E-mail Question and Answer [Last Updated Wednesday, Dec. 12 at 9:45am]

1. 9-626(a)(3) states that the "liability of a debtor or a secondary obligor for a deficiency is limited..." and then adopts the rebuttable presumption rule for nonconsumer transactions. Then end of the first paragraph in comment 3 seems to brush over the statutory language and states that the rule would apply to obligors or debtors, but the statutory language is pretty clear that an obligor, simply by virtue of being an obligor, is not included. What rule is applied when there is a deficient sale and the obligor is a different person than the debtor? Is the comment determinative despite the statutory language?

Keep in mind that when the Code uses the term “debtor” within the confines of section 9-626 (which focuses upon potential liability for a deficiency judgment), the term “debtor” should be understood to mean “debtor who is also an obligor.” You have to read it this way, because as a practical matter, a debtor that is NOT an obligor would not be liable on the debt anyway, and thus couldn’t be sued for a deficiency judgment. So any “debtor” that is being sued for a deficiency judgment must, it is being presumed, be an obligor --- the judge would simply dismiss a deficiency suit against a non-obligor debtor.

Also, keep in mind that if the debtor and the obligor were different people, and the obligor was actually injured by virtue of a commercially unreasonable sale (because the sale paid off less of the debt than it should have), the obligor would still have a cause of action for damages against the secured party under section 9-625(b). Section 9-625(c)(1).

2. Is it correct to say that a debtor has a right to redemption of collateral if the collateral is repossessed and sold at a foreclosure sale when the debtor was never in default? Or rather, do they have a right to redemption only by suing for conversion?

The secured party only has the power to sell collateral AFTER default. Section 9-610(a). If there’s no default, the sale isn’t valid. Section 9-617 does provide protection for good faith buyers at foreclosure sales that do not comply with Article 9, but even under section 9-617(a), the debtor’s right of redemption can only be terminated by sale if that sale occurs after default.

Thus, if there’s been no default, the debtor still has a right of redemption under section 9-623, and can exercise that right, even if the collateral is in the hands of a third party that bought the collateral at the foreclosure-sale-that-shouldn’t-have-happened.

3. I had a question about assignment 11, specifically when a secured party has a PMSI in inventory. The example you gave in class was: PMSI over a furniture store's inventory by seller who provides the inventory. vs. a PMSI by a bank who provides money to purchase inventory secured by the furniture store's inventory. In that case you apply section 9-324(b).

Do you apply 9-324(b) just when you have a two PMSIs and inventory, or would it also be applied if bank did not have a PMSI, but rather had security agreement with inventory as collateral to give a loan to renovate showroom?

The example I gave in class did not involve conflicting PMSIs in the same inventory. It involved a secured party with a prior perfected security interest in all inventory (including after-acquired), and a seller that was selling inventory to the debtor and taking back a PMSI.

The seller, to get PMSI priority over the first-in-time secured party, has to jump through the hoops of section 9-324(b) (filing before debtor takes possession of the goods, and seller has to provide prior notification to the prior-in-time secured party of seller’s intention to take a PMSI in certain inventory and describing what that inventory is).

You may be getting confused because the rationale for the section 9-324(b) notification requirement is the risk that without that notification, the prior in time secured party might advance funds to the debtor believing the new inventory was collateral against which the prior in time secured party would have priority. But just because the prior-in-time secured party might advance funds to the debtor based on that mistaken impression wouldn’t make the security interest a PMSI. If the debtor had already acquired “rights in the collateral” when it obtained the goods from the seller, then the prior-in-time secured party’s advance against those same goods would not have enabled the debtor to acquire the goods, and thus it wouldn’t be a PMSI (even though the seller’s interest in the same goods would be a PMSI).

For example, take the following hypo: 1) Debtor borrows $150,000 from Bank, which takes/perfects a security interest in all of Debtor’s inventory, including after-acquired. 2) One year later, Debtor buys 100 widgets from Seller, which takes a PMSI in the widgets. 3) Unaware that the widgets are Seller’s purchase money collateral, Bank advances $10,000 to Debtor based upon those widgets.

In this problem, Bank’s security interest in the widgets is not a PMSI, b/c Bank’s advance did not enable the Debtor to acquire the widgets --- Debtor had already acquired the widgets from the Seller. But keep in mind that because Bank is prior perfected, Bank doesn’t need PM status to have priority. Bank will already get priority, based upon first to file, unless Seller qualifies for PM priority. [Which, in this example, Seller wouldn’t qualify for, since there was no pre-notification under section 9-324(b).]

4. My notes say that under § 9-317(a)(2)(B), a security interest that attaches AFTER a lien creditor acquires its lien has priority only if, before the judgment lien arose, a financing statement was filed and a security agreement was signed. To me, this seems to say that a security interest that attaches AFTER a lien creditor acquires its lien has priority only if its security interest is perfected (attachment plus filing financing statement) BEFORE the lien creditor acquires its lien. What am I missing?

The statement in your notes is correct. Your conclusion in the next sentence is not. Keep in mind that a financing statement can have been filed, and a security agreement can have been signed, but there still might not be a valid security interest yet!

Take this example: 1) On January 2, Debtor goes to Bank to get a loan, secured by Debtor's equipment. Bank files a financing statement covering the equipment, and Debtor signs a security agreement covering the equipment. Bank doesn't loan Debtor the money yet, however, because Bank has to run a credit check on the Debtor. Bank begins the credit check. 2) On January 5, Creditor (who has a judgment against Debtor) levies on the equipment. 3) On January 7, Bank receives the credit check, which (by mistake) doesn't show the judgment against Debtor. Bank then goes ahead and loans $30,000 to Debtor.

In this situation, Bank doesn't get its security interest until January 7, because it didn't give value until that date (it wasn't committed to make the loan before then). Thus, that's the date its security interest attached and was perfected. That's after Creditor got its judgment lien. But, under § 9-317(a)(2)(B), Bank's security interest will have priority over Creditor in this situation.

NOTE: If Bank hadn't had the Debtor sign the security agreement back on January 2, and instead Debtor had signed the security agreement on January 7 when the loan was made, then § 9-317(a)(2)(B) wouldn't protect Bank, and instead would give Creditor's lien priority over Bank's security interest.

5. Will accessions (section 15.05 of Understanding Secured Transactions) and commingled goods (section 15.06 of Understanding) be covered on the final exam? They were included in our reading assignment but not discussed in class or on the slides.

No. The subject of commingling of cash proceeds (and its impact on identifiability, since a security interest extends only to identifiable proceeds) is covered, but the specific priority rules in section 9-336 for commingled goods are not, and neither are the specific priority rules in section 9-335 on accessions.

6. In class, you said (in discussing the rationale for purchase money priority) that granting purchase money priority to a purchase money secured party doesn't harm the first in time creditor (the secured party with a security interest in after-acquired property of that type). But if the PM secured party gets priority over an earlier secured party, doesn’t that mean the secured party will be later in line if there is a bankruptcy proceeding?

Yes, but so what? If the PM secured party hadn't extended the credit, the debtor most likely would not have been able to acquire that asset in the first place --- and the prior-in-time secured party thus wouldn't have gotten a security interest in it by virtue of its after-acquired property clause. The idea is that granting PM priority to the PM secured party doesn't leave the prior-in-time secured party any worse off than it would have been had the PM credit not been extended.

§ 9-338 does not apply in the situation of the wrongly-rejected filing, but there is a separate priority rule in § 9-516(d) that does apply. Under § 9-516(d), if the filing officer wrongly rejects the filing, it is generally effective, but not as against a purchaser who gives value in reasonable reliance upon the absence of the financing statement from the filing records. Thus, take this example: (1) Debtor grants Bank a security interest in Debtor's printing press. (2) Bank tries to file a financing statement, but is wrongly rejected. (3) One week later, and before Bank has made a successful filing, Debtor sells the printing press to Smith, who does not know that Bank has a security interest. Bank's wrongly-rejected financing statement is not effective not to perfect the Bank's security interest as against Smith, who takes free of that security interest under § 9-516(d).

If instead Debtor had kept the printing press, but had instead filed for bankruptcy, Bank's financing statement would have been sufficient to perfect the security interest as against the bankruptcy trustee, who (as a lien creditor) is not entitled to the protection of § 9-516(d).

8. I am trying to reconcile § 9-324(b) and § 9-330. Is there a situation where one party may have a purchase money security interest in inventory under § 9-324(b) and another party/purchaser has a possessory interest in chattel paper that constitutes proceeds of that inventory under § 9-330? It seems that the comments suggest that the PMSI in inventory would win in any situation, but they are vague and difficult for me to understand. Moreover, I can’t figure out if or how § 9-330(e) would apply.

Yes. § 9-324(b) provides that if a secured party qualifies for PM priority as to inventory (over a conflicting security interest in the same inventory), that priority extends to proceeds of the inventory, but only in the following situations: (1) if the proceeds are "chattel paper or an instrument ... if so provided in Section 9-330" and (2) if the proceeds are "identifiable cash proceeds ... received on or before the delivery of the inventory to a buyer." Let's take several examples to illustrate.

Example 1: Bank has prior perfected security interest in Debtor's inventory. Seller sells Debtor new machines, taking a PMSI in the machines and takes the steps necessary to qualify for priority under § 9-324(b). Debtor sells the machines to Buyer, who pays cash before taking delivery. Both Bank and Seller have a security interest in the cash proceeds, but Seller's PM priority in the inventory extends to the cash proceeds, so Seller has priority in the cash proceeds over Bank.

Example 2: Bank has a prior perfected security interest in Debtor's inventory and accounts. Seller sells Debtor new machines, taking a PMSI in the machines and takes the steps necessary to qualify for priority under § 9-324(b). Debtor sells the machines to Buyer on 30-day open account. Both Bank and Seller have a security interest in the account. Under the language of § 9-324(b), Seller's PM priority in the inventory does not extends to the account (it is not chattel paper, an instrument, or identifiable cash proceeds). Thus, Bank has priority in the account over Seller, and Bank's priority will extend to the proceeds of the account (once Buyer pays the account).

Example 3: Bank has a prior perfected security interest in Debtor's inventory. Seller sells Debtor new machines, taking a PMSI in the machines and takes the steps necessary to qualify for priority under § 9-324(b). Debtor sells the machines to Buyer on an installment contract (with Debtor retaining title until the Buyer completes performance under the contract). Seller does not take possession of the contract. Both Bank and Seller have a security interest in the contract (which is "chattel paper"). Seller's PM priority in the inventory does not extend to the chattel paper because Seller does not satisfy the "if so provided in Section 9-330" language contained in § 9-324(b). Seller is deemed to have given "new value" for the chattel paper because Seller extended PM credit to enable the Debtor to buy the inventory. § 9-330(e). But, while the Seller gave "new value," it didn't take possession of the chattel paper and thus can't claim priority over Bank's interest in the chattel paper (which is claimed merely as proceeds of inventory) under § 9-330(a). Thus, Bank's security interest in the chattel paper will have priority over Seller's interest in the chattel paper.

Example 4: Bank has a prior perfected security interest in Debtor's inventory. Seller sells Debtor new machines, taking a PMSI in the machines and takes the steps necessary to qualify for priority under § 9-324(b). Debtor sells the machines to Buyer on an installment contract (with Debtor retaining title until the Buyer completes performance under the contract). Seller takes possession of the contract. Both Bank and Seller have a security interest in the contract (which is "chattel paper"). Seller's PM priority in the inventory extends to the chattel paper because Seller does satisfy the "if so provided in Section 9-330" language contained in § 9-324(b). Seller is deemed to have given "new value" for the chattel paper because Seller extended PM credit to enable the Debtor to buy the inventory. § 9-330(e). Seller also took possession of the chattel paper and thus can claim priority over Bank's interest in the chattel paper (which is claimed merely as proceeds of inventory) under § 9-330(a). Thus, Seller's PM priority extends to the contract, and Seller has priority over Bank with respect to the contract.

9. In class, you suggested that a secured party taking a security interest in an instrument should take possession of it because the instrument has the character of negotiability. But you also said that a filing a financing statement can protect the secured party from having its interest avoided by the bankruptcy trustee. Are these statements consistent?

Yes. A security interest in an instrument can be perfected either by filing, § 9-312(a), or by possession, § 9-313(a). However, because an instrument has the character of negotiability, § 9-330(d) provides that a purchaser of an instrument that gives value and takes possession of it will take priority over a prior security interest in the instrument. Therefore, perfection by possession is the preferred method of perfection for a security interest in an instrument, because that makes it impossible for the debtor to negotiate (transfer) the instrument to a good faith purchaser for value.

But remember that the bankruptcy trustee is not a "purchaser for value" within the meaning of § 9-330(d). The trustee only has the status of a lien creditor. Therefore, since a security interest in an instrument can be perfected by a filing, perfection by filing would be sufficient to ensure the secured party would have priority over the bankruptcy trustee if the debtor filed for bankruptcy.

10. You said that a statement of account under § 9-210(a) only confirms the balance of the debt on the specific date of the statement and does not create a representation that the secured party will not lend the debtor additional amounts in the future (which might be secured thanks to a future advance clause, or because the secured party takes another security interest to secure that future loan). You suggested that estoppel would not be appropriate unless the secured party makes a representation about its intention to lend the debtor additional funds. What sort of representation would be enough?

It would depend upon the nature of the statement, because estoppel is always a contextual, highly fact-dependent doctrine. If the secured party said "AT THE PRESENT TIME, WE DO NOT EXPECT TO LOAN THE DEBTOR ANY ADDITIONAL FUNDS," that's not unequivocal enough for a subsequent lender to rely upon. In the future, the already-perfected secured party could change its mind and loan the debtor additional funds, and thus a subsequent lender couldn't reasonably rely upon such an equivocal statement. If the statement was instead, "WE REPRESENT THAT IN THE FUTURE, WE WILL NOT LOAN THE DEBTOR ADDITIONAL FUNDS,” that's a more certain statement that could form the basis of an estoppel (or at least a strong estoppel argument).

11. I understand that § 9-315(a)(1) is about attachment and § 9-507(a) is about perfection and you have to read both provisions together. Under § 9-507(a), financing statement is still effective even if the secured party consents to the disposition. However, § 9-315(a)(1) states that a security interest continues unless the secured party authorized the disposition. Is there a difference between authorizing and consenting to the disposition? Does this mean that if a secured party consents to the disposition, it will lose its security interest in that particular good but will maintain perfection over that good? That doesn't seem right.

There's a big difference. § 9-315(a)(1) says that a security interest will continue in the collateral following sale of the collateral unless the secured party authorized its disposition "FREE OF THE SECURITY INTEREST." In other words, the secured party could either authorize a sale free of its security interest, or it could allow the sale but only subject to its existing security interest. In the former case, the buyer would take free of the security interest; in the latter case, the buyer would take subject to the security interest.

§ 9-507(a) would only be relevant in the latter case. In the former case, the security interest no longer exists after the sale, and if the security interest no longer exists, the filed financing statement can no longer be sufficient to perfect it. In the latter case, the security interest still exists, and the filed financing statement remains effective to perfect that security interest (even though the financing statement identifies the original debtor and not the buyer).

12. About the problem we dealt in class about Bert Smith incorporating his business as Bert's Plumbing, Inc. and the effect of this on an after-acquired clause in the security agreement entered into by Bert Smith before he incorporated — if we conclude that Bert's Plumbing Inc. is not a new debtor under § 9-203(d), what would be the consequence regarding after-acquired property acquired by Bert's Plumbing? Is it correct to say that the secured party would have no security interest in those items?

Yes, that's correct. If Bert's Plumbing, Inc. is not a "new debtor," then the original security agreement agreed to by Bert Smith, and the after-acquired property clause in that agreement, will not bind Bert's Plumbing, Inc. Thus, the new assets acquired by Bert's Plumbing, Inc. would not be "collateral" unless Bert's Plumbing, Inc. either (a) expressly ratified the security agreement originally entered into by Bert Smith, or (b) entered into a new security agreement with the secured party which covered the present and after-acquired property of Bert's Plumbing, Inc.