978-1285427003 Chapter 23 Lecture Note Part 2

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You Be The Judge: Conseco Finance Servicing Corp. v Lee1

Facts: Lila Williams purchased a new Roadtrek 200 motor home from New World R.V. Inc. She paid

about $14,000 down and financed $63,000, giving a security interest to New World. The R.V. company

assigned its security interest to Conseco Finance, which perfected. Two years later, Williams returned

the vehicle to New World (the record does not indicate why), and New World sold the R.V. to Robert

and Ann Lee, for $42,800. A year later, Williams defaulted on her payments to Conseco.

The Lees sued Conseco, claiming to be BIOCs and asking for a court declaration that they had sole

title to the Roadtrek. Conseco counterclaimed, seeking title based on its perfected security interest. The

trial court ruled that the Lees were BIOCs, with full rights to the vehicle. Conseco appealed.

You Be the Judge: Were the Lees BIOCs?

Holding: Judgment for Conseco. The court devoted only a few sentences to this issue. Section 9-320

enables a BIOC to take free and clear of a security interest created by the seller. Unfortunately, Lila

Williams, not the seller, created this security interest. Section 9-320 does not help the Lees, and

Conseco’s security interest is valid and enforceable.]

Question: The Lees’ argument is far more persuasive. Common sense tells me they should win and

I thought the UCC tried to create reasonable, sensible results. Why Conseco win?

Question: What does §9-320 provide?

Question: Did the seller—New World R.V. Inc.—create this security interest?

Question: Did New World still hold Williams’ debt when the Lees purchased the R.V.?

Question: What does that mean?

Answer: Typically, it means that Conseco purchased Williams’ loan from New World at a discount

Question: So although New World was an original party to Williams’ security interest, §9-320

does not apply because New World did not create the interest.

Question: Does that leave the Lees without any legal remedy?

Buyers of Consumer Goods

In the case of consumer goods purchased from a debtor-seller, a buyer takes free of a security interest

if he is not aware of the security interest, he pays value for the goods, he is buying for his own family

or household use, and the second party has not yet filed a financing statement.

Buyers of Chattel Paper, Instruments, and Documents

A buyer who purchases chattel paper or an instrument in the ordinary course of her business and then

takes possession generally takes free of any security interest.

1 2004 WL 1243417 Court of Appeals of Texas, 2004.

Liens

A lien is a security interest created by law (rather than by agreement).

Tele-Maker Hypothetical Case — The text offers a hypothetical case concerning Tele-Maker, which

sells 500 televisions to Retailer, keeping a security interest in the sets and proceeds. Customers sign

chattel paper when they purchase on credit. The chattel paper is proceeds, so Tele -Maker’s security

interest extends to the paper. Retailer sells the chattel paper to Financer. Retailer then defaults on its

obligation to Tele-Maker.

Tele-Maker cannot repossess the televisions, because each customer was a BIOC. Tele -Maker is

also barred from seizing the chattel paper, because the buyer of chattel paper (Financer) takes it free of

a perfected security interest.

Question: What could Tele-Maker have done to prevent this disaster?

Answer: Take possession! The surest way to perfect a security interest in something as easily

transferable as chattel paper is to take it home with you. No financer will purchase chattel paper, or

Priorities Among Creditors

Priority Involving a PMSI

Question: First, some basics about priorities among creditors. On January 5, Andrew took a

security interest in Danielle’s entire inventory but did not perfect. On February 5, Peggy took a

security interest in the same inventory and perfected the same day. On March 5, Danielle defaults

on all obligations. Whose claim to the inventory has priority?

Question: Between two perfected security interests, which has priority?

Question: Article 9 creates an exception for PMSIs. What is that exception?

Comment: Why does Article 9 permit a PMSI holder to take priority over the holder of an

earlier-perfected security interest? Part of the reason is historical: under pre-Code law, many states

granted special priority to PMSI holders. The other reason is that this exception, while giving

additional rights to certain creditors (holders of PMSIs), actually benefits the debtor. This rule enables

a debtor, who already owes money to one creditor, to obtain additional merchandise from other

creditors, perhaps boosting business.

Suppose a retailer borrows money from a bank for use in remodeling its store. The bank takes a

security interest in the retailer’s inventory and perfects. When remodeling is complete, the retailer asks

the bank for additional credit to purchase merchandise. The bank refuses. Other creditors are unlikely

to lend additional money based on the same collateral, since they will be aware that the bank has a

prior claim to the inventory. The retailer, however, may be able to buy additional merchandise from a

supplier if the supplier can obtain a satisfactory security interest. Article 9 allows the supplier to take a

PMSI in the goods it sells, and then gives that PMSI priority over the earlier security interest, provided

the supplier follows the rules.

Question: What are the requirements for a PMSI to take priority over an earlier-perfected interest?

Inventory: A PMSI in inventory takes priority over a conflicting perfected security interest if it

meets two conditions:

Before filing its PMSI, the secured party must check for earlier security interests and notify

holders of those interests of the new PMSI, and

The secured party must perfect its PMSI before the debtor receives the inventory.

Non-inventory: A PMSI in collateral other than inventory takes priority over a conflicting security

interest if the PMSI is perfected at the time the debtor receives the collateral or within 20 days

after he receives it.

Case: In Re Roser2

Facts: Robert Roser obtained a loan from Sovereign Bank which he promptly used to buy a car.

Nineteen days later, Sovereign filed a lien with the state of Colorado. The bank expected that,

with a perfected interest, it would have priority over everyone else.

Unknown to Sovereign Bank, Roser had declared bankruptcy only 12 days after he purchased

the car. Later, the bankruptcy Trustee argued that he had priority over Sovereign because the

bankruptcy filing happened before Sovereign perfected its security interest. When the court found

for the Trustee, Sovereign Bank appealed.

Issue: Did Sovereign Bank, a PMSI holder, obtain priority over the bankruptcy Trustee?

Excerpts from Judge Hartz’s Decision:

The Bankruptcy Code gives the bankruptcy Trustee the rights and powers of a person who

acquired a judicial lien on the debtor’s property at the time that the bankruptcy petition was

filed. In general, the Trustee can avoid liens that are unperfected when the petition for

bankruptcy is filed. But in some circumstances a lien that is perfected after the bankruptcy filing

may nevertheless have priority.

The Bank presents a straightforward argument why its lien would have priority under Colorado

law over a lien of a judgment creditor who obtained judgment at the time Roser filed for

bankruptcy. Under the UCC:

If a person [1] files a financing statement [2] with respect to a purchase money

security interest [3] before or within twenty 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.

There is no doubt that the Bank satisfied the requirements of this section. The filing of a lien

constitutes the filing of a financing statement. Nor is there any dispute that the Bank held a

purchase money security interest in Roser’s vehicle. Thus, because the Bank filed its lien within

20 days of Roser’s obtaining the vehicle, it contends that [the] UCC gives its lien a priority over

any rights in the vehicle–including the Trustee’s interest.

The Trustee’s arguments to the contrary are not persuasive. The Trustee cannot avoid the Bank’s

lien. We REVERSE the judgment of the district court and REMAND for further proceedings

consistent with this opinion.

Question: Why is does the bankruptcy Trustee want priority over the bank’s lien?

Answer: The trustee can avoid liens that are unperfected when the bankruptcy petition is filed. In

Question: The Colorado UCC seems straightforward. What then was the issue?

2 613 F.3d 1240; 2010 U.S. App. LEXIS 14817, United States Court of Appeals for the Tenth Circuit, 2010.

Additional Case: Citizens Bank of Americus v. Federal Financial

Services, Inc.3

Facts: On December 5, Charles H. Logging (CHL) borrowed $225,000 from Citizens Bank to buy a

skidder, and signed a promissory note to repay the money along with a UCC-1 listing the skidder as

collateral. The bank filed the form the next day. CHL used the loan to pay other debts.

Two weeks later, Pioneer Machinery delivered the skidder for demonstration purposes only. At the

end of December, CHL decided to buy the machine. On December 30, CHL signed a contract of sale

subject to CHL’s obtaining insurance and also subject to Pioneer’s signature. On February 6, CHL

obtained its insurance, executed a note to Federal Financial, and signed a UCC-1 listing the skidder as

collateral. Federal Financial paid Pioneer and filed its financing statement on February 10.

CHL defaulted and both Citizens Bank and Federal Financial sought the skidder.

The trial court found for Federal Financial and Citizens appealed.

Issue: Does the PMSI holder obtain priority?

Holding: Affirmed for Federal Financial. Federal Financial had a PMSI in the skidder, and filed within

the statutory period (currently 20 days, though in Georgia it was 15 days when this case was decided).

Citizens argues that Federal failed to timely file, because CHL had the skidder in December. However,

the seller still owned it. CHL was only a bailee. CHL became the owner only in February, and Federal

promptly perfected.

Question: What is so special about a PMSI?

Question: How does one obtain a PMSI?

Question: Are the goods in this case inventory or non-inventory?

Question: What is the difference?

Question: To obtain priority for a non-inventory PMSI, what must a company do?

Question: Did Citizens have an earlier perfected PMSI?

Question: Was Federal Financial required to file within 20 days of the skidder’s December

delivery?

Answer: No. Federal Financial had to file within 20 days of the debtor’s taking possession. When

Default and Termination

Generally, a debtor defaults when he fails to make payments due or enters bankruptcy proceedings.

When the debtor defaults, the secured party may take possession of the collateral. When a debtor does

3 509 S.E.2d 339 Georgia Court of Appeals, 1998.

not default, but pays the full debt, the secured party must complete a termination statement, a

document indicating that it no longer claims a security interest in the collateral.

Ethics

If students were assigned the ethical question concerning foreclosing on the farmer, this is a good

opportunity to discuss it. This problem is a classic one from the annals of American farming (and

farming around the world). It arises every day, and not just in connection with farming. It is a common

dilemma for any lender: allow a non-performing (i.e. non-paying debtor) to hold and use loan collateral

in business to attempt to raise enough revenue to make loan payments, and perhaps lend additional

working capital to the debtor, or seize the collateral, sell it, and sue for deficiency. The latter course

may offer the lender the best chance to minimize its losses, but is often the kiss of death for the

borrower. Of course, there is no easy answer. The case demonstrates the human aspect of credit from

both sides of the bargaining table. First, obviously, is the farmer, who cannot possibly improve his

plight without the equipment that he cannot afford. Second, though, is the bank officer, who must

decide how much “slack” to give this particular farmer, considering questions such as:

Is the farm family working hard, doing everything possible to make ends meet?

Has this family simply had bad luck, in terms of weather and crop prices?

Realistically, are things going to improve enough so that it makes sense to extend additional

credit? Will prices rise? Is it financially possible for this farmer to earn enough over the next

few years to catch up on his loan payments?

If the bank repossesses, what will it do with the equipment? Is there a strong market, locally,

for used equipment? If the bank sells the goods at auction, will it recoup its loan? If a sale of

the goods is likely to leave a deficiency, is there any likelihood that the farmer can satisfy it?

Multiple Choice Questions

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

(d) Obtaining a duly executed financing statement

2. CPA QUESTION Under the UCC Secured Transactions Article, perfection of a security interest

by a creditor provides added protection against other parties in the event the debtor does not pay its

debts. Which of the following parties is not affected by perfection of a security interest?

(a) Other prospective creditors of the debtor

(b) The trustee in a bankruptcy case

(d) A subsequent personal injury judgment creditor

3. CPA QUESTION Mars, Inc., manufactures and sells VCRs on credit directly to wholesalers,

retailers, and consumers. Mars can perfect its security interest in the VCRs it sells without having

to file a financing statement or take possession of the VCRs if the sale is made to which of the

following:

(a) Retailers

(b) Wholesalers that sell to distributors for resale

(d) Wholesalers that sell to buyers in ordinary course of business

4. When Michelle buys a laptop, she pays an extra fee so that the computer arrives at her door with

the latest version of Microsoft Word pre-installed. Under Article 9, the word processing program is

considered:

(a) “goods”

(b) “services”

(d) none of the above

5. Alpha perfects its security interest by properly filing a financing statement on January 1, 2010.

Alpha files a continuation statement on September 1, 2014. It files another continuation statement

on September 1, 2018. When will Alpha’s financing statement expire?

(a) January 1, 2015

(b) September 1, 2019

(d) Never

Essay Questions

1. 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?

Answer: 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

2. The Copper King Inn, Inc. had money problems. It borrowed $62,500 from two of its officers,

Noonan and Patterson, but that did not suffice to keep the inn going. So Noonan, on behalf of

Copper King, arranged for the inn to borrow $100,000 from Northwest Capital, an investment

company that worked closely with Noonan in other ventures. Copper King signed an agreement

giving Patterson, Noonan, and Northwest a security interest in the inn’s furniture and equipment.

But the financing statement that the parties filed made no mention of Northwest. Copper King went

bankrupt. Northwest attempted to seize assets, but other creditors objected. Is Northwest entitled

to Copper King’s furniture and equipment?

Answer: No. Northwest’s name was omitted from the financing statement. Minor omissions are

acceptable, but the court held that this was not minor. It is essential that any potential creditors be

3. Sears sold a lawn tractor to Cosmo Fiscante for $1,481. Fiscante paid with his personal credit card.

Sears kept a valid security interest in the lawnmower but did not perfect. Fiscante had the machine

delivered to his business, Trackers Raceway Park, the only place he ever used the machine. When

Fiscante was unable to meet his obligations, various creditors attempted to seize the lawnmower.

Sears argued that because it had a PMSI in the lawnmower, its interest had perfected automatically.

Is Sears correct?

Answer: No. A PMSI in consumer goods perfects automatically. A consumer good is one that is

4. 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?

Answer: It went to Whayne’s world. Taking the money from the taxpayer’s creditor Whayne rather

than the taxpayer Panbowl resulted in a windfall to the state. Whayne has a perfected PMSI in the

5. You Be the Judge: WRITING PROBLEM Dupont Feed bought and sold

agricultural products. Dupont borrowed $300,000 from Wells Fargo Bank and gave Wells Fargo a

security interest in all inventory, including after-acquired inventory. Wells Fargo perfected its

interest by filing on June 17, 1982. Later, Dupont borrowed $150,000 from the Rushville National

Bank and used the money to buy fertilizer. Dupont gave a PMSI to Rushville in the amount of

$150,000. Rushville filed its financing statement in February 1984 at the County Recorder’s office

—the wrong place to file a financing statement for inventory. Then Dupont took possession of the

fertilizer, and finally, in December 1984, Rushville filed correctly, with the Indiana Secretary of

State. Dupont defaulted on both loans. Rushville seized the fertilizer, and Wells Fargo sued,

claiming that it had perfected first. Rushville asserted that it had a PMSI, which took priority over

an earlier-filed security interest. Does Rushville’s PMSI take priority over Wells Fargo? (Go

slowly, the rules are very technical.) Argument for Rushville: It is black letter law that PMSIs

take priority over virtually everything, including interests perfected earlier. We are not fools at

Rushville: we would not loan $150,000 to buy inventory if our security interest in that inventory

was instantly inferior to someone else’s. Argument for Wells Fargo: A PMSI in inventory gets

priority only if the secured party perfects before the debtor receives the collateral. When Dupont

obtained the fertilizer, Rushville had not perfected, because it had filed in the wrong office. It only

perfected long after Dupont bought the inventory; thus, Rushville’s PMSI does not get priority.

Answer: Wells Fargo wins. The court ruled:

The exception to the “first to file or perfect” rule for purchase money security interests in inventory

is relevant in this case. Rushville claims that it had a valid purchase money security interest

In order to acquire priority, a purchase money secured creditor must satisfy each of these three

requirements. Because Rushville filed its financing statement covering [the] inventory with the

Discussion Questions

1. 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?

Answer: 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

As to the ethics, one could argue that the Danneman’s are responsible for signing, but in reality, no

one other than a lawyer would recognize the document for what it was. The document was drafted

2. In the opening scenario, the bank demanded $5000 from poor Sam for his Jeep that had been

repossessed and sold to someone else. As we have seen, Article 9 gives the bank the right to

demand this payment. But is that fair? Should Article 9 change, so that a person like Sam does not

have to pay? Or is the law reasonable now?

3. After reading this chapter, will your behavior as a consumer change? Are there any types of

transactions that you might be more inclined to avoid?

4. After reading this chapter, will your future behavior as a businessperson change? What specific

steps will you be most careful to take to protect your interests?

5. A perfected security interest is far from perfect. We examined several exceptions to normal

perfection rules involving BIOCs, consumer goods, and so on. Are the exceptions reasonable?

Should the UCC change to give the holder of a perfected interest absolute rights against absolutely

everyone else?