Secured Transactions

At issue is whether the $4,000 check constitutes cash proceeds.

A security interest in collateral automatically attaches to identifiable proceeds. Proceeds include whatever is acquired upon the sale of collateral. If the proceeds are identifiable cash proceeds (which includes checks) and the security interest in the original collateral is perfected, the perfected security interest in the proceeds continues indefinitely. Here, the retailer had a perfected security interest in the entertainment system. The buyer acquired the $4,000 check from the friend in exchange for the system. Thus, the check is identifiable cash proceeds, and the retailer has a perfected security interest in the check.

1.b. The bank has a perfected security interest in the manufacturer's present accounts that existed on March 15 and any future accounts. (30%)

As stated above, for a security interest to be enforceable against a debtor, the interest must first "attach" to the collateral. Here, the bank gave value in the form of a loan, and the manufacturer signed a writing describing the loan and collateral. However, since the manufacturer sold the accounts that existed on February 1 to the finance company, a question arises as to whether the manufacturer continued to have rights in those accounts. Since UCC Art. 9 treats a sale of accounts as creating a security interest in the purchaser, the seller (debtor) is deemed to retain rights in the accounts for attachment purposes until the purchaser perfects its security interest. Since the finance company did not perfect its security interest, the manufacturer is treated as continuing to have rights in the accounts that existed on February 1, even though the manufacturer sold the accounts to the financing company. Thus, the bank attached its security interest to the manufacturer's "present and future" accounts as of March 15, including those that were sold to the finance company that remained active on March 15. In addition, the bank filed a financing statement on March 15, perfecting its security interest in the manufacturer's present accounts that existed on that date and any future accounts.

Whether the finance company has an interest in the home entertainment system depends on the status of the buyer.

Generally, a security interest that is enforceable against the debtor is said to have "attached" to the collateral. Attachment requires that: (i) value has been given by the secured party, (ii) the debtor has rights in the collateral, and (iii) the debtor has authenticated a security agreement that describes the collateral, or the secured party has possession or control of the collateral pursuant to a security agreement. Here, the finance company gave value in the form of a $5 million loan, the retailer had rights in its inventory, and the debtor authenticated the loan agreement. Thus, the finance company has a security interest in all the retailer's present and future inventory. Inventory includes goods, other than farm products, that are held for sale or lease. As a retailer of home electronic equipment, the entertainment system is part of the retailer's inventory and the financing company's security interest attached to it. Perfection of a security interest is generally necessary for the secured party to have rights in the collateral that are superior to any rights claimed by third parties. A security interest in goods can be perfected by filing a financing statement. Here, the finance company perfected its interest in the inventory by properly filing a financing statement. A buyer of collateral subject to a perfected security interest generally takes the collateral subject to that interest. However, a buyer in the ordinary course of business (BOCB) takes free of a security interest created by the buyer's seller, even if the security interest is perfected and the buyer knows of its existence. A BOCB is a person who: (i) buys goods; (ii) in the ordinary course of business; (iii) from a merchant who is in the business of selling goods of that kind; (iv) in good faith; and (v) without knowledge that the sale violates the rights of another in the same goods. In order to qualify as a buyer, the purchaser must give new value, which in addition to paying cash for the goods includes purchasing the goods on credit. In this case, the buyer bought the home entertainment system in the ordinary course of the retailer's business. The buyer purchased the system on credit in good faith and without knowledge of the retailer's interest. Thus, the buyer is a BOCB and takes the system free of the finance company's security interest. If a buyer obtains goods under the BOCB exception free of the security interest in the goods created by the buyer's seller, the buyer may, in turn, sell the goods to a second buyer who also takes the goods free of that security interest. The second buyer is not required to qualify as a BOCB. Consequently, the friend takes the home entertainment system free of the finance company's security interest.

The issue is whether the retailer's perfected security interest in the bicycle is enforceable against the friend who received the bicycle as a gift. (30%)

If collateral is transferred and the transferee of the collateral is not a buyer, the security interest generally continues in the collateral, unless the secured party has authorized its sale free of the security interest. Here, the retailer did not authorize the man to dispose of the bicycles free of the security interest because the man signed an agreement that he would not sell or dispose of the collateral until he paid the balance owed on the purchase price. In addition, the friend does not fall under any Article 9 exceptions that would allow the friend to take the bicycle free of the retailer's security interest. The friend does not qualify as either a consumer buyer or a buyer in the ordinary course of business because the friend did not give value for the bicycle. The friend received the bicycle as a birthday gift. Thus the friend cannot qualify as a buyer. Accordingly, the friend does not own the bicycle free of the retailer's security interest.

At issue is whether the retailer has an interest in the home entertainment system even though it did not file its interest.

If the substance of the transaction is the creation of a security interest, then Article 9 applies regardless of the form of the transaction. The retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer is limited in effect to a reservation of a security interest. In this case, even though the retailer retained title to the system, the substance of the agreement was to create a security interest, which attached to the entertainment system. The retailer gave value by selling the entertainment system on credit, the buyer had rights in the entertainment system, and the buyer signed an agreement that recognized the retailer's retention of an interest in the system as security for payment of the remainder of the purchase price. A PMSI in goods exists when a secured party sold goods to the debtor, and the debtor incurs an obligation to pay the secured party all or part of the purchase price. A PMSI in consumer goods is automatically perfected upon attachment. Consumer goods are those goods acquired primarily for personal, family, or household purposes. Here, the retailer has a PMSI in the system because the buyer purchased the system from the retailer on credit and granted a security interest in the system. The system is a consumer good because the buyer purchased it for use in her home. Thus, the retailer's PMSI is automatically perfected without filing a financing statement. A buyer of collateral subject to a perfected security interest generally takes the collateral subject to that interest. However, a consumer buyer of consumer goods takes free of a security interest, even if perfected, unless prior to the purchase the secured party filed a financing statement covering the goods. A consumer buyer is a person who: (i) buys consumer goods for value; (ii) for his own personal, family, or household use; (iii) from a consumer seller; and (iv) without knowledge of the security interest. This is often referred to as the "garage sale" rule. Here, the friend gave value for the system in the form of a $4,000 check. (Note: Although the buyer agreed to hold the check for 90 days, a check is a negotiable instrument that is payable upon demand, and therefore constitutes value given.) In addition, the friend purchased the system for his own household use, the buyer was a consumer seller because she was not in the business of selling home electronic equipment, and the friend had no knowledge of the retailer's security interest. Thus, the friend is a consumer buyer of consumer goods. Because the retailer did not file its PMSI, the friend takes the system free of the retailer's security interest.

(a) The first issue is whether the retailer has a perfected security interest in the bicycles. (35%)

Under Article 9, for a security interest to be enforceable against a debtor, the interest must attach to the collateral. 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). Here, the retailer's security interest attached on June 1st when (i) the retailer gave value by selling the bicycles to the man on credit; (ii) the man had rights in the bicycles; and (iii) the man signed a security agreement that identified the bicycles as collateral. Moreover, the retailer has a special kind of security interest called a purchase money security interest (PMSI). A PMSI is a 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. Here, the retailer sold the two bikes to the man on credit and retained a security interest in the bicycles. Thus, the retailer has a PMSI in the bicycles. While the retailer, as a secured party, has rights against the man, in order to have priority over a third party, perfection of its security interest is necessary. A secured party can perfect a security interest by (i) filing a financing statement; (ii) possessing the collateral; (iii) controlling the collateral; or (iv) perfecting automatically. A PMSI in consumer goods perfects automatically. In other words, a security interest in a consumer good is perfected as soon as it attaches. A consumer good is a good that is acquired primarily for personal, family, or household purposes. Here, the man purchased the bicycles for himself and his girlfriend to use on vacation. Since the bikes were purchased for personal purposes, they are consumer goods and the retailer's interest was automatically perfected. Thus, the retailer holds a perfected security interest in the bicycles as of June 1st.

2. Obligation Upon Default

Upon default, a secured party may notify an account debtor (the person obligated on an account) to make payment to the secured party. In addition, the secured party may exercise any rights of the debtor with respect to the obligation of the account debtor. In a commercially reasonable manner, the secured party may collect from the account debtor, and, if the account debtor does not pay, the secured party may enforce the obligation of the account debtor. As stated above, the bank has an attached and perfected security interest in the accounts. Because the manufacturer is in default on its bank loan, the bank can exercise the rights of the manufacturer and seek direct payment from the retail stores. Since the bank has notified the retail stores of its security interest, if the retail stores refuse to pay the bank, the bank can enforce the obligation just as the manufacturer would have been able to do. Thus, the retail stores are incorrect; they do have an obligation to pay the bank, not the manufacturer.

1.c. With regard to the manufacturer's pre-February 1 accounts, the Bank's perfected security interest has priority over the finance company's unperfected security interest (20%)

When there are two or more perfected secured parties with rights in the same collateral, the first to file or perfect has priority. If only one security interest is perfected, and the other is not, then the perfected interest takes priority over the unperfected one. Here, the bank has a perfected security interest in the manufacturer's present and future accounts, as of March 15. So, the bank has priority over accounts existing at that time and those arising after March 15. Specifically, the bank has priority to accounts that were purchased by the finance company on February 1 that continued to exist on March 15.

(b) The second issue is whether the buyer is a consumer buyer that takes free of the retailer's perfected security interest in the bicycle. (35%)

While a PMSI in consumer goods automatically perfects, that perfection does not guarantee priority in a dispute over the same collateral. A consumer buyer of consumer goods takes free of a security interest, even if perfected, unless prior to purchase, the secured party filed a financing statement covering the goods. In other words, the holder of a PMSI in consumer goods could lose to a consumer buyer if he/she does not file a financing statement. 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. Under these facts, the buyer is a consumer buyer. The buyer bought the bicycle at a garage sale for $400, for his own personal use, from the man, who is a consumer seller, and the buyer had no knowledge of the retailer's security interest in the bicycle. Finally, the retailer did not file a financing statement prior to the buyer's purchase. Accordingly, the buyer is a consumer buyer, and he owns the bicycle free of the retailer's security interest in the bicycle.

1.a. Finance company has an unperfected security interest in the manufacturer's accounts that existed on February 1. (30%)

While generally UCC Art. 9 does not apply to a sale, there is an exception for the sale of rights to payment, such as accounts, chattel paper, payment intangibles, and promissory notes. The sale is treated as creating a security interest in the rights to payment with the purchaser of the rights being the secured party. An account includes the right to payment for property sold, leased, licensed, or for services rendered (such as a company's accounts receivable). Here, the manufacturer sold its outstanding rights to be paid by the retail stores to which it had sold clothing. As such, the collateral is characterized as an account, and the transaction is subject to Art. 9. A security interest is enforceable against the debtor with respect to the collateral if the interest has attached to the collateral. Attachment requires that value be given by the secured party, the debtor has rights in the collateral, and the debtor has authenticated a security agreement that describes the collateral, or the secured party has control of the collateral pursuant to a security agreement. The basic rule is that a security interest attaches only to rights that the debtor has. Here, the finance company gave value by purchasing the right to payment, the manufacturer had rights in their accounts to receive payment for the clothing it sold to stores, and the manufacturer signed a writing describing the transaction. Although the manufacturer's business model creates ongoing obligations with retail stores, the financing company purchased only the manufacturer's outstanding rights to be paid at that time. Thus, the financing company had an enforceable security interest to the manufacturer's outstanding accounts that existed as of February 1. Perfection of an attached security interest is generally necessary for the secured party to have superior rights over third parties that have security interests in the same collateral. A secured party can perfect a security interest by (i) filing a financing statement; (ii) possessing the collateral; (iii) controlling the collateral; or (iv) perfecting automatically. A security interest in accounts may be perfected only by filing. Here, the finance company did not file a financing statement. Consequently, the finance company's security interest was unperfected.