Module 29: Secured Transactions

Overview

The concept of secured transactions is important to modern business. A creditor often requires some security from the debtor beyond a mere promise to pay. In general, the creditor may require the debtor to provide some collateral to secure payment on the debt. The creditor then becomes known as a secured party because the debt repayment has additional assurance of collateral rather than just the mere promise to repay. If the debt is not paid, the creditor then can resort to the collateral. Under revised Article 9 of the UCC, the collateral is generally personal property or fixtures. You need to understand the concept of attachment as discussed in this module. You also need to understand the important concept of perfection discussed in this module that allows a secured party to obtain greater rights over many third parties. Be sure to understand the three methods by which perfection can be accomplished. The examination also covers rules of priorities when competing interests exist in the same collateral. Before beginning the reading you should review the key terms at the end of the module.

A. The Elements of Secured Transactions

B. Attachment of Security Interests

C. Perfecting a Security Interest

D. Other Issues under Secured Transactions

E. Priorities

F. Rights of Parties upon Default

G. Other Rights of Parties

Key Terms

Multiple-Choice Questions

Multiple-Choice Answers and Explanations

Simulation

Simulation Solution

A. The Elements of Secured Transactions

1. The parties
a. Secured party is the person/bank that provides credit to the debtor and takes an interest in the debtor’s collateral to help assure repayment of the debt
(1) Debtor is entity (or person) that owes either payment or some specified performance to the secured party
(2) Security interest is legal interest in collateral that secures either payment or debtor’s specified performance of some obligation
(3) Security agreement is transaction that creates security interest
2. Types of collateral
a. Goods: Moveable, tangible personal property, which is classified by the initial reason the debtor bought the goods (these classifications are very important)
(1) Consumer goods are goods that were purchased for personal use
(2) Equipment is goods that were purchased for use in a business
(3) Inventory is goods that were purchased for sale or lease to a third party
EXAMPLE
Think of a computer. If I purchased a computer for use in my home, it is a consumer good. If I purchased a computer to use for my business, even if it is in my home, then the computer is equipment. If I purchased the computer to resell at my computer store, then it is inventory.
(4) Fixtures are goods that have been attached permanently or relatively permanently to real property
(5) Farm products are goods produced on a farm such as livestock or crops.
b. Indispensible paper: Collateral evidenced by a writing
(1) Instruments, which include negotiable instruments (see Module 28) as well as stock, bonds, and other investment securities.
(2) Chattel paper is a writing that provides evidence of the monetary obligation and the security interest in the good. Basically, a piece of paper that recites the indebtedness.
(3) Documents of title, such as bills of lading and warehouse receipts (This is discussed in more detail in Module 28, subsection M.)
c. Intangibles include
(1) Account, or account receivable
(2) Commercial tort claim
(3) General intangibles, includes anything else that may be considered collateral, such as intellectual property rights or goodwill.
3. The security agreement
a. This is an agreement between the debtor and the creditor, which gives the creditor a security interest in the debtor’s collateral.
b. Requirements of a valid security agreement
(1) The agreement must be in writing, unless the creditor has physical possession of the collateral (a pledge)
(2) Must be signed by the debtor; creditor’s signature is not required
(3) A reasonable description of the collateral

B. Attachment of Security Interests

1. Attachment is a term used to describe the moment when security interest is enforceable against a debtor by the secured party
2. Security interest attaches when all of the following occur in any order (these are important)
a. Secured party gives value (value is any consideration that supports any contract)
(1) Preexisting claim (although not consideration) is value
EXAMPLE
D already owes S $5,000 on a previous debt. Subsequently, D signs a security agreement giving S an interest in some furniture owned by D. Value has been given by S based on the previous debt.
EXAMPLE
A bank grants a loan to allow B to purchase a washer and dryer. This extension of credit is a typical type of value.
b. Debtor has rights in collateral
(1) Debtor must have rights in collateral
(a) Ownership interest suffices or having some right to possession of collateral but debtor is not required to have actual legal title
EXAMPLE
M obtains a loan from a bank to purchase a sofa. She signs a security agreement granting the credit union a security interest in any sofa that she will buy with this loan. Attachment cannot occur until she buys a sofa. Note that the other two elements of attachment have occurred.
c. A valid security agreement (See A.3. above for requirements of security agreement) unless the secured party has a pledge (physical possession of the collateral)
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 1 THROUGH 6

C. Perfecting a Security Interest

1. Entails steps in addition to attachment (with one exception discussed later) to give secured party priority over many other parties that may claim collateral
a. Attachment focuses primarily on rights between creditor and debtor
b. Perfection, however, focuses on rights between various other parties that may claim an interest in same collateral
(1) Generally, perfecting a security interest gives (constructive) notice to other parties that the perfecting party claims an interest (security interest) in certain collateral
(2) Only an attached security interest can be perfected
2. There are three primary ways that an attached security interest may be perfected—these are important
a. Most security interests either can or must be perfected by filing financing statement(s) in the appropriate state office
b. Secured party takes possession of collateral, or in certain cases takes control
c. Automatic perfection can occur, but only with consumer goods
3. Depending on the type of collateral there may be only one way or there may be several ways to perfect
4. Perfection by filing financing statement(s)
a. Financing statement requirements
(1) Names of the debtor and the secured party
(2) Indication of collateral covered; descriptions such as “all assets” are sufficient
(3) Signatures are not required on a financing statement; the debtor’s signature, however, is required on the security agreement, see A.3. above.
(4) Minor errors in financing statement do not invalidate it if they are not seriously misleading
(5) Law now allows that filing may be done either electronically or in writing
b. Filings last for five years but can be continued with a continuation statement if filed within six months of expiration
c. Financing statements can be refiled for each new five-year period
5. Perfection by secured party’s possession or control of collateral
a. Possession means actual physical possession of the collateral
EXAMPLE
Clint needed some cash so he took his saxophone to a pawnbroker. The pawnbroker loaned Clint $100 and took the saxophone as collateral.
b. Control is similar to possession, but control applies to collateral that cannot be physically possessed (e.g., electronic documents of title, deposit accounts, or investment property)
c. Secured party must use reasonable care to preserve collateral and may charge reasonable expenses to do so
6. Automatic perfection
a. Under the following conditions, perfection is accomplished by completing attachment with no further steps
(1) Purchase money security interest in consumer goods
(a) Purchase money security interest (PMSI) occurs in two important cases
1] Seller retains security interest in same item sold on credit to secure payment
2] Another party, such as bank, provides loan for and retains security interest in same item purchased by debtor
(b) “In consumer goods” means that goods are bought primarily for personal, family, or household purposes
EXAMPLE
B buys a refrigerator for his home from Friendly Appliance Dealer on credit. Friendly has B sign a written security agreement. Because all three elements needed for attachment took place, this is automatic perfection. This is true because the refrigerator is a purchase money security interest in consumer goods.
EXAMPLE
Same as previous example except that Second Intercity Bank provides the loan having B sign a security agreement. This is also a purchase money security interest in consumer goods. Perfection takes place when all three elements of attachment occur.
EXAMPLE
In the two examples above, if B had purchased the refrigerator for use in a restaurant, the collateral would be equipment. Therefore, automatic perfection would not occur. However, the secured party could file a financing statement to perfect the security interest in both cases.
(2) PMSIs may arise in other goods such as equipment and inventory, but there is no automatic perfection in those goods because they are not consumer goods.
(3) Perfection by attachment does not occur for motor vehicles, trailers, or both—perfected by a lien on certificate of title filed with state
(a) Automatic perfection is not effective against bona fide purchaser for value who buys goods from consumer for consumer use
1] Is effective, however, if secured party had filed
EXAMPLE
B purchases a washer and dryer from Dear Appliances for use in his home giving Dear a security interest, then sells the washer and dryer to C for a fair price for C’s household use. C is unaware of the security interest that Dear has in the washer and dryer. Dear’s PMSI is not effective against C.
EXAMPLE
Same example as above except that Dear had filed a financing statement. Dear wins because filing is effective even against a subsequent bona fide purchaser such as C even if he buys for consumer use.
EXAMPLE
In the two examples above, if C had purchased the items from B for other than consumer use, C is not free of Dear’s security interest. This is so because the rule only applies to bona fide purchasers for consumer use. The extra step of filing would not be needed.
2] Is effective if subsequent purchaser knows of security interest before buying
EXAMPLE
An appliance dealer sells a freezer to Jack for family use. Assume attachment has occurred. Jack then sells it to Cindy who is aware of the security interest that the dealer still has in the freezer. Even if Cindy is buying this for household use, she takes it subject to the security interest.
(4) Sale of promissory notes
(5) Assignment of health care insurance to health care provider
(6) Temporary automatic perfection for twenty days for instruments, certificated securities, negotiable documents, and proceeds of sale of perfected security interest

D. Other Issues under Secured Transactions

1. Security interests in goods acquired in the future
a. An after-acquired property clause, sometimes referred to as a floating lien, allows the secured party to acquire a security interest in good that the debtor acquires in the future
(1) Not permitted to be used on consumer goods
(2) Typically used for inventory and equipment
EXAMPLE
Fred agreed to buy Billy’s furniture store. Billy financed the sale himself and took a security interest in all current inventory and equipment and all after-acquired inventory and equipment. Billy filed a financing statement covering this transaction.
Analysis: Billy has a perfected security interest in all current inventory and equipment. If and when Fred purchases additional furniture for resale or goods, such as a computer, for use in the store, then Fred will have a security interest in those goods as well.
2. Computer software embedded in goods is treated as part of those goods and not as software
3. Field warehousing is used to perfect security interest (analogous to possession or control)
a. Debtor keeps inventory on his/her premises under control of third party such as bonded warehouseman or secured party’s employee
b. Secured party keeps control over inventory such as use of separate room or fenced-off portion with sign showing secured party’s control
4. Consignments
a. Consignment of security interest
(1) If it is a “true consignment,” consignee is simply a sales agent who does not own the goods but sells them for consignor
(a) “True consignment” exists when
1] Consignor retains title to goods
2] Consignee has no obligation to buy goods
3] Consignor has right to all proceeds (pays consignee commission)
EXAMPLE
Manufacturer (consignor) gives possession of goods to a marketing representative (consignee) to sell those goods on commission.
(b) To perfect his/her interest, a consignor must
1] File a financing statement under secured transactions law and give notice to the consignee’s creditors who have perfected security interests in the same type of goods. Notice must contain description of the goods to be delivered and be given before the consignee receives possession of goods
EXAMPLE
P delivers goods to A on consignment. The consignment is a “true consignment” in that P has title to the goods and pays A a commission for selling the goods. Any goods that are unsold are returned by A to P. A does not pay for any unsold goods. Creditors of A can assert claims against the goods that A possesses unless P has given notice to the creditors. The general way to accomplish this is by filing a financial statement under the secured transactions law.
(2) If transaction is not a true consignment because it is actually a sale from creditor to debtor in which debtor then owns the goods, look for a security agreement. Attachment and perfection occur as in typical secured transaction
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 7 THROUGH 14

E. Priorities

1. If more than one party claims a security interest in same collateral, rules of priority should be examined. These rules determine which party has the best rights to the collateral. This is extremely important, both on the exam and in real life, because frequently the value of the collateral is insufficient to pay all creditors and the first creditor gets paid in full before the lower priority creditor receives anything.
2. A secured party will prevail over an unsecured party. Unsecured parties are usually referred to as general creditors.
3. If both parties are secured, then the following rules apply:
a. If neither party is perfected, then the interest that attached first prevails
b. A perfected party will prevail over an unperfected party
c. If both parties are perfected, then generally, the first interest that was perfected prevails
(1) A very important exception may arise if one of the party’s perfected interests is a PMSI
(2) A PMSI may take priority over all other security interests, even those security interests perfected prior to the PMSI.
(3) For the PMSI to gain this “super priority” status certain rules must be followed; the rules vary depending on what type of goods the PMSI has perfected in
(4) If the goods are equipment or consumer goods, then the PMSI party has 20 days after the debtor receives possession of the collateral to perfect the PMSI
(a) If the PMSI party follows this rule, then it will prevail over other perfected security interests in the same collateral.
EXAMPLE
Fred agreed to buy Billy’s furniture store. Billy financed the sale himself and took a security interest in all current inventory and equipment and all after-acquired inventory and equipment. Billy filed a financing statement covering this transaction on June 1, 2010. On May 29, 2011, Fred purchased and took delivery of a new computer from Mega for use at his store. Fred purchased the computer on credit and entered into a security agreement with Mega giving Mega a security interest in the computer that Fred had purchased. Mega filed a financing statement covering this transaction on June 10, 2011. If Fred defaults on his payments to Mega and Billy, who has priority to the recently purchased computer?
Analysis: Although Billy’s security interest in after-acquired equipment arose first, Mega has a PMSI in the computer and perfected within the 20-day window, so Mega will prevail. If Mega had waited until June 25th to perfect its interest in the computer, Mega would have a PMSI, but would not gain the priority over Billy because Mega did not perfect within the 20-day window.
(b) Technically the 20-day rule does apply to consumer goods, but the creditor with a PMSI in consumer goods does not need to file a financing statement since perfection occurs automatically.
(5) If the goods are inventory, the PMSI party must perform two tasks to gain priority over earlier perfected interests:
(a) Perfection must occur prior to or simultaneously to the debtor receiving the inventory
NOTE: There is no 20-day window for inventory.
(b) Written notice must be given to all holders of prior perfected security interests in the collateral
EXAMPLE
Fred agreed to buy Billy’s furniture store. Billy financed the sale himself and took a security interest in all current inventory and equipment and all after-acquired inventory and equipment. Billy filed a financing statement covering this transaction on June 1, 2010. Fred purchased some furniture to resell in his store from Highpoint Furniture Corp. Highpoint sold the furniture to Fred on credit and took a PMSI in the furniture it sold Fred. If Highpoint wants to get priority over Billy’s earlier perfected interest on future inventory, Highpoint must provide written notice to Billy of its PMSI and perfect its interest in the furniture. Both tasks must be performed prior to the furniture being delivered to Fred.
4. Secured creditors versus subsequent buyers of collateral
a. Buyers in the ordinary course of business take free of any security interest whether perfected or not (be sure to know this one)
(1) In general, buying in the ordinary course of business means buying from inventory of a person or company that normally deals in those goods
(2) Buyer has priority even if s/he knows that security agreement exists between the seller and a secured party, but buyer must have possession of the collateral
(3) Purpose is to allow purchasers to buy from merchants without fear of security agreements between merchants and other parties
EXAMPLE
S, a dealer in stereos, obtained financing from L by securing the loan with her inventory in stereos. B purchases one of the stereos from that inventory. B takes the stereo free of the security interest that L has in the inventory of S whether it is perfected or not.
b. Distinguish between buyers in the ordinary course of business and the subsequent bona fide purchaser from consumers
(1) The latter defeats only a purchase money security interest in consumer goods (perfection on attachment) unless filing takes place—applies to sale by consumer to consumer
(2) The former applies whether buyer is consumer or not but seller is dealer in those goods
EXAMPLE
See previous example. The result is the same whether or not B was a consumer when he bought the stereo in the ordinary course of business from S.
EXAMPLE
Refer again to the same example using S, L, and B. Now let’s add on one more security interest: B is buying the stereo on credit from S and for his own personal use. Attachment has occurred. There is perfection by attachment because between B and S, it is a purchase money security interest in consumer goods. If B sells the stereo to N, his neighbor, for consumer use, then N takes the stereo free of the perfected security interest (unless S had filed or N had notice of the security interest).
5. Secured creditors versus other creditors
a. Possessor of negotiable document of title has priority over other creditors
b. Lien creditor (e.g., repairman or contractor)
(1) Has priority over an unperfected security interest
(a) Knowledge of security interest is immaterial
(2) Has priority over a security interest perfected after attachment of the lien unless it is a purchase money security interest perfected within the 20-day grace period
(3) A security interest perfected before the lien usually has priority
c. Trustee in bankruptcy as a lien creditor
(1) Trustee has the rights of a lien creditor from the date of filing of petition in bankruptcy
(a) So has priority over a security interest perfected after date of filing petition unless it is a purchase money security interest perfected within the 20-day grace period
(2) Trustee also takes the position of any existing lien creditor
(3) A security interest perfected before the bankruptcy trustee usually has priority
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 15 THROUGH 24

F. Rights of Parties upon Default

1. If collateral consists of claims (e.g., receivables), the secured party has the right of collection from third parties
a. Secured party may notify third party to pay secured party directly
b. Secured party must account for any surplus and debtor is liable for any deficiency
c. Secured party may deduct his/her reasonable expenses
2. Secured party may retain collateral already in his/her possession or may take possession or control from debtor
a. May do so him/herself if s/he can without breach of the peace. Breaching the peace means violating the law. Typically the issue is trespass, in other words, secured party may not trespass to repossess the collateral.
b. Otherwise, s/he must use judicial process to foreclose on collateral
c. Secured party has duty to take reasonable care of collateral in his/her possession
(1) Expenses to protect collateral are responsibility of debtor
3. If secured party proposes to satisfy obligation by retaining the collateral, s/he must
a. Send written notice to debtor
b. Must notify other secured parties (who have sent written notice of their interest), unless consumer goods
c. Can only retain consumer goods if debtor has paid less than 60% of the purchase price or obligation
(1) If 60% or more has been paid for a PMSI in consumer goods, secured party must sell collateral within ninety days after taking possession or be liable to the debtor unless debtor waives this right to sale after the default
4. Secured party may sell collateral
a. May be a public or a private sale
b. Must use commercially reasonable practices—this right cannot be waived by debtor
c. Must sell within a reasonable time
d. Must notify debtor of time and place of public sale or time after which private sale will occur unless collateral is perishable, threatens to decline in value, or is type sold on a recognized market
(1) Must also notify other secured parties (who have sent written notice of their interest) unless collateral consists of consumer goods
e. Secured party may buy at any public sale and also at a private sale if rights of debtor protected
f. Distribution of the sale proceeds. The following are paid in order, with each level paid in full before any money is distributed to the next level.
(1) Secured party’s expenses
(2) Secured part’s debt
(3) Junior security interests
(4) Any remainder to the debtor
5. Debtor has right to redeem collateral before secured party disposes of it by paying
a. Entire debt, and
b. Secured party’s reasonable expenses
6. Most remedies can be varied by agreement if reasonable
a. Provision that secured party must account for any surplus to debtor cannot be varied by agreement
7. Good-faith purchaser (i.e., for value and with no knowledge of defects in sale) of collateral takes free of debtor’s rights and any secured interest or lien subordinate to it
a. Receives debtor’s title
b. If sale was improper, remedy of debtor is money damages against secured party who sold collateral, not against good-faith purchaser
NOW REVIEW MULTIPLE-CHOICE QUESTIONS 25 THROUGH 30

G. Other Rights of Parties

1. Debtor has right to request that creditor show proof of unpaid debt or request that creditor correct incorrect filings on collateral
a. Creditor must either show that debt or filing is correct or make correction
2. When debtor pays debt in full, s/he has right to termination statement of creditor which creditor files or in some cases provides to debtor
a. This provides notice that earlier filing has been satisfied
3. After expenses are paid for repossessing collateral, storage, and reselling collateral, excess proceeds go to secured party, then to other lien holders

KEY TERMS

Attachment. When the secured party’s security interest becomes enforceable against the debtor.

Collateral. Property that is subject to a security interest. It is used to help assure a secured party that the debt will be repaid.

Consumer goods. A type of collateral that was purchased for personal use.

Debtor. The party in a secured transaction who owes an obligation to the secured party.

Default. When the debtor fails to make scheduled payment to a secured party. When this occurs it allows the secured party to take action against the collateral.

Equipment. A type of collateral that was purchased for a business use.

Financing statement. A document filed with the state government that perfects security interest in collateral

Floating lien. A security interest in the future inventory or equipment that the debtor acquires.

Inventory. A type of collateral that was purchased for resale.

Perfection. When the secured party’s security interest is enforceable against third parties. Perfection cannot occur before attachment.

Pledge. When the secured party perfects by taking possession of the collateral.

Purchase money security interest (PMSI). Arises when the secured party extends credit to the debtor to purchase a specific good. The secured party takes a security interest in that specific good.

Secured party. A creditor who receives a promise from a debtor to repay a debt and the debtor also provides collateral to assure repayment of the debt.

Security agreement. The contact between the debtor and secured party, which creates a security interest in the collateral.

Security interest. The interest in the collateral that helps to assure repayment of the debt.

Multiple-Choice Questions (1–30)

B. Attachment of Security Interests

1. Under the Revised UCC Secured Transaction Article, when collateral is in a secured party’s possession, which of the following conditions must also be satisfied to have attachment?

a. There must be a written security agreement.

b. The public must be notified.

c. The secured party must receive consideration.

d. The debtor must have rights to the collateral.

2. Under the Revised UCC Secured Transaction Article, which of the following after-acquired property may be attached to a security agreement given to a secured lender?

  Inventory Equipment
a. Yes Yes
b. Yes No
c. No Yes
d. No No

3. Gardner Bank loaned Holland Company $20,000 to purchase some inventory to resell in its store. Gardner had Holland sign a security agreement that listed as collateral all present and future inventory of Holland as well as the proceeds of any sales of the inventory. Later, Boldon Company, who was aware of Gardner’s security interest, extended credit to Holland but Holland failed to pay back either Gardner or Boldon. Boldon has sought to defeat the security interest pointing out that Gardner never filled out a financing statement. Which of the following is correct?

a. Gardner has an enforceable security interest that is valid against Holland and has priority over Boldon’s interests.

b. Gardner does not have an enforceable security interest valid against Holland or against Boldon.

c. Gardner does have an enforceable security interest valid against Holland but not valid against Boldon.

d. Gardner does not have an enforceable security interest valid against Holland but does have one valid against Boldon.

4. Article 9 of the UCC which governs security interests has added some items that now are covered by security interests law. Which of the following is true?

a. Security interests in tort claims already assessed by a court of law are covered.

b. After-acquired commercial tort claims are covered.

c. Both a and b.

d. Neither a nor b.

5. Under the Revised Secured Transactions Article of the UCC, which of the following requirements is necessary to have a security interest attach?

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6. Under the Revised UCC Secured Transaction Article, which of the following events will always prevent a security interest from attaching?

a. Failure to have a written security agreement.

b. Failure of the creditor to have possession of the collateral.

c. Failure of the debtor to have rights in the collateral.

d. Failure of the creditor to give present consideration for the security interest.

C. Perfecting a Security Interest

7. Perfection of a security interest permits the secured party to protect its interest by

a. Avoiding the need to file a financing statement.

b. Preventing another creditor from obtaining a security interest in the same collateral.

c. Establishing priority over the claims of most subsequent secured creditors.

d. Denying the debtor the right to possess the collateral.

8. Under the Revised UCC Secured Transaction Article, what is the effect of perfecting a security interest by filing a financing statement?

a. The secured party can enforce its security interest against the debtor.

b. The secured party has permanent priority in the collateral even if the collateral is removed to another state.

c. The debtor is protected against all other parties who acquire an interest in the collateral after the filing.

d. The secured party has priority in the collateral over most creditors who acquire a security interest in the same collateral after the filing.

9. A secured creditor wants to file a financing statement to perfect its security interest. Under the Revised UCC Secured Transaction Article, which of the following must be included in the financing statement?

a. A listing or description of the collateral.

b. An after-acquired property provision.

c. The creditor’s signature.

d. The collateral’s location.

10. Which of the following transactions would illustrate a secured party perfecting its security interest by taking possession of the collateral?

a. A bank receiving a mortgage on real property.

b. A wholesaler borrowing to purchase inventory.

c. A consumer borrowing to buy a car.

d. A pawnbroker lending money.

11. Under the Revised UCC Secured Transaction Article, which of the following actions will best perfect a security interest in a negotiable instrument against any other party?

a. Filing a security agreement.

b. Taking possession of the instrument.

c. Perfecting by attachment.

d. Obtaining a duly executed financing statement.

12. Grey Corp. sells computers to the public. Grey sold and delivered a computer to West on credit. West executed and delivered to Grey a promissory note for the purchase price and a security agreement covering the computer. West purchased the computer for personal use. Grey did not file a financing statement. Is Grey’s security interest perfected?

a. Yes, because Grey retained ownership of the computer.

b. Yes, because it was perfected at the time of attachment.

c. No, because the computer was a consumer good.

d. No, because Grey failed to file a financing statement.

13. In which of the following cases does a seller have automatic perfection of a security interest as soon as attachment takes place?

I. Purchase money security interest in consumer goods.

II. Purchase money security interest in inventory.

III. Purchase money security interest in equipment.

a. I only.

b. I and II only.

c. II and III only.

d. I, II, and III.

14. Mars, Inc. manufactures and sells computers on credit directly to wholesalers, retailers, and consumers. Mars can perfect its security interest in the computers it sells without having to file a financing statement or take possession of the computers if the sale is made to

a. Retailers.

b. Wholesalers that sell to distributors for resale.

c. Consumers.

d. Wholesalers that sell to buyers in the ordinary course of business.

E. Priorities

15. Under the Revised Secured Transaction Article of the UCC, which of the following purchasers will own consumer goods free of a perfected security interest in the goods?

a. A merchant who purchases the goods for resale.

b. A merchant who purchases the goods for use in its business.

c. A consumer who purchases the goods from a consumer purchaser who gave the security interest.

d. A consumer who purchases the goods in the ordinary course of business.

16. Under the Revised UCC Secured Transaction Article, what is the order of priority for the following security interests in store equipment?

I. Security interest perfected by filing on April 15.

II. Security interest attached on April 1.

III. Purchase money security interest in noninventory goods attached April 11 and perfected by filing on April 20.

a. I, III, II.

b. II, I, III.

c. III, I, II.

d. III, II, I.

17. Noninventory goods were purchased and delivered on June 15. Several security interests exist in these goods. Which of the following security interests has priority over the others?

a. Security interest in future goods attached June 10.

b. Security interest attached June 15.

c. Security interest perfected June 20.

d. Purchase money security interest perfected June 24.

18. Under the Revised Secured Transaction Article of the UCC, what would be the order of priority for the following security interests in consumer goods?

I. Financing statement filed on April 1.

II. Possession of the collateral by a creditor on April 10.

III. Financing statement perfected on April 15.

a. I, II, III.

b. II, I, III.

c. II, III, I.

d. III, II, I.

19. A party who filed a security interest in inventory on April 1 would have a superior interest to which of the following parties?

a. A holder of a mechanic’s lien whose lien was filed on March 15.

b. A holder of a purchase money security interest in after-acquired property filed on March 20.

c. A purchaser in the ordinary course of business who purchased on April 10.

d. A judgment lien creditor who filed its judgment on April 15.

20. W & B, a wholesaler, sold on credit some furniture to Broadmore Company, a retailer. W & B perfected its security interest by filing a financing statement. Lean purchased some furniture from Broadmore for his home. He was unaware of W & B’s perfected security interest. McCoy purchased some furniture from Broadmore for her home. She was aware that Broadmore’s inventory was subject to security interests since Broadmore was having financial problems and had to buy the furniture on credit. Norsome purchased some furniture from Broadmore for use in his business. Broadmore defaults on its loans from W & B, who wants to repossess the furniture purchased and delivered to Lean, McCoy, and Norsome. From which parties can W & B legally repossess the furniture?

a. McCoy.

b. Lean and McCoy.

c. Norsome.

d. None of these parties.

21. Rand purchased a sofa from Abby Department Store for use in her home. Abby had her sign a security agreement for the balance Rand owed. Rand did not pay the balance and sold the sofa to her neighbor, Gram, for use in his home. Gram did not realize that Rand had not paid off the balance. Abby filed a financing statement after Rand defaulted. This filing was also after Gram purchased the sofa from Rand. Which of the following is correct?

a. Abby can repossess the sofa from Gram since it has a written security agreement covering the sofa.

b. Abby can repossess the sofa from Gram since it perfected its security agreement by filing.

c. Abby can repossess the sofa from Gram since it obtained automatic perfection.

d. Abby has no right to repossess the sofa from Gram.

22. Wine purchased a computer using the proceeds of a loan from MJC Finance Company. Wine gave MJC a security interest in the computer. Wine executed a security agreement and financing statement, which was filed by MJC. Wine used the computer to monitor Wine’s personal investments. Later, Wine sold the computer to Jacobs, for Jacobs’ family use. Jacobs was unaware of MJC’s security interest. Wine now is in default under the MJC loan. May MJC repossess the computer from Jacobs?

a. No, because Jacobs was unaware of the MJC security interest.

b. No, because Jacobs intended to use the computer for family or household purposes.

c. Yes, because MJC’s security interest was perfected before Jacobs’ purchase.

d. Yes, because Jacobs’ purchase of the computer made Jacobs personally liable to MJC.

23. Rally Co. has purchased some inventory from Kantar Corporation to sell to customers who will use the inventory primarily for consumer use. Which of the following is not correct?

a. If Kantar sells the inventory to Rally on credit and takes out a security interest using the inventory as collateral, this a purchase money security interest.

b. If Kantar sells the inventory to Rally on credit and takes out a security interest using the inventory as collateral, this is a purchase money security interest in consumer goods.

c. If Kantar sells the inventory to Rally but Rally pays for it by getting a loan from a bank who takes out a security interest using the inventory as collateral, this is a purchase money security interest.

d. If a customer purchases some inventory on credit from Rally for home use and signs a written security agreement presented by Rally that lists the inventory as collateral for the credit, this is a purchase money security interest in consumer goods.

24. On June 15, Harper purchased equipment for $100,000 from Imperial Corp. for use in its manufacturing process. Harper paid for the equipment with funds borrowed from Eastern Bank. Harper gave Eastern a security agreement and financing statement covering Harper’s existing and after-acquired equipment. On June 21, Harper was petitioned involuntarily into bankruptcy under Chapter 7 of the Federal Bankruptcy Code. A bankruptcy trustee was appointed. On June 23, Eastern filed the financing statement. Which of the parties will have a superior security interest in the equipment?

a. The trustee in bankruptcy, because the filing of the financing statement after the commencement of the bankruptcy case would be deemed a preferential transfer.

b. The trustee in bankruptcy, because the trustee became a lien creditor before Eastern perfected its security interest.

c. Eastern, because it had a perfected purchase money security interest without having to file a financing statement.

d. Eastern, because it perfected its security interest within the permissible time limits.

F. Rights of Parties upon Default

Items 25 and 26 are based on the following:

Drew bought a computer for personal use from Hale Corp. for $3,000. Drew paid $2,000 in cash and signed a security agreement for the balance. Hale properly filed the security agreement. Drew defaulted in paying the balance of the purchase price. Hale asked Drew to pay the balance. When Drew refused, Hale peacefully repossessed the computer.

25. Under the Revised UCC Secured Transaction Article, which of the following remedies will Hale have?

a. Obtain a deficiency judgment against Drew for the amount owed.

b. Sell the computer and retain any surplus over the amount owed.

c. Retain the computer over Drew’s objection.

d. Sell the computer without notifying Drew.

26. Under the Revised UCC Secured Transaction Article, which of the following rights will Drew have?

a. Redeem the computer after Hale sells it.

b. Recover the sale price from Hale after Hale sells the computer.

c. Force Hale to sell the computer.

d. Prevent Hale from selling the computer.

27. Under the Revised UCC Secured Transaction Article, which of the following statements is correct concerning the disposition of collateral by a secured creditor after a debtor’s default?

a. A good-faith purchaser for value and without knowledge of any defects in the sale takes free of any subordinate liens or security interests.

b. The debtor may not redeem the collateral after the default.

c. Secured creditors with subordinate claims retain the right to redeem the collateral after the collateral is sold to a third party.

d. The collateral may only be disposed of at a public sale.

28. Bean defaulted on a promissory note payable to Gray Co. The note was secured by a piece of equipment owned by Bean. Gray perfected its security interest on May 29 Bean had also pledged the same equipment as collateral for another loan from Smith Co. after he had given the security interest to Gray. Smith’s security interest was perfected on June 30. Bean is current in his payments to Smith. Subsequently, Gray took possession of the equipment and sold it at a private sale to Walsh, a good-faith purchaser for value. Walsh will take the equipment

a. Free of Smith’s security interest because Bean is current in his payments to Smith.

b. Free of Smith’s security interest because Walsh acted in good faith and gave value.

c. Subject to Smith’s security interest because the equipment was sold at a private sale.

d. Subject to Smith’s security interest because Smith is a purchase money secured creditor.

29. Under the Revised Secured Transactions Article of the UCC, which of the following remedies is available to a secured creditor when a debtor fails to make a payment when due?

  Proceed against
the collateral		 Obtain a general judgment
against the debtor
a. Yes Yes
b. Yes No
c. No Yes
d. No No

30. In what order are the following obligations paid after a secured creditor rightfully sells the debtor’s collateral after repossession?

I. Debt owed to any junior security holder.

II. Secured party’s reasonable sale expenses.

III. Debt owed to the secured party.

a. I, II, III.

b. II, I, III.

c. II, III, I.

d. III, II, I.

Multiple-Choice Answers and Explanations

Answers

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Explanations

1. (d) Under the Revised Article 9 on Secured Transactions, attachment of a security interest takes place when the secured party gives value, the debtor has rights in the collateral, and one of the following three is true:

a. The secured party must possess the collateral if the debtor agrees to it
b. The secured party must have control of certain types of collateral, or
c. The secured party must have a signed security agreement (or an authenticated electronic transmission).

Answer (a) is incorrect: While a written security agreement is normally required; no such agreement is needed when the secured party has physical possession of the goods. Answer (b) is incorrect because notice is not required for attachment. Answer (c) is incorrect because the secured party must provide consideration, not receive consideration, for attachment to occur.

2. (a) An after-acquired property clause in a security agreement allows the secured party’s interest in such property to attach once the debtor acquires the property, without the need to make a new security agreement. These clauses are typically used for inventory and accounts receivable, and can also be used for equipment. After-acquired clauses are not valid for consumer goods though.

3. (a) The security interest did attach because there was a signed security agreement, Gardner gave value, and Holland had rights in the collateral. Upon attachment, Gardner’s security interest is fully enforceable against Holland. Even though Gardner never perfected the security interest, it still has priority over Boldon’s interests because Boldon was aware of the security interest.

4. (a) Security interests in tort claims are covered under the Revised UCC Secured Transactions Article; this is not true of after-acquired commercial tort claims.

5. (c) In order for attachment of a security interest to occur, three elements must take place. First, the secured party must give value, second, the debtor must have rights in the collateral, and third, there must be a security agreement. This security agreement may be oral if the secured party has possession or control of the collateral. Otherwise, it must be in writing and signed by the debtor. An exception to the signature requirement is made if it is an authenticated electronic transmission. The filing of a security interest is one method of perfecting a security interest, but it is not necessary for attachment.

6. (c) In order for a security interest to attach, there must be a valid security agreement, the secured party must have given value, and the debtor must have rights in the collateral. If any one of these items is missing, attachment cannot take place. Answer (a) is incorrect because the security interest may be oral if the secured party has possession or control of the collateral. Answer (b) is incorrect because if the security agreement is in writing, the secured party does not need possession of the collateral to achieve attachment. Answer (d) is incorrect because the secured party must give value, not necessarily consideration. A preexisting claim, although not consideration, does count as value.

7. (c) Perfection of a security interest is important in that it establishes for a secured party priority over the claims that may be made by most subsequent secured creditors. Answer (a) is incorrect because there are three methods of obtaining perfection and one of them is filing a financing statement. Answer (b) is incorrect because subsequent creditors may still obtain security interests in the same collateral although they will normally obtain a lower priority. Answer (d) is incorrect because of times the debtor retains possession of the collateral.

8. (d) Perfection by filing a financing statement will not defeat all other parties who acquire an interest in the same collateral; rather, perfection by filing gives the secured party most possible rights in the collateral. Note, purchasers from a merchant in the ordinary course of business take the collateral free from any prior perfected security interest. The only time a purchaser would take the collateral subject to a prior perfected security interest would be when the purchaser knew that the merchant was selling the goods in violation of a financing statement. Answer (a) is incorrect because a creditor need not perfect the security interest in order to enforce it against the debtor. Answer (c) is incorrect because the filing of a financing statement does not protect the debtor’s rights but rather the creditor’s rights. Answer (b) is incorrect, because if the collateral is removed from the state and the secured party fails to perfect in the new state, then a subsequent secured party in the new state may get priority in the collateral over the original secured party.

9. (a) Filing a financing statement is one method of perfecting a security interest in personal property. Under the Revised UCC Secured Transaction Article, a financing statement must include the following: the names of the debtor and creditor, and a listing or description of the collateral. Answers (b), (c), and (d) are incorrect because neither an after-acquired property provision, the creditor’s signature, nor the collateral’s location are required to be included in the financing statement.

10. (d) One way to perfect a security interest is for the secured party to take possession of the collateral in addition to attaining attachment. A pawnbroker lending money is such a case. There is a security agreement which may be oral since the secured party has possession of the collateral. The secured party gives value by lending the money. The third step in attachment is that the debtor has rights in the collateral such as ownership. Since these steps constitute attachment, perfection is accomplished by the pawnbroker, the secured party, taking possession of the collateral. Answer (a) is incorrect because the secured transactions laws apply to security interests in personal property, not real property; additionally, the homeowner will have possession of the home, not the bank. Answers (b) and (c) are incorrect because in both cases the purchasers of inventory and the car will have possession of the goods; the secured party will not have possession.

11. (b) In general, the best way to perfect a security interest in a negotiable instrument is to take possession of the instrument. This is true because negotiable instruments are easily negotiated to other holders who can become holders in due course. Answer (a) is incorrect because a holder can become a holder in due course even if a security agreement is filed. Answer (c) is incorrect because perfecting by attachment requires a purchase money security interest in consumer goods. Answer (d) is incorrect because this cannot even accomplish perfection until it is filed.

12. (b) Since West purchased the computer for personal use and the computer itself was the collateral for the security agreement, the fact pattern involves a purchase money security interest in consumer goods. Therefore, once attachment took place, perfection was automatic. Answer (c) is incorrect because since the computer was a consumer good, perfection was automatic upon attachment. Answer (d) is incorrect because filing a financing statement is not required for perfecting a purchase money security interest in consumer goods. Answer (a) is incorrect because retaining or obtaining possession, not ownership, by the secured party is a way to perfect. In any event, Grey Corp. did not retain either ownership or possession since they sold and delivered the computer to West.

13. (a) Automatic perfection (perfection by attachment) takes place in the case of a purchase money security interest (PMSI) in consumer goods only. Answers (b), (c), and (d) are incorrect because they include PMSI in inventory or equipment which do not qualify for automatic perfection.

14. (c) Mars holds a purchase money security interest in the goods sold, which allowed the buyers of these goods to secure the credit for their purchase. When a purchase money security interest is in consumer goods, the secured party (Mars) obtains perfection when attachment takes place without the need to file a financing statement or take possession or control of the collateral. Answers (a), (b), and (d) are incorrect because in those cases the goods comprise inventory, not consumer goods.

15. (d) Buyers in the ordinary course of business take goods free of any security interest whether perfected or not. The buyer can be, but need not be, a consumer. Answer (a) is incorrect because a merchant who purchases consumer goods for resale may not be buying in the ordinary course of business. Answer (b) is incorrect because the merchant who buys the consumer goods for use in his/her business may not be buying in the ordinary course of business. Answer (c) is incorrect because although a consumer can take goods free of a security interest when buying from another consumer, this requires certain facts along with a purchase money security interest in consumer goods. There are no facts in the question to show this.

16. (c) In general, a purchase money security interest in noninventory has priority over nonpurchase money security interests if it was perfected within 20 days after the debtor received the collateral. Item III, therefore, has the first priority because the purchase money security interest was perfected on April 20, 2010, which was within twenty days of the attachment. Item I has priority over Item II because the security interest in Item I was perfected, while the security interest in Item II was not.

17. (d) A purchase money security interest in noninventory goods has a special rule. Since it was perfected within twenty days after the debtor got possession of the collateral, it has priority over all of the others. Answers (a) and (b) are incorrect because unperfected security interests have a lower priority than perfected security interests. Answer (c) is incorrect because although this security interest was perfected before the purchase money security interest, the latter has priority if perfected within twenty days of the debtor taking possession of the collateral.

18. (a) Since security interest I was perfected first when the financing statement was filed on April 1, it has the first priority. Security interest II was perfected on April 10 when the creditor took possession of the collateral. It has the second priority. Security interest III has the third priority since it was perfected last on April 15.

19. (d) The party perfected by filing a security interest in inventory on April 1. S/he would therefore have priority over a judgment lien creditor who filed later on April 15. Answer (a) is incorrect because the mechanic’s lien was filed on March 15 before the perfection of the security interest. Therefore, the mechanic’s lien has priority over the perfected security interest. Answer (b) is incorrect because the holder of the purchase money security interest in after-acquired property filed and perfected before April 1. Answer (c) is incorrect because a purchaser in the ordinary course of business is free of other security interests even if they are perfected before s/he purchases the inventory.

20. (d) Lean, McCoy, and Norsome all purchased the furniture in the ordinary course of business. As such, all three parties take free of the security interest even if it was perfected. This is true whether they purchased the furniture for consumer or business use and whether they knew of the security agreement or not.

21. (d) Abby had a perfected security agreement because of the purchase money security interest in consumer goods. This, however, is not effective against a good-faith purchaser for value who buys from a consumer for consumer use as in the case of Gram. Perfection by filing is, however, effective in such a case but only if the filing is done before Gram purchases the sofa. Answer (a) is incorrect because the attachment of the written security interest makes it enforceable against Rand, not Gram. Answer (b) is incorrect because the filing of the financing statement took place after Gram bought the sofa. Answer (c) is incorrect because, although Abby did accomplish automatic perfection by way of the PMSI in consumer goods, this type of perfection was not effective against Gram because he was a good-faith purchaser for value who bought it from a consumer (Rand) for consumer use.

22. (c) MJC obtained a security interest in the computer purchased by Wine and perfected it by filing. Answer (a) is incorrect. Even though when Jacobs later purchased it for consumer use he was unaware of MJC’s security interest, MJC still has priority. This is true because the filing is constructive notice to all subsequent parties. MJC has priority and may repossess the computer even if Jacobs was unaware of the filed security interest. Answer (b) is incorrect because the filing of the financing statement gives MJC priority over Jacob despite his intended use for family. Answer (d) is incorrect: Jacobs is not personally liable to MJC because he made no contract and did not agree to take on liability with MJC.

23. (b) Because Kantar has a security interest in the inventory it sold and is also using the same inventory as collateral for the credit, this is a purchase money security interest. However, because the items Rally purchased are inventory, not consumer goods, in Rally’s hands, this is not a PMSI in consumer goods. Answer (a) is not chosen because this does describe a PMSI since Kantar retained a security interest in the same items sold on credit to secure payment. Answer (c) is not chosen because a PMSI includes a third party giving a loan who retains a security interest in the same items purchased by the loan. Answer (d) is not chosen because this is a PMSI in consumer goods since the customer purchased the items for his/her home use.

24. (d) When a purchase money security interest uses noninventory as collateral, it has priority over prior competing interests as long as it is perfected within twenty days of the debtor obtaining possession of the collateral. Answers (a) and (b) are incorrect since the collateral in this fact pattern was equipment, and Eastern filed within twenty days, Eastern has priority over the trustee in bankruptcy. Answer (c) is incorrect: Perfection was not automatic since it was a purchase money security interest in equipment, not in consumer goods. Furthermore, since the secured party did not have possession of the collateral, the way to perfect this security interest is by filing a financing statement.

25. (a) After Hale repossesses the computer and sells it in a commercially reasonable fashion, Hale may obtain a deficiency judgment for the amount still owed after the proceeds from the sale pay the expenses of repossession and sale and the debt owed to Hale. Hale may not, however, retain any amounts beyond what Hale is owed, thus answer (b) is incorrect. Any remaining proceeds go to the debtor after repossession and sale expenses and secured parties are paid. Answer (c) is incorrect because for consumer goods, such as the personal computer in this fact pattern, the goods must be sold if the debtor has paid more than 60% of the debt secured by the consumer goods. In this fact pattern, Drew paid two-thirds of the debt. Answer (d) is incorrect because Hale must notify Drew in writing of the impending sale unless Drew had agreed otherwise in writing.

26. (c) Since Drew has paid two-thirds of the price, which is over 60% payment on the secured debt for consumer goods, Hale is obligated to sell the computer rather than keep it in satisfaction of the debt. Answer (a) is incorrect because the debtor may redeem before, not after, the sale. Answer (b) is incorrect because Hale, not Drew, may keep the proceeds needed to pay off repossession and sale expenses and the debt owed to Hale. Any excess would go to Drew. Answer (d) is incorrect because Hale has the right to sell the repossessed computer to pay off the secured debt unless Drew properly redeems the interest s/he has in the computer.

27. (a) Upon the debtor’s default, the secured party may take possession of the collateral and sell it. A good-faith purchaser for value buys the collateral free of any liens or security interests. Answer (b) is incorrect because the debtor has the right to redeem the collateral before the secured party disposes of it. The debtor does this by paying the debt in full as well as the secured party’s reasonable expenses. Answer (c) is incorrect as a good-faith purchaser of the collateral takes it free of the debtor’s rights and any secured interest or lien subordinate to it. Answer (d) is incorrect because although the collateral may be disposed of by a public sale, it also may be disposed of by a private sale if the sale uses commercially reasonable practices.

28. (b) A good-faith purchaser for value at a private sale will take the property free from any security interest or subordinate liens in the property, but remains subject to security interests which are senior to that being discharged at the sale. In this case, Smith perfected his security interest later than Gray and has a subordinate interest in the property. Thus, Walsh takes the equipment free from this subordinate security interest. Answer (a) is incorrect because the fact that Bean is current in his payments to Smith would not affect Smith’s interest in the property. Answer (c) is incorrect because as long as Walsh is a good-faith purchaser for value, it doesn’t matter if the equipment is sold at a public or private sale. Answer (d) is incorrect because Smith is not a purchase money secured creditor since the proceeds of Smith’s loan to Bean were not used to purchase the equipment acting as collateral.

29. (a) If the debtor defaults on the debt, the secured party may proceed against the collateral. This extra protection is one of the main reasons for having secured transactions. If the creditor chooses, s/he may obtain a general judgment against the debtor.

30. (c) Under the UCC, after a secured creditor rightfully sells the debtor’s collateral after repossession, the secured party’s reasonable sale expenses are paid first. Next, the debt owed to the secured party is paid. Any junior security holders then get paid to the extent of any money remaining.

Simulation

Task-Based Simulation 1

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Situation

On January 2, 2013, Gray Interiors Corp., a retailer of sofas, contracted with Shore Furniture Co. to purchase 150 sofas for its inventory. The purchase price was $250,000. Gray paid $50,000 cash and gave Shore a note and security agreement for the balance. On March 1, 2013, the sofas were delivered. On March 10, 2013, Shore filed a financing statement.

On February 1, 2013, Gray negotiated a $1,000,000 line of credit with Float Bank, pledged its present and future inventory as security, and gave Float a security agreement. On February 20, 2013, Gray borrowed $100,000 from the line of credit. On March 5, 2013, Float filed a financing statement.

On April 1, 2013, Dove, a consumer purchaser in the ordinary course of business, purchased a sofa from Gray. Dove was aware of both security interests.

Items 1 through 6 refer to the fact pattern. For each item, determine whether (A), (B), or (C) is correct.

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Simulation Solution

Task-Based Simulation 1

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Explanations

1. (B) Gray gave Shore a security agreement on January 2. Shore also gave value but Gray did not receive the goods or have rights in them until March 1. Therefore, it was not until March 1 that attachment occurred.

2. (C) Perfection took place on March 10, when Shore filed the financing statement, since attachment had already been accomplished. Note that the filing was needed for perfection since this was not a purchase money security interest in consumer goods but in inventory.

3. (A) Float gave value by giving the $1,000,000 line of credit on February 1. On this same date, Gray gave Float a security agreement. Since Gray had rights in the collateral it already possessed, attachment took place on February 1 for that inventory possessed.

4. (C) Perfection occurred on March 5, when Float filed the financing statement, since attachment had already taken place previously.

5. (B) Generally, when two parties have perfected security interests in the same collateral, the first to either file or perfect has priority. When a purchase money security interest exists in the collateral, however, the general rule may vary, depending on whether the collateral is inventory or noninventory. In this case the collateral is inventory. A purchase money security interest in inventory may obtain priority over previously perfected conflicting security interests if (1) the purchase money security holder perfects his interest in the inventory at the time the debtor receives the inventory, and (2) the purchase money security holder provides written notice of his purchase money security interest and a description of the inventory to all holders of conflicting security interests who have filed financing statements covering the same type of inventory. If the purchase money security holder does not take these steps, the general rule applies. Answer (A) is incorrect because Shore did not take the necessary steps for its purchase money security interest to obtain priority. Answer (B) is correct because the general rule applies, and Float filed first. Answer (C) is incorrect because when both security interests are perfected, priority is not based on the order of attachment.

6. (C) A buyer in the ordinary course of business takes free of any security interests even if perfected and even if the buyer is aware of the security interests. Therefore, answers (A) and (B) are incorrect because Dove purchased the goods in the ordinary course of business.

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