New York Creditor Rights BAr Exam Questions

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July 2017
A garment manufacturer sells clothing to retail stores on credit terms pursuant to
which the retail stores have 180 days after delivery of the clothing to pay the
purchase price. Not surprisingly, the manufacturer often has cash-flow problems.
On February 1, the manufacturer entered into a transaction with a finance
company pursuant to which the manufacturer sold to the finance company all of
the manufacturer’s outstanding rights to be paid by retail stores for clothing. The
transaction was memorialized in a signed writing that described in detail the
payment rights that were being sold. The finance company paid the manufacturer
the agreed price for these rights that day but did not file a financing statement.
On March 15, the manufacturer borrowed money from a bank. Pursuant to the
terms of the loan agreement, which was signed by both parties, the manufacturer
granted the bank a security interest in all of the manufacturer’s “present and future
accounts” to secure the manufacturer’s obligation to repay the loan. On the same
day, the bank filed a properly completed financing statement in the appropriate
filing office. The financing statement listed the manufacturer as debtor and the
bank as secured party. The collateral was indicated as “all of [the manufacturer’s]
present and future accounts.”
There are no other filed financing statements that list the manufacturer as debtor.
On May 25, the manufacturer defaulted on its repayment obligation to the bank.
Shortly thereafter, the bank sent signed letters to each of the retail stores to which
the manufacturer sold clothing on credit. The letters instructed each retail store to
pay to the bank any amounts that the store owed to the manufacturer for clothing
purchased on credit. The letter explained that the manufacturer had defaulted on
its obligation to the bank and that the bank was exercising its rights as a secured
party.
The finance company recently learned about the bank’s actions. The finance
company informed the bank that the finance company had purchased some of the
rights to payment being claimed by the bank. The finance company demanded that
the bank cease its efforts to collect on those rights to payment.
Meanwhile, some of the retail stores responded to the bank’s letters by refusing to
pay the bank. These stores contend that they have no obligations to the bank and
that payment to the manufacturer will discharge their payment obligations.
© 2017 National Conference of Bar Examiners These materials are copyrighted by the
NCBE and are reprinted with the permission of NCBE. These materials are for personal
use only and may not be reproduced or distributed in any way.
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1. As between the bank and the finance company, which (if either) has a
superior right to the claims against the retail stores for the money the retail
stores owe the manufacturer for clothing they bought on credit before
February 1? Explain.
2. Are the retail stores correct that they have no obligations to the bank and
that paying the manufacturer will discharge their payment obligations?
Explain.
ANSWER TO MEE 3
1. The Bank has a Superior Claim to the Claims Against the Retail Stores for the
Money the Retail Stores Owe the Manufacturer.
1.a. The first issue is whether the bank and/or the financing company have a
security interest in the accounts receivable.
Article 9 of the UCC governs the law of secured transactions. A security interest is
an interest that one party--the secured party--has in the non-real property, known
as
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collateral, of another--the debtor. The security interest is created to provide
collateral, similar to a down-payment or insurance--of a loan or other item of value
provided by the secured party to the debtor. A security interest is created under
Article 9 when a proper security agreement is executed and when attachment
occurs. A security agreement is properly executed when there is a contract that (1)
identifies the debtor and secured party, (2) identifies the collateral with a
description sufficient to reasonably identify the collateral property, (3) grants the
secured party an interest in that collateral in exchange for something of value, and
(4) is signed by the parties. A description sufficient to meet the requirements of a
security agreement can usually constitute the category classification identified by
Article 9, including "inventory," "equipment," or "accounts receivable." The
collateral can be for both present and future acquired collateral of that category,
but the fact that the collateral covers future acquired property must be expressly
stated in the security agreement. Attachment occurs when (1) the secured party
provides the debtor with something of value, (2) the debtor has rights in the
collateral, and (3) a valid security agreement has been created.
In this case, the financing company executed a contract that provided the finance
company would pay the manufacturer for the rights to all of the manufacturer's
current and future accounts receivable (i.e. the debt owed by the customers of the
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manufacturer for goods sold to them on credit). The agreement identified the
collateral according to its UCC description of "accounts" and expressly stated that
it would cover only the outstanding and present obligations owed. The agreement
further identified the manufacturer as the debtor party and the financing company
as the secured party, and expressly granted the secured party the rights to the
accounts. Therefore, a valid security agreement was created between the
manufacturer and the financing company. In addition, attachment occurred
because the manufacturer had present rights in the collateral accounts receivable,
even if they did not have possession of the money actually owed, and the
financing company paid the agreed price to the manufacturer. Therefore, both
attachment and a signed security agreement were created between the
manufacturer and the financing company in all of the manufacturer’s present and
outstanding accounts receivable.
In addition, the bank also executed a valid security agreement that identified the
manufacturer as the debtor, the bank as the secured party. The agreement provided
the bank with an express grant to the rights in all present and future acquired
accounts receivable, which is sufficient to satisfy both the requirement of a
reasonable description of the collateral and an express grant of after-acquired
collateral. The agreement was signed by both parties, and thus constituted a valid
security agreement. Lastly, attachment occurred because the manufacturer had
present rights in the collateral accounts receivable, and the bank provided the
manufacturer with funds for the loan, which is certainly something of value to the
manufacturer. Therefore, the bank too had a security interest in the accounts
receivable outstanding at the time of the security agreement's execution, as well as
all future acquired accounts receivable.
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1.b. The second issue is whether the bank or the financing company has a priority
interest in the accounts receivable collateral that they both have a security interest
in.
Because it is possible for a debtor to provide the same collateral to multiple
secured parties, secured parties are able to perfect their security interests, which
provides them with a greater priority over unperfected security interests. This is
important when a debtor party defaults on one or both of the security interests he
has secured with the same collateral, as it determines the priority rights the secured
parties have over the same collateral. A secured party with a perfected interest in
collateral has a higher priority over a secured party with an unperfected interest. In
order to perfect an interest, the most common method is filing a financing
statement with the appropriate Secretary of State's office. A financing statement
must be (1) authorized to be filed by the debtor party, (2) identify the secured
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party and debtor party, and (3) identify the collateral (including through the use of
super-generic descriptions). The proper filing of a financing statement acts as
constructive notice to the world that the secured party has a collateral interest in
the property.
In this case, the bank properly filed a financing statement listing the debtor as the
manufacturer and the bank as the secured party, and all the manufacturer's present
and future accounts as the collateral interest. Assuming it was filed in the correct
Secretary of State's office, the bank's interest was thus perfected upon the filing of
the financing statement. The financing company, however, did not file a financing
statement. Therefore, their interest in the outstanding collateral at the time they
signed the security agreement with the manufacturer is unperfected.
Because a perfected interest will have priority over an unperfected interest, the
bank will have a superior right to the claims against the retail stores for the money
owed on the accounts receivable over the financing company.
2. The retail stores are incorrect that they have no obligation to pay the bank and
that paying the manufacturer directly will discharge their payment obligations.
The issue is whether the retail stores have to comply with the bank's demand that
they pay the bank the debts owed, rather than the manufacturer.
When a debtor defaults on a security agreement, the secured party is entitled to
take possession of the collateral property, either as payment for the debt defaulted
on and owed, or to sell in a commercially reasonable manner to satisfy the debt
owed. In the case of accounts receivable, the secured party has the right to make a
demand on the parties owing the debtor and whom the secured party has a
collateral interest in the accounts receivable of. Once such a demand has been
reasonably made to the debted parties owing the debtor under an accounts
receivable that has been sold to the secured party, they must comply with the
lawful demand.
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In this case, the debtor manufacturer defaulted on the loan with bank. The
collateral interest attached to the security agreement the bank had with the
merchant provides that the bank has an interest in all present and future- acquired
accounts receivable of the merchant. When the debtor manufacturer defaulted on
the loan, the bank gave proper notice to the retail stores owing the merchant debts
under an accounts receivable system. At such time, the retail stores must comply
with the lawful demand of the secured party- bank. Indeed, that is the entire value
in purchasing an accounts receivable portfolio.
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Therefore, the retail stores are incorrect in asserting that they can pay the
manufacturer instead of the bank, and must comply with the bank's lawful request
for direct payment to satisfy the defaulted debt owed by the manufacturer.
ANSWER TO MEE 3
1. Bank v. Finance Company. The bank has a superior right to the claims against
the retail stores for the money the retail stores owe the manufacturer for clothing
they bought on credit before February 1. The issue is whether the bank or the
finance company has priority in the retail store accounts.
Secured transactions are governed by Article 9 of the Uniform Commercial Code
("UCC"). Under Article 9 of the UCC, a creditor has rights in collateral against a
debtor if that creditor has attached her security interest to the collateral.
Attachment occurs when: (1) the creditor gives value to the debtor; (2) there is a
contract or agreement between the creditor and the debtor indicating that the
creditor will obtain a security interest in specific collateral; and (3) the debtor has
rights in the collateral (which is typically achieved through possession or
ownership). Furthermore, a creditor may also have rights against third party
claimants in the same collateral if they perfected their security interest. Typically,
for intangible goods such as accounts receivable, perfection is achieved by filing a
financing statement in the appropriate public office. In a priority dispute, perfected
attached creditors have priority and superior rights over unperfected attached
creditors in the same goods.
Here, the finance company is an unperfected attached creditor in the outstanding
retail store clothing accounts that existed on February 1. The finance company
attached its security interest to these accounts when it (1) paid the manufacturer
the agreed price for the rights; (2) created a contract between the manufacturer and
the finance company that was signed by both parties memorializing the security
interest the finance company would take in the accounts as collateral; and (3) the
manufacturer has rights in the accounts as the owner of those accounts receivable
from the retail clothing stores. Therefore, the finance company attached its
security interest to these accounts. However, the finance company failed to perfect
its security interest because it did not file a
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financing statement putting others on notice of its security interest. It also does not
have possession or control over these accounts.
On the other hand, the bank is a perfected attached creditor in all of the
manufacturer's accounts, both existing before and after March 15. The bank
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attached its security interest to these accounts. The bank gave the manufacturer
money in exchange for this security interest. The bank and the manufacturer
entered into a signed agreement that described the security interest that the bank
was taking in the present and future accounts of the manufacturer as collateral,
creating a contract describing the security interest. Furthermore, as stated earlier,
the manufacturer has rights as the possessor and owner of these accounts with the
retail clothing store. Therefore, the bank attached its security interest to these
accounts. The bank also perfected its security interest by filing a financing
statement. The financing statement must include the name and address of the
debtor, the name and address of the creditor, and a description of the collateral that
a security interest was taken in. This description in the financing statement can be
super generic as long as it allows others to be put on notice of a security interest
and make a reasonable follow-up. Here, all these requirements were met because
the manufacturer is listed, the bank is listed, and the collateral is described as all of
the manufacturer's present and future accounts. Therefore, the bank is a perfected
attached creditor.
Furthermore, it should be noted that the bank obtained an after-acquired collateral
clause in its security agreement, which is permissible and enforceable as a security
interest in all good except for consumer goods. Here, accounts receivable are not
consumer goods, and therefore it is enforceable. This overlaps with the security
interest of the finance company because the bank's interest includes all of the
existing retail clothing store accounts that were present on February 1.
Because a perfected attached creditor has priority over an unperfected attached
creditor in the same collateral, the bank has a superior claim. Therefore, the bank
has a superior right to the claims against the retail stores for the money the retail
stores owe to the manufacturer for clothing they bought on credit before February
1.
2. Retail Stores v. Bank. The retail stores are incorrect that they have no obligation
to the bank and their payment obligations are not discharged by paying the
manufacturer. The issue is whether the bank has validly exercised its powers of the
accounts receivable.
When a default occurs, the secured party may take steps necessary to collect on its
rights in the collateral in which it took a security interest. A default is defined by
the security agreement. In this case, failure of the manufacturer to repay its
obligation to the bank constitutes a default. Strict foreclosure is one method of a
creditor may use to enforce its rights. In a strict foreclosure, the secured party
takes possession or control of the collateral and keeps it as her own and discharges
the debt of the debtor. Here, the bank
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has exercised its right to direct payment on the accounts receivable to go to the
bank rather than to the manufacturer. This is done to satisfy the debt.
This can be likened to an assignment of rights under contract law. In this case, the
bank has been assigned rights in the accounts receivable as a result of the security
interest and security agreement between the parties. The assignor is the
manufacturer and the assignee is the bank. The obligor is the retailor, who still has
the obligation to pay. The retailers have notice of this obligation because the bank
has informed them, and they are aware of the assignment taken as a result of the
default and security interest in the goods.
The retailers cannot refuse to pay. The retailors do not have any interest in the
account receivable that is free and clear of the security interest, and their
obligation is outstanding. They can only assert those defenses against the bank that
it would have against the manufacturer. Therefore, the debt is not discharged by
paying the manufacturer because it has notice that an assignment of the account
has been made to the bank. It must pay the bank to satisfy its obligations.
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July 2018
MEE QUESTION 3
In 2015, a man purchased a convenience store that sells gasoline and snack-type
grocery items. The man’s store is located within two miles of three other
convenience stores that are larger and contain small dining areas. When he bought
the store, the man planned to expand it as soon as he could in order to offer the
same services and products as the other three stores in the area.
In 2017, the local zoning board passed an ordinance that rezoned the district in
which all four stores are located from “light commercial” to “residential.”
Convenience stores are not “residential” uses. The zoning ordinance contained
typical language protecting existing nonconforming uses.
In early 2018, the man decided to expand his store by 1,100 square feet to add a
small dining area. To finance this expansion, he obtained a $200,000 loan
commitment from a local bank, with the funds to be disbursed at such times and in
such amounts as the bank determined to be appropriate if, in the bank’s good-faith
judgment, there was “satisfactory progress” being made on the project. Documents
reflecting this commitment were signed by the man and the bank, and a mortgage
to secure the repayment of the loan was promptly and properly filed in the local
land records office.
Two weeks after obtaining the loan commitment, the man signed a contract with a
general contractor for construction of the store expansion. In compliance with its
loan commitment, the bank disbursed $50,000 to the man, who, in turn, paid that
sum to the general contractor. Construction began immediately thereafter.
© 2018 National Conference of Bar Examiners These materials are copyrighted by the
NCBE and are reprinted with the permission of NCBE. These materials are for personal
use only and may not be reproduced or distributed in any way.
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Four weeks into the project, a plumbing subcontractor installed all the plumbing
fixtures. After the general contractor failed to pay the $20,000 agreed price to the
subcontractor, the subcontractor immediately filed a mechanic’s lien against the
man’s property in the local land records office to secure its claim for $20,000.
Eight weeks into the project, the bank disbursed an additional $40,000 to the man,
who, in turn, paid $40,000 to the general contractor. The general contractor used
these funds to pay various creditors, but not the plumbing subcontractor.
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Two weeks ago, a bank loan officer learned for the first time about the mechanic’s
lien. The next day, when the man approached the bank about making another
disbursement, the loan officer refused. The man asserts that, under the loan
agreement, the bank is obligated to disburse further funds.
1. Is the expansion project a nonconforming use? Explain.
2. Assuming that the expansion project does not violate the zoning
classification, is the bank obligated to disburse further funds? Explain.
3. Does the mechanic’s lien have priority, in whole or in part, over the bank’s
mortgage? Explain.
ANSWER TO MEE 3
1. Expansion project is not a nonconforming use because non-conforming use is
only limited to the extent of original use and does not permit substantial expansion
after the enactment of zoning code
The issue is whether the expansion project after the enactment of zoning ordinance
ceases to be a nonconforming use protected under the zoning ordinance and thus
violates the zoning ordinance. Government has broad power to enact zoning
statute to promote an area's morale, heath, safety and general welfare. Valid use
that existed prior to the zoning code that does not comply with the zoning code is
sometimes protected under the category of "nonconforming use" and does not
constitute a violation of zoning code. However, the non-conforming use is limited
to the extent of its prior usage and cannot be substantially expanded. A substantial
expansion of the use would cause the use to lose the protection status of
"nonconforming use" and violates zoning code.
Here, the local zoning board passed an ordinance that rezoned the district from
light commercial to residential. The zoning ordinance contains typical language
protecting existing nonconforming uses. Convenience stores are not residential
use. Because the man's convenience store existed prior to the passage of zoning
code, it was protected and man can continue operate the store under the zoning
statute. However, the man can
not substantially expand it to add a dining area. Here, the man planned to expand
his store by 1110 square feet. The expansion was substantial enough to lose the
protection of "nonconforming use" and thus violate the zoning statute.
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2. Bank is not obligated to further funds because this decision is made in goodfaith judgment.
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The issue is whether bank is obligated to disburse further funds under the contract.
A party owes the other party to the contract a duty of good faith and fair dealing.
Here, the loan contract specifically states that funds would be disbursed at such
times and in such amounts as the bank determined to be appropriate, if, in the
bank's good-faith judgment, there was satisfactory progress being made on the
project. Thus, bank has discretion as
to determine whether or not to disburse the funds under the contract.
Because general contractor failed to pay the plumbing subcontractor, the plumbing
subcontractor has filed a mechanic lien against the man's property in the local
lands office. Bank's interest in the loan is also secured by the man's property.
"Satisfactory progress being made on the project" is undefined and ambiguous.
Bank may feel unsafe about its interest in man's property due to the mechanic lien
and thus deem the progress made on the project is unsatisfactory. Bank may also
no longer trust or have confidence in man's ability to finish the project due to the
existence of mechanic lien. Thus, bank's decision to reject making another
disbursement is made in good-faith and supported by valid reasons. Bank has no
obligation to disburse further funds
3. Mechanic's lien has priority as to the $40,000 loan provided by the bank, but is
subordinate to the $50,000 loan by the bank.
The issue is whether the mechanic's lien has priority over bank's mortgage. Man's
obligation to repay the loan is secured by a mortgage. Thus, bank has a security
interest in man's property. There are 3 requirements for a valid security interest to
exist: 1) the
debtor has rights 2) secured party has given value and 3) secured party has
authenticated a security agreement indicating the collateral. All 3 requirements are
satisfied here. The man has rights in his property, the bank extended value by
making a $200,000 loan commitment to the man and they signed a mortgage
agreement. This interest is also perfected because the loan was promptly and
properly filed in the local records office.
Mechanic also has a lien interest in the man's property. Between a lien creditor and
a perfected security interest, security interest will prevail as long as the interest is
perfected before the person becomes the lien creditor.
For the $50,000 loan made to the man two weeks after obtaining the loan
commitment, bank will have priority because the interest arises before the
mechanic filed a lien against man's property. Mechanic had notice of bank's
mortgage as mortgage is properly filed in the local records office.
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However, mechanic will have priority over the $40,000 loan made by the bank
eight weeks into the project. If the future advance is obligated/mandatory, then
disbursement of future advance will relate back to the date the security interest is
perfected and has priority to other liens that arise after the security interest is
perfected. However, if the future advance is only
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optional, then future advance will not have priority over liens that arise before the
future advance is made.
Here, bank's loan contract states that bank has discretion to disburse funds as long
as the decision is made in good-faith. Thus, it's not mandatory for bank to disburse
fund to the man. The $40,000 disbursement will not relate back to the date when
interest is perfected. Instead, because it arises after the mechanic lien arises; it will
lose to mechanic lien.
Some jurisdictions adopt rule that mechanic lien will have priority over all other
security interest in the collateral. Mechanic lien is usually a lien that arises because
mechanic has performed some work but is unpaid for it. As a result, mechanic
filed a lien to secure the payment obligation. In these jurisdictions, mechanic lien
will have priority over other security interests. If the state in the current case
adopts this rule, then mechanic's lien will
have priority over the bank's mortgage, for $20,000 amount.
ANSWER TO MEE 3
1. Nonconforming Use
The expansion constitutes nonconforming use. At issue is whether the grandfather
clause to the zoning ordinance implies the right to expand nonconforming use.
Zoning ordinances are generally constitutional and do not require compensation as
long as they do not constitute takings. To avoid a taking, most zoning ordinances
include provisions to grandfather-in existing uses that do not conform with the
terms of the new ordinance. But such provisions do not generally permit the
expansion of the nonconforming use.
Here, the zoning ordinance plainly entitles the man to keep his store in its present
condition, even though it violates the new zoning ordinance. But the grandfather
provision will not permit his expansion of the store because it only applies to
continued use. An expansion by more than a thousand square feet would constitute
much more than continued use. Because the expansion would constitute more than
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mere continued use, does not fall within the exception to the zoning ordinance.
Hence, because the expansion will not fall within the exception to the zoning
ordinance, the expansion project constitutes a non-conforming use.
2. Obligation to Disburse Funds
The bank is not obliged to disburse further funds. At issue is whether the existence
of a lien permits the bank to excuse its granting of further advances. An optional
future advance is one that a creditor may but is not required to make. Typically,
the grant of the
advance is tied to conditions, which are within the discretion of the creditor. Here,
the loan agreement provides that the bank must disburse funds only when, and in
such amounts as, it is
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determines is appropriate based on its good faith judgment of whether there has
been satisfactory progress. In light of the subcontractor's lien, the bank has
declined to grant the advance. The bank is within its power to do so because it
could conclude that the existence of the subcontractor lien and the accompanying
disagreement among the parties has frustrated the advancement of the project.
Hence, the bank is not obliged to disburse further funds.
3. Priority
The mechanic has part priority. At issue is when did the loans occur. The general
rule is
that creditor's take priority in the order in which they make loans. But where a
creditor does not immediately record her loan, this analysis may be changed based
on the particular recording act at issue. There is an exception to the general rule
for optional future advances. An optional advance is one that a creditor need not
make. Typically,
each optional advance is treated as a separate loan. The rationale for this rule is to
prevent a creditor from obtaining priority over all future creditors without taking
on any risk. A creditor will prevail under both a notice and race notice statute if it
both loans and records first.
Here, the bank made a $200,000 loan commitment to the man but reserved the
right to determine if and when it should issue payments based on its good faith
belief that there was progress in the project. The subcontractor then attached a
lien. Under a traditional loan arrangement, the bank would have had complete
priority--no matter the recording system-- because it loaned and recorded first.
Under this arraignment, each disbursement constituted an optional advance. As
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such, each disbursement took priority in the order in which it was made. The bank
initially made a disbursement of $50,000. The subcontractor then secured a
$20,000 lien and properly recorded it. Finally, the bank disbursed an additional
$40,000. When it made this disbursement, the bank had record notice of the
attachment of the lien. Hence, if each disbursement is treated as a separate loan,
the bank only has priority over the first $50,000 disbursement. The lien creditor
has priority over the remainder of the mortgage.
July 2016
MEE 4
Two years ago, PT Treatment Inc. (PTT), incorporated in State A, decided to build
a new $90 million proton-therapy cancer treatment center in State A. The total cost
to PTT for purchasing the land and constructing the building to house the
treatment facility was $30 million. PTT financed the purchase and construction
with $10 million of its own money and $20 million that it borrowed from Bank.
To secure its obligation to Bank, PTT granted Bank a mortgage on the land and all
structures erected on the land. The mortgage was properly recorded in the county
real estate records office, but it was not identified as a construction mortgage.
Two months after the mortgage was recorded, PTT finalized an agreement for the
purchase of proton-therapy equipment from Ion Medical Systems (Ion) for $60
million. PTT made a down payment of $14 million and signed a purchase
agreement promising to pay the remaining $46 million in semi-annual payments
over a 10-year period. The purchase agreement provided that Ion has a security
interest in the proton-therapy equipment to secure PTT’s obligation to pay the
remaining purchase price. On the same day, Ion filed a properly completed
financing statement with the office of the Secretary of State of State A (the central
statewide filing office designated by statute), listing “PT Treatment Inc.” as debtor
and indicating the proton-therapy equipment as collateral.
Shortly thereafter, Ion delivered the equipment to PTT and PTT’s employees
installed it. The equipment was attached to the building in such a manner that,
under State A law, it is considered a fixture and an interest in the equipment exists
in favor of anyone with an interest in the building.
The new PTT Cancer Treatment Center opened for business last year.
Unfortunately, it has not been an economic success. For a short period, PTT
contracted with State A Oncology Associates (Oncology) for the latter’s use of the
proton-therapy equipment pursuant to a lease agreement, but Oncology failed to
pay the agreed fee for the use of the equipment, so PTT terminated that
arrangement. To date, PTT has been unsuccessful in its efforts to collect the
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amounts that Oncology still owes it. PTT’s own doctors and technicians have not
attracted enough business to fully utilize the cancer treatment center or generate
sufficient billings to meet PTT’s financial obligations. PTT currently owes Ion
more than $30 million and is in default under the security agreement. Ion is
concerned that PTT will soon declare bankruptcy.
© 2016 National Conference of Bar Examiners These materials are copyrighted by the
NCBE and are reprinted with the permission of NCBE. These materials are for personal
use only and may not be reproduced or distributed in any way.
6
In a few days, Ion will be sending a technician to the PTT facility to perform
regular maintenance on the equipment. Ion is considering instructing the
technician to complete the maintenance and then disable the equipment so that it
cannot be used by PTT until PTT pays what it owes.
1. In view of PTT’s default, if Ion disables the proton-therapy equipment, will
it incur any liability to PTT? Explain.
2. If PTT does not pay its debts to either Bank or Ion, which of them has a
superior claim to the proton-therapy equipment? Explain.
3. Does Ion have an enforceable and perfected security interest in any of
PTT’s assets other than the proton-therapy equipment? Explain.
ANSWER TO MEE 4
1) The issue is whether disabling PTT's proton-therapy equipment would be a
viable remedy for Ion to pursue.
When a debtor defaults on a security agreement, a secured creditor may pursue a
variety of remedies. The creditor may initiate a replevin action to acquire the
property, or it may use self-help to repossess the property provided that this does
not lead to a breach of the peace. In many jurisdictions, the debtor's mere presence
and objection to a self- help repossession is enough to compel the creditor to use
legal process. In line with the general disfavoring of self-help methods, a creditor
may not extra-legally destroy or deactivate its collateral, particularly when such
actions are likely to lead to large consequential damages for the debtor, and may
forfeit important rights in any subsequent sale of the property.
In this case, Ion would propose to surreptitiously disable (what could be lifesaving) cancer equipment under the guise of performing a routine maintenance.
This action is not reasonably calculated to allowing Ion to recoup its security
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interest; on the contrary, it is likely to cause severe and unforeseen consequential
damages to PTT and may even be tortious. As such, Ion would quite possibly be
held liable to PTT for such actions, and should use legal process to recover its
security interest in the collateral.
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2) The issue is whether Bank or Ion has a superior claim to the proton- therapy
equipment.
a) Ion's Interest in the Proton-Therapy machines
In order for a security interest to attach, a debtor must (1) have paid value; (2)
have rights in the collateral; and (3) there must be a security agreement describing
the collateral or the creditor must have possession or control over the collateral. A
valid security agreement must be a record authenticated by the debtor that
"reasonably describes" the collateral. A transaction in which a seller transfers
property to a buyer and retains a security interest in that property as collateral is
called a seller "purchase money security interest" (seller PMSI). Tangible property
in machinery or other products used for the ordinary functioning of a business is
called "equipment". A PMSI in equipment can be perfected by filing a financing
statement which gives describes the collateral and gives the name of the debtor in
the appropriate state office. PMSIs in equipment will take priority over all other
security interests if a financing statement is filed within 20 days of the debtor
taking possession of the property.
In this case, Ion sold proton therapy equipment to PTT and retained a security
interest in the equipment as collateral, thus creating a seller PMSI in equipment.
Its interest attached upon the execution of the security agreement, and perfected
when it filed financing statement with the state office, giving the proper name of
the debtor and adequately describing the collateral.
b) Ion's Interest in the Equipment After it Became a Fixture v. the Bank's Interest
in the Facility
After property becomes a fixture, an interest in the property exists in favor of
anyone with an interest in the real property. A holder of a PMSI in the fixture may
retain priority over a mortgage holder by a filing a fixture financing statement in
the proper real estate records office within 20 days of the property being
incorporated as a fixture. If it fails to do so, it retains its security interest, but it is
subordinated to the interest of the property's mortgage holder.
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In this case, though Ion had a PMSI in the equipment, it knew that the equipment
was going to be installed as a fixture in the facility and yet failed to file a fixture
financing statement in the real estate records office. Therefore, the Bank has
priority over Ion in the equipment, which is now a part of the greater facility. Of
course, the Bank's interest in the equipment only goes to the extent of the facility's
outstanding obligation, and any surplus would still go to Ion.
13
3) The issue is whether Ion has an enforced and perfected security interest in any
other PTT assets.
A secured creditor's interest automatically attaches in the proceeds of the
collateral. While an interest in cash proceeds also perfects automatically,
perfection can be maintained in non-cash proceeds via the "same office rule" - if a
financing statement for the proceeds can be filed in the same office where the
financing statement for the initial collateral was filed, then perfection is
maintained throughout. Proceeds can be the product of a sale or a lease of the
collateral, and can be either tangible or intangible, the latter including accounts
and rights to payment.
In this case, PTT contracted with Oncology for its use of the equipment for a
period of time, and on the latter's default acquired an interest in a right to payment
from Oncology. This right to payment could be characterized as a "proceed" of the
equipment in which Ion had a PMSI. Therefore, provided that an interest in PTT's
right to receive payment from Oncology could be perfected by filing in the same
office as the equipment, Ion would have an enforceable and perfected security
interest in any recovery that PTT may receive from Oncology on the lease.
ANSWER TO MEE 4
1. Ion can disable the proton-therapy equipment.
When a debtor defaults on his payments under an attached security agreement, the
secured creditor can repossess the collateral using self-help methods as long as he
does not breach the peace. For equipment that is too bulky to be removed for
repossession, the secured creditor may render the collateral unusable. A security
agreement attaches when (1) the secured party gives value; (2) a security
agreement is authenticated by the debtor; and (3) the debtor has rights in the
collateral. Here, Ion (the secured creditor) provided PTT (the debtor) with the
proton-therapy equipment, PTT signed a purchase agreement that provided for a
security interest, and shortly thereafter Ion delivered the equipment. Therefore, the
security interest attached when the equipment was delivered. It is undisputed that
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PTT is in default. Therefore, as long as Ion does not breach the peace, it can
render the equipment unusable in order to protect its security interest.
2. Bank has a superior claim to the proton-therapy equipment.
The issue is whether Bank's purchase money mortgage has a superior claim to
Ion's PMSI in equipment that is a fixture. Generally, security interests in fixtures
are considered junior to a security interest in real property unless the security
interest in the fixture was a purchase-money security interest (PMSI) and that
interest was perfected
within 20 days of installation. In order to perfect a security interest in a fixture, the
interest must be recorded in the county real estate records office. Generally,
PMSIs in equipment have priority over other security interests so long as the
security interest was perfected before delivery AND the PMSI secured creditor
sent notice to the other secured creditors. Here, state law states the equipment is a
fixture and in favor of anyone with an interest in the building.
Perfection is required to put other secured creditors on notice that there is a
security interest. Without perfection, a secured creditor cannot assert .Bank's
mortgage interest is properly recorded and therefore perfected. Ion did not file a
statement for the fixture in the county real estate records office, so therefore it is
not perfected against Bank's mortgage interest. Ion also did not send notice to
Bank of its security interest. Therefore, Bank's interest in the equipment is
superior.
3. Ion has an enforceable and perfected security interest in Oncology's lease
payments.
The issue is whether the amount due on the Oncology lease can be considered
proceeds of Ion's equipment. Generally, a security interest automatically attaches
to proceeds. This interest must be perfected. Under the same-office rule, if a
security interest in the type of proceed can be perfected by filing a statement in the
same office as the original collateral, that proceed is automatically perfected. The
right to receive payments for a lease is considered an account. An account can be
perfected by filing a statement in the statewide filing system. Since Ion has filed a
statement for the equipment in the statewide filing system, its interest in the
payments due on the Oncology lease is perfected.
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