Secured Transactions - Texas Bar Exam 2014

Front 1

Basic Approach to Secured Transaction Problem

Back 1

1. Is the transaction within scope of Article 9?
2. Classify the collateral
3. Determine if a security interest has been created, that is, has attachment occurred
4. Determine if the security interest has been properly perfected
5. Determine who are making claims to the collateral
6. Apply proper priority rules and rules regarding repossession

Front 2

Options of Potential Creditor

Back 2

1. Outright refusal
2. Obtain promise to repay (called unsecured or general creditor): if debtor fails to pay, creditor must bring suit, get judgment, and have sheriff seize enough of debtor's non-exempt property to satisfy the judgment (expensive and time-consuming)
3. Obtain surety
4. Obtain collateral: creditor requires debtor to place some of debtor's property at risk so that if debtor does not pay, creditor may take property

Front 3

Collateralized Transaction

Back 3

Any transaction (regardless of its form) which is intended to create a security interest in personal property or fixtures

Property used as collateral may be:
1. Already owned by debtor
2. To be acquired with loan, that is, a purchase money security interest (PMSI)
3. After-acquired

Front 4

Purchase Money Security Interest (PMSI)

Back 4

Special type of security interest in goods that has priority over all other security interests in the same goods if certain requirements are met

PMSI arises if:
1. Creditor sells the collateral to debtor on credit and retains a security interest in the collateral, or
2. Creditor advances funds which are used by debtor to purchase the collateral

Front 5

Sales of Receivables

Back 5

Outright sale of accounts, chattel paper, payment intangibles, and promissory notes are covered by Article 9

Front 6

Consignments (definition)

Back 6

Consignor (owner of goods) retains title to goods and delivers them to consignee (retailer) for sale to public; if goods aren't sold, consignee may return them to consignor

In cases where creditor of consignee would have hard time distinguishing inventory that consignee is selling on consignment from inventory that consignee actually owns, Art 9 considers the consignment to be a security interest and requires consignor to comply with its provisions to give notice to consignee's creditors

Front 7

Consignments which Must Comply with Article 9

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1. Consigned goods are worth a total of $1000 or more;
2. Consignor did not use the goods for personal, family, or household purposes; and
3. Consignee is a person who:
a. deals in goods of that kind under a name other than the consignor's;
b. isn't an auctioneer; and
c. isn't generally known by her creditors to be substantially engaged in selling the goods of another (ex. the goods aren't being sold at a "consignment store")

Front 8

Agricultural Liens Created by Statute

Back 8

Art 9 covers agricultural liens, that is, nonpossessory liens on farm crops such as crops and livestock created by state law in favor of a person who provides goods or services to a farmer

Front 9

Lease-Purchase Agreements

Back 9

Art 9 does not govern true leases of personal property, but a lease which is actually an installment sale is covered

Examples of evidence of secured transaction:
Lessee cannot terminate lease and:
a. lease term is equal to or greater than remaining economic life of goods, or
b. lessee owns property at end of lease term, or
c. lessee has option to buy for nominal consideration at end of lease term

Front 10

Exclusions from Article 9

Back 10

1. Rights governed by federal law (ex. ships, planes, etc)
2. Real property (except fixtures)
3. Tort claims (however, commercial tort claims - business claims that don't involve personal injury - are covered; ex. unfair competition)
4. Deposit accounts in consumer transactions (ex. checking accounts)
5. Statutory liens (ex. mechanics lien, landlord lien)
6. Wage assignments

Front 11

Classification of Collateral (overview)

Back 11

Many rules regarding perfection, priority, repossession, resale, etc. depend on the type of collateral involved

Mutually exclusive - any particular item can be only one type of collateral

Debtor's use of determinative - classify collateral from debtor's perspective

Front 12

Goods

Back 12

1. Movable items and fixtures
2. Specific inclusions:
a. Standing timber
b. Growing crops
c. Unborn young of animals
3. Specific exclusions:
a. Money
b. Minerals before extraction
c. Collateral that fits other categories

Front 13

Classifications of Goods

Back 13

1. Equipment (most commonly tested)
2. Consumer goods
3. Inventory
4. Farm products

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Equipment

Back 14

Anything used in a business other than inventory and farm products

Includes goods bought by a non-profit organization or a governmental subdivision/agency

Default category - if a good does not fit within the other categories, it is deemed to be equipment

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Inventory

Back 15

Goods that are held for sale or lease (on TX bar exam, usually arises in a retail setting - ex. televisions at a retail store)

Front 16

Consumer goods

Back 16

anything used primarily for personal, family or household use (ex. everything I own - car, clothes, tv, computer, etc)

Front 17

Farm products

Back 17

Crops, livestock, unmanufactured products of livestock (ex. eggs), and supplies used or produced in farming operations are farm products if (1) they are in the possession of or used by a farmer and (2) in an unmanufactured condition (ex. pasteurizing milk is likely not manufacturing, but making ice cream is likely manufacturing)

Front 18

Multiple Uses - Principal Use Determinative

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Category into which tangible collateral is placed doesn't depend on the nature of the collateral but rather on the primary use to which the debtor puts the collateral at the time the interest attaches

ex. tractor can be inventory if the debtor holds the tractor for sale; it can be equipment if the debtor uses it in his lawn mowing business; it can be a consumer good if debtor uses it to mow the lawn of his house

Front 19

Semi-tangible and intangible collateral (not as common as tangible collateral on bar exam)

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1. Instruments that represent money (checks, drafts)
2. Documents of title under Art 7 - written/electronic representation of goods (ex. warehouse receipt - goods in storage; bill of lading - goods in transit)
3. Chattel paper - writing(s) evidencing 2 things: monetary obligation plus security interest in or lease of goods
4. Account - any right to payment of money for goods sold or leased or for services rendered not evidenced by an instrument or chattel paper (ex. accounts receivable of a business - what clients owe you)
5. Deposit accounts with a financial institution (ex. checking account)
6. Investment property (ex. stock)
7. Commercial tort claims that don't involve personal injury (ex. unfair competition)
8. General intangibles (ex.patents, liquor license)

Front 20

Proceeds

Back 20

Whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds (ex. Jim used car and computer as collateral for loan; Jim traded in car for truck and sold computer for cash; truck and cash are proceeds of the original collateral)

May include collateral a creditor could not have a security interest in if originally used as collateral (such as cash in above example)

Front 21

Attachment (definition; elements)

Back 21

Attachment = process by which a security interest is created and becomes enforceable against the debtor so the creditor can repossess the collateral if the debtor does not pay

3 elements (VCR):
1. creditor gave value (ex. lend you money or good/services on credit)
2. contract - the security agreement
3. debtor has rights in collateral

Elements of attachment may occur in any order; no attachment until all elements satisfied

Front 22

Contract - the Security Agreement

Back 22

K between debtor and creditor in which debtor gives creditor a security interest in the collateral

Methods of proving the security agreement:
1. Oral - security agreement may be oral only if collateral is in creditor's possession (called pledge); creditor has duty to take reasonable care of collateral in creditor's possession
2. Authenticated record - requirements:
a. Evidence of record - written or electronic as long as it is signed
b. Description of collateral - reasonably identify the property
3. Control - creditor has right to sell/cash in the collateral without further action from debtor

Front 23

Debtor has Rights in the Collateral

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Debtor cannot give a security interest in property without having rights in the property such as ownership or identification to a contract

Debtor cannot use another person's property as collateral without that person's permission

Front 24

After-Acquired Property

Back 24

1. Using new property as collateral for old loan - debtor can agree that new acquisitions of property will serve as additional collateral for an old loan (referred to as a floating lien and is very common with inventory)
2. Consumer good exception - an after-acquired property clause will work only for consumer goods acquired within 10 days of creditor giving value
3. Commercial tort claim exception - after-acquired property clauses will not work with commercial tort claims

Front 25

Future Advances

Back 25

As a general rule, security agreement covers only the transaction for which it was created and once the secured obligation in that transaction is satisfied, the security interest in the collateral is extinguished; however, if the parties contemplate that they will have other transactions in the future (ex. bank expects to make series of loans to debtor over a few years), parties may agree that the security agreement covers not only the current transaction, but also any future advances made by the creditor to the debtor

Front 26

Perfection versus Attachment

Back 26

Attachment - gives creditor righs in the collateral as against the debtor

Perfection - serves as constructive notice and gives creditor rights in the collateral as against third parties who might also have an interest in the same collateral

Security interest cannot be perfected in collateral unless it has attached to the collateral

Front 27

Perfection - definition

Back 27

process by which creditor protects the security interest from most other claimants to the same collateral

Front 28

Elements of Perfection

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1. Attachment (VCR):
a. Creditor gives value
b. Contract - security agreement
c. Debtor has rights in the collateral
2. Act of Perfection - depends on type of collateral:
a. Possession of collateral by creditor
b. Filing of financing statement by creditor
c. Automatic permanent - attachment alone is sufficient
d. Automatic temporary - attachment alone sufficient for short period of time
e. Control
f. Notation of security interest on certificate of title

Front 29

Perfection by Possession

Back 29

1. Almost all collateral may be perfected by possession
2. Exceptions: accounts; deposit accounts; nonnegotiable documents; electronic documents; electronic chattel paper; general intangibles
3. Loss of possession - if creditor no longer has possession of the collateral, perfection is lost; 20 day exception for instruments, negotiable documents, and certificated securities

Front 30

Filing of Financing Statement - The UCC-1

Card 1

Back 30

1. Almost all collateral may be perfected by filing
2. Exceptions - deposit accounts; money
3. Requirements of financing statements:
a. Names of debtor and creditor
b. Addresses of debtor and creditor
c. Debtor's authorization in an authenticated record - cannot be oral; automatic if debtor authenticated underlying security agreement; debtor may authorize financing statement after filing
d. Description of the collateral - broad terms permissible; ex. "all assets"
e. Description of the land if collateral timber, minerals, fixtures or crops
4. Minor errors in financing statement okay that are not seriously misleading
5. Designation of debtor - very important as financing statement is filed under debtor's name
6. Change in debtor's name - still perfected if debtor owned collateral at time of name change or acquired it within 4 months of name name; not perfected with respect to collateral debtor acquired more than 4 months after name change - must refile to be perfected

Front 31

Perfection by Filing of Financing Statement - UCC-1 (Card #2)

Back 31

7. Place of filing - Secretary of State's Office in Austin, Texas (exception: fixtures, minerals, timber to be cut = county where mortgage on real estate would be filed)
8. Financing statement effective for 5 years from date of filing (exception: recorded real property mortgage covering fixtures continues until mortgage is released or satisfied)
9. To extend effectiveness of filing, creditor should file continuation statement within 6 months prior to the expiration date and before the 5 years expires
10. Termination statement
a. Consumer goods = required (creditor must file termination statement in timely manner - earlier of within 20 days after debtor's written demand or within 1 month after there is no outstanding secured obligation or commitment to make advances, even without a demand from the debtor)
b. Non-consumer goods = only upon the debtor's request (creditor must provide debtor with a termination statement within 20 days of written demand; debtor has responsibility of filing the termination statement and must incur the cost)
11. Person may not file a financing statement the person knows is forged, contains a material false statement, or is groundless (minimum penalty = $5000)

Front 32

Automatic Permanent Perfection

Back 32

1. Purchase Money Security Interest (PMSI) in consumer goods (only for consumer goods that are NOT either certificate or title items or fixtures)

Example = Wells Fargo loans Jim money which which he buys a refrigerator; if he signs a security agreement giving Wells Fargo a security interest in the refrigerator, Wells Fargo is perfected without having to file a financing statement assuming the money is actually used to buy the collateral
2. Assignment of insignificant amount of debtor's accounts
3. Sale of promissory notes

Front 33

Automatic Temporary Perfection

Back 33

1.Proceeds - automatically perfected for 20 days from debtor's receipt of the proceeds
2. New value for instruments, negotiable documents, and certified securities - creditor automatically perfected for 20 days (grace period to perfect using normal methods) from time of attachment if creditor gives new value (ex. On May 1, Jim grants Bank a security interest in a promissory note he owns and Bank lends him $100; Bank is automatically perfected for 20 days, but Bank must file or take possession within 20 days or its security interest will become unperfected)
3. Delivery of instrument, negotiable document, or certified security to debtor for 20 days for certain purposes (examples of these purposes include for sale, exchange, or presentation of the collateral)

Front 34

Control

Back 34

1. Investment property, nonconsumer deposit accounts, electronic documents, and electronic chattel paper
2. Defined - control basically means creditor has right ot sell or cash in collateral without further action from debtor (ex. delivering bearer form); if a deposit account, secured party has control if security party is the bank in which the deposit account is maintained

Front 35

Notation on Certificate of Title

Back 35

1. Items covered = motor vehicles, boats, manufactured housing
2. Perfection if collateral consumer goods or equipment = notation of security interest on certificate of title (ex. Bank agrees to lend Jim $3000 if he uses his car as collateral; Jim signs valid security agreement and Bank immediately files a financing statement describing his car; because his car is a consumer good, Bank is not perfected; to be perfected, Bank needed to note its security interest directly on Jim's car's certificate of title)
3. Perfection if collateral inventory = file or take possession (ex. if debtor is a car dealer, creditor should perfect by filing or taking possession of the cars)

Front 36

Special Rules for Proceeds

Back 36

1. General rule = perfection continues for 20 days
2. When perfection continues beyond 20 days:
a. Same office - original security interest perfected by filing and a financing statement covering the proceeds would be filed in the same place as the original collateral (ex. both inventory and equipment are perfected by filing in the Secretary of State's Office)
b. Identifiable cash proceeds
c. Proceeds perfected within the 20 days

Front 37

Multi-State Transactions

Back 37

1. Issue - what state's version of the UCC is used to determine whether a creditor is perfected?
2. General rule = law of state where debtor is located (principle residence of individual; law of state where registered organization is organized; place of business or chief executive office of unregistered organization)
3. Exceptions where creditor must follow law of the collateral's location:
a. Security interests perfected by possession
b. Fixtures
c. Tiber
d. Agricultural liens = law of state where farm crop covered by lien is located
4. Other exceptions
a. Certificate of title items = law of state which issued most recent certificate of title
b. Deposit accounts = law of state in which bank has its chief executive office
5. Debtor or collateral changes state - if debtor moves, perfection continues for 4 months
a. Perfection by possession = continues as long as perfected under new state's law
b. Certificate of title items = continues for as long as it would have under original certificate of title

Front 38

Priorities - Approach

Back 38

Crux of secured transactions

1. Classify persons claiming the collateral
2. Determine who prevails

By contract, the competing parties may agree to a priority order different from the normal rules - called subordination.

Front 39

Secured Creditor versus Unsecured/General Creditor

Back 39

Secured creditor prevails

Perfected status of secured creditor is irrelevant

Ex. Jim granted Bank a security interest in his computer; Jim has financial difficulties and quits paying both Bank and his Visa account; Bank has priority in the computer regardless of Bank's perfected status because Visa is unsecured

Front 40

Secured Party versus Secured Party

Back 40

1. Both creditors unperfected = first to attach prevails
2. One creditor perfected = perfected creditor prevails
3. Both creditors perfected - general rule = first creditor to either (1) file or (2) perfect; does not matter which creditor first had security agreement with debtor, which creditor attached first, or which creditor perfected first if one creditor filed before that perfection
4. Exception: PMSI creditor in goods (other than inventory and livestock) prevails (even though second) if it is perfected (1) at the time debtor receives possession of the collateral, or (2) within 20 days of when debtor received possession of collateral
c. PMSI creditor in inventory or livestock prevails if (1) PMSI creditor perfected at time debtor receives possession of inventory/livestock, and (2) proper notice to holders of conflicting security interest
d. Exception for deposit accounts - secured party with control prevails
e. Exception for investment property - secured party who has control over investment property has priority over a secured party who does not have control (ex. secured party who perfected by filing)

Front 41

Secured Party versus Donee

Back 41

If debtor makes a gift of the collateral to a donee, collateral remains subject to the security interest in the donee's hands

Front 42

Secured Party versus Purchaser

Back 42

1. General rule = secured party prevails
2. Debtor has permission to sell = purchaser prevails
3. Secured party unperfected at time of purchase - purchaser wins if (1) buyer gives value, (2) receives delivery of item, and (3) has no knowledge of security interest at time of delivery; but if PMSI creditor perfects within 20 days after debtor receives collateral but after debtor sells collateral to purchaser, creditor will prevail over the "gap" purchaser
4. Buyers in the ordinary course of business can prevail even over a perfected creditor if (a) good faith, (b) without knowledge of security interest violation, (c) purchase of goods that are not farm goods, (d) ordinary purchase from person in the business of selling goods of the kind, (e) security interest created by seller, and (f) creditor not perfected by possession
5. Garage sale/Ebay rule: consumer purchaser of consumer goods prevails if (a) consumer goods in seller's hands, (b) consumer goods in buyer's hands, (c) buyer has no knowledge of security interest, (d) buyer pays value, (e) creditor not perfected by possession, (f) creditor's interest is unfiled prior to purchase
6. Non-buyer in the ordinary course of business can prevail over secured creditor for future advance amounts (not prior advances) made after the first of these events occurs: (a) secured creditor obtains knowledge of purchase, or (b) 45 days have elapsed from date of purchase
7. Holder in due course will prevail over earlier perfected interests in the negotiable instrument

Front 43

Secured Creditor versus Lien Creditor

Back 43

1. Lien creditor = acquired a judicial lien by levy on the debtor's property (includes bankruptcy trustee)
2. If secured creditor unperfected at time lien attached, then lien creditor prevails
3. If secured creditor perfected at time lien attached, then secured creditor prevails
4. If PMSI creditor perfects by filing within 20 days after debtor receives possession, creditor will defeat lien creditors who obtained liens in the gap period
5. Secured creditor will lose priority to a lien creditor for future advances after both of the following 2 things occur: 1) secured creditor obtains knowledge of lien, and 2) 45 days elapse from date of lien

Front 44

Secured Creditor versus Statutory Mechanics Lien

Back 44

Statutory lien prevails if following conditions satisfied:
1. Person furnished services or materials with respect to the goods covered by the security interest,
2. Furnishing was in ordinary course of business, and
3. Collateral is in the possession of the statutory lien holder

Front 45

Proceeds

Back 45

priority for proceeds is the same as the priority in the original collateral as long as the security interest in the proceeds is perfected

Front 46

Fixtures

Back 46

Ordinary building materials cease to be goods when incorporated into structure and are real property

Creditor with security interest in these ordinary building materials loses its security interest once construction occurs

Fixture = good which is not completely integrated into building although it is so related to the real estate than an interest in it arises under real estate law; can be removed but some damage will occur to realty (ex. light fixtures, hot water heater)

Front 47

Fixtures - Secured Party versus Holder of Real Property Mortgage

Back 47

1. General rule - secured party wins if:
a. perfected before real estate interest recorded, and
b. perfected with a fixture filing (financing statement which (1) describes the real property and (2) filed in office where mortgage on real property would be recorded)
2. PMSI creditor, even though perfected after real property interest is of record, can prevail if:
a. PMSI perfected by fixture filing,
b. perfected within 20 days of good becoming a fixture, and
c. competing real estate interest is not a construction mortgage (loan which enabled whole building process to begin and thus not defeated by later PMSI)
3. If good is readily removable, it will be treated as a regular good, rather than as a fixture, and thus may be perfected without a fixture filing
4. Security interest in fixtures that is perfected in any manner prevails over a later-acquired judicial lien, even if the perfection was not done via a fixture filing

Front 48

Crops

Back 48

perfected security interest in crops has priority over a conflicting interest in the land on which crops are growing; it does not matter who filed or perfected first

Front 49

Impact of Bankruptcy

Back 49

bankruptcy of the debtor may change the normal priority rule

Front 50

Remedies Triggered by Debtor's Default

Back 50

Default - not defined in UCC; means not paid but term may include other things specified in the security agreement such as taking collateral out-of-state without permission or not keeping the collateral insured

Front 51

Repossession

Back 51

1. Upon default, creditor may repossess
2. No judicial action needed: self-help remedy
3. Creditor need not give debtor notice
4. Limitation on repossession: no breach of peace - fact question to determine whether peace was breached
5. Creditor cannot delegate duty not to breach peace to the repo person/company; thus, if repo person breaches peace, creditor is strictly liable even if repo person is an independent contractor; this liability could be for conversion of the repossessed item, actual damages, and even punitive damages

Creditor nor has choice after a proper repossession:
1. Resell Collateral - sue for deficiency, give surplus to creditor
2. Strict Foreclosure - keep collateral and call things square

Front 52

Sale of Collateral by Creditor - Notice of Sale

Back 52

1. Notice required
2. Exceptions: perishable collateral, collateral threatening to decline speedily in value, collateral is customarily
3. Contents of notice: a) description of debtor/secured party; b) description of collateral; c) method of sale; d) statement that debtor is entitled to accounting and the charge, if any; e) time and place of public sale; f) if collateral is consumer goods, notice must also 1) explain that debtor is liable for deficiency; 2) telephone # of person from whom debtor can obtain amount needed to redeem collateral; 3) telephone #/address from which debtor can get additional info about sale; 4) notice must be sent a reasonable amount of time before sale; 5) debtor must receive notice unless debtor waived notice in an authenticated agreement after default

Front 53

Sale of Collateral by Creditor - Debtor's Right to Redeem

Back 53

Debtor has ability to cure the default and regain collateral if:
1. creditor has not yet sold or entered into a K to sell collateral
2. strict foreclosure has not yet occurred
3. debtor has not waived the right to redeem after default
4. debtor must tender fulfillment of all obligations secured by the collateral (not just late payments)
5. debtor must tender creditor's reasonable expenses (ex. advertising)

Front 54

Sale of Collateral by Creditor - Standard of Care

Back 54

All aspects of the sale, that is, the method, manner, time, place, and terms must be commercially reasonable - fact question whether sale was commercially reasonable

Merely because a better price could have been obtained does not make sale unreasonable but if difference in price is substantial, sale will be closely analyzed

Burden of proof on creditor to show commercial reasonableness of sale in a deficiency suit

Front 55

Sale of Collateral by Creditor - Ability of Creditor to Purchase at Resale

Back 55

Public Sale (auction) = yes

Private Sale = only if:
1. collateral is customarily sold in a recognized market (ex. stock market), or
2. collateral is subject to widely distributed standard price quotations

Front 56

Sale of Collateral by Creditor - Title of Purchaser at Resale

Back 56

reselling creditor warrants title, possession, and quiet enjoyment of the collateral by the purchaser unless creditor takes steps to disclaim the warranties

Front 57

Sale of Collateral by Creditor - Application of Resale Proceeds

Back 57

1. reasonable expenses of reselling creditor
2. satisfaction of debt
3. satisfaction of subordinate creditors
4. surplus, if any, to debtor (really rare)

Front 58

Sale of Collateral by Creditor - Deficiency

Back 58

creditor is unsecured for the deficiency amount

Front 59

Sale of Collateral by Creditor - Penalty for Not Complying with Resale Requirements

Back 59

1. Creditor liable for actual damages - liability could be to debtor or to other creditors
2. Consumer goods - creditor is automatically liable for amount equal to finance charge plus 10% of the principal
3. Effect on creditor's ability to recover deficiency:
a. consumer transactions = absolute bar to recovery of deficiency
b. nonconsumer transactions = rebuttable presumption that value of collateral was equal to amount of debt; secured creditor may prove otherwise and still recover a deficiency

Front 60

Sale of Collateral by Creditor - If Collateral Accounts or Instruments

Back 60

creditor directs the obligor to make payments directly to the creditor, rather than to debtor

Front 61

Strict Foreclosure

Back 61

1. Creditor retains collateral in total satisfaction of debt
2. Requirements for strict foreclosure:
a. Debtor consents - express (debtor agrees in authenticated record after default) or implied (debtor fails to object to creditor's proposal to strictly foreclose within 20 days of when creditor sent notice)
b. Creditor sends authenticated notice to retain collateral to debtor; if collateral no consumer good, notice to creditors who have perfected by filing, notation on certificate of title or who have given notice to creditor
c. If debtor or another creditor objects in writing within 20 days, creditor may not keep collateral and must conduct a sale
3. Exception for high equity (debtor has paid 60% of price) consumer goods - resale necessary within 90 days of repossession