II. Nature of the Security Interest

I. Introduction

II. Nature of the Security Interest

III. Attachment

A. Authenticated Security Agreement

B. Description Requirement

C. Rights in the Collateral

IV. Perfection

A. Collateral Categorization

B. Sufficiency of Financing Statement

1. Debtor’s Name

2. Creditor’s Name

3. Description Requirement

C. Possession

C. Deposit Accounts & Control

V. Priority

A. Introduction, Theory, & Mechanics

B. Nature & Limits

C. Secured & Unsecured Creditors

D. Purchase Money Security Interests

VI. Proceeds

VII. Deposit Accounts/Transfer of Property

VIII. Changes

A. Change of Location & Choice of Law

1. Law

2. Debtor Location

B. Change in Debts & Debtors

1. After-Acquired Property

2. Future Advances

C. Change in Name & Entity Structure

IX. Default

X. Limits

A. Intellectual Property

B. Federal Property, Set-off

C. Characterization

D. Securitization

I. Introduction

• Understanding Banks
• Bank Deposit = Unsecured Loan
• Customer who deposits money in bank becomes creditor of bank
• Not a shoebox/technical trust relationship
• Debtor and creditor
• What do the banks do with the money?
• Following the money
• Demand deposit
• Customer deposits $1000 into checking account
• Bank has reserve requirement of 10%
• So, must hold $100 as vault cash
• Or as balance with local Federal Reserve Bank
• Bank can lend $900 to someone
• Bank Makes the Loan
• Bank collects fee
• Alternatives
• Traditional lending
• Bank waits to collect loan when due
• Securitization
• Bank sells loan to third party and gets more cash now
• Bank lends that out and restarts cycle
• Focus on volume of lending that can be supported as function of different mechanism for lending
• Who finances the banks?
• Where does the money come from that supports the additions loans made during securitizations?
• Making Loans
• Framing the Lending Decision
• Loan Amount = F (Anticipated Cash Flows, Anticipated Asset Values)
• What weight should we attach to cash flow?
• What weight should we attach to anticipated values?
• Allocation Schemes under Insufficiency
• The Situation
• Many entities have claims/settlements
• Starting Points
• Creditor beats debtor
• But true of every creditor
• Not every claim can be satisfied
• We need an allocation rule
• Ex Ante Schemes
• Private Ordering through Contract
• Article 9 is permissive structure
• Will allow some parties to agree to allocation/priority rules for assets
• Protective Schemes
• Special priority positions given to those who cannot protect themselves through contract
• May be nonconsensual creditors generally
• Tort victims
• Government
• Rights are implemented through specific statutory priorities
• Or through state or federal liens
• Ex Post Schemes
• Core idea
• These schemes look to facts as determined at time of insufficiency as basis for allocations
• First Come, First Served
• Grab law
• Race to the assets
• Individualized Assessment Systems
• Keyed to need or ability to use assets effectively
• Lottery Schemes
• Random distributions at time of insufficiency
• Questions about Possibilities
• Private v. Public Ordering
• What judgments should we make about relative role of private & public offerings?
• Should private orderings (contractual parties) have some special status?
• Should we seek to create mandatory public ordering?
• Rent-Seeking
• Might ppl invest resources in fight for hearts of public officials empowered to impose ordering?
• Would this fight dissipate any of the advantages to be achieved from public ordering?
• Implementation Costs
• How much should we care about cost of implementing the allocation scheme?
• Are individualized determination based on complex info such as need/ability to use assets good?
• Do we again face rent-seeking if these determinations are allowed?
• Fairness
• Would scheme of random distributions achieve low cost at price of some fairness?
• Would law or large numbers achieve fairness when many cases considerered?
• 4 Steps for Creating a Perfected Security Interest
• Creditor lends $ to Debtor
• Debtor promises to repay loan to Creditor
• Debtor grants a security interest in a particular asset to Creditor
• Creditor gives notice of security interest to public
• Key attributes of security interest
• Property rights
• Secured creditor has right to repossess collateral after default [9-609]
• Also has right to sell property [9-610)
• Or keep property it in satisfaction of debt [9-620]
• Priority rights
• Secured creditor has priority over unsecured creditors [9-201]
• Reified Priority System
• Key Idea
• Priority not tied only to time in line, but to time in line as to particular assets
• Having special property in one asset creates no rights in another asset
• Article 9 as Assets Reservation System
• Priority Rule
• Creditor that files first FS for class of assets usually has priority [9-322(a)(a)]
• This matters when creditors have competing security interests in same assets
• Problem
• Facts
• 1/1: $10K loan from Finco to Corp; SA & FS for equipment
• 2/1: $10K loan from Bank to Corp; SA & GS for inventory
• 3/1: $10K loan from Creditco to Corp; Unsecured
• 3/15: INV = $5K; EQ = $15K
• Security Interests
• Finco: SI in EQ worth $15K; owed $10K
• Bank: SI in INV worth $5K; owed $10K
• Unsecured Debts
• Finco: $0
• Bank: $5K
  Creditco: $10K
• Asssets
• $5K in EQ
• Pro Rata Rule
• Total Debts: 0 + 5 + 10 = 15
• Total Assets: 5
• Bank gets (5/15) x 5 = $1,667
• Creditco gets (10/15) x 5 = $3,333
• Final Distribution
• Finco gets $10K
• Bank gets $5K + $1,667 = $6,667
• Creditco gets $3,333
• Unsecured Creditor Hypo
• Facts
• Three unsecured creditors
• A is owed $100
• B is owed $200
• C is owed $300
• Pro Rata Calculation
• Total Debts = $600
• A gets (100/600) = 1/6 of assets
• B gets (200/600) = 1/3 of assets
• C gets (300/600) = 1/2 of assets
• Pro Rata Rule (Bankruptcy Code)
• Total the unsecured claims against assets
• Total the assets
• For each creditor, give that creditor the fraction of the assets that creditor holds of claims
• Equal Asset Distribution Rule
• Key Idea
• Creditors should share assets equally
• Line up creditors and pass out dollar bills until run out or creditor fully paid
• Equal Loss Distribution Rule
• Creditors should bear losses equally
• Line up creditors in order of debts from high to low
• Hand dollar bills to one owed most until his debt equals second highest debt
• Then hand bills to the next until equals the third highest
• Do this until money runs out of creditor fully paid
• Assessing the 3 Rules
• Distributional Differences
• Largest Claimant
• Equal Loss > Pro Rata > Equal Assets
• Smallest Claimant
• Equal Assets > Pro Rata > Equal Loss
• Aggregate amount of debt v. distribution of debt
• Equal assets
• Best situation for two creditors versus third is to have equal debts
• Pro rata
• No transfer incentives (no advantageous reallocation)
• Equal loss
• Best situation for two creditors versus third is to pool debts
• Bottom Line
• Distribution v. Total
• Distribution of debts rather than just amount of debt matters under some rules
• Added Monitoring Burden
• Rules might create substantial monitoring burden that otherwise does not exist w pro rata
• Our situation
• We do not have pure pro rata
• Priority hierarchies create similar monitoring burdens as other loss regimes

II. Nature of the Security Interest

• Priority Rule [9-322(a)(1)]
• Priority dates from the earlier of the time
• A filing covering the collateral is first made or
• Security interest of agricultural lien is first perfected
• If there is no period thereafter when there is neither filing nor perfection
• Can negotiate contractual subordination in face of prior FS
• First-to-File Rule
• Ignoring perfection through possession, first to file a FS wins
• Problem 1
• Facts
• 1/1: $10K loan from Finco to Debtor; SA & FS = EQ
• 2/1: $10L loan from Bank to Debtor; SA & FS = EQ
• Priority
• Finco filed first, so Finco wins
• Problem 2
• Facts
• 1/1: $10K loan from Finco to Debtor; SA = EQ
• 2/1: $10K loan from Bank to Debtor; SA & FS = EQ
• 2/2: Debtor files FS = EQ
• Priority
• Bank filed first, so Bank wins
• Problem 3
• Facts
• 1/1: FS = EQ bt Debtor & Finco
• 2/1: $10K loan from Bank to Debtor; SA & FS = EQ
• 3/1: $10K loan from Finco to Debtor: SA = EQ
• Priority
• Finco filed first so Finco wins
• Possession
• Perfection through possession (or control) complicates
• Leads to “earlier of” formulation
• Problem
• Facts
• 1/1: $10K loan from Finco to Debtor; SA = Computer; Perfect = possession
• 2/1: $10K loan from Bank to Debtor; SA/FS = Computer
• 3/1: Finco FS = Computer; Gives up possession of Computer
• Priority
• Earlier of time a filing covering collateral is first made OR SI is first perfected
• Finco wins
• Definition of Security Interest [1-201(b)(35)]
• Interest in personal property or fixtures which secures payment or performance of an obligation

III. Attachment

A. Authenticated Security Agreement

• Attachment [9-203(a)]
• Security interest attaches to collateral when
• It becomes enforceable against the debtor with response to collateral
• Unless an agreement expressly postpones the time of attachment
• Enforceability [9-203(b)]
• Security interest is enforceable against debtor and third parties w respect to collateral only if
• Value has been given;
• The debtor has rights in the collateral or the power to transfer rights to a secured party; and
• One of the following conditions is met
• Debtor has authenticated a security agreement that provides description of collateral
• Simple Security Interest
• Facts
• 1/1: Promissory note bt Bank & Debtor; SA = EQ
• “Debtor gives SI in copier (serial number X) to Bank to secure debt”
• Bank’s rights
• Standard SI
• Money is lent
• SA is signed
• Collateral described appropriately w serial number
• After-Acquired Property[9-204(a)]
• Allows Debtor to grant SI in after-acquired property
• Simplifies transactions
• Debtor need not repeatedly execute new SAs as assets change
• Problem
• Facts
• 1/1: $ loans by Bank to Debtor; SA = INV, EQ, GI (now & after owned, include Das Kapital)
• 1/1: Debtor expects Das Kapital
• 7/1: Debtor gets Das Kapital
• SI in Das Kapital
• Debtor cannot grant SI unless they have interest in property
• Thus, SI does not arise until 7/1, when debtor acquires Das Kapital
• Waiving the Right to Seize Collateral
• Facts
• 1/1: $ loan by Bank to Debtor; SA = EQ
• “D hereby grants Bank SI in EQ, but Bank hereby waives its rights to repossess”
• Limits on Seizure
• Noting requires that secured creditor seize collateral after default
• Breach of peace rule limits utility of right of repossession, anyway
• Bankruptcy filing by debtor also could prevent seizure
• Waiver
• Waiver of rights generally okay, but only debtors have non-waivable rights [9-602(2)]
• Security Interest?
• Yes, this creates an effective security interest
• Waiving Priority Rights
• Facts
• 1/1: $ loaned by B to D; SA = EQ
• “D grants B SI in EQ, but Bank must share value of EQ pro rata w/ D’s unsecured creditors”
• Division of Proceeds
• Art 9 does NOT limit how SC distributes proceeds of collateral
• SP could agree to share proceeds w another creditor
• Security Interest?
• Yes, this SI should be good
• Building the SI Brick-by-Brick
• Problem 1
• Facts
• 1/1: $ loaned by B to D; Agmt
• “On default, B has right to exercise rights that Art. 9 SC would have”
• Need collateral
• No specific collateral is described – fails 9-203(b)(3)(A)
• This transaction only has right to repossess
• Problem 2
• Facts
• 1/1: $ loaned from B to D; Agmt
• “On default, B has rights that SC would have under Part VI of Art. 9”
• Description Issue
• Question re description of collateral
• Otherwise, gives lender property rights of SC
• SC should be able to waive priority rights
• If collateral had been specified, this would be fine to create SI
• Since it is outside standard practice, it is a risk
• Clark
• Facts
• Chrysler lends Clark $85K
• Clarke gives mortgage of an Inn; FS = Liquor License
• Licenses are not assignable
• After-Acquired Property
• Chrysler could have avoided problems by including AAP clause in K
• AAP covers property that D later acquires, and stuff D has that later becomes property
• Property Interest Requirement
• Negative rights v. positive rights
• Chrysler had not right to act against property – no right to repossess, sell, or keep
• How Big Must Property Be?
• 1-201(b)(25) says nothing about the scope of the positive rights required to have SI
• More limited rights may suffice as long as positive rights
• Negative Rights
• May influence likelihood of payment
• Close to securing payment or performance of obligation
• Probably just give rise to right to sue for breach rather than ability to get injunction enforcing
• Incomplete interests
• If intended that SC have less than full set of rights
• Safer to create SI and remove rights
• Less safe to create the desired rights individually
• Bollinger
• Facts
• 1/13/72: ICC PN $150K to B; SA/FS = Mach & EQ
• 12/5/74: Z&J PN $150K to B; FS = Mach &EQ
• 3 Possible Docs as SAs
• Does FS suffice?
• Case law is split
• American Card = No; need SI grant
• Amex-Protein = Yes; no magic phrases required
• Reality is that it does NOT suffice
• Good reason to file FS before SI as way of reserving priority position
• Deals can fall through, though, leaving FS naked
• Does PN suffice?
• “PN is further secured by SI in certain SA to be delivered”
• This contemplates an addt document of SA
• “PN is secured by SI in certain SA bt B & ICC”
• Why isn’t this enough?
• Do letters suffice?
• Pre-deal letters
• Sating it will do deal if given security
• Post-deal docs
• B send list of collateral to Z&J
• Letters discussing management of collateral
• Court finds these letters show intent to create SA
• Thus, intent suffices to create SA
• But, intents can change and what about statute of frauds re 3rd parties
• Third-Party Effects
• How do we burden 3rd parties?
• Will Debtor internalize costs?
• Why should we require authenticated SA?
• Ex Ante Effects
• How sensitive/elastic will party behavior be to formal rule we announce for SA requirements
• Soft rules encourage parties to be careless
• Third party effects and ex post costs should control the rule we select
• Status of Financing Statements
• Don’t infer too much
• FS does not contain creation or grant language, usually
• Careful SC will file FS before lending $, so FS is record before SI is created

B. Description Requirement

• Description requirement generally
• Structurally
• Implements the Reified Priority System
• Read to K!
• Just a Q of K interpretation in statutory framework provided by sections 9-108 and 9-203
• Sufficiency of Description [9-108(a)]
• Description sufficient – whether or not specific – if it reasonably identifies what is described
• Examples of reasonable ID [9-108(b)]
• Description reasonably IDs collateral if it IDs by
• Specific listing
• Category
• A type of collateral defined in UCC
• Quantity
• Computation/allocational formula or procedure
• Any other method if the identity of collateral is objectively determinable
• Supergenic description not sufficient [9-108(c)]
• Description of collateral as “debtor’s assets” or “all personal property” or similar words NOT okay
• When description by type is insufficient [9-108(e)]
• Description by type only is insufficient for
• Commercial tort claim
• In consumer transaction, consumer goods, security entitlement, securities account, commodities account

• Baldwin
• Facts
• North Dakota, 2004
• B places cattle on CC feedlots
• Cattle eat, get fat, get sold
• C claims SI in certain of B’s cattle
• Cattle feeding agmt – lot # is not filled in
• Farm Products [9-102(a)(34)]
• Means goods, other than standing timber, w respect to which D engaged in farming and are
• Crops grown, growing, or to be grown including
• Livestock, born or unborn
• Supplies used in farming operation
• Products of crops/livestock in their unmanufactured states
• Shelby County
• Facts
• VD sells inventory on credit to H
• 11/2/82: FS = all inventory, notes, accounts receivable, machinery and equipment now owned or later acquired, including all replacements or subs”
• 12/97: B loans $ to H; SA = Inventory and GI
• Priority for inventory
• Key clause
• All inventory, including but not limited to X whether now owned or later acquired, including Y
• Comma is key
• No comma after X in Shelby
• Third party reliance on SA
• What can Bank rely on?
• SA?
• Letter?
• FS ? – what risks does above FS have?
• Answer
• 9-322(a)(1) Priority Rule
• Earlier of first to file or perfect wins
• VD filed first
• Later granted SI in all inventory – beats Bank based on first filing
• Moral
• FS sets risk for loss of priority
• Rules of Construction
• Anti-Drafter Rules (Contra Proferentum)
• Drafters will often face rules that will resolve ambiguities against drafter
• Anti-Broad Security Interest Rules
• Although Article 9 is neutral, judges often reluctant to enforce broad Sis
• More is Less
• Adding info to description may give judge basis for excluding collateral – if too broad
• Tethering
• Given important 3rd party effects of, useful to tie K defs and collateral descriptions to objects that are readily assessable to 3rd parties
• Includes Article 9 defs and standard industry practices

C. Rights in the Collateral

• Derivation Principle
• Secured Creditor takes through its Debtor
• Example
• D leases goods
• SC can take D’s lessee interest in collateral
• But SC’s rights will be limited to those held by debtor
• Debtors and Obligors
• Definition of Debtor [9-102(a)(28)]
• Person having interest, other than SI/lien, in collateral (whether or not obligor)
• Seller of accounts, chattel paper, payment intangibles, or promissory notes
• Consignee
• Definition of Obligor [9-102(a)(59)]
• Person that, with respect to obligation secured by SI in (or agricultural lien on) collateral
• Owes payment or other performance of obligation
• Has provided property other than collateral to secure payment or other performance or obligation, or
• Is otherwise accountable in whole or in part for payment or other performance of obligation

• People’s Bank
• Facts
• 10/5/99: $ from C to Brooks; SA/FS = Cattle
• FS says “Louie Dickerson”
• 11/02: $ from P to Brook; SA/FS = Cattle
• FS says “Brooks L. Dickerson
• Version 1
• 5/5: Brooks sells cattle to Bryan
• Version 2
• 5/5 Glenbrook Cattle Company sells cattle to Bryan
• Farm Security Act [7 USC 1631]
• Purchases free of SI
• Buyer in ordinary course of biz buys farm product from seller engaged in farming operation - purchases free of security interest by seller
• Even if SI is perfected
• Even if buyer knows of the SI
• Purchases subject to SI
• Buyer of farm products takes subject to SI created by seller if
• In case farm product produced in state that has central filing system
• Buyer has failed to register w Sec of St. prior to purchase of products
• SP has filed effective FS or notice that covers products being sold
• Moglia
• Trust as Entity
• Run-up
• 1/1: Fee transfer of Hope Diamond from Corp to 3rd party
• 2/1: Corp grants SI in HD to Bank
• Bank’s rights
• First transfer ends rights of corp in HD
• Corp has no rights in HD so cannot later grant SI in it
• Facts
• 1/1: Trust gives $14 M to USC
• “Only USC can collect, no SI allowed”
• Title transfers if change of control of outboard
• 2/1: Outboard grants SI in corp’s rights in trust to Bank
• Trust as K
• Run up
• 1/1: Corp grants SI in HD to Bank
• 2/1 Corp does fee transfer of HD to 3rd party
• Bank’s rights
• SI now granted prior to fee transfer
• SI survives fee transfer – unless buyer in ordinary course of business
• Facts
• 1/1: Conditional Fee transfer of $14M from outboard to USC
• “Only USC can collect and no SI allowed”
• 2/1: Outboard grants SI in corp’s rights in HD
• Negative Pledges
• Facts
• 1/1: Corps borrows $100 from Bank unsecured
• 2/1: Corp borrows $200 from Finco w/ negative pledge
• “Corp promises to not grant SI in any of its assets”
• 3/1: Corp borrows $300 from Creditco; SA/FS = All assets
• Corp broke promise to Finco
• $400 in assets and now is insolvent
• 3/1: Sharing agmt bt Finco & Creditco
• Possible Answers
• Proceed pair by pair
• Creditco > Bank
• Bank = Finco
• Finco ? Creditco
• Separate property rights from purely contractual rights
• Step 1 = $300 to Creditco on its SI
• Step 2 = $100 pro rata to Bank & Finco as USCs
• Step 3 = Neg pledge as contractual right of parity bt Cred & Finco
• Reallocate their funds pro rata

IV.