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1. The terms used in secured transactions.
2. The elements of an enforceable security interest.
3. How and why security interests are perfected.
4. How priority disputes among creditors are decided.
5. A secured creditor’s remedies when a debtor defaults.
This chapter covers transactions in which the payment of a debt is secured (guaranteed) by personal property owned by the debtor or in which the debtor has a legal interest. The importance of being a secured creditor cannot be overemphasized—secured transactions are as basic to modern business as credit.
I. THE TERMINOLOGY OF SECURED TRANSACTIONS
UCC Article 9 applies to secured transactions.
A. SECURED TRANSACTION
Transaction in which payment of a debt is guaranteed by personal
property owned by the
debtor or in which the debtor has a legal interest.
B. SECURED INTEREST, SECURED PARTY, COLLATERAL, AND DEBTOR
A security interest is any interest “in personal property
or fixtures which secures payment or performance of an obligation”
[UCC 1–201(37)]. A secured party is any person in whose favor
there is a security interest [UCC 9–105(1)(m)]. Collateral
is the property subject to a security interest [UCC 9–105(1)(c)].
Debtor is the party who owes the payment [UCC 9–105(1)(d)].
II. CREATING SECURITY INTERESTS
A creditor’s rights attach to collateral, creating an enforceable
security interest against a debtor if the following requirements
are met [UCC 9–203].
A. WRITTEN SECURITY AGREEMENT
(1) It must be signed by the debtor and (2) contain a description
of the collateral, (3) which the description must reasonably identify
[UCC 9–203(1), 9–110]. Or the secured party must possess
the collateral.
B. SECURED PARTY MUST GIVE VALUE
Value is any consideration that supports a contract [UCC 1–201(44)]).
C. DEBTOR MUST HAVE RIGHTS IN THE COLLATERAL
The debtor must have an ownership interest or right (current or
future legal interest) to obtain
possession of the collateral.
III. PURCHASE-MONEY SECURITY INTEREST
A PMSI is (1) retained in, or taken by the seller of, goods to
secure part or all of the price, or (2) taken by a lender, such
as a bank, as part of a loan to enable a debtor to buy the collateral
[UCC 9–107].
IV. PERFECTING A SECURITY INTEREST
Perfection is the process by which secured parties protect themselves
against the claims of
others who wish to satisfy their debts out of the same collateral.
A. PERFECTION BY FILING
Filing is the most common means of perfecting a security interest.
1. What a Financing Statement Must Contain It must contain
(1) the signature of the debtor,
(2) the names and addresses of both the debtor and the creditor,
and (3) a description of the
collateral by type or item [UCC 9–402(1)].
2. Where to File a Financing Statement
Depending on how the collateral is classified: county clerk (consumer
goods), secretary of
state (other collateral), or both [UCC 9–401].
B. PERFECTION WITHOUT FILING
1. Perfection by Possession
A creditor can possess collateral and return it when the debt
is paid [UCC 9–203(1)(a)].
For some securities, negotiable instruments, and nonnegotiable
transferable instruments, this
is the only way to perfect.
2. Purchase-Money Security Interest—Automatic Perfection
A PMSI in consumer goods (and, in some states, farm equipment
under a certain value) is
perfected automatically when it is created. The seller need do
nothing more [UCC 9–302(1)(d)].
C. EXCEPTIONS TO ARTICLE 9 PERFECTION
A security interest in a motor vehicle is perfected by noting
the interest on the certificate of title. Other exceptions include
investment securities subject to Article 8 and property subject
to the Federal Aviation Act.
D. COLLATERAL MOVED TO ANOTHER JURISDICTION
1. Continues to Be Perfected for Up to Four Months From the
date it is moved or for the period
remaining in the perfection in the original jurisdiction, whichever
expires first [UCC 9–103(1)(d), (3)(e)]. Collateral moved
from county to county within a state (if local filing is required)
may not have a four-month limit [UCC 9–403(3)].
2. Automobiles
If the original state does not require a certificate of title,
perfection automatically ends four months after the move. If the
original state requires title registration, and the security interest
is noted on the certificate, perfection continues after the car
is moved to another state requiring a certificate until the car
is registered there [UCC 9–103(2)].
E. EFFECTIVE TIME OF PERFECTION
A financing statement is effective for five years [UCC 9–403(2)].A
continuation statement filed within six months before the expiration
date continues the effectiveness for five more years (and so on)
[UCC 9–403(3)].
III. THE SCOPE OF A SECURITY INTEREST
A. PROCEEDS
Proceeds include whatever is received when collateral is sold
or otherwise disposed of. A
secured party has an interest in proceeds that perfects automatically
on perfection of the
security interest and remains perfected for at least ten days
after the debtor receives the
proceeds. The interest remains perfected for more than ten days
if—
1. A filed financing statement covers the original collateral
and the proceeds are property (or
cash used to acquire property) in which a security interest may
be perfected by filing in
the same office [UCC 9–306(3)(a)].
2. There is a filed statement that covers the original collateral
and the proceeds are
identifiable cash proceeds [UCC 9–306(3)(b)].
3. The security interest in the proceeds is perfected before
the expiration of the ten-day
period [UCC 9–306(3)(c)].
B. AFTER-ACQUIRED PROPERTY
A security agreement may provide for coverage of after-acquired
property [UCC 9–204(1)]—collateral acquired by a debtor
after execution of a security agreement.
May consist of any property except consumer goods.
C. FUTURE ADVANCES
A security agreement may provide that future advances against
a line of credit are subject to
a security interest in the collateral [UCC 9–204(3)].
D. THE FLOATING -LIEN CONCEPT
A floating lien is a security agreement that provides for the
creation of a security interest
in any (or all) of the above. The concept can apply to a shifting
stock of goods—the lien can
start with raw materials and follow them as they become finished
goods and inventories
and as they are sold, turning into accounts receivable, chattel
paper, or cash [UCC 9–205].
IV. RESOLVING PRIORITY DISPUTES
When several creditors claim a security interest in the same collateral
of a debtor, which interest has priority?
A. SECURED PARTY V. UNSECURED PARTY
Secured parties (perfected or not) prevail over unsecured creditors
and creditors who have obtained judgments against the debtor but
who have not begun the legal process to collect on those judgments
[UCC 9–301].
B. SECURED PARTY V. LIEN CREDITOR
1. Secured Party’s Priority
Any perfected security interest has priority over lien creditors
who acquired their liens after perfection.
2. Lien Creditor’s Priority
A lien creditor has priority over an unperfected security interest.
Exception: a PMSI filed
within ten days (in many states, twenty days) after debtor receives
possession of collateral
has priority over lien creditor rights that arise between the
time the PMSI attaches and the
time of filing [UCC 9–301(2)].
C. WHEN MORE THAN ONE PARTY IS SECURED
1. The General Rule
The first interest to be filed or perfected has priority over
other filed or perfected security
interests. If none of the interests has been perfected, the first
to attach has priority [UCC 9-312(5)].
2. Exception—PMSI
When the first in time to file or perfect is a PMSI, the PMSI
is first in priority rights to the
collateral. Also—
a. Inventory
A perfected PMSI prevails over a previously perfected security
interest if the holder of the
PMSI perfects and gives the holder of the other interest written
notice of the PMSI
before the debtor takes possession of the new inventory [UCC 9–312(3)].
b. Other Collateral
A PMSI has priority over a previously perfected security interest
if the PMSI is
perfected either before or within ten days after the debtor takes
possession. No notice is
required [UCC 9–312(4)].
D. SECURED PARTY V. BUYER
1. The General Rule
A security interest in collateral continues even after the collateral
has been sold unless the
secured party authorized the sale [UCC 9-306(2)].
2. Exception—Buyer in the Ordinary Course of Business
Takes goods free of any security interest (unless the buyer knows
that the purchase violates a third party’s rights) [UCC 1–201(9),
9-307(1)].
3. Exception—Buyer of Farm Products from a Farmer
Under the Food Security Act of 1985, the buyer takes free of a
security interest unless he
or she (1) receives notice of the interest within one year before
the purchase; (2) fails to
register with the secretary of state before the purchase, and
the secured party perfects his or
her interest centrally; or (3) receives notice from the secretary
of state that the products
are subject to an effective financing statement (EFS).
4. Exception—Buyer of Consumer Goods from Consumer
The consumer must not know of the original interest; the purchase
must occur before the
secured party files a statement [UCC 9–307(2)].
5. Exception—Buyer of Chattel Paper and Instruments
If chattel paper perfected by filing is sold to another purchaser
who gives new value and
takes possession of the paper in the ordinary course of the purchaser’s
business, without
knowledge that it is subject to a security interest, the new purchaser
will have priority
over the secured creditor [UCC 9–308]. (The creditor has
rights in the proceeds.)
V. OTHER RIGHTS AND DUTIES UNDER ARTICLE 9
A. INFORMATION REQUESTS
When filing, creditors can ask the filing officer to note the
file number, the date, and the hour
on a copy of the statement and send it to the creditor [UCC 9–407(1)].
Others (such as
prospective creditors) can ask the filing officer to provide a
certificate that gives information
on possible perfected financing statements [UCC 9–407(2)].
B. ASSIGNMENT, AMENDMENT, AND RELEASE
A secured party can release part or all of the collateral [UCC
9–406], or assign part or all
of the security interest [UCC 9–405(2)]. A filed financing
statement can be amended, if
both parties sign [UCC 9–402].
C. REASONABLE CARE OF COLLATERAL
A secured party in possession of collateral must use reasonable
care in preserving it
[UCC 9–207(1), (3)]. If it increases in value, the party
can hold the increased value or profit
as additional security [UCC 9–207(2)(c)].
D. THE STATUS OF DEBT
When the debtor asks, the secured party must tell the debtor the
amount of the unpaid debt
(within two weeks of the debtor’s request) [UCC 9–208].
E. TERMINATION STATEMENT
When a debt is paid, the secured party can send a termination
statement to the debtor or
file it with the original financing statement.
1. If the Collateral Is Consumer Goods
The statement must be filed within one month after the debt is
paid, or—if the debtor requests
the statement in writing—within ten days of receipt of the
request, whichever is earlier
[UCC 9–404(1)].
2. If the Collateral Is Other Goods
The statement must be filed or furnished to the debtor within
ten days after a written request is
made by the debtor.
VII. DEFAULT
Default is whatever the parties stipulate in their agreement [UCC
9–501(1)]. It occurs
most often when the debtor fails to make payments or goes bankrupt.
A. BASIC REMEDIES
1. Execution and Levy
A secured party give up the security interest and proceed to judgment
on the debt (this is
done if the value of the collateral is less than the debt and
the debtor has other assets)
[UCC 9–501(1)].
2. Take Possesion of the Collateral
A secured party can take possession of the collateral [UCC 9–503]
and retain it for
satisfaction of the debt [UCC 9–505(2)] or resell it and
apply the proceeds toward the debt
[UCC 9–504] (see below).
B. SECURED PARTY’S RIGHT TO TAKE POSSESION OF THE COLLATERAL
A secured party can take possession of the collateral without
a court order, if it can be
done without a breach of the peace [UCC 9–503]. Generally,
this means not going
onto the debtor’s property, which could be trespass.
C. DISPOSITION OF COLLATERAL
1. Retention of Collateral by the Secured Party
a. Notice
A secured party must give written notice to the debtor. In all
cases except consumer goods,
notice must also be sent to any other secured party from whom
the secured party has
received notice of a claim.
b. If Debtor or Other Secured Party Objects within Twenty-One
Days
The secured party must sell or otherwise dispose of the collateral
[UCC 9–505(2)].
2. Consumer Goods
If the collateral is consumer goods with a PMSI and the debtor
has paid 60 percent or
more on the price or loan, the secured party must sell within
ninety days, [UCC 9–505(1),
9–507(1)] .
3. Disposition Procedures
(1) A sale must be in a commercially reasonable manner and (2)
the debtor must be
notified of the sale [UCC 9–504].
a. What Qualifies as a Commercially Reasonable Sale?
When collateral is sold in the usual manner in the usual market
for selling such goods or in
conformity with reasonable commercial practices among dealers
in the type of property
sold [UCC 9–507].
b. The Secured Party Must Give Written Notice to the Debtor
To the debtor. In all cases except consumer goods, notice must
also be sent to any other
secured party from whom the secured party has received notice
of a claim [UCC 9–504(3)], unless the collateral is perishable
or is customarily sold in a recognized market.
4. Proceeds from Disposition
Must be applied to (1) expenses stemming from the retaking, holding,
or preparing for sale, (2) satisfaction of the debt, (3) creditors
with subordinate security interests [UCC 9–504(1)], and (4)
surplus to the debtor. The debtor is liable for any deficiency.
5. Deficiency Judgment
In most cases, if a sale of collateral does not repay the debt,
the debtor is liable for any deficiency. A creditor can obtain
a judgment to collect.
6. Redemption Rights
Before the secured party retains or disposes of the collateral,
the debtor or any other secured
party can take the collateral by tendering performance of all
secured obligations and
paying the secured party’s expenses [UCC 9–506].