19 - 127 - 1 © 2007 prentice hall, business law, sixth edition, henry r. cheeseman chapter 27...

© 2007 Prentice Hall, Business Law, sixth edition, Henry R. Cheeseman 19 - 127 - 1

Chapter 27Secured Transactions

and Security Interests in Personal Property


Secured TransactionSecured Transaction

A transaction that is created A transaction that is created when a creditor makes a loan to a when a creditor makes a loan to a debtor in exchange for the debtor in exchange for the debtor’s pledge of personal debtor’s pledge of personal property as security.property as security.


Basic Terminology• Debtor – The party who owes

payment or other performance of the secured obligation.

• Secured Party – A seller, lender, or other party in whose favor there is a security interest, including a party to whom accounts or chattel paper has been sold.

• Security Interest – An interest in personal property or fixtures that secures payment or performance of an obligation.


Basic Terminology (continued)

• Security Agreement – The agreement between the debtor and the secured party that creates or provides for a security interest.

• Collateral – The property subject to a security interest, including accounts and chattel paper that have been sold.


Security Interest in Personal Property

• Tangible personal property– Equipment– Vehicles– Furniture– Computers– Clothes– Jewelry

• Intangible personal property– Securities– Patents– Trademarks– Copyrights


Personal Property and Credit• Personal property is often

sold on credit– Unsecured credit

• No interest in collateral• If debtor defaults, creditor must

sue debtor

– Secured credit• Purchaser pledges collateral

– Creditor may recover collateral in case of default


Secured Transaction

• Creditor extends credit to debtor and takes security interest.

• Secured party is seller, lender, or third party.

• Secured party can foreclose on collateral if debtor fails to pay.

• Governed by Revised Article 9 of the UCC.


Two-Party Secured Transaction

Sale of Goods on Sale of Goods on CreditCredit

Secured Interest in Secured Interest in the Goodsthe Goods

Buyer-DebtorBuyer-DebtorSeller-Lender Seller-Lender

Secured CreditorSecured Creditor


Three-Party Secured Transaction

Sale of GoodsSale of Goods

Buyer-DebtorBuyer-Debtor SellerSeller

Lender-Secured Lender-Secured CreditorCreditor

Security Security Interest in the Interest in the GoodsGoods

Loan of Loan of FundsFunds


Personal Property Subject to a Security Agreement

• Goods• Instruments• Chattel paper• Documents of title• Accounts• General intangibles


Personal Property Subject to a Security Agreement

• Goods, including:– Consumer goods bought or

used primarily for personal, family, or household purposes

– Equipment bought or used primarily for business

– Farm products including crops, livestock and supplies used or produced in farming operations


Personal Property Subject to a Security Agreement (continued)

• Goods (continued)

– Inventory held for sale or lease, including work in progress and materials

– Fixtures affixed to real estate so as to become part thereof

• Instruments, such a checks, notes, stocks, bonds, and other investment securities


Personal Property Subject to a Security Agreement (continued)

• Chattel paper, such as a conditional sales contract

• Documents of title, including bills of lading and warehouse receipts

• Accounts, such as accounts receivable

• General intangibles, such as patents, copyrights, money franchises, and royalties


Written Security AgreementWritten Security Agreement

The agreement between the The agreement between the

debtor and the secured party that debtor and the secured party that

creates or provides for a security creates or provides for a security

interest.interest.


Written Security AgreementTo be valid, a written security

agreement must:1. Clearly describe the collateral

so that it can be readily identified.

2. Contain the debtor’s promise to repay the creditor, including terms of repayment.

3. Set forth the creditor’s rights upon the debtor’s default.

4. Be signed by the debtor.


Attachment• Debtor must have current or

future legal right in or right to possession of collateral.

• Rights of secured party attach to collateral.

• Creditor has enforceable security interest in property.

• Debt can be satisfied out of collateral.


The Floating-Lien Concept• A security interest in

property that was not in possession of the debtor when the security agreement was executed.

• A floating lien can attach to:– After-acquired property– Future advances– Sale proceeds


Perfecting a Security Interest• Establishes the right of a

secured creditor against other creditors who claim an interest in the collateral.

• Perfection is a legal process.


Perfection of a Security Interest (continued)

The three main methods of perfecting a security interest under the UCC are:

1.Perfection by filing a financing statement

2.Perfection by possession of collateral

3.Perfection by a purchase monetary security interest in consumer goods


Perfection by Filing a Financing Statement

• A document filed by a secured creditor with the appropriate government office that constructively notifies the world of his or her security interest in personal property.

• Financing statements are effective for five years from the filing date.

• State law specifies where the financing statement must be filed.


Perfection by Possession of Collateral• If a secured creditor has physical

possession of the collateral, no financing statement has to be filed.

• The creditor’s possession is sufficient to put other potential creditors on notice of his or her secured interest in the property.

• A secured creditor who holds the debtor’s property as collateral must use reasonable care in its custody and preservation.


Perfection by a Purchase Money Security Interest in Consumer Goods

• An interest a creditor automatically obtains when it extends credit to a consumer to purchase consumer goods.

• The creditor does not have to file a financing statement or take possession of the goods to perfect his or her security interest.


Summary: Methods for Perfecting a Security Interest

Perfection Method

How Created

Financing statement

Creditor files a financing statement with the appropriate government office.

Possession of collateral

Creditor obtains physical possession of the collateral.

Purchase money security interest

Creditor extends credit to a debtor to purchase consumer goods and obtains a security interest in the goods.


Termination Statement• A document filed by a

secured party that ends a secured interest because the debt has been paid.

• Must be filed within one month after the debt is paid or 10 days after receipt of the debtor’s written demand (whichever occurs first).


Priority of Claims• Priority – The order in

which conflicting claims of creditors in the same collateral are solved.

• The priority of claims is determined according to:

1. Whether the claim is unsecured or secured

2. The time at which secured claims were attached or perfected


UCC Rules for Determining Priority

1. Secured versus Unsecured Claims.

• A creditor who has the only secured interest in the debtor’s collateral has priority over unsecured interests.

2. Competing Unperfected Secured Claims.

• If two or more secured parties claim an interest in the same collateral but neither has a perfected claim, the first to attach has priority.


UCC Rules for Determining Priority (continued)

3. Perfected versus Unperfected Claims.

• If two or more secured parties claim an interest in the same collateral but only one has perfected his or her security interest, the perfected security interest has priority.

4. Competing Perfected Secured Claims.

• If two or more secured parties have perfected security interests in the same collateral, the first to perfect has priority.


UCC Rules for Determining Priority (continued)

5. Perfected Secured Claims in Fungible, Commingled Goods.

• If a security interest in goods is perfected, but the goods are later commingled with other goods and the goods become part of a product or mass and lose their identity, the security interests rank equally, according to the ratio that the cost of goods to which each interest originally attached bears to the cost of the total product or mass.


Exceptions to the Perfection-Priority Rule

• Purchase money security interest: inventory as collateral

• Purchase money security interest: non-inventory as collateral

• Buyers in the ordinary course of

business

• Secondhand consumer goods


DefaultDefault

Failure to make scheduled Failure to make scheduled payments when due, bankruptcy of payments when due, bankruptcy of the debtor, breach of the warranty the debtor, breach of the warranty of ownership as to collateral, and of ownership as to collateral, and other events defined by the parties other events defined by the parties to constitute default [UCC 9-to constitute default [UCC 9-501(1)].501(1)].


Default and Remedies

• Upon default by the debtor, the secured party may reduce his or her claim to judgment, foreclosure, or otherwise enforce his or her security interest by any available judicial procedure.


Default

• The debtor will be considered in default if they:– Fail to make scheduled

payments.– File for bankruptcy.– Breach the warranty of

ownership as to the collateral.– Are in violation of any event

defined in the security agreement.


UCC Remedies for Default (

The UCC provides the secured party with the following remedies:

1. Taking possession of the collateral

2. Relinquishing the security interest and proceeding to judgment on the underlying debt

3. Security agreements covering real and personal property


Repossession• The secured party may cure

the default by taking possession of the collateral.– The secured party may then:

• Retain the collateral.

• Sell or dispose of the collateral and satisfy debt from proceeds.


Retention of Collateral

• The secured creditor may retain possession.– Must notify debtor, unless

debtor renounced rights in writing.

• Secured creditor may not retain property if: – There is a written objection.– The goods are consumer

goods and the debtor has paid 60 percent of the cash price or loan.


Disposition• The creditor may dispose of

goods in any commercially reasonable method.

• The proceeds must first be applied to:– Reasonable expenses of

retaking, holding, and preparing collateral for sale.

– Satisfying balance owed.– Satisfaction of any

subordinate claims.– Debtor gets surplus.


Deficiency and Redemption

• The secured party may bring an action to recover any deficiency.

• The debtor or another secured party may redeem the collateral before the lienholder has disposed of it, entered into a contract for sale, or discharged the debtor’s obligations.


Relinquishing the Security Interest

• The creditor may relinquish his security interest and proceed to judgment to recover underlying debt.– Usually chosen when value of

collateral has been reduced below value of secured interest.


Surety Arrangement

• Third person (surety or co-debtor) agrees to be liable for payment of another person’s debt.

• Surety is also called accommodation party or cosigner.

• Surety is primarily liable for paying principal’s debt.


Guaranty Arrangement• Third person (guarantor)

agrees to pay debt of principal debtor if he defaults.

• Guarantor is secondarily liable on debt.


Defenses of a Surety or Guarantor

• Guarantor or surety may allege the same defenses that the principal debtor has.

• The defense of fraudulent inducement to enter as guarantor/surety may be alleged.

• Duress may be alleged.• Guarantor/surety may not

assert debtor’s incapacity.

19 - 127 - 1 © 2007 prentice hall, business law, sixth edition, henry r. cheeseman chapter 27...

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