Assignment 32 Secured Creditors Against Secured Creditors: The Basics. Problem Problem 32.1: Bank 1 vs. Bank 2
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1 Assignment 32 Secured Creditors Against Secured Creditors: The Basics Reference: Understanding Secured Transactions, Chapter 10 Problem 32.1: Bank 1 vs. Bank 2 Bank 1 August 1: Bank 1 makes UCC-1 filing vs. Debtor August 10: debtor signs security agreement August 10: Bank 1 approves/makes loan Bank 2 August 5: Bank 2 makes UCC-1 filing vs. Debtor August 5: debtor signs security agreement August 5: Bank 2 approves/makes loan Problem Which Statement Is Correct? A. Bank2 has priority because its security interest was first to attach B. Bank2 has priority because its security interest was first to be perfected C. Bank1 has priority because its security interest was first to be perfected D. Bank1 has priority because it was first to file Bank2 has priority becaus... 0% 0% 0% 0% Bank2 has priority becaus... Bank1 has priority becaus... Bank1 has priority becaus... Problem 32.1 Priority between conflicting secured parties is generally based upon first-to-file-orperfect [ 9-322(a)(1)] Bank 2 s security interest was first to attach (on August 5) and first to be perfected (on August 5), but Bank 1 was first to file (on August 1) Bank 1 s SI is thus entitled to priority over Bank 2 s SI in the same collateral 1
2 Problem Which Statement Is Correct? 1 year ago: Estes granted PMSI to Bank in debtor s computer, to secure $75,000 loan Security agreement contained no provisions regarding future advances Bank filed UCC-1 covering equipment Estes wants to borrow another $40,000 from Bank (using same equipment as collateral) Problem 32.3 A. Bank has to have Estes sign new security agreement, and Bank must file new UCC-1 B. Bank has to have Estes sign a new security agreement, but Bank doesn t need new UCC-1 filing C. Bank doesn t need Estes to sign new security agreement, but does need new UCC-1 filing D. Bank doesn t need new security agreement or new UCC-1 filing Bank has to have Estes si.. 0% 0% 0% 0% Bank has to have Estes si.. Bank doesn t need Estes t... Bank doesn t need new s... Problem 32.3 Security agreement can provide that collateral will secure future loans, but security agreements don t automatically cover future loans [ 9-204(c)] If original security agreement had a future advance clause, computer would secure the original $75,000 loan and the new $40,000 loan It didn t, so new $40,000 loan would be unsecured, unless Estes signed new security agreement granting another SI in the computer Problem 32.3 If Estes executes a new security agreement, granting another SI in the computer to secure the new $40,000 loan, Bank need not file a new financing statement Original UCC-1 covers equipment, which is sufficient to describe the collateral ( equipment ) Original UCC-1 is sufficient to perfect the new security interest, and Bank s priority for this new SI will relate back to date of filing 2
3 Problem 32.4: Bob s Boat 1 year ago: Carol loaned Bob $1,000, and took a SI in Bob s boat, perfected by UCC-1 filing 11 months ago: BCA loaned Bob $45,000 BCA took SI in Bob s boat, perfected by filing Now: BCA has repossessed the boat, which is worth $32,000 Bob asks Carol to loan him $31,000, to prevent BCA from collecting. Would this stop BCA? Bob wants priority for repayment of the loans as follows: Carol: $1,000 loan (Loan #1) Carol: $31,000 loan (Loan #3) BCA: $45,000 loan (Loan #2) Problem 32.4 BCA wants priority for repayment of the loans as follows: Carol: $1,000 loan (Loan #1) BCA: $45,000 loan (Loan #2) Carol: $31,000 loan (Loan #3) Problem 32.4 If Bob/Carol security agreement covers future advances, or if Bob grants Carol another SI in the boat to secure the new loan, then Carol s SI which is entitled to priority over BCA under 9-322(a)(1) would secure a total balance of $32K This may dissuade BCA from trying to sell the boat, as value of boat is only $32K [Problem 26.2], but BCA could still go ahead and repossess the boat anyway Problem 32.5 and Future Advances What could BCA have done to avoid the risk posed by Problem 32.4? Can alter Article 9 priority by contract [ 9-339] BCA should ve refused to make the loan to Bob unless Carol had agreed to subordinate her SI to BCA, to the extent of any future advances BCA could have loaned Bob an additional $1,000 to pay of debt to Carol, obtained termination statement [ 9-513] 3
4 Problem 32.2 March 21: Centurion Bank takes SI in the present and after-acquired flight simulators of AirCo, files UCC-1 covering flight simulators July 21: First Bank takes SI in the present and afteracquired flight simulators of FlightCo, files UCC-1 covering flight simulators Nov. 4: FlightCo sells flight simulator #4 to AirCo (w/out knowledge or consent of First Bank) Both AirCo and FlightCo are now in default, and both Centurion Bank and First Bank are trying to repossess flight simulator #4. Which creditor has priority? Problem 32.2: Arguments Centurion Bank: we have first priority under first to file or perfect [ 9-322(a)(1)] We filed on March 21; First Bank filed on July 21 First Bank: Centurion Bank s March 21 filing couldn t have given effective notice to us On March 21, AirCo hadn t bought flight simulator #4, which was owned by FlightCo A third party dealing with FlightCo wouldn t think to search under AirCo Priority of SIs in Transferred Collateral (a) Except as otherwise provided in subsection (b), a security interest created by a debtor is subordinate to a security interest in the same collateral created by another person if: (1) the debtor acquired the collateral subject to the security interest created by the other person; (2) the security interest created by the other person was perfected when the debtor acquired the collateral; and (3) there is no period thereafter when the security interest is unperfected. (b) Subsection (a) subordinates a security interest only if the security interest... otherwise would have priority solely under Section 9-322(a) or Priority of SIs in Transferred Collateral (a) Except as otherwise provided in subsection (b), a security interest created by AirCo is subordinate to a security interest in the same collateral created by FlightCo if: (1) AirCo acquired the collateral subject to the security interest created by FlightCo; (2) the security interest created by FlightCo was perfected when AirCo acquired the collateral; and (3) there is no period thereafter when the security interest [created by FlightCo] is unperfected. (b) Subsection (a) subordinates a security interest only if the security interest... otherwise would have priority solely under Section 9-322(a) or
5 In Problem 32.2, First Bank has priority under the dual debtor rule [ 9-325(a)] AirCo took title to the simulator subject to perfected SI that FlightCo had previously granted to First Bank 9-322(a)(1) applies only to conflicting SIs created by the same debtor, not ones created by different debtors 9-325(a) subordinates Centurion s SI (via the afteracquired clause in agreement w/airco) to First Bank s prior SI (derivative title principle) Problem 32A Suppose Bank holds a SI in all of Debtor s equipment (incl. after-acquired equipment), perfected by UCC-1 filing Debtor owes Bank $500K on its line of credit Debtor buys a new drill press from Seller, for use in his business Seller takes a SI to secure unpaid purchase price, files UCC-1 that day Which Statement Is Correct? A. Bank s SI in the drill press (as after-acquired property) has priority over Seller s SI, because Bank was first to file B. Seller s SI in the drill press has priority over Bank s SI Bank s SI in the drill press... 0% 0% Seller s SI in the drill pre.. A perfected purchase money security interest (PMSI) in goods other than inventory has priority over a conflicting SI in the same goods, if the PMSI is perfected when the debtor receives possession of the collateral or within 20 days thereafter [ 9-324(a)] Purchase Money Priority 5
6 Problem 32A Seller took PMSI in drill press in equipment (noninventory) Seller perfected this PMSI w/in 20 day grace period after Debtor took possession of collateral Thus, Seller s PMSI gets priority over Bank s SI under the after-acquired clause [ 9-324(a)] If Seller had perfected after the 20-day grace period, Bank would have had priority under 9-322(a)(1) Purchase Money Priority Rationales for purchase money priority (1) Purchase money priority enables debtor to obtain credit to purchase new assets, despite having previously entered into security agreement covering after-acquired property (2) Purchase money priority doesn t harm prior secured party, because debtor s new liability is offset by debtor s acquisition of new asset Problem 32B Problem 32B. Which Statement Is Correct? Bank1 holds a SI in all of Debtor s equipment (incl. after-acquired equipment), perfected by filing Debtor owes Bank1 $500K on its line of credit May 1: Debtor buys a new drill press for $20K cash May 2: to replenish his cash account, Debtor borrows $20K from Bank2, signs agreement granting Bank2 a purchase money security interest in the drill press May 3: Bank2 files UCC-1 covering the drill press A. Bank2 has a perfected PMSI in the drill press and has PM priority over Bank1 [ 9-324(a)] B. Bank1 has priority in the drill press under first to file or perfect Bank2 has a perfected PM.. 0% 0% Bank1 has priority in the... 6
7 In Problem 32B, Bank1 has priority under first to file [ 9-322(a)(1)] Bank2 does not have a PMSI in the drill press, and thus does not qualify for PM priority Obligation incurred to Bank2 ($20,000 loan) did not enable the debtor to acquire the drill press (debtor had already bought it the day before), and thus was not a purchase money obligation [ 9-103(a)(2)] How should Bank2 have acted differently, if it expected to have priority? Problem 32C Bank holds SI in all of D s equipment, including afteracquired equipment, perfected by UCC-1 filing May 1: D rents a drill press from Seller for 30 days May 31: D decides to buy the drill press, signs installment contract granting Seller a SI to secure payment of the purchase price June 1: Seller files UCC-1 covering the drill press First priority: Bank, or Seller? Bank will argue that Seller didn t file within the 20- day grace period after D got possession (the first day of the lease term) But, Seller has PM priority under 9-324(a) During lease term, D wasn t a debtor and drill press wasn t collateral (this was a true lease ) Drill press only became collateral when D acquired rights (when D bought it) and D became a debtor [ 9-324, cmt 3], so that s when 20-day grace period started Seller filed w/in grace period, so Seller gets PM priority over Bank [ 9-324(a)] Sara W manufactures stereo speakers, but has experienced large bad debt losses One of her dealers filed for bankruptcy, owing her $150K That dealer s inventory lender had a first priority floating lien on all of the Dealer s inventory (incl. after-acquired), perfected by filing How might Sara address this risk in the future? Problem
8 PM Priority (Inventory) [ 9-324(b)] To get PM priority, Sara must (1) File UCC-1 vs. speakers before Dealer takes possession of them (no 20-day grace period!) [ 9-324(b)(1)], and (2) Send prior-in-time inventory lender an authenticated notice that describes the speakers and states Sara expects to take a PMSI in them [ 9-324(b)(2), (4)] Prior-in-time inventory lender must receive this notice w/in 5 yrs prior to Dealer taking possession of the speakers [ 9-324(b)(3)] Inventory Lending Bank has floating lien on Dealer s inventory, to secure Dealer s line of credit with Bank Bank wants to ensure that at all times, Dealer s inventory level (and its value) justifies the amount Dealer wants to borrow Bank does not want to risk being undersecured! Thus, when extending additional credit to Dealer, Bank should: Ensure Dealer has enough inventory on hand (by reviewing invoices for current inventory), or Ensure Dealer has enough inventory on order (by reviewing pending purchase orders) Example (Inventory Financing) $ 1 Million Revolving Credit Line Inventory Loan Balance Credit Available 300 units 3,000 units 750 units $ 75,000 $ 750,000 $ 200,000 $ 925,000 $ 250,000 $ 800,000 Rationale for 9-324(b)? Bank would finance Dealer s inventory by loaning Dealer a specified percentage of Dealer s invoices for new inventory If Dealer has granted a PMSI to Sara vs sets of speakers, Bank needs to know this Otherwise, Bank might allow Dealer to borrow money against that 1000 sets of speakers Bank would then inadvertently be double financing Dealer s inventory! 8
9 Bank has prior floating lien on Dealer s inventory, perfected by UCC-1 filing Dealer buys 1000 sets of speakers from Sara, Sara complies with 9-324(b) Dealer sells a set of speakers to Royce for $1,000 cash Who has first priority in this $1,000? Problem 32.6 PM Priority as to Proceeds If PM secured party qualifies for PM priority under 9-324(a) (noninventory), this priority extends to identifiable proceeds of the PM collateral [ 9-324(a)] Note: this assumes that the SI in proceeds is properly perfected under 9-315(c), (d) If PM secured party qualifies for PM priority under 9-324(b) (inventory), priority extends to identifiable cash proceeds of the PM collateral [ 9-324(b)], so Sara has priority over Bank as to $1,000 cash paid by Royce Same problem, but now assume that when Royce buys the speakers, he signs an installment contract (chattel paper) The chattel paper is proceeds of the inventory sold to Royce Who has first priority in the chattel paper: Bank, or Sara? Problem 32.6 PM Priority in Proceeds If PM secured party qualifies for PM priority under 9-324(b) (inventory), this priority also extends to proceeds in the form of chattel paper or an instrument [ 9-324(b)], so Sara has priority over Bank as to the right to collect payments from Royce under the contract 9
10 Same problem, but now assume that when Royce buys the speakers, he buys them at a 90 days same as cash sale The account owed by Royce is proceeds of the inventory sold to him Who has first priority in the account: Bank, or Sara? Problem 32.6 PM Priority: Accounts as Proceeds Although Sara had PM priority as to the speakers, that priority does not extend to proceeds of the speakers that are accounts [ 9-324(b)] Conflicting SIs in Dealer s accounts are governed by first-to-file-or-perfect [ 9-322(a)(1)] Bank will thus have priority to collect account owed by Royce This exception for accounts financers limits the practical benefit of 9-324(b) PM priority Conflicting PMSIs D buys a crane for its business D pays 50% of the price in cash, and grants Seller a SI for the 50% unpaid balance Seller files a UCC-1 covering the crane D borrowed the downpayment from Bank, and granted Bank a SI in the crane Bank files a UCC-1 covering the crane Conflicting PMSIs Seller, Bank have PMSI in the crane If both Seller and Bank file w/in the 20-day grace period, 9-324(a) doesn t resolve the dispute between them! 9-324(g)(1): Seller PMSI has priority over conflicting PMSI of third-party lender Bank may have expected first priority; what should it have done differently? 10
11 Conflicting PMSIs If Bank expected to have first priority in the crane, Bank should refuse to extend the loan to D unless Seller agrees to subordinate its SI to Bank [ 9-339] Why put this burden (the burden to obtain on a subordination agreement) on Bank rather than on Seller? 11
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