Assignment 11
Priority: Secured Party v. Buyer
Reference: Understanding Secured
Transactions Ch. 11
• Did Burnside take the
tractor free of Bank’s
SI, or subject to it?
• Can Bank get a
judgment against
Burnside for the $8,500
unpaid debt that Henson
owes to Bank?
Problem 1
Problem 1
• Burnside buys a used tractor from Henson for
$6,000 (assume Henson acquired and used it in
farming operations)
• Burnside gets demand from Commerce Bank
– Bank: “We have a SI in the tractor, to secure
payment of $8,500 that Henson owes us.”
– Burnside had no knowledge of Bank’s SI
Article 9’s Baseline Priority Rule
• Baseline rule follows from “derivative title”
• Unless Article 9 provides otherwise:
– “[A] security interest is effective according to its
terms between the parties, against purchasers of the
collateral, and against creditors.” [§ 9-201(a)]
• “Purchaser” includes a buyer [§ 1-201(b)(29), (30)]
– SI “continues in collateral notwithstanding sale” [§
9-315(a)(1)] (thus, buyer takes subject to SI unless
Article 9 rules provide an exception)
1
Exception: Buyer v. Unperfected SI
Problem 1
• § 9-317(b): Unless Article 9 provides otherwise, a
buyer of goods takes free of a SI in the goods if
buyer gives value and takes possession of goods:
• Thus, if Bank had perfected its SI by filing a
UCC-1 covering the tractor, then Burnside
took it subject to Bank’s SI [§§ 9-201(a), 9315(a)(1)]
• By contrast, if Bank had not properly perfected
its SI by filing (or otherwise), then Burnside
took the tractor free of Bank’s SI [§ 9-317(b)]
– Without knowledge of the SI, and
– Before SI is perfected
• Estoppel warranted vs. unperfected secured party
(buyer relied on seller’s ostensible ownership, had
no reason to know of secured party’s claim)
• Assume Bank had properly perfected its SI in the
tractor by filing a UCC-1 covering the tractor
• If Burnside doesn’t turn over possession of the
tractor to Bank, can Bank sue him for the $8,500
unpaid debt?
– No! Although Burnside does take title to the tractor
subject to Bank’s SI, Burnside does not implicitly
assume personal liability to Bank for Henson’s debt
– Unless Burnside personally agreed to assume that debt,
Bank cannot get judgment vs. Burnside on the debt
– Bank could only get judgment in tort, for conversion of
its collateral (amount = FMV = $6,000)
Authorized Sales and Sales in
“Ordinary Course”
• Ordinarily, an inventory lender can’t repossess
inventory that has been sold to buyers
– A “buyer in ordinary course of business” takes free
of a SI created by its seller [§ 9-320(a)]
– An inventory lender’s security agreement typically
explicitly authorizes the debtor to sell inventory, in
ordinary course of business, “free and clear” of
lender’s SI [§ 9-315(a)(1)]
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§ 9-315(a)(1). Except as otherwise provided in this
article and in Section 2-403(2):
(1) a security interest or agricultural lien continues in
collateral notwithstanding sale, lease, license, exchange, or
other disposition thereof unless the secured party
authorized the disposition free of the security interest or
agricultural lien; and
(2) a security interest attaches to any identifiable
proceeds of collateral.
§ 1-201(b)(9). “Buyer in ordinary course of business”
means a person that buys goods in good faith, without
knowledge that the sale violates the rights of another person
in the goods, and in the ordinary course from a person,
other than a pawnbroker, in the business of selling goods of
that kind. A person buys goods in the ordinary course if the
sale to the person comports with the usual or customary
practices in the kind of business in which the seller is
engaged or with the seller’s own usual or customary
practices…. A buyer in ordinary course of business may
buy for cash, by exchange of other property, or on secured
or unsecured credit…. “Buyer in ordinary course of
business” does not include a person that acquires goods in a
transfer in bulk or as security for or in total or partial
satisfaction of a money debt.
Problem 2
• BankGroup bought 12 suites of office furniture from
College Furniture, Inc. (College) for office use
– BankGroup agreed to accept the furniture in satisfaction of a
debt owed to BankGroup by College’s president
• BankGroup has now received demand from Hawthorn
Bank (which holds SI in all of College’s inventory,
perfected by UCC-1 filing): “College owes us $150K;
pay us this amount or surrender the furniture”
• Is Bank’s demand proper?
§ 1-201(b)(9). “Buyer in ordinary course of business”
means a person that buys goods in good faith, without
knowledge that the sale violates the rights of another person
in the goods, and in the ordinary course from a person,
other than a pawnbroker, in the business of selling goods of
that kind. A person buys goods in the ordinary course if the
sale to the person comports with the usual or customary
practices in the kind of business in which the seller is
engaged or with the seller’s own usual or customary
practices…. A buyer in ordinary course of business may
buy for cash, by exchange of other property, or on secured
or unsecured credit…. “Buyer in ordinary course of
business” does not include a person that acquires goods
in a transfer in bulk or as security for or in total or
partial satisfaction of a money debt.
3
• BankGroup is not a BOCB b/c it acquired the
furniture “in total or partial satisfaction of a
money debt” [§ 1-201(b)(9)]
– Rationale: this sort of transaction isn’t “ordinary”
– “Ordinary course” sales are sales that would generate
“proceeds” to which Hawthorn Bank’s SI could attach
– There’s no reason for BankGroup to assume College
Furniture was authorized to sell inventory in a way that
would not produce “proceeds”
– Thus, BankGroup took title to the furniture subject to
Hawthorn Bank’s SI, b/c Hawthorn did not authorize
this sale “free of” its SI [§ 9-315(a)(1)]
“Bulk Sales”
• A “bulk sale” is a sale that:
– Is not in ordinary course of the seller’s business,
– Is of more than ½ of the seller’s inventory, in terms of
value, and
– Occurs when Buyer knows or should know that the seller
will not continue to operate the same/similar kind of
business after the sale [§ 6-102(1)(c)]
• Buyer in bulk sale is not BOCB [§ 1-201(b)(9)], but the
sale of 12 suites of furniture to BankGroup is almost
certainly not a “bulk sale” under these standards
BOCB Questions: Problem 2
• Suppose BankGroup had paid cash for the
furniture instead
– Question 1: Was this a sale “in bulk” so as to
deprive BankGroup of BOCB status?
– Question 2: What if BankGroup bought the
furniture in a “Going Out of Business” sale?
– Question 3: What if BankGroup knew that
Hawthorn Bank had a SI in the furniture?
Problem 2
• Irrelevant if sale was “going out of business sale”
– Liquidation sales are “ordinary” for debtors going out
of business; further, lenders customarily authorize
liquidation sales in these contexts
• It is also irrelevant that BankGroup might have known
Hawthorn Bank had SI in the furniture at time of sale
– Mere knowledge of a SI doesn’t defeat BOCB status;
buyer loses BOCB status if it knows that the sale
violates secured party’s rights [§ 1-201(b)(9)]
4
• Northeast Airlines has a $450MM
line of credit w/ BankGroup
Industrial Credit (BIC)
Problem 3
– Collateral: all of Northeast’s
aircraft fleet (incl. after-acquired)
• Northeast has policy: after its
planes log 40,000 flight hours,
Northeast Airlines sells them to
Turkmenistan Airlines and
replaces them w/new planes
• Is Turkmenistan Airlines a BOCB
that takes free of BIC’s SI in the
planes?
§ 1-201(b)(9). “Buyer in the ordinary course”
means a person that buys goods in good faith,
without knowledge that the sale violates the rights
of another person in the goods, and in the ordinary
course from a person, other than a pawnbroker, in
the business of selling goods of that kind. A person
buys goods in the ordinary course if the sale to the
person comports with the usual or customary
practices in the kind of business in which the seller
is engaged or with the seller’s own usual or
customary practices…. A buyer in ordinary course
of business may buy for cash, by exchange of other
property, or on secured or unsecured credit….
Problem 3
Problem 3
• Text suggests buyer would be BOCB, as long as the
sale of used planes “comports with the usual or
customary practices” of airlines generally, or with
Northeast’s own “usual or customary practices” [§ 1201(b)(9)]
• Contrary view (weight of case authority): no, b/c
Northeast is not “in the business of selling” planes,
which is a threshold condition for BOCB status [§ 1201(b)(9)] (planes are not “inventory” in the hands
of Northeast) [Sindone v. Farber (N.Y. 1980)]
• In the face of this uncertainty, buyer of used
goods (like Turkmenistan Airlines) should
directly confirm, from secured party (BIC) that
secured party expressly authorized the sale free
and clear of its lien
• Can Turkmenistan Airlines argue that BIC had
implicitly authorized such non-ordinary course
sales?
5
• TA may argue that by “course of performance,”
BIC has authorized Northeast to sell its used
planes free and clear
– If so, TA would take free of BIC’s SI under § 9315(a)(1)
• Relevant facts:
– Has Northeast regularly conducted similar sales
of planes without BIC’s consent?
– If so, did BIC know?
– If so, did BIC object or attempt to enforce its SI
against the buyer(s)?
• Courts have been willing to find implied
authority to sell “free and clear” based on a past
“course of performance” between the debtor and
the secured party
– Most of the reported cases involve repeated sales of
livestock
– The same pattern, however, could apply to an airline
selling planes (or Hertz selling used cars)
– If BIC failed to object to past sales, and never asserted
its SI vs. buyers like Turkmenistan Airlinse, court
may find this course of performance created implied
authority to sell free/clear
§ 1-303(a). A “course of performance” is a sequence of
conduct between the parties to a particular transaction that
exists if:
(1) the agreement of the parties with respect to the
transaction involves repeated occasions for performance by a
party; and
(2) the other party, with knowledge of the nature of the
performance and opportunity for objection to it, accepts the
performance or acquiesces in it without objection....
§ 1-303(d). A course of performance ... is relevant in
ascertaining the meaning of the parties’ agreement, may give
particular meaning to specific terms of the agreement, and may
supplement or qualify the terms of the agreement.
§ 1-303(f).... [A] course of performance is relevant to
show a waiver or modification of any term inconsistent with
the course of performance.
Problem 3
• How could a lender like BIC have behaved
differently to address this risk?
– Establish an explicit “release price” (i.e., “if you
pay us at least $1.5MM/per plane in sale proceeds,
we will consent to sale of the plane free and clear
of our interest”)
– Enforce its rights promptly in the event of any
unauthorized sale
– Clear communication w/debtor (no waiver)
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• NE sells a used plane to
Turkmenistan Airlines for
$2.1MM
– BIC had established a
$1.5MM “release price” for
the sale, but
– Turkmenistan Airlines
didn’t know this
– NE completes the sale, but
does not turn over the sale
proceeds to BIC as agreed
• Effect of the sale?
Problem 4
– Rationale: failure of debtor to comply w/condition doesn’t
negate fact that lender authorized the sale
A. Turkmenistan
Airlines takes plane
subject to BIC’s SI
• The better view, however, is that on these facts, the
Seller’s authorization to sell free/clear was conditional,
and the condition was not satisfied
B. Turkmenistan
Airlines gets plane
free of BIC’s SI
– Thus, Buyer took subject to BIC’s security interest [§ 9201(a)]
– Buyer (not in ordinary course) was on notice, should have
confirmed w/BIC the terms of its consent (e.g., Buyer
could’ve paid sale price to BIC directly)
Problem 6
• Bank takes PMSI in Haines’s
new tractor (acquired by
Haines for personal use)
• Six months later, Haines
sells the tractor to Anthony
for $4,000 cash
• Did Anthony take the tractor
subject to Bank’s SI, or free
and clear of it?
• A few wrong decisions have ruled for Buyer in this
situation
A. Subject to
B. Free and clear
C. Can’t say
§ 9-320(b). [Buyer of consumer goods.] Except as otherwise
provided in subsection (e), a buyer of goods from a person who
used or bought the goods for use primarily for personal, family,
or household purposes takes free of a security interest, even if
perfected, if the buyer buys:
(1) without knowledge of the security interest;
(2) for value;
(3) primarily for the buyer’s personal, family, or household
purposes; and
(4) before the filing of a financing statement covering the
goods.
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“Garage Sale” Exception [§ 9-320(b)]
• In a sale transaction, a buyer of goods takes free of
a SI, even if it was perfected, if:
– The goods were “consumer goods” in seller’s hands
– The buyer pays value, without knowledge of SI
– The goods are also “consumer goods” in the hands of
the buyer, and
– Secured party did not either (1) file a financing
statement covering the goods or (2) take possession of
the goods (i.e., secured party had relied on automatic
perfection) [§ 9-320(e)]
Problem 5
• Bank takes PMSI in Haines’s new tractor
(acquired for personal use)
• Haines later sold the tractor to Marvin’s Farm
Implement Co. (“Marvin’s) for $4,000 cash
– Marvin’s did not know of Bank’s SI in the tractor
• Marvin’s resold tractor to Anthony for $5,000
– Anthony likewise did not know of Bank’s SI
• Does Bank still have a valid SI in the tractor?
• If Anthony didn’t know of Bank’s SI, he takes the
tractor free of that SI, b/c Bank did not file a UCC-1
covering tractor [§ 9-320(b)]
– Automatic perfection rule for PMSIs in consumer
goods creates an ostensible ownership problem
– While those in the business of lending understand the
risk that consumer goods may be subject to autoperfected PMSIs, consumers may not appreciate this
– To avoid the risk posed by § 9-320(b), Bank must file
UCC-1 covering the tractor
Problem 5
• In this situation, the “garage sale” rule of §
9-320(b) does not apply
– Haines-to-Marvin’s sale was not “consumer-toconsumer” sale (to Marvin’s, the tractor was
“inventory”)
– Likewise, the Marvin’s-to-Anthony sale was
not “consumer-to-consumer” sale
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• Anthony is a buyer in ordinary course of
business (BOCB), but a BOCB only takes free
of a SI created by its own seller [§ 9-320(a)]
– Bank’s SI was created by Haines (the prior owner of
the tractor), not by Marvin’s (Anthony’s seller)
– Anthony took the tractor free of any SI that Marvin’s
may have granted covering its inventory, but
– Anthony took the tractor subject to Bank’s perfected
PMSI that was granted by Haines (the auto-perfected
PMSI in consumer goods), under the derivative title
rule [§§ 9-201(a), 9-315(a)(1)]
Problem 5: Due Diligence Burden?
• To avoid this risk when buying used goods, the
buyer can’t ONLY search the UCC records
under the name of its immediate seller
• Instead, proposed buyer must:
– Reconstruct the “chain of title” (i.e., must identify
any prior owner(s) of the goods), and
– Search for relevant filings under the names of any
prior owner(s) (any SI perfected by those filings may
have survived)
Problem 5: “Created by Its Seller”
• BOCB rule [§9-320(a)] rests on “implied
authority” (i.e., an inventory lender authorizes
ordinary course sales by its own Debtor)
– But, Bank was loaning money to Haines (a consumer),
and taking a PMSI in consumer goods (not inventory)
– There’s no reason to infer Bank would have
authorized Haines to re-sell the tractor
– Bank had no agreement with Marvin’s (and no course
of dealing with Marvin’s) from which authority to sell
could be implied
• Sept. 1: Debtor buys an office
copier (for business use) from
Seller, who takes PMSI
• Sept. 10: After Debtor’s staff
complains about the copier, the
Debtor sells it to Buyer
Problem
– Buyer searched and found no
UCC-1 covering the copier
• Sept. 19: Seller files UCC-1
covering the copier
• Did Buyer take subject to Seller’s
SI, or free of it?
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§ 9-317(e). [Purchase-money security interest.]
Except as otherwise provided in Sections 9-320
and 9-321, if a person files a financing statement
with respect to a purchase-money security interest
before or within 20 days after the debtor receives
delivery of the collateral, the security interest takes
priority over the rights of a buyer, lessee, or lien
creditor which arise between the time the security
interest attaches and the time of filing.
• Seller was unperfected at time of sale to Buyer, and
such buyers are usually protected from unknown,
unperfected SIs [§ 9-317(b)], but
• Seller filed its UCC-1 within 20 days after Debtor
took delivery of the copier
• § 9-317(e): Seller’s PMSI thus takes priority over the
intervening rights of Buyer [despite § 9-317(b)]
Buyers of Goods Securing Future Advances
Problem 7
• In a line of credit arrangement, the collateral
typically secures not only amounts already
borrowed and not repaid, but also future advances
• Suppose Buyer buys a machine from Debtor, but
does not take it free and clear of Bank’s perfected
SI (which secures future advances)
– Clearly, Debtor takes machine subject to SI that secures
balance due on debt on the date of the sale
– But what about advances made to Debtor AFTER the sale?
– Also, on these facts, § 9-320(b) doesn’t protect the Buyer
(this was not a “consumer-to-consumer” sale; copier was
“equipment” in hands of Debtor, so garage sale rule does
not apply)
• Bank has perfected SI in all present and afteracquired equipment of Draco
• Two months ago, Draco sold three used computers
to Smith (w/out Bank’s knowledge or consent)
– On date of sale, Draco owed Bank = $5,000
– Today, Draco owes Bank = $30,000
• How much does Smith have to pay Bank to get
“clear title” to the three computers? $5,000?
$30,000? Some other amount?
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§ 9-323(d) [Buyer of goods.] Except as otherwise
provided in subsection (e), a buyer of goods other than a
buyer in ordinary course of business takes free of a
security interest to the extent that it secures advances made
after the earlier of:
(1) the time the secured party acquires knowledge of
the buyer’s purchase; or
(2) 45 days after the purchase.
§ 9-323(e) [Advances made pursuant to commitment;
priority of buyer of goods.] Subsection (d) does not
apply if the advance is made pursuant to a commitment
entered into without knowledge of the buyer’s purchase
and before the expiration of the 45-day period.
• Scenario 1: Sale to Smith on September 1; First
Bank learned of the sale on October 1; on that
date, balance on line of credit = $10,000
– Computers Smith bought are subject to First Bank’s
SI to the extent of $10,000; later advances ($20,000)
to Draco are not secured by the computers
• Does this result make sense?
– Yes; once First Bank knows of the sale, it can act to
freeze the credit line and repossess computers
– Bank should not get priority for advances made after
that, unless Bank was previously contractually bound
to make those advances [§9-323(e)]
• Smith took computers subject to SI, to extent
of $5,000 owed to First Bank on date he
bought them [§§ 9-201(a), 9-315(a)(1)]
• B/c computers also secured future advances,
they also secure repayment of advances made
to Draco (a) w/out knowledge of sale to Smith
and (b) w/in 45 days after that sale [§ 9323(d)]
– Thus, the answer depends on (a) What date did sale
take place? (b) When did First Bank learn of it?
• Scenario 2: Sale occurred August 1; First
Bank learned of the sale on October 1 (more
than 45 days later)
– Assume balance of debt on September 14 (45
days after sale) = $25,000; computers are
subject to First Bank’s SI to that extent
– Any advances to Draco after September 14
would not be secured by the computers sold to
Smith, unless First Bank had previously
committed to make them [§ 9-323(e)]
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What Should Have Happened?
• Smith should have searched UCC records; he
would’ve discovered prior UCC-1 filing in
favor of First Bank
• Smith then could’ve refused to purchase unless
First Bank specified an agreed “release price”
• If Smith complied w/ conditions expressed by
First Bank, Smith would then “take free” [§ 9315(a)(1)]
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