to be able to have the investment property sold without further action from the owner

Question 33

stocks certificates and bonds (certified and uncertified)

Answer 33

certified securities - must take possession; if the stock or bond is represented by a certificate, the secured party must take possession of the certificate to obtain control. if there certificate is not in bearer form, the secured party must also have the specific person endorse the certificate over to him

uncertified securities - owner contacts issuer; if the stock or bond is not represented by a certificate to obtain control the secured party must have the owner notify the issuer to reregister the securities in the name of the secured party or have the issuer agree to follow the secured partys instructions regarding the security

Question 34

securities accounts

Answer 34

few people actually physically possess the stocks or bonds they own. they instruct brokers or mutual fund companies to purchases stocks, bonds, or mutual fund shares on their behalf and hold them in a securities account

a creditor can perfect a security a security interest in such an account in much the same way a secured party would gain control over an uncertificated security. the owner of the account must contact the broker or mutual fund company and instruct the broker that the secured party now has whatever right in the account the has or that the broker is to comply with the secured partys orders without further consent of the owner

Question 35

automatic perfection

Answer 35

article 9 provides that a security interest can be perfected simply by the attachment of the security interest without any added requirements

Question 36

PMSI in consumer goods

Answer 36

a PMSI arises where the creditor either sells the collateral to the debtor on credit and reserves a security interest or advances the funds that are used to purchase the collateral and reserves a security interest. the only type of PMSI that is automatically perfected is a PMSI in consumer goods. a PMSI in inventory or equipment collateral must be filed to be valid

Question 37

small scale assignment of accounts

Answer 37

a small scale assignment of accounts is automatically perfected

Question 38

temporary perfection

Answer 38

1. twenty day period for proceeds - a security interest in process from original collateral is continuously perfected for 20 days from the debtors receipt of the proceeds
2. interstate shipments (four month grace period) - where collateral is taken from one state to another, perfection in the first state generally is valid for four months after the collateral is brought into the second state. to maintain its priority the creditor must perfect in the new state within this four month period

Question 39

priorities

Answer 39

the heart of article 9 is its allocation of rights or priorities between conflicting interests in collateral. conflicts can arise, for example, between a secured creditor and a buyer of the collateral, between editors with a security interest in the same collateral. priorities are discussed below in the order of highest priority

Question 40

ranking of priority

Answer 40

1. a buyer in the ordinary course of business of inventory that serves as collateral for a security agreement created by the seller; holders in due course of negotiable instruments and holders of possessory liens
2. the holder of a properly perfected PMSI in collateral
3. the holder of a perfected security interest in, or a judicial lien that has attached to, the collateral
4. the holder of an unperfected security interest in the collateral
5. the debtor

Question 41

buyers in the ordinary course

Answer 41

a buyer who buys goods from a merchants inventory in the ordinary course of the sellers business has the highest priority in collateral. such a buyer takes free of a perfected security interest in the inventory, even if hey knows of the security interest, unless he knows that the sale is in violation of the security agreement. the buyer need not be purchasing for consumer use. a buyer in the ordinary course of business of equipment also takes free of perfected security interests.

Question 42

holders in due course and the like

Answer 42

like a buyer in the ordinary course, a holder in due course of a negotiable instrument, or a holder to whom a negotiable document of title has been negotiated, takes priority over an earlier perfected security interest. this, the best way to perfect a security interest in such items is to take possession of them. taking possession of negotiable instruments generally prevents other persons from gaining status as a HDC or the like

Question 43

holder of possessory liens - mechanics liens

Answer 43

in most states, a repairer who does not get paid for repairing goods can place a mechanics lien on the goods. the lien is valid as long as the repairer keeps possession of the goods. such possessory liens generally have priority over existing perfected security interests

Question 44

properly affected PMSI

Answer 44

the person with the next highest priority in collateral is a holder of a properly perfected PMSI. proper perfection depends on the nature of the collateral.

1. PMSI in consumer goods automatically perfected
2. exception (second hand consigner purchaser without notice) - if a buyer of consumer goods resells the goods to another consumer buyer, the second hand buyer will take free of an automatically perfected PMSI in consumer goods as long as the second hand consumer buyer had no notice of the security interest. this is often called the garage sale rule

Question 45

PMSI in inventory

Answer 45

prior perfection and notice required for priority.

a PMSI in inventory has priority over a prior perfected security interest in the same inventory collateral only if:

a the PMSI is perfected when the debtor gets possession of the collateral (filing must occur before the inventory is delivered to the debtor) and

b. any secured party who has filed a security interest in the same collateral is given notice of the PMSI before the debtor receives the inventory

Question 46

noninventory PMSI

Answer 46

priority if filing within a 20 day grace period

a PMSI in noninventory collateral has priority over conflicting security interests in the same collateral as long as the PMSI is perfected within 20 days after the debtor receives possession of the collateral

a. if perfected within the 20 day grace period, perfection relates back to the day that debtor got possession (which means the PMSI is superior to security interests created during the 20 day grace period
b. there is no requirement that the secured party notify other secured parties as must be done with an inventory PMSI

Question 47

perfected security interests

Answer 47

perfected security interests and judicial liens that have attached have the next highest priority after properly perfected PMSIs. if there are conflicting perfected security interests or liens in the same collateral the following rules apply

conflicting perfected security interests - first to file or perfect
conflict between perfected security interest and judicial lien
trustee in bankruptcy - lien creditor as of the date of filing

Question 48

conflicting perfected security interests - first to file or perfect

Answer 48

where there are conflicting perfected security interests in the same collateral, priority goes to the creditor who was first to either file or perfect

a. thus, if both parties perfected by filing, the one who filed first has priority, even if perfection was not completed upon filing
b. if one party perfected by filing and the other party perfected by some other method, the party who filed will have priority if he filed before the other party perfected

Question 49

conflict between perfected security interest and judicial lien

Answer 49

a judicial lien will have priority if it attached before the security interest was perfected. if the security interest was perfected before the judicial lien was attached, it has priority

Question 50

trustee in bankruptcy - lien creditor as of the date of filing

Answer 50

a. a trustee in bankruptcy is treated as a hypothetical lien creditor on all of the debtors property as of the date the bankruptcy petition is filed
b. thus, the bankruptcy trustee is subordinate to all prior perfected security interests but has priority over subsequently perfected security interests less they have retroactive effect

Question 51

unperfected security interest

Answer 51

unperfected security interests have priority only over the debtor. if there are 2 unperfected security interests in the same collateral, the first to attach has priority

Question 52

debtor

Answer 52

after default, the debtor has the lowest priority in the collateral

Question 53

priority rules may be modified contractually

Answer 53

although article 9 provides rules for priority, parties entitled to priority under article 9 may constructionally subordinate their rights to the rights of other parties. thus, if a client wishes to lend money to a debtor buy all of the debtors assets are subject to a security interest that would be superior to the clients security interest, all is not lost; the client can negotiate with the other secured creditor for a subordination

Question 54

rights on default

Answer 54

right to take possession of and sell collateral
retention of collateral in satisfaction of debt
debtors right of redemption
judicial action against debtor

Question 55

right to take possession of and sell collateral

Answer 55

the right to the possession of and sell the collateral on default is the most important and most used of the rights on default

Question 56

retention of collateral in satisfaction of debt

Answer 56

1. transactions not involving consumers - after default, a secured party may keep the collateral in full or partial satisfaction of the debt
2. transactions involving consumers - with consumers, the secured party may keep the collateral only in full satisfaction of the debt
3. notice must be given in full or partial satisfaction cases - in either case, the secured party must give notice of its intent to keep the collateral to the debtor and other secured parties
4. compulsory disposition of consumer goods - in consumer goods cases where the debtor has paid at least 60% of the loan, the secured party must sell the collateral within 90 days after repossession, unless the debtor waives this right

Question 57

debtors right of redemption

Answer 57

pay all creditors in full; until the sale or discharge of the debt through retention of the collateral, the debtor may redeem the collateral by paying all of the obligations secured by the collateral plus all reasonable expenses incurred relating to the repossession

Question 58

judicial action against debtor

Answer 58

instead of using self help, on default, the secured party may bring an ordinary judicial action for the amounts due and levy on the collateral after judgment. the secured party may have the collateral seized at the same time that he or she begins the judicial action

Question 59

taking possession

Answer 59

self help - no requirement for judicial action; the secured party may take possession by self help without judicial process if she can do so without a breach of the peace

collection rights of secured party - with collateral such as accounts and instruments, upon default where agreed, the secured party is entitled to notify the account debtor to make payment to her, rather than to the debtor who is in default

replevin action - the secured party may always take possession of the collateral by replevy (a judicial action seeking the transfer of personal property)

Question 60

sale

Answer 60

after default and repossession, the secured party may sell or lease the collateral, either in its condition when taken or after reasonable preparation or processing. disposition may be by either public auction or private sale

a. the sale or lease must be commercially reasonable in all respects: method, manner, time, place and terms
b. the debtor and others parties must generally be given notice of the sale
c. the sale wipes out all subordinate interests, such as the interest of secured parties with lower priority, lien creditors and the debtors interest. a good faith purchases of the collateral at the sale takes free of all subordinate interests, but it subject to superior interests
d. the debtor has the right to redeem by paying off the indebtedness and costs before the sale, but this right is cut off by the sale
e. proceeds
f. proceeds insufficient to pay expenses of sale and debt

Question 61

proceeds of a default sale are distributed in the following order

Answer 61

1. first to pay the expenses of repossession and sale
2. second, to pay creditors with a security interest in the collateral in order of priority; the creditor with the highest priority must be paid in full before any proceeds can go to the secured creditor with the next highest priority
3. finally, any surplus is paid to the debtor