CHAPTER 28
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.
Summary:
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).
Requirements:
·
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.
PERFECTION
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
party, and
(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.
MAINTAINING PERFECTION
• 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.