Scope and Mechanics of Article 9
Article 9 of the UCC applies toANYtransaction intended to create asecurityinterestin personal property or fixtures (not mortgages on real property). A security interest gives a creditor the right to sell a debtor’s property in order to satisfy a debt.
Generally, in an Article 9 transaction, personal property or fixtures secure the payment of a debt or insure performance of a contract obligation with the property serving as collateral.
There are three main parties to an Article 9 transaction:
Secured Party.The secured party is the creditor who possesses the benefit of the security interest.
Debtor.The debtor is the party who has an ownership interest or other sufficient interest in the personal property securing the obligation.
Obligor.The obligor is the party held responsible for the underlying obligation (usually also the debtor, but could be a type of guarantor).
Collateral
Collateralrefers to the property in which a security interest is created, and it extends toidentifiableproceedsfrom the property that serves as collateral. Article 9 defines different types of collateral as follows:
Goods.Goods are all things that are movable when a security interest attaches.
Consumer Goods.Consumer goods are goods that are used mainly for personal, family, or household purposes.
Inventory.Inventory includes goods that are kept by a person for sale or lease (does not include goods that are only being held for repair).
Accounts.A security interest in a debtor’s “accounts” covers any right to payment of a monetary obligation, whether or not earned by performance, for property that has been or is to be sold (i.e., accounts receivable). A secured party can collect directly from the person who owes the debtor if the debtor defaults.
Attachment Elements
Attachmentis essentially how a security interest is created. A security interest attaches to collateral when it becomes enforceable against the debtor with respect to the collateral, unless an agreement expressly postpones the time of attachment. Avalid attachment requires that:
The creditor extends value to the debtor (almost any consideration will suffice);
the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party;AND
A§9-203(b)(3)condition is met.
§ 9-203(b)(3) is usually satisfied by authentication of a security agreement or when the creditor takes control of the collateral from the debtor.
Authentication requires the debtor to authenticate the security agreement by providing the creditor with a reasonable description of the collateral in writing. Signature, thumbprint, initials, mechanical reproductions, etc., are all adequate proof of authentication of the security agreement so long as the debtor possessed the intent to authenticate the writing.
Consignment
Aconsignmentis a transaction in which a person delivers goods to a merchant for the purpose of sale in which:
The merchant:
Deals in goods of that kind under a name other than the name of the person making delivery;
IsNOTan auctioneer;AND
IsNOTgenerally known by its creditors to be substantially engaged in selling the goods of others.
The aggregate value of the goods is $1,000 or more at the time of each delivery;
The goods areNOTconsumer goods immediately before delivery;AND
The transaction doesNOTcreate a security interest that secures an obligation.
Article 9 provides that in order to determine the rights of a consignee’s creditor, the consignee (the debtor) has rights and title to the goods identical to those of the consignor. Under a consignment, the consignee possesses the full ownership interest of the consignor in the goods, such that as the security interest of the consignee’s creditor will attach to them.
Specification Clauses.
Default.The parties may specifically define what constitutes a default. If left undefined, non-payment generally constitutes a default.
Acceleration.The parties may provide for the acceleration of payments upon the happening of a specified event (e.g., full balance becomes due if payment is 7 days late).
Covenants.The parties may covenant certain things to each other regarding the collateral (e.g., the secured party may require the debtor to maintain insurance covering the collateral property).
Use or Disposition of Collateral by a Debtor
A security agreement willNOTbe invalid because the debtor possesses a right to use or dispose of the property serving as collateral.
Collateral in Secured Party’s Possession
A secured party must use reasonable care in the custody and preservation of collateral in the secured party’s possession.
Accessions
An accession is collateral that doesNOTlose its identity when physically united with other goods (e.g., a jet engine serving as collateral does not lose its identity when it is installed into a jet). A security interest may be created in the property that does not lose its identity and continues in the accession collateral.
Commingled Goods
A commingled good is collateral that loses its identity when physically united with other goods (e.g., 100 pounds of flour serving as collateral loses its identity when physically united with other ingredients to form cake products). If collateral becomes commingled with other goods, a security interest attaches to the product that results.
Methods of Perfection
Generally, there are three different methods in which a security interest may be perfected:
Filing.The filing of a “financing statement” or the security agreement with the state is the primary method of perfection. The filingMUSTbe filed by an authorized party (authorization is presumed by the debtor’s authentication of the security agreement). Minor errors will not invalidate the financing statement unless the error makes it seriously misleading. The filing must contain:
The debtor’s name;
if the debtor is a registered organization, the financing statement must provide the official registered name of the organization.
The secured party’s name;
An adequate description of the collateral;AND
The filing fee.
Taking Possession.A secured party may perfect a security interest in negotiable documents, goods, instruments, or money by taking mere possession of such items.
Automatic Perfection.The following security interests are perfected automatically when they attach:
A purchase-money security interest in consumer goods;AND
An assignment of accounts which doesNOTby itself or in conjunction with other assignments to the same assignee transfer a significant part of the assignor’s outstanding accounts.
Perfected vs. Unperfected Interests
A perfected security interest has priority over a conflicting unperfected security interest in the same collateral (even if the unperfected interest is a purchase-money security interest in inventory).
Multiple Perfected Creditors
Between multiple perfected creditors, the first to file obtains priority (even if a party files before they perfect for priority purposes).
Some collateral is not subject to the state filing system or cannot otherwise be filed. In these instances, the first to perfect obtains priority.
Generally, knowledge of a prior unperfected interest will not prevent a potential secured party from filing first to obtain priority.
Lien Creditors
Lien creditors possess virtually the same status as perfected secured creditors. Accordingly, if a party becomes a lien creditor before a secured party files or perfects, the lien creditor will enjoy priority over that party. Their priority also extends to future advances secured:
Before the lien arose;
Within 45 days of the lien;OR
Without knowledge of the lien.
Buyers in the Ordinary Course of Business
A buyer in the ordinary course of business takes the item free of a security interest created by the buyer’s seller even if the security interest is perfectedand the buyer knows of its existence.The protected buyer may sell the purchased collateral to a third-party free of the secured party’s security interest (“shelter principle”).
The term “buyer in ordinary course of business” is defined in UCC Article 1 as “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 . . . in the business of selling goods of that kind.” UCC § 1-201 (b)(9). Reading sections 9-320 (a) and 1-201 (b)(9) together establishes that one can be a buyer in the ordinary course of business if one knows merely that the property purchased is subject to a perfected security interest but not if one knows that the sale violates some term of the seller’s security agreement with the secured party.SeeUCC § 9-320 cmt. 3.
The purpose of the “Buyer in the Ordinary Course of Business” rule is to facilitate sales transactions between the debtor and its customers. If the debtor’s customers can buy from the debtor freely, without having to worry about security interests, the debtor is likely to sell more inventory, receive more cash, and pay down the debt to the secured party more quickly than if the rule allowed secured parties to follow their security interests into the buyer’s hands.
Consumers Buying from Consumers
A buyer of consumer goods take the goods free of a security interest, even if perfected, if the buyer buys:
Without knowledge of the security interest;
For value;
Primarily for the buyer’s personal, family, or household purposes;AND
Before the filing of a financing statement covering the goods.
Purchase-Money Security Interest (PMSI)
Generally, PMSIs have priority over prior perfected security interests if the PMSI is properly executed. A PMSI is either:
A security interest held by the seller of collateral to secure payment of all or part of the price;OR
A security interest of a person that gives value to a debtor so that the debtor may acquire rights in or the use of collateral.
A PMSI ininventorycollateral has priority over a conflicting security interest in the same collateral if the PMSI is perfected at the time the debtor receives possession and notice is provided to prior creditors. However, an unperfected PMSI in inventory will NOT have priority over a perfected security interest in the same collateral.
A PMSI innon-inventory collateral(e.g., regular goods) has priority over a conflicting security interest in the same collateral if the PMSI is perfected at the time the debtor receives possession of the collateral or within 20 days thereafter (i.e., the creditor has a 20-day grace period to file upon receipt of the collateral).
Remember, a PMSI inconsumergoodsperfects automatically upon attachment (no filing required).
Right to Repossess
Upon default, the secured party may attempt to take possession of the collateral without judicial process so long as they do not commit abreach of the peace. Article 9 does not define what actions constitute a breach of the peace; however, breaking into locked property will generally suffice. Some case law suggests thatANYopposition to the entry or seizure, however slight, normally results in a breach of the peace.
Right to Dispose of Collateral
Upon default, a secured party may sell, lease, license, or otherwise dispose of any or all of the collateral in its present condition or in any commercially reasonable manner.
Sale (Non-Judicial Foreclosure)
Upon default, a secured party may dispose of collateral in its possession by way of a sale so long as it iscommerciallyreasonableas to method, manner, time, place, and terms. Article 9 requires the secured party to sendreasonablenotificationof the time and place of any public sale to the debtor and any secondary obligor in atimelymannersuch that the debtor and any secondary obligor have sufficient time to take appropriate steps to protect their interests (e.g., by taking part in the sale).
Strict Foreclosure (Purchase Rules)
Unless otherwise agreed, a secured party may purchase the collateral at a public or private saleONLY IFthe collateral is of a kind that is customarily sold on a recognized market (e.g., stock market) or the subject of widely distributed standard price quotations.
Right to Collect Directly
Upon default, a secured party has the right to collectdirectlyfrom the account debtor (the person who owes the debtor on the account). To exercise this right, the secured party must send anauthenticatednotificationto the account debtor informing the account debtor that the amount due has been assigned and that the payment is to be made to the assignee. Upon receipt of proper notification, the account debtor may discharge its payment obligationONLYby payment to the assignee (the secured party).
Non-Complying Disposition of Collateral
When a creditor makes a non-complying disposition of collateral under Article 9, the debtor can:
Recover actual damages;
Actual damages are those reasonably calculated to put an eligible claimant in the position that it would have occupied had no violation occurred.
Recover statutory damages;OR
If the collateral involved is consumer goods, the amount of minimum statutory damages must be at least: the credit loan interest amount + 10% of the loan’s principal amount.
$500 in statutory damages is also recoverable for each violation of certain Article 9 provisions.
Be subject to judicially mandated disposition of the collateral.
If the creditor is attempting to improperly dispose of collateral, a court may order or restrain collection, enforcement, or disposition of the collateral on appropriate terms and conditions (e.g., the court could order the creditor to allow the debtor to redeem the collateral, conduct a public sale, etc.).
Right of Redemption
Generally, a debtor or any secondary obligor has the right to redeem (i.e., reclaim) collateral until the secured party has disposed of it or entered into a contract for its disposition. To redeem collateral, the debtor must:
Fulfill all obligations secured by the collateral;AND
Pay the reasonable expenses and attorney’s fees.
Surplus and Deficiency
Generally, when a secured party sells or disposes of collateral, the amount collected varies from the amount of the obligation.
If the sale brings inMOREthan the underlying obligation, the secured party must pay the debtor for any surplus.
Conversely, when the sale brings inLESSthan the underlying obligation, the obligor is liable for any deficiency.
However, neither side is liable for any surplus or deficiency if the underlying transaction involves the sale ofaccounts,chattel paper,payment intangibles, orpromissorynotes.
Article 9 does not expressly address the right of a creditor to recover any deficiency in a consumer goods transaction after violating Article 9. Different jurisdictions have adopted the following two rules to address this issue:
Absolute Defense.Some jurisdictions deny the secured creditorANYdeficiency if they violate Article 9.
Rebuttable Presumption Rule.In some jurisdictions, if the secured creditor violates Article 9, it is presumed that the proceeds from the disposition (i.e., sale) are equal to the debt owed. In order to rebut, the secured creditor then has the burden to show that even at a complying disposition, the collateral is worth less than the amount owed by the debtor.
Fornon-consumer goodstransactions, Article 9 expressly applies the rebuttable presumption rule.
