UCC Security Interests in Proceeds of Collateral:

Perfection, Priority, and Impact of Debtor’s

Bankruptcy

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Janet M. Nadile, Special Counsel, Milbank LLP, New York

Edwin E. Smith, Partner, Morgan, Lewis & Bockius LLP, New York and Boston

Steven O. Weise, Partner, Proskauer Rose LLP, Los Angeles

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Proceeds Issues

UCC Security Interests in Proceeds of Collateral: Perfection, Priority, and Impact of Debtor’s Bankruptcy.

Steve WeiseProskauer Rose LLP

September 1, 2021

Janet NadileMilbank LLP

Edwin E. SmithMorgan, Lewis & Bockius LLP

Proceeds issues

UCC Security Interests in Proceeds of Collateral

Janet Nadile

Milbank LLP

Edwin E. SmithMorgan, Lewis & Bockius LLP

Steve Weise

Proskauer Rose LLP

6

September 2021

Proceeds issues

Outline of program

• Meaning of ‘proceeds’• Article 9 rules

• Attachment of security interest • Perfection of security interest • Priority of security interest

• Proving what is ‘proceeds’• Bankruptcy Code § 552 issues

• Pre-petition property• ‘Equities of the case’ rule

• All statutory cites are to the UCC (unless otherwise indicated) and all emphasis is added

7

Proceeds issues

Definition of ‘proceeds’

§ 9-102(a)(64):

‘Proceeds’ . . . means the following property:(A) whatever is acquired upon the sale, lease, license, exchange, or

other disposition of collateral;(B) whatever is collected on, or distributed on account of, collateral;(C) rights arising out of collateral;(D) to the extent of the value of collateral, claims arising out of the

loss, nonconformity, or interference with the use of, defects or infringement of rights in, or damage to, the collateral; or

(E) to the extent of the value of collateral . . . , insurance payable by reason of the loss or nonconformity of, defects or infringement of rights in, or damage to, the collateral.

8

Proceeds issues

The outer reaches of ‘proceeds’ and beyond – ‘use’ of collateral

•1st Source Bank v. Wilson Bank & Trust, 735 F.3d 500 (6th Cir. 2013) (accounts not ‘proceeds’ of rigs used to generate accounts)

•In re Wright Grp., Inc., 443 B.R. 795 (Bankr. N.D. Ind. 2011) (fees paid to use a miniature golf course are not proceeds of the pencils used to keep score)

•In re Las Vegas Monorail, 429 B.R. 317 (Bankr.D. Nev. 2010) (rider fees not ‘proceeds‘ of monorail franchise)

•In the Matter of Value-Added Communications, 139 F.3d 543 (5th Cir. 1998) (fees for use of pay phones not ‘proceeds‘ of phones)

9

Proceeds issues

The outer reaches of ‘proceeds’ and beyond – ‘use’ of collateral

•In re Gamma Ctr., Inc., 489 B.R. 688, 696 (Bankr. N.D. Ohio 2013) (‘[T]he court is not persuaded that accounts receivable or funds collected thereon as the result of using equipment collateral constitute proceeds under the UCC.’)

•In re S & J Holding Corp., 42 B.R. 249, 250 (Bankr. S.D. Fla. 1984) (cash revenues generated by video game machines and vending machines do not constitute ‘proceeds’)

10

Proceeds issues

The outer reaches of ‘proceeds’ and beyond – commercial tort claims

• City Sanitation, LLC v Burdick (In re Am. Cartage, Inc.), 656 F.3d 82 (1st Cir. 2011) (commercial

tort claim not ‘proceeds’ of interference with use of equipment)

• In re Puerto Rico Hospital Supply, Inc., 617 B.R. 181 (Bankr. D.P.R. 2020) (Secured party cannot

have a security interest in a commercial tort claim as proceeds of other collateral)

• In re EPD Investment Co., 2020 WL 6937351 (Bankr. C.D. Cal. 2020) (security interest cannot

attach to proceeds of settlement of commercial tort claims because a security interest

cannot encumber after-acquired commercial tort claims and must describe commercial tort

claims with some specificity)

• In re Alliance Insurance Group of Akadelphia, Inc., 2019 WL 1992622 (Bankr. W.D. Ark. 2019)

(Secured party’s security interest did not attach to any commercial tort claims the debtor

might have against third parties for converting or interfering with the debtor’s book of

business (also known as referrals) because, even if the claims were proceeds of collateral,

the claims were not specifically described in the security agreements and did not exist when

the security agreements were entered into)

11

Proceeds issues

The outer reaches of ‘proceeds’ and beyond – avoidance actions

•In re EPD Investment Co., 2020 WL

6937351 (Bankr. C.D. Cal. 2020)

(security interest cannot attach to

proceeds of avoidance action)

12

Proceeds issues

The outer reaches of ‘proceeds’ and beyond – insurance

•§ 9-102(a)(64) – ‘proceeds’ includes ‘to the extent of the value of collateral . . . , insurance payable by reason of the loss or nonconformity of, defects or infringement of rights in, or damage to, the collateral.’

• In re Richard M. Judy Family Trust, 614 B.R. 685 (Bankr. W.D. Mo. 2020) (Priority of perfected PMSI in an item of equipment destroyed by fire had priority in the portion of the insurance proceeds attributable to the item over a bank with a perfected security interest in all equipment, even though the bank was listed as the loss payee on the insurance policy)

• In re PES Holdings, Inc., 2021 WL 24719 (D. Del. 2021) (business interruption insurance can be ‘proceeds’)

13

Proceeds issues

The outer reaches of ‘proceeds’ and beyond – distributions on stock etc.

•In re Hastie, 2 F.3d 1042 (10th Cir. 1993) (dividend on stock not proceeds of the stock)

•§ 9-102(a)(64): ‘proceeds’ includes ‘whatever is collected on, or distributed on account of, collateral’

14

Proceeds issues

The outer reaches of ‘proceeds’ and beyond – PIK payments

•U.S. v. Carolina Eastern Chemical Co., Inc., 638 F. Supp. 521 (D.S.C. 1986) (PIK payments not proceeds of crops)

•Sweetwater Production Credit Ass'n v. O'Briant, 764 S.W.2d 230 (Tex. 1988) (PIK payments are proceeds)

•In re Vaqueria Las Martas, Inc., 617 B.R. 429 (Bankr. D.P.R. 2020) (Security interest in the debtor’s milk quota - a license to produce milk for the fresh milk market - but no security interest in the debtor’s cows did not have a security interest in the debtor’s milk or the proceeds thereof as the milk was not proceeds of the quota)

15

Proceeds issues

The outer reaches of ‘proceeds’ and beyond – intercreditor agreements

•BOKF, N.A. v. JP Morgan Chase Bank, N.A. (In re MPM Silicones, LLC), 518 B.R. 740 (Bkrtcy. S.D.N.Y. 2014) (distributions under a Chapter 11 plan are not ‘proceeds’ of secured creditors’ collateral)

•In re Energy Future Holdings, Corp., (Bankr. D.Del. March 11, 2016) (same)

•In re Energy Future Holdings, Corp., (Bankr. D.Del. April 12, 2016) (same)

16

Proceeds issues

Non-Article 9 issues

•Non-Article 9 original collateral can generate proceeds that are Article 9 collateral (but only as ‘original’ collateral, not as ‘proceeds’ of Article 9 collateral)

o Real estate rents once collected

o Sale of real property for note or payment right

o But see In re Anderson, 599 B.R. 504 (D. Md.), appeal filed, (4th Cir. July 24, 2019) (secured party with a mortgage on real property and a security agreement covering insurance proceeds had a security interest in the proceeds of an insurance claim for damage to the real property)

17

Proceeds issues

Article 9 adjacent rules – proceeds of consigned goods

In re Pettit Oil Co., 575 B.R. 905 (9th Cir. BAP

2017) (Subordination of consignor’s consignment interest to the security interest of the consignee’s inventory secured party extends to proceeds of consigned goods)

18

Proceeds issues

Non-Article 9 issues

•Application of Article 9 rules by analogy?

o Proceeds of agricultural liens, § 9-322(g) & cmt. 12

o Proceeds of statutory liens

•Article 9 collateral can result in non-Article 9 proceeds, but Article 9 security interest would not attach to the proceeds if the type of proceeds are outside the scope of Article 9

19

Proceeds issues

Attachment

•Security interest in collateral attaches to ‘identifiable’ proceeds of collateral, §§ 9-203(f), 9-315(a)(2)

oMay use method of tracing to identify collateral, § 9-315(b)(2)

•Restatement Restitution and Unjust Enrichment § 59

20

Proceeds issues

Attachment -- tracing

Universal CIT Credit Corp. v. Farmers Bank of Portageville, 358 F.Supp. 317 (E.D. Mo. 1973) (Use of trust law equitable tracing principles to identify proceeds)

21

Proceeds issues

Perfection

Perfected security interest in collateral is automatically perfected in proceeds (if identifiable) for at least 20 days, § 9-315(c) (if security interest attaches)

22

Proceeds issues

Perfection

•Security interest becomes unperfected after 20 days unless:

o Financing statement perfects security interest in original collateral and proceeds are type of collateral where filing in the same office would perfect the security interest and proceeds have not been acquired with cash proceeds, or

o Proceeds are identifiable cash proceeds, or

o Security interest in proceeds perfected by regular means before end of 20 days

•§ 9-315(d)

23

Proceeds issues

Priority (general rule)

§ 9-322(b)(1):

‘the time of filing or perfection as to a security interest in collateral is also the time of filing or perfection as to a security interest in proceeds’

24

Proceeds issues25

Priority in accounts that are proceeds of inventory

•Account is proceeds of inventory

•SP-1 wins as to accounts

•§ 9-322(b)(1) (priority dates to time of filing against the original collateral-inventory)

•Lesson: It pays to be first to file

1 2 3

SP-1 files on

inventory

SP-2 files

on accounts

Day

Inventory

sold +

account

arises

Proceeds issues26

Priority in accounts that are proceeds of inventory

•Account is proceeds of inventory•SP-1 wins as to accounts•§ 9-322(b)(1) (relates back to time of filing against

accounts)•Lesson: Review search reports for prior filings against

your intended collateral and items that may be proceeds of your intended collateral

1 2 3

SP-1 files

on accounts

SP-2 files on

inventory

Day

Inventory

sold +

account

arises

Proceeds issues27

Priority: non-temporal rules (other than PMSIs)

Super (non-temporal) priority in original collateral extends to certain proceeds, § 9-322(c) if:

•Secured party has super-priority in original collateral under §§ 9-327 – 9-331 (deposit accounts, investment property, l/c rights, chattel paper, instruments)

•Security interest in proceeds is perfected

•Proceeds are ‘cash proceeds‘ or same type of collateral as original collateral:

o ‘“Cash proceeds” means proceeds that are money, checks, deposit accounts, or the like,’ § 9-102(a)(9)

Proceeds issues28

Priority: non-temporal rules (other than PMSIs)

Super (non-temporal) priority in proceeds has priority over security interest in proceeds as ‘proceeds’ if other rules of Article 9 would give it priority, § 9-322(f)

Proceeds issues

Priority – non-temporal rules (other than PMSIs)

In re Delano Retail Partners, LLC, 2017 WL 3500391 (Bankr. E.D. Cal. 2017)

(Under § 9-332(b) lien creditor that levies on deposit account can have priority over perfected security interest in deposit account as ‘proceeds’ of other collateral)

29

Proceeds issues

Priority in stock distributions as proceeds of stock

•SP-2 wins as to right to dividend•§§ 9-322(c)(2) & 9-328(5)•Lesson: It pays to be ‘super’•SP-1 should consider taking possession of stock

to prevent SP-2 from taking possession

30

1 2 3

SP-1 files as

to dividends

SP-2 takes

possession

of stock

Day

Dividend

declared

Proceeds issues

Priority in payments on chattel paper as proceeds of the chattel paper

• SP-2 wins as to right to payment• §§ 9-322(c)(2) & 9-330(b), (c)• SP-1 should consider taking possession of chattel paper to

prevent SP-2 from taking possession• Discussion Point: Commercial Money Center and 2010 Revisions

to Article 9

31

1 2 3

SP-1 files as to

payment right

stripped from

chattel paper

SP-2 takes

possession

of chattel

paper

Day

Account

debtor

makes

payment

Proceeds issues

Commercial Money Center and 2010 Revisions to Article 9

New language to § 9-102 comment 5.d provides:

Thus, an assignment of the lessor‘s right to payment under a lease also transfers the lessor’s rights with respect to the leased goods under Section 2A-523. If, taken together, the lessor‘s rights to payment and with respect to the leased goods are evidenced by chattel paper, then, contrary to In re Commercial Money Center, Inc., 350 B.R. 465 (Bankr. App. 9th Cir. 2006), an assignment of the lessor‘s right to payment constitutes an assignment of the chattel paper. Although an agreement excluding the lessor‘s rights with respect to the leased goods from an assignment of the lessor‘s right to payment may be effective between the parties, the agreement does not affect the characterization of the collateral to the prejudice of creditors of, and purchasers from, the assignor.

32

Proceeds issues33

Priority in proceeds of PMSI collateral

•Both SP-1 and SP-2 have a security interest in the account as ‘proceeds’ of equipment

•SP-2 wins as to account•§ 9-324(a)

1 2 3

SP-1 files on

equipment

SP-2 obtains

PMSI in

equipment

Day

Equipment

sold and

account

arises

Proceeds issues34

Priority in proceeds of PMSI collateral

•Both SP-1 and SP-2 have a security interest in the money as ‘proceeds’ of inventory

•SP-2 wins as to money (if received at or before delivery of goods to buyer)

•§ 9-324(b)

1 2 3

SP-1 files as

to inventory

SP-2 obtains

PMSI in

inventory

Day

Inventory

sold for cash

Proceeds issues35

Priority in proceeds of PMSI collateral

•SP-2 wins as to chattel paper•No superpriority under § 9-324(b), so the

general first-to-file priority rule of § 9-322(a)(1) applies

1 2 3

SP-1 files on

inventory

SP-2 obtains

PMSI in

inventory

Day

Inventory

sold, chattel

paper arises,

SP-2 takes

possession

Proceeds issues36

Priority in proceeds of PMSI collateral

•SP-1 wins as to account

•§ 9-324(b)

•SP-2 would win if its filing were first

1 2 3

SP-1 files on

inventory

SP-2 obtains

PMSI in

inventory

Day

Inventory

sold and

account

arises

Proceeds issues37

Proving what are the ‘proceeds’

• In re Aerogroup International, Inc., 2019 WL 2120735 (Bankr. D. Del. 2019) (even if some portion of the settlement payment was for a loss to the value of the debtors’ intellectual property, and thus proceeds of THL’s collateral, it was not ‘identifiable proceeds’)

• In re Montreal, Maine & Atlantic Railway, Ltd., 956 F.3d 1 (1st Cir. 2020) (secured party must prove ‘value’ of the proceeds of its collateral when there are other assets being disposed of at the same time)

• In re JMF Cab, Inc., 614 B.R. 648 (Bankr. D. Mass. 2020) (Must apportion bulk payment for assets to ‘proceeds’)

• Wheeling & Lake Erie Railway Co. v. Keach, 606 B.R. 1 (D. Me.), appeal filed, (1st Cir. Sept. 7, 2019) (Secured party failed to identify what portion, if any, of a global settlement of claims against the shipper were its collateral.)

Proceeds issues38

Bankruptcy Code issues – Bankruptcy Code § 552

‘Except as provided in subsection (b) of this section, property acquired by the estate or by the debtor after the commencement of the case is not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case.’

Proceeds issues39

Bankruptcy Code issues – Bankruptcy Code § 552 – what is ‘property’ and when is it ‘acquired’?

•In re Financial Oversight and Management Board for Puerto Rico, 948 F.3d 457 (1st Cir. 2020) (‘mere expectancy’ is not ‘property’ and cannot be ‘acquired’ until it is ‘property’)

Proceeds issues40

Bankruptcy Code issues – Bankruptcy Code §552(b)(1)

‘if the debtor and an entity entered into a security agreement before the commencement of the case and if the security interest created by such security agreement extends to property of the debtor acquired before the commencement of the case and to proceeds … of such property, then such security interest extends to such proceeds, products, offspring, or profits … acquired by the estate after the commencement of the case to the extent provided by such security agreement and by applicable nonbankruptcy law,’

Proceeds issues41

Bankruptcy Code issues – Bankruptcy Code §552(b)(1) – ‘equities of the case exception’

• ‘… except to any extent that the court, after notice and a hearing and based on the equities of the case, orders otherwise.’• Legislative history suggests that ‘equities of the

case’ exception was intended to compensate a debtor’s estate for the use of unencumbered property expenditures that augment the value of the secured party’s collateral, creating a windfall for the secured party. H. Rep. No. 95-595, 95th

Cong., 1st Session 376-377 (1977)