Secured Transactions

Question 1

ISSUE: May a secured party dispose of collateral after the debtor’s default without first notifying the debtor? ANSWER: No. The company has a claim against the bank with respect to the sale of the gramophone because the bank did not send the company a notification of disposition before the sale.

Answer 1

After default by the debtor, a secured party may dispose of the collateral. If it does so, the proceeds of that disposition will be applied first to the expenses of that process and then to the satisfaction of the debtor’s obligation to the secured party. Before disposing of the collateral, however, the secured party must send the debtor a reasonable authenticated notification of disposition. The only exception to this notification requirement is if the collateral is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market. There is no indication that the gramophone in this problem fits into any of those categories. Therefore, because the bank sent no notification to the company before the disposition, the disposition was improper. This breach of the bank’s obligation may expose the bank to liability to the company for damages or lessen the amount of any deficiency recoverable by the bank after application of the proceeds of sale to the company’s obligation.
[NOTE: An examinee might mention that a private sale of collateral, such as occurred here, is permissible if commercially reasonable. This is true. But this does not obviate the requirements with respect to pre-disposition notification.]

Question 2

ISSUE: Whose rights are superior as between the rights of a secured party having possession of an item of collateral and a person who has a judicial lien on the same item? ANSWER: The bank’s security interest in the gramophone is superior to the judgment creditor’s lien because the bank’s security interest was perfected before the judgment creditor obtained his lien.

Answer 2

Except as otherwise provided in the UCC, a security agreement is effective against creditors. UCC § 9-317 provides such an exception, however. That section indicates that a security interest is subordinate to the rights of a person who became a lien creditor before the security interest was perfected. Here, the judgment creditor is a lien creditor under § 9-102 because of his judicial lien. Thus, the bank’s security interest in the gramophone will be subordinate to the rights of the judgment creditor only if the bank’s security interest was not perfected when the judgment creditor became a lien creditor.
A security interest is not perfected unless it has “attached.” A security interest attaches when it becomes enforceable unless the time of attachment has been postponed by agreement. Thus, the bank’s security interest in the gramophone cannot be perfected unless it is enforceable. A security interest is enforceable if the three criteria in UCC § 9-203(b) have been satisfied. The first two criteria are clearly satisfied: “value” has been given (because the loan was made) and the debtor (the company) had rights in the gramophone (the company owned it). The third criterion can be satisfied in several ways. Here, it is satisfied because the collateral is in the possession of the secured party pursuant to the debtor’s security agreement. The gramophone was in the possession of the bank, and this was pursuant to the company’s “security agreement.” A “security agreement” is an agreement that creates or provides for a security interest. Thus, the oral agreement between the company’s owner (speaking for the company) and the bank is a security agreement pursuant to which the bank took possession of the gramophone. Accordingly, when the bank took possession of the gramophone, its security interest was enforceable and attached.
An attached security interest can be perfected in many ways. In the case of security interests in goods, one method of perfection is for the secured party to take possession of the goods. Thus, the bank’s possession of the gramophone not only was an element of enforceability and attachment but also resulted in perfection of the security interest.
Because the bank’s security interest in the gramophone was perfected before the judgment creditor became a lien creditor, the bank’s security interest is superior to the judgment creditor’s judicial lien.
[NOTE: An examinee may mention that the language in the loan agreement, standing alone, would be insufficient to create an enforceable and attached security interest in the gramophone. This is accurate, but the bank’s possession of the gramophone pursuant to the oral agreement is sufficient. Thus, the security interest is enforceable and attached whether or not the language in the written loan agreement would suffice in the absence of the bank’s possession. Some examinees may discuss the elements of enforceability of a possessory security interest in the answer to question 1 and refer back to that discussion in their answer to this question. Such examinees should get credit for that analysis as part of their answer to question 2. Examinees may organize their answers either way and receive full credit.]

Question 3

ISSUE: Does a security agreement describing collateral as “all personal property” create an enforceable security interest in a debtor’s property? ANSWER: No. The bank does not have an enforceable security interest in the company’s other assets because the description of the collateral in the loan agreement is insufficient to create an enforceable security interest in those assets.

Answer 3

A security interest attaches when it becomes enforceable unless the time of attachment has been postponed by agreement. The three criteria in UCC § 9-203(b) have not been satisfied. The first two criteria are clearly satisfied: “value” has been given (because the loan was made) and the debtor (the company) has rights in its personal property (because it owns it). The third criterion has not been satisfied.
Here, because the bank does not have possession of the remaining personal property of the company (and other specialized criteria are inapplicable), the bank’s security interest in that personal property is enforceable only if the requirements of UCC § 9-203(b) are met. Under that provision, the debtor must have authenticated (i.e., signed or its electronic equivalent) a security agreement that contains a description of the collateral. The loan agreement is a security agreement inasmuch as it creates or provides for a security interest. Moreover, it is authenticated inasmuch as we are told in the question that the loan agreement was signed by the company’s owner. However, the description of the collateral in the security agreement is insufficient. Subject to some exceptions, a description of personal property is generally sufficient if it reasonably identifies what is described. However, the UCC provides that descriptions of a debtor’s property such as “all of the debtor’s personal property” or words of a similar import do not reasonably identify the collateral. Here, the description of the collateral in the loan agreement is “all personal property” owned by the company. Therefore, the description is insufficient, and accordingly the security agreement does not satisfy the requirements of UCC § 9-203(b).
Thus, the bank’s security interest in the company’s assets (other than the gramophone in the possession of the bank discussed in Point One) is not enforceable. Since the security interest is not enforceable, it did not attach; since the security interest did not attach, the security interest is not perfected.
[NOTE: An examinee may mention that “all personal property” is a sufficient indication of collateral in a financing statement. That is true. But the filing of a financing statement cannot perfect a security interest that does not attach. Therefore, the security interest is not perfected here even if the financing statement would be sufficient to perfect a security interest that, unlike here, attached.]

Question 4

ISSUE: What are the rights of a buyer of accounts (i.e., the finance company) that has not filed a financing statement? ANSWER: The sale by the manufacturer to the finance company of the right to be paid by the retail stores for items of clothing is a sale of accounts governed by Article 9 of the UCC, and the finance company is said to have a “security interest.” Because the finance company did not file a financing statement, this security interest is unperfected.

Answer 4

The sale by the manufacturer to the finance company of the right to be paid by the retail stores is a sale of “accounts” as that term is defined in Article 9 of the Uniform Commercial Code. A sale of accounts is governed by UCC Article 9 even though the transaction is not one in which property secures an obligation. Because Article 9 governs a sale of accounts, Article 9 vocabulary is applied to the sale, so that the rights of the buyer of the accounts are referred to as a “security interest,” the sold accounts are “collateral,” the seller (the garment manufacturer in this problem) is the “debtor,” and the buyer (the finance company in this problem) is the “secured party.” Moreover, because the agreement of sale is “an agreement that creates or provides for a security interest,” it is a security agreement.
The finance company’s security interest is enforceable and has attached because the three criteria in UCC § 9-203 are satisfied: (i) “value” has been given inasmuch as the finance company has paid the purchase price, (ii) the debtor (the manufacturer) had rights in the collateral (the accounts sold), and (iii) the debtor “authenticated” (signed or its electronic equivalent, a security agreement containing a description of the collateral. The finance company’s security interest, however, is not “perfected” because no financing statement has been filed with respect to the transaction.
Accordingly, the finance company has an unperfected security interest in the rights to be paid by the retail stores.

Question 5

ISSUE: What are the rights of a party (i.e., the bank) to whom a security interest in accounts has been granted if that secured party has filed a financing statement? ANSWER: The manufacturer granted to the bank an enforceable and attached security interest in the right to be paid by the retail stores. Because the bank filed a financing statement with respect to this security interest, the bank’s security interest is perfected.

Answer 5

The bank also has an enforceable and attached security interest in the right to be paid by the retail stores that bought clothing from the manufacturer on credit. First, value has been given because the bank loaned money to the manufacturer. Second, the debtor (the manufacturer) still had rights in the collateral. This is the case because even though the manufacturer had already sold the accounts to the finance company, the finance company’s interest was unperfected. Third, the manufacturer authenticated (signed, in this case) a security agreement containing a description of the collateral (the accounts).
Unlike the finance company’s security interest, the bank’s security interest is perfected because the bank filed a properly completed financing statement.
[NOTE: An examinee might mistakenly assert that the bank does not have an enforceable security interest in the pre-February 1 accounts because one of the three elements of an enforceable and attached security interest (that the debtor had rights in the collateral) is not satisfied inasmuch as the garment manufacturer had previously sold those accounts to the finance company. This assertion would be accurate if the finance company had perfected its interest, but, as indicated in UCC § 9-318, if a buyer of accounts does not perfect its interest, the seller is treated as continuing to have rights in those accounts. Thus, in this case, the manufacturer continues to have sufficient rights in the pre-February 1 accounts for the bank’s security interest to attach.
Nonetheless, an examinee who makes that mistaken assertion should receive some credit for recognizing that a debtor must have rights in the collateral for a creditor to have an enforceable security interest in that collateral. Such an examinee should also conclude that, because the bank has obtained no rights in the pre-February 1 accounts from the garment manufacturer, the retail stores would have no obligation to pay the bank amounts due on those accounts even after receiving the notifications of assignment from the bank. An examinee who reaches that conclusion based on the mistaken assertion should receive full credit if the examinee also correctly notes that the bank has a right to collect from the retailers on the post-February 1 accounts (which were not sold to the finance company). Conversely, an examinee who asserts, in answer to the first question, that the bank does not have an enforceable security interest but nonetheless concludes, in answer to the second question, that the retail stores must pay the bank to discharge their payment obligation on the pre-February 1 accounts, should not receive credit for that conclusion inasmuch as, under UCC § 9-406, the bank would not be an assignee and its notice to the retail stores would have no effect.]>

Question 6

ISSUE: If a buyer of accounts has not filed a financing statement, what are that buyer’s rights against a party to whom a security interest in those accounts has been subsequently granted and who has filed a financing statement? ANSWER: The finance company’s unperfected security interest in the rights to be paid by the retail stores is subordinate to the bank’s perfected security interest in those rights.

Answer 6

An unperfected security interest is subordinate to a perfected security interest in the same property. Therefore, because the finance company’s security interest in the rights to be paid by the retail stores is unperfected while the bank’s security interest in those rights is perfected, the finance company’s interest in those rights is subordinate to the bank’s security interest in them. This is the case even though the sale of the rights to the finance company occurred before the bank was granted a security interest in them.

Question 7

ISSUE: May an account debtor discharge its obligation on an account that has been assigned by paying the assignor even after the account debtor learns that the account has been assigned? ANSWER: Yes. Because the retail stores received authenticated (signed) notifications of the assignment of their accounts to the bank and directions to pay the bank, they can discharge their obligations on the accounts only by paying the bank, the assignee.

Answer 7

The retail stores are “account debtors” on the accounts. Under UCC § 9-406, an account debtor with respect to assigned accounts is entitled to discharge its obligation by paying the assignor only until the account debtor receives notice of the assignment to the assignee, authenticated by either the assignor or the assignee, directing the account debtor to make payment to the assignee. Once such a notice has been received, the account debtor is entitled to discharge only by paying the assignee. The retail stores have received a notice of the assignment authenticated (signed) by the assignee (the bank) directing them to pay the assignee. Accordingly, under UCC § 9-406, the retail stores can discharge their obligations on the accounts only by paying the bank (the assignee).
[NOTE: When an account debtor receives notification of an assignment, the account debtor may request reasonable proof that the assignment has been made and, until such proof is furnished, may still discharge its obligation by paying the assignor. Under these facts, there is no indication that any of the retail stores (the account debtors) requested such proof.]
 

Question 8

ISSUE: When the debtor is in default under a security agreement, does the secured creditor have the right to disable equipment that is part of the collateral? ANSWER: Yes. Because PTT defaulted under its security agreement with Ion, Ion is entitled to take possession of the equipment that is collateral for that obligation or leave the equipment at PTT’s premises and render it unusable.

Answer 8

Ion has an enforceable security interest in the proton-therapy equipment under the criteria set forth in UCC § 9-203(b). The security interest is enforceable because (i) Ion gave value to PTT by providing credit to PTT, which PTT used to purchase the proton-therapy equipment, (ii) PTT acquired rights in the proton-therapy equipment when it purchased the equipment from Ion, and (iii) PTT authenticated (i.e., signed or its electronic equivalent) a security agreement that described the proton-therapy equipment and granted Ion a security interest in it.
Following a debtor’s default, if the collateral is “equipment,” a secured party may leave the equipment in place and render it unusable. The secured party may pursue this option “without judicial process, if it proceeds without breach of the peace.” Although “breach of the peace” is not defined, courts may look to, inter alia, public harm or loss of public order.
“Equipment” is a defined term under Article 9 of the UCC, referring to “goods other than inventory, farm products, or consumer goods.” The term “goods” means “all things that are movable when a security interest attaches” and also includes fixtures. Here, the proton-therapy equipment clearly constitutes goods, and it is not inventory, farm products, or consumer goods, so it is “equipment.”
Accordingly, because PTT has defaulted, Ion is entitled to disable the equipment if it can do so without breach of the peace. Here, its technician will be in the facility performing routine maintenance on the equipment and can disable it at that time. The technician will be lawfully in the facility, and there is nothing to indicate that the technician would have to engage in any violent, disruptive, or illegal behavior to prevent the equipment from being used. Without some reason to believe that there will be a breach of the peace, Ion can lawfully instruct its technician to disable the equipment.
[NOTE: Examinees may note that Ion’s security interest is perfected. While analysis of perfection is necessary in order to answer Point Three, it is not necessary in order to answer this question.]

Question 9

ISSUE: When collateral becomes a fixture, what are the relative rights of a person who has a security interest in the collateral and a mortgagee of the real property to which the collateral is affixed? ANSWER: Because the equipment has become a fixture and Ion did not make an effective “fixture filing,” Bank’s interest in the equipment is superior to that of Ion.

Answer 9

Bank has a mortgage on the land and the building in which the proton-therapy equipment is housed. The facts also state that, as a result of the installation, the equipment became a fixture. Accordingly, Bank’s mortgage extends to the equipment.
Ion has a perfected security interest in the proton-therapy equipment. The security interest is enforceable under UCC § 9-203(b), and thus (in the absence of an agreement to the contrary under UCC § 9-203(a)) the security interest is attached. This is because all three elements of UCC § 9-203(b) have been satisfied: “value” has been given (the proton-therapy equipment has been delivered to PTT), PTT has rights in the proton-therapy equipment, and the signed purchase agreement qualifies as a security agreement that contains a description of the collateral. Ion’s security interest is perfected under UCC §§ 9-308 and 9-310 because a financing statement properly listing the debtor and indicating the collateral was filed in the office of the State A Secretary of State. (State A is the correct state in which to file the financing statement because perfection of this security interest is governed by the law of the state in which PTT is located; in this case, PTT is located in State A because, as a corporation, PTT is a “registered organization” and, thus, is located in the state under whose laws it is organized.)
[NOTE: Inasmuch as State A is the only state mentioned in this problem, examinees who do not do this conflict-of-laws analysis should nonetheless be able to receive full credit.]
A security interest in fixtures (such as that of Ion), even if perfected, is ordinarily subordinate to a conflicting interest of an “encumbrancer of the related real property,” such as Bank. There are, however, a number of exceptions to this rule. One exception relates to the priority of a “purchase-money security interest” in fixtures as against an encumbrancer of the related real property. (Ion has a purchase-money security interest in the equipment because the equipment secures credit given by Ion to allow PTT to buy the equipment.) Because the security interest of Ion is a purchase-money security interest, had Ion made a “fixture filing” before the equipment became a fixture or within 20 days thereafter, the security interest of Ion would have had priority over Bank’s mortgage. Ion did not make a fixture filing, though. While Ion did perfect its security interest by filing the financing statement with the Secretary of State, that financing statement did not qualify as a “fixture filing” because a fixture filing must provide a description of the real property to which the collateral is related and must be filed in the office in which a mortgage on the related real estate would be filed, not in the state’s central filing office. Therefore, no exception to the general rule is applicable and the security interest of Ion in the equipment is subordinate to the interest of Bank.

Question 10

ISSUE: Does a person who has a security interest in equipment also have a security interest in the debtor’s right to be paid by a lessee who leased the equipment? If so, is the security interest perfected? ANSWER: Ion has a security interest in PTT’s rights under the lease with Oncology because those rights are proceeds of its collateral. Because the security interest of Ion in the equipment was perfected by filing, its security interest in the rights to payment is perfected.

Answer 10

A secured party that has a security interest in collateral also has a security interest in any identifiable “proceeds” of the collateral. Proceeds include “whatever is acquired upon the lease of collateral.” Thus, PTT’s rights under the lease with Oncology are proceeds of the proton-therapy equipment in which it has a security interest. As a result, Ion has a security interest in PTT’s rights against Oncology under the lease.
Whether Ion’s security interest in the rights under the lease is perfected is important because this will determine Ion’s rights compared to those of other parties who have a claim to the rights under the lease. A security interest in proceeds of collateral is perfected for at least 20 days if the security interest in the original collateral was perfected. Ion’s security interest in the proton-therapy equipment was perfected by the filing of the financing statement with the Secretary of State. As a result, Ion’s security interest in the proceeds of that equipment (the rights against Oncology under the lease) is perfected for at least 20 days. The security interest will remain perfected after the 20-day period if, inter alia, the security interest in the original collateral was perfected by a filing in the same office in which a security interest in the proceeds could be perfected by filing. Here, PTT’s rights under the lease with Oncology constitute chattel paper because the lease evidences both a monetary obligation and a lease of specific goods. A security interest in chattel paper may be perfected by filing a financing statement in the Secretary of State’s office in State A, the same office in which PTT filed the financing statement with respect to the equipment. Thus, the security interest in the chattel paper (the proceeds) is perfected not only for the first 20 days but thereafter as well.
 

Question 11

ISSUE: Does a security interest in a store’s inventory survive sale of an item of that inventory to a buyer who acquires the item in good faith in an ordinary-course transaction? ANSWER: No. The buyer obtained the home entertainment system free of the finance company’s perfected security interest because the buyer was a buyer in ordinary course of business. Because the buyer owned the home entertainment system free of the security interest, the buyer’s sale to the friend was free of that interest.

Answer 11

The finance company had an enforceable, attached security interest in all of the retailer’s inventory, including the home entertainment system later sold to the buyer. All three elements of enforceability and attachment under UCC § 9-203 were satisfied: value was given (the loan), the debtor (the retailer) had rights in the inventory, and the debtor (the retailer) authenticated a security agreement containing a description of the collateral. Moreover, the finance company’s security interest was perfected by the filing of the financing statement.
As a general rule, a security interest continues notwithstanding the sale of collateral. But this general rule is subject to several exceptions. In particular, a “buyer in ordinary course of business” (BIOCOB) takes free of a security interest created by its seller even if the security interest was perfected. Under these facts, the buyer was a BIOCOB. She appears to have bought the home entertainment system in good faith and in the ordinary course from a person in the business of selling goods of the kind (the retailer) without knowledge that the sale to her violated the rights of a third party. Because the buyer was a BIOCOB, she acquired the home entertainment system free of the finance company’s security interest.
Under the “shelter principle,” once the buyer acquired the home entertainment system free of the finance company’s security interest, any subsequent transfer of the system by the buyer to someone else was also free of the finance company’s security interest. Accordingly, when the friend acquired the home entertainment system from the buyer, it was free of the finance company’s security interest.

Question 12

ISSUE: What are the rights of a seller of goods who “sells” those goods on credit to a consumer but purports to retain title to the goods until the full purchase price is paid? Do the seller’s rights survive a resale of those goods by the buyer to another consumer? ANSWER: The retailer’s retention of title to the home entertainment system in the credit sale to the buyer was a security interest in the system. While the security interest was automatically perfected, the friend acquired the system free of the retailer’s security interest.

Answer 12

While the agreement between the retailer and the buyer indicated that the retailer was retaining title to the home entertainment system, the substance-over-form rules of secured transactions law indicate that the retailer’s interest was not ownership but, rather, a security interest. Article 9 governs any transaction regardless of form that creates a security interest in personal property by contract. All the elements of attachment and enforceability of this security interest were satisfied.
The retailer’s security interest was perfected even though the retailer did not file a financing statement. This is because the retailer’s security interest was a “purchase-money security interest” in “consumer goods.” The security interest was a purchase-money security interest because it was retained by the seller to secure payment of the remainder of the sales price. The home entertainment system constituted “consumer goods” because it was used primarily for personal, family, or household purposes. A purchase-money security interest in consumer goods perfects upon attachment without the filing of a financing statement. Therefore, the retailer’s security interest in the home entertainment system was a perfected security interest while the system was owned by the buyer.
As a general rule, a security interest continues notwithstanding the sale of collateral. Thus, under this general rule, the retailer’s security interest in the home entertainment system would continue after the buyer’s sale of the system to the friend. But this general rule is subject to several exceptions. In this case, the friend acquired the system free of the retailer’s security interest under the consumer-to-consumer exception in UCC § 9-320 because the home entertainment system was used for personal, family, or household purposes of the buyer before the sale and of the friend after the sale, and the friend acquired the system for value, without knowledge of the retailer’s security interest, and before a financing statement was filed with respect to that security interest. (As noted above, the retailer was not required to file a financing statement to perfect its security interest because it was a purchase-money security interest in consumer goods.)

Question 13

ISSUE: Does a secured party obtain an interest in the proceeds of a debtor’s sale of the secured party’s collateral? ANSWER: Yes. Because the retailer had a perfected security interest in the home entertainment system at the time of its sale to the friend, the retailer obtained a security interest in the $4,000 check as proceeds from the sale of the system; the security interest in the check was perfected for 20 days and remained perfected thereafter because the check constituted “cash proceeds.”

Answer 13

The check constituted “proceeds” of the home entertainment system because that term includes, inter alia, whatever is obtained on the sale of collateral. When collateral is disposed of, a secured party automatically obtains a security interest in identifiable proceeds of the collateral. Accordingly, when the home entertainment system was sold by the buyer to the friend, and the buyer received the check in return, the check constituted proceeds of the home entertainment system and the retailer (which had a security interest in the system) thereby obtained a security interest in the check. Because the retailer’s security interest in the system had been perfected, its security interest in the check as proceeds was perfected as well. That perfection ceases after 20 days, however, unless one of three criteria in UCC § 9-315(d) is satisfied. In this case, UCC § 9-315 was satisfied because the check was “cash proceeds.” Thus, the retailer’s security interest in the check was continuously perfected after the sale of the system to the friend.

Question 14

ISSUE: Does Bank have an enforceable and attached security interest in the collateral described in the loan agreement? ANSWER: Yes. Bank has an enforceable and attached security interest in the property described in the loan and security agreement.

Answer 14

A security agreement is enforceable and attached if the three criteria described in UCC § 9-203 are satisfied. The first criterion is that “value has been given.” This is satisfied by the loan from Bank to Acme. The second criterion is that the debtor “has rights in the collateral or the power to transfer rights in the collateral to a secured party.” This is satisfied with respect to Acme’s inventory and accounts. The third criterion is satisfied because Acme has authenticated (signed, in this case) a security agreement that provides a description of the collateral. Thus, since all three criteria have been satisfied, Bank’s security interest in the property described in the loan and security agreement is enforceable and attached.

Question 15

ISSUE: Does Bank’s security interest cover Acme’s rights to payment from customers who obtained repair services from Acme on credit? ANSWER: Yes. Acme’s rights to payment from customers who obtained repair services on credit are “accounts” subject to Bank’s security interest.

Answer 15

Bank’s security interest covers “accounts,” as the term is defined in the Uniform Commercial Code. Acme’s rights to payment for repair services provided on credit are accounts because they are “rights to payment for services rendered or to be rendered.” Thus, these rights to payment are subject to Bank’s security interest.

Question 16

ISSUE: Does Bank’s security interest cover the used violins that are for sale in Acme’s store? ANSWER: Yes. The used violins that are for sale in Acme’s store are “inventory” subject to Bank’s security interest.

Answer 16

Bank’s security interest covers “inventory.” The used violins that are for sale in Acme’s store are “inventory” under UCC § 9-102 because they are “goods which are held by a person for sale.” Thus, those violins are subject to Bank’s security interest.

Question 17

ISSUE: Does Bank’s security interest cover the violins in Acme’s possession that it is repairing for others? ANSWER: No. The violins in Acme’s possession that it is repairing for others are not covered by Bank’s security interest because they are not “inventory” and are not owned by Acme.

Answer 17

Bank’s security interest does not cover the violins that Acme is repairing for their owners. This conclusion can be reached in either of two ways. First, those violins are not “inventory” because they are not held by Acme for sale or lease. Second, because the violins are not owned by Acme, but rather are owned by the individuals who brought them to Acme to be repaired, the security interest would not attach because Acme has neither rights in those violins nor the power to transfer rights in them to a secured party.
[NOTE: An examinee might argue that Acme has some rights in the violins it holds for repair because it has lawful possession of them, the right to repair them, the right to collect payment for repairs, and (in some jurisdictions) the right to assert an artisan’s lien if a repair bill is unpaid. An examinee who makes an argument of this sort should also note that these limited rights will not help Bank for two reasons. First, as already noted, the violins don’t fall within the scope of the security interest in any event, because they are not “inventory” or “accounts.” Second, even if the violins held for repair were within the scope of the security agreement, Bank’s rights against the owners of the violins would be no greater than Acme’s and it could, at best, arrange for repairs to be performed and collect amounts due. Moreover, while it is possible that, because Acme deals in violins and the owners of the violins brought to Acme for repair entrusted them to Acme, buyers in ordinary course of business of those violins would get good title to them under UCC § 2-403, that provision does not give rights to secured parties.]

Question 18

ISSUE: Does Bank’s security interest cover the wood used by Acme in repairing violins? ANSWER: Yes. The wood used by Acme in repairing violins is “inventory” and subject to Bank’s security interest.

Answer 18

Bank’s security interest in inventory covers the wood that Acme uses to repair violins. “Inventory” includes “raw materials” that are consumed in the business of the debtor. Thus, Bank has a security interest in the wood as inventory.

Question 19

ISSUE: Does Bank’s security interest cover the Gambretti plane? ANSWER: No. The Gambretti plane is not included in Bank’s collateral.

Answer 19

The Gambretti plane that Acme uses to shape the violins it repairs is not “inventory” because it is not held for sale or lease by Acme and does not otherwise fit into the other categories of “inventory” under UCC § 9-102. Rather, the Gambretti plane is “equipment” and not covered by Bank’s security interest.

Question 20

ISSUE: Does Bank’s security interest cover the Red Rosa violin after its sale to the violinist? ANSWER: No. The Red Rosa violin was subject to Bank’s security interest prior to its sale, but the violinist was probably a buyer in ordinary course of business and therefore took the violin free of Bank’s security interest under UCC § 9-320.

Answer 20

Bank’s security interest in inventory covered the violin “Red Rosa” when it was held by Acme for sale. Furthermore, under UCC § 9-315, except as otherwise provided in Article 9 “a security interest continues in collateral notwithstanding sale unless the secured party authorized the disposition free of the security interest.”
Here, there are no facts to indicate that Bank authorized the disposition of Red Rosa free of its security interest. Nonetheless, the violinist’s interest in Red Rosa is likely to prevail over Bank’s security interest because the violinist probably qualifies as a “buyer in ordinary course of business.”
Under UCC § 9-320, “a buyer in ordinary course of business 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.” Under UCC § 1-201, a buyer in ordinary course of business is “a person that buys goods in good faith, without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person in the business of selling goods of that kind.”
Acme is in the business of selling rare violins like Red Rosa, and the violinist apparently bought Red Rosa in the ordinary course of Acme’s business. There are no facts to indicate that the purchase was in bad faith or irregular in any way. Although the violinist was aware of Bank’s security interest in Acme’s inventory, there was no indication that the sale to the violinist violated any of Bank’s rights. Thus, while the violinist was aware of the existence of the security interest, that knowledge does not disqualify the violinist as a buyer in ordinary course who takes free of a security interest. As a buyer in ordinary course of business, the violinist would take Red Rosa free of Bank’s security interest.

Question 21

ISSUE: Is Bank’s security interest superior to the interest of a judicial lien creditor in the same property? ANSWER: Yes. Bank’s security interest in its collateral was perfected; therefore, the security interest is superior to the rights of a judicial lien creditor that arose subsequently.

Answer 21

A security interest is subordinate to the rights of a person who becomes a lien creditor before the security interest is perfected. Thus, if Bank’s security interest was not perfected at the time that creditor obtained its judicial lien, the security interest would be subordinate to that lien. Bank’s security interest was perfected, however. A security interest is perfected when it has attached and the other elements of perfection have been satisfied. As described in Point One, Bank’s security interest in its collateral was attached. The filing of the financing statement was sufficient to perfect this attached security interest. Thus, both elements of perfection were satisfied and Bank’s security interest was perfected before the lien creditor obtained its lien. Therefore, the security interest is superior to the rights of the lien creditor.
 

Question 22

ISSUE: What is the nature of the bank’s claim to the business’s equipment? ANSWER: The bank has a perfected security interest in the business’s equipment.

Answer 22

The bank has met all criteria necessary for it to have an attached and enforceable security interest in the business’s equipment. First, value must be given. This criterion is fulfilled by the loan made by the bank to the business. Second, the debtor must have rights in the collateral. Clearly, the business has rights in its equipment. Third, either the secured party must take possession of the collateral or the debtor must authenticate a security agreement containing a description of the collateral. The agreement that the business owner signed is a “security agreement” because it is an agreement that creates or provides for a security interest. By signing the security agreement, the business owner authenticated it. Therefore, all three criteria are fulfilled, and the bank has an enforceable and attached security interest.
A security interest is perfected when it has attached and when any additional steps required for perfection have occurred. Generally speaking, the additional steps will either be possession of the collateral by the secured party or the filing of a financing statement with respect to the collateral. In this case, the bank filed a financing statement naming the debtor and sufficiently indicating the collateral. The collateral indication is sufficient because it identifies the collateral by type of property. The fact that the financing statement was filed before the security interest was created is not a problem. Even though the security agreement had not yet been signed, the business had authorized the filing of the financing statement in an authenticated record. Moreover, the financing statement may be filed before the security agreement is created.

Question 23

ISSUE: What is the nature of the finance company’s claim to the business’s equipment? ANSWER: The finance company also has a perfected security interest in the business’s equipment.

Answer 23

The finance company’s security interest is enforceable and attached for the same reasons as the bank’s security interest. The loan from the finance company to the business constitutes value, the business has rights in the collateral, and the business owner has authenticated a security agreement containing a description of the collateral. The finance company’s security interest is perfected because the finance company filed a financing statement with respect to it that provides that the business is the debtor and indicates that the collateral is equipment.

Question 24

ISSUE: As between the bank and the finance company, whose claim to the business’s equipment has priority? ANSWER: The bank’s security interest has priority over the finance company’s security interest because the bank’s financing statement was filed first.

Answer 24

As between two perfected security interests, the general rule is that the security interest that was the earlier to be either perfected or the subject of a filed financing statement has priority. While the finance company’s security interest was perfected before the bank’s (March 15 vs. March 22), the bank’s financing statement was filed even earlier, on March 2. Thus, under the first-to-file-or-perfect rule of UCC § 9-322, the bank’s security interest has priority. No exceptions to the general rule apply here.

Question 25

ISSUE: Do the claims of the bank and the finance company continue in the item of equipment sold by the business to the competitor? ANSWER: Yes. A security interest in collateral continues notwithstanding its sale unless an exception applies. Because the security interests of the bank and the finance company were perfected and the competitor was not a buyer in ordinary course of business, no exception applies and the security interests of both creditors continue in the equipment sold to the competitor.

Answer 25

As a general rule, a security interest in collateral continues notwithstanding the fact that the debtor has sold the collateral to another person. Thus, unless an exception applies, the security interests of the bank and the finance company will continue in the item of equipment sold to the competitor.
A buyer of goods will take free of an unperfected security interest in those goods. However, when the competitor bought the business’s equipment, both the bank and the finance company had perfected security interests in the equipment.
A buyer can take free even of a perfected security interest in goods if the buyer is a “buyer in ordinary course of business.” However, the competitor was not a buyer in ordinary course of business. To be a “buyer in ordinary course of business,” a buyer must buy goods from a seller that is in the business of selling goods of that kind. The competitor bought this equipment from a seller that is not in the business of selling goods of this kind, so the competitor was not a buyer in ordinary course of business with respect to these goods.
Because no exception applies, the security interests of the bank and the finance company continue even after the item of equipment was sold to the competitor.

Question 26

ISSUE: Is a purchase-money security interest in consumer goods perfected even though there has been no filing of a financing statement? ANSWER: Yes. The retailer’s security interest in the bicycles attached on June 1. Because this interest was a purchase-money security interest in consumer goods, it was automatically perfected when it attached.

Answer 26

The retailer’s security interest in the bicycles attached on June 1 when the man bought the bicycles (acquiring rights in the collateral), signed a security agreement containing a description of the collateral, and received value from the retailer (by being given credit with which to purchase the bicycles).
Despite the retailer’s failure to file a financing statement, its security interest was perfected. Pursuant to UCC § 9-309, a security interest is automatically perfected upon attachment if the goods are “consumer goods” and the security interest is a “purchase-money security interest.”
In this case, the bicycles sold by the retailer to the man were consumer goods at the time of sale. The bicycles were “goods” because they were “movable when a security interest attaches.” They were also consumer goods because they were “bought for use primarily for personal, family, or household purposes.”
The retailer’s security interest in these consumer goods was also a “purchase-money security interest.” A purchase-money security interest is an interest that secures a debt that was incurred in order to “enable the debtor to acquire rights in or the use of the collateral.” Here, the man incurred an obligation to the retailer to purchase the bicycles, so the security interest he gave the retailer to secure that obligation was a purchase-money security interest.
Because the retailer’s security interest was a purchase-money security interest in consumer goods, it was automatically perfected on June 1, when the interest attached to the bicycles.

Question 27

ISSUE: Does a person who buys consumer goods for personal use take those goods free of a prior perfected purchase-money security interest in the goods? ANSWER: Yes. The buyer took the bicycle free of the retailer’s security interest because (i) the retailer did not file a financing statement covering the bicycle, (ii) the bicycle was “consumer goods,” and (iii) the buyer bought the bicycle for value, without knowledge of the retailer’s security interest, and for personal use.

Answer 27

A security interest continues in collateral, even after a sale or other disposition of that collateral, unless the creditor authorized the disposition “free of the security interest” or another Article 9 exception applies.
However, a buyer of goods, like the buyer here, can take free of a prior security interest in those goods under certain circumstances. For example, under UCC § 9-317(b), buyers who give value and receive delivery of goods without knowledge of an unperfected security interest in the goods can take free of the prior security interest. Under UCC § 9-320, a buyer in ordinary course of business can take free of the prior security interest. In this case, the retailer’s security interest was perfected when the buyer purchased the bicycle, so UCC § 9-317 does not protect the buyer. The buyer also is not a protected “buyer in ordinary course of business” because he did not purchase from a person who is in the business of selling bicycles.
The buyer can, however, qualify for the protection of UCC § 9-320. That section provides that a buyer of goods from a person who used them for personal, family, or household purposes takes free of a perfected security interest in the goods if (1) the buyer had no knowledge of the security interest, (2) the buyer gave value for the goods, (3) the buyer purchased the goods primarily for personal, family, or household purposes, and (4) the purchase occurred before the filing of a financing statement covering the goods.
The buyer met all of these criteria. The man used the bicycle for personal purposes. The buyer purchased the bicycle from the man, and the buyer had no knowledge of the retailer’s security interest. The buyer gave value ($400) for the bicycle, and he bought it “primarily for personal, family, or household purposes,” as he planned to use it for recreation, which is a personal rather than a business use. Finally, no financing statement had been filed. Therefore, under UCC § 9-320, the buyer took free of the retailer’s security interest.

Question 28

ISSUE: Does a person who receives consumer goods as a gift take those goods subject to a prior perfected security interest in them? ANSWER: Yes. The retailer’s security interest continues in the bicycle that the man gave to the friend. Thus, the retailer can recover the bicycle from the friend because the friend did not give value for the bicycle or buy it in the ordinary course of business.

Answer 28

As noted in Point Two, the retailer did not authorize the man to dispose of the bicycle. Consequently, the retailer’s security interest continued in the bicycle even after the man transferred ownership of the bicycle to the friend. The retailer’s security interest in the bicycle will be effective against the friend unless some other provision of Article 9 allows the friend to take the bicycle free of that security interest.
Unfortunately for the friend, there is no Article 9 provision that allows him to take free of the retailer’s interest. The friend’s basic problem is that he is not a buyer of the bicycle – he received the bicycle as a gift and did not give value for it. Thus, the friend is not protected by any of the applicable exceptions, such as UCC § 9-317 which protects buyers who give value for goods subject to an unperfected security interest, or UCC § 9-320(a) which protects buyers in the ordinary course of business, or UCC § 9-320 which protects buyers of consumer goods who give value.
In short, the retailer’s security interest continues in the bicycle that the man gave to the friend. The friend took the bicycle subject to that security interest.
 

Question 29

ISSUE: What are the relative rights of a creditor with a perfected security interest in a debtor’s inventory and a buyer who bought an item of the inventory in ordinary course of business? ANSWER: Because Consumer was a buyer in ordinary course of business with respect to the bicycle, Consumer took the bicycle free of Bank’s security interest.

Answer 29

While a security interest in collateral generally continues in that collateral even after the collateral has been sold, that principle is subject to important exceptions. In particular, a buyer in ordinary course of business “takes free of a security interest” created by its seller “even if the security interest is perfected and the buyer knows of its existence.”
Here, Recycled sold the bicycle to Consumer. Consumer took free of Bank’s security interest – which was created by Recycled, its seller – if Consumer was a “buyer in ordinary course of business.” A buyer in ordinary course of business is “a person that buys goods in good faith, without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person in the business of selling goods of that kind.”
On these facts, Consumer is a buyer in ordinary course of business. First, Consumer bought the bicycle from Recycled, which is in the business of selling goods of the kind that Consumer bought – bicycles. Second, the sale occurred “in the ordinary course,” i.e., in the seller’s usual way. Third, Consumer acted honestly and in a manner consistent with reasonable commercial standards of fair dealing. Thus, Consumer acted in “good faith.” Finally, there are no facts to suggest that Consumer knew that the sale was in violation of Bank’s rights.
As a buyer in ordinary course of business, Consumer took the bicycle free of Bank’s security interest, and Bank’s security interest is extinguished.

Question 30

ISSUE: What are the relative rights of a creditor with a perfected security interest in a debtor’s inventory and a lien creditor of the debtor with respect to an item of equipment that the debtor received in exchange for an item of inventory? ANSWER: Although Bank’s security agreement does not cover the equipment of Recycled, the used computer, which is equipment, constitutes proceeds of the inventory of Recycled, and Bank’s security interest in the inventory extends to proceeds of the inventory. Because Bank’s interest was perfected before Utility became a lien creditor, Bank has a prior claim to the used computer.

Answer 30

The security agreement pursuant to which Bank obtained its perfected security interest covers only inventory. The used computer was not held by Recycled for sale or lease, so it is not inventory. Rather, it is equipment. Thus, it is not included in the description of collateral in the security agreement.
However, Recycled obtained the computer in exchange for a bicycle that was inventory (and, thus, collateral). Because the computer was “acquired upon the exchange of collateral,” the computer is “proceeds” of that collateral. A security interest in collateral extends to identifiable proceeds of that collateral. Thus, Bank has a security interest in the computer. In addition, the security interest in the computer as proceeds is perfected because the security interest in the original collateral (the bicycle) was perfected by the filing of a financing statement in the same office in which a financing statement would be filed in order to perfect a security interest in the computer.
Because Bank has a perfected security interest in the used computer as proceeds, it has priority over Utility’s later judgment lien.

Question 31

ISSUE: What are the relative rights of a creditor with a perfected security interest in a debtor’s inventory, a lien creditor of the debtor, and a supplier who has sold items of inventory to the debtor on credit, retaining title to the items, but has not filed a financing statement? ANSWER: Bank’s perfected security interest in the bicycle helmets is superior to Manufacturer’s unperfected security interest and to Utility’s later judgment lien. Manufacturer’s security interest is subordinate to Utility’s judgment lien.

Answer 31

While the contract with Manufacturer provides that Manufacturer retains title to the helmets until Recycled pays for them, the purported retention of “title” is limited in effect to retention of a “security interest.” Manufacturer’s security interest is not perfected because Manufacturer has not filed a financing statement, and there is no other basis for it to claim perfection of its security interest.
Bank has a security interest in the inventory of Recycled. Bank perfected that interest by filing a financing statement. Because the bicycle helmets are held for sale by Recycled, they are inventory and are subject to Bank’s security interest.
Bank’s security interest has priority over Manufacturer’s security interest because a perfected security interest has priority over an unperfected security interest.
Because Bank has a perfected security interest in the bicycle helmets, it has priority over Utility’s later judgment lien. However, Utility’s judgment lien has priority over Manufacturer’s security interest in the bicycle helmets because Manufacturer’s interest is unperfected.
[NOTE: An examinee might correctly note that Manufacturer’s security interest is a “purchase-money security interest.” That point is irrelevant to the answer, however. A perfected purchase-money security interest can, under proper circumstances, have priority over other security interests, but Manufacturer’s security interest was not perfected because no financing statement was filed and no other criterion for perfection has been satisfied. Thus, the general rule of UCC § 9-322 – a perfected security interest has priority over an unperfected security interest – determines the priority of the competing security interests in this case. An examinee might erroneously state that Manufacturer’s purchase-money security interest is automatically perfected without the need for filing pursuant to UCC § 9-309. This is incorrect, because only a purchase-money security interest in consumer goods qualifies for this special rule, and the helmets are “inventory” rather than “consumer goods.”]