Introduction to Liens and Debtor-Creditor Law
Copyright � 1985 and 1989 by Mark S. Scarberry
Here are materials I wrote several years ago as part of a projected multi-volume set on the Uniform Commercial Code. I now use the materials to provide an introduction to liens and to debtor-creditor law. See especially sections 1.08 through 1.11. Note that the citations are to the pre-1999 version of U.C.C. Art. 9. Permission is hereby granted for copying of these materials for classroom use provided that they are copied in their entirety, including this paragraph.
Mark S. Scarberry
Pepperdine Univ. Caruso School of Law
Chapter 1: A Basic Introduction To Article 9 Secured Transactions
1.01����� Scope Of Chapter
1.02����� Security And The Idea Of The Lien
1.03����� Basic Concepts
1.04� -- Attachment: Enforceability Against The Debtor
1.05� -- Perfection: Rights As Against Third Parties
1.06� -- Priority: Determining Which Claimant Has Superior Rights To
����� ����� The Collateral
1.07� -- Lien Avoidance In Bankruptcy: The Acid Test
1.08� The Contrast Between The Rights Of Unsecured Creditors And
����� Article 9 Secured Parties
1.09� -- The Unpaid Unsecured Creditor's Rights
1.10� -- The Unpaid Secured Party's Superior Rights
1.11� -- Two Illustrations Of The Superiority Of The Secured Party's
����� ����� Rights
1.12����� Reasons For Taking Security Under Article 9
1.13����� Reasons For Giving Security Under Article 9
1.14����� Innovative Features Central To Article 9
1.15� -- Uniform Applicability To All Security Interests Regardless Of
����� ����� Form Or Characterization By Parties
1.16 -- -- The Lease Intended As Security
1.17 -- -- Coverage Of Other Security Devices That May Be Created
[Further sections omitted]
�1.01 Scope Of This Chapter
���� This chapter is designed to provide an introduction to secured
transactions under Article 9. The important concepts and innovative
features central to Article 9 are discussed. The importance of Article
9 security is discussed both in terms of the superiority of the secured
party's rights over those of an unsecured creditor and in terms of the
extent of Article 9 secured financing in the United States economy. The
basic questions of why to take security and why to give security are
also discussed. This chapter will provide helpful background
information for the attorney who does not deal regularly with Article 9.
�1.02 Security And The Idea Of The Lien
Security in its broad sense includes any circumstance that makes performance of an obligation more likely. For example, a third party guarantee of a debt may be considered a form of security, since it makes the payment of the debt more likely. A creditor who obtains the guarantee of a credit-worthy third party may decide not to seek other security.
In its narrower sense, security means a right to look to particular property for payment of an obligation. This property right is called a "lien." In some sense a creditor who does not have a lien ‑‑ an unsecured creditor ‑‑ also has a right to look to the debtor's property (at least the debtor's non‑exempt property) for repayment of the debt, through the process of enforcement of judgments. However, the unsecured creditor has no property interest in the debtor's property until he obtains a judicial lien through the process of enforcement of judgments; the expense, delay, and uncertainty involved in that process leave the unsecured creditor in a weak position.1
Liens may be imposed on the debtor's property without his consent, as in the case of judicial liens,2 common law and statutory liens,3 and tax liens.4
Liens may also be created consensually, by agreement of the debtor. Real property mortgages and deeds of trust create consensual liens on real property, which are governed by the law of real property. Article 9 governs consensual liens created in personal property, and 6in some cases in fixtures5; such liens, called "security" interests,"6 are created by Article 9 "security agreements,"7 which may take many forms.8 A creditor who has an Article 9 security interest is called a "secured party."9
1.����� See sections 1.09 and 1.11 below.
2. Judicial liens are those liens obtained by a plaintiff through judicial process in the course of obtaining and enforcing a money judgment. They include attachment and execution liens, which are generally obtained by levy on specific property under a writ of attachment or writ of execution. They also include judgment liens, which are generally obtained either by recording of the judgment (or an abstract of it) in the relevant real property records or simply by the docketing of the judgment; judgment liens extend to all real property owned by the debtor in the county in which the judgment is recorded or docketed. Cf. the discussion of remedial equitable liens designed to remedy unjust enrichment at section ______ below.
3. Common law and statutory liens are those which arise by operation of law, without agreement of the parties. They include artisans' liens in favor of those who furnish services or materials to repair or improve personal property, materialmen's and mechanics' liens in
favor of those who furnish materials or services to repair or improve real property, landlords' liens, and other types of liens.
4.��� See 26 USC �� 6321‑6323 (IRC �� 6321‑6323) (the federal tax lien
����� statutes). Tax liens are actually a type of statutory lien, but
����� they are very different from other statutory liens and merit
����� separate discussion. See R. Jordan and W. Warren, Bankruptcy
5.����� UCC �� 9‑102(1), 9‑104(j).
6.����� UCC � 1‑201(37).
7.����� UCC � 9‑105(1)(1).
8.����� See UCC � 9‑102(2).
9.����� UCC � 9‑105(1)(m).
� 1.03 Basic Concepts
The application of Article 9 to the various phases of a transaction will be considered in detail in Chapter 2. It will be helpful, however, to consider initially four basic concepts relevant to Article 9 security interests: attachment, perfection, priority, and lien avoidance in bankruptcy.
� 1.04 -- Attachment: Enforceability Against The Debtor
For a security interest to be enforceable against the debtor with respect to an item of collateral, it must have attached to the item.1 If the security interest has attached to the collateral, the secured party will have the rights discussed below2 to look to the collateral upon the debtor's default. For tangible collateral this primarily means the right to take possession of the collateral and sell it.3 For intangible collateral (such as accounts owed to the debtor) this primarily means the right to make collections from the debtor's debtors4 (called "account debtors"5). If the security interest has not at attached to the collateral, the would‑be secured party has no such rights.6
Attachment of the security interest to an item of collateral occurs when all three of the following requirements are met:
1.� the debtor has signed a written security agreement that describes the collateral, or the debtor has made an oral security agreement and the secured party is in possession of the collateral pursuant to the debtor's agreement;
2.� the secured party has given value; and
���� ����� 3.����� the debtor has obtained rights in the collateral.7
����� These requirements will be discussed in detail in Chapter 2. Note however that "value" is defined broadly.8� For example, a creditor who takes a security interest to secure a pre‑existing debt has given value for the security interest ("new value" is not required).9 Further, binding promises or contractual obligations can be value even before the promises or obligations are carried out.� For example, a binding commitment to extend credit is value.10 Also note that if the debtor agrees to give a security interest in collateral which the debtor plans to acquire, the security interest cannot attach to the collateral until the debtor acquires the collateral, or at least some rights in it.11� Once a security interest has attached to collateral it is enforceable against the debtor with respect to that collateral. If it never attaches to any collateral (because, for example, the debtor did not sign a written security agreement and the collateral is not in the secured party's possession), then the creditor is unsecured.12
1.�� UCC � 9‑203(1), (2).
2.�� See section 1.09 below.
3.�� See UCC �� 9‑503 and 9‑504.
4.�� See UCC � 9‑502.
5.�� � 9‑105(1)(a).
6.�� See UCC � 9‑203, Official Comment 1.
7.� UCC � 9‑203(1).
8.� See UCC � 1‑201(44).
9.� UCC � 1‑201(44)(b).
10. UCC � 1‑201(44)(a), (d).
11.� UCC � 9‑203(1)(c). The point at which a debtor's interest in the collateral is sufficient to constitute "rights in the collateral"
���� is discussed below at section
12.� UCC � 9‑203, Official Comment 5 (rejecting the theory that an oral
agreement creates an equitable lien enforceable against the debtor
in the absence of a written agreement). But see 1 Gilmore,
Security Interests In Personal Property (hereinafter "Gilmore")
�� 345-46 (1965), in which the late Professor Gilmore, one of the
principal drafters of Article 9, argues that Comment 5, which he wrote, overstates the case against equitable liens.� See section ___________ below for a further discussion of equitable liens, including the very different remedial equitable liens imposed by courts of equity to remedy unjust enrichment.
� 1.05 -- Perfection: Rights As Against Third Parties
Attachment deals with enforceability against the debtor; perfection deals with enforceability as against third parties who have claims to the collateral.1 For example, after giving a security interest in a piece of equipment ‑‑ say, a lathe ‑‑ to the secured party, the debtor may sell the lathe to a purchaser who knows nothing about the security interest. Unless the secured party perfected its security interest before the sale to the purchaser, the secured party will probably not have a security interest in the lathe in the hands of the purchaser.2� Similarly, if a debtor gives security interests in a drill press to two secured parties, and only one of the secured parties perfects his security interest, the one who perfected will have superior rights ("priority") in the drill press.3
Perfection of a security interest in an item of collateral occurs when:
��� 1.��� the security interest attaches to the item, and
���������� 2.����� any further steps required by Article 9 are taken.4
In some cases Article 9 does not require any further steps, so the
security interest is automatically perfected when it attaches. For
example, if a seller sells goods (other than a motor vehicle) to a buyer
for consumer purposes, and the seller retains a security interest in the
goods to secure the unpaid portion of their price, the seller's
"purchase money security interest in consumer goods" will be
Usually, however, Article 9 requires the secured party to file a financing statement which covers the collateral or take possession of the collateral to perfect a security interest in that collateral.6 (Depending on the type of collateral involved, the secured party may be able to use 7 either method, may have to file, or may have to take possession.7)This requirement reflects the concern, of ancient origin, that enforcement of "secret liens" is unfair to creditors and other third parties.8
A financing statement usually is a bare‑bones document that contains only the names and addresses of the debtor and secured party, a statement indicating the types or describing the items of collateral covered by the security interest, and the signature of the debtor.9 The security agreement itself does not have to be filed.10
Because the financing statement is filed in a public officell and is indexed under the debtor's name,12 creditors and other persons who deal with the debtor can determine that a security interest may exist.� They then can inquire as to the details of the security agreement.13 Similarly, if the secured party has taken possession of the collateral, the debtor's lack of possession of it is deemed sufficient to put
creditors and other person s on notice that the debtor may not own the collateral free and clear.14
1.���� See, e.g., UCC �� 9-301 and 9-312.
2.� See UCC � 9-306(2), which provides that a security interest
��� continues in collateral notwithstanding sale of the collateral,
��� unless the secured party authorized the sale or unless Article 9
��� otherwise provides. UCC � 9-301(1)(b) "otherwise provides" by
��� protecting buyers from unperfected security interests. If the
��� lathe were part of the debtor's inventory the buyer would likely
��� take free of even a perfected security ,interest under UCC
��� � 9-307(1) as a buyer in ordinary course.
3.� UCC � 9-312(5). Actually the rule is that the first secured party to file a financing statement or perfect its security interest has priority. The example assumes that the unperfected secured party failed to file a financing statement and failed to take possession of the drill press. If that secured party filed a financing statement before the other secured party but still does not have a perfected security interest because its security interest never attached (e.g., there is no written security agreement), then the security interest is not even enforceable against the debtor; that secured party has no enforceable rights that can have any priority at all, and thus the other secured party's perfected security interest would have priority.
4.����� UCC � 9‑303(1).
5. ���� UCC � 9‑302(1)(d).
6.� See UCC �� 9-302 (financing statement must be filed to perfect all security interests, with certain exceptions), 9-302(1)(a) (providing exception to filing requirement for security interest perfected by possession), and 9-305 (providing that security interest in certain types of collateral may be perfected by possession).
7.����� See section ________ below.
8. ����� See 1 Gilmore 438-39.
9. ����� See UCC � 9-402(1).
10.����� UCC � 9-402, Official Comment 2.
11.����� See UCC � 9-401.
12.����� UCC � 9-403(4).
13.� See UCC � 9‑402, Official Comment 2.
14.� See J. White and R. Summers, Handbook Of The Law Under The Uniform
Commercial Code (hereinafter White and Summers) 933-34 (2nd Ed 1980).
� 1.06 ‑‑ Priority: Determining Which Claimant Has
Superior Rights To The Collateral
As illustrated in Section 1.05, two or more parties other than the debtor may assert claims to the collateral. The question then is which claimant has "priority," meaning the superior rights, and which claimant is subordinate. As stated in Section 1.05, the secured party usually must perfect its security interest to have priority over other claimants.
However, eventual perfection of the security interest is not a guarantee that the secured party will have priority. For example, a perfected security interest will be subordinate to a judicial lien which arose in the collateral before the security interest was perfected,1 or to the interest of an innocent buyer who bought the collateral from the debtor before the security interest was perfected.2� Thus the timing of perfection is often crucial.
Further, in many cases two secured parties each have a perfected security interest in the collateral. If both have perfected security interests it might seem reasonable to give priority to the one who perfected first. However, Article 9 gives priority to the first one who either perfects its security interest in the collateral or files a financing statement that covers the collateral.3� Recall that a security interest cannot be perfected until it attaches.4� Article 9 permits the secured party to file a financing statement before the security interest attaches to the collateral;5 such a pre‑attachment filing cannot perfect the security interest, but it can establish priority as against other secured parties. The "first to file or perfect" rule gives the secured party an incentive to file as early as possible.6
Special rules apply to purchase money security interests under Article 9. A credit seller who takes a security interest in the collateral to secure part or all of its price has a purchase money security interest.7 A lender who lends money to the debtor to acquire the collateral, and who takes a security interest in the collateral to secure that loan, has a purchase money security interest, if the debtor in fact uses the loan proceeds to acquire the collateral.8� A purchase money security interest in collateral other than the debtor's inventory has priority over all other security interests and almost all judicial liens if it is perfected within ten days after the debtor receives the collateral.9� For reasons to be discussed below, there are stricter requirements for a purchase money security interest in the debtor's inventory to qualify for special purchase money priority as against other secured parties.10
There are other priority rules which govern the rights of secured parties as against purchasers of collateral (such as the favored buyer in ordinary course"11 ), holders of statutory or common law liens,12 and other parties. Chapter 2 discusses all of the priority rules in detail.
1. ����� UCC � 9‑301(1)(b) and Official Comment 3 thereto. Section
���� 9‑301(1)(b) could be interpreted as subordinating only security
���� interests which are in existence (attached) and unperfected as of
���� the time the judicial lien arises. However, it is actually
���� interpreted to mean that any security interest which is perfected
���� after the judicial lien arises (or which is never perfected) is
���� subordinate. Thus, any security interest that attaches to
���� collateral after a judicial lien has arisen in the collateral will
���� be subordinate, even if it is perfected the instant it attaches.
2.����� UCC � 9-301(1)(c).
3.����� UCC � 9-312(5).
4.����� See section 1.05 above.
5.�� UCC � 9-303(1) and Official Comment 1 thereto; UCC � 9-402(1) and Official Comment 2 to � 9-402.
6.�� See section �� ��below for a description of the circumstances under which a secured party would "pre-file."
7.����� UCC � 9-107(a).
8.����� UCC � 9-107(b).
9.����� UCC � 9-312(4).
10.����� See UCC � 9-312(3) and section ����� �below.
11.����� See UCC � 9-307(1).
12.����� See UCC � 9‑310.
�1.07 ‑‑ Lien Avoidance In Bankruptcy: The Acid Test
When the debtor enters a bankruptcy proceeding, the debtor's trustee in bankruptcy (or the debtor-in-possession in a Chapter 11 reorganization) has powers which he can use to try to avoid liens, including security interests. If the trustee succeeds, he will have saved more of the debtor's assets for distribution to the general unsecured creditors whom he represents. The secured party whose security interest is avoided then becomes one of those unsecured creditors, at least if she has no other security. Since unsecured creditors typically receive very little in bankruptcy, the secured party is vitally concerned with whether the security interest will be avoided
in bankruptcy. This has been termed the "acid test" for security
����� The trustee in bankruptcy has two major powers to attack security
interests. They are the "hypothetical lien creditor" power2 and the
power to avoid preferences.3 The former power permits the trustee to
avoid most security interests that are unperfected when the petition in
bankruptcy is filed.4 The latter power permits the trustee in many
cases to avoid security interests which are either acquired by the
secured party to secure a pre-existing debt5 _or which are perfected more than ten days after they attach.6 The possibility of a security
interest being avoided in the debtor's bankruptcy proceeding makes it
extremely hazardous for the secured party to delay in perfecting its
security interest. The prudent secured party will therefore make sure
that the security interest is perfected as soon as it attaches, or, if
that is not possible, that it is perfected within ten days after
����� The debtor also has an avoiding power in bankruptcy. The debtor
can avoid non-possessory, non-purchase money security interests in
certain property (such as household goods) that the debtor could
otherwise exempt.7� Secured parties who take possession of the
collateral (e.g., pawnbrokers), and secured parties who are careful to
obtain and maintain8 purchase money status are not affected.
1.��� White and Summers 993.
2.��� See Bankruptcy Code � 544(a)(1).
3.��� See Bankruptcy Code � 547.
4.��� Section 544(a)(1) gives the trustee the state law rights of a
hypothetical lien creditor who obtained a judicial lien in all of
��� the debtor's property as of the time the bankruptcy proceeding
commenced, that is, when the petition in bankruptcy was filed.
��� Such a lien creditor would have priority over any security interest
��� that was not perfected at the time the petition in bankruptcy was
��� filed (except for certain purchase money security interests).
Therefore the trustee's rights are superior to such a security
interest (again with the purchase money exception). However, the
secured party is not merely subordinated in some way; the secured
��� party entirely loses its security interest. See section ________
5. This is a classic preference, received shortly (within 90 days) before bankruptcy on account of antecedent debt. See section __________ below.
6.� In this case the Bankruptcy Code performs sleight-of-hand by deeming the delay in perfection to be a delay in creation of the security interest. Thus, artificially, the security interest is
deemed to have been given after the debt arose, even though in reality it may have been given contemporaneously. Thus it is deemed to be for antecedent debt. If the delayed perfection occurs within 90 days before the petition is filed, the security interest
will likely be avoided as a preference. See section ��� �below.
7.� See Bankruptcy Code � 522(f). Also see the unfair trade practice regulation cited in note 4 to section 1.10 below.
8. See section �below, discussing how a secured party can ensure
��� that its security interest is a purchase money security interest,
��� and section ______ below, discussing perils to purchase money
��� status from cross‑collateralization clauses, future advance
��� clauses, and refinancing arrangements.
�1.08 The Contrast Between the Rights of Unsecured
Creditors And Article 9 Secured Parties
The value of an Article 9 security interest is best shown by contrasting the rights of unsecured creditors and Article 9 secured parties. The Article 9 secured party has substantial advantages over an unsecured creditor in obtaining payment. As discussed in � 1.12 below, in most cases the primary reason for taking security is that the existence of the security interest creates strong pressure on the debtor to pay voluntarily. Those pressures are created by the prospect of the secured party exercising its rights in the event the debtor does not voluntarily pay. Those rights are far superior to the rights of an unpaid unsecured creditor.
� 1.09 -- The Unpaid Unsecured Creditor's Rights
If the debtor is unable to or adamantly refuses to pay, an unsecured creditor must sue the debtor, obtain a judgment, and obtain a lien on particular property of the debtor through the local procedures for enforcing judgments. Only then, after the unsecured creditor has become a secured judicial lien creditor, does the creditor obtain payment, by foreclosing on the lien at an execution sale.1
Several obstacles may confront the unsecured creditor en route to the essential judicial lien. First, although most collection actions result in default judgments, some are defended by the debtor. Even a meritless defense causes expense and delay. A colorable defense that can survive summary judgment may cause a delay of years. In some cases the creditor may be able to obtain a pre-judgment attachment lien but, even if so, the lien cannot be foreclosed until after a judgment is obtained.
Second, the creditor who obtains a judgment may have difficulty in locating sufficient property of the debtor. During the time spent obtaining a judgment, property can be hidden or dissipated, even if sufficient property existed previously. In the case of an individual
debtor, most or all of the property that can be located may be exempt
from being used to satisfy the judgment.2
Third, even if property can be found and a judicial lien is
obtained, the property may already be subject to other liens, including
Article 9 security interests. The judicial lien will be subordinate to
an Article 9 security interest unless the judicial lien arises before
the security interest is perfected.3 The potential judicial lien
creditor cannot count on any secured parties having been foolish enough
not to perfect their security interests. Further, other creditors of
the debtor may have already obtained judicial liens on the property
which will have priority over the new judicial lien because they were
"first in time."4� That means that the new judicial lien creditor will
receive payment out of proceeds of sale of the property only if there is
money left over after the proceeds are used to pay off the debts held by
the prior lien holders, including any secured parties. In most cases
there will be no money left over, if there is a prior lien.
Fourth, if the debtor enters bankruptcy proceedings within 90 days
after the new judicial lien creditor obtained its lien, the lien will
probably be avoided -- eliminated -- as a preference.5� That will return
the judicial lien creditor to its previous status as an unsecured
creditor; as such the creditor will likely receive very little in the
����� Thus the unsecured creditor's attempt to obtain payment is an
expensive, time-consuming, and uncertain venture.
1.� On the topic of enforcement of judgments, see generally 9 Debtor-Creditor Law ��( 37.01-37.07 (T. Eisenberg ed.-in-chief 1985). Note that at � 37.07 [B] it is stated that an execution lien created by levy on personal property relates back to the date the writ of execution was delivered to the sheriff. A substantial number of jurisdictions follow that rule, but the majority rule is that the lien is created at the time of levy with no relation back. See S. Riesenfeld, Cases And Materials On Creditors' Remedies And Debtors' Protection (hereinafter "Riesenfeld") 154-57, 160-61 (3rd Ed 1979).
2.� See 9 Debtor-Creditor Law �( 37.03 (T. Eisenberg ed.-in-chief 1985).
3.��� See UCC � 9-301(1)(b) and Official Comment 3 thereto.
4.� See, e.g., Cal. Civ. Code � 2897 ("Other things being equal, different liens upon the same property have priority according to the time of their creation . . ."); N.Y. Civ. Proc. R. � 5234 (b) (multiple execution liens have priority based on time of levy, except that liens arising from levies made by the same officer have priority based on the order in which the writs of execution were delivered to the officer -- thus preventing the officer from favoring one creditor over another).
5. Bankruptcy Code � 547; see, e.g., In re Lassiter, 42 Bankr. 631
(Bankr. ED Mo. 1984).
� 1.10 -- The Unpaid Secured Party's Superior Rights
By contrast to the weak position of an unsecured creditor, an Article 9 secured party is entitled to immediate possession of the collateral when the debtor defaults.1� If possession can be obtained without breaching the peace, then the secured party can take possession of tangible collateral by "self-help" without going to court.2� The secured party can then sell the collateral and apply the proceeds to its debt, again without going to court.3� If the collateral consists of debts owed to the debtor (such as accounts), the secured party (without going to court) can notify the account debtors (the debtor's debtors) to pay the secured party directly, and they are then obligated to do so.4� The debtor generally cannot claim any exemption for the collateral; exemption statutes do not prevent a debtor from voluntarily transferring a security interest in exempt property.5� If the secured party followed the proper steps in creating its security interest and perfecting it (usually by filing a financing statement in a public office6), the security interest will usually have priority over other liens.7
Even in bankruptcy, a secured party with a properly perfected
security interest will usually be protected. To simplify a complicated
subject, the secured party is likely to obtain ether the collateral or
its value in the debtor's bankruptcy proceeding.8� There may be
substantial delays,9 and there are some risks for the secured party,10
but the position of the secured party is much preferable to that of the
unsecured creditor in bankruptcy.
It is true that the secured party is subject to certain general risks inside or outside of bankruptcy. The collateral may have been over-valued and may sell for less than the amount of the debt, especially in a liquidation. The collateral may have disappeared or may have been destroyed or damaged. The debtor may have committed fraud the collateral (or some part of it) may not even have ever existed.11� However, the secured party has practical ways to minimize these risks,12 and, to the extent that the debt remains unpaid -- to the extent that there is a deficiency -- the secured party has the same rights as an unsecured creditor to sue the debtor.13
1. UCC � 9-503 (first sentence).
2. UCC � 9-503 (second sentence).
3. UCC � 9-504(1).� If necessary the secured party can obtain
possession by judicial process (replevin or claim and delivery) and
then sell the collateral itself, or the secured party can choose to proceed entirely by judicial action in which a court officer conducts the sale of the collateral. UCC � 9-503, 9-501(1), (5).
4.�� UCC �� 9-502(1) (right to notify account debtors on default of debtor), 9-318(3) (account debtor's right to pay assignor/debtor ceases when notification to pay assignee is given).
5.�� See State v. Avco Financial Service of New York, 50 N.Y. 2d 383, 429 NYS 2d 181, 406 NE 2d 1075 (1980), and cases cited therein. However, Bankruptcy Code � 522(f) permits a debtor in bankruptcy to avoid non-possessory, non-purchase money security interests in certain property that would otherwise be exempt, such as household goods. Further, a Federal Trade Commission unfair trade practice regulation prohibits lenders and retail installment sellers from taking a non-possessory, non-purchase money security interest in household goods. 16 CFR � 444.2(a).
6.����� UCC �� 9‑302(1), 9-401.
7.�� See UCC �� 9-312(5) (secured party who is first to either perfect a
���� security interest in the collateral or file a financing statement
���� has priority over other secured parties); 9-301(1)(b) and Official
���� Comment 3 thereto (security interest has priority over judicial
���� lien unless judicial lien arises before security interest is
���� perfected). However, the security interest may still be junior to
���� common law or statutory liens and may be junior to a purchase money
���� security interest in the collateral. See UCC � 9-310 and 2 Gilmore
���� 886-89 concerning common law and statutory liens, and UCC �
���� 9-312(3), (4) concerning purchase money priority. There are also
���� other residual risks of non‑priority. See sections � �below.
8.����� See section ����� �below.
9.����� See section ����� �below.
10.� See section �� �below. Also see section 1.07 above and note 4
���� to this section 1.10.
11.����� See section ����� �below.
12.� See S. Krause, H. Kripke, and J. Seidman, Business Frauds, Their Perpetration Detection And Redress, 20 Bus. Law. 83, 93-101, 104-12 (1964).
13.����� See UCC � 9-504(2).
� 1.11 �- Two Illustrations Of The Superiority Of The
The Secured Party's Rights
Two final points illustrate the superiority of the secured party's rights over those of an unsecured creditor. First, consider an
unsecured creditor who searches the public records, finds no financing statements filed against the debtor, and then extends credit to the debtor, whose assets consist of equipment and inventory. How will that unsecured creditor fare against a secured party who obtained a security interest in the equipment and inventory at some time before the unsecured creditor's record search but who failed to file until sometime later (or failed to file at all)?
Some states' pre-Code law would have protected such an unsecured creditor who lent in the "gap" period when a secured party was unreasonably delaying to file.1� Article 9 does not. Under Article 9, the unsecured creditor, as unsecured creditor, cannot complain when collateral is taken by a secured party to pay secured debts whether the security interest is perfected or unperfected.2 Only when the unsecured creditor obtains a judicial lien does the unsecured creditor obtain any rights in the property, and unless that judicial lien is obtained before the security interest is perfected, the security interest will have priority.3 The unsecured creditor may complain that it was misled into extending credit by the secured party's delay in perfecting. However, even under pre-Code law the debtor could grant perfectly valid security interests after the unsecured creditor made the record search and extended credit; the unsecured creditor should not therefore have been misled by the absence of any filings into thinking that the assets would be available to it.
The point is that a creditor who desires to be sure that some or all of the debtor's personal property will be available for satisfaction of the debt must take an Article 9 security interest in the property. An unsecured creditor cannot safely rely on the absence or apparent absence of security interests.
The second point that illustrates the superiority of the secured party's rights involves the rights of an unpaid credit seller of goods. An unpaid credit seller of goods that have been delivered generally has no more right to the goods than does any, other unsecured creditor, such as the telephone company, unless the seller has obtained a signed agreement from the buyer creating a security interest in the goods to secure their price. The goods belong to the buyer, and all that the seller owns is an unsecured debt.4 �Even in the very limited situations in which an unpaid credit seller has a right to reclaim the goods,5 the seller will often find that a secured creditor of the buyer has a security interest in the goods which is superior to the seller's reclamation rights.6
On the other hand, a credit seller of goods who obtains a security interest in the goods to secure payment of the purchase price can repossess the goods if the buyer fails to pay.7� Further, assuming the goods are not inventory in the hands of the buyer, the seller's "purchase money security interest" will have priority over all other security interests and all judicial liens, if the seller perfects the security interest within ten days after the buyer receives the goods.8 This is very generous protection and of course is far superior to the rights of the unsecured credit seller of goods.
1.���� Gilmore 485‑88.
2.� UCC � 9-301, Official Comment 3. Of course, if the debtor enters
��� bankruptcy proceedings, the trustee in bankruptcy can avoid
��� unperfected security interests (and even perfected security
��� interests in some cases if the secured party delayed in
��� perfecting). See section 1.07 above and section � �below.
3.���� UCC � 9-301(1)(b) and Official Comment 3 thereto.
4.���� See White and Summers 292, 1025-29.
5.� See UCC � 2-702(2), which permits the credit seller in some cases
��� to reclaim delivered goods when he discovers that the buyer is
��� insolvent. See also White and Summers 1025-29; Bankruptcy Code
��� � 546(c) (recognizing to some extent the seller's UCC � 2-702(2)
��� reclamation right in bankruptcy, provided the seller demands return
��� of the goods in writing within ten days after delivery). See
��� section � �above [in the volume on Article 2] for a discussion
��� of the reclamation right and of its very limited assistance to most
��� unpaid sellers.
6.� See, e.g., In re Samuels and Co., 510 F2d 139, 154, 16 UCC Rep Serv 577, 596 (dissenting opinion of Judge Godbold), revd, 526 F2d 1238, 18 UCC Rep Serv 545 (CAS, 1976) (adopting Judge Godbold's dissenting opinion), cert. denied 429 U.S. 834. Contra: Lavonia Mfg. Co. v. Emery Corp. (In re Emery Corp.), 38 Bankr 489 (Bankr ED Pa 1984), which was incorrectly decided. See B. Smith, UCC Survey: Secured Transactions, 40 Bus Law 1487 1510‑11 (1985). [Lavonia was later reversed, as it should have been. 52 Bankr. 944 (1985 Ed Pa)].
7.���� UCC � 9-503.
8.���� UCC �� 9-12(4), 9-301(2).
�1.12 Reasons For Taking Security Under Article 9
As sections 1.08 through 1.11 suggest, there are several reasons why a creditor may desire to take a security interest.
Although the secured party's rights on default are far superior to an unsecured creditor's rights, most reasonable creditors are much more interested in having the debtor voluntarily pay the debt than in exercising even the best rights on default. There are costs and inconveniences that accompany enforcement of rights against a debtor, not all of which can be quantified or recovered. Thus the primary purpose in most cases for taking security is the strong pressure it puts on the debtor to repay the debt voluntarily, so as not to lose the collateral.
The prospect of being sued by an unsecured creditor is not a happy one, but it lacks the impact and immediacy that the secured party's rights carry. On default the secured party can take possession of tangible collateral immediately, usually without going to court;1 this
prospect is fearsome, both to the consumer who faces the humiliation and inconvenience of losing his automobile or furniture, and to the business entity which faces an immediate shutdown if its inventory or vital equipment is taken. If the collateral is intangible, the secured party, if it is not already making collections, can notify the account debtors and collect the intangibles; this cuts off the debtor's source of funds.2 Thus the existence of the security interest creates strong pressure on the debtor to pay voluntarily.
���� Of course, the advantages on default of having security if the
debtor does not pay voluntarily are also important reasons for taking
security. Those advantages are catalogued in sections 1.08 through
1.11. Taking a security interest will help to avoid delay and expense
and will increase the likelihood of repayment, inside or outside of
bankruptcy.2� There are even transactions, generally pledges, in which
the enforcement of the security interest is so easy and risk-free that
the likelihood of voluntary repayment and the general credit-worthiness
of the debtor become relatively unimportant. These transactions include
some���� securities margin loans and all pawnbroker transactions.
���� Finally, in some transactions the request for security tests the
sincerity of the debtor and may force the debtor to face reality. An
extreme non-Article 9 example is the request by a bank for a mortgage on
the debtor's home to secure a business loan. The homestead exemption,
which is generous in many states, is in effect waived by the giving of
the mortgage.3� The sincerity of the debtor's expressed optimism about
the success of the business venture is tested by such a request, and it
may also cause honest reappraisal of the venture by the debtor. Large
dollar-exemptions are less likely to be found in regard to property
covered by Article 9 (except perhaps mobile homes), but to some extent a
request for security under Article 9 has a similar effect, especially in
light of its effect on any Chapter 11 reorganization.4
1.��� See UCC � 9-503.
2.� See UCC � 9-502(1). Further, under � 9-502(1) the secured party
��� has the right to take from the debtor any collections the debtor
��� has made if they can still be identified as proceeds of the
��� intangible collateral (although that will probably require judicial
��� action). See section � �below. If the secured party is already
��� collecting the intangibles before default, the secured party can
��� continue to do so. The secured party can also cut off the debtor's
��� source of funds by refusing to make new advances. See section _____
3. Texas, however, restricts the enforceability of non-purchase money mortgages on homesteads.
4.���� See section ���� �below.
� 1.13 Reasons For Giving Security Under Article 9
Article 9 security interests are given voluntarily by agreement of the debtor. In the absence of good reasons for doing so, no debtor should agree to grant a security interest. As discussed in the previous sections, a security interest gives the secured party substantial leverage to force the debtor to repay the obligation, exposes the debtor to swift and often devastating action if payment is not made, and prevents the debtor in most cases from claiming the collateral as exempt. It permits the secured party to receive the collateral or its value in bankruptcy, thus probably reducing the value of assets which an individual debtor (or a corporate debtor's stockholders) can retain in bankruptcy, and makes reorganization of a business in a Chapter 11 bankruptcy proceeding more difficult.1
Counsel for a debtor should therefore be sure that the debtor understands the effects of the granting of a security interest and has considered other possible options. However, if credit is desired, it will often be necessary, or even advantageous, to grant security interests.
A theoretical dispute rages over why debtors incur secured debt. Although some of the theorists deny that it is so (or at least deny that it ought to be so), desired credit often cannot be obtained on an unsecured basis.2 The discussion in the previous sections should make clear why a lender often refuses to accept the weak position of unsecured creditor when the debtor's credit‑worthiness is less than stellar. Thus the primary reason for granting security is to obtain credit that is not available on an unsecured basis.
A secondary reason is that if unsecured credit of the amount desired could be obtained, the time for repayment, the interest rate, and other terms might be unacceptable to the debtor. For example, automobile loans to consumers payable over 48 months are common; unsecured personal loans to consumers, if available, must usually be paid off in a much shorter time, and at a much higher interest rate.
This is not to say that secured credit is always inexpensive. Depending on the type of collateral involved and on the amount of trust the secured party has for the debtor, the secured creditor may incur substantial costs monitoring or "policing" the collateral. The interest rate charged by the secured party will reflect these costs. Such costs tend to be high when the debtor's credit‑worthiness is not excellent and when the collateral changes rapidly, as with a "floating lien" security interest that covers a business's accounts. The secured party may demand daily reports on the accounts and daily turnover of collections.3 Collateral such as equipment which the debtor is expected to keep and which will ordinarily have a life of several years does not need to be monitored so closely, and policing costs should be low. Thus a debtor who can obtain sufficient unsecured credit would seldom choose to borrow against accounts, but might choose to buy new equipment on secured credit so as to get a lower interest rate than on an unsecured loan.
An additional reason for giving security arises in cases in which a creditor demands security for a previously unsecured debt which is payable on demand or which could otherwise be accelerated. In such a case if the debtor gives security it may win at least a 90 day respite from vigorous collection activities by the creditor; if the creditor pushes the debtor into filing a petition in bankruptcy within 90 days
after the security interest was granted, the security interest will be avoided as a preference, since it was given to secure an antecedent debt.4 On the other hand, if the debtor grants such a security interest it is almost an invitation to the debtor's remaining unsecured creditors to file an involuntary petition in bankruptcy against the debtor within that 90 day period.5
1. See section ��� �below.
2.� See J. White, Efficiency Justification For Personal Property Security, 37 Vand. L. Rev. 473, 473-75, 491-94, 508 (1984). Professor White considers and attempts to refute the recent theoretical arguments that the existence of security is not economically efficient and does not lead to increased availability of credit to debtors. See also 1 Asset Based Financing: A Transactional Guide �1.04 (H. Ruda Ed-in-Chief 1985) ("there is a recognition that the smaller or starting or undercapitalized business can get credit only via secured borrowings.")
3.� See 3 Asset Based Financing: A Transactional Guide �26.01[d]
(H. Ruda Ed-in-Chief 1985).
4.� See Bankruptcy Code � 547 and section below. Further, the
��� newly secured creditor may choose to grant additional financing to
��� the debtor. To the extent that the newly secured party does make
��� further advances to the debtor after granting of the security
��� interest, the security interest will not be avoidable under � 547.
��� See Bankruptcy Code � 547(c)(4), and section �below.
5.� If the 90 day period passes without the filing of a petition in bankruptcy, the security interest will no longer be avoidable as a preference, assuming the creditor is not an "insider." See Bankruptcy Code � 547(b)(4). If the unsecured creditors permit the security interest to become unavoidable they decrease further the small dividend they would receive in any eventual bankruptcy proceeding.
�1.14 Innovative Features Central to Article 9
Article 9 was drafted at a time when the law of personal property security had become complex, arcane, and unclear. Many different types of agreements were used to create personal property security, and each type had its own set of complex rules. It was usually (though not always) possible to create the security interests that commercial needs demanded, but the procedures were often expensive and complex, and a relatively high degree of uncertainty as to priorities and other matters existed.1
The concept of the drafters was that Article 9 would remedy these unfortunate attributes of personal property security through incorporation of certain basic features that were to a greater or lesser extent innovative.
Under Article 9, all security interests (with narrow exceptions) are governed by one law -- Article 9 -- regardless of how the parties characterize or label the transaction.2� Only functionally important differences between transactions, such as differences between types of collateral,3 cause transactions to be treated differently by the law.
Outright sales of certain intangibles (accounts and chattel paper) are also governed by Article 9.4 That usually allows avoidance of the often difficult question of whether a transaction is an outright assignment, or an assignment for security;5 it also makes the UCC filing records more helpful to potential assignees of such intangibles, because both outright assignments and security assignments must be perfected to be valid as against subsequent assignees.6
Article 9 expands the range of permitted security practices, and the procedures for those practices are simplified and made less expensive, as compared to pre-Code law. In particular, the use as collateral of property acquired by the debtor after signing of the security agreement ("after-acquired property") is much easier under Article 9,7 as is the securing of credit extended after signing of the agreement ("future advances").8� Article 9 also eliminates the legal requirement that the secured party engage in costly policing of the collateral.9
Finally, Article 9 instituted a system of notice filing that permits the filing of a simple, bare-bones document called a "financing statement rather than requiring filing of the security agreement itself.10� The financing statement can be filed prior to execution of the security agreement11 prior to the debtor's acquisition of some or all of the collateral,12 and prior to the extension of some or all of the credit.13� This permits near certainty that the security interest has priority over other security interests,14 ease of use of after-acquired property as collateral,15 and ease of use of revolving loans in which further advances are made at regular intervals.16� The new filing system is especially beneficial to secured parties making revolving loans against rapidly changing accounts or inventory, since only one financing statement needs to be filed.17
Each of these basic features is described in more detail in the following sections.
1.����� See Official Comment 1 to UCC � 9-101. See generally 1 Gilmore
����� 1-286 for a thorough treatment of pre-Code security devices.
2.����� See section 1.15 below.
3.��� See section 1.18 below.����� Other significant functional differences are (1) whether the secured party has possession of the collateral not (see section ____ below), and (2) whether the security interest is a purchase money security interest or not (see section _____ below).
4.��� UCC � 9-102(1)(b). See section ����� �below.
5. ����� See section ����� �below.
6.����� See section ����� �below.
7.����� See section ����� �below.
8.����� See section ����� �below.
9.����� See section ����� �below.
10.����� See section ����� �below.
11.����� See section ����� �below.
12.����� See section ����� �below.
13.����� See section ����� �below.
14.����� See section ����� �below.
15.����� See section ����� �below.
16.����� See section ����� �below.
17.����� See section ����� �below.
�1.15 -- Uniform Applicability To All Security Interests
��� ��� Regardless Of Form Or Characterization By Parties
A key feature of Article 9 is that, with narrow exceptions, ante transaction which creates a security interest in personal property is governed by Article 9.1� The transaction may be in any conceivable form -- conditional sale, chattel mortgage, trust receipt, pledge,2 etc. -- but it is governed by Article 9 if it is intended to create a security interest.3 "Security interest" in turn is broadly defined to mean "an interest in personal property or fixtures which secures payment or performance of an obligation."4� Try as he might, a creditor cannot obtain a consensual lien on personal property without it being governed by Article 9, unless one of Article 9's narrow exclusions applies.5 This ensures the integrity of the Article 9 filing system and ensures that debtors obtain the protections provided in Article 9.
The all-inclusive functional scope of Article 9 responds to the history of security in personal property. The proliferation of security devices before Article 9's adoption was due in part to the ingenuity of
creditors' lawyers in creating a new device whenever the law governing old devices seemed too restrictive. Article 9 is designed to prevent that from happening.6
1. See UCC �� 9-102(1), 9-104.
2. See UCC � 9-102(2).
3. UCC � 9-102(1).
4. UCC � 1-201(37).
5. See UCC � 9-102(1), Official Comment 1.See also 1 Gilmore 296.
6. As Professor Gilmore explained:
The long history of the proliferation of independent security devices . . . is brought to an end. Whatever else counsel confronted by a novel situation may do, he may not, under Article 9, invent a new device which, if eventually it wins judicial recognition, will develop its own set of rules, its own metaphysical structure, and, in time, its own filing system. However counsel may solve this novel situation, whatever name he may give to the documents he drafts, he will end up, if the "transaction" is one "intended to create a security interest," with an Article 9 security interest, subject to the Article 9 rules, the Article 9 metaphysics, and most importantly, the Article 9 filing system.
1 Gilmore 296.
�1.16 -- -- The Lease Intended As Security
One device that creditors (and debtors) often use to attempt to avoid various consequences of a secured credit transaction is the lease. When the substance of a transaction is a secured sale or a secured purchase money loan, the parties may use a lease form for the transaction, for tax and financial accounting reasons.1� The Code expressly deals with the case of leases that are actually secured transactions and includes them within the scope of Article 9.2� If, for the example, the "lessee" has an option at the end of the "lease" to become the owner free or for a nominal sum, the "lease" is a security agreement and the "lessor's" interest is a security interest.3� Of course, few cases are so clear cut, and the question of whether a "lease" is a true lease or one intended as security has generated much litigation.4
Consider the impact of a finding that a "lease" of goods is a secured transaction rather than a true lease. If the "lessor" did not file a financing statement, the "lessor" will usually find that it only has an unperfected security interest. If the "lessee" is in bankruptcy,
that unperfected security interest will be avoided, leaving the "lessor"
as a mere unsecured creditor. Even outside of bankruptcy, there may be
(1) another secured party whose perfected security interest in the goods
has priority over the "lessor's" unperfected security interest, (2) a
judicial lien creditor who has priority over the unperfected security
interest, (2) a tax lien claimant who has priority, or (3) even a buyer
who bought the goods from the "lessee" thinking the "lessee" owned them
and who takes the goods free of the "lessor's" interest. Even if no
competing interests have priority, the "lessor" will be limited by
Article 9's default provisions if the "lease" is not a true lease; thus,
for example, the "lessor" cannot simply cancel the "lease" and take back
the machine as its own if the "lessee" defaults. Rather, the "lessor"
will have to sell or otherwise dispose of the goods and account to the
debtor for any surplus obtained above the amount of the debt.5
����� The impact on the "lessor" may seem harsh, but it is necessary. If
simply calling a transaction a "lease" (or something else) could exempt
it from Article 9's coverage (and thus excuse the failure to file a
financing statement), secured creditors could not rely on the Article 9
filing system to be complete,6 creditors could evade the debtor
protection provisions of Article 9, and the law would shortly return to
the chaotic, balkanized state that preceded adoption of Article 9.
1. See section ��� �below.
2.� UCC � 1-201(37) (second paragraph). When Article 2A (covering true leases) was added to the UCC in 1987, section 1-201(37) was expanded to provide more guidance as to when a "lease" is actually a disguised security interest.
3.��� UCC � 1-201(37) (second paragraph).
4.��� See section ��� �below.
5. ��� See section ��� �below.
6.� It should be noted, however, that the Article 9 filing system is ��� already incomplete in that no filing is required with respect to a ��� true lease. The new Article 2A of the UCC does not require any ��� filing or other public notice, despite vigorous arguments that it ��� should. See section � �below. For this and other reasons (e.g., ��� the void title doctrine with regard to stolen goods), a prudent ��� secured party will generally check the debtor's title to the ��� collateral before extending credit. See section � �below.
�1.17 -- -- Coverage Of Other Security Devices That May Be Created
The Code expressly deals with leases, but other new devices that might be "cooked up" are subject to the same analysis. Suppose an equipment seller sold equipment to a buyer under a credit contract which provided that only a "defeasible fee" in the equipment would be
transferred to the buyer. On failure of the buyer to make any required payment, title would revert to the seller. The Code does not deal with this specifically. The Code does provide that conditional sales contracts in which the seller purports to retain title give the seller a security interest,1 and the buyer obtains title,2 but the Code does not mention title reversion agreements. However, the seller's "possibility of reverter"3 is an interest in personal property "which secures payment or performance of an obligation." Thus it is simply a security interest, and the transaction which creates it is subject to Article 9, as a "transaction (regardless of its form) which is intended to create a security interest."4
Thus Article 9 is designed to prevent creative lawyers, even ones much more creative than the authors, from creating personal property security devices that are not covered by Article 9.5
1. UCC � 1-201(37) (second sentence).
2. UCC �� 1-201(37) and 2-401(1).
3. See Restatement, Property �� 153(1) and 154, under which the
seller's interest would be classified as a possibility of reverter.
4. See UCC �� 1-201(37) and 9-102(1).
5. UCC � 9-102, Official Comment 1. See also note 6 to section 1.15