CHAPTER 26 SECURED TRANSACTIONS: PRIORITIES AND DEFAULT DAVIDSON, KNOWLES & FORSYTHE Business Law: Cases and Principles in the Legal Environment (8 th Ed.)

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 2 PRIORITIESPRIORITIES Creditor who has status of perfected secured party can maximize chances of money owed. Creditor who has status of perfected secured party can maximize chances of money owed. Status gives creditor first claim to the collateral. Status gives creditor first claim to the collateral. Perfected secured party will have priority over general and lien creditor including trustee in bankruptcy. Perfected secured party will have priority over general and lien creditor including trustee in bankruptcy. Secured party disposed of collateral, excess money owed to secured party may be applied to claims of other creditors. Secured party disposed of collateral, excess money owed to secured party may be applied to claims of other creditors.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 3 CONFLICTING SECURITY INTERESTS Code validates a first-in-time and first-in- right approach. Code validates a first-in-time and first-in- right approach. Those who have a perfected claim first have priority. Those who have a perfected claim first have priority. Creditor/lender file financing statement covering transaction before all requirements for attachment have been met. Creditor/lender file financing statement covering transaction before all requirements for attachment have been met. Date of filing controls priority in collateral. Date of filing controls priority in collateral.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 4 Code justifies “race to the recording office” as necessary protection of the public filing system. Code justifies “race to the recording office” as necessary protection of the public filing system. CONFLICTING SECURITY INTERESTS

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 5 Order of Perfection. Order of Perfection. – Filing represents one method of perfection. – Purchase of money security interests in consumer goods, one may rely of automatic perfection. – Perfect by taking possession of the collateral. – First to perfect has priority. CONFLICTING SECURITY INTERESTS

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 6 Order of Attachment. Order of Attachment. – When no creditor has perfected its security interest in the collateral. – First interest to attach has priority to the collateral. – An unperfected secured creditor will not enjoy preferred status in bankruptcy proceedings. CONFLICTING SECURITY INTERESTS

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 7 EXCEPTIONSEXCEPTIONS Important exceptions to the general rules of priority, which include: Important exceptions to the general rules of priority, which include: – Purchase Money Security Interests. – Bona Fide Purchaser of Consumer Goods. – Buyer in the Ordinary Course of Business. – Common Law and Statutory Liens. – Fixtures.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 8 EXCEPTIONSEXCEPTIONS Purchase Money Security Interests. Purchase Money Security Interests. – Held by a purchase money secured party. – Purchase money security interest contradicts first-to-file-or-to-perfect. – Security interest is purchase money security to extent that it is: Taken by seller of collateral to secure all/part of price. Taken by seller of collateral to secure all/part of price. Taken by person who by making advances gives value to enable the debtor acquire rights. Taken by person who by making advances gives value to enable the debtor acquire rights.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 9 EXCEPTIONSEXCEPTIONS Purchase Money Security Interests. Purchase Money Security Interests. – Gives lenders priority if they are first to file or perfect. – UCC, attempts to balance both parties interests. – Perfected floating lien loses to later property perfected.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 10 EXCEPTIONSEXCEPTIONS Purchase Money Security Interests. Purchase Money Security Interests. – This exception applies only if: PMSI is perfected before the debtor gets the inventory. PMSI is perfected before the debtor gets the inventory. PMSI secured creditor gives written notice describing inventory to those previously filed financing statements covering the collateral. PMSI secured creditor gives written notice describing inventory to those previously filed financing statements covering the collateral. – PMSI creditor in collateral (other than inventory). – Has priority over a previously perfected floating lien in same collateral.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 11 EXCEPTIONS Purchase Money Security Interests. Purchase Money Security Interests. – Code in determining priority applies first-to-or- to-perfect rules. – So long as PMSI is perfected at time debtor gets collateral or within 10 days afterwards.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 12 EXCEPTIONSEXCEPTIONS Buyers in the Ordinary Course of Business. Buyers in the Ordinary Course of Business. – Purchasers who are buying from a seller who routinely sells from inventory. – Code allows buyer who purchases goods in the ordinary course of the seller’s business. – Buyer takes priority over a previously perfected security interest provided that the buyer: Acts in good faith and Acts in good faith and Does not know that the sale violates the rights of a third party. Does not know that the sale violates the rights of a third party.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 13 EXCEPTIONSEXCEPTIONS Bona Fide Purchasers of Consumer Goods. Bona Fide Purchasers of Consumer Goods. – Another class of persons who may have priority over previously perfected security interest. – Consumer goods: used or bought for personal, family, or household purposes. – Code limits priority to purchase of this type of collateral.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 14 EXCEPTIONS Bona Fide Purchasers of Consumer Goods. Bona Fide Purchasers of Consumer Goods. – Limitations over previously perfected security interests: Buyer ignorant of security interest. Buyer ignorant of security interest. Must pay value for the goods. Must pay value for the goods. Uses goods for personal, family or household use. Uses goods for personal, family or household use. – By filing a financing statement covering consumer good before buyer purchases it, not bona fide purchaser, will have priority claim.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 15 CONFLICTS BETWEEN SECURITY INTERESTS AND LIENS Judicial Liens. Judicial Liens. – Acquired by creditor in a judicial proceeding. – Equal to Security Interests. – Courts apply “first in time, first in right.” Statutory Liens. Statutory Liens. – Possessory or Non-Possessory. – Tax liens. Consensual Liens. Consensual Liens.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 16 CONFLICTS BETWEEN SECURITY INTERESTS AND TRUSTEE IN BANKRUPTCY Several things happen when debtor files for bankruptcy: Several things happen when debtor files for bankruptcy: – Bankruptcy court enters order for relief and issues automatic stay. – Trustee manages the debtor’s estate (Chapter 7). – Trustee is treated as a judicial lien holder.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 17 ENFORCEMENT OF THE SECURITY INTEREST Debtor Default: fails to meet obligations set out in security agreement. Debtor Default: fails to meet obligations set out in security agreement. UCC allows secured party, upon debtor’s default, to take possession of collateral and dispose of it in satisfaction of secured party’s claim. UCC allows secured party, upon debtor’s default, to take possession of collateral and dispose of it in satisfaction of secured party’s claim. UCC provides debtor with certain protections. UCC provides debtor with certain protections.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 18 DEFAULTDEFAULT UCC does not define default, parties provide definition in each security agreement. UCC does not define default, parties provide definition in each security agreement. Common examples of default include: Common examples of default include: – Nonpayment of financial obligations. Acceleration clause: when default occurs, secured party may be allowed to declare entire debt due and payable immediately. Acceleration clause: when default occurs, secured party may be allowed to declare entire debt due and payable immediately.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 19 NON-CODE REMEDIES Non-UCC remedies, the secured party may: Non-UCC remedies, the secured party may: – Become a judgement creditor. – Garnish debtor’s wages. – Replevy the goods. Code remedies include: Code remedies include: – Strict foreclosure; and/or – Resale of the collateral. Remedies are cumulative. Remedies are cumulative.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 20 NON-CODE REMEDIES Permit secured parties to file lawsuit to foreclose on security interest in collateral. Permit secured parties to file lawsuit to foreclose on security interest in collateral. Secured party may obtain writ of execution directing sheriff to recover and sell collateral. Secured party may obtain writ of execution directing sheriff to recover and sell collateral. Secured party can use judgment as basis for garnishing debtor’s wages to satisfy debt. Secured party can use judgment as basis for garnishing debtor’s wages to satisfy debt.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 21 CODE REMEDIES: REPOSSESSION Secured party may repossess the collateral without obtaining a judicial procedure. Secured party may repossess the collateral without obtaining a judicial procedure. Repossession by self-help must be done without breach of the peace. Repossession by self-help must be done without breach of the peace. Repossession carries dangers if involves breach of peace: Repossession carries dangers if involves breach of peace: – Tort liability. – UCC liability. – Loss of right to a deficiency judgement.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 22 “REALIZING ON THE COLLATERAL: STRICT FORECLOSURE Following default and repossession, secured party generally has two options: Following default and repossession, secured party generally has two options: – Collateral sold with proceeds applied to the debt. – Retain collateral in complete satisfaction of debt. Keeping collateral in satisfaction of secured debt called strict foreclosure. Keeping collateral in satisfaction of secured debt called strict foreclosure.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 23 STRICT FORECLOSURE Strict foreclosure beneficial because: Strict foreclosure beneficial because: – Value of collateral may be equal to amount of debt. – Court actions and expenses are avoided. – No subsequent controversies about resale price being fair. – UCC sets requirements for effecting strict foreclosure.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 24 STRICT FORECLOSURE Keeping collateral in satisfaction of the debt requires secured party to: Keeping collateral in satisfaction of the debt requires secured party to: – Send written notice to debtor, unless debtor waived right to require sale of collateral. – Send written notice to other secured party who claimed an interest in the collateral. – Wait twenty one days for parties to respond with objections.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 25 STRICT FORECLOSURE Strict foreclosure not permitted in certain situations: Strict foreclosure not permitted in certain situations: – When any party entitled to notice objects. – Debtor has paid at least 60% of cash price of purchase money security interest (PMSI) in consumer goods or at least 60% of the loan for all other security interests. Sale of collateral required and seller fails to sell within 90 days, secured party liable for conversion or damages. Sale of collateral required and seller fails to sell within 90 days, secured party liable for conversion or damages.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 26 DISPOSITION BY SALE Secured creditor may choose to satisfy debtor’s obligation by reselling, leasing, or disposing of the collateral. Secured creditor may choose to satisfy debtor’s obligation by reselling, leasing, or disposing of the collateral. Secured parties use foreclosure by sale remedy more often than strict foreclosure. Secured parties use foreclosure by sale remedy more often than strict foreclosure. Code’s provision for resale allows secured party to realize highest resale price possible. Code’s provision for resale allows secured party to realize highest resale price possible. Reduces possibility of deficiency judgment. Reduces possibility of deficiency judgment.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 27 DISPOSITION BY SALE Sale may be private or public. Sale may be private or public. Sale must be conducted in commercially reasonable manner. Sale must be conducted in commercially reasonable manner. Public sale or auction more ordinary method. Public sale or auction more ordinary method. Code encourages private sale through commercial channels, which increase chances for higher resale price. Code encourages private sale through commercial channels, which increase chances for higher resale price.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 28 DISPOSITION BY SALE Notice. Notice. – Secured parties notify debtors of time and place of public or private sale. – The secured party must notify: Debtor, unless debtor has waived notification or there is threat of immediate loss of collateral. Debtor, unless debtor has waived notification or there is threat of immediate loss of collateral. Junior secured parties claiming an interest in non- consumer goods, provided they gave written notice of interest. Junior secured parties claiming an interest in non- consumer goods, provided they gave written notice of interest.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 29 DISPOSITION BY SALE Commercially Reasonable Sale. Commercially Reasonable Sale. – Code states sale must be commercially reasonable. – Held in accordance with practices consistent for that type of collateral. – Conducted in usual manner for a recognized market. – Conducted pursuant to court order or approved by a creditor’s committee.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 30 DISPOSITION BY SALE Commercially Reasonable Sale. Commercially Reasonable Sale. – Failure to obtain better prices does not make a sale commercially unreasonable. – Following sale of collateral, creditor is entitled to receive a deficiency judgment for the unpaid balance of secured debt.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 31 DISPOSITION BY SALE Commercially Reasonable Sale. Commercially Reasonable Sale. – If sale is improperly carried out: Seller may be barred from recovering any deficiency or subject to other penalties under the Code. Seller may be barred from recovering any deficiency or subject to other penalties under the Code. Permits secured party to recover the deficiency, but reduces from this amount the debtor’s damages. Permits secured party to recover the deficiency, but reduces from this amount the debtor’s damages. Opts for a compromise between two views. Opts for a compromise between two views.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 32 DISPOSITION BY SALE Proceeds. Proceeds. – According to UCC, secured party must apply proceeds in this order: Payment of reasonable expenses of retaking and disposing of collateral, including attorney’s fees. Payment of reasonable expenses of retaking and disposing of collateral, including attorney’s fees. Satisfaction of the debt owed to secured party. Satisfaction of the debt owed to secured party. Payment to eligible junior secured creditors. Payment to eligible junior secured creditors. Payment of any surplus is paid to the debtor. Payment of any surplus is paid to the debtor.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 33 DEBTOR’S RIGHTS Debtor may redeem collateral at any time before the secured party has disposed of it. Debtor may redeem collateral at any time before the secured party has disposed of it. Redemption consist of debtor’s tendering payment of all obligations, including: Redemption consist of debtor’s tendering payment of all obligations, including: – Expenses incurred by secured party in retaking and preparing the collateral for disposition. – Arranging for resale. – Extinguishing secured party’s security interest in the collateral.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 34 DEBTOR’S RIGHTS Expenses may include attorneys’ fees and legal expenses. Expenses may include attorneys’ fees and legal expenses. Waiver of redemption cannot occur in the security agreement. Waiver of redemption cannot occur in the security agreement.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 35 SECURED PARTIES’ DUTIES Take reasonable care of the collateral while in their possession, before or after default. Take reasonable care of the collateral while in their possession, before or after default. Liable for any losses by failure to meet this obligation. Liable for any losses by failure to meet this obligation. Do not lose security interest of loss occurs. Do not lose security interest of loss occurs. Secured party can charge debtor payment of reasonable expenses. Secured party can charge debtor payment of reasonable expenses.

© 2004 West Legal Studies in Business A Division of Thomson Learning BUSINESS LAW: Cases & Principles Davidson Knowles Forsythe 8 th Ed. 36 SECURED PARTIES’ DUTIES Turn any surplus proceeds over to the debtor or apply to reduce secured obligation. Turn any surplus proceeds over to the debtor or apply to reduce secured obligation. Keep collateral identifiable. Keep collateral identifiable. UCC Section identifies the liability that secured parties incur when their noncompliance results in a loss to the debtor or junior secured creditors. UCC Section identifies the liability that secured parties incur when their noncompliance results in a loss to the debtor or junior secured creditors.