Secured Transactions

Vengeancia (updated December 2014) Bouvier’s Law Dictionary here. Please read about Philip Dru. Blurbs on Admiralty from Freedom School here. Also, check out testimony from James Traficant, RIP. Read here, Democratic Underground. Traficant was framed, new evidence.

The following information was adapted from this: Introduction.

Commerce Means Intercourse

Commerce Means Intercourse

SURETYSHIP (Heb. עַרְבוּת), one person’s undertaking to fulfill the obligation of another toward a third person (called the arev, ḥayyav, and nosheh, respectively). In Jewish law fulfillment of an obligation is secured primarily through the assets of the debtor – “a man’s possessions are his surety” (BB 174a; see *Lien) – and it is in addition to this that a person may serve as a surety for the fulfillment of the debtor’s obligation toward his creditor. Read more.

Whenever the payment of a debt is guaranteed, or secured, by personal property owned by the debtor or in which the debtor has a legal interest, the transaction becomes known as a secured transaction. The concept of the secured transaction is as basic to modern business practice as the concept of credit. Logically, sellers and lenders do not want to risk nonpayment, so they will not sell goods or lend money unless the promise of payment is somehow guaranteed. Indeed, business as we know it could not exist without laws permitting and governing secured transactions.

Article 9 of the Uniform Commercial Code (UCC) governs secured transactions. This chapter first presents the basic concept and terminology of the secured transaction and then discusses how the rights and duties of creditors and debtors are created and enforced. Debtor-creditor transactions that are not covered under Article 9 are discussed in the next chapter. As will become evident, the law of secured transactions tends to favor the rights of creditors.

Landmark in the Law: Article 9 Security Interest

Section 1: Terminology of Secured Transactions.

The UCCs terminology is now uniformly adopted in all documents used in situations involving secured transactions.

A brief summary of the UCCs definitions of terms relating to secured transactions follows.

1. A security interest is any interest in personal property or fixtures which secures payment or performance of an obligation [UCC 1201(37)].

2. A secured party is a lender, a seller, or any person in whose favor there is a security interest, including a person to whom accounts or chattel paper have been sold [UCC 9105(1)(m)]. (Chattel paper is any writing evidencing a debt secured by personal property) The terms secured party and secured creditor are used interchangeably.

3. A debtor is the party who owes payment or performance of the secured obligation, whether or not that party actually owns or has rights in the collateral (defined below). When the debtor and the owner of collateral are not the same person, the term debtor may refer to the actual owner of the collateral, the person responsible for the obligation, or both, depending on the context in which the term is used [UCC 9105(1)(d)].

4. A security agreement is the agreement that creates or provides for a security interest between the debtor and a secured party [UCC 9105(1)(e)]. 5. Collateral is the property subject to a security interest, including accounts and chattel paper that have been sold [UCC 9105(1)(c)]. These basic definitions form the concept under which a debtor-creditor relationship becomes a secured transaction relationship.

Section 2: Creating Security Interests.
Before a creditor can become a secured party, the creditor must have a security interest in the collateral of the debtor. Three requirements must be met for a creditor to have an enforceable security interest:

1. Either (a) the collateral must be in the possession of the secured party pursuant to an agreement, or (b) there must be a written security agreement describing the collateral and signed by the debtor.
2. The secured party must give value.
3. The debtor must have rights in the collateral.

Once these requirements have been met, the creditors rights are said to attach to the collateral. Attachment gives the creditor an enforceable security interest against the debtor.[UCC 9203].

When the collateral is not in the possession of the secured party, a security agreement must be in writing to be enforceable. To be effective, (1) the security agreement must be signed by the debtor, (2) it must contain a description of the collateral, and (3) the description must reasonably identify the collateral [UCC 9203(1); UCC 9110].

The secured party must give value, which, according to UCC 1201(44), is any consideration that supports a simple contract. In addition, value can be security given for a preexisting (antecedent) obligation or any binding commitment to extend credit. Normally, the value given by a secured party takes the form of a direct loan or involves a commitment to sell goods on credit.

The debtor must have rights in the collateral; that is, the debtor must have some ownership interest or right to obtain possession of that collateral. The debtors rights can represent either a current or a future legal interest in the property. For example, a retail seller-debtor can give a secured party a security interest not only in existing inventory owned by the retailer but also in future inventory to be acquired by the retailer.

Section 3: Purchase-Money Security Interest.
Often sellers of consumer durable goods, such as computers and appliances, agree to extend credit for part or all of the purchase price of those goods. Also, lenders not necessarily in the business of selling such goods often agree to lend much of the purchase price for them. There is a special name for the security interest that the seller or the lender obtains when such a transaction occurs. It is called a purchase-money security interest (PMSI). Formally, such an interest exists when one or the other of the following conditions arises:

1. A security interest is retained in, or taken by the seller of, the collateral to secure part or all of its price.
2. 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 rights in the collateral or to use it [UCC 9107].

In either situation, a lender or seller has essentially provided a buyer with the purchase money to buy goods. Suppose that Benjamin wants to purchase an entertainment center from USA Appliances. The purchase price is $900. Not being able to pay cash, Benjamin signs a purchase agreement to pay $100 down and $50 per month until the balance plus interest is fully paid. USA Appliances is to retain a security interest in the purchased goods until full payment has been made. Because the security interest was created as part of the purchase agreement, it is a PMSI.

The same result will occur if Benjamin goes to Statewide Bank and borrows the $900 to buy the entertainment center from USA Appliances. Once Benjamin has signed a loan agreement with Statewide Bank, with the to-be-purchased goods as collateral, Statewide Bank has a PMSI the moment the goods are purchased from the appliance store. Obviously, if Benjamin uses the money for other purposes, Statewide Bank will not have a security interest. For this reason, Statewide Bank might arrange to pay the $900 directly to USA Appliances.

Section 4: Perfecting a Security Interest.
A creditor has two main concerns if the debtor defaults (fails to pay the debt as promised): (1) satisfaction of the debt through possession of the collateral and (2) priority over any other creditors and purchasers who may have rights in the same collateral. The concept of attachment, which establishes the criteria for creating an enforceable security interest, deals with the former concern; the concept of perfection deals with the latter.
Even though a security interest has attached, the secured party must nevertheless take steps to protect its claim to the collateral over claims that third parties may have. Third parties may be other secured creditors, nonsecured creditors, trustees in bankruptcy…or purchasers of the collateral that is the subject matter of the security agreement. Perfection represents the legal process by which secured parties protect themselves against the claims of third parties who may wish to have their debts satisfied out of the same collateral.

The most common method of perfecting a security interest is by the filing of a financing statement with the appropriate state or local official….The UCC requires a financing statement to contain (1) the signature of the debtor, (2) the names and addresses of both the debtor and the creditor, and (3) a description of the collateral by type or item [UCC 9402(1)].


The UCC requires that a financing statement be filed under the name of the debtor [UCC 9402(1)]. If the debtor is an individual, the financing statement must be filed in the name of the individual, but if the debtor is a partnership or corporation, the financing statement must be filed under the partnership or corporate name [UCC 9402(7)]. If a financing statement identifies the debtor by an incorrect name, the statement may be ineffective to perfect a security interest.

What happens to the perfected secured party’s interest when the debtor changes its name, as might happen as a result of a business reorganization? In this situation, if the name change causes the financing statement to become seriously misleading, the filing is not effective to perfect a security interest in collateral acquired by the debtor more than four months after the change, unless a new appropriate financing statement is filed before the expiration of that time [UCC 9402(7)]. To accomplish the change, the secured party merely files a new financing statement, which is signed by the secured party instead of the debtor [UCC 9402(2)(d)].
Assume that a debtor, Thomas T. Dibello, borrows money from a Pennsylvania bank, which in turn takes a security interest in Dibello’s store inventory. The bank properly files a financing statement that lists Thomas T. Dibello as the debtor’s name. Shortly thereafter, Dibello incorporates his business and changes the name of the business to Just for Kids, Inc. The bank will continue to be protected as to the existing collateral and as to new collateral acquired by the debtor during the four months following the name change, even if the bank fails to refile. At the end of the four-month period, however, the bank must refile under the new business name of the debtor. Otherwise, its security interest in any collateral acquired after this point will be unperfected.


Both the security agreement and the financing statement must contain a description of the collateral in which the secured party has a security interest. The UCC requires that the security agreement include a description of the collateral, because no security interest in goods can exist unless the parties agree on which goods are subject to the security interest and then describe these goods in writing. The purpose of describing collateral in the financing statement is for the benefit of persons who might later wish to lend to the debtor or purchase the collateral; the description puts these persons on notice that certain goods in the debtors possession are already subject to a security interest.

Sometimes, the descriptions in the security agreement and the financing statement differ, with the description in the security agreement being more precise and the description in the financing statement more general. For example, a security agreement for a commercial loan to a manufacturer may list all the manufacturers equipment subject to the loan by serial number, whereas the financing statement may simply state all equipment owned or hereafter acquired.

To avoid problems arising from such differences, a secured party may repeat exactly the security agreements description in the financing statement or file the security agreement itself as a financing statement (assuming the security agreement meets the previously discussed criteria). Alternatively, where permitted, the creditor might file a combination security agreement-financing statement form. If the financing statement is too general or vague, a court may find it insufficient to perfect a security interest.


Depending on the classification of collateral, filing is done either centrally with the secretary of state, locally with the county clerk or other official, or both, according to state law. According to UCC 9401, a state may choose one of three alternatives (see the text of UCC 9401 in appendix C for these alternatives).(3) In general, financing statements for consumer goods should be filed with the county clerk. Other kinds of collateral require filing with the secretary of state [UCC 9401].(4) An improper filing reduces a secured partys claim in bankruptcy to that of an unsecured creditor.

The classification of collateral is important not only in determining where to file but also in determining whether filing is necessary. Exhibit 303 summarizes the various classifications of collateral and the methods of perfecting a security interest in them.

In two types of situations, security interests can be perfected without the filing of a financing statement. First, when the collateral is transferred into the possession of the creditor, the creditors security interest in the collateral is perfected. Second, a PMSI in consumer goods is perfected automatically. These two situations are discussed below. In addition, UCC 9302(1) mentions other security interests that can be perfected without the filing of a financing statement, including a security interest created by an assignment of a beneficial interest in a trust or a decedents estate.


Certain items, such as stocks, bonds, and jewelry, are commonly transferred into the creditors possession when they are used as collateral for loans. This transfer is known as a pledge. (When the debt is paid, the collateral is returned to the debtor.) One of the benefits for creditors of having possession of the collateral is that the security agreement is perfected in these circumstances without filing.

For most collateral, however, possession by the secured party is impractical, because it denies the debtor the right to use or derive income from the property to pay off the debt. For example, if a farmer took out a loan to finance the purchase of a piece of heavy farm equipment, using the equipment as collateral, the purpose of the purchase would be defeated if the farmer transferred the collateral into the creditors possession.
Note that with respect to negotiable instruments, nonnegotiable transferable instruments, and certain securities (such as stocks and bonds), with a few exceptions, the only way to perfect a security interest properly is through possession by the secured party. Remember, a security agreement need not be in writing to create a security interest [UCC 9203(1)]. Thus you can create and perfect a security interest at the same time by possession of the collateral.


In certain circumstances, a security interest in tangible collateral can be perfected automatically at the time of a credit salethat is, at the time that a PMSI is created under a written security agreement. Note that this automatic-perfection rule with regard to PMSIs applies only when the goods are consumer goods (defined as goods bought or used by the debtor primarily for personal, family, or household purposes). The seller in this situation need do nothing more to protect his or her interest. There are exceptions to this rule, however, that cover security interests in fixtures and in motor vehicles [UCC 9302(1)(d)]. In states that have not adopted the 1972 UCC amendments(5) or that have decided to retain certain pre-1972 sections, a PMSI in farm equipment under a certain statutory value is also automatically perfected by attachment.
Concept Summary 30-1

There are sources of law other than UCC Article 9 that deal with the perfection of security interests. The three most important sources are federal law, such as the Federal Aviation Act; UCC Article 8, which deals with investment securities; and state certificate-of-title laws that deal with motor vehicles.

Most states require a certificate of title for any motor vehicle, boat, or motor home. The normal methods described above for perfection of a security interest typically do not apply to such vehicles. Rather, perfection of a security interest only occurs when a notation of such an interest appears on the certificate of title that covers the vehicle.

As an example, suppose that your commercial bank lends you 80 percent of the money necessary to purchase a new car. You live in a state that requires certificates of title for all automobiles. If your bank fails to have its security interest noted on the certificate of title, its interest is not perfected. That means that a good faith purchaser of your car would take it free of the banks interest. In most states, purchasers of motor vehicles can either buy or extend credit on those vehicles with the confidence that no security interest exists that is not disclosed on the certificate of title.(6)

Obviously, collateral may be moved by the debtor from one jurisdiction (state) to another. In general, a properly perfected security interest in collateral moved into a new jurisdiction continues to be perfected in the new jurisdiction for a period of four months from the date on which the collateral was moved into the new jurisdiction or for the period of time remaining under the perfection in the original jurisdiction, whichever expires first [UCC 9103(1)(d); UCC 9103(3)(e)]. Collateral moved from county to county within a state (if local filing is required), rather than from one state to another, however, may not be subject to a four-month limitation [UCC 9403(3)].

To illustrate, suppose that on January 1, Smith secures a loan from a Nebraska bank by putting up all his wheat-threshing equipment as security. The Nebraska bank files the security interest centrally with the secretary of state. In June, Smith has an opportunity to harvest wheat crops in South Dakota and moves his equipment into that state on June 15. The law just mentioned means that the Nebraska banks perfection remains effective in South Dakota for a period of four months from June 15. If the Nebraska bank wishes to retain its perfection priority, it must perfect properly in South Dakota, the jurisdiction in which the machine is located, during this four-month period. Should the bank fail to do so, its perfection would be lost after four months, and subsequent perfected security interests in the same collateral in South Dakota would prevail.
Among mobile goods, automobiles pose one of the biggest problems. If the original jurisdiction does not require a certificate of title as part of its perfection process for an automobile, perfection automatically ends four months after the automobile is moved into another jurisdiction. When a security interest exists on an automobile in a state in which title registration is required, and when the security interest is noted on the certificate of title, the perfection of the security interest continues after the automobile is moved to another state requiring a certificate of title until the automobile is registered in the new state [UCC 9103(2)]. Because each title state requires that the holder surrender the old certificate of title to obtain a new one, and because the secured party typically holds the certificate, the secured party usually is able to ensure that the security interest is noted on the new certificate of title.

A financing statement is effective for five years from the date of filing [UCC 9403(2)]. If a continuation statement is filed within six months prior to the expiration date, the effectiveness of the original statement is continued for another five years, starting with the expiration date of the first five-year period [UCC 9403(3)]. The effectiveness of the statement can be continued in the same manner indefinitely.

Section 5: The scope of a security interest.
A security agreement can cover various types of property in addition to collateral already in the debtors possession, including the proceeds of the sale of collateral, after-acquired property, and future advances.
Business Law in Action: Has Anyone Seen the Proceeds

Proceeds include whatever is received when collateral is sold, exchanged, collected, or disposed of. A secured party has an interest in the proceeds of the sale of collateral. For example, suppose a bank has a perfected security interest in the inventory of a retail seller of heavy farm machinery. The retailer sells a tractor out of this inventory to a farmer, a buyer in the ordinary course of business. The farmer agrees, in a retail security agreement, to pay monthly payments for a period of twenty-four months. If the retailer should go into default on the loan from the bank, the bank is entitled to the remaining payments the farmer owes to the retailer as proceeds.

A security interest in proceeds perfects automatically upon perfection of the secured partys security interest and remains perfected for ten days after receipt of the proceeds by the debtor. One way to extend the ten-day automatic period is to provide for such extended coverage in the original security agreement. This is typically done when the collateral is the type that is likely to be sold, such as a retailers inventory.
The UCC provides that in the following circumstances the security interest in proceeds remains perfected for longer than ten days after the receipt of the proceeds by the debtor:

1. When a filed financing statement covers the original collateral and the proceeds are collateral in which a
security interest may be perfected by a filing in the office or offices with which the financing statement has
been filed. Furthermore, a secured creditors interest automatically perfects in property that the debtor
acquires with cash proceeds, if the original filing would have been effective as to that property and the
financing statement indicates that type of property [UCC 9306(3)(a)]. Thus, in the farm equipment
of property example above, if the retailer used the farmers monthly payments to acquire additional
inventory, the bank would be entitled to that inventory, providing that the banks original filing was effective as
to that property and the financing statement indicated that type of property.

2. Whenever there is a filed financing statement that covers the original collateral and the proceeds are identifiable cash proceeds [UCC 9306(3)(b)].

3. Whenever the security interest in the proceeds is perfected before the expiration of the ten-day period
[UCC 9306(3)(c)].

After-acquired property is collateral that is acquired by the debtor after the execution of the security agreement. The after-acquired property may consist of inventory, equipment, farm animals, or virtually any other kind of property, except for consumer goods acquired more than ten days after the secured party gives value [UCC 9204(2)]. The security agreement itself may include a clause to provide for coverage of after-acquired property [UCC 9204(1)]. This is particularly useful for firms that want to obtain financing for the purchase of inventory (products to be sold in the ordinary course of the firms business). A secured party whose security interest is in existing inventory knows that the debtor will replace that inventory, thereby reducing the collateral subject to the security interest.

Generally, when the debtor purchases new inventory to replace the inventory that is sold, the secured party wants this newly acquired inventory to be subject to the original security interest. Thus, the after-acquired property clause continues the secured party’s claim to any inventory acquired thereafter. This is not to say that such an original security interest will be superior to the rights of all other creditors with regard to this after-acquired inventory, as will be discussed later.

Consider a typical example. Liberta buys factory equipment from Stedler on credit, giving as security an interest in all of her equipmentboth what she is buying and what she already owns. The security interest with Stedler contains an after-acquired property clause. Six months later, Liberta pays cash to another seller for additional equipment. Six months after that, Liberta goes out of business before she has paid off her debt to Stedler. Stedler has a security interest in all of Libertas equipment, even the equipment bought from the other seller.

Often, a debtor will arrange with a bank to have a continuing line of credit under which the debtor can borrow funds intermittently. Advances against lines of credit can be subject to a properly perfected security interest in certain collateral. The security agreement may provide that any future advances made against that line of credit are also subject to the security interest in the same collateral. For example, Holtzman is the owner of a small manufacturing plant with equipment valued at $1 million. He has an immediate need for $50,000 of working capital, so he secures a loan from Northeastern Bank and signs a security agreement, putting up all his equipment as security. The security agreement provides that Holtzman can borrow up to $500,000 in the future, using the same equipment as collateral for any future advances. In such cases, it is not necessary to execute a new security agreement and perfect a security interest in the collateral each time an advance is made to the debtor [UCC 9204(3)].

A security agreement may provide for the creation of a security interest in proceeds of the sale of the collateral that was the subject matter of the secured transactionafter-acquired property, future advances, or both. Such an agreement is referred to as a floating lien. Floating liens commonly arise in the financing of inventories. A creditor is not interested in specific pieces of inventory, because they are constantly changing, so the lien floats from one item to another as the inventory changes.

For example, suppose that Ski Paradise, Inc., a cross-country ski dealer, has a line of credit with New England Community Bank to finance an inventory of cross-country skis. Ski Paradise and New England Community enter into a security agreement that provides for coverage of proceeds, after-acquired inventory, present inventory, and future advances. This security interest in inventory is perfected by a central filing (with the secretary of state). One day, Ski Paradise sells a new pair of the latest cross-country skate skis, for which it receives a used pair in trade. That same day, it purchases two new pairs of skate skis from a local manufacturer with an additional amount of money obtained from New England Community. New England Community gets a perfected security interest in the used pair of skate skis under the proceeds clause, has a perfected security interest in the two new pairs of skate skis purchased from the local manufacturer under the after-acquired property clause, and has a security interest in all of these skis and those in present inventory that were purchased with money advanced to Ski Paradise and secured by the future-advance clause.

All of this is accomplished under the original perfected security agreement. The various items in the inventory have changed, but New England Community still has a perfected security interest in Ski Paradises inventory, and hence it has a floating lien on the inventory. Exhibit 30-4 illustrates graphically the concept of a floating lien.

The concept of the floating lien can also apply to a shifting stock of goods. Under Section 9205, the lien can start with raw materials and follow them as they become finished goods and inventories and as they are sold, turning into accounts receivable, chattel paper, or cash.

Section 6: Resolving Priority Disputes.
What happens when several creditors claim a security interest in the same collateral of a debtor? This important issue is addressed by the UCC with a set of rules for determining which of the conflicting security interests has priorityor the best claim to the collateralwhen the debtor goes into default. The question of priority is particularly important when the debtor is in bankruptcy. In this situation, only the perfected secured party will recover, and other creditors may end up with little or nothing.

In general, secured creditors prevail over unsecured creditors and over creditors who have obtained judgments against the debtor but who have not begun the legal process to collect on those judgments [UCC 9301]. In other words, once a security interest attaches, it has priority over the claims of other creditors who do not have a security interest. This priority does not depend on whether the security interest has been perfected.

A lien creditor is one who has a lien on the property because of a judgment. Any security interest that is perfected has priority over the claims of lien creditors who acquired their liens after perfection. In contrast, a lien creditor has priority over a party with a security interest that has not yet been perfected. A so-called ten-day exception to this rule, however, provides as follows: if a secured party files with respect to a PMSI during a ten-day period after the debtor receives possession of the collateral, the secured party’s claim has priority over the lien creditors rights that arise between the time the security interest attaches and the time of filing [UCC 9301(2)]. In many states, this so-called grace period has been extended to twenty days.

When more than one party has a secured interest in the collateral of a defaulting debtor, the issues of perfection and timing become critical, as does the type of collateral involved. There are several general rules and, of course, exceptions to those rules.

THE GENERAL RULE Among secured parties, the general rule of priority is as follows: The first security interest to be filed or perfected has priority over other filed or perfected security interests. If, however, none of the conflicting security interests has been perfected, the first security interest to attach has priority [UCC 9312(5)].

For example, suppose that West Bank filed a financing statement covering Algers inventory on March 1, and Friendly Savings and Loan filed a financing statement covering the same inventory on April 1. West Banks interest would have priority over Friendlys interest. It would not matter which lender made its loan and attached its security interest first. If West Bank failed to perfect its security interest, however, and Friendly perfected its interest, then Friendlys interest would have priority as the only perfected security interest. If both failed to perfect their interests, then the first to attach would have priority. Thus, if West Bank had a security agreement covering Algers inventory on March 1 and advanced money to Alger on the same day, and Friendlys agreement and advance were made on April 1, West Bank would have priority over Friendly.

AN EXCEPTION: THE PMSI The general rule, as previously stated, is that the first in time to file or perfect is first in priority rights to the collateral. This rule is always applicable when the first in time to perfect is a PMSI. The UCC provides, however, that under certain conditions a PMSI, properly perfected, will prevail over a non-PMSI in after-acquired collateral, even though the non-PMSI was the first in time to perfect.

If the collateral is inventory, a perfected PMSI will prevail over a previously perfected non-PMSI provided that the holder of the PMSI perfects and gives the holder of the non-PMSI security interest written notice of his or her interest before the debtor takes possession of the newly acquired inventory [UCC 9312(3)].

If the collateral is other than inventory, a PMSI will have priority over a previously perfected non-PMSI provided that the PMSI is perfected either before or within ten days after the debtor takes possession. No notice is required [UCC 9312(4)].

To illustrate: Retailer Elena needs a loan of money to be used as working capital. On May 1, she obtains a one-year installment loan from West Bank, signing a security agreement and putting up her present inventory plus any after-acquired inventory as collateral. That same date, West Bank perfects its non-PMSI by filing a financing statement centrally. On August 1, Elena learns that she can purchase directly from Martin, a manufacturer, $10,000 worth of new inventory, which is a bargain. Because she cannot pay this amount in cash, she signs a security agreement with Martin, giving Martin a security interest in the newly purchased inventory. The new inventory is delivered on September 1, as ordered. On September 7, a fire destroys most of Elenas store and warehouse. There remains only a part of the new inventory, and its value is insufficient to cover both debts. Who has priority with regard to the remaining inventory, West Bank or Martin? If Martin perfected by filing and gave West Bank written notice of its security interest prior to September 1, the date Elena received possession, Martin prevails. If Martin did not meet these conditions, West Bank prevails.
Suppose that the collateral is equipment, rather than inventory, and Martin perfected on September 8, after the fire. Because Martin properly perfected its PMSI within ten days after Elena received delivery, Martin prevails over West Bank for the remaining after-acquired equipment.

In general, a security interest in collateral continues even after the collateral has been sold unless the secured party has authorized the sale [UCC 9306(2)]. There are exceptions, however, and they allow the buyers of collateral sold without the secured partys authorization to take that collateral free of the security interest, even in situations when the security interest has been perfected. We examine those situations next.

BUYERS IN THE ORDINARY COURSE OF BUSINESS To require buyers to find out if there is an outstanding security interest on a merchants inventory would impose a time-consuming restriction and would certainly inhibit commerce. Therefore, the UCC provides that a person who buys in the ordinary course of business will take the goods free from any security interest attached to those goods, even if the security interest is perfected and even if the buyer knows of its existence [UCC 9307(1)]. A buyer in the ordinary course of business is defined as any person who, in good faith and without knowledge that the sale is in violation of the ownership rights or security interest of a third party in the goods, buys in ordinary course from a person in the business of selling goods of that kind [UCC 1201(9)].

Suppose retail seller Chad secures a loan from West Bank and puts up his existing appliance inventory and any appliance inventory thereafter acquired as collateral. Chad signs a security agreement and a financing statement, which West Bank properly perfects. Later Chad sells an appliance from inventory covered by the security agreement to Lee, and Lee pays cash. If Chad goes into default on the loan, West Banks prior perfected security interest has no effect on Lee. Lee took the appliance completely free of West Banks security interest, even though perfected, and West Bank loses this item of collateral for satisfaction of the debt. (Of course, West Bank has rights in any identifiable cash proceeds.)
In the following case, the court must determine at what point a buyer becomes a buyer in the ordinary course of the sellers business.

Superior Court of Pennsylvania, 1985.
338 Pa.Super. 257,
487 A.2d 953.

BACKGROUND AND FACTS The Big Knob Volunteer Fire Company agreed to buy a fire truck from Hamerly Custom Productions, Inc., which was in the business of assembling component parts into fire trucks. The Volunteer Fire Company paid Hamerly $48,000 toward the $51,836 purchase price. Under their contract, Hamerly agreed to deliver the truck within twenty to seventy days of receiving the chassis from a third party supplier. The contract also provided that title to the truck would not pass to the Volunteer Fire Company until the price had been paid in full. Hamerly ordered the chassis from Lowe & Moyer Garage, Inc., and on receiving the chassis began transforming it into a fire truck, painting Big Knob Volunteer Fire Department on the cab. The chassis was subject to a security interest. Hamerly, however, did not pay Lowe & Moyer for the chassis, nor did it complete the truck or deliver it to the Volunteer Fire Company. Consequently, both the Volunteer Fire Company and Lowe & Moyer sued Hamerly. Hamerly surrendered the truck to Lowe & Moyer, which dropped its suit. The Volunteer Fire Company obtained a default judgment against Hamerly for specific performance and then sued Hamerly and Lowe & Moyer to replevy (repossess) the truck. The trial court found in favor of Lowe & Moyer for the chassis or its value, reasoning that because title had not passed, the Volunteer Fire Company was not a buyer in the ordinary course of business. The Volunteer Fire Company appealed.

SPAETH, President Judge:
* * * *
* * * The trial court held that the Volunteer Fire [Company] was not a buyer in ordinary course because there was no sale to it. Relying on the definition of sale as the passing of title from the seller to the buyer for a price, [Section] 2106(a), the trial court held that [n]either title to the truck passed, nor was delivery made to plaintiff.
The point at which a person becomes a buyer in ordinary course is subject to considerable controversy because the Code does not specify the moment at which the status is conferred. The controversy arises in the context of both [Section] 9307(a) and [Section] 2403(b) of the Code. * * *
The cases are * * * divided. Cases denying recovery to a party on the ground that the party was not a buyer in ordinary course reason that a sale is required, [Section] 1201; a sale requires transfer of title, [Section] 2106(a); and a transfer of title occurs either when agreed upon by the parties or upon physical delivery, [Section] 2401(2). Absent satisfaction of these criteria, the buyer will not prevail even though some or all of the purchase price has been paid. * * * This reasoning places the buyer who has paid in advance for goods not yet delivered in an extremely vulnerable position.
* * * *
The modern trend in contests between a buyer without possession and a secured creditor, typically the inventory financer, is to ignore or deemphasize the concept of
sale. Instead of focusing on passage of title (delivery), courts and commentators increasingly favor identification as the critical moment that determines when a buyer becomes a buyer in ordinary course. * * *
* * * *
* * * [C]ourts have with increasing frequency held that passing of title (when agreed to or occurring upon delivery, [Section] 2401(2)) is not essential to a person becoming a buyer in ordinary course of business. We agree with these courts, and hold that identification rather than delivery is the point at which a person becomes a buyer in ordinary course of business. Since here the fire truck was identified to the contract, the Volunteer Fire Company did become a buyer in ordinary course of business. Upon entrusting the goods to Hamerly, which dealt in goods of that kind, Lowe & Moyer gave Hamerly the power to transfer its rights to a buyer in ordinary course of business, and Hamerly exercised that power when it painted the Volunteer Fire Departments name on the cab of the fire truck, identifying the goods to the contract and making the Volunteer Fire [Company] a buyer in ordinary course of business.

DECISION AND REMEDY The court held that the Volunteer Fire Company was entitled to possession of the truck free of the security interest.

BUYERS OF FARM PRODUCTS Under the UCC, a buyer of farm products takes the products subject to a security interest, even if the buyer knows nothing about the existence of a security agreement [UCC 9307(1)]. Under the Food Security Act of 1985,(9) however, buyers in the ordinary course of business include buyers of farm products from farmers. Under the Food Security Act, a secured party is not protected against a buyer of farm products from a farmer unless one of the following events occurs:

1. The buyer has received notice of the security interest within one year before the purchase.

2. The buyer fails to register with the secretary of state before the purchase, and the secured party has
properly perfected his or her interest centrally.

3. The buyer has received notice from the secretary of state that the farm products being sold are subject to an
effective financing statement (EFS). An EFS is a form that a secured party must file in addition to an Article 9 financing statement to protect his or her interest in a farmers products in those states with EFS
filing systems. Profile: Article 9 Security Interest

BUYERS OF CONSUMER GOODS FROM CONSUMERS Carla, a consumer, purchases a refrigerator from an appliance store on credit, because she cannot pay the full purchase price. A written security agreement exists in which the seller takes a PMSI in the consumer goods. Further, the seller need not file a financing statement, because, when a PMSI is taken in consumer goods, perfection occurs automatically [UCC 9302(1)(d)]. Later, Carla sells the refrigerator to her next-door neighbor, Nan, who purchases itas a purchaser not in the ordinary course of businessfor home use without any knowledge of the credit arrangements between Carla and the original seller. Subsequently, Carla defaults on the credit payments to the seller. What are the sellers rights? The seller had a perfected PMSI in the refrigerator when it was held by Carla. Under UCC 9307(2), however, the perfection is not good against the next-door neighbor.

UCC 9307(2) requires that a person in the position of this next-door neighbor must purchase (give value for) the goods for personal, family, or household use, and without knowledge of the original sellers security interest, and that the purchase must take place before the secured party has filed a financing statement. In this case, recall that the seller took a PMSI, which is perfected automatically. No filing was required. Hence, the next-door neighbor purchased the refrigerator free and clear before the seller had filed a financing statement. The seller could have avoided this possibility simply by filing a financing statement, even though a PMSI had been perfected.

BUYERS OF CHATTEL PAPER AND INSTRUMENTS Another purchaser who may not be subject to a secured partys interest despite perfection is the purchaser of chattel paper and instruments. This protection is provided by UCC 9308. As previously defined, chattel paper is a writing or writings that evidence both a monetary obligation and a security interest in specific goods. Instrument means a negotiable instrument as defined in UCC 3104, or a certificated security as defined in UCC 8102, or basically any other writing that evidences a right to the payment of money and is not itself a security agreement or lease transferred in the ordinary course of business by delivery with any necessary indorsement or assignment [UCC 9105(1)(i)]. Security interests in instruments can be perfected only by possession.

Chattel paper is a very important class of collateral used in financing arrangements, especially in automobile financing. When chattel paper is sold by a creditor, the creditor can deliver it over to the assignee, who is then responsible for collecting the debt directly from the debtor. This arrangement is known as notification or direct collection. As an alternative, a creditor can sell chattel paper to an assignee with the understanding that the creditor will retain the chattel paper, make collections from the debtor, and then remit the money to the assignee. This kind of transaction is nonnotification or indirect collection. The widespread use of both methods of dealing with chattel paper is recognized by the UCC, and hence the UCC permits perfection of a chattel paper security interest either by filing or by taking possession of the chattel paper.

Problems arise when perfection of chattel paper is made by filing only. If the chattel paper is thereafter sold to another purchaser who gives new value and takes possession of the paper in the ordinary course of the purchasers business, without knowledge that it is subject to a security interest, the new purchaser will have priority over the secured creditor. (Of course, the creditor has rights in the proceeds.)

Section 7: Other Rights and Duties under Article 9.
The security agreement itself determines most of the rights and duties of the debtor and creditor. Article 9 of the UCC, however, imposes some rights and duties that are applicable in the absence of a security agreement to the contrary.

Under UCC 9407(1), a creditor has the option, when making the filing, of asking the filing officer to make a note of the file number, the date, and the hour of the original filing on a copy of the financing statement. The filing officer must send this copy to the person making the request. Under UCC 9407(2), a filing officer must also give information to a person who is contemplating obtaining a security interest from a prospective debtor. The filing officer must give a certificate that provides information on possible perfected financing statements with respect to the named debtor. The filing officer will charge a fee for the certification and for any information copies provided.

A secured party can assign part or all of the security interest to another, called the assignee. That assignee becomes the secured party of record if, for example, he or she either makes a notation of the assignment somewhere on the financing statement or files a written statement of assignment [UCC 9405(1), (2)]. Whenever desired, a secured party of record also can release part or all of the collateral described in a filed financing statement. This ends his or her security interest in the collateral [UCC 9406].
It is also possible to amend a financing statement that has already been filed. Note, however, that the amendment must be signed by both parties. The debtor signs the security agreement, the original financing statement, and the amendments [UCC 9402]. All other secured transaction documents, such as releases, assignments, continuations of perfection, perfections of collateral moved into another jurisdiction, and termination statementsall of which are discussed in this chapter) need only be signed by the secured party.

If a secured party is in possession of the collateral, he or she must use reasonable care in preserving it. Otherwise, the secured party is liable to the debtor [UCC 9207(1); UCC 9207(3)]. If the collateral increases in value, the secured party can hold this increased value or profit as additional security unless it is in the form of money, which must be remitted to the debtor or applied toward reducing the secured debt [UCC 9207(2)(c)]. Additionally, the collateral must be kept in identifiable condition unless it consists of fungible goods (goods that are naturally alike, such as wheat or oil) [UCC 9207(2)(d)]. Finally, the debtor must pay for all reasonable charges incurred by the secured party in preserving, operating, and taking care of the collateral in possession [UCC 9207(2)(a)].

During the time that the secured debt is outstanding, the debtor may wish to know the status of the debt. If so, the debtor need only sign a statement that indicates the aggregate amount of the unpaid debt at a specific date (and perhaps a list of the collateral covered by the security agreement). The secured party must then approve or correct this statement in writing. The creditor must comply with the request within two weeks of receipt; otherwise, the creditor is liable for any loss caused to the debtor by the failure to do so [UCC 9208(2)]. One such request is allowed without charge every six months. For each additional request, the secured party can require a fee not exceeding $10 per request [UCC 9208(3)].

When a secured debt is paid, the secured party may send a termination statement to the debtor or file such a statement with the filing officer to whom the original financing statement was given. If the financing statement covers consumer goods, the termination statement must be filed by the secured party within one month after the debt is paid, orif the debtor requests the termination statement in writingit must be filed within ten days of receipt of the request after the debt is paid, whichever is earlier [UCC 9404(1)]. In all other cases, the termination statement must be filed or furnished to the debtor within ten days after a written request is made by the debtor.

If the affected secured party fails to file such a termination statement, as required by UCC 9404(1), or fails to send the termination statement within ten days after proper demand, the secured party will be liable to the debtor for $100. Additionally, the secured party will be liable for any loss caused to the debtor.

Section 8: Default.
Article 9 of the UCC defines the rights, duties, and remedies of a secured party and of the debtor upon the debtors default. Should the secured party fail to comply with his or her duties, the debtor is afforded particular rights and remedies.

The topic of default is one of great concern to secured lenders and to the lawyers who draft security agreements. What constitutes default is not always clear. In fact, Article 9 does not define the term. Consequently, parties are encouraged in practice and by the UCC to include in their security agreements certain standards to be applied should default occur. In so doing, parties can stipulate the conditions that will constitute a default [UCC 9501(3)]. Typically, because of the disparity in bargaining position between a debtor and a creditor, these critical terms are shaped by the creditor in an attempt to provide the maximum protection possible. The ultimate terms, however, are not allowed to go beyond the limitations imposed by the good faith requirement of UCC 1203 and the unconscionability doctrine.

Although any breach of the terms of the security agreement can constitute default, default occurs most commonly when the debtor fails to meet the scheduled payments that the parties have agreed upon or when the debtor becomes bankrupt. If the security agreement covers equipment, however, the debtor may have warranted that he or she is the owner of the equipment or that no liens or other security interests are pending on that equipment. Breach of any of these representations can result in default.

A secured party’s remedies can be divided into two basic categories:

1. A secured party can relinquish a security interest and proceed to judgment on the underlying debt, followed by execution and levy. Execution is an action to carry into effect the directions in a court decree or judgment. Levy is the obtaining of money by legal process through the seizure and sale of property, usually done after an execution has been issued. Execution and levy are rarely done unless the value of the secured collateral has been reduced greatly below the amount of the debt and the debtor has other nonexempt assets available to satisfy the debt.

2. A secured party can take possession of the collateral covered by the security agreement [UCC 9503]. Upon taking possession, the secured party can retain the collateral for satisfaction of the debt [UCC 9505(2)] or can sell the collateral and apply the proceeds toward the debt [UCC 9504].

The rights and remedies under UCC 9501(1) are cumulative. Therefore, if a creditor is unsuccessful in enforcing rights by one method, another method can be pursued. The UCC does not require election of remediesthat is, the creditor need not choose between an action on the obligation and the repossession of the collateral.

When a security agreement covers both real and personal property, the secured party can proceed against the personal property in accordance with the remedies of Article 9. Alternatively, the secured party can proceed against the entire collateral under procedures set down by local real estate law, in which case the UCC does not apply [UCC 9501(4)].

For example, this situation occurs when the security interest on a corporate loan applies to the manufacturing plant (real property) and also to the inventory (personal property). Determining whether particular collateral is personal or real property can prove difficult, especially in dealing with fixturesthings affixed to real property (see Chapter 48). Under certain circumstances, the UCC allows the removal of fixtures upon default; such removal, however, is subject to the provisions of Article 9 [UCC 9313].


UCC 9503 states that [u]nless otherwise agreed, a secured party has on default the right to take possession of the collateral. In taking possession, a secured party may proceed without judicial process if this can be done without a breach of the peace. The underlying rationale for this self-help provision of Article 9 is that it simplifies the process of repossession for creditors and reduces the burden on the courts. Because the UCC does not define breach of the peace, however, it is not always easy to predict what will or will not constitute a breach of the peace.

Generally, the creditor or the creditor’s agent cannot enter a debtor’s home, garage, or place of business without permission. Consider a situation in which an automobile is collateral. If the repossessing party walks onto the debtor’s premises, proceeds up the driveway, enters the vehicle without entering the garage, and drives off, it probably will not amount to a breach of the peace. In some states, however, an action for wrongful trespass could start a cause of action for breach of the peace or other tortious action. Whether a creditor’s trespass onto a debtors property was enough to breach the peace is at issue in the following case.

Law in the Extreme: All This for $370!

Appellate Court of Illinois,
Fifth District, 1996.
277 Ill.App.3d 1078,
661 N.E.2d 1171,
214 Ill.Dec. 726.


James Koontz bought a car and financed the purchase with a loan from Chrysler Credit Corporation. When Koontz failed to repay the loan, Chrysler sent M&M Agency to take possession of the vehicle. M&M entered Koontzs yard, where the vehicle was parked in the light of the front porch, to repossess the vehicle. While the repossession was in progress, Koontz, who was in his underwear, rushed outside and shouted, Dont take it! The repossessor did not respond and proceeded to take the vehicle. Chrysler sold the car and then filed a suit in an Illinois state court against Koontz to recover the difference between the purchase price and the amount that Koontz owed on the loan. Koontz argued that Chrysler’s repossession of the car over his oral protest was a breach of the peace. The court entered a judgment in favor of Chrysler, and Koontz appealed.

Justice MAAG delivered the opinion of the court:
* * * *
* * * [T]he likelihood of a breach of the peace increases in proportion to the efforts of the debtor to prevent unauthorized intrusions and the creditors conduct in defiance of those efforts.
* * * Chrysler enjoyed a limited privilege to enter Koontzs property for the sole and exclusive purpose of effecting the repossession. So long as the entry was limited in purpose (repossession), and so long as no gates, barricades, doors, enclosures, buildings, or chains were breached or cut, no breach of the peace occurred by virtue of the entry onto his property.

DECISION AND REMEDY The Appellate Court of Illinois affirmed the lower courts judgment.

Once default has occurred and the secured party has obtained possession of the collateral, the secured party may sell, lease, or otherwise dispose of the collateral in any commercially reasonable manner [UCC 9504(1)]. Any sale is always subject to procedures established by state law.

RETENTION OF COLLATERAL BY SECURED PARTY The UCC recognizes that parties are sometimes better off if they do not sell the collateral. Therefore, a secured party can retain collateral, but this general right is subject to several conditions. The secured party must send written notice of the intention to retain the collateral to the debtor if the debtor has not signed a statement renouncing or modifying his or her rights after default. In the case of consumer goods, no other notice need be given. In all other cases, notice must be sent to any other secured party from whom the secured party in possession of the collateral has received written notice of a claim of interest in the collateral in question.

If within twenty-one days after the notice is sent, the secured party receives an objection in writing from a person entitled to receive notification, then the secured party must sell or otherwise dispose of the collateral in accordance with the provisions of UCC 9504 (disposition procedures under UCC 9504 will be discussed shortly). If no such written objection is forthcoming, the secured party can retain the collateral in full satisfaction of the debtors obligation [UCC 9505(2)].

CONSUMER GOODS When the collateral is consumer goods with a PMSI, and the debtor has paid 60 percent or more of the cash price or loan, then the secured party must sell or otherwise dispose of the collateral in accordance with the provisions of UCC 9504 within ninety days. Failure to comply opens the secured party to an action for conversion (the wrongful taking of anothers propertysee Chapter 6) or other liability under UCC 9507(1) unless the consumer-debtor signed a written statement after default renouncing or modifying the right to demand the sale of the goods [UCC 9505(1)].

DISPOSITION PROCEDURES A secured party who does not choose to retain the collateral must resort to the disposition procedures prescribed under UCC 9504. The UCC allows a great deal of flexibility with regard to disposition. The only real limitation is that it must be accomplished in a commercially reasonable manner. UCC 9507(2) supplies some examples of what does or does not meet the standard of commercial reasonableness:

The fact that a better price could have been obtained by a sale at a different time or in a different method from that selected by the secured party is not of itself sufficient to establish that the sale was not made in a commercially reasonable manner. If the secured party either sells the collateral in the usual manner in any recognized market therefore or if he sells at the price current in such a market at the time of sale or if he has otherwise sold in conformity with reasonable commercial practices among dealers in the type of property sold, he has sold in a commercially reasonable manner.

A secured party is not compelled to resort to public sale to dispose of the collateral. The party is given latitude under the UCC to seek out the best terms possible in a private, commercially reasonable sale. Generally, no specific time requirements must be met; however, the time must ultimately meet the standard of commercial reasonableness.

The secured party should diligently arrange to sell the collateral at the best price possible and avoid self-serving acts that raise suspicions of commercial unreasonableness. Assume that Boender, a secured party, advertises a private sale in a newspaper that is not likely to be read by potential purchasers, requires a minimum deposit of $50,000 with each purchasers bid (while exempting himself from the deposit requirement), and then purchases the property at the sale for himself, only to resell it shortly thereafter at a substantial profit to a prearranged buyer. Boenders conduct unreasonably diminishes the number of potential purchasers available at the sale. With fewer participants at the sale, the final purchase price is likely to be reduced. When the purchase price is low, the debtor may fail to satisfy its outstanding debt to Boender or to enjoy a surplus from the sale of the collateral (deficiency and surplus are discussed later in this chapter). In such a situation, the debtor may recover any loss caused by Boenders failure to comply with the requirement of commercial reasonableness under the UCC [UCC 9507].

Notice of any sale must be sent by the secured party to the debtor if the debtor has not signed a statement renouncing or modifying the right to notification of sale after default. For consumer goods, no other notification need be sent. In all other cases, notification must be sent to any other secured party from whom the secured party in possession of the collateral has received written notice of a claim of interest in the collateral [UCC 9504(3)]. Such notice is not necessary, however, when the collateral is perishable or threatens to decline speedily in value or when it is of a type customarily sold on a recognized market. Generally, notice of the place, time, and manner of the sale is required if the sale is to be classified as a sale conducted in a commercially reasonable manner. At issue in the following case is whether a sale of collateral was conducted in a commercially reasonable manner.

Supreme Court of Nebraska, 1995.
247 Neb. 641,
529 N.W.2d 66.

BACKGROUND AND FACTS David Anderson and For-Med, Inc., signed a security agreement with the First Westside Bank for $79,924.89, plus interest. The collateral for the loan was Andersons Blue Bird motor home. Anderson and For-Med defaulted, and the bank took possession of the Blue Bird. The bank solicited bids for the motor home by word of mouth from other financial institutions, Blue Bird dealers, and some of its customers. Ultimately, the bank sold the motor home to a bank customer for $60,000. The buyer repaired the motor home at a cost of $22,000 and sold it two and a half years later for $58,000. Meanwhile, the bank sued For-Med and Anderson in a Nebraska state court for the difference between the amount due on the loan and the proceeds from the Blue Birds sale. The court entered a judgment in favor of the bank. For-Med and Anderson appealed, acknowledging that although the price in the banks sale had not been wholly unreasonable, the sale had not been commercially reasonable, because it had not been advertised sufficiently.

CAPORALE, Justice.
* * * *
* * * [I]t is the secured partys duty to the debtor to use all fair and reasonable means to obtain the best price under the circumstances, but the creditor need not use extraordinary means.
* * * *
* * * [U]nder particular circumstances, a sale may be commercially reasonable notwithstanding the lack of advertising.
Among the other factors to be considered in determining whether a sale of collateral was commercially reasonable is the adequacy or insufficiency of the price at which it was sold. Here, the collateral was resold 2 1/2 years after the purchaser acquired it, for an amount far less than he had invested in its purchase and repair. In light of that circumstance and the admission of For-Med and Anderson that the price at which the collateral was sold was not wholly unreasonable, it cannot be said that the [lower] courts finding that the sale was commercially reasonable is clearly wrong.

DECISION AND REMEDY The Supreme Court of Nebraska affirmed the lower courts decision.

PROCEEDS FROM DISPOSITION Proceeds from the disposition of the collateral must be applied in the following order:

1. Reasonable expenses stemming from the retaking, holding, or preparing for sale are paid first. When
authorized by law and if provided for in the agreement, these expenses can include reasonable attorneys fees
and legal expenses.
2. Satisfaction of the balance of the debt owed to the secured party must then be made.
3. Creditors with subordinate security interests whose written demands have been received prior to the
completion of distribution of the proceeds are then entitled to receive the remaining proceeds from the sale
[UCC 9504(1)].
4. Any surplus generally goes to the debtor.

DEFICIENCY JUDGMENT Often, after proper disposition of the collateral, the secured party has not collected all that is still owed by the debtor. Unless otherwise agreed, the creditor is entitled to obtain a deficiency judgment, which makes the debtor liable for any deficiency. Note, however, that if the underlying transaction was a sale of accounts or of chattel paper, the secured party can collect the deficiency by requesting a court to order a deficiency judgment only if the security agreement so provides [UCC 9504(2)].

REDEMPTION RIGHTS Any time before the secured party disposes of the collateral or enters into a contract for its disposition, or before the debtor’s obligation has been discharged through the secured party’s retention of the collateral, the debtor or any other secured party can exercise the right of redemption of the collateral.

The debtor or other secured party can do this by (1) tendering performance of all obligations secured by the collateral and (2) paying the expenses reasonably incurred by the secured party in retaking the collateral and maintaining its care and custody, including legal expenses and reasonable attorneys fees if the security agreement so provides [UCC 9506].


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