Assignment 2
Attachment of the Security Interest:
The Basic Requirements
Reference: Understanding Secured
Transactions §§ 1.04, 2.01, 2.02,
3.01, 3.02, 3.03
• 3 prerequisites for attachment
of a security interest
– 1) Effective security agreement
[§ 9-203(b)(3)] covering the
collateral
– 2) “Value” must have been
given [§ 9-203(b)(1)]
– 3) Debtor must have “rights in
the collateral” [§ 9-203(b)(2)]
• SI “attaches” when last of these
3 prerequisites has occurred
Attachment
“Attachment” and “Perfection”
• Creation of a SI is
called “attachment”
– Typically evidenced by
a document entitled
“Security Agreement”
– Once SI attaches, it is
enforceable vs. debtor [§
9-201(a)]
• To make an “attached”
SI fully effective vs.
third parties (e.g.,
buyers, other creditors),
it must be “perfected”
– “Perfection” evidenced
(typically) by filing a
financing statement
(also called UCC-1)
“One-Time” Secured Loans
• Debtor borrows lump sum (all at once), to be repaid
in installments or in a lump sum, and grants SI in a
specific item(s) of property
– E.g., Debtor borrows $$ from Bank to buy car, grants
SI in car to Bank (“purchase money” SI)
– E.g., Debtor borrows money from Loan Shark, and
grants Loan Shark a SI in Debtor’s watch
• Security agreement for such a loan often uses a
specific collateral description (e.g., “Debtor’s 2008
Honda Accord, VIN #1HLQU1520KA186392”)
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Line of Credit Loans
• Debtor borrows only “as needed” against a predetermined maximum amount (“line of credit”)
– Interest accrues only on the amount actually borrowed
at any time, not on the entire credit line
– Payments occur monthly (or, with business lines of
credit, even on a daily basis)
• Lines of credit include:
– Credit card agreements (typically unsecured)
– “Home equity” line of credit (secured by home)
– Business line of credit (secured by business assets)
After-Acquired Collateral
• § 9-204(a): “[A] security agreement may
create or provide for a security interest in afteracquired collateral.”
– E.g., Debtor grants Bank a security interest in “all
of Debtor’s inventory, whether now-owned or
after-acquired”
– Each time Debtor acquires a “new” item of
inventory in the future, Bank’s SI will attach to that
new inventory, by virtue of after-acquired property
clause [§ 9-203(b)(2)]
Line of Credit Loans
• In the business context, a line of credit is often
secured by a “pool” of all collateral of a
particular type or types (not just one discrete
item of property)
• Security agreements for such loans typically
use generic collateral descriptions, e.g., “all of
the Debtor’s inventory”
Collateral Description
• Allowing SI in generic “classes” of collateral,
and in “after-acquired” collateral of those
types, creates transactional efficiencies
– Bank can describe collateral in generic terms (“all
inventory”) rather having to define each item of
inventory with specificity
– Bank and Debtor only have to sign one security
agreement (e.g., no need to sign a new agreement
each time Debtor gets new shipment of inventory)
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Collateral Description
• The true purpose of collateral description
requirement is to enable judge (in event of a
dispute) to identify whether a particular item of
property is subject to a SI
Problem 1(a): How Would You Classify the
Debtor’s Mercedes S550 Under Article 9’s
Collateral Scheme?
– If the description is sufficiently specific, this isn’t
problematic
– If the description is generic, then it becomes critical
that the creditor correctly classified the property
“Goods” [§ 9-102(a)(44)]
• “Goods” are tangible items that are movable at
the time the SI attaches
• Article 9 has 4 mutually exclusive categories
of goods: (1) consumer goods; (2) farm
products; (3) inventory; and (4) equipment
• Classification is based upon debtor’s primary
use of the goods
Types of Goods
• Goods are “consumer goods” if they are “used or
bought for use primarily for personal, family, or
household purposes” [§ 9-102(a)(23)]
• Goods are “farm products” if debtor is engaged in
farming and goods are (a) crops, (b) livestock, (c)
farming supplies, (d) products of crops or
livestock [§ 9-102(a)(34)]
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Types of Goods
• Goods are “inventory” if they are not farm
products and are held for sale or lease, raw
materials, or materials used or consumed in
business [§ 9-102(a)(48)]
• Goods are “equipment” if they are not consumer
goods, farm products, or inventory (equipment is
the “residual” category of goods) [§ 9-102(a)(33)]
• How would a box of
paper clips be
categorized under
Article 9’s
classification
scheme?
• Would the debtor’s
use of them matter?
Problem 1(c)
Problem 1: Possible Classifications
CONSUMER
GOODS
INVENTORY
FARM
PRODUCTS
EQUIPMENT
BEAGLE
Maybe
Maybe
(if dog is a pet) (if debtor runs
a pet store and
this dog is for
sale)
Maybe
(if debtor is a
dog breeder)
Maybe
(if debtor runs
guided hunts
using this dog)
MERCEDES
Maybe
Maybe
(car is debtor’s (debtor is car
personal car)
dealer and car
is for sale)
No
Maybe
(car is debtor’s
“company”
car)
• If used for personal, family, household use,
paper clips are “consumer goods” [§ 9102(a)(23)]
• If used for business purposes, paper clips are
“inventory” and not “equipment”
– Inventory includes “materials used or consumed in
business” [§ 9-102(a)(48)] even if not held for sale
or lease
– § 9-102 cmt. 4a: “[G]oods used in a business are
equipment if they are fixed assets or have … a
relatively long period of use, but are inventory … if
they are used up or consumed in a short period of
time in producing a product or providing a
service.” [E.g., paper clips in an office; toner in an
office copier; gas in a company car, etc.]
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Problem 1(d): How Would You Classify the
Debtor’s Home?
Problem 1(d): Home
• Lender cannot create a SI in real property
using an Article 9 security agreement
– A “security interest” can be created in “personal
property” or “fixtures” [§ 9-109(a)(1)]
– However, Article 9 does not apply to a lien on real
property other than fixtures [§ 9-109(d)(11)]
– To create a valid lien on real estate, lender would
have to have debtor execute a mortgage/deed of
trust covering the home (real property law)
Intangible Collateral
• “Account” [§ 9-102(a)(2)]: right to payment
for property sold or to be sold, or services
rendered or to be rendered (and certain other
specific payment rights)
• “General intangible” [§ 9-102(a)(42)]: any
intangible right that is not an “account”
– This includes “choses in action” (legal claims),
intellectual property rights, and goodwill
§ 9-102(a)(2). “Account” ... means a right to payment of a
monetary obligation, whether or not earned by
performance, (i) for property that has been or is to be sold,
leased, licensed, assigned, or otherwise disposed of, (ii) for
services rendered or to be rendered, (iii) for a policy of
insurance issued or to be issued, ... (v) for energy provided
or to be provided, (vi) for the use or hire of a vessel under a
charter or other contract, (vii) arising out of the use of a
credit or charge card ..., or (viii) as winnings in a lottery or
other game of chance.... The term does not include (i)
rights to payment evidenced by chattel paper or an
instrument, (ii) commercial tort claims, (iii) deposit
accounts, (iv) investment property ... or (vi) rights to
payment for money or funds advanced or sold [other than
rights arising out of use of a credit card] ....
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§ 9-102(a)(42). “General intangible” means any
personal property, including things in action, other
than accounts, chattel paper, commercial tort
claims, deposit accounts, documents, goods,
instruments, investment property, letter-of-credit
rights, letters of credit, money, and oil, gas, or
other minerals before extraction. The term
includes payment intangibles and software.
Problem 1(f): Debtor’s Right to a Tax Refund?
Note: This is the residual “catch-all” category
for anything that doesn’t fit any other collateral
classification (incl. all intellectual property)
Problem 1(f): Tax Refund?
Problem 1(e): Debtor’s Checking Account?
• By catch-all, right to collect a tax refund is a
“general intangible” (specifically, a “payment
intangible”) [§ 9-102(a)(61)]
– The term “account” excludes “rights to payment for
money or funds advanced or sold” (unless arising
from use of a credit card)
– Thus, if a security agreement described the collateral
as only “all of Debtor’s accounts,” it would not cover
the Debtor’s income tax refund!
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Problem 1(e): Checking Account
• Checking account is “deposit account” [§ 9102(a)(29)], not an “account” [§ 9-102(a)(2)]
• Suppose Litton loans Crouch $2,500, and
Crouch signs a security agreement granting
Litton a security interest in “all of Debtor’s
accounts.”
• Would Litton have a SI in Crouch’s checking
account? Why or why not?
• PCB made line of credit loan to
Hawley Implement Co., a
dealer in farm machinery
– Collateral description in security
agreement: “all of Debtor’s farm
equipment”
• Hawley is now in default. Can
PCB repossess and sell
machinery on Hawley’s sale
floor?
Problem 6
• Question: when the parties used the term
“accounts” to describe the intended collateral,
did they mean ...
– Only those rights that are “accounts” as defined in
Article 9?, or
– Any rights the two of them mutually understood to
be “accounts” (which might include a bank account)?
• Parties could have defined the term precisely,
for purposes of their security agreement; if they
didn’t, should we presume the parties meant
“the Article 9 definition”?
• Under Article 9, the collateral is “inventory”
(not “equipment”) in hands of Hawley
Implement Co. (held for sale or lease)
• In context, though, it appears Hawley intended
to grant a SI in its inventory (if Hawley is only
a retailer and is not actually engaged in farming
activity, Hawley probably has few or no assets
that are “equipment” as defined by Article 9)
• A court probably ought to interpret “farm
equipment” in this context to mean “inventory”
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Problem 6
In re Shenandoah Warehouse Co.
• The other problem is that the agreement
described the collateral as “all of the Debtor’s
farm equipment,” but without making clear
whether that included “after-acquired” (or only
the stuff on hand at the time of the agreement)
– Problem: Hawley has probably sold all of the
original collateral and replaced it with new units!
• Debtor (auto parts dealer) granted SI in
Debtor’s “inventory and accounts” (no
reference to “after-acquired”
• Court: SI in all of “Debtor’s inventory”
implicitly covers after-acquired inventory
• Should the court imply that the agreement
covered “after-acquired” property of that type?
– Rationale: inventory is sold/replaced; old
accounts are paid and new accounts arise
• Suppose security
agreement covers “all
of Debtor’s general
intangibles”
• Would it cover
debtor’s right to
receive damages in a
lawsuit?
Problem
1(g)
• Classification of a cause of action varies under
Article 9 depending on the nature of the action
– If the claim is a tort claim involving business
activity, it is a “commercial tort claim” [§ 9102(a)(13)]
– Note: noncommercial tort claim cannot be the
subject of an Article 9 SI [§ 9-109(d)(12)]
– If the claim arises in contract, it is a “general
intangible” (which includes “things in action”)
[§ 9-102(a)(42)]
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• Putnam County Bank (PCB) loaned Junior Davis
$5,000, but only after Butch (Junior’s dad) orally
agreed to put up his Lexus and his Rolex as collateral
• 3 prerequisites for attachment
of a security interest
Attachment
– Effective security agreement [§
9-203(b)(3)] covering the
collateral
– “Value” must have been given
[§ 9-203(b)(1)]
– Debtor must have “rights in the
collateral” [§ 9-203(b)(2)]
• SI “attaches” when last of these
3 prerequisites has occurred
– PCB prepared a “Security Agreement” that identified the
collateral as “Butch Davis’s car and Rolex watch”
– Junior signed it, and physically delivered the Rolex to PCB
– Butch retained possession of the car
• Does PCB have valid SI in the car and/or the watch?
Problem
2
§ 9-203(b) [Enforceability.] … [A] security interest is
enforceable against the debtor and third parties with respect
to the collateral only if:
(1) value has been given;
(2) the debtor has rights in the collateral or the power to
transfer rights in the collateral to a secured party; and
(3) one of the following conditions is met:
(A) the debtor has authenticated a security agreement
that provides a description of the collateral …;
(B) the collateral is not a certificated security and is
in the possession of the secured party under Section
9-313 pursuant to the debtor’s security agreement ….
Article 9’s Statute of Frauds
• SI can be nonpossessory (debtor keeps possession
of collateral prior to default, e.g., the Lexus) or
possessory (secured party holds the collateral until
repayment, also called a “pledge,” e.g., the Rolex)
• Nonpossessory SI must be created in a record that
is authenticated by the debtor [§ 9-203(b)(3)(A)]
– A signed writing is an authenticated record, but a
mere oral agreement is not
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• Rolex: b/c PCB has possession, an oral security
agreement is sufficient [§ 9-203(b)(3)(B)],
assuming PCB can prove that an oral agreement
with Butch actually took place
– Turning over possession of the Rolex corroborates
Butch’s orally-stated intent to grant a SI in it
– Note, however: oral agreement may be hard to
prove, especially if Butch denies its existence
• Lexus: for a nonpossessory SI, security
agreement must be in an “authenticated record”
Problem 2
• PCB has two potential problems with its
claimed security interest in the Lexus
– 1) Butch did not sign the security agreement
(instead, Junior signed it)
– 2) Does the agreement adequately describe the
Lexus by using the description “Butch Davis’s
car”?
Media-Neutrality: Key Terms
• “Record”: information inscribed on a
tangible medium (e.g., a writing) or stored
in an electronic medium retrievable in a
perceivable form [§ 9-102(a)(69)]
• “Authenticate”: to sign a record, or
otherwise encrypt or process it, with the
intent of adopting it [§ 9-102(a)(7)]
• There is a written “Security Agreement” that describes
the Lexus, but was it authenticated by the debtor?
– Butch (the owner of the Lexus) is the “debtor” [§ 9102(a)(28)]
– Junior is the “obligor” (he owes the debt) [§ 9-102(a)(59)],
but he is not the “debtor”
• Thus, it is Butch that must authenticate agreement for
attachment to occur under § 9-203(b)(3)
– If Butch authorized Junior to act as his agent [§ 1-103(b),
UCC incorporates agency principles], Junior’s signature =
Butch’s signature, SI is valid
– If not, no SI attached to the Lexus!
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§ 9-108. Sufficiency of Description....
(b) [Examples of reasonable identification.] Except as
otherwise provided in subsection (d), a description of collateral
reasonably identifies the collateral if it identifies the collateral by:
(1) specific listing;
(2) category;
(3) except as otherwise provided in subsection (e), a type of
collateral defined in [the UCC] ...
(4) quantity;
(5) computational or allocational formula or procedure; or
(6) except as provided in subsection (c), any other method,
if the identity of the collateral is objectively determinable.
• First Bank loaned Crouch $20K,
to be repaid in 1 year
– Crouch verbally agreed to grant
a SI in his computer servers
– First Bank confirmed the verbal
agreement in an e-mail message
to Crouch, which reasonably
identified the servers
• Crouch is now in default. Can
First Bank repossess the servers?
Problem 4
• Does the description “Butch Davis’s car”
reasonably identify the Lexus?
• It depends
– If, at time of security agreement, Butch owned
only 1 car, and it was this Lexus, then yes
– If Butch owned multiple cars, it wouldn’t be clear
from the description which one of those cars was
intended to be covered!
– Thus, a more specific description would have
been better (e.g., make, model, VIN #)
• The e-mail is a “record,” but it is not authenticated
by the debtor (Crouch)
– “Debtor” means the owner of the collateral [§ 9102(a)(28)(A)]
– Thus, there is still no binding security agreement
under § 9-203(b)
• If he had confirmed Bank’s e-mail by sending a
return e-mail (record capable of being retrieved in
“perceivable form”), § 9-203(b)(3) would’ve been
satisfied, and Bank would’ve had SI in the servers
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• E-mail said: “Your
acceptance of these terms
shall be manifested by your
acceptance of the loan
proceeds”
• Crouch accepted the loan
proceeds
• Why isn’t that good
enough?
Problem 5
Problem 4
• ABC Corp. owed Bank $500K (unpaid loan)
• Bank agreed to extend the due date of the loan
for 6 months if ABC’s CEO, Lambert, would
grant Bank a SI in two Picassos (FMV =
$5MM) as collateral
– Lambert then signed a security agreement that
described the two Picassos by name/picture
• Despite the extension, ABC still defaulted
§ 1-204. Value
• Lambert now argues that Bank’s claimed SI is
invalid b/c:
– A. The “security agreement” was not supported by
consideration
– B. Lambert didn’t receive value (ABC did)
– C. Bank didn’t give sufficient value ($500K loan
amount was only 10% of FMV of the Picassos)
– D. Lambert was only a co-owner of the Picassos
and thus lacked sufficient “rights in the collateral”
• Which arguments (if any) are correct?
Except as otherwise provided in Articles 3, 4, 5 and 6, a
person gives value for rights if the person acquires them:
(1) in return for a binding commitment to extend credit
or for the extension of immediately available credit,
whether or not drawn upon and whether or not chargeback
is provided for in the event of difficulties in collection;
(2) as security for, or in total or partial satisfaction of, a
preexisting claim;
(3) by accepting delivery under a preexisting contract
for purchase; or
(4) in return for any consideration sufficient to support
a simple contract.
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Problem 5
• § 9-203(b)(1) requires only that “value” be given to
support a security agreement
– Pre-existing debt (e.g., ABC debt owed to Bank) also
constitutes “value” [§ 1-204(2)]
– Besides, Bank’s extension of the due date by six
months = legal consideration, even if it doesn’t advance
any additional funds [§ 1-204(4)]
– Value doesn’t have to be given to the debtor (Lambert);
value here was given to obligor (ABC Corp.); debtor
can grant a SI to secure the debt of another person
• Even if Lambert is only a co-owner with his siblings, he
still has a “property” right as a co-owner
– As tenant in common, he has a co-equal possessory
right, as well as a “share” that he can transfer by gift,
sale, devise, or inheritance
– This is sufficient for a SI to attach [§ 9-203(b)(2)]
• However, Bank’s SI can attach only to Lambert’s rights
in the collateral (his rights as a co-owner)
– Thus, Bank could sell only Lambert’s rights as coowner (not those of his siblings)
– Bank should have had Lambert’s siblings join in the
security agreement
Problem 5
• Bank’s SI in the Picassos is valid
– § 9-203(b)(1) doesn’t require “fair value” for a SI
to attach, only that some “value” be given
– Fact that Picassos are worth 10X the amount of the
debt is irrelevant
– Enforcement would occur by sale (not by
forfeiture); if Picassos sold for >> $5,000,000, the
excess sale proceeds over the $500K debt go back
to Lambert (this reflects his “equity” in the
Picassos) [§ 9-615(d)(1)]
Problem 9
• Bank plans to extend a general operating line of
credit to Trump Contracting, Inc.
• If Bank’s security agreement uses the collateral
description, “All of Debtor’s personal property of
every type, now owned or after-acquired,” that
description is not sufficient under § 9-108(c)
• What’s the problem with that description?
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§ 9-108. Sufficiency of Description.
(a) [Sufficiency of description.] Except as
otherwise provided in subsections (c), (d), and
(e), a description of personal or real property is
sufficient, whether or not it is specific, if it
reasonably identifies what is described....
(c) [Supergeneric description not sufficient.]
A description of collateral as “all the debtor’s
assets” or “all the debtor’s personal property” or
using words of similar import does not
reasonably identify the collateral.
• Does it make sense for
UCC Article 9 to prohibit a
“supergeneric” description?
Why/why not?
– The concern here is arguably
potential creditor
overreaching, not doubt
regarding reasonable
identification
Problem 9: “Supergenerics”
• The description “all personal property” is a
supergeneric description that is NOT sufficient
for attachment purposes [b/c it “does not
reasonably identify the collateral,” § 9-108(c)]
• Thus, if Bank uses this description, the security
agreement will not create a valid security interest
in ANY of the Debtor’s property
• Compare this description: “All of the Debtor’s
equipment, inventory, farm products, consumer
goods, accounts, general intangibles, software, …
[listing every type of collateral defined in the UCC],
presently owned or after-acquired”?
– This description is the functional equivalent of “All
of the Debtor’s personal property”
– But, it is clearly sufficient for attachment purposes!
[It describes the collateral generically by UCC type,
which is explicitly authorized by § 9-108(b)(3)]
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§ 9-108. Sufficiency of Description....
(b) [Examples of reasonable identification.]
Except as otherwise provided in subsection (d), a
description of collateral reasonably identifies the
collateral if it identifies the collateral by:
(1) specific listing;
(2) category;
(3) except as otherwise provided in subsection
(e), a type of collateral defined in [the UCC] ...
[In other words, a “generic” description by UCC
type “reasonably identifies” the collateral”]
Problem 8
• Last year: Consumer Finance loaned Bowman $50K to
pay off gambling debts
– Bowman granted Consumer Finance a security interest in his
Porsche
• Bowman later borrowed another $15K from Consumer
Finance to pay his child’s tuition
• Bowman later defaulted, and Consumer Finance
repossessed/sold his Porsche for $55K
• Can it apply all of the proceeds to Bowman’s unpaid debt
(which is $65K)?
§ 9-204. After-Acquired Property; Future
Advances. . . .
(a) [After-acquired collateral.] Except as
otherwise provided in subsection (b), a security
agreement may create or provide for a security
interest in after-acquired collateral. . . .
(c) [Future advances and other value.] A
security agreement may provide that collateral
secures ... future advances or other value, whether or
not the advances or value are given pursuant to
commitment.
• Answer: it depends
– If Consumer Finance’s security agreement did not
contain a “future advances” clause, then the SI in
the Porsche would secure only the initial $50K debt
(not the later $15K loan)
• In this event, Consumer Finance would have to return
$5K surplus proceeds to Bowman
– If Consumer Finance’s security agreement
contained enforceable “future advances” clause, the
SI in the Porsche would secure the full $65K
unpaid debt
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The “Relatedness” Standard
• Section 9-204(c) does not require that future
advances be related to (or have the same
purpose as) the original loan advance
• Some courts, however, have engrafted a
“relatedness” or “same class” rule
– On this theory, Bowman might try to argue that the
later advance was unrelated to the original loan
(and that the later advance was thus unsecured)
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