Class 11 Secured Transactions, Fall, 2017 Priority: Nature and Limits 9/20/2018 Class 11 Secured Transactions, Fall, 2017 Priority: Nature and Limits Randal C. Picker James Parker Hall Distinguished Service Professor of Law The Law School The University of Chicago Copyright © 2001-17 Randal C. Picker. All Rights Reserved.

Marshaling I Debtor Bank USC Finco 9/20/2018 Marshaling I Debtor Bank 1/1: $100 SA, FS: EQ and Inv 2/1: $100 SA, FS: EQ How should we divide EQ = $100 and Inv = $99? 3/1: $100 USC Finco September 20, 2018

Answer Inventory First? $99 from Inv to Bank $1 from Eq to Bank 9/20/2018 Answer Inventory First? $99 from Inv to Bank $1 from Eq to Bank $99 from Eq to Finco $0 to USC September 20, 2018

Answer Equipment First? Marshaling Doctrine $100 from Eq to Bank 9/20/2018 Answer Equipment First? $100 from Eq to Bank $49.50 from Inv to Finco $49.50 from Inv to USC Marshaling Doctrine Collect from Inv first September 20, 2018

Marshaling II Debtor Bank USC Finco 9/20/2018 Marshaling II Debtor Bank 1/1: $100 SA, FS: EQ 2/1: $100 SA, FS: EQ 3/1: $100 How should we divide EQ = $100 and Inv = $99? USC Finco September 20, 2018

Answer Inventory First? $33 from Inv to Bank, Finco and USC 9/20/2018 Answer Inventory First? $33 from Inv to Bank, Finco and USC $67 from Eq to Bank $33 from Eq to Finco Bank gets 100, Finco gets 66, USC gets 33 September 20, 2018

Answer Equipment First? $100 from Eq to Bank $49.50 from Inv to Finco 9/20/2018 Answer Equipment First? $100 from Eq to Bank $49.50 from Inv to Finco $49.50 from Inv to USC September 20, 2018

Marshaling III Debtor Bank USC Finco 9/20/2018 Marshaling III Debtor Bank 1/1: $100 SA, FS: EQ 2/1: $100 2/1: $100 SA, FS: EQ 3/1: $100 How should we divide EQ = $100 and Inv = $99? USC Finco September 20, 2018

Answer Inventory First? $33 from Inv to Bank, Finco and USC 9/20/2018 Answer Inventory First? $33 from Inv to Bank, Finco and USC $67 from Eq to Bank (for total of $100) $16.50 from Eq to Finco/USC ($49.50 total) September 20, 2018

Answer Equipment First? Sequence Irrelevant? $100 from Eq to Bank 9/20/2018 Answer Equipment First? $100 from Eq to Bank $49.50 from Inv to Finco $49.50 from Inv to USC Sequence Irrelevant? September 20, 2018

Marshaling IV Debtor Bank USC Finco 9/20/2018 Marshaling IV Debtor Bank 1/1: $100 SA, FS: EQ 2/1: $100 How should we divide EQ = $80 and Inv = $99? 3/1: $100 USC Finco September 20, 2018

Answer Inventory First? $33 from Inv to Bank, Finco and USC 9/20/2018 Answer Inventory First? $33 from Inv to Bank, Finco and USC $67 from Eq to Bank ($100) $6.50 from Eq to Finco/USC ($39.50) September 20, 2018

Answer Equipment First? Sequence Matters! $80 from Eq to Bank 9/20/2018 Answer Equipment First? $80 from Eq to Bank $9 from Inv to Bank ($89) $45 from Inv to Finco $45 from Inv to USC Sequence Matters! September 20, 2018

Bottom Line So Far Marshaling I is Traditional Situation 9/20/2018 Bottom Line So Far Marshaling I is Traditional Situation Sequence of Realization Matters This is true with multiple security interests (M I) But also true with single security interest if secured creditor is undersecured (M IV) September 20, 2018

Marshaling V Debtor Bank Finco 9/20/2018 Marshaling V Debtor Bank 1/1: $100 SA, FS: EQ 2/1: $100 SA, FS: EQ 1/1: Guarantee Owner How should we divide EQ = $100 and Owner assets = $99? Finco September 20, 2018

Answer Path 1 Owner Assets First? $99 from Owner to Bank 9/20/2018 Answer Path 1 Owner Assets First? $99 from Owner to Bank $1 from Eq to Bank $99 from Eq to Finco Equipment First? $100 from Eq to Bank, $0 to Finco September 20, 2018

Answer Path 2 Owner Assets First? $99 from Owner to Bank 9/20/2018 Answer Path 2 Owner Assets First? $99 from Owner to Bank $1 from Eq to Bank Owner steps into Bank’s shoes and collects $99 from Equipment Finco gets 0 September 20, 2018

Answer Path 2 Path 1 or Path 2? Equipment First? $100 from Eq to Bank 9/20/2018 Answer Path 2 Equipment First? $100 from Eq to Bank $0 to Finco This is the subrogation path Finco gets 0 in both paths in version 2 Path 1 or Path 2? September 20, 2018

Computer Room Computer FAB Room Peoples 9/20/2018 Computer Room 1/25/81: Computer Room Files Ch 11 7/1/81: $ Computer Room FAB SA: AR, INV, CR FS: Same How should the INV and AR be distributed? 9/18/81 $ to buy EQ SA, FS: AR Matthews Must Peoples collect first on the guarantee? Guarantee Peoples September 20, 2018

Marshaling Doctrine Yes, as to Two Security Interests 9/20/2018 Marshaling Doctrine Yes, as to Two Security Interests Traditional doctrine applies in situation where one secured creditor has access to only one fund, second secured creditor has access to two Done only if no harm to two-funds creditor No, as to Guarantee: What is at stake here? September 20, 2018

Marshaling Doctrine Answer Conflict in cases 9/20/2018 Marshaling Doctrine Answer Conflict in cases Trustee in bankruptcy is looking to reduce claims against bankruptcy estate But guarantor may just substitute in for creditor September 20, 2018

Meaning of Marshaling for Priority Theory 9/20/2018 Meaning of Marshaling for Priority Theory Extends Priority By taking a security interest in, say, equipment, if marshaling is implemented, a secured creditor effectively has a superior claim as to inventory See result in Marshaling I hypo September 20, 2018

Guarantees Again Debtor Bank Finco 9/20/2018 Guarantees Again Debtor Bank 1/1: $100 SA, FS: EQ 2/1: $100 SA, FS: EQ 1/1: Guarantee Owner How should we divide EQ = $100 and Owner assets = $99? Finco September 20, 2018

Answer 1/1 Transaction Bank is first If Bank collects from EQ, Finco gets nothing If Bank collects from Owner, Owner will try to step into Bank’s debt and take over senior position on EQ and Finco would get nothing September 20, 2018

Guarantees Again Debtor Bank Finco 9/20/2018 Guarantees Again Debtor Bank 3/1: $100 SA, FS: EQ 2/1: $100 SA, FS: EQ 3/1: Guarantee Owner How should we divide EQ = $100 and Owner assets = $99? Finco September 20, 2018

Answer 3/1 Transaction Finco is first Finco will collect from EQ and Bank will have to draw on guarantee Finco will get 100, Bank 99 and Owner nothing September 20, 2018

Delaware Truck: Starting Points 9/20/2018 Delaware Truck: Starting Points 8/20/84: $75K Del Repair Royal Bank SA: INV, EQ, AR FS: Same 9/23/84 NJSS 9/6/84 Financed Sale Guarantee & Mortgage SA: ?All Assets? FS: 8/29/84: INV, EQ 10/4/84: AR Fandrick E&J Wilson Del Truck Guarantees (F&E, no J) September 20, 2018

Who Has Priority in the AR? 9/20/2018 Who Has Priority in the AR? Royal Bank filed first, so it has priority September 20, 2018

The Surrender Agreement and AR Collection 9/20/2018 The Surrender Agreement and AR Collection Del Repair Royal Bank What are the consequences of the Surrender Agreement? 5/27/88 Surrender Agreement E&J Wilson Fandrick What are the consequences of the collection of AR? Del Truck Customers $99K on AR September 20, 2018

Answer Surrender Agreement 9/20/2018 Answer Surrender Agreement Transfer of assets from Del Repair to Del Truck should reduce Del Truck debt SI of Royal Bank will survive sale Del Truck will still have guarantee against Fandrick September 20, 2018

Answer AR Collection See 9-607(a) and Comment 5 September 20, 2018 9/20/2018 Answer AR Collection See 9-607(a) and Comment 5 September 20, 2018

9-607 Comment 5 5. Collections by Junior Secured Party. 9/20/2018 9-607 Comment 5 5. Collections by Junior Secured Party. A secured party who holds a security interest in a right to payment may exercise the right to collect and enforce under this section, even if the security interest is subordinate to a conflicting security interest in the same right to payment. September 20, 2018

9/20/2018 9-607 Comment 5 Whether the junior secured party has priority in the collected proceeds depends on whether the junior secured party qualifies for priority as a purchaser of an instrument (e.g., the account debtor’s check) under Section 9-330(d), as a holder in due course of an instrument under Sections 3-305 and 9-331(a), or as a transferee of money under Section 9-332(a). See Sections 9-330, Comment 7, 9-331, Comment 5, and 9-332. September 20, 2018

Answer AR Collection Say the Court: See 9-607(a) and Comment 5 9/20/2018 Answer AR Collection See 9-607(a) and Comment 5 Say the Court: “Consequently, in the absence of countervailing considerations, Royal Bank had a right to require plaintiff to disgorge the proceeds of the accounts receivable to the extent of its priority lien interest.” September 20, 2018

Answer Does Royal Bank have to exercise that right? September 20, 2018 9/20/2018 Answer Does Royal Bank have to exercise that right? September 20, 2018

The Settlement Agreement 9/20/2018 The Settlement Agreement Del Repair Royal Bank Lawsuit Lawsuit 4/89:Assignment Settlement 1. RB Position to DT 2. Subordination E&J Wilson Fandrick Del Truck What does the settlement agreement do? September 20, 2018

Answer This is the second key issue in the case. 9/20/2018 Answer This is the second key issue in the case. Does the Royal Bank debt survive the settlement? As majority notes, intent of parties to transaction clear What is stake? How should that matter? September 20, 2018

Answer And what of the subordination? 9/20/2018 Answer And what of the subordination? Is this the 1/1 guarantee vs. the 3/1 guarantee? September 20, 2018

The Delaware Truck Lawsuit 9/20/2018 The Delaware Truck Lawsuit Del Repair Can Del Truck sue the Wilsons on their guarantee to Royal Bank? Lawsuit E&J Wilson Fandrick Del Truck Lawsuit September 20, 2018

Lingering Issues Marshaling Wilsons as Subrogees to Bank’s Position 9/20/2018 Lingering Issues Marshaling Note issue that Del Truck would try to argue that Royal Bank would have had to look to Wilson guaranty before collecting from AR Probably a loser but not sure Wilsons as Subrogees to Bank’s Position Had Wilson’s paid on the guarantee, they would have in effect purchased the Bank’s position September 20, 2018

9/20/2018 9-322(a)(1) Conflicting perfected security interests and agricultural liens rank according to priority in time of filing or perfection Priority dates from the earlier of the time a filing covering the collateral is first made or the security interest or agricultural lien is first perfected, if there is no period thereafter when there is neither filing nor perfection September 20, 2018

4-9: Secured Creditors and Lien Creditors (1/4) 9/20/2018 4-9: Secured Creditors and Lien Creditors (1/4) Corp USC 1/1: $ SA: Collateral 2/1 FS: Collateral Bank September 20, 2018

9-201(a) (a) [General effectiveness.] 9/20/2018 9-201(a) (a) [General effectiveness.] Except as otherwise provided in [the Uniform Commercial Code], a security agreement is effective according to its terms between the parties, against purchasers of the collateral, and against creditors. September 20, 2018

4-9: Secured Creditors and Lien Creditors (1/4) 9/20/2018 4-9: Secured Creditors and Lien Creditors (1/4) Corp LC USC 3/1: Run State Law Process 1/1: $ SA: Collateral 2/1 FS: Collateral 3/1 Who has priority? Bank September 20, 2018

9/20/2018 9-317(a) (a) [Conflicting security interests and rights of lien creditors.] A security interest or agricultural lien is subordinate to the rights of: (1) a person entitled to priority under Section 9‑322; and September 20, 2018

9/20/2018 9-317(a) (2) except as otherwise provided in subsection (e), a person that becomes a lien creditor before the earlier of the time: (A) the security interest or agricultural lien is perfected; or (B) one of the conditions specified in Section 9-203(b)(3) is met and a financing statement covering the collateral is filed. September 20, 2018

Lien Creditor: 9-102(a)(52) “Lien creditor” means: 9/20/2018 Lien Creditor: 9-102(a)(52) “Lien creditor” means: (A) a creditor that has acquired a lien on the property involved by attachment, levy, or the like; (B) an assignee for benefit of creditors from the time of assignment; (C) a trustee in bankruptcy from the date of the filing of the petition; or September 20, 2018

9/20/2018 Lien Creditor: 9-102(a)(52) (D) a receiver in equity from the time of appointment. September 20, 2018

9/20/2018 4-9: Answer Perfected—attached and filed — before lien creditor status, so Bank wins (9-317(a)(2)(A)) September 20, 2018

4-9: Secured Creditors and Lien Creditors (2/4) 9/20/2018 4-9: Secured Creditors and Lien Creditors (2/4) Corp USC 1/1: $ SA: Collateral Bank September 20, 2018

4-9: Secured Creditors and Lien Creditors (2/4) 9/20/2018 4-9: Secured Creditors and Lien Creditors (2/4) Corp USC LC 2/1: Run State Law Process 1/1: $ SA: Collateral 3/1 FS: Collateral 3/1 Who has priority? Bank September 20, 2018

9/20/2018 4-9: Answer Lien creditor wins, as became lien creditor before Bank was perfected and before financing statement was filed (9-317(a)) September 20, 2018

4-9: Secured Creditors and Lien Creditors (3/4) 9/20/2018 4-9: Secured Creditors and Lien Creditors (3/4) Corp USC 1/1 FS: Collateral Bank September 20, 2018

4-9: Secured Creditors and Lien Creditors (3/4) 9/20/2018 4-9: Secured Creditors and Lien Creditors (3/4) Corp LC USC 2/1: Run State Law Process 1/1 FS: Collateral 3/1: $ SA: Collateral Bank 3/1 Who has priority? September 20, 2018

9/20/2018 4-9: Answer Naked financing statement insufficient, so lien creditor wins (9-317(a)) September 20, 2018

4-9: Secured Creditors and Lien Creditors (4/4) 9/20/2018 4-9: Secured Creditors and Lien Creditors (4/4) Corp USC 1/1: No $ SA: Collateral 2/1 FS: Collateral Bank September 20, 2018

4-9: Secured Creditors and Lien Creditors (4/4) 9/20/2018 4-9: Secured Creditors and Lien Creditors (4/4) Corp LC USC 3/1: Run State Law Process 1/1: No $ SA: Collateral 2/1 FS: Collateral 3/2 Who has priority? 3/2: $ Bank September 20, 2018

4-9: Answer Note that SI is not perfected on 3/1 Change from Prior Law 9/20/2018 4-9: Answer Note that SI is not perfected on 3/1 No money lent, so no value given, so not attached under 9-203 Change from Prior Law 9-317(a)(2)(B) protects this See 9-317 Comment 4 September 20, 2018

8/1: EQ worth $10K: Who gets it? 9/20/2018 Subsequent SIs? Corp 2/1: $10K USC 1/1: $10K USC 3/1 SA: EQ FS: EQ 8/1: EQ worth $10K: Who gets it? Bank September 20, 2018

Answer Answer Other Law? Under Article 9, secured creditor takes ahead of unsecured creditor Other Law? Bankruptcy preferences (but 8/1, so not here) Fraudulent Transfer? See Aptix September 20, 2018

Knowledge and Textured-Priority Rules 9/20/2018 Knowledge and Textured-Priority Rules Debtor 1/1: $100 SA: EQ Bad FS: EQ Bank 2/1: $100 SA, FS: EQ With K 3/1: $100 SA, FS: EQ No K Who has priority? Finco Creditco September 20, 2018

Knowledge and Textured-Priority Rules 9/20/2018 Knowledge and Textured-Priority Rules With Knowledge Rule, Circular Priority Possible B > F: Knowledge F > C: First to make good filing C > B: No knowledge, Bank as unperfected September 20, 2018

4-10: Negative Pledges Corp Finco Creditco Bank 9/20/2018 4-10: Negative Pledges Corp 2/1: $20,000 w/negative pledge Finco “Corp promises that it will not grant a security interest in any of its assets” 3/1: SA: All Assets FS: Same $30,000 1/1 $10,000 USC Creditco Bank 3/1: $40,000 in assets: Who has priority? September 20, 2018

Try This Separate property rights from purely contractual rights 9/20/2018 Try This Separate property rights from purely contractual rights Step 1: Distribute $30,000 to Bank on its security interest September 20, 2018

9/20/2018 Try This Step 2: Distribute remaining $10,000 pro rata to Credito and Finco as unsecured creditors ($3,333/$6,667) September 20, 2018

9/20/2018 Try This Step 3: Treat the negative pledge as a contractual right of parity between Finco and Bank, so reallocate their funds ($36,667) pro rata ($14,667 to Finco and $22,000 to Bank) September 20, 2018

Mudge Redding Bank How does the Bank do? 9/81: $100K SA: INV, EQ ?FS? 9/20/2018 Mudge 9/81: $100K Redding Bank How does the Bank do? SA: INV, EQ ?FS? Negative Pledge & Stock Escrow 7/31/81 Financed Sale 3(f). It is agreed that the assets of M & M Welding, Inc., a Wyoming corporation, or its successor corporation shall not be mortgaged for more than the presently existing indebtedness without Sellers[’] consent until the total purchase price herein agreed to be paid shall have been paid in full. Such consent shall not be unreasonably withheld. Mudges September 20, 2018

Tortious Interference with Contracts 9/20/2018 Tortious Interference with Contracts Restatement (Second) of Torts, Sec. 766 “One who intentionally and improperly interferes with the performance of a contract (except a contract to marry) between another and a third person by inducing or otherwise causing the third person not to perform the contract, is subject to liability to the other for the pecuniary loss resulting to the other from the failure of the third person to perform the contract.”

9-401: Alienability of Debtor’s Rights 9/20/2018 9-401: Alienability of Debtor’s Rights (a) [Other law governs alienability; exceptions.] Except as otherwise provided in subsection (b) and Sections 9‑406, 9‑407, 9‑408, and 9‑409, whether a debtor’s rights in collateral may be voluntarily or involuntarily transferred is governed by law other than this article. September 20, 2018

9-401 (Cont.) (b) [Agreement does not prevent transfer.] 9/20/2018 9-401 (Cont.) (b) [Agreement does not prevent transfer.] An agreement between the debtor and secured party which prohibits a transfer of the debtor’s rights in collateral or makes the transfer a default does not prevent the transfer from taking effect. September 20, 2018

Comment 5 to 9-401 5. Negative Pledge Covenant. 9/20/2018 Comment 5 to 9-401 5. Negative Pledge Covenant. Subsection (b) is an exception to the general rule in subsection (a). It makes clear that in secured transactions under this Article the debtor has rights in collateral (whether legal title or equitable) which it can transfer and which its creditors can reach. It is best explained with an example. September 20, 2018

9/20/2018 Comment 5 to 9-401 Example 2 A debtor, D, grants to SP a security interest to secure a debt in excess of the value of the collateral. D agrees with SP that it will not create a subsequent security interest in the collateral and that any security interest purportedly granted in violation of the agreement will be void. Subsequently, in violation of its agreement with SP, D purports to grant a security interest in the same collateral to another secured party.

9/20/2018 Comment 5 to 9-401 Subsection (b) validates D’s creation of the subsequent (prohibited) security interest, which might even achieve priority over the earlier security interest. See Comment 7. However, unlike some other provisions of this Part, such as Section 9‑406, subsection (b) does not provide that the agreement restricting assignment itself is “ineffective.” Consequently, the debtor’s breach may create a default.