SECURED TRANSACTIONS: TERMINOLOGY
• Secured Transaction: A transaction in which the payment of a debt is guaranteed, or secured, by collateral
(i) owned by the debtor or
(ii) in which the debtor has a legal interest.
• Collateral: Property, including accounts and chattel paper (i.e., a note evidencing a debt secured by personal property), which is subject to a security interest.
• Security Interest: An interest in personal property or fixtures -- i.e., improvements to real property -- which secures payment or performance of an obligation.
• Security Agreement: An agreement creating or memorializing a security interest granted by a debtor to a secured party.
• Secured Party (a/k/a Secured Creditor): A lender, seller, or any other person who is a beneficiary of a security interest, including a person to whom accounts or chattel paper has been sold.
· Debtor: A party who owes payment or performance of a secured obligation, whether or not he or she actually owns or has any right in the collateral.
CREATING A SECURITY INTEREST
• In order for a creditor’s security interest to attach (i.e., to become enforceable):
(1) The debtor must have rights in the collateral; and
(2) The secured party must give value (e.g., extension of credit, consideration) in exchange for an interest in the collateral; and either
(3) The collateral must be in the secured party’s possession, OR
(4) When the collateral is not in the secured party’s possession, there must be a written security agreement (a) describing the collateral in such a way that it can be reasonably identified and (b) signed by the debtor.
Thus, when the collateral is not in the possession of the secured party, a security agreement must be in writing to be enforceable.
· The agreement must be signed by the debtor, contain a description of the property, and the description must reasonably identify the property involved (the collateral).
· The secured party must give value (any consideration that supports a simple contract).
· The debtor must have some legal right in the collateral or ownership interest. This can be a present or future interest in the property.
Purchase Money Security Interest
Sellers of durable goods (refrigerators, computers, etc) often extent credit on part or all of the purchase price of the goods. This type of interest is know as the PMSI (Purchase Money Security Interest).
· A security interest is retained in or taken by the seller of the collateral to secure part or all of its price.
· A security interest is taken by a person who, by making advances or incurring an obligation, gives something of value that enables the debtor to acquire the rights in the collateral or to use it.
More on the PMSI later herein.
A creditor could lose out if the debtor defaults on their payment. How do they get satisfaction of the debt if they don’t have possession of the collateral or how do they get priority over OTHER creditors who may have rights in the same collateral?
The concept of attachment (still requires legal steps, however, to protect the claim) deals with the first concern and perfection (the legal process by which secured creditors obtains priority (protection) over other creditors) deals with the last concern.
PERFECTION BY FILING
• Perfection: The process by which secured parties protect their security interests in collateral against the claims of third parties who may look to the same collateral to satisfy the debtor’s obligations to them.
• A secured party can perfect a security interest by filing a financing statement with the appropriate state or local office.
• Financing Statement: A document, filed under the debtor’s name, that is prepared by the secured creditor to give notice to third parties that the creditor claims an interest in the collateral and contains:
(1) the debtor’s name and signature,
(2) the addresses of both the debtor and the secured
(3) a description of the collateral by item or type.
• All of the foregoing information must be accurate, otherwise the filing will not perfect the creditor’s security interest.
Problems can occur when the name of the company or entity changes names (a business reorganizes). A new financing statement must be filed within four months of the change or all rights are lost.
The description and classification of the goods is vitally important (see Exhibit 28-4 in the text). There may be differences between the security agreement and the financing statement.
Where it is filed? Generally
at the local county courthouse, but in any case (in
• Perfection by Possession: A secured creditor can perfect his or her security interest by taking possession of the collateral until the debtor has paid the debt for which the collateral was pledged. For example, stocks, bonds, jewelry.
• If the secured party possesses the collateral, he or she must use reasonable care in preserving it; otherwise, the secured party will be liable to the debtor for any loss in the collateral’s value.
• Purchase-Money Security Interest (“PMSI”): A security interest that arises when a seller or creditor extends credit for part or all of the purchase price of goods purchased by the buyer/debtor.
• Except in certain cases (e.g., automobiles), a PMSI is automatically perfected at the time of the credit sale.
• Motor Vehicles -- Most states require a certificate of title for any automobile, motorcycle, boat, or motor home. In those states, a security interest in the vehicle can only be perfected if it is reflected on the certificate of title.
• What if the collateral is moved to another jurisdiction (ie., another state)? As a general rule, a perfected security interest in movable collateral remains perfected for up to four months after the debtor moves the collateral to another state. After that time, the secured creditor must re-perfect in the new state in order to retain the priority of his or her interest on the collateral.
• A financing statement is effective for five years from the date it is filed. If it is not renewed, it lapsed (becomes worthless).
• BUT, it can be continued for a longer period via a Continuation Statement- a statement that, if filed within six months prior to the expiration of a financing statement, will extend the financing statement’s term for another five years from the expiration date of the original statement.
SCOPE OF SECURITY INTERESTS
Just what is covered, anyway?
• In addition to covering collateral already in the debtor’s possession, a security agreement can cover other types of property, including:
• Proceeds: Money or other valuable asset(s) received when collateral is sold or otherwise disposed of (e.g., money from sale of inventory that was subject to a security interest).
• After-Acquired Property: Property acquired by the debtor after the execution of the security agreement (e.g., replacement inventory, equipment, farm animals, etc.) generally within 10 days of the agreement or the agreement may call for all “after acquired” items as well (this is the typical clause unless the security agreement deals with specific equipment, for example).
• Line of Credit: (future advances) Often a debtor will arrange with a bank to have a continuing line of credit under which the debtor can borrow funds as needed. Future advances against that line of credit are subject to a properly perfected security interest in the same collateral that secures the initial loan.
• Floating Lien: A security interest in collateral that is retained even when the collateral changes in character, classification, and/or location. The most common example is inventory. Recall inventory must be sold to generate income and it must be replaced to enable more future sales. The character of the inventory probably will change due to seasonal demand.
PRIORITIES - - WHO GETS THE COLLATERAL (First)?
• Secured vs. Unsecured Interests: Secured creditors generally prevail against unsecured creditors and judgment creditors who have not begun legal process to collect on their judgment.
• Perfected vs. Unperfected Security Interests: When one secured party has a perfected security interest in collateral and another secured party has an unperfected security interest in the same collateral, the perfected interest prevails.
• Secured Party vs. Lienholder: A perfected security interest prevails against a lienholder’s claim that arose after perfection. On the other hand, a lienholder generally has priority over a later-perfected security interest.
• Conflicting Perfected Security Interests: When two or more secured parties have perfected security interests in the same collateral, generally the first to perfect has priority.
• Conflicting Unperfected Security Interests: When two or more secured parties have unperfected security interests in the same collateral, generally the first to attach has priority.
• Buyers in the Ordinary Course: A person who buys goods “in the ordinary course of business” will take the goods free from any security interest, even if the security interest is perfected and even if the buyer knows of its existence.
• A “buyer in the ordinary course” is defined as any person who, in good faith and without knowledge that the sale is in violation of a third party’s ownership rights or security interest, buys from a person who is in the business of selling goods of the kind bought.
• Second-Hand Buyers of Consumer Goods: A person who purchases a consumer good for personal, family, or household use, and without knowledge of the original seller’s security interest, takes the good free and clear of any unfiled security interest -- including the original seller’s PMSI, which perfects without filing, unless actually filed by the original seller prior to the second-hand purchase (and this is rarely done). For example- a garage sale someone sells their refrigerator covered under a PMSI. Unless a filed agreement has been made (recall a PMSI does not require a filing- and thus here the possible problem), the second hand purchaser gets it free and clear.
• Information Requests: A party who is considering taking a security interest is entitled by the U.C.C. to obtain a certificate from the relevant filing office(s) identifying all perfected financing statements on file for that debtor.
• Assignment and Release: A secured party may, at its discretion, assign part or all of a security interest to another party and/or release part or all of the collateral covered by a security interest.
• Amending a Financing Statement: A filed financing statement may be amended. The amendment must be agreed to and signed by both the debtor and the secured party.
• Status of the Debt: A debtor may request that the secured creditor confirm the debt remaining and/or the collateral covering the remainder of the debt.
• Termination: When a secured debt is fully paid, the secured party generally must send a termination statement to the debtor and file a copy with the appropriate filing office.
REMEDIES ON DEFAULT
• Default: A debtor’s failure to pay a debt when due and/or a secured party’s failure to discharge a debt when paid.
· Execution and Levy: a secured party can relinquish its security interest and proceed to judgment on the underlying debt. If successful, the secured party will proceed to:
• Execution: The process of carrying out the effect of a court decree or judgment; and
• Levy: Seizure and sale of property, subject to a writ of execution, to satisfy a debt.
• Repossession: A secured party can take possession of the collateral and either (i) retain it for satisfaction of the debt, or (ii) resell it and apply the sale proceeds to the debt remaining.
DISPOSITION PROCEDURES AND PROCEEDS
• A secured party who chooses to dispose of collateral must:
(1) sell it in a commercially reasonable manner, and
(2) notify the debtor of the time and place of the sale.
Any time before the secured party disposes of the collateral or enters into a contract to dispose of it, the debtor may exercise its redemptive power to get it back if they tender performance (payment) of all obligations still owed and any expenses incurred by the secured party in retaking the collateral, maintaining it, and any other fees to date (including legal).
• Proceeds from disposition must be applied (ordered) as follows:
(1) reasonable expenses stemming from retaking, holding, or preparing for sale (which may include attorneys’ fees and other legal expenses);
(2) satisfaction of the balance of the debt due to the secured party;
(3) satisfaction of other secured creditors from whom written demand for proceeds has been received; and
(4) any surplus to the debtor.
• If some of the debt remains unsatisfied after all of the collateral has been disposed of, the secured creditor may obtain a deficiency judgment against the debtor.