Part V Perfecting an Article 9 Security Interest
Chapter 17 Perfection As To Goods Subject To Certificate Of Title Legislation
A. Generally
New section 9-102(a)(10) defines “certificate of title” essentially as a certificate of title issued pursuant to a statute requiring that a security interest be indicated on the title in order for the security interest to be perfected. As we saw in Chapter 12 (Perfection Generally), under new section 9-311(b) filing a financing statement is neither necessary nor sufficient to perfect a security interest in goods subject to a certificate of title statute requiring as a condition of perfection that the security interest be indicated on the certificate of title.
Rather, under new section 9-311(a)(2), to perfect a security interest in goods subject to a certificate of title statute requiring "lien notation" (for the most part vehicles operated on a highway) a secured party must comply with the demands of the statute for getting its security interest noted on the certificate of title covering the goods. See, e.g., A.R.S. § 47-9311(A), pointing to Title 28 of the Arizona Revised Statutes (Arizona's motor vehicle code).
Subject to certain qualifications as to timing and choice of law, the operative principle is that if the security interest is noted on a certificate of title covering the goods then the security interest is perfected but if the security interest is not so noted (the certificate is "clean") then the security interest is not perfected. As discussed further below, under new section 9-311(d), perfection of a security interest in goods held for sale or lease by a debtor engaged in selling such goods is outside the lien notation scheme and the usual modes of perfection provided for in new Article 9 apply.
Perfection by lien notation typically requires a secured party to apply for a title indicating its security interest to the agency responsible for administering the certificate of title statute. In most states, including Arizona, there is no need to submit the security agreement and an application signed by the debtor is enough.
Perfection by lien notation typically requires a secured party to apply for a title indicating its security interest to the agency responsible for administering the certificate of title statute. In most states, including Arizona, there is no need to submit the security agreement and an application signed by the debtor is enough.
Most states, including until very recently Arizona, have employed a “title holder” scheme according to which the certificate of title is issued to the debtor and the security interest is noted on the title. To view a sample of a certificate of title, this one as employed in Arizona (until any change in the system as is discussed below is made), click here. You will see the place for lien notation on the title.
In 2003, Arizona made two important changes to its certificate of title system. The first is that no longer are certificates of title to be issued to the vehicle owners. Rather they go to the secured party and a “new” certificate cannot be issued to the vehicle owner until the secured debt has been satisfied (or the secured party has consented in writing or electronically to the transfer of title). A.R.S. § 28-2132(D).
Second, paper certificates of title will be replaced by electronic certificates of title. Initially the use of an electronic title will be voluntary, but this could change if the electronic title scheme is deemed successful. A.R.S. § 28-2064. The administrative burden imposed on secured parties associated with holding certificates of title is what led to certificate of title laws under which the title was issued to the vehicle owner. That burden seemingly would be reduced in an electronic certificate of title system.
The switch to a “lien holder” scheme undoubtedly will reduce the risk of fraud resulting from the issuance of paper titles to vehicle owners while the secured debt remains unpaid. The use of electronic titles could further reduce the risk of fraud as a person taking an interest in a vehicle subject to a security interest will not be relying on the physical state of a paper title. It is not entirely clear whether paper titles will be replaced entirely or whether electronic titles will be used only when a vehicle is subject to a security interest and a paper title will be issued when the debt secured by the vehicle is paid.
As is explored in Chapter 24 (Continuing Perfection – Changes as to the Use of the Collateral or the Location of the Collateral or the Debtor; Security Interests in Proceeds), exactly how an electronic certificate of title system will interface with the new Article 9 sections dealing with goods covered by certificates of title, many of which appear to contemplate the issuance of paper titles, is not clear.
Two other matters that will be considered more fully in later chapters warrant mention here. First, some certificate of title statutes provide that a transfer of a vehicle is not effective without a transfer of a certificate of title covering the vehicle and such provisions may impact the operation of Article 9 provisions designed to protect certain buyers against certain security interests. See Chapter 27 (Secured Party Versus Buyer). What effect such provisions in certificate of title statutes actually have, in turn, may depend on whether the certificate of title statute involved provides that in the event of a conflict between the certificate of title statute and Article 9 the latter should control.
Second, how a certificate of title statute affects disputes between or among persons having an interest in a vehicle generally depends on whether a certificate of title covering a vehicle actually has been issued. Problems can arise where a certificate of title is not applied for or issued even though the parties contemplated that an application be made and a title issued. This can happen when a party who had responsibility for making an application, for whatever reason, does not do so.
The point is that it should always be clear who has responsibility for making an application for a certificate of title and, ultimately, the creditor the perfection of whose security interest depends on lien notation should make sure that a certificate of title noting the creditor’s security interest is in fact issued. There is less of a problem in “lien holder” states than in “title holder” states, but problems can and do arise even in lien holder states. See Chapter 24 (Continuing Perfection – Changes as to the Use of the Collateral or in the Location of the Collateral or the Debtor; Security Interests in Proceeds) and Chapter 27 (Secured Party Versus Buyer).
B. Goods As To Which Lien Notation Is Required
Certificate of title statutes differ from state to state and the differences have meant that Article 9 and a specific certificate of title law may not mesh very well. The Uniform Motor Vehicle Certificate of Title Act (UMVCTA), which has been adopted in many states, is aimed at producing greater harmony among the statutes, but differences persist.
It is enough here to understand that a creditor first must decide if the goods in which it seeks to take and perfect a security interest are within the scope of a particular certificate of title law, in which case lien notation and not filing is necessary to perfect, and the creditor then must comply with the specific requirements of that particular certificate of title statute.
Because of the differences among the statutes it is risky to generalize about when lien notation rather than filing is required. However, for the most part, certificate of title laws cover vehicles that must be registered for use on a state's highways. An important exception in Arizona is that mobile homes must be titled and security interests in them perfected by lien notation. In many states, including Arizona, trailers must be registered and titled.
Boat trailers and boats pose interesting issues. At least in Arizona, a boat trailer must be titled, but a boat, even a powerboat, need not be titled (although it must be registered with the Game and Fish Department). The result is a difference in the perfection requirements for boats and boat trailers. As to the latter, but not the former, lien notation is necessary. The difference in perfection requirements for boats and trailers will be revisited in the context of automatic perfection. See Chapter 18 (Perfection by Doing Nothing -- Automatic Perfection).
A more important generalization, referred to above, is that both Article 9 and the many certificate of title statutes except from the lien notation scheme security interests in goods held for sale or lease by a person in the business of selling such goods, i.e., inventory. See new 9-311(d).
Therefore, to perfect a security interest in a dealer's inventory of cars and trucks, for example, a creditor must file a financing statement even though security interests in cars and trucks not held as inventory are subject to the lien notation requirements. If goods are subject to a certificate-of-title statute and the debtor is in the business of leasing but not of selling such goods then lien notation is required. See Official Comment 4 to new 9-311.
C. Choice of Law
Under new section 9-303(c), the law of a state issuing a certificate of title covering goods governs perfection and non-perfection. Somewhat curiously, new section 9-303(a) indicates that there need be no nexus between the debtor or the goods and the state issuing a certificate of title covering the goods. The rule stated in new section 9-303(a) means that a secured party, theoretically, is free to choose to apply for a certificate of title in any state and this freedom of choice, again theoretically, can pose problems for searchers who must locate the state system in which to conduct a search.
The difficulty for searchers is compounded by the fact that a security interest in a vehicle is indexed according to the vehicle identification number (VIN) and it is not possible to search for all outstanding security interests created by a particular debtor simply by requesting a search under the debtor's name.
However, certificates of title are issued in conjunction with registering a vehicle for use on a state's highways. Consequently, in practice a secured party reasonably will apply for a certificate of title from the state where a vehicle will be kept and used, most often the state of the debtor's residence, and it is that state's law that governs perfection and non-perfection.
For example, if a seller of new cars in Tucson, Arizona sells a vehicle to a buyer who resides in Tucson and the parties expect the buyer to keep and use the car in Arizona then the dealer should comply with the Arizona certificate of title statute. If, on the other hand, the buyer is from Albuquerque, New Mexico and the car will have to be registered in New Mexico for use in New Mexico, then the dealer should apply for a New Mexico title.
The case of In re Custer, 50 UCC Rep. Serv. 2d 608 (Bkcy N.D. Iowa 2003), illustrates how the flexibility in the certificate of title system, especially where the debtor holds the title (i.e., a title holder statute is involved, as discussed in subpart F below) can create problems. In Custer, a South Dakota dealer sold a vehicle to an Iowa purchaser. It appears that at the time of the sale the vehicle was owned by a California party who had obtained a South Dakota title for the vehicle. The California party released its interest in the vehicle and the dealer obtained a South Dakota title in its name.
The dealer prepared the title so that the debtor could obtain an Iowa certificate of title on which the security interest (that had been assigned to the entity that actually financed the purchase) could be noted. However, the debtor delayed applying for the Iowa certificate of title so long that the security interest was not timely perfected and the security interest was avoidable by the trustee in a bankruptcy proceeding commenced by the debtor shortly after the debtor returned to Iowa.
The avoidance of security interests that are not timely perfected is the subject of Chapter 26 (Secured Party Versus Lien Creditor; Future Advances; Bankruptcy) and Chapter 30 (Secured Party Versus Trustee in Bankruptcy).
As will be explored further below and more fully in Chapter 24 (Continuing Perfection -- Changes as to the Use of the Collateral or in the Location of the Collateral or the Debtor; Security Interests in Proceeds), most problems arise when vehicles are moved from one state to another and a certificate of title is issued by the state to which a vehicle is moved, raising the question of which state's law governs perfection and non-perfection.
D. The Timing and Duration of Perfection
Under new section 9-303(b), goods are covered by a certificate of title from the time a valid application and required fee are tendered to the appropriate authorities. The drafters of new Article 9 intend that perfection should date from the time goods are covered by a certificate of title (assuming a security interest is noted on the title) and that perfection of the security interest will continue so long as the goods are covered by the certificate of title (or until the certificate of title ceases to be effective under the law of the state issuing the title, for example, because a certificate of title has been issued by another state). See Official Comment 3 to 9-303.
However, the certificate of title statute of a state issuing a title in fact governs the timing and duration of perfection of a security interest and the law of some states, including Arizona, contains a "relation back" provision under which perfection dates from the time a security agreement is properly executed if the secured party duly applies for a certificate of title within some prescribed period of time, ten days under the Arizona statute and the UMVCTA.
These relation back periods can cause problems for searchers and the drafters have urged that they be eliminated. See Official Comment 6 to new 9-303 and Official Comment 5 to new 9-311. But, until the recommended change is made the relation back period in a governing certificate of title statute will control.
E. Exclusivity of Lien Notation Scheme
The lien notation scheme is largely exclusive in that possession by the creditor of the certificate of title itself will not perfect a security interest in the covered vehicle. See new section 9-311(b). Cf. Noble v. Bonnett, 557 P.2d 248 (Ariz. 1978). Under former Article 9 it was unclear whether possession (or "repossession ") of the vehicle could perfect a security interest in a covered vehicle.
New Article 9 makes clear that possession will re-perfect, for example, where a vehicle has been moved to another state without permission and the creditor repossesses the vehicle, but possession will not serve to perfect a security interest in the first instance. See new sections 9-311(b), 9-313(b), 9-316(d) and Official Comment 7 to new 9-311.
It is important to note that under new section 9-311(b) lien notation in compliance with a certificate of title law is the equivalent of filing insofar as priority over a lien creditor is concerned (which is the basic test of perfection under Article 9). See Official Comment 6 to new 9-311.
As was discussed in Chapter 10 (The Need for Value and Debtor’s Rights in the Collateral), certificate of title laws may impact security interests in vehicles subject to a certificate of title law otherwise than as to the permissible means of perfecting such security interests. Specifically, although conditioning transfer of a certificate of title to a buyer on payment, under UCC Article 2, section 2-401, does not prevent title from passing to the buyer and operates only to create a security interest, it could happen that the certificate of title law itself alters this UCC rule.
Thus, a certificate of title law could make a sale not accompanied by a transfer of the certificate of title completely void (as opposed to simply voidable), thereby qualifying the general rule of alienability provided for in new section 9-401 and considered in Chapter 25 (The How and Why of Priority). The Texas certificate of title law at issue in the case of Arcadia Financial, Ltd v. Southwest-Tex Leasing Co., Inc., 47 UCC Rep. Serv. 2d 1371, 78 S.W. 3d 619 (Tex. App. 2002), discussed in Chapter 10 in connection with the requirement that a debtor have rights in collateral in order for a security interest to attach under new section 9-203, appeared to so provide. Where a certificate of title law does provide that a sale not accompanied by a certificate of title is void, the further issue arises as to whether the UCC or the certificate of title law governs. There was a provision in the Texas certificate of title law under which in the event of a conflict the UCC was to control.
The point here is that certificate of title laws must be carefully examined to determine whether or not they make transfer of a certificate of title a condition of the passage of title (or other interest such as will support a security interest) and, if so, whether the certificate of title law trumps the UCC rules regarding the passage of title of a vehicle subject to a certificate of title law (and rights in such vehicles).
Making receipt of a certificate of title a condition of an effective transfer of a vehicle also can be problematic to the extent that a state moves to an electronic certificate of title scheme. The ultimate effect of the change will depend somewhat on whether paper titles are replaced entirely by electronic certificates of title or whether a paper title is issued when the debt secured by a vehicle is paid. But, either way, as discussed in Chapter 27 (Secured Parties Versus Buyers), conditioning an effective transfer on receipt of a certificate of title could conceivably prevent a buyer from becoming a buyer in ordinary course entitled to the special priority given to such buyers under new section 9-320(a).
F. Incompleteness of the Lien Notation Scheme
Fraudulent acquisition of a "clean title," a certificate of title on which a security interest is not noted, is much less likely today than it once was. This is so because of widespread sharing among motor vehicles departments of computerized information and because of various bond requirements. However, fraud involving doctored titles or claims of lost titles is still possible, especially where debtors are given control of certificates of title, as is true in so-called "title holder" states. Cf.Official Comment 6 to new 9-303.
By agreement between the debtor and secured party or as dictated by a particular certificate of title statute, secured parties may have possession of certificates of title and the risk of fraud is reduced by these "lien holder" schemes. But, because of the costs associated with lien holding, in most states debtors have been given possession of certificates of title. Moreover, while infrequent, mistakes by motor vehicles department personnel leading to the issuance of a clean title where a secured party has duly applied for a title noting a security interest are not unknown.
If a creditor or buyer extends value in reliance on the clean title, the question that arises is who as between the original creditor and a later creditor or buyer should prevail in the event of a dispute. In Doherty v. Obregon, 433 P.2d 52 (Ariz.App. 1967), decided under an earlier version of Arizona's certificate of title law, the court held in favor of the original creditor on the ground that creditor had duly complied with the certificate of title law and had done all that it could do to perfect its security interest. The rationale of the Obregon decision is sound and may well be applied should such a dispute arise under new Article 9.
It is desirable to give some degree of protection to non-dealer buyers, such as is provided for in new section 9-337 and discussed in Chapter 24 (Continuing Perfection -- Changes as to the Use of the Collateral or in the Location of the Collateral or the Debtor; Security Interests in Proceeds). However, even with the changes in the certificate of title lien notation system aimed at reducing the risk of mistake or fraud the message to creditors and buyers is that they should not rely on the physical appearance of a certificate of title and should check with the motor vehicles department to be sure there are not any outstanding encumbrances. Cf. Wallace Imports, Inc. v. Howe, 673 P.2d 961 (Ariz. App. 1983) (Distinguishing Obregon).
As explained above, some states, including Arizona, have adopted electronic certificate of title legislation according to which no paper title is issued until any security interest has been satisfied (or the secured party consents in writing or electronically to the transfer of title). One may expect the risk of an Obregon-type situation arising to be further reduced by such a system but, again, fraud or error leading to the issuance of a “clean” paper title before a security interest has been satisfied will still be possible.
In Obregon the dispute was between parties both of whom were relying on certificates of title issued by the same state. It also can happen that certificates of title are issued by more than one state. The new Article 9 scheme contemplates that there be only one certificate of title covering goods at any one time and that it will be clear which state's law governs perfection and non-perfection. However, because of fraud and the lack of complete coordination among state agencies responsible for administering certificate of title statutes from state to state, more than one certificate of title covering the same goods may be issued and be outstanding. See Official Comment to 6 to 9-303.
Deciding which state's law governs perfection in these rare but not unheard of cases requires applying new sections 9-316(d) and (e) and the examination of these sections is best left to Chapter 24 (Continuing Perfection -- Changes as to the Use of the Collateral or in the Location of the Collateral or the Debtor; Security Interests in Proceeds). And, again, the interface between the new Article provisions, especially those dealing with situations involving “clean” titles, and electronic certificate of title laws has yet to be clarified.
The next five problems will help you get a handle on the certificate of title lien notation scheme exception to perfection under Article 9 itself.
Problem 17.1 (interactive)
Delbert Dealer, an Arizona automobile dealer, sells a new automobile to Betty Buyer, an Arizona resident, in Arizona. The automobile is purchased for use on the Arizona highways. Betty pays $2,000 down and agrees to pay the balance over four years. Betty gives Delbert an interest in the automobile to secure the unpaid price.
How should Delbert perfect its security interest?
If Delbert submits an application for a certificate of title nine days after the purchase contract is signed is the security interest perfected and, if so, as of what date?
Do your answers differ depending on whether former or new Article 9 applies?
Would your answer to the question of how Delbert should perfect its security interest change if Delbert knows Betty is just passing through Arizona and resides and will use the vehicle in California?
Which state's law, that of Arizona or that of California, governs perfection if Delbert applies for and obtains a California certificate of title?
Does it make any difference to perfection and the timing of perfection whether Arizona or California law governs?
Problem 17.2 (interactive)
Dupe You, Inc. is a seller of new automobiles. Dupe You is an Arizona corporation doing business in Phoenix, Arizona and San Diego, California. Dupe You acquires a fleet of new automobiles to add to its inventory. The purchase is financed by Southwestern Bank, which takes a security interest in the automobiles to secure the unpaid price of the fleet of automobiles.
How should Southwestern Bank perfect its security interest in the fleet of automobiles under new Article 9?
By way of review of important material covered in Chapter 13 (Overview of Perfection by Filing), where should Southwestern Bank file its financing statement? Would filing be proper if the facts of Problem 17.2 were that Dupe You was an automobile rental agency that leased but did not sell automobiles (except to dispose of and replace automobiles that were leased)?
Problem 17.3 (interactive)
Lisa Lender lends to Donald Debtor in Arizona. Donald delivers the certificate of title for his Honda automobile to Lisa as security for the loan.
Is the security interest in the Honda perfected under new Article 9?
Would your answer change if Lisa took possession of the Honda?
Problem 17.4 (interactive)
Western Bank finances the purchase of an automobile by Donna Debtor in Arizona. Western duly applies to the Arizona Motor Vehicle Department for a certificate of title noting Western's security interest. Such a title is issued to Western. Subsequently, Donna is able, through fraud or mistake, to acquire a paper title on which Western’s security interest is not noted. Donna sells the vehicle to Delbert Dealer in Arizona and Delbert pays an amount unadjusted for the amount of the security interest. Donna defaults on the loan to Western. Western tracks the vehicle to Delbert and demands that Delbert satisfy the loan debt or turn the vehicle over to Western.
Who wins this dispute?
As noted above, under contemporary certificate of title systems disputes such as that in Problem 17.4 generally should not arise. However, what should a creditor such as Delbert Dealer do to be safe?
Problem 17.5 (interactive)
Delia Dealer in Arizona sells to Byron Buyer a new cabin cruiser boat and boat trailer that are to be kept and used in Byron's business in Arizona. Delia takes an interest in the boat and boat trailer to secure the unpaid purchase price of each.
How should the security interests be perfected under new Article 9?
G. Vehicle Financing As A Three-Party Transaction
It is useful here to anticipate some complexity that often exists as to an already not uncomplicated perfection scheme. That complexity arises because vehicle financing, whether the debtor is a dealer and the vehicles are inventory (in which case a financing statement is required) or the debtor is a person other than a dealer holding a vehicle for sale (in which case lien notation is required), often is a three-party transaction.
In a three-party transaction there will be two debtors and two creditors. For example, if you buy an automobile on credit from a retailer and the retailer takes a security interest in the vehicle then you are the debtor and the retailer is the secured creditor. But, quite likely the dealer has borrowed from a lender who finances the dealer's acquisition of inventory, including the vehicle you have purchased on credit. Consequently, the dealer is a creditor as to you but a debtor as to the lender.
There are many variations on three-party transactions. Recall from Chapter 4 (Scope of Article 9) that under new section 9-109(a)(3) sales of contracts are treated as secured transactions. The details determine what each creditor must do to perfect its security interest. New section 9-310(c) tracks former section 9-302(2) by providing that if a security interest is perfected when it is assigned then no further action is needed to perfect the interest against creditors of and transferees from the debtor who created the security interest.
The effect of this section is that where a creditor has been assigned an already perfected security interest the assignee-creditor need not take further action to perfect the assigned security interest. The perfection continues even where the assignee’s name is different from that of the assignor because, as was explained in Chapter 14 (The Nitty Gritty of Filing), although the secured party’s name must appear on the financing statement it is the debtor’s name that is important for indexing and searching and the secured party’s name is required only to allow the notification required by certain priority rules discussed in Part VI to be sent. See Official Comment 4 to new 9-310. See also, In re Hergert, 275 B.R. 58 (Bkcy D. Idaho 2002).
However, the assignee-creditor is excused from further action only where the assigned security interest was in fact perfected at the time of the assignment. Moreover, whether the assignment of a security interest is effective and whether the assigned security interest is perfected are separate matters. It should also be noted that new section 9-310(c) refers to the need to file a financing statement. As discussed earlier, under new section 9-311(c) lien notation in compliance with a certificate of title statute is the equivalent of filing.
The foregoing discussion of new section 9-310(c) assumes that there has been an assignment of a security interest. It could happen that a different secured party enters the picture by taking its own security interest in a vehicle already subject to a security interest held and perfected by lien notation by another creditor. In such a case, new section 9-310(c) presumably would not apply.
Thus, in the case of In re Morgan, 291 B.R. 795 (Bkcy E.D. Tenn. 2003), a creditor who took a security interest in a vehicle in connection with refinancing a loan that had enabled the debtor to purchase the vehicle delayed having its security interest noted on a certificate of title covering the vehicle for two years and until after the debtor filed bankruptcy.
The court held that under the state certificate of title law there was no perfection of the refinancing creditor’s security interest until another title noting its security interest was issued. It further held that although the proceeds of the refinancing loan had been used to satisfy the secured debt of a creditor who had timely perfected the refinancing creditor could not be subrogated to the claim of the other creditor because the state certificate of title law did not allow for any such subrogation.
The net result was that perfecting the security interest after bankruptcy had been filed violated the automatic stay and was void and, therefore, the security interest was avoidable by the trustee in bankruptcy. The extent to which a trustee may avoid a security interest not perfected on the date of bankruptcy and the automatic stay are matters dealt with in Chapter 26 (Secured Party Versus Lien Creditor; Future Advances; Bankruptcy).
You may test your understanding of the three-party financing arrangements in the next problem.
Problem 17.6 (interactive)
Delbert Dealer in Problem 17.1 borrows from Friendly Finance Company. Delbert assigns to Friendly the contract of sale involved in Problem 17.1.
Is Friendly protected against a trustee in bankruptcy if Betty Buyer files bankruptcy? Recall that protection against a trustee in bankruptcy turns on perfection.
Is Friendly protected against a trustee in bankruptcy if Delbert files bankruptcy?
What advice would you give to Friendly if you were advising Friendly as to bankruptcy risks?
Other issues arising in three-party transactions, including the extent to which defenses against an assignor/debtor may be raised against an assignee/secured party are considered in Chapter 37 (Foreclosure as to Intangibles).
CASE COMMENTARY
In re Judith Baker, 430 F.3d 858 (7th Cir. 2005)
In re James Baker, 345 B.R. 261 (D. Colo. 2006)
In re Snelson, 330 B.R. 643 (Bkcy E.D. Tenn. 2005)
In re Jeans, 326 B.R. 722 (Bkcy W.D. Tenn. June 28, 2006)
Genesee Regional Bank v. Palumbo, 9 Misc.3d 823 (N.Y. Supreme Court 2005)
Vibbert v.PAR, Inc., 224 S.W.3d 317 (Tex. App. March 23, 2006)
2011-08-22 update