Business Law Chapter 27

The priority of the claims is determined according to

(1) whether the claim is unsecured or secured and (2) the time at which secured claims were attached or perfected. The UCC establishes rules for determining priority of claims of creditors

default

(Article 9 of the UCC defines the rights, duties, and remedies of the secured party and the debtor in the event of default.) The term default is not defined. Instead, the parties are free to define it in their security agreement. Events such as failing to make scheduled payments when due, bankruptcy of the debtor, breach of the warranty of ownership as to the collateral, and other such events are commonly defined in security agreements as default. (On default by a debtor, the secured party may reduce a claim to judgment, foreclose, or otherwise enforce a security interest by any available judicial procedure [Revised UCC 9-601(a)])

(Case 27.2 STATE COURT CASE Deficiency Judgment) John Deere Construction & Forestry Co. v. Parham

(Deere repossessed the Dozer, and after notifying Parham of his redemption rights, which he did not exercise, sold the Dozer for $40,000. Deere filed a deficiency action, seeking to recover from Parham the remaining balance due. Deere filed a motion for summary judgment. Parham also filed a motion for summary judgment, arguing that it had not been given proper notice of the sale as required by the state Retail Installment Act that applied to sales of goods for personal, family, or household use. The trial court held in favor of Parham. Deere appealed.) The court of appeals reversed the grant of summary judgment to Parham. Thus, Deere can proceed to recover the deficiency judgment from Parham.

UCC rules for establishing priority of claims are as follows:

1-Secured versus unsecured claims. (A creditor who has the only secured interest in the debtor's collateral has priority over unsecured interests.) 2-Competing unperfected security interests. (If two or more secured parties claim an interest in the same collateral but neither has a perfected claim, the first to attach has priority [Revised UCC 9-322(a)(3)].) 3-Perfected versus unperfected claims. (If two or more secured parties claim an interest in the same collateral but only one has perfected a security interest, the perfected security interest has priority [Revised UCC 9-322(a)(2)].) 4- Competing perfected security interests. (If two or more secured parties have perfected security interests in the same collateral, the first to perfect (e.g., by filing a financing statement, by taking possession of the collateral) has priority [Revised UCC 9-322(a)(1)].) 5-Perfected secured claims in fungible, commingled goods. (If a security interest in goods is perfected but the goods are later commingled with other goods in which there are also perfected security interests and the goods become part of a product or mass and lose their identity, the security interests rank equal and according to the ratio that the original cost of goods of each security interest bears to the cost of the total product or mass [Revised UCC 9-336].)

Perfection by Filing a Financing Statement

A creditor filing a financing statement in the appropriate government office is the most common method of perfecting a creditor's security interest in collateral [Revised UCC 9-501]. The person who files the financing statement should request the filing officer to note on his or her copy of the document the file number, date, and hour of filing. (To be enforceable, a financing statement must contain the name of the debtor, the name and address of the secured party or a representative of the secured party, and the collateral covered by the financing statement [Revised UCC 9-502(a)]. The secured party can file the security agreement as a financing statement. A financing statement that provides only the debtor's trade name does not provide the name of the debtor sufficiently [Revised UCC 9-503(c)].)

Perfection by a Purchase Money Security Interest in Consumer Goods

A creditor who extends credit to a consumer to purchase a consumer good under a written security agreement obtains a purchase money security interest in the consumer good. (The agreement automatically perfects the creditor's security interest at the time of the sale Example Marcia buys a $1,500 television for her home on credit extended by the seller, Television Store. Television Store requires Marcia to sign a security agreement. Television Store has a purchase money security interest in the television that is automatically perfected at the time of the credit sale.)

future advances

A debtor may establish a continuing or revolving line of credit at a bank. Certain personal property of the debtor is designated as collateral for future loans from the line of credit. A maximum limit that the debtor may borrow is set, but the debtor can draw against the line of credit at any time. (Any future advances made against the line of credit are subject to the security interest in the collateral. A new security agreement does not have to be executed each time a future advance is taken against the line of credit [Revised UCC 9-204(c)].) (Example A technology company establishes a $1 million line of credit at a bank and pledges its patents as security for loans taken against the line of credit. The company borrows $600,000 against the line of credit. The loan is secured by the patents. The technology company pays back the $600,000. Subsequently, the company borrows $500,000 against the line of credit. This loan is secured by the patents.)

floating lien

A floating lien can attach to after-acquired property, sale proceeds, and future advances A security agreement may provide that the security interest attaches to property that was not originally in the possession of the debtor when the agreement was executed.

Secured party

A person in whose favor a security interest is created or provided under a security agreement [Revised UCC 9-102(a)(72)]. (Example In the previous example, the John Deere retail dealer is the secured creditor. The secured party can be the seller (e.g., the John Deere retail dealer), another lender (e.g., a bank), or buyer of accounts (e.g., an investor who purchases the security interest).)

Debtor—

A person who has an ownership or other interest in the collateral and owes payment of a secured obligation [Revised UCC 9-102(a)(28)]. (Example A farmer who purchases a large John Deere tractor from a retail dealer on credit and gives the secured creditor an interest in the collateral is the debtor.)

collateral

A security interest may be given in various types of personal property that becomes collateral for the loan. This includes tangible personal property and intangible personal property [Revised UCC 9-102(a)(12)].

three-party secured transaction.

A three-party secured transaction arises when a seller sells goods to a buyer who has obtained financing from a third-party lender (e.g., a bank) and the third-party lender takes a security interest in the good (Example A business purchases an airplane from an airplane manufacturer. The business obtains a loan to purchase the airplane from a bank, which obtains a security interest in the airplane. The airplane manufacturer is paid for the airplane out of the proceeds of the loan. This is a three-party secured transaction. The airplane manufacturer is the seller, the purchasing business is the buyer-debtor, and the bank is the lender-secured creditor.)

UCC Financing Statement (Form UCC-1)

A uniform financing statement form, used in all states [Revised UCC 9-521(a)]. A financing statement can be filed electronically using a state's e-filing system [Revised UCC 9-102(a)(18)].

repossession

After repossessing the goods, the secured party can either (1) retain the collateral, or (2) sell, lease, license, or otherwise dispose of it and satisfy the debt from the proceeds of the sale or disposition. There is one caveat: The secured party must act in good faith, with commercial reasonableness, and with reasonable care to preserve the collateral in the party's possession [Revised UCC 9-603, 9-610(a), 9-620]. (Example Western Drilling, Inc. purchases a piece of oil-drilling equipment on credit from Halliburton, Inc. Halliburton files a financing statement covering its security interest in the equipment. If Western Drilling fails to make the required payments, Halliburton can foreclose on its lien and repossess the equipment.)

tangible personal property

All things that are movable when a security interest attaches can be used as collateral for a secured transaction Accessions( are goods that are physically united with other goods in such a manner that the identity of the original goods is not lost [Revised UCC 9-102(a)(1)].) (Example A GPS system that is installed in an automobile.) Consumer goods (bought or used primarily for personal, family, or household purposes [Revised UCC 9-102(a)(23)]. Examples Household televisions, computers, electronic devices, furniture, and furnishings.) Equipment( bought or used primarily for business [Revised UCC 9-102(a)(33)]. Examples Business trucks, moving cranes, and assembly line equipment.) Farm products,( including crops, aquatic goods, livestock, and supplies produced in farming operations [Revised UCC 9-102(a)(34)]. Examples Wheat, fish, cattle, milk, apples, and unborn calves.) Inventory (held for sale or lease, including work in progress and materials [Revised UCC 9-102(a)(48)]. Example Raw materials used in production of goods)

intangible personal property

All things that are nonphysical personal property when a security interest attaches Accounts (that include a right to payment of a monetary obligation for personal or real property sold or leased, services rendered, and policies of insurance [Revised UCC 9-102(a)(1)]. Chattel paper, (which is a record that evidences both a monetary obligation and a security interest in specific goods [Revised UCC 9-102(a)(11)]. Tangible chattel paper is inscribed on a tangible medium [Revised UCC 9-102(a)(78)]. Electronic chattel paper is evidenced by information stored in an electronic medium [Revised UCC 9-102(a)(31)].) Deposit accounts ([Revised UCC 9-102(a)(29)]. Examples Demand, time, savings, passbook, or similar accounts maintained at banks and other financial institutions.) General intangibles ( [Revised UCC 9-102(a)(42)]. Examples Patents, copyrights, royalties, and the like.) Instruments ( [Revised UCC 9-102(a)(47)]. Examples Negotiable instruments such as checks and notes, stocks, bonds, and other investment securities [Revised UCC 9-102(a)]. Revised Article 9 of the UCC does not apply to transactions involving real estate mortgages, landlord's liens, artisan's or mechanic's liens, liens on wages, judicial liens, and the like. These types of liens are usually covered by other laws.)

Security agreement

An agreement that creates or provides for a security interest [Revised UCC 9-102(a)(73)]. (Example In the prior example, when the farmer purchased the John Deere tractor from the retail dealer on credit, the retail dealer may require, as a condition of the sale, that the farmer sign a security agreement giving the retail dealer a secured interest in the tractor. If this is done and the farmer defaults on the payments, the John Deere retail dealer can foreclose on its security agreement and recover the tractor.)

Security interest

An interest in the collateral, such as personal property or fixtures, that secures payment or performance of an obligation [UCC 1-201(b)(35)]. (Example In the previous example, the debtor-farmer gave the retail dealer-secured creditor a security interest in the John Deere tractor.)

two-party secured transaction

Such transactions occur, for example, when a seller sells goods to a buyer on credit and retains a security interest in the goods. (Example A farmer purchases equipment on credit from a farm equipment dealer. The dealer retains a security interest in the farm equipment that becomes collateral for the loan. This is a two-party secured transaction. The farmer is the buyer-debtor and the farm equipment dealer is the seller-lender-secured creditor.)

artisan's lien ( super-priority liens. An artisan's lien is possessory; that is, the artisan must be in possession of the property to effect an artisan's lien.)

If a worker in the ordinary course of business furnishes services or materials to someone with respect to goods and receives a lien on the goods by statute prevails over all other security interests in the goods unless a statutory lien provides otherwise. (Example Janice borrows money from First Bank to purchase an automobile. First Bank has a purchase money security interest in the car and files a financing statement. The automobile is involved in an accident, and Janice takes the car to Joe's Repair Shop (Joe's) to be repaired. Joe's retains an artisan's lien on the car for the amount of the repair work. When the repair work is completed, Janice refuses to pay. She also defaults on her payments to First Bank. If the car is sold to satisfy the liens, the artisan's lien is paid in full from the proceeds before First Bank is paid anything.)

secured credit

In some credit transactions, particularly those involving large or expensive items, a creditor may agree to extend credit only if the purchaser pledges some personal property as collateral for the loan. This is called secured credit. If the debtor defaults on the loan, the creditor may seek to recover the collateral under a lawful foreclosure action.

retain the collateral

In the event of a debtor's default, a secured creditor who repossesses collateral may propose to retain the collateral in satisfaction of the debtor's obligation. Notice of the proposal must be sent to the debtor unless the debtor has signed a written statement renouncing this right. In the case of consumer goods, no other notice need be given [Revised UCC 9-620(a)].

dispose of the collateral

In the event of a debtor's default, a secured party who chooses not to retain the collateral may sell, lease, or otherwise dispose of the collateral in its current condition or following any commercially reasonable preparation or processing. Disposition of collateral may be by public or private proceeding. The method, manner, time, place, and terms of the disposition must be commercially reasonable [Revised UCC 9-610]. (The secured party must notify the debtor in writing about the time and place of any public or private sale or any other intended disposition of the collateral unless the debtor has signed a statement renouncing or modifying the rights to receive such notice. In the case of consumer goods, no other notification need be sent. The proceeds from a sale, a lease, or another disposition are applied to pay reasonable costs and expenses, satisfy the balance of the indebtedness, and pay subordinate (junior) security interests. The debtor is entitled to receive any surplus that remains [Revised UCC 9-608].)

right of redemption

In the event of a debtor's default, the debtor or another secured party may redeem the collateral before the priority lienholder has disposed of it, entered into a contract to dispose of it, or discharged the debtor's obligation by having exercised a right to retain the collateral. may be accomplished by payment of all obligations secured by the collateral, all expenses reasonably incurred by the secured party in retaking and holding the collateral, and any attorneys' fees and other legal expenses provided for in the security agreement and not prohibited by law [Revised UCC 9-623].

after-acquired property

Many security agreements contain a clause that gives the secured party a security interest in after-acquired property of the debtor. After-acquired property is property that the debtor acquires after the security agreement is executed [Revised UCC 9-204(a)]. (Example Manufacturing Corporation borrows $100,000 from First Bank and gives the bank a security interest in both its current and after-acquired inventory. If Manufacturing Corporation defaults on its loan to First Bank, the bank can claim any available original inventory as well as enough after-acquired inventory to satisfy its secured claim.)

perfection by possession of collateral

No financing statement has to be filed if the creditor has physical possession of the collateral. (The rationale behind this rule is that if someone other than the debtor is in possession of the property, a potential creditor is on notice that another may claim an interest in the debtor's property. A secured creditor who holds the debtor's property as collateral must use reasonable care in its custody and preservation [Revised UCC 9-310, 9-312(b), 9-313]. Example Karen borrows $3,000 from Alan and gives her motorcycle to him as security for the loan. Alan does not file a financing statement. Another creditor obtains a judgment against Karen. This creditor cannot recover the motorcycle from Alan. Even though Alan has not filed a financing statement, his security interest in the motorcycle is perfected because he has possession of the motorcycle)

personal property

Tangible personal property includes equipment, vehicles, furniture, computers, clothing, jewelry, and the like. Intangible personal property includes securities, patents, trademarks, and copyrights. (often sold on credit. This means the purchaser-debtor borrows money from a lender-creditor to purchase the personal property. Sometimes a lender extends unsecured credit to a debtor to purchase personal property. In this case, the creditor takes no interest in any collateral to secure the loan but bases the decision to extend credit on the credit standing of the debtor. If the debtor defaults on the loan, the creditor must sue the debtor to try to recover the unpaid loan amount.)

buyer in the ordinary course of business

purchases goods from a merchant takes the goods free of any perfected or unperfected security interest in the merchant's inventory, even if the buyer knows of the existence of the security interest. ( rule is necessary because buyers would be reluctant to purchase goods if a merchant's creditors could recover the goods if the merchant defaulted on loans owed to secured creditors [Revised UCC 9-320(a), UCC 1-201(9)]) a person who buys goods in good faith, without knowledge that the sale violates the rights of another person in the goods. The buyer purchases the goods in the ordinary course from a person in the business of selling goods of that kind.

State law specifies where a financing statement must be filed.

secretary of state or the county recorder's office in the county of the debtor's residence or, if the debtor is not a resident of the state, in the county where the goods are kept or in another county office or both. ( Most states require financing statements covering farm equipment, farm products, accounts, and consumer goods to be filed with the county clerk [Revised UCC 9-501].) (Financing statements are available for review by the public. They serve as constructive notice to the world that a creditor claims an interest in a property. Financing statements are effective for 5 years from the date of filing [Revised UCC 9-515(a)].)

secured party

the seller, lender, or other party in whose favor there is a security interest. If the debtor defaults and does not repay the loan, generally the secured party can foreclose and recover the collateral.

Financing statement

—The record of an initial financing statement or filed record relating to the initial financing statement [Revised UCC 9-102(a)(39)]. This is Form UCC 1 (UCC Financing Statement). The financing statement is usually filed with the appropriate state office to give public notice of the secured party's security interest in the collateral. (Example In the previous example, if the retail dealer (the secured creditor) files a financing statement, it has given public notice of its secured interest in the collateral, the John Deere tractor.)

Collateral—

The property that is subject to a security agreement [Revised UCC 9-102(a)(12)]. (Example In the previous example, the John Deere tractor is the collateral for the security agreement.)

Pankratz Implement Company v. Citizens National Bank (Case 27.1 STATE COURT CASE Filing a Financing Statement)

The supreme court of Kansas held that the misspelling of the debtor's name misled creditors and was therefore ineffectual in giving CNB notice of Pankratz's security interest in the tractor. The state supreme court affirmed the court of appeals judgment in CNB's favor.

taking possession of the collateral

This taking is usually done by repossession of the goods from the defaulting debtor. A secured party may repossess the collateral pursuant to judicial process or without judicial process if the self-help repossession of the collateral does not breach the peace [Revised UCC 9-609(b)].

deficiency judgment

Unless otherwise agreed, after a debtor's default, if the proceeds from the disposition of collateral are not sufficient to satisfy the debt to the secured party, the debtor is personally liable to the secured party for the payment of the deficiency. (Example Sean borrows $15,000 from First Bank to purchase a new automobile. He signs a security agreement, giving First Bank a purchase money security interest in the automobile. Sean defaults after making payments that reduce the debt to $13,250. First Bank repossesses the automobile and sells it at a public auction for $11,000. The selling expenses and sales commission are $1,250. This amount is deducted from the proceeds. The remaining $9,750 is applied to the $13,250 balance of the debt. Sean remains personally liable to First Bank for the $3,500 deficiency ($13,250 balance − $9,750 proceeds).)

sales proceeds of the sale, exchange, or disposition

Unless otherwise stated in a security agreement, if a debtor sells, exchanges, or disposes of collateral subject to such an agreement, the secured party automatically has the right to receive the sale proceeds of the sale, exchange, or disposition [Revised UCC 9-102(a)(64), 9-203(f), 9-315(a)]. (Example Zip, Inc. is a retail automobile dealer. To finance its inventory of new automobiles, Zip borrows money from First Bank and gives the bank a security interest in the inventory. Zip sells an automobile that is subject to the security agreement to Phyllis, who signs an installment sales contract, agreeing to pay Zip for the car in 24 equal monthly installments. If Zip defaults on its payment to First Bank, the bank is entitled to receive the remaining payments from Phyllis.)

security agreement

Unless the creditor has possession of the collateral, there must be a security agreement signed by the debtor that creates a security interest in personal property to a creditor [Revised UCC 9-102(a)(73)] must (1) describe the collateral clearly so that it can be readily identified ; (2) contain the debtor's promise to repay the creditor, including terms of repayment (e.g., interest rate, time of payment); (3) set forth the creditor's rights on the debtor's default; and (4) be signed by the debtor. (The debtor must have a current or future legal right in or the right to possession of the collateral. The rights of the secured party attach to the collateral)

secured transaction.

When a creditor extends credit to a debtor and takes a security interest in some personal property of the debtor

Relinquishing the Security Interest and Proceeding to Judgment on the Underlying Debt

When a debtor defaults, instead of repossessing the collateral, a secured creditor may relinquish the security interest in the collateral and proceed to judgment against the debtor to recover the underlying debt. ( This course of action is rarely chosen unless the value of the collateral has been reduced below the amount of the secured interest and the debtor has other assets from which to satisfy the debt [Revised UCC 9-601(a)) (Example Suppose Jack borrows $100,000 from First Bank to purchase a piece of equipment, and First Bank perfects its security interest in the equipment for this amount. Jack defaults when he owes $80,000 on the loan. If the equipment has gone down in value to $60,000 at the time of default but Jack has other personal assets to satisfy the debt, it may be in the bank's best interest to relinquish its security interest, sue Jack, and proceed to judgment on the underlying debt. If the secured creditor obtains a judgment against the debtor but the debtor has no money to pay the judgment, the secured creditor can proceed to take possession of the collateral.)

termination statement

When a secured consumer debt is paid, the secured party must file a termination statement with each filing officer with whom the financing statement was filed. The termination statement must be filed within one month after the debt is paid or 20 days after receipt of the debtor's written demand, whichever occurs first [Revised UCC 9-513(b)]. If the affected secured party fails to file or send the termination statement as required, the secured party is liable for any other losses caused to the debtor

perfection of a security interest

establishes the right of a secured creditor against other creditors who claim an interest in the collateral. a legal process The three main methods of perfecting a security interest under the UCC are (1) perfection by filing a financing statement, (2) perfection by possession of collateral, and (3) perfection by a purchase money security interest in consumer goods.

Revised Article 9 (Secured Transactions)

includes modern and efficient rules that govern secured transactions in personal property. Revised Article 9 contains many new provisions that recognize the importance of electronic commerce, including rules for the creation, filing, and enforcement of electronic secured transactions.

continuation statement

may be filed up to 6 months prior to the expiration of a financing statement's 5-year term. Such statements are effective for a new 5-year term. Succeeding continuation statements may be filed [Revised UCC 9-515(d), 9-515(e)].

Attachment

means that the creditor has an enforceable security interest against the debtor and can satisfy the debt out of the designated collateral [Revised UCC 9-203(a)].

Article 9 (Secured Transactions) of the Uniform Commercial Code (UCC)

overns secured transactions where personal property is used as collateral for a loan or the extension of credit.