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Part Eight:
Debtor and Creditor Relations
CONTENTS
Chapter 37 Secured Transactions and Suretyship
Chapter 38 Bankruptcy
ETHICS QUESTIONS RAISED IN THIS PART
1. Is it ethical for a business to refuse to deal with a customer if the customer has gone through bankruptcy?
2. Is it ethical for a business or individual to discharge its debts in bankruptcy? Who bears the cost of the loss
that the creditors sustain when a debtor is discharged in bankruptcy?
3. Some commentators have called the bankruptcy laws "legal thievery." Why could they use this term to
describe the bankruptcy laws?
4. Do the bankruptcy laws encourage risk taking by businesses and lending agencies?
5. In the past employers would often terminate an employee if a creditor garnished the employee's wages.
Today, State statutes usually prohibit such firings. Is it ethical for an employer to fire an employee whose
wages are garnished? Why?
ACTIVITIES AND RESEARCH PROBLEMS
1. Have students bring copies of financing agreements which they have signed to class to examine the terms
and compare them to those in agreements signed by other students. In the alternative, have students obtain a
blank copy of a financing agreement from a bank or other lending agency.
2. Have students research the exemptions found in the state statutes of the state where they live. Compare the
state exemptions to those found in the Federal Bankruptcy Code. Then work through problems using first
the exemptions found in the Bankruptcy Code and then those found in the state statute. For what type of
debtor are the federal exemptions more favorable? For what type of debtor are the state exemptions more
favorable? Have students explain their answers.
3. Have students research cases involving fraudulent transactions and voidable preferences in your area to look
for interesting fact situations that have been set aside by the trustee in bankruptcy.
4. If bankruptcy cases are heard in your area, visit the bankruptcy court to see and hear the kinds of cases that
Chapter 37
SECURED TRANSACTIONS AND SURETYSHIP
I. Secured Transactions In Personal Property
A. Essentials of Secured Transactions
B. Classification of Collateral
1. Goods
a. Consumer Goods
b. Farm Products
c. Inventory
d. Equipment
e. Fixtures
f. Accession
4. Other Kinds of Collateral
C. Attachment
1. Value
2. Debtor's Rights in Collateral
3. Security Agreement
a. Authenticating Record
b. Authenticating Record Not Required
c. Consumer Goods
d. After-Acquired Property
e. Future Advances
D. Perfection
1. Filing a Financing Statement
a. What to File
b. Duration of Filing
c. Place of Filing
d. Subsequent Change of Debtor’s
Location
2. Possession
3. Automatic Perfection
4. Temporary Perfection
5. Perfection by Control
E. Priorities Among Competing Interests
1. Against Unsecured Creditors
2. Against Other Secured Creditors
a. Perfected versus Unperfected
b. Perfected versus Perfected
c. Unperfected versus Unperfected
b. Avoidance of Preferential Transfers
F. Default
1. Repossession
2. Sale of Collateral
3. Acceptance of Collateral
II. Suretyship
A. Nature and Formation
1. Types of Sureties
2. Formation
B. Rights of Surety
1. Exoneration
2. Reimbursement
3. Subrogation
4. Contribution
C. Defenses of Surety and Principal Debtor
1. Personal Defenses of Principal Debtor
2. Personal Defenses of Surety
3. Defenses of Both Surety and Principal Debtor
Cases in This Chapter
Border State Bank of Greenbush v. Bagley
Livestock Exchange, Inc.
Kimbrell’s Of Sanford, Inc. v. KPS, Inc.
Chapa v. Traciers & Associates
American Manufacturing Mutual Insurance
Company v. Tison Hog Market, Inc.
Chapter Outcomes
After reading and studying this chapter, the student should be able to:
Name and define the various types of collateral.
Explain the purposes, methods, and requirements of attachment and
perfection.
Discuss the priorities among the various parties who may have
competing interests in collateral and the rights and remedies of the
TEACHING NOTES
Since debt is an enormous part of American life and commerce, public policy
demands certain things: 1) the means by which debt is created and
transferred must be as simple and inexpensive as possible, 2) risks to
lenders should be minimized and 3) lenders should have some way to collect
unpaid debts.
I. SECURED TRANSACTIONS IN PERSONAL PROPERTY
Security is given to convince a creditor to extend credit, or sometimes to
negotiate favorable terms.
Transactions involving security in personal property are governed by Article 9
of the UCC which provides a simple and unified structure for secured
financing transactions while it allows new forms of secured financing to be
created as needed. Article 9 does not apply to security interests without
consent that arise by operation of law, such as mechanics’ or landlords’
A. ESSENTIALS OF SECURED TRANSACTIONS
Every consensual secured transaction involves a debtor, a secured party,
collateral, a security agreement, and a security interest.
Debtor — person who owes payment or performance of an obligation
Secured party — the creditor — the lender, seller, or other person who
possesses the security interest in the collateral
Collateral — personal property subject to the security interest
Security agreement — agreement that gives the creditor the right to
specific property owned by the debtor if he fails to repay the debt
Security interest— right in personal property that secures payment or
performance of an obligation
NOTE: See Figure 37-1 for an illustration of the rights of the debtor and the secured party.
*** Chapter Outcome***
Name and define the various kinds of collateral.
B. CLASSIFICATION OF COLLATERAL
Most of the provisions of Article 9 apply to all kinds of personal property, but
some apply only to particular kinds of collateral.
Goods
Tangible personal property. Subdivided into 1) consumer goods, 2)
equipment, 3) farm products, 4) inventory, and 5) fixtures.
Consumer Goods — Those goods purchased primarily for personal, family,
or household uses.
Farm Products — Crops or livestock or supplies used or produced in
Indispensable Paper
Three kinds of collateral involve rights evidenced by indispensable paper: 1)
chattel paper, 2) instruments, and 3) documents.
Chattel Paper — A writing that indicates both a monetary debt and a
security interest in specific goods. A lease of goods is also covered by this
definition as well as typical retail installment contracts.
Instruments — Writings that demonstrate a right to payment of money, are
transferable by proper delivery, and are not a security agreement or lease.
This category also includes stocks and bonds.
Documents — Writings that evidence title, such as bills of lading and
warehouse receipts; may be either negotiable or nonnegotiable.
Investment Property — Investment security (stocks and bonds), security
accounts, commodity contracts, and commodity accounts.
Intangibles
Neither goods nor indispensable paper, i.e., accounts and general
intangibles.
Other Kinds of Collateral
Proceeds — whatever is received upon sale, lease, license, exchange, or
other disposition of collateral; the secured party, unless the security
agreement states otherwise, has rights to the proceeds.
Also includes: timber to be cut, minerals, motor vehicles, mobile goods
(goods used in more than one jurisdiction), and money. Revised Article 9 also
adds the following kinds of collateral: commercial tort claim, letter-of-credit
rights and deposit accounts (a demand, savings, time, or similar account at a
bank).
*** Chapter Outcome***
Explain the purposes, methods, and requirements of attachment and perfection.
C. ATTACHMENT
Describes a security interest which is enforceable against the debtor (or
other parties) because the interest has “attached to” the collateral. A
security interest attaches to the collateral when: (1) the secured party has
given value; (2) the debtor has acquired rights in the collateral; and (3) a
security agreement has been formed.
Value
The term value is broadly defined and includes consideration under contract
law, a binding commitment to extend credit, and an antecedent debt.
Debtor’s Rights in Collateral
Security Agreement
A security agreement provides the creditor a security interest and must (with
certain exceptions discussed below), (1)be authenticated by the debtor and
(2) contain a reasonable description of the collateral.
Authenticating Record — Authentication can occur in one of two ways.
First, the debtor can sign a written security agreement. (Signing includes any
symbol executed with the intention to authenticate.) Second, in recognition
of e-commerce and electronic security agreements, Revised Article 9
provides that a debtor can authenticate a security agreement by executing
or otherwise adopting a symbol, or by encrypting or similarly processing a
record in whole or in part, with the present intent of the authenticating party
to adopt or accept the record.
Authenticating Record Not Required — The security agreement does
require an authenticating record when some types of collateral are pledged
CASE 37-1
BORDER STATE BANK OF GREENBUSH v. BAGLEY
LIVESTOCK EXCHANGE, INC.
Court of Appeals of Minnesota, 2004
690 N.W.2d 326
http://scholar.google.com/scholar_case?
case=11200679180282154995&q=690+N.W.2D+326&hl=en&as_sdt=2,34
Lansing, J.
Bert Johnson, doing business as Johnson Farms, and Hal Anderson entered into an oral
cattle-sharing contract in December 1997. Approximately one month later, they
memorialized the oral contract in written form. Under the written instrument, Anderson
agreed to care for and breed cattle owned by Johnson and Johnson would receive a
“guaranteed” percentage of the annual calf crop. The contract further provided that the cattle
Johnson placed with Anderson were “considered to be owned by Johnson Farms and any
offspring is to be sold under Johnson Farms’ name.” The contract required Johnson Farms
Peterson, was caring for an ill family member, he had no additional help at his farm, he had
insufficient feed for the cattle, and he had not planted hay for the coming winter.
Nevertheless, according to Anderson, they continued to discuss their cattle-sharing contract,
and he eventually agreed to continue based on certain modifications: (1) the share
percentage would be a straight 40/60 split, without Johnson’s “guaranteed” percentage; (2)
Johnson would provide feed, including beet tailings; (3) Johnson would provide additional
pasture; and (4) the agreement would include approximately 500 cattle, instead of the
original 151 cattle.
Johnson testified that he discussed the cattle-sharing agreement with Anderson in
October 1999 and that he agreed to send Anderson beet tailings, which were free to him, so
long as Anderson paid the cost of shipping. Johnson also testified that he and Anderson
agreed that approximately 500 cattle would be cared for under the cattle-sharing agreement,
rather than the original 151 cattle. But Johnson denied that he had agreed to provide feed,
other than the beet tailings, and denied that he had agreed to change the provision that
“guaranteed” that his percentage of the calf crop would be calculated on the initial number
of cows regardless of whether each produced a calf that survived.
In December 2000, 289 calves that had remained with Anderson were sold at Bagley
Livestock Exchange. The livestock exchange knew of Border State’s security interest in
Anderson’s livestock but, after discussing the agreement with Johnson, determined the
security interest did not attach to the calves. The livestock exchange issued a check to
Johnson Farms in the amount of $119,403. Thereafter, Johnson gave Anderson a check for
$19,404, representing Anderson’s share of the sale proceeds, less $55,000 that Johnson
claimed as repayment for money advanced to Anderson to purchase feed.
These claims were tried to a jury in September 2003. Following Border State Bank’s
case-in-chief, Johnson and Bagley Livestock Exchange moved for a directed verdict. The
district court granted the motion, finding that, under the cattle-sharing agreement, Johnson
did not “grant” Anderson an “ownership interest” in the calves. Border State Bank appeals
from the directed verdict on its conversion claim.
Following the directed verdict, Anderson presented evidence on his breach-of-contract
counterclaim against Johnson, and the counterclaim was submitted to the jury. In response to
special-verdict questions, the jury determined that the written contract between Anderson
and Johnson had been modified, Johnson breached the contract, and Johnson’s breach
directly caused damages to Anderson in the amount of $92,360. *** Johnson appeals ***.
* * *
The parties do not dispute that Anderson signed a security agreement and that value was
given. The security agreement stated that the collateral included, in part, “all livestock
owned or hereafter acquired” and Anderson’s “rights, title and interest” in such livestock.
The financing statements covered “all livestock,” whether “now owned or hereafter
acquired, together with the proceeds from the sale thereof.” The parties also do not dispute
the validity of these descriptions or the assertion that “livestock” includes cattle and calves.
What is disputed is whether the bank’s security interest attached to the 289 calves sold in
December 2000 under Anderson and Johnson’s cattle-sharing agreement. [Citation.]
* * * The district court stated on the record that the cattle-sharing contract had not
“granted” Anderson an “ownership interest” in the calves, specifically finding that “the
modifications testified to by Mr. Anderson in the light most favorable to Border State Bank
collateral, as the term is used in Article 9, include full ownership and limited rights that fall
short of full ownership. [UCC] §9-203 U.C.C. cmt., para. 6. [Citations.] Simply stated, the
UCC “does not require that collateral be owned by the debtor.” [Citation.]
* * * For purposes of the UCC, “sufficient rights” arise with far less than full ownership.
[Citation.] Ownership or title is not the relevant concern under Article 9; “the issue is
whether the debtor has acquired sufficient rights in the collateral so that the security interest
would attach.” [Citation.] The “rights in the collateral” language is a “gateway through
which one looks to other law to determine the extent of the debtor’s rights.” [Citation.] Thus,
“[a]ll or some of owner’s rights can be transferred by way of sale, lease, or license [and a]
person with transferable rights can grant an enforceable security interest in those rights.”
[Citation.] A “security interest will attach to the collateral only to the extent of the debtor’s
rights in the collateral”; mere possession of the collateral is insufficient to support an
Consumer Goods — A creditor may not obtain a security interest in
household goods, but may obtain a purchase money security interest or a
pledge (nonpossessory security interest).
After-Acquired Property — A security agreement may provide a secured
party with a security interest in after-acquired property, property that the
debtor currently neither owns nor has rights to but may acquire at some
time. This is a “continuing general lien” or a Coating lien.
D. PERFECTION
To be enforceable and effective against claims by third parties (including
other creditors of the debtor, the debtor’s trustee in bankruptcy, and
transferees of the debtor), the security interest must be perfected. This
requires an attachment of the security interest plus: 1) filing a financing
statement, 2) possession by the secured party of the collateral, 3) automatic
perfection based on attachment (only in certain transactions), 4) as specified
by the Code for a temporary time or, 5) by the secured party taking control
of the collateral.
NOTE: See Figure 37-2: Requirements for Enforceability of Security Interests.
Filing a Financing Statement
Filing a financing statement is the most common method of perfecting a
security interest under Article 9. Filing is required to perfect a security
interest in general intangibles and accounts except for assignments of
What to File — Article 9 uses a system of “notice filing,” which indicates
merely that a person may have a security interest in the collateral. It also
authorizes and encourages filing financing statement electronically. Though it
need not be highly detailed, the financing statement must include the name of
the debtor, the name of the secured party or a representative of the secured
party, and an indication of the collateral. If the financing statement substantially
complies with these requirements, minor errors will not render the financing
statement ineffective. Significantly, as revised, Article 9 no longer requires the
debtor’s signature on the financing statement in order to facilitate paperless or
electronic filing. The 2010 Amendments provide greater guidance as to the
name of an individual debtor to be provided on a financing statement. As
amended, Section 9–503 offer two alternative provisions:
Alternative A provides that, if the debtor holds an unexpired driver’s
license issued by the State where the financing statement is filed, the
debtor’s name as it appears on the driver’s license is the name required
Duration of Filing — Usually effective for five years, unless maturity date is
stated. A continuation statement filed within six months of expiration will
extend it another five years. Security interests in motor vehicles follow
di1erent rules.
Place of Filing — Revised Article 9 greatly simplifies the place or places of
filing: except for real-estate-related collateral financing statements must be
filed in a central location designated by the state.
If the debtor is an individual the financing statement is to be filed in the
state of the individual’s principal residence; for a registered organization the
place of filing is the State where the debtor is organized.
Subsequent Change of Debtor’s Location — If the debtor moves to
another state after the initial filing, the security interest remains perfected
until the earliest of (a) the time the security interest would have terminated
in the State in which perfection occurred; (b) four months after the debtor
moved to the new State; or (3) the expiration of one year after the debtor
Possession
Possession is the only way to permanently perfect a security interest in
instruments, and is the desired way to perfect as to negotiable documents
and chattel paper. Also referred to as a pledge. Delivery of the collateral is
the key. Possession is not available as a means of perfecting a security
interest in accounts and general intangibles.
Automatic Perfection
In some situations, a security interest is automatically perfected on
attachment. The most important situation to which automatic perfection
applies is a purchase money security interest in consumer goods (except
motor vehicles).
