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Secured Transactions and Commercial Paper


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Scope of Article 9
Article 9 applies to CONSENSUAL security interests in personalty and fixtures
If the law is real estate you apply the law of mortgages
If the collateral, object of the backup is personalty or fixtures, apply Article 9
Generally, personalty = goods
Only applies to voluntary or consensual collateralizations, not statutory or mechanics liens
Article 9 Definitions
Debtor: entity that owes the money
Secured party or creditor: entity who lends the money
Security Agreement: Contract or Record
Security Interest: Right that creditor has in debtor’s personalty or fixtures
Collateral: Personalty or fixtures creditor can look to in satisfaction on the debt
Tangible Collateral
1) Consumer goods – used for personal/familial use
2) Equipment – used in business
3) Inventory – goods held for sale or lease
4) Farm Products – have to do with livestock, crops
5) Fixtures – attached to property
***Key purposes for classifying these is the primary use in the hands of the debtor. This is a subjective test
Intangible or Semi-Tangible Collateral
1) Patent and trademark rights
2) Copyrights
3) Stocks, bonds, and mutual funds
4) Proceeds received from the sale of collateral
5) Accounts (any right to payment for goods or services)
6) Promissory notes and drafts
Creation of Enforceable Security Interest
Attachment means the security interest is enforceable
Asking “Is security interest enforceable?” is asking “has it attached?”
Need the following:
V: Value must be given
C: Contract or security agreement or record is required. Note: If the secured party is in possession of the collateral there is no need for a record. If the debtor is in possession of the collateral we need a record. In most instances do need a record and that record must be
a) authenticated by the debtor (authenticated = signed or electronically marked) and
b) reasonably identify the collateral
R: Rights in the collateral to encumber in the first place – debtor must have rights in the collateral in the first place to have attachment. Note that “after acquired collateral clauses” are enforceable
Perfection of Security Interests
Perfection is best understood as a publicity device. It is something the secured party does to put the world on record or constructive notice of the secured party’s existence. Proper perfection helps to protect the secured party from competing creditors – get first priority.
Remember creditor who perfects first is SUPREME.
How do you attain Perfection?
1) By the secured party’s taking possession of the collateral. Taking possession until debt is paid = perfection
2) ***Automatic perfection for purchase money security interests (PMSIs) in consumer goods
To encourage lending to consumers, PMSIs in consumer goods are perfected automatically, upon attachment.
3) The most common route to perfection: the secured party files notice of the secured interest in the public records. Proper filing puts world on notice or constructive notice of the filer’s claim.
Need to know what’s filed to put the world on notice: security agreement could be filed but rarely is so instead typically file a financing statement which is a simple document to provide interested parties with enough information to make follow-up inquiries.
Article 9 aims to encourage electronic filing and it is “media neutral”
Requisite Contents of a Financing Statement
Keep it Simple and sparse – need only contain:
1) Debtor’s name and address
2) Secured creditor’s name and address and
3) A description of the collateral. Super generic descriptions “all of debtor’s assets” is permissible
Where is the financial statement filed?
Centrally with the State Secretary of State in the state where the debtor is located. If debtor is an individual, located in the state of her principle residence. If debtor is a registered organization (like a corporation) then it is located in the state under whose laws it is organized.
Exceptions: If the collateral is timber, minerals, or fixtures (something to do with land), then file locally in the county where the underlying realty is located
Priority is the very purpose of collateral and the secured party seeks to subordinate, not to share (want to squash competitors)
Each claimant is entitled to satisfaction in FULL before any inferior claimant is entitled to take.
Attached Unperfected Creditor
This is the Article 9 creditor who creates an enforceable security interest (attaches) but either never bothers to protect or tries to protect but botches it
Lien Creditor
General unsecured creditor who goes to court to get a judicial lien on the collateral
Perfected Attached Creditor
This is the Article 9 claimant who succeeds in attaining perfection (does everything right)
Non-Ordinary Course Buyer
Entity purchasing collateral outside of ordinary commerce (like buying guitar from auto mechanic – taking some risk because not doing things in the ordinary course)
Buyer in the Ordinary Course
Purchase collateral from merchant’s inventory (buy guitar from guitar store) – supreme winners
General Unsecured Creditor
Lender who never bothered to collaterize in anyway – losers
Order of Priorities (first to last)
1) Buyer in the Ordinary Course
2) Perfected Attached Creditor
3) Lien Creditor
4) Non-Ordinary Course Buyer
5) Attached Unperfected Creditor
6) General Unsecured Cerditor
Attached Unperfected Creditor v. The World
Attached Unperfected Creditor's interest will be enforceable against the debtor and will defeat any subsequent Attached Unperfected Creditor (later in time Attached Unperfected Creditor ) and General Unsecured Creditor.
Attached Unperfected Creditor will lose to Perfected Attached Creditor, Lien Creditor, and to any buyer without knowledge of the security interest
Perfected Attached Creditor v. The World
Perfect Attached Creditor defeats everyone except:
1) Perfected Attached Creditor who filed first
2) Certain PMSI-holders and
3) The Buyer in the Ordinary Course
Definition: Default
Debtor is in breach of the agreement, typically for failure to pay.
Perfected Attached Creditor v. Perfected Attached Creditor
First in time, first in right
Note: For purposes of determining priority, Article 9 gives special effect to filling – allows for early filing and if early filer subsequently attaches, she is allowed to the benefit of her earlier filing and the priority will relate back to the earlier filing.
PMSI's Holder v. (AACF)
1) AACF v. PMSI-holder when the collateral is equipment: PMSI-holder just has to file properly within 20 days after the debtor comes into possession of new goods to defeat the AACF
But for the PMSI there wouldn’t have been the new goods from the AACF
2) AACF v. The PMSI-holder when the collateral is inventory:
PMSI has to satisfy 2 requirements:
1) Must file properly before debtor takes possession and
2) PMSI must notify the AACF before debtor takes possession. This prevents debtor from committing fraud since bad faith debtor could try and get AACF giving more value so Article 9 try to close the door to that kind of debtor fraud – PMSI has to get the notification out to the AACF and prevent AACF from later being duped by bad debtor.
After Acquired Collateral Financier (AACF)
Secured creditor who takes as collaeteral a security interest in the debtor’s equipment/inventory now held or after acquired.
Perfected Attached Creditor v. Buyer in the Ordinary Course
PAC loses out to BIOC – Buyer in ordinary course of business gets to take free of a perfected security interest in seller’s inventory.
Want to prevent commerce and consumerism and to honor buyer’s reasonable expectations
Buyers in ordinary course reign supreme, beat everyone else – promote consumerism and reasonable buyer reliance/expectation interests
Default: Self-Help Repossession
Self help repossession is permissible, so long as creditor does not breach the peace, we allow purely privatized self-help. A breach of the peace occurs when the secured party’s actions are likely to cause violence. Thus, the relevant question is not whether or not an actual fight broke out, but whether the secured party did something provocative or likely to cause violence.
Repossession made over ANY protest by the debtor, however mild the protest, constitutes a breach of the peace. For that matter, if the repossessor misuses the color of law, by for example impersonating a law enforcement office, he or she has used constructive force and therefore has breached the peace.
Civil and criminal penalties will attach to creditors in this context.
Repossession in debtor’s home? Home enjoys a zone of privacy.
Secured party may not enter a debtor’s home without voluntary and contemporaneous consent.
Repossession outside the home? Get more latitude.
Secured party may take the collateral as long as there is no debtor objection.
Default: Repossession by Judicial Action
If secured party chooses not to resort to self help, party may go to court to get a judicial writ ordering the sheriff to obtain possession of the collateral and deliver it to the secured party. In NY this is called a “writ of replevin.”
Default: Strict Foreclosure
Assuming repossession by self help or judicial action, what next? Can do strict foreclosure.
Definition: Strict foreclosure occurs when the secured party retains the collateral in full satisfaction of the outstanding debt. In other words, the creditor lawfully retains the collateral and the debt in turn is cancelled.
Tends to work best when value of the collateral roughly approximates the value of the debt
How do you strictly foreclose?
Secured party must send a written proposal to retain the collateral in satisfaction of the debt.
Who do you send the proposal for strict foreclosure to?
If consumer goods, it is sent to debtor and secondary obligors. A secondary obligor is a guarantor of the underlying debt.
When it isn’t consumer goods, send to debtor and other secured parties who told the party about their interest along with perfected secured parties and secondary obligors.
***If any of the notified parties objects within 20 days after the notice is sent, strict foreclosure will not be allowed and collateral must be disposed of by sale. Can object for any or no reason – do not have to show cause to object, just do it within 20 days.
Default: Strict Foreclosure: Consumer Goods and the 60% Rule
If collateral is consumer goods and paid 60% of the loan or 60% of the cash price if it is a PMSI, then strict foreclosure will not be allowed and instead the secured party must sell the property in 60 days or be liable for conversion.
This is meant to avoid rewarding creditors with windfalls
Default: Sale
The secured party may sell the collateral and apply the sale proceeds to the debt. The secured party chooses whether the sale will be public (ie: a public auction) or private.
Requirements for Sale
1) Every aspect of the sale must be: commercially reasonable
2) Prior to sale, reasonable notice must be sent. Article 9 has standard notice forms which if used are presumptively commercially reasonable – just use the form.
a) If the collateral is consumer goods, notice must be sent to debtor and secondary obligors
b) All other kinds of collateral, send notice to debtor and those parties that have advised the secured party of their interest as well as perfected secured parties and secondary obligors
c) If disposition by pubic sale, must state time and place of the sale. If disposition by private sale, must state time after which the sale will go forth.
d) ***For consumer goods, additional protection provisions are mandatory including how any deficiency will be calculated and how debtor can redeem
e) How much advance notice is required? There is no bright line. The standard is one of commercial reasonableness. However, in a nonconsumer transaction, notice is deemed sent within a reasonable time if its sent 10 days or more before the time of the sale.
f) ***May the secured party buy at sale? At a public sale, yes. At a private sale, absent external market checks, no, because there is too much potential for unregulated self dealing
Default: Action for Deficiency Judgment
If outstanding debt is greater than the collateral, then the secured party can proceed against debtor for a deficiency judgment. If a secured party sells collateral at low price to inside buyer, price that an independent third party would have paid, rather tan the actual amount paid is the price that will be used in calculating any deficiency.
Debtor's Limited Right to Redemption
Once secured party resells collateral or completes strict foreclosure, the debtor’s right to redeem the collateral is cut off.
To redeem: debtor must pay amount owed (missed payment(s)) plus accrued interest and secured parties reasonable expenses including attorney’s fees.
If the security agreement contains an acceleration clause (which permits creditor to declare the full balance due in the event of default), to redeem debtor must: pay off the entire unpaid balance plus accrued interest plus secured party’s reasonable expenses including attorney’s fees
Commercial Paper: Article 3 of the UCC
When a negotiable instrument is duly negotiated to a holder in due course, the holder in due course takees the instrument free of all claims to it, free of personal defenses and subject only to real defense
Negotiable Instruments: Promissory Note
“I promise to pay to the order of X, signed”
Think of the promissory note as the promise maker, it contains an affirmative promise to pay (“I promise”) and not just a mere IOU.
There are 2 parties to a note: Promisor = maker, Promissee = payee.
Negotiable Instruments: The Draft
“Pay to the order of X, X amount, signed” – typically just a check
Think of the draft as the commander, it contains an order or command. Thus a check is a draft because it contains a command or order.
3 parties: Drawer = does the order, Drawee = ordered to do the paying (typically the bank), Payee = beneficiary of the order, entity that gets to collect
Indorser: Appears in the context of promissory notes and checks = signs on the back of the check.
Requirements for a Negotiable Interest
W: Writing
O: Payable to order or bearer
S: Signed by the maker or drawer
S: For a Sum Certain
U: Unconditional Promise and no additional promises
P: Payable on demand or at a definite time
P: Payable in Currency
Requirements for a Negotiable Interest: Other Points
1) The instrument must be signed by the maker if it is a promissory note or by the drawer if it is a draft. Any authentication found anywhere on the instrument qualifies (can be initials, identifying mark, etc) – this is NOT a formal standard.
2) The instrument must contain an unconditional promise to qualify as a promissory note or unconditutional order to qualify as a draft.
Negotiable Instrument v. Contract
By contrast “conditional” = a contract
Express condition = contract and not negotiable instrument (ex: “if”)
Also, if something is “governed by” or “subject to” another writing then it is non-negotiable and a contract. Rationale: holder of Article 3 shouldn’t be required to look to another document to determine essential rights.
But, merely referring to another writing doesn’t make a promise or order conditional. A promise or order is ont conditional simply because it happens to refer to another writing for statement of rights for an ancillary matter (acceleration, etc). Reference to on outside source with respect to a tangential/ancillary matter is permitted.
If instruments limits payment to particular source or fund then it is conditional.
Sum Certain
Specifically ascertainable sum – required for a negotiable instrument. Must have this from what the writing says or reference to an outside source.
Interest rate can be ascertained from a reference in the instrument to some general index or announced rate of some named financial institution.
To be negotiable, sum certain has to be payable in currency. Currency is money, including foreign currency. ***Money does not mean goods.
To be negotiable, the writing cannot contain any additional promise orders. **Remember, 2’s a crowd.
To be negotiable, the instrument must be payable on demand or at a definite time.
1) On Demand:
An instrument is payable on demand when it specifically states that it is payable “on demand” or “at sight” or “on presentation”
If instrument is silent at time of payment, it is still negotiable and payable on demand
2) Definite Time:
Instrument is payable at definite time if it is payable on or before a stated date or at a fixed period after a stated date
Acceleration clauses are permissible and do not destroy negotiability.
By Contrast: “Payable when my first grandchild is born” is nonnegotiable because this future event is not linked to a date certain.
To be negotiable, the writing must be payable to order or bearer
1) Payable to order
Must use the word “order” or “assigns” in connection with the payee’s name
2) Payable to bearer
Means it is payable to anyone who happens to have it, satisfied if: “pay to bearer,” “pay to order of bearer,” “Pay to cash,” “pay to order of cash” = these are Article 3 terms of art that will satisfy the standard
Note: “Pay to Andy” is NOT negotiable, it is just a contract because it does not contain the magic words “order” or “assigns” or “bearer”
Commercial Paper: Contract or Signature Liability
Defendant signed negotiable instrument. Remember: when you sign it, you promise to pay it and that’s how you get sued.
Who signed it?
1) The maker: enters into a contract by signing his name on the promissory note, agreeing to pay and if he doesn’t he can be sued.
2) The indorser: indorser signs his name on the back of the instrument. By signing, indorser promises that if the check bounces and he is notified, he will pay. If he doesn’t pay, then he can be sued.
3) The drawer is the party who signs the check – by signing the check you promise that if it bounces and you are notified you will pay. If you do not pay, you can be signed.
4) ***Drawee: party who pays the draft, typically the bank. Drawee does not sign and therefore the drawee is not liable (This is “Signature Liability”)
5) What if “without recourse” is accompanying the signature. This term is used by endorsers and drawers and represents a disclaimer of liability so pass title but assume no signature liability.
Commercial Paper: Warranty or Transfer Liability
Think of this as seller’s liability for selling a defective instrument.
Who might be sued?
Any transferor who SELLS that negotiable instrument. Thus, if the transferor is not a donor he is potentially on the hook here.
Who is entitled to sue the defendant for breach of warranty?
If defendant indorsed the instrument any plaintiff in possession of the instrument may sue.
REMEMBER: When defendant indorses, warranties run with the instrument.
If defendant never indorsed the instrument then only the defendant’s immediate transferee may sue.
NOTE: The warranties will not run with the instrument.
Commercial Paper: Warranty Liability: Warranties Made by the Defendant
1) Defendant promises: plaintiff has good title to the instrument
2) Defendant promises: that all signatures are genuine and authorized. Thus, forgery is a breach of warranty.
3) Defendant promises: the instrument has not been materially altered. If it has been altered, it is defective.
4) Defendant promises: there is no defense or claim against the defendant, meaning the instrument is enforceable
5) Defendant promises: she has no knowledge of any bankruptcy or insolvency proceeding against the maker or the drawer
Due Negotiation: Properly Transfering a Negotiable Instrument
Due negotiation or “duly negotiated” means there has been a proper transfer of the instrument. If the instrument has been properly transferred then the transferee is considered a holder and may be permitted to be a holder in due course. By contrast, if the facts support the conclusion that the instrument has been improperly transferred then the transferee will never be able to benefit as a transferee.
How is an instrument properly transferred when payable to order?
It is negotiated by delivery of the instrument to that payee.
Any further negotiation requires that the payee indorsed the instrument and delivered it to the transferee.
The indorsement has to be authorized and valid.
How is an instrument properly transferred when payable to bearer?
No indorsement is requred
Commercial Paper: Due Negotiation: Types of Indorsement
Must be Special or Blank and Restrictive or Unrestrictive
The Special Indorsement:
One that names a particular person as the indorsee. The indorsee must sign in order for that instrument to be further negotiated.
The Blank Indorsement
One that does not name a specific indorsee, it may be negotiated by delivery alone.
The Restrictive Indorsement
It contains a restriction
Holder in Due Course: Value
Holder must give value for the instrument. Note: giving value does not mean giving consideration which is a contract principle.
Consideration and Value differ in 2 ways:
1) A mere promise is not value for Article 3 purposes.
2) Old value is good value for Article 3 purposes
Holder in Due Course: In Good Faith
Means Honesty in fact = subjective test, rule of pure heart and empty head
Must acquire instrument without notice it is overdue, subject to defense or claim, etc.
Holder in Due Course: In Good Faith: Notice Test
It is an objective test.
Did the holder know or have reason to know of the problem?
If holder has notice or reason to know instrument should have been paid then he/she is not a holder in due course
Notice when:
1) Payable at definite time: holder is not a holder in due course if buy too late
2) Principle is in arrears: if holder had notice that it was in arrears (overdue) then won’t be a holder in due course. If interest is in arrears then that’s ok, can still qualify as a holder in due course.
Holder in Due Course: In Good Faith: Notice of defense/claim against instrument's enforcement
Face of instrument should have told you something was wrong, cannot be holder in due course
Holder in Due Course: In Good Faith: Notice of obligation of party is voidable
Then obligation is voidable to the party
Can still qualify as a holder in due course if didn’t know of the defenses of voidability
Holder in Due Course: In Good Faith: Notice of competing claim/instrument
If instrument lost or stolen from true owner, transferee could still qualify as holder in due course if instrument was duly negotiated and transferee did not have notice or reason to know of the theft of loss.
Holder in Due Course: In Good Faith: Notice of fiduciary breach of duty
If didn’t actually know of the breach, then can still be holder in due course.
The Holder in Due Course and the Shelter Rule
A transferee acquires whatever rights the transferor had. The transferee “takes shelter” in the status of the transferor.
This rule allows the transferee “to step into the shoes” of the HDC, even though she otherwise clearly fails to meet the requirements of due course holding. Thus, transferee has all the rights of a Holder in Due Course even though the transferee is a mere donee or otherwise fails to qualify.
The Benefits of Holder in Due Course Status: The HDC takes free from claims and personal defenses, but subject to real defenses.
HDC (and subsequent transferees who take “Shelter” in the status) takes the instrument free from claims, personal defenses subject only to real defenses
Claim is a right to a negotiate instrument because of superior ownership. HDC gets to defeat superior owner
Holder in Due Course gets to take free from personal defenses.
Personal defenses include every defense available in ordinary contract actions such as:
1) Lack of Consideration
2) Unconscionability
3) Waiver
4) Estoppel
5) Fraud in the inducement
"Real" v. "Personal" Fraud
Real Fraud = there has been a misrepresentation about the instrument
If real fraud exists then the note is not enforceable.
Personal Fraud = fraud in the inducement
Personal fraud is ineffective against a holder in due course
"Material Alteration" as a real defense
Change in the terms of the instrument
If maker is negligent, he is estopped from making a material alteration defense. If leave blanks, would be negligent
The Holder in Due Course takes subject to the real defenses (think MAD FIFI4):
M: Material
A: Alteration
D: Duress
F: Fraud
I: in the
F: Fact
I: Incapacity
I: Illegality
I: Infancy
I: Insolvency

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