Part V Perfecting an Article 9 Security Interest
Chapter 18 Perfection By Doing Nothing -- Automatic Perfection
A. Generally
As you will recall, filing is the usual step required for perfection. See Chapter 12 (Perfection Generally). But, as was also pointed out in that chapter, perfection is achieved in certain cases by doing nothing, i.e., automatically. The most familiar case of perfection on attachment is that for purchase money security interests in consumer goods under new section 9-309(1). This exception to filing and possession, and its components, purchase money security interest and consumer goods, are explored and explained at length in subpart B below.
Other instances of automatic perfection, also found in former Article 9, include a security interest temporarily perfected without delivery in instruments or certificated securities, a security interest in proceeds perfected for 20 days if the security interest in the original collateral is perfected (as discussed in Chapter 16 (Perfecting Security Interests in Proceeds and Other Later Acquired Property)), an assignment of accounts that does not involve a significant part of the outstanding accounts of the assignor, a security interest arising under Article 2 or 2A or Article 4, and an assignment for the benefit of creditors of the assignor.
New Article 9 makes certain changes to the former Article 9 scheme by providing for perfection on attachment as to (1) sales of payment intangibles and promissory notes (which, as discussed in Chapter 4 (Scope of Article 9), were outside the scope of former Article 9), (2) certain security interests in letters of credit, (3) security interests in investment property created by a broker, and (4) security interests created by the assignment of a health-care insurance receivable to a provider.
Automatic perfection for security interests in beneficial interests in trusts, which was not part of former Article 9 as enacted in many states, including Arizona, has been eliminated by new Article 9. The change in the treatment of assignments of beneficial interests in trusts was made because of an increased use of such interests as collateral. The proper way to perfect a security interest in a beneficial interest in a deed of trust is dealt with in Chapter 20 (Perfection as to Fixtures and Other Real Estate-Related Collateral). Temporary perfection for certain collateral such as instruments and documents of title has not been eliminated but rather moved to new section 9-312.
There were differing rationales for the situations where filing was not required ranging from the fact that the transaction was not really a financing transaction or the transaction was so out of ordinary course that a creditor might not think about perfecting its interest to transactions in which the creditor was relying on possession for perfection and there was a need to allow a debtor or other party temporary access to the collateral to accomplish a transfer of the collateral.
As was noted in Chapter 17 (Perfection as to Goods Subject to Certificate of Title Legislation), perfection by compliance with a certificate of title law is the equivalent of filing a financing statement. See new 9-311(c). Such is not the case as to automatic perfection and, as will be seen in Part VI (Priority), relying on automatic perfection poses a risk in consumer goods cases that can be avoided only by filing a financing statement.
B. Automatic Perfection as to Purchase Money Security Interests in Consumer Goods
1. In general
Perhaps the most important instance of automatic perfection is that for a purchase money security interest in consumer goods. Under former section 9-302(1)(d) there was perfection on attachment as to a purchase money security interest in consumer goods other than a security interest in a vehicle required to be registered or in a fixture as to which a creditor desired the protection against real estate parties achieved by making a fixture filing.
New section 9-309(1) tracks former section 9-302(1)(d) in substance, but rather than state the rule in terms of an exception to filing, new section 9-309(1) provides that a purchase money security interest in consumer goods, other than one that is subject to a statute or treaty (such as a certificate of title law), is perfected on attachment.
The exemption from filing for purchase money creditors in the consumer context is premised on a belief that requiring all creditors who extend such purchase money credit to file would place a burden on the filing system that is outweighed by the protection accorded to the relatively few creditors who take interests in consumer goods after the debtor already owns them. The exemption from filing for purchase money security interests in consumer goods is made even though the effect is to create the possibility of a secret lien.
2. When a Security Interest is a Purchase Money Security Interest
The distinction between purchase and non-purchase money interests is important throughout the law of secured financing and in bankruptcy and whether a security interest is or is not purchase money can be controlling as to matters other than automatic perfection. Here the question is whether there is a purchase money security interest in goods such as will result in automatic perfection.
Under new section 9-103(b)(1), a security interest is a purchase money security interest in goods to the extent that the goods are purchase money collateral with respect to the security interest. "Purchase money collateral," under new section 9-103(a)(1), means goods or software that secure a "purchase-money obligation" with respect to the collateral. New section 9-103(a)(2), in turn, defines a "purchase-money obligation" as an "obligation incurred as all or part of the price of the collateral or for value given to enable the debtor to acquire rights in or the use of the collateral if the value is in fact so used."
Thus, for a security interest to be a purchase money security interest in goods under new section 9-103 the goods must secure a purchase money obligation and this means that the obligation must have been incurred to secure the price of the collateral or the value must have been given by the creditor to enable the debtor to acquire rights in the collateral and the value must have been in fact so used.
The classic instance of a purchase money security interest in goods historically has been a conditional sales contract, i.e., a contract under which the seller takes an interest in the goods sold to secure the unpaid purchase price of the goods and that instance of a purchase money security interest is captured in new section 9-103(a)(2).
The other type of purchase money credit is that involving a loan that enables the debtor to acquire rights in the collateral. Under new section 9-103(a)(2), a loan results in a purchase money security interest only to the extent the loan ("the value") actually is used to acquire the goods. To help assure that loan proceeds are actually used to acquire goods, lenders should be advised to make checks payable to the seller of the goods (or the debtor and seller).
3. The Requirement that the Goods be "Consumer Goods"
As was true under former section 9-302(1)(d), for there to be perfection on attachment under new section 9-309(1) there must be a purchase money security interest in goods that are consumer goods. As discussed in Chapter 5 (Classification of Collateral), under new section 9-102(a)(44) "goods" essentially means things that are moveable when a security interest attaches and under new section 9-102(a)(23) goods are "consumer goods " if they are used or bought for use primarily for personal, family, or household purposes.
Article 9 separately defines a "consumer transaction" as one in which the secured obligation was incurred by an individual for personal, family or household purposes. See new 9-102(a)(26). However, the automatic perfection rule requires only that the collateral be consumer goods and not that the secured obligation have been incurred for a consumer purpose.
You may explore the basics of perfection on attachment for a purchase money security interest in consumer goods under new section 9-309(1) in the next three problems.
Problem 18.1 (interactive)
Donald Debtor borrows from Southern Bank to acquire appliance parts from Stella Seller. Donald gives Southern an interest in the appliance parts that Donald will acquire from Stella and in appliance parts that Donald already owns. Donald uses the proceeds of the loan from Bank to acquire the appliance parts from Stella.
Which of Southern’s security interests are purchase money under new Article 9?
Suppose that Donald acquired the appliance parts from Stella on credit and used the loan from Southern to take a vacation. Would your answer be different?
Problem 18.2 (interactive)
Donna Debtor acquires a computer from Sid Seller on credit and gives Sid an interest in the computer to secure its price. Donna runs a consulting business out of her home. Donna uses the computer both in her business and to play electronic games.
Is Sid's interest in the computer perfected without the need for Sid to file a financing statement?
Would answer to the question be more certain if the security agreement contained a covenant that Donna would use the computer only for personal use?
Problem 18.3 (interactive)
Assume the basic facts of Problem 18.2. Assume, however, that Donna Debtor borrowed from Lisa Lender to acquire the computer and gave Lisa an interest in the computer to secure the loan.
Under what further assumptions may you conclude that Lisa's security interest in the computer is perfected automatically under new Article 9?
What specific action would you advise Lisa to take to help assure that its security interest is perfected without filing? Why?
It is important to understand what automatic perfection means to third parties. You may explore this point in the next problem.
Problem 18.4 (interactive)
Assume the basic facts of Problem 18.2. Assume further that Donna Debtor acquired the computer primarily to play electronic games. Suppose that after acquiring the computer from Sid Seller, Donna goes to Lisa Lender for a loan and offers Lisa an interest in the computer as collateral.
How can Lisa protect herself against any competing interest that might be asserted by Sid?
As noted earlier, certificate of title laws can impact the availability of automatic perfection. Take another look at the language of new section 9-309(1) and then consider the next problem.
Problem 18.5 (interactive)
Assume the facts of Problem 17.5 in Chapter 17 (Perfection as to Goods Subject to Certificate of Title Legislation) (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) except that Byron buys the cabin cruiser and boat trailer for personal use.
As to which items of property is Delia's security interest perfected without doing anything?
Recall the rationale for the automatic perfection of purchase money security interests in consumer goods set out above. Is this a case where the rationale breaks down?
In Part VI (Priority), it will be seen that there is a risk for a creditor who relies on automatic perfection under new section 9-309(1) and to protect against that risk a creditor may be advised to file even where automatic perfection is possible. For now just make a note that there is such a risk.
C. Automatic Perfection of a Security Interest in Software
Software is an increasingly important source of collateral. The question arises whether a security interest in software can be perfected automatically. Under new section 9-309(1), as set forth above, a security interest can be perfected automatically only where the software constitutes consumer goods and the security interest is purchase money.
As discussed in Chapter 5 (Classification of Collateral), software constitutes goods under new section 9-102(a)(44) if it is embedded into a computer in such a way that it would customarily be considered part of the computer or by acquiring a computer a person acquires a right to use the software in connection with the computer in which the software is embedded.
Software satisfying the definition of ''goods'' in new section 9-102(a)(44), for example, a computer operating system, can be ''consumer goods'' if it is used or bought for use primarily for personal, family or household purposes under new section 9-102(a)(23). However, for there to be automatic perfection not only must the software be consumer goods but the security interest must be a purchase money security interest.
Former Article 9 did not specifically address the question of whether or when a security interest in software could be or was purchase money. New section 9-103(c) indicates that a security interest in software is a purchase-money security interest to the extent that: (1) the security interest also secures a purchase-money obligation incurred with respect to goods in which the secured party holds or held a purchase-money security interest; (2) the debtor acquired its interest in the software in an integrated transaction in which it acquired an interest in the goods; and (3) the debtor acquired its interest in the software for the principal purpose of using the software in the goods.
According to Official Comment 5 to new section 9-103, the circumstances under which a security interest in goods may be accompanied by a purchase money security interest in software are limited. Specifically, there will be a purchase money security in software only where the software was acquired by the debtor in an integrated transaction in which the debtor acquired the goods and the software together and the debtor acquired the software for the principal purpose of using the software in the goods.
It seems, therefore, that any time (a) software is goods under new section 9-102(a)(44), (b) the secured party has a purchase money security interest in the computer in which the software is embedded, and (c) there is a security interest in the software that secures the obligation incurred in acquiring the software and also in acquiring the computer, then the security interest in software is a purchase money security interest. New section 9-103(b)(3) confirms this conclusion.
Note that because of the requirement that there be an integration of the software with the computer for a security interest in the software to be purchase money it also seems that if there is a purchase money security interest in software then, as discussed in Chapter 5 (Classification of Collateral), the software constitutes goods under new section 9-102(a)(44). If the software is used or bought for use for personally, family or household purposes, then under new section 9-102(a)(23) the software will be consumer goods and there can be automatic perfection of the security interest in the software under new section 9-309(1).
The question of when a security interest in software can be perfected automatically may be explored in the next problem.
Problem 18.6 (interactive)
Byron Buyer acquires a computer for personal use that is "bundled" with a suite of software from Stella Seller. Byron agrees to pay 10% down and the balance in 12 equal monthly installments and gives Stella a security interest in the computer and software suite to secure the purchase price of the system. Two weeks later Byron acquires from Stella graphics software for personal use that Byron also acquires on credit giving Stella an interest in the graphics software to secure its price and also to secure the price of the earlier acquired computer and software suite.
In what property does Stella have a purchase money security interest?
In what property would the security interests be perfected automatically under new section 9-309(1?
Is the security interest in the graphics software even enforceable?
In Chapter 11 (Enforceability and Attachment of Security Interests in Consumer Transactions) it was noted that cross collateralizing and refinancing or consolidation of debts can threaten the status of a security interest as a purchase money security interest. The loss of purchase money status also can affect priority and enforceability of a security interest in bankruptcy. See Chapters 26 (Secured Party Versus Lien Creditor) and 30 (Secured Party Versus Trustee in Bankruptcy). Oversimplifying somewhat, new sections 9-103(e), (f), and (g), applicable to other than consumer-goods transactions, generally provide that the purchase money character of security interest will be preserved in situations where it would be lost because of cross collateralizing and consolidation and refinancing.
New section 9-103(h) provides that the rules applicable to other than consumer-goods transactions in new sections 9-103(e), (f), and (g) do not apply in consumer-goods transactions and rather courts are to fashion appropriate rules and should not be influenced by new sections 9-103(e), (f), and (g) in doing so. Consumer-goods transaction is defined in new section 9-102(a)(24) essentially as a consumer transaction in which the collateral is consumer goods.
CASE COMMENTARY
First National Bank v. Lubbock Feeders, L.P., 183 S.W.3d 875 (Tex. App. 2006)
In re Commercial Money Center, Inc., 350 B.R. 465 (B.A.P. 9th Cir. 2006)
2011-08-22 update