Problem 1. Assignment 11 Priority: Secured Party v. Buyer. Article 9 s Baseline Priority Rule. Problem 1

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1 Assignment 11 Priority: Secured Party v. Buyer Reference: Understanding Secured Transactions Ch. 11 Problem 1 Burnside buys a used tractor from Henson for $6,000 (assume Henson acquired and used it in farming operations) Burnside gets demand from Commerce Bank Bank: We have a SI in the tractor, to secure payment of $8,500 that Henson owes us. Burnside had no knowledge of Bank s SI Did Burnside take the tractor free of Bank s SI, or subject to it? Can Bank get a judgment against Burnside for the $8,500 unpaid debt that Henson owes to Bank? Problem 1 Article 9 s Baseline Priority Rule Baseline rule follows from derivative title Unless Article 9 provides otherwise: [A] security interest is effective according to its terms between the parties, against purchasers of the collateral, and against creditors. [ 9-201(a)] Purchaser includes a buyer [ 1-201(b)(29), (30)] SI continues in collateral notwithstanding sale [ 9-315(a)(1)] (thus, buyer takes subject to SI unless Article 9 rules provide an exception) 1

2 Exception: Buyer v. Unperfected SI 9-317(b): Unless Article 9 provides otherwise, a buyer of goods takes free of a SI in the goods if buyer gives value and takes possession of goods: Without knowledge of the SI, and Before SI is perfected Estoppel warranted vs. unperfected secured party (buyer relied on seller s ostensible ownership, had no reason to know of secured party s claim) Problem 1 Thus, if Bank had perfected its SI by filing a UCC-1 covering the tractor, then Burnside took it subject to Bank s SI [ 9-201(a), 9-315(a)(1)] By contrast, if Bank had not properly perfected its SI by filing (or otherwise), then Burnside took the tractor free of Bank s SI [ 9-317(b)] Assume Bank had properly perfected its SI in the tractor If Burnside doesn t turn over possession of the tractor to Bank, can Bank sue him for the $8,500 unpaid debt? No! Burnside does take title to the tractor subject to Bank s SI But, Burnside does not become personally liable to Bank for Henson s debt (unless he personally agreed to assume that debt) Bank could only get judgment in tort, for conversion of its collateral (amount = FMV = $6,000) Problem 2 BankGroup bought 12 suites of office furniture from College Furniture, Inc. (College) for office use BankGroup agreed to accept the furniture in satisfaction of a debt owed to BankGroup by College s president BankGroup has now received demand from Hawthorn Bank (which holds SI in all of College s inventory, perfected by UCC-1 filing): College owes us $150K; pay us this amount or surrender the furniture Is Bank s demand proper? 2

3 Authorized Sales and Sales in Ordinary Course Ordinarily, an inventory lender can t repossess inventory that has been sold to buyers A buyer in ordinary course of business takes free of a SI created by its seller [ 9-320(a)] Plus, an inventory lender s security agreement with the debtor typically authorizes the debtor to sell the inventory in ordinary course of business free and clear of lender s SI [ 9-315(a)(1)] 9-315(a)(1). Except as otherwise provided in this article and in Section 2-403(2): (1) a security interest or agricultural lien continues in collateral notwithstanding sale, lease, license, exchange, or other disposition thereof unless the secured party authorized the disposition free of the security interest or agricultural lien; and (2) a security interest attaches to any identifiable proceeds of collateral (b)(9). Buyer in ordinary course of business means 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, other than a pawnbroker, in the business of selling goods of that kind. A person buys goods in the ordinary course if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the seller s own usual or customary practices. A buyer in ordinary course of business may buy for cash, by exchange of other property, or on secured or unsecured credit. Buyer in ordinary course of business does not include a person that acquires goods in a transfer in bulk or as security for or in total or partial satisfaction of a money debt. Problem 2: BankGroup is not a BOCB b/c it acquired the furniture in total or partial satisfaction of a money debt [ 1-201(b)(9)] Rationale: this sort of transaction isn t ordinary Further, Hawthorn Bank authorized ordinary course sales that would generate proceeds to which Hawthorn Bank s SI could attach; there s no reason for BankGroup to assume College was authorized to sell inventory in this way (should ve investigated further) Thus, BankGroup took title to the furniture subject to Hawthorn Bank s SI, unless Hawthorn actually did authorize this sale free of its SI [ 9-315(a)(1)] 3

4 BOCB Questions: Problem 2 Suppose BankGroup had paid cash instead Question 1: Was this a sale in bulk so as to deprive BankGroup of BOCB status? Question 2: What if BankGroup bought the furniture in a Going Out of Business sale? Question 3: What if BankGroup knew Hawthorn had a SI in the furniture? Bulk Sale A bulk sale is a sale that: Is not in ordinary course of the seller s business, Is of more than ½ of the seller s inventory, in terms of value, and Occurs when Buyer knows or should know that the seller will not continue to operate the same/similar kind of business after the sale [ 6-102(1)(c)] Buyer in bulk sale is not BOCB [ 1-201(b)(9)], but sale of furniture to BankGroup is not likely a bulk sale Problem 2 Irrelevant if sale was going out of business sale Such as sale is ordinary for debtor going out of business; further, lender would customarily authorize such a sale as a way to liquidate the inventory Also irrelevant that BankGroup might have known Hawthorn Bank had SI in the furniture at time of sale Mere knowledge of a SI doesn t defeat BOCB status; buyer loses BOCB status if it knows that the sale violates secured party s rights [ 1-201(b)(9)] Northeast Airlines has $450MM line of credit w/ BankGroup Industrial Credit (BIC), secured by its aircraft fleet (incl. after-acquired) After its planes log 40,000 flight hours, Northeast Airlines sells them to Turkmenistan Airlines and replaces them w/new planes Does BIC s SI survive such sales, or is Turkmenistan Airlines a BOCB? Problem 3 4

5 1-201(b)(9). Buyer in the ordinary course means 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, other than a pawnbroker, in the business of selling goods of that kind. A person buys goods in the ordinary course if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the seller s own usual or customary practices. A buyer in ordinary course of business may buy for cash, by exchange of other property, or on secured or unsecured credit. Problem 3 One view: buyer would be BOCB, as long as the sale of used planes comports with the usual or customary practices of airlines generally, or with Northeast s own usual or customary practices [ 1-201(b)(9)] Contrary view (weight of authority): no, b/c Northeast is not in the business of selling planes, which is a threshold condition for BOCB status [ 1-201(b)(9)] (planes are not inventory in the hands of Northeast) [Sindone v. Farber (N.Y. 1980)] TA may argue that by course of performance, BIC has authorized Northeast to sell its used planes free and clear If so, TA would take free of BIC s SI under 9-315(a)(1) Relevant facts: Has Northeast regularly conducted similar sales of planes without BIC s consent? If so, did BIC know? If so, did BIC object or attempt to enforce its SI against the buyer(s)? 1-303(a). A course of performance is a sequence of conduct between the parties to a particular transaction that exists if: (1) the agreement of the parties with respect to the transaction involves repeated occasions for performance by a party; and (2) the other party, with knowledge of the nature of the performance and opportunity for objection to it, accepts the performance or acquiesces in it without objection (d). A course of performance... is relevant in ascertaining the meaning of the parties agreement, may give particular meaning to specific terms of the agreement, and may supplement or qualify the terms of the agreement (f)... [A] course of performance is relevant to show a waiver or modification of any term inconsistent with the course of performance. 5

6 Courts have been willing to find implied authority to sell free and clear based on a past course of performance between the debtor and secured party Many cases involve repeated sales of livestock, but the same pattern could apply to an airline selling planes If BIC failed to object to past sales, and never asserted its SI vs. buyers of the planes, court may find course of performance created implied authority to sell free/clear How could BIC have behaved differently? Establish an explicit release price (i.e., if you pay us at least $1.5MM/per plane in sale proceeds, we will consent to sale of the plane free and clear of our interest ) Enforce its rights vs. any unauthorized sale Clear communication w/debtor (no waiver) NE sells a used plane to Turkmenistan Airlines for $2.1MM BIC had established a $1.5MM release price for the sale, but Turkmenistan Airlines didn t know this NE completes the sale, but does not turn over the sale proceeds to BIC as agreed Effect of the sale? Problem 4 A. Turkmenistan Airlines takes plane subject to BIC s SI B. Turkmenistan Airlines gets plane free of BIC s SI A few (probably wrong) decisions have ruled for Buyer in this situation Rationale: failure of debtor to comply w/condition doesn t negate lender s authority to sell, where Buyer was not aware of the condition Better view: Seller s authorization to sell free/clear was conditional, and condition is not satisfied Thus, Buyer took subject to BIC s security interest [ 9-201(a)] Buyer (not in ordinary course) was on notice, should have confirmed w/bic the terms of its consent (e.g., Buyer could ve paid sale price to BIC directly) Problem 5 Bank takes PMSI in Haines s new tractor (acquired for personal use) Haines later sold the tractor to Marvin s Farm Implement Co. for $4,000 cash Marvin s was unaware of Bank s SI in the tractor Marvin s resold tractor to Anthony for $5,000 Anthony was likewise unaware of Bank s SI Does Bank still have a valid SI in the tractor? 6

7 Although Anthony is a buyer in ordinary course of business (BOCB) when he buys tractor from Marvin s, a BOCB only takes free of a SI created by its own seller [ 9-320(a)] Here, Bank s SI was created by Haines (prior owner of the tractor), not by Marvin s (Anthony s seller) Anthony took the trailer subject to any SI that Marvin s had granted covering its inventory, but Anthony took the tractor subject to Bank s perfected PMSI that was granted by Haines (auto-perfected PMSI in consumer goods) [ 9-201(a), 9-315(a)(1)] Problem 5: Created by Its Seller BOCB rule [ 9-320(a)] is based on implied authority (i.e., inventory lender typically authorizes ordinary course sales by its own Debtor) But, Bank was loaning money to Haines (a consumer), and taking a security interest in consumer goods (not inventory) There s no reason to infer that Bank would have authorized Haines to sell the tractor to a dealer like Marvin s (or any resale by Marvin s)! Bank had no agreement with Marvin s (and no course of dealing with Marvin s) from which that authority could be implied Problem 5: Due Diligence Burden? To avoid this risk when buying used goods, buyer can t ONLY search the UCC records under the name of its seller! Instead, buyer must Reconstruct the chain of title (i.e., must identify any prior owner(s) of the goods) Search for relevant filings under the names of any prior owner(s) Problem 6 Now assume that Haines had sold the tractor to Anthony directly, for $4,000 in cash Does Anthony take the tractor subject to Bank s security interest, or free and clear of it? A. Subject to B. Free and clear 7

8 9-320(b). [Buyer of consumer goods.] Except as otherwise provided in subsection (e), a buyer of goods from a person who used or bought the goods for use primarily for personal, family, or household purposes takes free of a security interest, even if perfected, if the buyer buys: (1) without knowledge of the security interest; (2) for value; (3) primarily for the buyer s personal, family, or household purposes; and (4) before the filing of a financing statement covering the goods. Garage Sale Exception [ 9-320(b)] In a sale transaction, a buyer of goods takes free of a SI, even if it was perfected, if: The goods are consumer goods in seller s hands The buyer pays value, without knowledge of SI The goods are also consumer goods in the hands of the buyer, and Secured party did not either (1) file a financing statement covering the goods or (2) take possession of the goods (i.e., secured party relied on automatic perfection) [ 9-320(e)] If Anthony didn t know of Bank s SI, he takes the tractor free of that SI, b/c Bank did not file a UCC-1 covering tractor [ 9-320(b)] Automatic perfection rule for PMSIs in consumer goods creates an ostensible ownership problem While those in the business of lending understand the risk that consumer goods may be subject to autoperfected PMSIs, consumers may not appreciate this To avoid the risk posed by 9-320(b), Bank must file UCC-1 covering the tractor Sept. 1: Debtor buys a copier (business use) from Seller, who takes SI to secure unpaid purchase price Sept. 10: When Debtor s staff complains about copier, Debtor sells it to Buyer Buyer searched UCC records and found no UCC-1 covering copier Sept. 19: Seller files UCC-1 Did Buyer take subject to Seller s SI, or free of it? Bonus Problem 8

9 9-317(e). [Purchase-money security interest.] Except as otherwise provided in Sections and 9-321, if a person files a financing statement with respect to a purchase-money security interest before or within 20 days after the debtor receives delivery of the collateral, the security interest takes priority over the rights of a buyer, lessee, or lien creditor which arise between the time the security interest attaches and the time of filing. Buyer will try to argue that Seller was unperfected at time of sale to Buyer [ 9-317(b)], but Seller filed its UCC-1 within 20 days after Debtor took delivery of the copier (even though Seller hadn t yet filed at time of sale to Buyer) 9-317(e): Seller s PMSI thus takes priority over the intervening rights of Buyer, despite 9-317(b) Also, on these facts, 9-320(b) doesn t protect the Buyer (this was not a consumer-to-consumer sale; copier was equipment in hands of Debtor) Buyers of Collateral that Secures Future Advances For a line of credit arrangement, the collateral typically secures not only amounts already borrowed and not repaid, but also future advances Suppose Buyer buys a machine from Debtor, but not free and clear Will that SI secure new loans made to Debtor AFTER the Buyer purchases the collateral? Problem 7 Bank has perfected SI in all present and afteracquired equipment of Draco Two months ago, Draco sold three used computers to Smith (w/out Bank s knowledge or consent) On date of sale, Draco owed Bank = $5,000 Today, Draco owes Bank = $30,000 How much would Smith have to pay Bank to get clear the title to the three computers? $5,000? $30,000? Some other amount? 9

10 9-323(d) [Buyer of goods.] Except as otherwise provided in subsection (e), a buyer of goods other than a buyer in ordinary course of business takes free of a security interest to the extent that it secures advances made after the earlier of: (1) the time the secured party acquires knowledge of the buyer s purchase; or (2) 45 days after the purchase (e) [Advances made pursuant to commitment; priority of buyer of goods.] Subsection (d) does not apply if the advance is made pursuant to a commitment entered into without knowledge of the buyer s purchase and before the expiration of the 45-day period. Smith took computers subject to SI, to extent of $5,000 owed to First Bank on date he bought them [ 9-201(a), 9-315(a)(1)] B/c computers also secured future advances, they also secure repayment of advances made to Draco (a) w/out knowledge of sale to Smith and (b) w/in 45 days after that sale [ 9-323(d)] Thus, answer depends on (a) what date did sale take place? and (b) when did First Bank learn of it? Scenario 1: Sale to Smith on September 1; First Bank learned of the sale on October 1; on that date, balance on line of credit = $10,000 Computers Smith bought are subject to First Bank s SI to the extent of $10,000; later advances ($20,000) to Draco are not secured by the computers Does this result make sense? Yes; once First Bank knows of the sale, it can act to freeze the credit line and repossess computers Bank should not get priority for advances made after that, unless Bank was previously committed to make those advances [ 9-323(e)] Scenario 2: Sale occurred August 1; First Bank learned of the sale on October 1 (more than 45 days later) Assume balance of debt on September 14 (45 days after sale) = $25,000; computers are subject to First Bank s SI to that extent Any advances to Draco after September 14 would not be secured by the computers sold to Smith, unless First Bank had previously committed to make them [ 9-323(e)] 10

11 What Should Have Happened? Smith should have searched UCC records; he would ve discovered prior UCC-1 filing in favor of First Bank Smith then could ve refused to purchase unless First Bank specified an agreed release price If Smith complied w/ conditions expressed by First Bank, Smith would then take free 11

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