Quiz 18: Security Interests in Property

Nero needs $500 to buy textbooks and other supplies. Olivia agrees to loan Nero $500, accepting Nero's computer as collateral. They put their agreement in writing. How can Olivia let other creditors know of her interest in the computer? (See Perfection of a Security Interest.)

What is a security interest? Who is a secured party? What is a security agreement? What is a financing statement?

What is a security interest? Who is a secured party? What is a security agreement? What is a financing statement?

Priority Disputes. Redford is a seller of electric generators. He purchases a large quantity of generators from a manufacturer, Mallon Corp., by making a down payment and signing an agreement to pay the balance over a period of time. The agreement gives Mallon Corp. a security interest in the generators and the proceeds. Mallon Corp. properly files a financing statement on its security interest. Redford receives the generators and immediately sells one of them to Garfield on an installment contract with payment to be made in twelve equal installments. At the time of the sale, Garfield knows of Mallon's security interest. Two months later, Redford goes into default on his payments to Mallon. Discuss Mallon's rights against purchaser Garfield in this situation. (See Priorities.)

Paul Barton owned a small property-management company, doing business as Brighton Homes. In October, Barton went on a spending spree. First, he bought a Bose surround-sound system for his home from KDM Electronics. The next day, he purchased a Wilderness Systems kayak from Outdoor Outfitters, and the day after that he bought a new Toyota 4-Runner financed through Bridgeport Auto. Two weeks later, Barton purchased six new iMac computers for his office, also from KDM Electronics. Barton bought all of these items under installment sales contracts. Six months later, Barton's property-management business was failing, and he could not make the payments due on any of these purchases and thus defaulted on the loans. Using the information presented in the chapter, answer the following questions. 1. For which of Barton's purchases (the surround-sound system, the kayak, the 4-Runner, and the six iMacs) would the creditor need to file a financing statement to perfect its security interest? 2. Suppose that Barton's contract for the office computers mentioned only the name Brighton Homes. What would be the consequences if KDM Electronics filed a financing statement that listed only Brighton Homes as the debtor's name? 3. Which of these purchases would qualify as a PMSI in consumer goods? 4. Suppose that after KDM Electronics repossesses the surround-sound system, it decides to keep the system rather than sell it. Can KDM do this under Article 9? Why or why not?

Liberty Bank loans Michelle $5,000 to buy a car, which is used as collateral to secure the loan. After repaying less than 50 percent of the loan, Michelle defaults. Liberty could repossess and keep the car, but the bank does not want it. What are the alternatives? (See Default.)

What three requirements must be met to create an enforceable security interest?

The four Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: What three requirements must be met to create an enforceable security interest?

Perfection. Marsh has a prize horse named Arabian Knight. In need of working capital, Marsh borrows $5,000 from Mendez, who takes possession of Arabian Knight as security for the loan. No written agreement is signed. Discuss whether, in the absence of a written agreement, Mendez has a security interest in Arabian Knight. If Mendez does have a security interest, is it a perfected security interest? Explain. (See Perfection of a Security Interest.)

What is the most common method of perfecting a security interest under Article 9?

The four Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: What is the most common method of perfecting a security interest under Article 9?

The Scope of a Security Interest. Edward owned a retail sporting goods shop. A new ski resort was being constructed in his area, and to take advantage of the potential business, Edward decided to expand his operations. He borrowed a large sum from his bank, which took a security interest in his present inventory and any after-acquired inventory as collateral for the loan. The bank properly perfected the security interest by filing a financing statement. Edward's business was profitable, so he doubled his inventory. A year later, just a few months after the ski resort had opened, an avalanche destroyed the ski slope and lodge. Edward's business consequently took a turn for the worse, and he defaulted on his debt to the bank. The bank then sought possession of his entire inventory, even though the inventory was now twice as large as it had been when the loan was made. Edward claimed that the bank had rights to only half of his inventory. Is Edward correct? Explain.

If two secured parties have perfected security interests in the collateral of the debtor, which party has priority to the collateral on the debtor's default?

The four Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: If two secured parties have perfected security interests in the collateral of the debtor, which party has priority to the collateral on the debtor's default?

Priorities. EX Services, Inc., was an excavating business. Union Bank made loans to EX, subject to a perfected security interest in its equipment and other assets, including "after-acquired property." In late 2006, EX leased heavy construction equipment from Mac's Machinery. The lease agreements required monthly payments, which EX often made late or missed. After eighteen months, Mac's demanded that EX either return the equipment or buy it. While attempting to obtain financing for the purchase, EX continued to make monthly payments. In November 2009, Mac's, which had not filed a financing statement to cover the transaction, demanded full payment of the amount due. Before paying the price, EX went out of business and surrendered its assets to Union, which prepared to sell them. Mac's objected and filed a lawsuit against Union to recover the equipment, claiming that the bank's security interest had not attached to the equipment because EX had not paid for it. Who has priority to the equipment, and why?

What rights does a secured creditor have on the debtor's default?

The four Learning Objectives below are designed to help improve your understanding of the chapter. After reading this chapter, you should be able to answer the following questions: What rights does a secured creditor have on the debtor's default?

Case Problem with Sample Answer-Default. Primesouth Bank issued a loan to Okefenokee Aircraft, Inc. (OAI), to buy a plane. OAI executed a note in favor of Primesouth in the amount of $161,306.25, plus interest. The plane secured the note. When OAI defaulted, Primesouth repossessed the plane. Instead of disposing of the collateral and seeking a deficiency judgment, however, the bank retained possession of the plane and filed a suit in a Georgia state court against OAI to enforce the note. OAI did not deny defaulting on the note or dispute the amount due. Instead, OAI argued that Primesouth Bank was not acting in a commercially reasonable manner. According to OAI, the creditor must sell the collateral and apply the proceeds against the debt. What is a secured creditor's obligation in these circumstances? Can the creditor retain the collateral and seek a judgment for the amount of the underlying debt, or is a sale required? Discuss. [ Okefenokee Aircraft, Inc. v. Primesouth Bank, 296 Ga.App. 872, 676 S.E.2d 394 (2009)] (See Rights and Duties of Debtors and Creditors.) -For a sample answer to Problem 19-4, go to Appendix G at the end of this text.

Purchase-Money Security Interest. In 2007, James Cavazos purchased a new Mercedes vehicle from a dealer and gave JPMorgan Chase Bank (Chase) a purchase-money security interest (PMSI) in the car. The state recorded Chase's lien on the original certificate of title. Cavazos then forged a release of the lien against the title and received a certified copy of the original title. In reliance of that title, NXCESS Motor Cars, Inc., bought the car. It sold the car to Xavier Valeri, who granted a PMSI to U.S. Bank. NXCESS warranted that the title was free of all liens. When a new title was issued, Chase learned of Cavazos's forgery It sued Cavazos, Valeri, and U.S. Bank for conversion (see Chapter 4). It demanded possession of the vehicle and that Cavazos repay the loan. Valeri and U.S. Bank contended that they were buyers in the ordinary course of business and had good title to the Mercedes because the state provided a title free of liens and claims. Cavazos is liable on the loan, but who has the right to possess the car? Which purchase-money security interest dominates? Explain your answers. [ NXCESS Motor Cars, Inc. v. JPMorgan Chase Bank, N.A. 317 S.W3d 462 (Tex.App.-Houston 2010)]

Disposition of Collateral. PRA Aviation, LLC, borrowed $3 million from Center Capital Corp. to buy a Gates Learjet 55B. Center perfected a security interest in the plane. PRA defaulted on the loan less than two years later and surrendered the jet. Center hired Business Air International, an aircraft broker, to sell it. Business Air reviewed the market, design, and mechanical condition of similar aircraft to arrive at a value estimate of $1.45 million. Business Air marketed the jet in trade publications, on the Internet, and by direct advertising to select customers for $1.59 million. There were three offers. The high bid was $1.35 million subject to an inspection. Center offered $1.3 million for a "cash deal, as is, where is, kick the tires, start the engines" deal. The buyer agreed. Center filed a suit in a federal district court against PRA to collect the deficiency PRA argued that the jet should have sold for $2.4 million to $2.9 million, considering the asking prices for newer aircraft. Was the sale commercially reasonable? Explain. [ Center Capital Corp. v. PRA Aviation, LLC, ____ FSupp.2d ___ (E.D.Pa. 2011)]

Question of Ethics In 1995, Mark Denton cosigned a $101,250 loan that the First Interstate Bank (FIB) in Missoula, Montana, issued to Denton' s friend Eric Anderson. Denton's business assets-a mini-warehouse operation-secured the loan. On his own, Anderson obtained a $260,000 U.S. Small Business Administration (SBA) loan from FIB at the same time. The purpose of both loans was to buy logging equipment with which Anderson could start a business. In 1997, the business failed. As a consequence, FIB repossessed and sold the equipment and applied the proceeds to the SBA loan. FIB then asked Denton to pay the other loan's outstanding balance ($98,460) plus interest. When Denton refused, FIB initiated proceedings to obtain his business assets. Denton filed a suit in a Montana state court against FIB, claiming, in part, that Anderson's equipment was the collateral for the loan that FIB was attempting to collect from Denton. [ Denton v. First Interstate Bank of Commerce, 2006 MT 193, 333 Mont. 169, 142 P3d 797 (2006)] 1 Denton's assets served as the security for Anderson's loan because Anderson had nothing to offer. When the loan was obtained, Dean Gillmore, FIB's loan officer, explained to them that if Anderson defaulted, the proceeds from the sale of the logging equipment would be applied to the SBA loan first. Under these circumstances, is it fair to hold Denton liable for the unpaid balance of Anderson's loan? Why or why not? 2 Denton argued that the loan contract was unconscionable and constituted a "contract of adhesion." What makes a contract unconscionable? Did the transaction between the parties in this case qualify? What is a "contract of adhesion"? Was this deal unenforceable on that basis? Explain.

Critical Thinking Legal Question. Review the three requirements for an enforceable security interest. Why is each of these requirements necessary?

Video Question To watch this chapter's video, Secured Transactions, go to www.cengagebrain.com. Register the access code that came with your new book or log in to your existing account. Select the link for the "Business Law Digital Video Library Online Access" or "Business Law CourseMate." Click on "Complete Video List," view Video 33, and then answer the following questions: 1 This chapter lists three requirements for creating a security interest. In the video, which requirement does Laura assert has not been met? 2 What, if anything, must the bank have done to perfect its interest in the editing equipment? 3 If the bank exercises its self-help remedy to repossess Onyx's editing equipment, does Laura have any chance of getting it back? Explain. 4 Assume that the bank had a perfected security interest and repossessed the editing equipment. Also assume that the purchase price (and the loan amount) for the equipment was $100,000, of which Onyx has paid $65,000. Discuss the rights and duties of the bank with regard to the collateral in this situation.

FACTS Camtech Precision Manufacturing, Inc., makes precision parts and assemblies for aerospace and defense customers. Camtech is a subsidiary of R J National Enterprises, Inc. (R J). R J had a nearly $4 million line of credit with Regions Bank in 2010. Regions Bank filed a series of financing statements with the appropriate state offices in Florida and New York to perfect security interests in the assets of R J and its related companies. All of the statements were filed on the UCC financing statement form used in all states. The forms listed R J as the debtor in the "Debtor" box and Avstar Aircraft Accessories, Inc., another R J subsidiary, as an additional debtor in the "Additional Debtor" box. Neither box, however, indicated that there were more debtors. Attached to each form was a sheet of plain paper that listed Camtech Precision Manufacturing, Inc., and Avstar Fuel Systems, Inc., as additional debtors. In 2010, R J and the others filed a petition in a federal bankruptcy court to declare bankruptcy. A committee of the companies' unsecured creditors asked the court to rule that Regions's financing statements failed to perfect the bank's security interest in the assets of Camtech and Avstar Fuel. ISSUE Was each financing statement seriously misleading because it did not mention or refer to the additional debtors (including Camtech) that were listed on an attached page? DECISION Yes. The court found that Regions's statements were seriously misleading and ineffective to perfect security interests in the assets of Camtech and Avstar Fuel. Because Regions failed to perfect its security interests, the bank was an unsecured creditor with respect to those two companies' assets. REASON Florida and New York have approved the use of a standard UCC form for listing additional debtors. Regions did not use this form, but merely listed Camtech and Avstar Fuel as additional debtors on a single sheet of plain paper attached to each financing statement. Minor errors in a financing statement do not undercut its effectiveness. Appending a list of additional debtors without a reference in the "Additional Debtor" box on the financing statement, however, was "an error and an omission that made the financing statements seriously misleading." Searches of the two states' records failed to reveal any financing statement that identified Regions as a secured creditor of Camtech or Avstar Fuel. This failure rendered Regions's financing statements ineffective to perfect its security interests in the assets of Camtech and Avstar Fuel. With respect to these assets, the bank's claim was reduced to that of an unsecured creditor. WHAT IF THE FACTS WERE DIFFERENT? Suppose that searches of the Florida and New York records had revealed that Regions was a secured creditor of Camtech and Avstar Fuel. Would the result have been different in this case? Explain.

Citizens National Bank of Jessamine County v. Washington Mutual Bank Court of Appeals of Kentucky, 309 S.W.3d 792 (2010). FACTS Rose Day transferred land and a mobile home to Anthony and Kim Reynolds. The deed was duly recorded at the appropriate county office. The deed description did not mention the mobile home, but it was clear from the record that the Reynoldses were purchasing both from Day. The Reynoldses executed a mortgage conveying a security interest in the property to Washington Mutual Bank. There was no mention of the mobile home in the mortgage. Furthermore, the Reynoldses did not obtain a title certificate to the mobile home in their names. Because the mobile home was therefore not legally affixed to the real property, its character did not change from personal property to real property. Several years later, the Reynoldses obtained a second mortgage from Citizens National Bank of Jessamine County. Again, there was no description of the mobile home in the mortgage. When the Reynoldses subsequently defaulted on both loans, Washington Mutual filed a complaint, claiming lien priority on both the real estate and the mobile home. Citizens was listed as an interested party and was served with the complaint. After being served, Citizens and the Reynoldses executed a title lien statement regarding the mobile home, which was recorded in the county clerk's office. The trial court ruled that the filing of the complaint and notice of the lawsuit by Washington Mutual created a priority claim in the mobile home. Citizens appealed that decision. The sole issue to be decided in the appeal was the priority of competing liens in the mobile home. ISSUE Did Citizens' security interest in the mobile home take priority over Washington Mutual's? DECISION Yes. The state appellate court reversed the trial court's decision. Washington Mutual's filing of a complaint and a notice of a pending lawsuit did not create a priority lien on the mobile home but applied only to the interest in the real estate. Citizens' security interest in the mobile home had priority because it was perfected when Citizens recorded the title lien. REASON The UCC explicitly "provides that the sole means of perfecting a security interest in personal property for which a certificate of title is issued is by placing a notation of the lien on the certificate of title." The court reasoned that Citizens (and the Reynoldses) had so perfected its lien, but Washington Mutual had not. "It is fundamental that unperfected security interests are subordinate to perfected security interests." It was irrelevant that Citizens had knowledge that Washington Mutual had filed a notice of a claim to both the real property and the mobile home. "Because Washington Mutual failed to perfect its lien under the mandates of the [UCC], its interest in the Reynoldses' manufactured [mobile] home must necessarily give way to Citizens' perfected claim." WHAT IF THE FACTS WERE DIFFERENT? Suppose that the mobile home had been affixed to the land and was regarded as real property. In that situation, which of the two security interests would take priority? Discuss.

Hicklin v. Onyx Acceptance Corp. Delaware Supreme Court, 970 A.2d 244 (2009). court5.delaware.gov FACTS Shannon Hicklin bought a 1993 Ford Explorer under an installment sales contract. When she fell three payments behind-still owing $5,741.65-Onyx Acceptance Corporation repossessed the car. The car was sold for $1,500 at a private auction held by ABC Washington-Dulles, LLC. After deducting the costs of repossession and sale, there was a deficiency under the contract of $5,018.88. Onyx filed a suit in a Delaware state court to collect this amount from Hicklin. To establish that the sale was commercially reasonable, Onyx offered proof only of the price. The court found that the fair market value of the car at the time of the sale was $2,335 and held that the sale was commercially reasonable solely because the auction price was more than 50 percent of this estimated market value at the time of the auction. The court granted Onyx a deficiency judgment, which a state intermediate appellate court affirmed. Hicklin appealed. ISSUE Does the price obtained on a sale of collateral prove, without more, that the sale was commercially reasonable? DECISION No. The Delaware Supreme Court reversed the lower court's judgment and remanded the case. REASON The appellate court explained that under UCC 9-610(a), Onyx could prove that its sale was commercially reasonable in one of two ways. It could show that every aspect of the sale was conducted in a commercially reasonable manner or, under UCC 9-627(b)(3), that the sale conformed with the reasonable commercial practices among dealers in the type of property that was the subject of the disposition. Onyx did not meet either of these standards. Because every aspect of a sale must be commercially reasonable, Onyx's showing only that the private auction sale grossed more than 50 percent of the value of the collateral was not enough. Onyx did not provide any proof of the details of the auction-its procedure, publicity, attendance, or convenience of location. Nor did Onyx offer any proof that the sale conformed to the accepted practices in its trade. FOR CRITICAL ANALYSIS-Ethical Consideration Why does UCC 9-627(b)(3) require that a sale be conducted in conformity with the reasonable commercial practices among dealers in the type of property that was the subject of the disposition?