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? 6. Under what circumstances should a secured party be allowed to repossess an item when the debtor defaults? Article 9 states that when a debtor is in default, the secured party can repossess the item so long as there is no "breach of the peace." What is a breach of the peace? 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 are filed. Oftentimes the real life stories of persons and businesses filing for bankruptcy are quite different from the stereotypes that students have in mind of bankruptcies. 5. Have students pretend they are filing bankruptcy themselves. First, have them make a list of all of their assets. Then, have them make a schedule of all of their debts. You might obtain copies of the forms used in the bankruptcy court in your district and have students complete them using themselves as the debtor. After they have listed all of their assets and debts, then have them chose which of their assets they would chose as exemptions. Finally, have them analyze whether from a purely business perspective bankruptcy would be a good alternative for them to consider at this point in their lives and careers. 6. Research cases involving attachment and perfection in your area. Under what sorts of fact situations do issues of attachment and perfection tend to arise? Have students find an interesting case involving either attachment or perfection. Then, have them suggest how a lawsuit could have been avoided. What action should the creditor have taken to avoid problems with the security agreement? Chapter 37 SECURED TRANSACTIONS AND SURETYSHIP 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 parties to a security agreement after default by the debtor. • Explain the requirements for the formation of a suretyship relationship. • Explain the rights of a creditor against a surety and the rights of a surety, including those of a cosurety. • 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. 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’ liens. Article 9 was substantially revised in 1998, and the 1998 revisions have been adopted in all States. In 2010, Article 9 was amended to respond to filing issues and address other matters that have arisen in practice with the 1998 Revisions of Article 9. The 2010 Amendments took effect on July 1, 2013; this delay allowed the States to adopt the amendments uniformly and have them begin at the same time. All States have adopted the 2010. This chapter covers Article 9 as revised in 1998 and 2010. 37-1 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 Purchase Money Security Interest— security interest in goods purchased; interest is retained either by the seller of the goods or by a lender who advances the purchase price A seller of goods who retains a security interest in them by a security agreement has a purchase money security interest (PMSI). A lender has a purchase money security agreement if the debtor uses the funds to purchase goods, which are the collateral to the secured transaction. 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. 37-2 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. 37-2a 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 farming operations. Inventory — Goods held for sale or lease including raw materials and work in progress. Equipment — Goods used primarily in business, including farming or the professions. Fixtures — Goods that are firmly attached to the realty so as to be considered part of the real property under state law. Accessions — Goods installed in or firmly affixed to personal property. 37-2b 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. 37-2c Intangibles Neither goods nor indispensable paper, i.e., accounts and general intangibles. Accounts — An “account receivable” is a right to receive payment for goods sold or leased or for services provided; includes contract rights. General Intangibles — Any personal property other than goods, accounts, chattel paper, documents, instruments, and money. Includes goodwill, literary rights, patents, and trademarks. 37-2d 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. 37-3 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. 37-3a Value The term value is broadly defined and includes consideration under contract law, a binding commitment to extend credit, and an antecedent debt. 37-3b Debtor’s Rights in Collateral Generally, a debtor has rights in any collateral that he owns or has in his possession. This rule would also apply to collateral that the debtor is actively acquiring from the seller. 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 or in the possession of the secured party pursuant to an agreement. A pledge is the delivery of personal property to a creditor. This rule applies to a security interest in negotiable documents, goods, instruments, money, and tangible chattel paper. Other situations in which a secured party does not need a record authenticated by the debtor include: (1) The collateral is a certificated security in registered form which has been delivered to the secured party Section 9-203(b)(3)(C). (2) The collateral is a deposit account, electronic chattel paper, investment property, or letter-of-credit rights and the secured party has control over the collateral 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 and Anderson mutually to agree when the calves would be sold and within thirty days of receiving money for the sale, Johnson Farms to pay the “remainder” to Anderson “for his keeping of [the] cattle.” In the fall of 1998 and 1999, calves bred under the contract were sold under the provisions of the written contract. Anderson testified that in October 1999, Johnson asked him to care for additional cattle on the same terms. Anderson initially declined, explaining to Johnson that he was ending his cattle business because of adverse personal circumstances. Anderson said that his father had died, his mother was in a nursing home, his partner, Linda 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 March 2000, Anderson negotiated with Border State Bank for loans totaling $155,528. To secure these loans, Anderson granted Border State Bank a security interest in, among other things, all of Anderson’s “rights, title and interest” in all “livestock” then owned or thereafter acquired. After the modification of the cattle-sharing contract, Johnson made a number of shipments of beet tailings to Anderson. When Johnson stopped the shipments, he sent checks totaling $55,000 to Anderson for the purchase of feed. In November 2000, Anderson encountered difficulty caring for the cattle due to heavy rainfall and lack of feed. The cattle were reclaimed by Johnson, but the calves remained with Anderson for sale. At trial, Anderson testified that some of the cattle that Johnson reclaimed were actually Anderson’s cattle or were cattle that belonged to Evonne Stephens, another person with whom Anderson had a cattle-sharing contract. 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. Border State Bank sued Bagley Livestock Exchange and Johnson, contending that they had converted Border State Bank’s perfected security interest in the calves sold in December 2000. *** Anderson served a counterclaim against Johnson, asserting breach of contract. 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 ***. * * * Article 9 of the Uniform Commercial Code, incorporated into Minnesota law, provides that a security interest attaches to collateral, and is enforceable against the debtor or third parties, when (1) value has been given; (2) the debtor “has rights in the collateral or the power to transfer rights”; and (3) the debtor has signed a security agreement that contains a description of the collateral. [UCC] 9-203(b). To perfect the security interest, both the security agreement and financing statement must contain an adequate description of the collateral. [Citation.] We liberally construe descriptions in the security agreement and financing statement because their essential purpose is to provide notice, not to definitively describe each item of collateral. [Citation.] 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 do not modify the terms of the agreement such that an ownership interest is granted.” Based on the arguments presented, the district court apparently determined that, for Border State Bank’s security interest to attach, Johnson would have had to grant Anderson an interest equivalent to ownership. The provisions of the Uniform Commercial Code’s Article 9, incorporated into Minnesota law, refer to “rights in the collateral,” not solely the “ownership” of the collateral. [UCC] §9-203(b)(2) (stating security interest may attach to collateral if” the debtor has rights in the collateral or the power to transfer rights in the collateral”). Rights in the 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 attachment, but the debtor need not have full ownership. [Citation.] * * * The district court did not analyze the modified cattle- sharing contract to determine the nature of Anderson’s rights in the calves or whether Anderson’s interests or rights were sufficient to permit attachment of a security interest. We conclude that the standard relied on by the district court is inconsistent with Minnesota law. The application of the incorrect standard prematurely terminated the analysis of the cattle-sharing agreement, which is necessary to determine whether Anderson’s rights in the collateral were sufficient for the bank’s security interest to attach. * * * Because the district court applied a standard of ownership that is inconsistent with Minnesota law, its finding that the security interest did not attach was influenced by an error of law. * * * On remand, the district court shall consider the cattle-sharing agreement to determine whether Anderson had “rights” in the calves, to which the bank’s security interest attached. 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 floating lien. Future Advances — A security agreement may include obligations for debts to be incurred in the future, if the debtor is permitted to take advances from an approved line of credit as needed. 37-4 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. 37-4a 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 isolated accounts. Filing may be used to perfect a security interest in any other kind of collateral, with the general exception of deposit accounts, letter-of-credit rights, and money. A financing statement may be filed before or after the security interest attaches. NOTE: Figure 37-3 shows a sample financing statement. 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 offers 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 to be used on the financing statement. If the debtor does not have such a driver’s license, either the debtor’s actual name or the debtor’s surname and first personal name may be used on the financing statement. • Alternative B provides that the debtor’s driver’s license name, the debtor’s actual name, or the debtor’s surname and first personal name may be used on the financing statement. 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 different 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. With real-estate-related collateral, the financing statement is to be filed in the office designated for the filing or recording of mortgages on the related real property, which is usually local. 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 transfers the collateral to a person, who becomes the debtor, in another State. The 2010 Amendments also address perfection issues related to after-acquired property when a debtor moves to a new State. Under the 2010 Amendments, this four-month period of perfection applies to security interests that attach to collateral acquired after the debtor moves. Thus, a filed financing statement that would have been effective to perfect a security interest in the collateral if the debtor had not changed its location is effective to perfect a security interest in collateral acquired within four months after the debtor relocates. 37-4b 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. One type of pledge is the field warehouse, where the debtor's unsold inventory is housed and then released as the goods are sold, at a specified quantity per week, or at any rate on which the parties agree. Thus, the secured party legally possesses the goods while allowing the debtor easy access to her inventory. 37-4c 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). CASE 37-2 KIMBRELL’S OF SANFORD, INC. v. KPS, INC. Court of Appeals of North Carolina, 1994 113 N.C.App 830,440 S.E.2d 329 http://scholar.google.com/scholar_case?case=59507666894516031 62&hl=en&as_sdt=2&as_vis=1 i=scholarr McCrodden, J. This action arises out of plaintiff’s attempt to recover from defendant KPS, Inc. a VCR which plaintiff had sold to defendant Burns and which Burns had immediately pawned at the Kendale Pawn Shop. Plaintiff filed a complaint in small claims court, and the magistrate, after a hearing on 17 February 1992, entered judgment denying plaintiff recovery of the VCR. Plaintiff appealed to the district court. Judge William A. Christian, sitting without a jury, entered judgment denying plaintiff recovery and dismissing the action. From this judgment, plaintiff appeals. Plaintiff offers one argument raising the issue of whether it was entitled to recover from defendant pawn shop a VCR plaintiff had sold to defendant Burns under a purchase money security agreement. * * * Plaintiff argues that the judgment denying it recovery of the VCR contravened Article 9 of the Uniform Commercial Code, [citation]. We agree. At the time defendant Burns purchased the VCR from plaintiff, he signed a purchase money security agreement, thereby granting plaintiff a purchase money security interest in the VCR. [UCC] §9-107 [Revised §9-103]. Since a VCR is a consumer good, [UCC] §9-109(1) [Revised §9-102(a)(23)], plaintiff did not have to file a financing statement in order to perfect its purchase money security interest in the VCR. [UCC] §9-302(1)(d) [Revised §9-309]. Defendant Burns failed to make any further payments for the VCR and defaulted on the security agreement. Therefore, plaintiff was entitled to recover possession of the VCR when it filed its action in small claims court. [UCC] §9-501 [Revised §9-601], 9-503 [Revised 9-609]. Accordingly, we hold that the trial court erred in dismissing plaintiff’s claim to recover possession of the VCR. * * * For the foregoing reasons, we reverse the judgment of the trial court and remand for entry of judgment in favor of plaintiff. Reversed. 37-4d Temporary Perfection Security interests in some types of collateral are automatically perfected but only for a temporary period. A security interest in negotiable documents or instruments is automatically perfected, without filing or taking possession, for twenty days from the time it attaches, to the extent of the new value given under a written security agreement. 37-4e Perfection by Control Control may be used to perfect a security interest in electronic chattel paper, investment property, non-consumer deposit accounts, and letter-of-credit rights NOTE: See Figure 37-4: Methods of Perfecting Security Interests. *** Chapter Outcome*** Discuss the priorities among the various parties who may have competing interests in collateral and the rights and remedies of the parties to a security agreement after default by the debtor. 37-5 PRIORITIES AMONG COMPETING INTERESTS Perfection of a security interest does not provide the secured party with a priority over all third parties; sometimes, even an unperfected but attached security interest has priority. Article 9 establishes a complex set of rules that determine the relative priorities among these parties. NOTE: See Figure 37-5: Priorities. 37-5a Against Unsecured Creditors An attached, though unperfected, security interest will defeat the claims of an unsecured creditor. 37-5b Against Other Secured Creditors Perfected versus Unperfected — Perfected interests prevail over those that are unperfected. Perfected versus Perfected — The first party to file or perfect will prevail. Exceptions: (1) A PMSI in noninventory collateral will take priority over a previously perfected security interest if perfection of the PMSI (i.e., filing) is accomplished when the debtor takes possession or within the twenty day grace period. (2) A PMSI in inventory has priority over earlier-filed security interests in inventory if the holder (a) perfects his interest in the inventory at the time the debtor receives the inventory;(b) sends an authenticated notification to the holder of a conflicting security interest; and if (c) the holder of the conflicting security interest receives the notification within five years before the debtor receives possession of the inventory; and (d) the notification states that person sending the notification has or will acquire a PMSI in inventory of the debtor and describes the inventory. (3) A security interest perfected by control in deposit accounts, letter-of-credit rights, or investment property has priority over a conflicting perfected security interest held by a secured party who does not have control. Unperfected versus Unperfected — If neither security interest is perfected, the first to attach has priority. If neither attaches, both creditors are general, unsecured creditors. 37-5c Against Buyers A security interest continues even in collateral that is sold, unless the secured party authorizes the sale, but in some cases, buyers of collateral sold without the secured party’s authorization take it free of the security interest. Buyers in the Ordinary Course of Business — someone who purchases in good faith, from a merchant, without knowledge that the sale violates a security interest of a third party — takes collateral free of any security interest created by her seller, even if the security interest is perfected and the buyer knows of its existence. Buyers of Farm Products — Protected by the Federal Food Security Act, which provides that buyers of farm products take free of most security interests. Some exceptions apply. Buyers of Consumer Goods — A consumer who buys without knowledge, for value, and for personal use will prevail over a prior PMSI that was automatically perfected. This purchase will, however, be subject to any security interest that has been perfected by filing. Buyers of Other Collateral — To the extent provided by U.C.C. Articles 3, 7, and 8, a secured party who has a perfected security interest in a negotiable instrument, a negotiable document of title, or a security has a subordinate interest to a purchaser of (1) the instrument who has the rights of a holder in due course, (2) the document of title to whom it has been duly negotiated, or (3) the security who is a protected purchaser. In addition, in certain instances a secured party who has a perfected security interest in chattel paper also may have subordinate rights to a purchaser of such collateral. 37-5d Against Lien Creditors A lien creditor (one who has acquired an interest in the property by judicial decree) with a perfected security interest or agricultural lien has priority over lien creditors who acquire their liens after perfection, An unperfected security interest or agricultural lien is subordinate to the rights of one who becomes a lien creditor before (1) its perfection or (2) a financing statement covering the collateral is filed and either (a) the debtor has authenticated a properly drawn security agreement, (b) if the collateral is a certificated security, the certificate has been delivered to the secured party, or (c) if the collateral is an uncertificated security, it is in possession of the secured party.. EXCEPTION: a purchase money security interest filed within 20 days after the debtor receives possession of the collateral takes priority over the rights of a lien creditor that arise prior to perfection. 37-5e Against Trustee in Bankruptcy A trustee in bankruptcy is a representative of an estate in bankruptcy; responsible for collecting, liquidating, and distributing the debtor’s assets. May invalidate secured claims in certain instances. NOTE: The role of a trustee in bankruptcy will be examined in greater detail in Chapter 39. Priority Over Unperfected Security Interest — The trustee in bankruptcy has priority over a creditor whose security interest was not perfected when the bankruptcy petition was filed. A creditor with a purchase money security interest who files within the statutory twenty day grace period after the debtor receives the collateral will defeat the trustee in bankruptcy, however, even if the bankruptcy petition is filed before the creditor perfects. Avoidance of Preferential Transfers — Trustee in bankruptcy may invalidate a transfer of property from the debtor, if all these are true: (1) it benefited a creditor; (2) it was for an antecedent debt; (3) the debtor was insolvent; (4) made on or within ninety days before the filing of the bankruptcy petition, and (5) it enabled the transferee to receive more than he would have received in bankruptcy. NOTE: See Figure 37-5: Priorities. 37-6 DEFAULT Upon default the secured party is entitled to possession of the collateral. Unless the debtor has waived his rights in the collateral after default, he has a right of redemption. 37-6a Repossession Unless the parties have agreed otherwise, the secured party may take possession of the collateral on default without judicial process if she can do so without a breach of the peace. Instead of repossessing the collateral, he may render it unusable and leave it on the debtor’s premises until disposing of it. CASE 37-3 CHAPA v. TRACIERS & ASSOCIATES Court of Appeals of Texas, Houston (14th Dist.), 2008 267 S.W.3d 386, 66 UCC Rep.Serv.2d 451 http://scholar.google.com/scholar_case?case=17834235023292100581&q=267+S.W.3d+386&hl=en&as_sdt=2,34 Guzman, J. In this appeal, we must determine whether appellants, the parents of two young children, have legally cognizable claims for mental anguish allegedly sustained when a repossession agent towed their vehicle out of sight before he realized their children were inside. The parents filed suit against the financing company, the repossession company it hired, I and the repossession agent who towed the vehicle. They asserted claims for mental anguish and its physical manifestations under (a) [UCC] section 9.609 * * * Ford Motor Credit Corp. (“FMCC”) hired Traciers & Associates (“Traciers”) to repossess a white 2002 Ford Expedition owned by Marissa Chapa, who was in default on the associated promissory note. Traciers assigned the job to its field manager, Paul Chambers, and gave him an address where the vehicle could be found. FMCC, Traciers, and Chambers were unaware that the address was that of Marissa’s brother, Carlos Chapa. Coincidentally, Carlos and his wife Maria Chapa also had purchased a white Ford Expedition financed by FMCC. Their vehicle, however, was a 2003 model, and the Chapas were not in default. On the night of February 6, 2003, Chambers went to the address and observed a white Ford Expedition. The license number of the vehicle did not match that of the vehicle he was told to repossess, and he did not see the vehicle’s vehicle identification number (“VIN”), which was obscured. Chambers returned early the next morning and still could not see the Expedition’s VIN. He returned to his own vehicle, which was parked two houses away. Unseen by Chambers, Maria Chapa left the house and helped her two sons, ages ten and six, into the Expedition for the trip to school. Her mother-in-law’s vehicle was parked behind her, so Maria backed her mother-in-law’s vehicle into the street, then backed her Expedition out of the driveway and parked on the street. She left the keys to her truck in the ignition with the motor running while she parked her mother-in-law’s car back in the driveway and reentered the house to return her mother-in-law’s keys. After Chambers saw Maria park the Expedition on the street and return to the house, it took him only thirty seconds to back his tow truck to the Expedition, hook it to his truck, and drive away. Chambers did not leave his own vehicle to perform this operation, and it is undisputed that he did not know the Chapa children were inside. When Maria emerged from the house, the Expedition, with her children, was gone. Maria began screaming, telephoned 911, and called her husband at work to tell him the children were gone. Meanwhile, on an adjacent street, Chambers noticed that the Expedition’s wheels were turning, indicating to him that the vehicle’s engine was running. He stopped the tow truck and heard a sound from the Expedition. Looking inside, he discovered the two Chapa children. After he persuaded one of the boys to unlock the vehicle, Chambers drove the Expedition back to the Chapas’ house. He returned the keys to Maria, who was outside her house, crying. By the time emergency personnel and Carlos Chapa arrived, the children were back home and Chambers had left the scene. Maria testified that the incident caused her to have an anxiety attack, including chest pain and numbness in her arm. She states she has continued to experience panic attacks and has been diagnosed with an anxiety disorder. In addition, both Carlos and Maria have been diagnosed with post-traumatic stress disorder. * * * The Chapas first argue that the trial court erred in granting summary judgment against them on their claim that appellees are liable under [UCC] section 9.609. This statute provides in pertinent part: (a) After default, a secured party: (1) may take possession of the collateral; (b) A secured party may proceed under Subsection (a): * * * (2) without judicial process, if it proceeds without breach of the peace. [Citation.] The Chapas correctly point out that this statute imposes a duty on secured creditors to take precautions for public safety when repossessing property. [Citation.] Thus, the creditor who elects to pursue nonjudical repossession assumes the risk that a breach of the peace might occur. [Citation.] A secured creditor “remains liable for breaches of the peace committed by its independent contractor.” [Citation.] Thus, a creditor cannot escape liability by hiring an independent contractor to repossess secured property. The Chapas assert that FMCC and Traciers, who employed Chambers as a repossession agent, are liable for any physical or mental injuries sustained by Carlos and Maria as a result of Chambers’s breach of the peace. But this argument presupposes that a breach of peace occurred. * * * * * * Most frequently, the expression “breach of the peace” as used in the Uniform Commercial Code “connotes conduct that incites or is likely to incite immediate public turbulence, or that leads to or is likely to lead to an immediate loss of public order and tranquility.” [Citations.] (“[S]ecured creditor, in exercising privilege to enter upon premises of another to repossess collateral, may not perpetrate ‘[a]ny act or action manifesting force or violence, or naturally calculated to provide a breach of peace’) [Citations.] (“[A]lthough actual violence is not required to find ‘breach of the peace,’ within meaning of self-help repossession statute, disturbance or violence must be reasonably likely, and not merely a remote possibility.”); [Citation.] (no breach of peace when vehicle repossessed from public street while debtor inside house). In addition, “[b]reach of the peace ... refers to conduct at or near and/or incident to seizure of property.” [Citations.] (“[E]ven in attempted repossession of a chattel off a street, parking lot or unenclosed space, if repossession is verbally or otherwise contested at actual time of and in immediate vicinity of attempted repossession by defaulting party or other person in control of chattel, secured party must desist and pursue his remedy in court.”) Here, there is no evidence that Chambers proceeded with the attempted repossession over an objection communicated to him at, near, or incident to the seizure of the property. To the contrary, Chambers immediately “desisted” repossession efforts and peaceably returned the vehicle and the children when he learned of their presence. Moreover, Chambers actively avoided confrontation. By removing an apparently unoccupied vehicle from a public street when the driver was not present, he reduced the likelihood of violence or other public disturbance. In sum, the Chapas have not identified and we have not found any case in which the repossession of a vehicle from a public street, without objection or confrontation, has been held to constitute a breach of the peace. [Citation,] (deputy sheriff did not breach the peace when he repossessed debtor’s truck because, even if he violated traffic regulation when he drove away, he did so before debtor had an opportunity to confront him); [Citation,] (no breach of the peace occurred when repossession from parking lot was not verbally or otherwise contested). We therefore conclude that Chambers’s conduct did not violate a duty imposed by [UCC] section 9.609. * * * We therefore affirm the judgment of the trial court. 37-6b Sale of Collateral The secured party may sell (at public or private sale), lease, or otherwise dispose of any collateral in its current condition at the time of default or following any commercially reasonable preparation or processing. The debtor may be entitled to any surplus and liable for any deficiency. 37-6c Acceptance of Collateral The secured party or lien holder may send written notice to the debtor and to other secured parties that he proposes to retain the collateral in satisfaction of the obligation. If he receives no objection within twenty days, he may retain the collateral. If there is an objection, however, he must dispose of the collateral as provided in the Code. In the case of consumer goods, if the debtor has paid 60 percent or more of the obligation the secured party who has taken possession of the collateral must dispose of it by sale, usually within ninety days after repossession. SURETYSHIP A surety is someone in addition to the debtor who promises to fulfill the obligation. Sureties are commonly used in contracts involving minors, so that there is a party with full contractual capacity responsible for the obligations arising from the contract. Sureties are often used in addition to security to further reduce the risks and are used instead of security interests when the use of a secured transaction is unavailable, too expensive or inconvenient. 37-7 NATURE AND FORMATION The suretyship relationship involves three parties—principal debtor, creditor, and surety—and three contractual obligations. Cosurety — each of two or more sureties who are liable for the same debt of the principal debtor Absolute Surety — surety liable to a creditor immediately upon the default of a principal debtor Conditional Guarantor of Collection — surety liable to a creditor only after the creditor has exhausted the legal remedies against the principal debtor. NOTE: The suretyship relationship is illustrated by Figure 37-6. 37-7a Types of Sureties A simple suretyship arrangement is one where the surety promises to repay the loan if the primary debtor defaults. In this arrangement, the surety’s promise gives the creditor recourse for payment against two persons—the principal debtor and the surety—instead of one, thereby reducing the creditor’s risk of loss. A common example is the assumption of a mortgage. However, a purchaser who does not assume the mortgage, but simply takes the property subject to the mortgage, is not personally liable for the mortgage; nor is he a surety for the mortgage obligation. In this case, the purchaser’s potential loss is limited to the value of the property, for although the mortgagee creditor may foreclose against the property, she may not hold the purchaser personally liable for the debt. 37-7b Particular Kinds of Suretyships In addition to these more general kinds of sureties, there are numerous specialized kinds of suretyship. These include (1) fidelity, (2) performance, (3) official, and (4) judicial. Fidelity bonds allow an employer to be protected from a dishonest employee, while a performance bond protects against a breach of contract performance. Official bonds guarantee that a public official will faithfully perform his duties, and judicial bonds cover losses from a judicial proceeding. NOTE: See Figure 37-7: Assumption of Mortgage. *** Chapter Outcome*** Explain the requirements for the formation of a suretyship relationship. 37-7c Formation All contract elements must be present, and the statute of frauds generally requires that surety agreements be in writing. The promise of a surety is not binding without consideration. *** Chapter Outcome*** Explain the rights of a creditor against a surety and the rights of a surety, including those of a cosurety. 37-8 DUTIES OF SURETY Upon default by the principal debtor, the creditor may proceed against the surety to enforce the surety’s undertaking. . A surety or guarantor usually has no right to compel the creditor to collect from the principal debtor or to take action on collateral provided by the principal debtor. Nor is the creditor required to give the surety notice of the principal debtor’s default unless the contract of suretyship provides otherwise. A guarantor of collection, on the other hand, has no liability until the creditor exhausts his legal remedies of collection against the principal debtor, including taking action on collateral provided by the principal debtor. Up to the amount of each surety’s undertaking, cosureties are jointly and severally liable for the principal debtor’s default. The creditor may proceed against any or all of the cosureties and collect from any of them the amount that that surety has agreed to guarantee, up to and including the entire amount of the principal debtor’s obligation. 37-9 RIGHTS OF SURETY If the surety is an absolute surety, the creditor may hold the surety liable as soon as the principal debtor defaults. In contrast, a surety who is a conditional guarantor of collection is liable only when the creditor exhausts his legal remedies against the principal debtor. 37-9a Exoneration The surety has the right of exoneration — to require that her principal debtor pay the creditor when the obligation is due or to get a judgment against the debtor. A surety also has a right of exoneration against his cosureties to require each to pay her proportionate share of the principal debtor’s obligation. 37-9b Reimbursement A surety who pays the creditor has a right to recover payment from the principal debtor. 37-9c Subrogation On payment of the principal debtor’s entire obligation, the surety “steps into the shoes” of the creditor. Called subrogation, this confers on the surety all the rights the creditor has against or through the principal debtor. 37-9d Contribution Cosureties have joint and several liability, meaning that the creditor can collect from them as a group or from each individually, up to the amount of each surety’s undertaking. A surety who pays the total obligation may require her cosureties to pay to her their proportionate shares. (This is called the right of contribution.) 37-10 DEFENSES OF SURETY AND PRINCIPAL DEBTOR The obligations the principal debtor and the surety owe to the creditor arise out of contracts, so the usual contractual defenses apply; some are available only to the principal debtor, some only to the surety, and others to both parties. NOTE: See Figure 37-8: Defenses of Surety and Principle Debtor. 37-10a Personal Defenses of Principal Debtor The defenses available only to a principal debtor are known as the personal defenses of the principal debtor. These include: • The incapacity of the principal debtor • Discharge of the principal debtor’s obligation in bankruptcy • Any setoff (claim outside the transaction in question) that the principal debtor has against the creditor 37-10b Personal Defenses of Surety Those defenses that only the surety may assert are called personal defenses of the surety. These include: • The incapacity of the surety • Noncompliance with the statute of frauds in the surety’s contract • The absence of mutual assent or consideration to support the surety’s obligation • Fraud or duress practiced by the creditor on the surety • Setoff by surety • Modification of the contract between the creditor and the principal debtor • Creditor’s release of security or a cosurety 37-10c Defenses of Both Surety and Principal Debtor A number of defenses are available to both the surety and the principal debtor. These include: • The principal debtor’s signature is forged on an instrument • Fraud or duress exerted by the creditor on the principal debtor • Fraudulent and material alteration of the contract instrument by the creditor • The absence of mutual assent or consideration to support the principal debtor’s obligation • The illegality or impossibility of performance of the principal debtor’s contract Performance by the principal debtor discharges both the principal debtor and the surety. The creditor’s refusal to accept payment or performance by either the principal debtor or the surety completely discharges the surety, but does not discharge the principal debtor. CASE 37-4 AMERICAN MANUFACTURING MUTUAL INSURANCE COMPANY v. TISON HOG MARKET, INC. United States Court of Appeals, Eleventh Circuit, 1999 182 F.3d 1284, cert. denied, 531 U.S.819, 121 S.Ct. 59, 148 L.Ed.2d 26 (2000) http://scholar.google.com/scholar_case?case=13887389829730083003&q=182+F.3d+1284&hl=en&as_sdt=2,34 Cox, J. [Every livestock dealer must execute and maintain a reasonable bond to secure the performance of its obligations. Thurston Paulk, doing business as Paulk Livestock Company (Paulk Livestock), and Coffee County Stockyard, Incorporated (Coffee County Livestock), both livestock dealers, applied to plaintiff American Manufacturing Mutual Insurance Company (American) to serve as a surety and issue bonds for them to meet their legal requirements. The applications for both bonds contained agreements to indemnify American for any losses that it might incur as a result of their issuance. The principal debtor on the first bond was Thurston Paulk, doing business as Paulk Livestock. The application was signed by Thurston Paulk in his role as the sole proprietor of Paulk Livestock. The indemnification agreement contained the purported signatures of Thurston Paulk and Betty Paulk. The principal debtor on the second bond was Coffee County Livestock. This application contained the signature of Thurston Paulk in his role as president of Coffee County Livestock and contained the purported signatures of Thurston Paulk, Betty Paulk, and Ashley Paulk. After the bonds were issued, Paulk Livestock and Coffee County Livestock purchased numerous hogs from defendants Tison Hog Market, Inc.; Gainesville Livestock Market, Inc.; Townsend Livestock Market; South Carolina Farm Bureau Marketing Association; and Georgia Farm Bureau Marketing Association, Inc. When the defendant hog sellers did not receive payment for the hogs, they made claims against American on the surety bonds for the purchase money that they were owed. American conducted an investigation and learned that the bonds’ indemnification agreements contained forged signatures of Ashley Paulk and Betty Paulk. American claimed that it would not have issued the bonds had it known that Betty and Ashley Paulk had not agreed to indemnify it, and it declared the bonds rescinded and returned all the premiums. American then brought an action seeking a declaratory judgment relieving it from liability to the defendants on the ground that the bonds were void under Georgia insurance law due to the fraudulent and material misrepresentations of the bonds’ principals. American argued that the principals had forged the signatures of Betty and Ashley Paulk on the indemnification agreements. The district court granted American’s motion for summary judgment.] It is well established under the common law of suretyship that “fraud or misrepresentation practiced by the principal alone on the surety, without any knowledge or participation on the part of the creditor or obligee, in inducing the surety to enter into the suretyship contract will not affect the liability of the surety.” [Citations.] From a practical standpoint, this common law treatment of a principal’s fraud is the only one that makes sense. A creditor does business with a principal in reliance upon the existence of a bond. The bond provides security for the creditor because normally the creditor would have no way of knowing whether the principal is insolvent or otherwise an unreliable party with which to engage in business. [Citation.] If the creditor’s ability to recover on a bond was dependent on the accuracy of the principal’s representations to the surety, then the value of the bond to the creditor would be greatly lessened because the creditor would have no way of knowing what representations were made in the procurement of the bond. More importantly for the case at bar, this common law approach * * * enables a livestock seller to deal freely with livestock dealers knowing that the required bond will protect them in the event of a default even if the principal hid facts from the surety when obtaining the bond. * * * Instead of applying * * * insurance law, however, the district court should have applied Georgia surety law. The surety bonds in this case are surety contracts that are not governed exclusively by the insurance law of Georgia. * * * The Georgia Code contains an entirely separate title that applies to suretyship contracts. [Citation.] The chapter defines a contract of suretyship as one “whereby a person obligates himself to pay the debt of another in consideration of a benefit flowing to the surety * * *” [citation]. This is the commonly understood definition of a surety relationship and describes the situation that we have in the case at bar. The Georgia Code does not contain a statement as to the effect of a principal’s fraud on a surety’s liability to the creditor. Georgia courts, however, have applied the common law and held that a surety is still liable to a creditor even if the principal commits fraud so long as the creditor does not participate in the fraud. [Citation.] * * * Applying the common law to the case at bar, there is no evidence that the defendants participated in any fraud. The fraud was committed solely by the principals. Under these circumstances, American is not relieved of liability on the bonds. * * * For the foregoing reasons, the district court's judgment is vacated, and we remand this case for further proceedings consistent with this opinion. Instructor Manual for Smith and Robersons Business Law Richard A. Mann, Barry S. Roberts 9781337094757, 9780357364000, 9780538473637
Download
Close
Close
