Attachment and Perfection. Attachment. One-Time Secured Loans. Assignment 2 Attachment of the Security Interest: The Basic Requirements

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1 Assignment 2 Attachment of the Security Interest: The Basic Requirements Reference: Understanding Secured Transactions 1.04, 2.01, 2.02, 3.01, 3.02, 3.03 Attachment and Perfection Creation of a SI is called attachment Typically evidenced by a document entitled Security Agreement Once SI attaches, it is enforceable vs. debtor [ 9-201(a)] To make an attached SI fully effective vs. third parties (e.g., buyers, other creditors), it must be perfected Perfection evidenced (typically) by filing a financing statement (also called UCC-1) 3 prerequisites for attachment of a security interest 1) Effective security agreement [ 9-203(b)(3)] covering the collateral 2) Value must have been given [ 9-203(b)(1)] 3) Debtor must have rights in the collateral [ 9-203(b)(2)] SI attaches when last of these 3 prerequisites has occurred Attachment One-Time Secured Loans Debtor borrows lump sum (all at once), to be repaid in installments or in a lump sum, and grants SI in a specific item(s) of property E.g., Debtor borrows $$ from Bank to buy car, grants SI in car to Bank ( purchase money SI) E.g., Debtor borrows money from Loan Shark, and grants Loan Shark a SI in Debtor s watch Security agreement for such a loan often uses a specific collateral description (e.g., Debtor s 2008 Honda Accord, VIN #1HLQU1520KA ) 1

2 Line of Credit Loans Debtor borrows only as needed against a predetermined maximum amount ( line of credit ) Interest accrues only on the amount actually borrowed at any time, not on the entire credit line Payments occur monthly (or, with business lines of credit, even on a daily basis) Lines of credit include: Credit card agreements (typically unsecured) Home equity line of credit (secured by home) Business line of credit (secured by business assets) Line of Credit Loans In the business context, a line of credit is often secured by a pool of all collateral of a particular type or types (not just one discrete item of property) Security agreements for such loans typically use generic collateral descriptions, e.g., all of the Debtor s inventory After-Acquired Collateral 9-204(a): [A] security agreement may create or provide for a security interest in afteracquired collateral. E.g., Debtor grants Bank a security interest in all of Debtor s inventory, whether now-owned or after-acquired Each time Debtor acquires a new item of inventory in the future, Bank s SI will attach to that new inventory, by virtue of after-acquired property clause [ 9-203(b)(2)] Collateral Description Allowing SI in generic classes of collateral, and in after-acquired collateral of those types, creates transactional efficiencies Bank can describe collateral in generic terms ( all inventory ) rather having to define each item of inventory with specificity Bank and Debtor only have to sign one security agreement (e.g., no need to sign a new agreement each time Debtor gets new shipment of inventory) 2

3 Collateral Description The true purpose of collateral description requirement is to enable judge (in event of a dispute) to identify whether a particular item of property is subject to a SI If the description is sufficiently specific, this isn t problematic If the description is generic, then it becomes critical that the creditor correctly classified the property Problem 1(a): How Would You Classify the Debtor s Mercedes S550 Under Article 9 s Collateral Scheme? Goods [ 9-102(a)(44)] Goods are tangible items that are movable at the time the SI attaches Article 9 has 4 mutually exclusive categories of goods: (1) consumer goods; (2) farm products; (3) inventory; and (4) equipment Classification is based upon debtor s primary use of the goods Types of Goods Goods are consumer goods if they are used or bought for use primarily for personal, family, or household purposes [ 9-102(a)(23)] Goods are farm products if debtor is engaged in farming and goods are (a) crops, (b) livestock, (c) farming supplies, (d) products of crops or livestock [ 9-102(a)(34)] 3

4 Types of Goods Problem 1: Possible Classifications Goods are inventory if they are not farm products and are held for sale or lease, raw materials, or materials used or consumed in business [ 9-102(a)(48)] Goods are equipment if they are not consumer goods, farm products, or inventory (equipment is the residual category of goods) [ 9-102(a)(33)] BEAGLE MERCEDES CONSUMER GOODS Maybe (if dog is a pet) Maybe (car is debtor s personal car) INVENTORY Maybe (if debtor runs a pet store and this dog is for sale) Maybe (debtor is car dealer and car is for sale) FARM PRODUCTS Maybe (if debtor is a dog breeder) No EQUIPMENT Maybe (if debtor runs guided hunts using this dog) Maybe (car is debtor s company car) How would a box of paper clips be categorized under Article 9 s classification scheme? Would the debtor s use of them matter? Problem 1(c) If used for personal, family, household use, paper clips are consumer goods [ 9-102(a)(23)] If used for business purposes, paper clips are inventory and not equipment Inventory includes materials used or consumed in business [ 9-102(a)(48)] even if not held for sale or lease cmt. 4a: [G]oods used in a business are equipment if they are fixed assets or have a relatively long period of use, but are inventory if they are used up or consumed in a short period of time in producing a product or providing a service. [E.g., paper clips in an office; toner in an office copier; gas in a company car, etc.] 4

5 Problem 1(d): How Would You Classify the Debtor s Home? Problem 1(d): Home Lender cannot create a SI in real property using an Article 9 security agreement A security interest can be created in personal property or fixtures [ 9-109(a)(1)] However, Article 9 does not apply to a lien on real property other than fixtures [ 9-109(d)(11)] To create a valid lien on real estate, lender would have to have debtor execute a mortgage/deed of trust covering the home (real property law) Intangible Collateral Account [ 9-102(a)(2)]: right to payment for property sold or to be sold, or services rendered or to be rendered (and certain other specific payment rights) General intangible [ 9-102(a)(42)]: any intangible right that is not an account This includes choses in action (legal claims), intellectual property rights, and goodwill 9-102(a)(2). Account... means a right to payment of a monetary obligation, whether or not earned by performance, (i) for property that has been or is to be sold, leased, licensed, assigned, or otherwise disposed of, (ii) for services rendered or to be rendered, (iii) for a policy of insurance issued or to be issued,... (v) for energy provided or to be provided, (vi) for the use or hire of a vessel under a charter or other contract, (vii) arising out of the use of a credit or charge card..., or (viii) as winnings in a lottery or other game of chance... The term does not include (i) rights to payment evidenced by chattel paper or an instrument, (ii) commercial tort claims, (iii) deposit accounts, (iv) investment property... or (vi) rights to payment for money or funds advanced or sold [other than rights arising out of use of a credit card]... 5

6 9-102(a)(42). General intangible means any personal property, including things in action, other than accounts, chattel paper, commercial tort claims, deposit accounts, documents, goods, instruments, investment property, letter-of-credit rights, letters of credit, money, and oil, gas, or other minerals before extraction. The term includes payment intangibles and software. Problem 1(f): Debtor s Right to a Tax Refund? Note: This is the residual catch-all category for anything that doesn t fit any other collateral classification (incl. all intellectual property) Problem 1(f): Tax Refund? Problem 1(e): Debtor s Checking Account? By catch-all, right to collect a tax refund is a general intangible (specifically, a payment intangible ) [ 9-102(a)(61)] The term account excludes rights to payment for money or funds advanced or sold (unless arising from use of a credit card) Thus, if a security agreement described the collateral as only all of Debtor s accounts, it would not cover the Debtor s income tax refund! 6

7 Problem 1(e): Checking Account Checking account is deposit account [ 9-102(a)(29)], not an account [ 9-102(a)(2)] Suppose Litton loans Crouch $2,500, and Crouch signs a security agreement granting Litton a security interest in all of Debtor s accounts. Would Litton have a SI in Crouch s checking account? Why or why not? Question: when the parties used the term accounts to describe the intended collateral, did they mean... Only those rights that are accounts as defined in Article 9?, or Any rights the two of them mutually understood to be accounts (which might include a bank account)? Parties could have defined the term precisely, for purposes of their security agreement; if they didn t, should we presume the parties meant the Article 9 definition? PCB made line of credit loan to Hawley Implement Co., a dealer in farm machinery Collateral description in security agreement: all of Debtor s farm equipment Hawley is now in default. Can PCB repossess and sell machinery on Hawley s sale floor? Problem 6 Under Article 9, the collateral is inventory (not equipment ) in hands of Hawley Implement Co. (held for sale or lease) In context, though, it appears Hawley intended to grant a SI in its inventory (if Hawley is only a retailer and is not actually engaged in farming activity, Hawley probably has few or no assets that are equipment as defined by Article 9) A court probably ought to interpret farm equipment in this context to mean inventory 7

8 Problem 6 The other problem is that the agreement described the collateral as all of the Debtor s farm equipment, but without making clear whether that included after-acquired (or only the stuff on hand at the time of the agreement) Problem: Hawley has probably sold all of the original collateral and replaced it with new units! Should the court imply that the agreement covered after-acquired property of that type? In re Shenandoah Warehouse Co. Debtor (auto parts dealer) granted SI in Debtor s inventory and accounts (no reference to after-acquired Court: SI in all of Debtor s inventory implicitly covers after-acquired inventory Rationale: inventory is sold/replaced; old accounts are paid and new accounts arise Suppose security agreement covers all of Debtor s general intangibles Would it cover debtor s right to receive damages in a lawsuit? Problem 1(g) Classification of a cause of action varies under Article 9 depending on the nature of the action If the claim is a tort claim involving business activity, it is a commercial tort claim [ 9-102(a)(13)] Note: noncommercial tort claim cannot be the subject of an Article 9 SI [ 9-109(d)(12)] If the claim arises in contract, it is a general intangible (which includes things in action ) [ 9-102(a)(42)] 8

9 3 prerequisites for attachment of a security interest Effective security agreement [ 9-203(b)(3)] covering the collateral Value must have been given [ 9-203(b)(1)] Debtor must have rights in the collateral [ 9-203(b)(2)] SI attaches when last of these 3 prerequisites has occurred Attachment Putnam County Bank (PCB) loaned Junior Davis $5,000, but only after Butch (Junior s dad) orally agreed to put up his Lexus and his Rolex as collateral PCB prepared a Security Agreement that identified the collateral as Butch Davis s car and Rolex watch Junior signed it, and physically delivered the Rolex to PCB Butch retained possession of the car Does PCB have valid SI in the car and/or the watch? Problem (b) [Enforceability.] [A] security interest is enforceable against the debtor and third parties with respect to the collateral only if: (1) value has been given; (2) the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party; and (3) one of the following conditions is met: (A) the debtor has authenticated a security agreement that provides a description of the collateral ; (B) the collateral is not a certificated security and is in the possession of the secured party under Section pursuant to the debtor s security agreement. Article 9 s Statute of Frauds SI can be nonpossessory (debtor keeps possession of collateral prior to default, e.g., the Lexus) or possessory (secured party holds the collateral until repayment, also called a pledge, e.g., the Rolex) Nonpossessory SI must be created in a record that is authenticated by the debtor [ 9-203(b)(3)(A)] A signed writing is an authenticated record, but a mere oral agreement is not 9

10 Rolex: b/c PCB has possession, an oral security agreement is sufficient [ 9-203(b)(3)(B)], assuming PCB can prove that an oral agreement with Butch actually took place Turning over possession of the Rolex corroborates Butch s orally-stated intent to grant a SI in it Note, however: oral agreement may be hard to prove, especially if Butch denies its existence Lexus: for a nonpossessory SI, security agreement must be in an authenticated record Media-Neutrality: Key Terms Record : information inscribed on a tangible medium (e.g., a writing) or stored in an electronic medium retrievable in a perceivable form [ 9-102(a)(69)] Authenticate : to sign a record, or otherwise encrypt or process it, with the intent of adopting it [ 9-102(a)(7)] Problem 2 PCB has two potential problems with its claimed security interest in the Lexus 1) Butch did not sign the security agreement (instead, Junior signed it) 2) Does the agreement adequately describe the Lexus by using the description Butch Davis s car? There is a written Security Agreement that describes the Lexus, but was it authenticated by the debtor? Butch (the owner of the Lexus) is the debtor [ 9-102(a)(28)] Junior is the obligor (he owes the debt) [ 9-102(a)(59)], but he is not the debtor Thus, it is Butch that must authenticate agreement for attachment to occur under 9-203(b)(3) If Butch authorized Junior to act as his agent [ 1-103(b), UCC incorporates agency principles], Junior s signature = Butch s signature, SI is valid If not, no SI attached to the Lexus! 10

11 Sufficiency of Description... (b) [Examples of reasonable identification.] Except as otherwise provided in subsection (d), a description of collateral reasonably identifies the collateral if it identifies the collateral by: (1) specific listing; (2) category; (3) except as otherwise provided in subsection (e), a type of collateral defined in [the UCC]... (4) quantity; (5) computational or allocational formula or procedure; or (6) except as provided in subsection (c), any other method, if the identity of the collateral is objectively determinable. Does the description Butch Davis s car reasonably identify the Lexus? It depends If, at time of security agreement, Butch owned only 1 car, and it was this Lexus, then yes If Butch owned multiple cars, it wouldn t be clear from the description which one of those cars was intended to be covered! Thus, a more specific description would have been better (e.g., make, model, VIN #) First Bank loaned Crouch $20K, to be repaid in 1 year Crouch verbally agreed to grant a SI in his computer servers First Bank confirmed the verbal agreement in an message to Crouch, which reasonably identified the servers Crouch is now in default. Can First Bank repossess the servers? Problem 4 The is a record, but it is not authenticated by the debtor (Crouch) Debtor means the owner of the collateral [ 9-102(a)(28)(A)] Thus, there is still no binding security agreement under 9-203(b) If he had confirmed Bank s by sending a return (record capable of being retrieved in perceivable form ), 9-203(b)(3) would ve been satisfied, and Bank would ve had SI in the servers 11

12 said: Your acceptance of these terms shall be manifested by your acceptance of the loan proceeds Crouch accepted the loan proceeds Why isn t that good enough? Problem 4 Problem 5 ABC Corp. owed Bank $500K (unpaid loan) Bank agreed to extend the due date of the loan for 6 months if ABC s CEO, Lambert, would grant Bank a SI in two Picassos (FMV = $5MM) as collateral Lambert then signed a security agreement that described the two Picassos by name/picture Despite the extension, ABC still defaulted Value Lambert now argues that Bank s claimed SI is invalid b/c: A. The security agreement was not supported by consideration B. Lambert didn t receive value (ABC did) C. Bank didn t give sufficient value ($500K loan amount was only 10% of FMV of the Picassos) D. Lambert was only a co-owner of the Picassos and thus lacked sufficient rights in the collateral Which arguments (if any) are correct? Except as otherwise provided in Articles 3, 4, 5 and 6, a person gives value for rights if the person acquires them: (1) in return for a binding commitment to extend credit or for the extension of immediately available credit, whether or not drawn upon and whether or not chargeback is provided for in the event of difficulties in collection; (2) as security for, or in total or partial satisfaction of, a preexisting claim; (3) by accepting delivery under a preexisting contract for purchase; or (4) in return for any consideration sufficient to support a simple contract. 12

13 Problem (b)(1) requires only that value be given to support a security agreement Pre-existing debt (e.g., ABC debt owed to Bank) also constitutes value [ 1-204(2)] Besides, Bank s extension of the due date by six months = legal consideration, even if it doesn t advance any additional funds [ 1-204(4)] Value doesn t have to be given to the debtor (Lambert); value here was given to obligor (ABC Corp.); debtor can grant a SI to secure the debt of another person Problem 5 Bank s SI in the Picassos is valid 9-203(b)(1) doesn t require fair value for a SI to attach, only that some value be given Fact that Picassos are worth 10X the amount of the debt is irrelevant Enforcement would occur by sale (not by forfeiture); if Picassos sold for >> $5,000,000, the excess sale proceeds over the $500K debt go back to Lambert (this reflects his equity in the Picassos) [ 9-615(d)(1)] Even if Lambert is only a co-owner with his siblings, he still has a property right as a co-owner As tenant in common, he has a co-equal possessory right, as well as a share that he can transfer by gift, sale, devise, or inheritance This is sufficient for a SI to attach [ 9-203(b)(2)] However, Bank s SI can attach only to Lambert s rights in the collateral (his rights as a co-owner) Thus, Bank could sell only Lambert s rights as coowner (not those of his siblings) Bank should have had Lambert s siblings join in the security agreement Problem 9 Bank plans to extend a general operating line of credit to Trump Contracting, Inc. If Bank s security agreement uses the collateral description, All of Debtor s personal property of every type, now owned or after-acquired, that description is not sufficient under 9-108(c) What s the problem with that description? 13

14 Sufficiency of Description. (a) [Sufficiency of description.] Except as otherwise provided in subsections (c), (d), and (e), a description of personal or real property is sufficient, whether or not it is specific, if it reasonably identifies what is described... (c) [Supergeneric description not sufficient.] A description of collateral as all the debtor s assets or all the debtor s personal property or using words of similar import does not reasonably identify the collateral. Problem 9: Supergenerics The description all personal property is a supergeneric description that is NOT sufficient for attachment purposes [b/c it does not reasonably identify the collateral, 9-108(c)] Thus, if Bank uses this description, the security agreement will not create a valid security interest in ANY of the Debtor s property Does it make sense for UCC Article 9 to prohibit a supergeneric description? Why/why not? The concern here is arguably potential creditor overreaching, not doubt regarding reasonable identification Compare this description: All of the Debtor s equipment, inventory, farm products, consumer goods, accounts, general intangibles, software, [listing every type of collateral defined in the UCC], presently owned or after-acquired? This description is the functional equivalent of All of the Debtor s personal property But, it is clearly sufficient for attachment purposes! [It describes the collateral generically by UCC type, which is explicitly authorized by 9-108(b)(3)] 14

15 Sufficiency of Description... (b) [Examples of reasonable identification.] Except as otherwise provided in subsection (d), a description of collateral reasonably identifies the collateral if it identifies the collateral by: (1) specific listing; (2) category; (3) except as otherwise provided in subsection (e), a type of collateral defined in [the UCC]... [In other words, a generic description by UCC type reasonably identifies the collateral ] Problem 8 Last year: Consumer Finance loaned Bowman $50K to pay off gambling debts Bowman granted Consumer Finance a security interest in his Porsche Bowman later borrowed another $15K from Consumer Finance to pay his child s tuition Bowman later defaulted, and Consumer Finance repossessed/sold his Porsche for $55K Can it apply all of the proceeds to Bowman s unpaid debt (which is $65K)? After-Acquired Property; Future Advances.... (a) [After-acquired collateral.] Except as otherwise provided in subsection (b), a security agreement may create or provide for a security interest in after-acquired collateral.... (c) [Future advances and other value.] A security agreement may provide that collateral secures... future advances or other value, whether or not the advances or value are given pursuant to commitment. Answer: it depends If Consumer Finance s security agreement did not contain a future advances clause, then the SI in the Porsche would secure only the initial $50K debt (not the later $15K loan) In this event, Consumer Finance would have to return $5K surplus proceeds to Bowman If Consumer Finance s security agreement contained enforceable future advances clause, the SI in the Porsche would secure the full $65K unpaid debt 15

16 The Relatedness Standard Section 9-204(c) does not require that future advances be related to (or have the same purpose as) the original loan advance Some courts, however, have engrafted a relatedness or same class rule On this theory, Bowman might try to argue that the later advance was unrelated to the original loan (and that the later advance was thus unsecured) 16