Chapter 25
SECURED TRANSACTIONS
Practice Test
Notice Concerning Article 9 Revision: The following cases and problems were decided under the
former Article 9. In each instance, the outcome would be the same under the revised code, although the
relevant sections of Article 9 have been renumbered and probably rewritten.
1. CPA QUESTION Under the UCC Secured Transactions Article, which of the following actions
will best perfect a security interest in a negotiable instrument against any other party?
(a) Filing a security agreement
(b) Taking possession of the instrument
(c) Perfecting by attachment
(d) Obtaining a duly executed financing statement
(b). CPA Examination, May 1994, #50.
3. Eugene Ables ran an excavation company. He borrowed $500,000 from the Highland Park State
Bank. Ables signed a note promising to repay the money and an agreement giving Highland a
security interest in all of his equipment, including after-acquired equipment. Several years later,
Ables agreed with Patricia Myers to purchase a Bantam Backhoe from her for $16,000, which he
would repay at the rate of $100 per month, while he used the machine. Ables later defaulted on his
note to Highland, and the bank attempted to take the backhoe. Myers and Ables contended that the
bank had no right to take the backhoe. Was the backhoe covered by Highland’s security interest? Did
Ables have sufficient rights in the backhoe for the bank’s security interest to attach?
Yes to both questions. The bank had a valid security interest in all of Able's equipment, including
after-acquired equipment. After-acquired clauses are valid. The only question is whether the bank's
security interest could attach to the backhoe. Attachment requires that the debtor has rights in the
collateral. But this does not mean that the debtor must own the goods. Here, Ables had the lawful use
and possession of the backhoe, based on his purchase agreement with Myers. He thus had rights in
the backhoe, and as soon as he took possession of it, the bank's security interest attached. The bank
gets the backhoe. United States v. Allies, 739 F. Sups. 1439, 1990 U.S. Dist. LEWIS 7064 (D. Kan.
1990).
5. John and Clara Lockovich bought a 22-foot Chaparrel Villian II boat from Greene County Yacht
Club for $32,500. They paid $6,000 cash and borrowed the rest of
the purchase money from
Gallatin National Bank, which took a security interest in the boat. Gallatin filed a financing statement
in Greene County, Pennsylvania, where the bank was located. But Pennsylvania law requires
financing statements to be filed in the county of the debtor’s residence, and the Lockoviches lived in
Allegheny County. The Lockoviches soon washed up in Bankruptcy Court. Other creditors demanded
that the boat be sold, claiming that Gallatin’s security interest had been filed in the wrong place. Who
wins? (Please be advised: this is a trick question.)
The creditors were right, but they still lost. Gallatin had filed in the wrong county, but its interest had
perfected automatically. Gallatin had taken a purchase money security interest in a consumer good,
which perfects automatically. The bank had not needed to perfect anywhere. IN RE Lockovich, 124
Bankr. 660, 1991 U.S. Dist. LEXIS 8486 (W.D. Pa. 1991).
7. McMann Golf Ball Co. manufactured, as you might suppose, golf balls. Barwell, Inc., sold McMann
a “preformer,” a machine that makes golf balls, for $55,000. Barwell delivered the machine on
February 20. McMann paid $3,000 down, the remainder to be paid over several years, and signed an
agreement giving Barwell a security interest in the preformer. Barwell did not perfect its interest. On
March 1, McMann borrowed $350,000 from First of America Bank, giving the bank a security
interest in McMann’s present and after-acquired property. First of America perfected by filing on
March 2. McMann, of course, became insolvent, and both Barwell and the bank attempted to
repossess the preformer. Who gets it?
First of America gets the machine. A perfected security interest takes priority over an unperfected
interest. Barwell, Inc. v. First of America Bank-Laporte, N.A., 768 F. Supp. 1312, 1991 U.S. Dist.
LEXIS 10222 (N.D. End. 1991).
9. The state of Kentucky filed a tax lien against Panbowl Energy, claiming unpaid taxes. Six months
later, Panbowl bought a powerful drill from Whayne Supply, making a down payment of $11,500 and
signing a security agreement for the remaining debt of $220,000. Whayne perfected the next day.
Panbowl defaulted. Whayne sold the drill for $58,000, leaving a deficiency of just over $100,000.
The state filed suit, seeking the $58,000 proceeds. The trial court gave summary judgment to the state
and Whayne appealed. Who gets the $58,000?
Reversed. Whayne has a perfected PMSI in the equipment. UCC §9-312(4) gives Whayne superiority
over all other security interests in the equipment, including prior filed security interests. Section 9312(4) is an exception to the general priority rule of UCC §9-312(5), which provides priority to the
first security interest to file or perfect. No rational vendor would sell goods on credit if it were immediately to be relegated to an inferior lien status. There was a drill for the Revenue Cabinet to attempt
to seize only because Whayne sold it on credit. Unless priority is given to PMSI holders, sales based
on credit will virtually cease.
11. ETHICS The Dannemans bought a Kodak copier worth over $40,000. Kodak arranged financing by
GECC and assigned its rights to that company. Although the Dannemans thought they had purchased
the copier on credit, the papers described the deal as a lease. The Dannemans had constant problems
with the machine and stopped making payments. GECC repossessed the machine and, without
notifying the Dannemans, sold it back to Kodak for $12,500, leaving a deficiency of $39,927. GECC
sued the Dannemans for that amount. The Dannemans argued that the deal was not a lease but a sale
on credit. Why does it matter whether the parties had a sale or a lease? Is GECC entitled to its
money? Finally, comment on the ethics. Why did the Dannemans not understand the papers they had
signed? Who is responsible for that? Are you satisfied with the ethical conduct of the Dannemans?
Kodak? GECC?
If the transaction is actually a sale with a security interest, Article 9 governs–and that is precisely
what the court held. The court granted the Danneman’s motion for summary judgment. The
agreement, though called a lease, was actually a financing arrangement with a security interest. The
“lessor” retained no real burdens of ownership. Further, GECC made a sweetheart sale back to the
manufacturer, leaving the Danneman’s with a substantial deficiency. GECC failed to comply with the
requirements of Article 9 and was not entitled to any money.
As to the ethics, one could argue that the Danneman’s are responsible for signing the agreement,
but in reality no one other than a lawyer would recognize the document for what it was. The document was obviously drafted by Kodak, which knew or should have known what kind of a transaction
it was initiating. The sweetheart sale does not look good in the light of day, and many would find the
court’s holding legally right and ethically appropriate. G.E. Capital Corp. v. Dannemann Associates,
Inc., 1995 Del. Super. LEXIS 131 (Super. Ct. Dela. 1995).