Security Interests & Agreements

Question 1

Secured transactions involve transactions based on credit and are governed by UCC Art. 9.

How does it generally work?

Answer 1

One party (debtor) receives something from another party (creditor or secured party) without paying immediately.

To ensure debtor will pay eventually, debtor gives creditor rights to a piece of debtor’s property as collateral (i.e., a security interest)

• A security interest (SI) = right given to creditor in debtor’s property
  
  • Collateral = property in which creditor obtains rights.
    
    • Right allows creditor to take or sell property if the debtor fails to fulfill the credit obligation (i.e., debtor doesn’t pay creditor)
    • arrangement memorialized in a security agreement.

Question 2

Attaching & Perfecting SI

Answer 2

1) Attachment:

• process by which collateral is used to secure the creditor’s interest.
  
  • effect: once a SI attaches, creditor has a right to take the collateral if debtor defaults

2) Perfection:

• process by which creditor secures her rights in the collateral as it relates to third parties
  
  • arises where 3rd parties also have an interest in the same piece of collateral
  • creditor must perfect her SI to have a greater interest in the collateral over 3rd parties.

Question 3

Art. 9 Applicability & Exceptions

Answer 3

UCC Art. 9 applies to any transaction intended to create a SI in property or fixtures.

Exceptions: Art. does not apply to certain transactions, notably:

1) transactions governed by fed., state, or foreign law
2) most real property transactions involving interests or liens on land (i.e., does not apply to mortgages on real property)
3) assignment of tort claims (except with respect to proceeds and priority in proceeds from tort claims)
4) assignment of claims for wages

Question 4

Secured Transactions vs. Contracts

Answer 4

K law and UCC A2 are about rules governing transactions of goods and services

Secured transaction and UCC A9 are about protecting or securing the exchange of goods or services, not rules governing how one can make such an exchange.

Question 5

Identifying & Classifying Collateral

Answer 5

Classifying the type of collateral involved in a transaction is important in determining how it’s secured.

The main categorizations are as follows:

1) Tangible Goods – 4 Types:
i) Farming Goods: items used/prodduced in farming (e.g., crops)
ii) Consumer Goods: items used for personal, household purposes
iii) Inventory: goods kept for sale or lease
iv) Equipment: catchall for tangible items that do not fit above (e.g., tractors, factor equipment, etc.)
2) Intangible Goods: most common of many types:
i) Instruments: writing representing the right to be paid money (e.g., promissory notes, checks, etc.)
ii) Documents: writing representing the right to receive goods (e.g, bills of lading, receipts, etc.)
iii) Chattel Paper: record evidencing an obligation and SI in goods or a lease of goods (e.g., a promissory note and security agreement)
iv) Accounts: a right to payment not evidenced by an instrument or chattel (i.e., accounts receivable)

• e.g., money owed to a dentist after seeing a patient
• does not include deposit accounts, investment property, or commercial tort claims

v) General Intangibles: e.g., patent rights, software, copyrights

Question 6

Consignment

Answer 6

Consignments may fall within the scope of A9. If so, the consignor’s security interest in the consigned goods is treated as a purchase-money security interest (PMSI) in inventory.

Consignments are transactions where an owner of goods/consignor (e.g., manufacturer or wholesaler) delivers goods to a merchant (consignee) for the purpose of sale.

Consignments as SI: consignment can be considered a SI if inventory consignee is selling on consignment is difficult to distinguish from inventory consignee actually owns:

• i.e., where consignee/merchant owns inventory that be could be mistaken by a creditor of consignee for similar inventory that is on consignment (i.e., ownded by consignor), the consignment is considered a SI and consignor must comply with A9 to give notice to consignee’s creditors.

Question 7

In order for a consignment to be subject to A9, the following requirements must be met:

Answer 7

1. A person (i.e., the consignor) must deliver goods to a merchant for the merchant to sell;
   2) The merchant (i.e., the consignee) must:
   a) Deal in goods of that kind,
   b) Not operate under the name of the consignor,
   c) Not be generally known by its creditors to be substantially engaged in selling the goods of others, and
   d) Not be an auctioneer;
   3) With respect to each delivery, the value of the goods delivered must be at least $1,000 at the time of the delivery; and
   4) The goods must not be consumer goods immediately before the delivery.

Question 8

Creation of SIs & Requirements for Attachment

Answer 8

SIs are created by security agreement (a contract) b/w debtor and creditor, which must be:

• in writing
• describe the collateral, and
• signed by the debtor.

Once SI attaches, it is secured, meaning creditor has a right to take the collateral if debtor defaults.

3 Requirements for Attachment:

1) Valid Security Agreement: an agreement which memorilizes SI
- may be evidenced by authenticated security agreement or creditor’s possession or control of collateral
- Authenticated SA: record authenticated by debtor that describes collateral

• Signing, initialing, etc. is adequate proof of authentication
• agreement must reasonably identify collateral

2) Value: secured party (i.e., creditor) must give value to create a SI
- e.g., creditor loans debtor money or delivers equipment in exchange for SI
- almost any consideration is sufficient.
3) Rights in the Collateral: debtor must have rights in property he offers as collateral
* ownership or possessory interest is usually sufficient.

Question 9

• After-aquired property*
• Future Advances*
• Specification Clauses*

Answer 9

UCC A9 generally gives discretion to parties to create their own terms regarding SAs.

1. After-aquired Property:
   a) SAs may include provies that give the SP/Creditor a SI in property aquired by debtor using funds loaned pursuant to the SA
   * e.g., L loans $5k to D, secured by attachment of D’s gold watch as collateral; the SA includes an AAP clause; L will have a SI in the gold watch, as well as property D acquires using the $5k.
2. Future Advances:
   a) SAs may contemplate future loans/advances from creditor to debtor based on D’s present collateral or collateral to be aquired in the future.

• in such cases, a new SA is not required
• e.g., L loans $2k to D secured by inventory in D’s business; the SA provides for future advances; D may get additional loans in the future from L.

3) Specification clauses:
a) Parties may include clauses specifying terms and/or creating provisions for potential events.
* e.g., parties may define what constitutes a default, may provide for acceleration of payments upon the happening of a certain event (e.g., one missed payment), etc.

Question 10

Attachment Rule Statement

Answer 10

A security interest that is enforceable against the debtor with respect to the collateral is said to have attached to the collateral.

In order to be enforceable, the secured party must: (i) give value, (ii) the debtor must have rights in the collateral, and (iii) the debtor has to either authenticate a security agreement that describes the collateral or have possession or control of the collateral.

OR… For attachment, three conditions must be met:

(i) value must be given by the secured party;
(ii) the debtor has rights in the collateral; and
(iii) the debtor authenticated a security agreement that describes the collateral (or the secured party has possession or control of the collateral pursuant to a security agreement).

The security interest can attach to collateral that the debtor acquires in the future.

• Collateral that is tangible includes goods, which are anything that can be moved when the security interest attaches.
• Equipment is anything that is not consumer goods, farm products, or inventory.

Question 11

A SI is perfected when:

Answer 11

Perfection of a security interest is necessary for the secured party to have a superior right in the collateral.

• A security interest is perfected when the collateral attaches and the secured party complies with one of the methods of perfection.
• • Those methods include:
    
    • filing a financing statement,
    • having possession or control of the collateral, OR
    • it can be automatically perfected.

Question 12

PRIORITY

Perfected vs. Perfected

Answer 12

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.

• If both security interests are perfected, then priority dates from the time of filing or perfection, whichever occurs first.

Question 13

Purchase Money Security Interest (PMSI)

(example of PMSI - Essay 2 - bank vs. manufacturer)

Answer 13

A “PMSI” is a special type of security interest that has different rules regarding perfection and priority.

• A PMSI in goods exists when a SP sold goods to the debtor and the debtor incurs an obligation to pay the SP all or part of the purchase price.

*** PMSI in goods other than inventory or livestock prevails over all other security interests in the collateral, even if they were previously perfected, if the security interest is perfected when the debtor receives possession of the collateral or within 20 days.***

OR…A PMSI is a special type of security interest in goods that has priority over other security interests in the same goods.

• It arises when a creditor sells goods to a debtor on credit and retains a security interest in those goods, or the creditor advances funds, which are then used to purchase the goods and the creditor reserves a security interest in those goods.

Question 14

Does a true lease of goods create a SI?

When does a transaction in the form of a lease create a SI?

(example of PMSI - Essay 2 - bank vs. manufacturer)

Answer 14

NO.

A true lease of goods does not create a security interest.

However, a transaction that appears to be in the form of a lease may actually be a secured transaction, creating a security interest.

A transaction in the form of a lease is treated as creating a SI if (i) the lessee must pay consideration to the lessor for the right to possess and use the goods for the term of the lease, (ii) the payment obligation cannot be terminated by the lessee, and (iii) one of the following four conditions is also met:

i) The original term of the lease is equal to or greater than the remaining economic life of the goods;
ii) The lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become owner of the goods;
iii) The lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement; or
iv) The lessee has an option to become the owner of the goods, for no additional consideration or nominal additional consideration, upon completion of the lease agreement.

Question 15

Perfection of SIs

Answer 15

A single piece of the D’s property may be attached as collateral to different SIs, in which case there will be numerous SIs in a single piece of collateral; perfection determines priority of the interests.

• i.e., once a SI is attached it is enforceable, but it must be perfected in order to give its holder (creditor) priority over other potential SIs to which collateral may be attached

Methods of Perfection:

1. filing
2. Taking possession (or control if not tangible, i.e., chattel paper)
3. Automatic perfection (PMSI)

Significance of Perfection:

1) a perfected SI has maximum priority over collateral as compared to other unperfected SIs in that collateral
* Perfected a SI creates a record of C’s SA that other potential Cs can see.

Attachment as a prerequisite:

1) attachment is a prerequisite for perfection…if collateral does not attach to a SI, it cannot be perfected

Question 16

6 Part, Step-by-step guide to approaching ST questions

Answer 16

Step 1—Determine that you have a secured transactions problem.

• (Trigger words = security agreement and/or security interest)

Step 2 – Identify and classify the property at issue.

• (Hint: Look at the call of the question.)

Step 3—Determine which parties have or claim an interest in the collateral.

Step 4—At least one will be a secured party with a security interest.

• For each security interest, assess:
  1. Attachment: Has that security interest attached? To which collateral? When?
  2. Perfection: Has the secured party perfected its security interest? When? How? Has anything happened that might cause the secured party to lose perfection?

Step 5—Use this information to find the appropriate priority rule.

Step 6—Apply the priority rule to the facts and resolve the dispute.

Question 17

Goods

Answer 17

Anything movable at the time a SI attaches

Also includes some collateral that is not technically “moveable”:

• fixtures
• standing timber
• unborn animals
• growing or unharvested crops
• manufactured homes

Question 18

What are the four mutually exclusive sub-categories of goods?

Answer 18

mnemonic: _C_hampion _G_ecko _F_acing _P_oodles; _I_guanas _E_scaped
1. Consumer Goods

• ​goods acquired primarily for personal, family use, or household purposes.
• e.g., electronics, furniture, boats, and home appliances.

2. Farm Products

• crops, livestock, supplies used (e.g., animal feed, fertilizer) or produced (e.g., eggs, vegetables) in farming operations.
• NOT FARM PRODUCTS: Farming Equipment (tractors, combines).

3. Inventory

• goods that are not farm products that are held for sale or lease (items on the shelf)
• also includes goods that are furnished under a service contract, raw materials, works in progress, or materials used or consumed in business.

4. Equipment

• defined as goods that don’t fit into any of the other definitions
• e.g., machinery, delivery vans, office equipment, and farm equipment.

Question 19

Can classification of goods change?

Answer 19

YES.

As collateral passes from debtor to debtor, or the principle use changes, the classification of a piece of collateral can change.

Example**: Beets on a farm are **farm products. But when they are purchased by a grocery store and held for sale, they are inventory. If you buy the beets and take them home, they are consumer goods.

Question 20

Four Types of Rights to Payment

Answer 20

1. Instrument:
   * promissory notes, checks, and drafts governed by UCC Article 3
2. Chattel Paper:
   * A record (paper or electronic) with two components
   i) a monetary obligation, and
   ii) a SI or a lease
   * Example: If an A9 secured transaction contract is used as collateral for a different loan, that would qualify as chattel paper; similarly, if your landlord uses your apartment lease as collateral for the loan, that would be chattel paper.
3. Accounts
   * A right to paymen tof a monetary obligation for property that is sold, leased, or licensed, or for services rendered (includes a company’s accounts receivable, the right to be paid under insurance policies, and amounts owing on credit cards).
4. Payment intangible
   * Our “catch-all” of rights to payment. (Caution: “Accounts” is very broad!)
   * Example: A right to be repaid a loan of money that does not itself qualify as an instrument or chattel paper is a payment intangible. (“Accounts” does not include rights to be repaid loans of money.)

Exam Tip: When classifying rights to payment, start first by determining whether it is chattel paper or instruments because those are the easiest to spot.

• If the collateral is neither of those, chances are it is going to be an account. But, accounts don’t encompass the right to be repaid a loan of money.
• So if you have a loan of money, and you are sure it is not chattel paper or an instrument, then and only then consider payment intangibles.

Question 21

Landlord leases property to lessee. Landlord gives Lender a security interest in Landlord’s rights under the lease. The collateral is ____________________________________ because it is a right to be paid under a lease.

Answer 21

Chattel Paper

Question 22

A landscaper gets a loan from bank and grants bank a security interest in her right to receive payment from clients for landscaping work.

The right to receive payment for landscaping work is probably an __________________because it is a right to be repaid for services rendered.

Answer 22

Account

Question 23

1. Blunder Muffin Paper Company gets a loan from a bank and pledges as collateral its rights to be paid for the paper it has sold on credit.

This could also qualify as an __________________ as it is a right to be repaid for goods sold.

2. But imagine if Blunder Muffin’s form agreement (used when paper are sold on credit) provides that the store retains a security interest in the paper sold until the buyer repays the purchase price.

These contracts, when used as collateral for the loan, are classified ________________________because the contracts include a right to payment plus a security interest.

Answer 23

1. Account
2. Chattel Paper

Question 24

1. A business loans money to many parties and holds numerous promissory notes that represent borrowers’ obligations to repay.
   * If the business then uses those promissory notes as collateral for a loan, the notes are classified as __________________.
2. Same facts as above, except that borrowers’ obligations were not represented by promissory notes. The business has no security interests in the borrowers’ property to secure these obligations.
   * If business uses these rights to payment as collateral for a loan from lender, then the collateral does not meet the definition of accounts, chattel paper, or Instruments. The collateral is classified as ____________________________________.

Answer 24

1. Instruments.
2. Payment Intangibles

Question 25

A consumer buyer is a person who:

Answer 25

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 26

Collateral - Property subject to the SI

Tangible Goods

Answer 26

1. Tangible Goods:
   * Goods—anything that is moveable at time that the SI attaches. The debtor’s principal use at the time the SI attaches determines the class of the goods
   i) Consumer goods—goods acquired primarily for personal, family, or household purposes
   ii) Farm products—goods that are crops or livestock and include supplies that are used or produced in farming
   iii) Inventory—goods, other than farm products, held for sale or lease; are furnished under a service contract; or consist of raw materials, works in process, or materials used or consumed in a business; usually refers to goods that are consumed in a business (e.g., fuel)
   iv) Equipment—catchall class; consists of goods that are not consumer goods, farm products, or inventory
   * Software—software embedded in goods is treated as part of goods in which it is embedded; software not embedded in goods is treated as a general intangible.

Question 27

Collateral - Property subject to the SI

Other Collateral

Answer 27

1. Other collateral—classification is determined without reference to the debtor’s use

A. Chattel paper—one or more records that evidence both

(i) a monetary obligation and
(ii) a security interest in specific goods or a lease of specific goods

B. Document—a document of title, which confers on the holder ownership rights in goods held by a bailee

C. Instruments—encompasses both negotiable and nonnegotiable instruments

D. Investment property—includes both certificated and uncertificated securities, as well as securities accounts

E. Accounts—the right to payment for property sold, leased, or licensed, or services rendered

F. Commercial tort claims—excludes tort claims by an individual for personal injury or death

G. Deposit accounts

H. Letter-of-credit right

I. General Intangibles: a residual category (e.g., copyrights)

Question 28

Eligible Transactions

Answer 28

1. General rule—Art. 9 governs a transaction that creates an SI in personal property or a fixture
2. Leases—covered under Art. 9 when the transaction, although in the form of a lease, is in substance a secured transaction
3. Consignments—if subject to Art. 9, the consignor’s SI in the consigned goods is treated as a PMSI in inventory
4. Liens—generally not generally subject to Art. 9
5. Agricultural liens—unlike other liens, generally subject to Art. 9
6. Purchases—generally, the sale of personal property is not subject to Art. 9
7. Real property transactions—not generally subject to Art. 9; but can apply to an SI in a secured obligation (e.g., a promissory note) even though the obligation is itself secured by a transaction or interest to which Article 9 does not apply (e.g., a real property mortgage)

Question 29

Security Agreement must satisfy the STATUTE OF FRAUDS

• authenticated record*
• possession of collateral*
• control of collateral*

Answer 29

1. Authenticated record—the security agreement must
   (i) be in a record;
   (ii) contain a description of the collateral; and
   (iii) be authenticated by the debtor

The description can list specific items or can identify the Art. 9 type of collateral (“all debtor’s equipment) unless the collateral is consumer goods or a commercial tort claim; a super-generic description (“all debtor’s assets”) is not sufficient.

An original authenticated security agreement can serve as a new debtor’s authenticated security agreement (i.e., the new debtor need not execute another agreement) by operation of law or by contract.

2. Possession of Collateral
   * can satisfy the SoF; the secured party’s possession must be pursuant to the security agreement
3. Control of the collateral
   * can satisfy the SoF; the secured party’s control must be pursuant to the security agreement

Question 30

After-acquired collateral

Answer 30

1. General rule—the SI may cover collateral owned when the security is granted and also collateral that the debtor acquires after the SI is given
2. Exceptions—an after-acquired clause is not effective for consumer goods, unless:
   i) the debtor acquires them within 10 days after the secured party gives value, or
   ii) a commercial tort claim.

Question 31

Rights and Duties of the SP

Answer 31

1. Duties arising from the SP’s possession or control of collateral—
   i) duty of care;
   ii) duty to keep collateral identifiable;
   iii) duty to relinquish possession or control of collateral

2. Rights and Risks arising from the SP’s possession or control of collateral—

i) right to charge for reasonable expenses;
ii) risk of loss or damage is on the debtor;
iiii) right to use or operate collateral;
iv) right to hold proceeds
3. Assignment of account rights—
* if the debtor assigns his right to receive payment from the account debtor to the SP , the SP may notify the account debtor to pay the SP; upon receipt of notification, the account debtor may discharge her obligation only by paying the assignee.

Question 32

Rights of the debtor

Answer 32

1. Accounting and other information from the secured party
2. Notification of account debtors by secured party—when account debtors are no longer required to make payments to the secured party

Question 33

Purchase-money security interest

PMSI in goods exists when:

Answer 33

1. PMSI in goods—exists when:
   i) A secured party gave value to the debtor and the debtor used the value to incur an obligation that enabled the debtor to acquire goods; OR
   ii) A secured party sold goods to the debtor, and the debtor incurred an obligation to pay the secured party all or part of the purchase price.
2. PMSI in software—exists only when:
   i) the debtor acquired his interest in software in an integrated transaction in which the debtor also acquired an interest in goods (e.g., a computer), AND
   ii) the debtor acquired that interest in the software for the principal purpose of using the software in the goods

Question 34

Accessions

Answer 34

1. Accessions—goods that are physically united with other goods such that the identity of the original goods is not lost
   i) SI created in collateral that becomes an accession—not lost due to the collateral becoming an accession;
   ii) also, an SI can be created in collateral that is an accession.

Question 35

Commingled Goods

Answer 35

1. Commingled goods—goods that are physically united with other goods such that their identity is lost in a product or mass
   i) No SI in specific goods that have been commingled—but an SI may attach to the product or mass that results when the goods are commingled
   ii) Existing SI in collateral that subsequently becomes commingled goods—the SI is transferred to the resulting product or mass