File EOE So That You Can T Be Beat in Bankruptcy

Secured TransactionsOutline

Cassi Franks

Fall 2010

Triple play of Art. 9

File EOE so that you can’t be beat in bankruptcy

Stay fully secured so you get what you are owed

Provide for default in SA so you can get collateral upon default

CHAPTER 1

General Definitions
Lien: an interest in the debtor’s property given by the law to protect a creditor
Two types:
Consensual lien: debtor voluntarily grants the interest
Mortgage: consensual lien on debtor’s real property
Security interest: consensual lien in personal property or fixtures
Involuntary lien: Not consensual
Judicial lien: arising from judicial proceedings
Statutory line: imposed by either statute or common law in favor of certain creditors the law deems worthy of protection
Examples: liens given to landlords, artisans, repairing personal property, attorneys, etc.
Pledge: the debtor (pledgor) gives physical possessin of the collateral to the creditor (the pledge) until the debt is paid
Possession perfects the creditor’s interest in the collateral, even against the bankruptcy trustee
Chattel mortgage: mortgaging of personal property (chattels), allowing the debtor to keep possession with a record of the mortgage kept in a designated place & indexed under the name of the debtor
Factor: a financing entity who loaned money against inventory the manufacturer put up as collateral in exchange for a lien in the inventory
Security interest: an interest in personal property & fixtures which secures payment or performance
Defined in UCC § 1-201(35)
Interest defined by Barnes as any interest at all that would support a claim of ownership, possession, right to use (ex: lease), or any other equitable claim
Note: ownership interest is not what is required- instead, it is equitable or title interest
Personal property or fixtures:
Barnes defined fixtures as those things that are so associated with the real estate that if you mortgaged/purchased/etc. the real estate, those things would go with it
Notice: not included here are services & real estate
Which secures
Barnes defined as standing in the place of performance; collateral
Thus, Art. 9 secures the personal payment obligation
Payment or performance
And if there is no payment or performance, then we get into the secondary part: the collateral
Security interest includes:
Any interest of a consignor & a buyer of accounts, chattel paper, a payment intangible, or a promissory note in a transaction that is subject to Art. 9.
Other definitions: See § 9-102
Article 9 & Bankruptcy
Perfected creditors
If you have met Article 9 requirements, if the debtor declares bankruptcy, the creditor (your client) can get the secured property (collateral) out of the estate.
Unperfected creditors
If you are an unperfected creditor, you don’t get anything until the following are paid in full: the expenses of the bankruptcy proceedings, wages of the bankrupt’s employees, some tax claims, & certain other priority claimants.
Anything that falls under these two categories is lost under the strong arm provisions in bankruptcy code § 544(a) & (b):
Unsecured creditors
Unperfected creditors
The trustee is always anunperfected lien creditor coming into existence on the date of the bankruptcy petition filing.
The validity of the security interest is a matter of state law & will be measured by state standards
If a security interest is determined to be unperfected, the interest is destroyed & the creditor becomes unsecured (falls into general creditor category)
Case: Benedict v. Ratner
FACTS: Hub Carpet was selling carpet to buyers on account. Ratner lent $15,000 to Hub in return for collateral (present & future A/R of Hub). At the time, the A/R was over $100,000, and thus, the debt was over-secured. The existence of the assignment was to be kept secret, & Hub reserved the right to dispose of the security (the accounts). Benedict is the trustee for Hub Carpet & sues Ratner
Justice Brandeis held that the conveyance was fraudulent under NY property law.
There was no notice of the conveyance, as it was to be kept secret. Thus, the public notice which was given at the time of the original transaction that such a security exists was eviscerated when that security was sold.
Note: only common law at time of this case
To have given proper notice, Ratner would have had to notify all of Hub’s customers of the transfer, telling them that he now owned the loan & they were to make payment to him & not Hub.
Everything that comes after this case, including Article 9, is because we believe in public notice
Public notice  “perfect”

CHAPTER 2: SCOPE

The Scope of Article 9
Security interest, defined in 1-201(35): an interest in personal property or fixtures which secures payment or performance of an obligation & includes interests of ….
Thus, elements are:
Interest
Personal property or fixtures
Which secures payment or performance of K
Obligation
Includes:
Consignments
Buyer of accounts
Buyer of chattel paper
Buyer of payment intangible
Promissory note in a transaction subj. to art. 9
*Barnes says that the categories of those specifically include in the definition are those that “would otherwise try to cheat.”
Barnes says: Memorize: A security interest is an interest in personal property or fixtures which includes debt or obligation to perform which includes consignments, buyers of accounts, chattel paper, or payment intangibles, or a promissory note in a transaction subject to article 9
Secured by personal property or fixtures but not real estate or services
Problem 2: Baker took his car into Mack’s Garage for repairs. He couldn’t pay the bill & mechanic wouldn’t return the car. State statute gave a repairman a possessory artisan’s lien on the property repaired.
Is the artisan’s lien an Article 9 Security interest?
No. 9-109(d)(2): Article 9 does not apply to liens (other than ag. liens) given by statute for services or materials
So, doesn’t apply to mechanic’s liens or landlord liens
If, prior to the work, Baker signed a statement giving the garage right to repossess if the bill wasn’t paid, does that create a S.I. under the Code?
9-109(a)(1): This created a security interest in personal property by contract, so Article 9 covers this agreement
Problem 3:Farmer Brown’s Vegetable Stand sold all of it/s A/R to Nightflyer Finance. It was an outright sale, not a loan.
Is this an Article 9 Security interest?
9-109(a)(3) - Art. 9 applies to sale of accounts - YES
Farmer Brown is termed an Art. 9 “debtor.”
Nightflyer must file an Art. 9 financing statement to perfect it’s interest
Perfection beats 3 categories:
Future perfected parties
All prior & future unperfected parties
A later lien creditor (including bankruptcy trustee)
Why would the Code drafters have brought an outright sale of accounts & chattel paper, payment intangibles, and promissory notes under Article 9?
It provides certainty- you don’t want to have to look at the fine print to determine whether it is or isn’t a sale- either it is or it isn’t. Putting it in Article 9 gives clear & concise answers to whether these categories are included- they are
Consignments
Example: Nikon sends Camera Land 20 cameras to sell, and only when the cameras are sold does Camera Land send any money to Nikon, with Camera Land keeping the profit. As a customer, you presume ostensible ownership (that CL owns the cameras). But how do you indicate that these items are actually owned by Nikon, and on consignment with CL?
Thus, consignments raise a problem with ostensible ownership.
OO - we want no one to claim interest in ppty w/o putting name in the public or taking actual possession
Defined in 9-102(20)
Consignments are included under Article 9 (9-109(a)(4))
And Article 9 says that if it is a consignment, no matter how you phrase it, you MUST comply with Article 9
Priority Section for Consignments - 9-319 & 9-322
319: Lose to a buyer
322: b/t multiple consignors: first to file (General FITFIR provision)
Problem 4: Antiques R Us holds goods & collects proceeds for antique dealers. ARU takes out a loan with ONB, listing as collateral “all its property.”
Will the bank’s S.I. reach the items in the store that belong to the dealers if the dealers never took steps required of consignors under Art. 9?
See § 9-102(a)(20)(A)(iii) - YES, if there is no public notice. You have to comply with Art. 9 w/r/t consignments. Must cure public notice problem!
Case: In re Fabers
The consignment agreement provided that the title to the rugs remained in the dealer until fully paid for. Dealer shipped to Fabers. Fabers went bankrupt.
It doesn’t do the dealer any good to say that they kept title.
BRIGHT LINE RULE: If I deliver goods for sale on consignment, or if I have a client who does so, the transaction MUST comply with Article 9.
No matter how the dealer tries to argue their case, they will still lose because they did not comply with Article 9.
The dealer failed to establish ostensible ownership, b/c he did not file.
Bankruptcy trustee wins!
Problem 5: Luke took a handcrafted sword to WOW, which was a large weapon dealer who sold items it manufactured itself or bought from other dealers. WOW agreed to sell the sword for Luke.
Is this an Art. 9 consignment so that Luke needs to take Art. 9 steps to protect himself from WOW’s other creditors who have an interest in the store inventory?
Must meet all requirements of 9-102(a)(2): Consignment means a transaction, regardless of its form, in which a person delivers goods to a merchant for the purpose of sale and the merchant … is not gen. known to be substantially engaged in selling goods of others; the aggregate value of the goods is $1,000 or more at time of deliver, the goods are not consumer goods immediately before delivery; and the transaction does not create a S.I. that secures an obligation
This IS an Art. 9 consignment, so Luke needs to take steps to protect himself from WOW’s creditors
Leases
§ 1-201(35): Whether a transaction in the form of a lease creates a security interest is determined pursuant to § 1-203
§ 1-203: Lease Distinguished from Security Interest
Whether a transaction in the form of a lease creates a lease or security interest is determined by the facts of each case.
Thus, Art. 9 does not have a clear answer to whether a lease is covered.
A transaction in the form of a lease creates a security interest if the consideration that the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease & is not subject to termination by the lessee and one of four factors are present.
**If it is terminable at any time for reasons stated in K, then it is not a security interest but rather a genuine lease.
Four factors:
Essentially a sale:
Original term of lease is equal to or greater than the remaining economic life of the goods
The lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become owner of the goods
Where you have problems:
The lessee has an option to renew the lease for the remaining economic life of the foods for no additional consideration or nominal additional consideration under compliance with the lease agreement
This basically means you’ve paid all of it already
The lessee has an option to become an owner of the goods for no additional consideration upon compliance with the loan agreement
Test for answering whether an amount is nominal:
Is there any reasonable choice to be made in the face of the value of those goods? Is the amount of what is to be paid so small in relation to the actual economic value of the goods that it would be unreasonable to turn down such a deal?
Ex: No reasonable business person would turn down goods worth $1000 for $50
If the lessee can get out of the lease by the end of the lease, then it is a true lease & not a security interest.
If they cannot, then go forward with analysis under § 1-203.
Problem 6:BIG (lessor) leased a duplicating machine to Connie. Lease was for 5 years, & the rental payments over the period exactly equaled the current FMV of the machine. The lease provided for a $5 purchase option at end of the lease. BIG did not file an Art. 9 FS Connie then borrowed money from ONB, signing a S.A. & granting ONB an interest in all its equipment. ONB perfected it’s security interest by filing a FS Connie failed to repay, & ONB seized the shop’s equipment, including duplicating machine.
In suit b/t ONB & BIG, who gets the machine?
Element of § 1-203(b)(1) met - this is a security interest, not a lease
Thus, ONB wins, b/c BIG failed to file.
Problem 7:Business Corp. leased a copier from Copies, Inc. for 5 years. At outset, copier had a FMV of $300,000 & a predicted 10-yr useful life. (Thus, presume a $30,000 depreciation.) Over the course of the lease, the rental payments would total $330,000. Lease provides Business has option to purchase copier at end of lease for $10,000.
Is this a true lease or a secured sale?
There is no mention of an early termination right
Look at § 1-203(b)(4) - lessee has option to purchase copier for nominal additional consideration
Nominal here b/c the value remaining of the asset is $150,000 & lessee can purchase for $10,000
Easy answer: if you see a lease, FILE.
Case: In re Architectural Millwork
Facts: Debtor Millwork filed for bankruptcy & retained two assets - a freightliner truck & a forklift - both the subject of leases. Debtor hadn’t paid on either of the leases.
When to determine whether a purchase option is nominal: the time of creation of the option to purchase
The forklift contained an option to purchase for $1 at end of lease - clearly nominal  Art. 9 transaction
The truck contained an option to purchase for the residual value - this would not be “nominal consideration.” It was actual value & debtor must make a “real choice” - do I want to purchase a truck for $9,000 when it is worth $9,000?
Court held that the truck agreement was a true lease
Test: What would a reasonable, sensible person, similarly situated, do? Would he have a choice?
Suretyships
Def.: usually in the form of a bond—either secures payment or performance of a party who is unable to do so
Suretyships are OUTSIDE Art. 9 - do not have to file
Problem 8: Crash Construction was hired by Mercy Hospital to build a new addition. Crash was required to get a surety to guaranty the performance of the job & the payment of all workers & suppliers (to avoid a mechanics lien on Mercy). Standard Surety issued the performance & pmt bond covering Crash’s obligation to Mercy. Crash borrowed money from ONB & gave as collateral the right to collect the progress payments from Mercy. ONB filed a financing statement. Halfway through the job, Crash went bankrupt. Standard Surety had to finish & pay off e’ees & suppliers. Standard then claimed (by subrogation) a superior right to unpaid monies retained by Mercy which were to be paid to Crash. ONB also claimed this money under its filed security interest, claiming Standard’s subrogation right was only an unfiled Art. 9 security interest. Who wins?
Crash’s rights to payments from Mercy is going to be called accounts- they had a right to payments for goods sold or services rendered.
Two answers here:
Suretyships are outside Art. 9 - don’t have to file
Do secured parties always lose to a surety?
It wasn’t ONB’s money, anyways, b/c Crash wasn’t the one who finished the work.
ONB knew that the accounts depended on the work being done, & they took that risk
But, as the surety company, you should file an Art. 9 financing statement every time to be safe. Then, in bankruptcy, you can say (1) we didn’t have to file & (2) we filed anyway.
Exclusions from Article 9
§ 9-109(c) & (d)
(c): Federal statutes (preemption)
Ex, Philko Aviation: Article 9 would apply to airplanes, but we file with FAA because the federal statute preempts. Thus, the winner will be the one who files with the FAA
(d)(1)-(2): Landlord’s liens & other Statutory liens (except agricultural)
Problem 9: LL wanted security for rent from Morley’s bookshop. Lease agreement said that all inventory would be subject to a lien in LL favor & could be seized in case of default.
Is the LL lien required to be perfected under Art. 9?
Yes, the LL’sliens is required to be perfected, because it was a consensual lien (the lease provided that the first failure to pay would allow the landlord to come in and take the books) - It was not a statutory LL lien
(d) (3): Assignment of wages of an employee
Problem 10: Jugular, an indep. insurance agent selling policies for many companies, did most business with MIA. To get a loan, Jugular gave bank a S.I. in all present & future commissions earned or to be earned from MIA. Does Art. 9 cover this assignment?
Jugular is an agent, NOT an employee.
It is a commission - Art. 9 covers
Not wages
Non-financing assignments
(d)(4)Sale of intangibles & quasi-intangibles as part of the sale of a business
(d)(5): assignment of intangibles & quasi-intangibles to a collection business
(d)(6): assignment of right to payment under a K to an assignee that is also obligated to perform under the K (delegation)
(d)(7): sale for full or partial satisfaction of a preexisting debt (no new value)
Problem 11: Dean soldhis entire business to John, including all tangible assets & outstanding A/R.
Must the buyer take the steps required by Art. 9?
No - It is a sale of accounts (which would normally be included under 9-109(a)(3)), but it is EXCLUDED under 9-109(d)(4) b/c part of a sale of business.
If a client refused to pay Dean & he sold to a collection agency, must the collection agency take Art. 9 steps?
No - 9-109(d)(5)
If Dean transferred a commissioned painting job to another artist, must the new artist take Art. 9 steps?
No - delegation - excluded under 9-109(d)(6)
(d)(8): individual assignment of an insurance claim
(d)(9): an assignment of a right represented by a judgment
(d)(10): right of recoupment or set-off
(d)(11): interest in or lien on real property
Problem 12: ONB agreed to loan LLC money, taking possession as collateral some real property mortgages & accompanying promissory notes given to LLC by its borrowers. Does ONB need to do anything in the real property recording office or under Art. 9 to protect its interest in this collateral?
Yes - must comply with Art. 9 if they want promissory notes (money); if they want right to real estate (mortgage) upon default, must also file in RE records
Promissory notes = instruments - filed with SOS under Art. 9
Mortgage filed with chancery clerk
9-109(d)(11) says doesn’t apply to real estate interests, but must compare that with 9-109(b) - Art. 9 application to a S.I. in a secured obligation is not affected by the fact that the obligation itself is secured by a transaction outside Art. 9
NOTE: Never only take the mortgage w/out promissory note - then all you get is real estate
(d)(12): assignment of a tort claim (except a commercial tort claim)
(d)(13): assignment of a consumer deposit account
Note: Assignments of commercial deposit accounts ARE within Art. 9
Problem 13: ONB issued Connie a credit card, and for collateral took a security interest in all items purchased using the card & her personal checking account with the bank. Does Art. 9 apply to the bank’s rights in this account?
No - it is a consumer deposit account & thus falls under 9-109(d)(13) exclusion.
Note: If they want to take an interest in the things bought with the card, they’d have to file an Art. 9 FS for all those items (difficult)
Article 9 protection
Bankruptcy trustee becomes lien creditor at time of filing for bankruptcy
9-317 says you take priority over bankruptcy trustee IF you have already filed
File early or lose in bankruptcy.
Article 9 protect you if you have a debt interest secured by personal property & the person files for bankruptcy, so long as you got there first (filed first).

Chapter 3: The Creation of a Security Interest