Part VI Priority

Chapter 29  Secured Party Versus Secured Party (continued)

A. Special Priority Rules for Certain Collateral

Under new section 9-322(f), the priority rules discussed in Chapter 28 (Secured Party Versus Secured Party) are subject to special priority rules in new sections 9-327, 9-328, 9-329, 9-330, 9-331 and 9-332, dealing with priority as to certain types of collateral ("the other rules of this part" as that language appears in new section 9-322(f)).

Other than for the exceptional cases dealt with in new section 9-330(c)(2), disputes as to proceeds of the collateral discussed in this subpart are governed by the rules in new section 9-322, including especially those in new sections 9-322(c), (d) and (e), discussed in subpart B below.

1. Priority of Conflicting Security Interests in a Deposit Account.

New section 9-327 sets forth four rules governing conflicts involving security interests in deposit accounts perfected by control. The meaning of control as to a deposit account is governed by new section 9-104. See Chapter 22 (Perfection as to Deposit Accounts, Letter of Credit Rights and Electronic Chattel Paper).  New section 9-327(1) provides that a security interest in a deposit account perfected by control has priority over a security interest not perfected by control.  Implicitly, under new section 9-327(1), a security interest in a deposit account perfected by control would have priority over an unperfected security interest in a deposit account.

Perfection by filing or automatically of a security interest in a deposit account is possible only to the extent the deposit account is proceeds because control is the exclusive mode of perfection as to a deposit account as original collateral. See new section 9-312(b)(1) and Chapters 12 (Perfection Generally) and 22 (Perfection as to Deposit Accounts, Letter of Credit Rights and Electronic Chattel Paper).  Section 9-327(1) would give priority to a security interest in a deposit account perfected by control over a security interest in a deposit account perfected by filing or perfected automatically because, under the language of the provision, a secured party having control "has priority over a conflicting security interest held by a secured party that does not have control."

New section 9-327(2) governs priority in the rare case where a bank enters into a control agreement under new section 9-104(a)(2) with more than one secured party. Under new section 9-327(2), the security interests perfected by control rank according to the time control was achieved.

If the bank with which a deposit account is maintained extends credit to a customer secured by an interest in the deposit account, the bank is perfected by control under new section 9-104(a)(1).  Under new section 9-327(3), a bank with which a deposit account is maintained normally has priority over all conflicting security interests in the deposit account, whether the competing secured parties claim interests in the deposit account as original collateral or as proceeds.  The rule of new section 9-327(3) allows a bank to extend credit to a depositor without the need to examine the public records or its own records to determine whether there is a conflicting security interest in the deposit account.

A secured party other than the bank can protect itself against the rule in new section 9-327(3) by becoming the bank's customer as to the deposit account.  Becoming a customer on an account is a way of getting control under new section 9-104(a)(3) and, under new section 9-327(4), a secured party who achieves control in this fashion gets priority over a bank with which the deposit account is maintained.

New section 9-104(a)(3) can affect the result of a priority dispute between a bank at which a deposit account is maintained and a secured party claiming a security interest in that account in a less obvious way.  As explained in Chapter 4 (Scope of Article 9), rights of set-off are generally outside the scope of Article 9.  As further explained in Chapter 31 (Secured Party Versus Statutory Liens Including Federal Tax Liens and Agricultural Liens), new section 9-340(a) gives priority to a bank exercising a right of set-off against a secured party holding a security interest in a deposit account.

However, the priority given by new section 9-340(a) is qualified by new section 9-340(c), which provides that "the exercise by a bank of a set-off against a deposit account is ineffective against a secured party that holds a security interest in the deposit account which is perfected by control under Section 9-104(a)(3), if the set-off is based on a claim against the debtor".

As noted above, the priority given by the rules of new section 9-327 does not extend to security interests in the proceeds of a deposit account. Priority as to proceeds of a deposit account is governed by new sections 9-322(c) through (e), as discussed in subpart B below.

Moreover, under new section 9-332(b), a transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor to violate the rights of the secured party.  For example, when a debtor draws a check on a deposit account subject to a security interest the payee on the check may cash the check and take the funds free of the security interest unless the payee acted in collusion with the debtor.

Under new section 9-332(b), the transferee takes free of any security interest without regard to whether the transferee has given value or relied on the transfer to its detriment.  According to Official Comment 3 to new section 9-332, the policy of new section 9-332 is to help ensure that security interests in deposit accounts do not impair the free flow of funds.

In Sonic Engineering, Inc. v. Konover Construction Co. South, 51 UCC Rep Serv. 2d 844 (Conn Super Ct 2003), the court rejected an attempt by a judgment creditor to rely on new section 9-332(b) in a dispute with a secured party over a cashiers check issued to a marshal who had levied on a deposit account in which the secured party had a security interest perfected by control, essentially because the check had not been issued to the judgment creditor and the marshal, as an officer of the court, could not be the judgment creditor's agent.

You may test the application of new section 9-327 in the next problem.

Problem 29.1    (interactive)

Lenny Lender lends to Delia Debtor and Delia signs a security agreement giving Lenny a security interest in a general bank account maintained at Northern Bank.  Lenny immediately files a financing statement.  Delia also borrowed from Northern and gave Northern a security interest in the bank account maintained at Northern.  Northern did not file a financing statement. 

Who has priority as to the bank account? 

If Lenny were claiming the bank account as proceeds of an inventory security interest that Lenny could prove were identifiable proceeds and Lenny had filed as to the inventory before Northern took an interest in the bank account to secure its loan, as between Lenny and Northern who would have priority? 

What could Lenny have done to gain priority over Northern? Explain your answer.

If Delia drew a check on the bank account maintained at Northern payable to Paul Payee and Paul cashed the check before either Lenny or Northern was able to reach the bank account to satisfy the debt owed by Delia (i.e., before default and foreclosure), would either Lenny or Northern be able to recover the money paid out of the bank account to Paul?

2. Priority of Security Interests in Investment Property.

New section 9-328 contains several rules that govern priority among conflicting security interests in investment property.  In Chapter 21 (Perfection as to Investment Property) it was explained that a security interest in investment property may be perfected by filing, delivery, control and, even automatically.  However, control is the preferred mode of perfection.  Thus, new section 9-328(1) states the most important general rule, namely, that a secured party who obtains control has priority over a secured party who does not have control.

Under this rule a secured party who perfects a security interest in investment property by getting control of the property has priority over a secured party who has not perfected a security interest in the property or has perfected a security interest in that property automatically, by delivery, or by filing.  The priority given by this rule does not turn on either temporal sequence or awareness of a conflicting security interest.

The other rule of most importance to secured parties generally is that found in new section 9-328(2).  Under this rule the first party to obtain control has priority over another party who also has perfected by control.  This rule is analogous to the first-to-file rule of section 9-322(a)(1) and is comparable to new section 9-327(1), dealing with deposit accounts.  The section appears more involved than it is because it states the rule of ranking according to timing of control in terms of the particular kinds of investment property and as to which control is achieved in different ways under Article 8.  See new section 9-106(a) and Chapter 21 (Perfection as to Investment Property).

New section 9-328(2) is subject to new sections 9-328(3) and 9-328(4), which, respectively, give priority to a security interest held by a securities intermediary in a security entitlement or in a securities account maintained with the securities intermediary and held by a securities intermediary and a security interest held by a commodity intermediary in a commodity account maintained with the commodity intermediary.

Under new section 9-328(5), a security interest in a certificated security in registered form that is perfected by delivery has priority over a security interest in such a security perfected otherwise than by control. This rule has an important practical application that requires some explanation.  It has been common practice for secured parties to perfect security interests in certificated securities by taking possession.  Taking possession constitutes "delivery" under Article 8, section 8-301.  Such delivery results in control of a certificate in bearer form under Article 8, section 8-106(a).  Under Article 8, section 8-106(b), there is control as to a security in registered form only if there is delivery and a proper indorsement.

However, delivery of a certificated security alone is sufficient to perfect a security interest in the security under new section 9-313(a).  Therefore, a secured party who takes possession of a certificated security in registered form without an indorsement does not have control but has perfected under new section 9-313(a) and would have priority over a party who perfects a security interest in the certificated security otherwise than by control, such as by filing.

New section 9-328(6) provides that conflicting security interests among brokers, securities intermediaries and commodities intermediaries that are perfected without control under new section 9-106(a), are of equal rank.  Finally, under new section 9-328(7), in all cases not governed by the rules stated in new sections 9-328(1) to 9-328(6), priority among conflicting security interests in investment property is governed by new sections 9-322 and 9-323.

You may consider the basics of the priority rules for investment property in the next two problems.

Problem 29.2   (interactive)

Donald Debtor borrows from Lisa Lender and grants Lisa Lender a security interest in all 1000 shares of Eclectic, Inc. stock held through a securities account with Bart Broker.  Lisa Lender perfects her security interest by filing a financing statement covering the shares of stock.  Later, Donald borrows from Friendly Finance Company and gives Friendly a security interest in the 1000 shares of Eclectic stock.  Friendly knows about Lisa's security interest.  Friendly perfects its security interest by control under new section 9-106(a) and Article 8, section 8-106(d)(1). 

Who has priority as to the shares of Eclectic stock?

Problem 29.3    (interactive)

Delia Debtor borrows from Lenny Lender and grants Lenny a security interest in 10 shares of General Electric Co. stock in registered form.  Lenny perfects by filing a financing statement covering the shares of stock.  Later, Delia borrows from Friendly Finance Company and gives Friendly a security interest in the 10 shares of General Electric Co. stock.  Friendly knows about Lenny's security interest.  Friendly takes possession of the 10 shares of stock but Delia does not indorse the certificates. 

Who has priority as to the 10 shares of General Electric Co. stock?

3. Priority of Security Interests in Letter of Credit Rights.

New section 9-329 governs priority among conflicting security interests in letter of credit rights.  Consistently with international letter of credit practices, new section 9-329(1) awards priority to a secured party who perfects a security interest directly in letter-of-credit rights, i.e., gets control over the letter-of-credit rights under new section sections 9-314(a) and 9-107, over another conflicting security interest held by a security party that does not have control.  Conflicting security interests that are perfected by control rank according to priority in time of obtaining control.

4. Priority of Security Interests in Chattel Paper and Instruments.

a. Generally

A person who takes a security interest in property is a purchaser under Article 1, sections 1-201(b)(29)and (b)(30).  Thus, parties who lend against chattel paper and other such collateral are purchasers of the chattel paper. In commercial financing, purchasers of chattel paper and instruments may leave the property in the possession of the debtor or take possession of it.

As has been noted, a person who leaves an instrument in the possession of a debtor risks losing out to a transferee who gets possession of the instrument, especially if the instrument is negotiable. This risk is explored in subpart A(4)(c) below.  A person who leaves chattel paper in the possession of a debtor also risks subordination. The reason is that there is a special priority for purchasers who take possession under conditions specified in new section 9-330  (formerly section 9-308).  New Article 9 extends the special priority to purchasers who get control of electronic chattel paper.

b. Chattel Paper

i. Priority as to chattel paper claimed merely as proceeds of inventory

Under new section 9-330(a), a purchaser of chattel paper has priority over a security interest in the chattel paper that is claimed merely as proceeds of inventory if:

the purchaser gives new value;

the purchaser takes possession of the chattel paper or the purchaser obtains control of the chattel paper under new section 9-105;

the purchaser takes possession or obtains control in good faith;

the purchaser takes possession or obtains control in the ordinary course of the purchaser's business; and

the chattel paper does not indicate that it has been assigned to an identified assignee other than the purchaser.

The meaning of "merely as proceeds of inventory" is not defined.  Essentially, it refers to the usual inventory financing situation where a creditor has lent against inventory as the primary collateral and has a claim to chattel paper only to the extent that the paper constitutes identifiable proceeds of the inventory.

Under former section 9-308(b) a purchaser could have priority even though the purchaser knew that the chattel paper was subject to a security interest.  New section 9-330(a) eliminates any reference to knowledge.  However, it adds a requirement that the chattel paper not indicate that it has been assigned to an identified assignee other than the purchaser.  According to Official Comment 5 to new section 9-330, the approach comports with the expectations of the parties that what the purchaser actually knows or does not know is not relevant.

An inventory financer might require a dealer to use pre-printed form contracts that bear a legend indicating that the paper is subject to a security interest in favor of the inventory financer or require that the dealer stamp the contracts to indicate that the inventory financer has a security interest and such a legend or stamp should deny a purchaser priority under new section 9-330(a).  However, a legend or stamp to the effect that the paper is subject to a security interest would not seem to be an indication that the paper has been assigned to "an identified assignee."

It is not clear why a specific legend on chattel paper should deny the priority given by new section 9-330(a) even though knowledge of the existence of a security interest does not.  But, the requirement is more easily applied than one that makes knowledge relevant.

As noted above, to qualify for the special priority in new section 9-330(a), the purchaser must take the chattel paper in good faith.  Under former Article 9, the requirement to act in good faith normally was easily met because good faith was defined in former Article 1, section 1-201(19) to mean honesty in fact, an essentially subjective test.  However, as originally proposed and adopted, new Article 9, in new section 9-102(a)(43), expanded the definition of good faith to require not only honesty in fact but also "the observance of reasonable commercial standards of fair dealing". Later, section 9-102(a)(43) was omitted and the additional requirement was added to the definition of good faith in what is now section 1-201(b)(20) of Article 1.  See Official Comment 20 to Article 1 (tracing the development of the current definition of good faith through Article 2, section 2-103 (Sales of Goods), Article 3, section 3-103 (Negotiable Instruments) and new 9-102 (Secured Transactions), to its present embodiment in Article 1, section 1-201(b)(20) (Applicable to all articles)).

As discussed at some length in Chapter 27 (Secured Party Versus Buyer), not all states have adopted the proposed revision of the definition of good faith in Article 1. Several states have retained the more limited, honesty in fact, definition. A review of which states have adopted the expanded definition and which states have retained the narrower definition may be found at:
http://www.law.unlv.edu/faculty/rowley/ra1_updates.htm.

However, a state retaining the narrower definition in Article 1 may nonetheless have adopted and retained new section 9-102(a)(43) containing the expanded definition of good faith. Arizona is one such state. In states that have adopted the narrower "honesty in fact" definition of good faith in Article 1, but the broader "honesty in fact" and "the observance of reasonable commercial standards of fair dealing" in Article 9, the question arises as to which definition governs good faith determinations necessary to the application of a new Article 9 priority provision. Arguably, the definition specific to Article 9 should control.

To the extent that the definition in new Article 9 section 9-102(a)(43) applies, there is an objective as well as a subject test of good faith, and good faith requires that a purchaser act not only honestly in fact but also in the observance of reasonable commercial standards of fair dealing.  As such, good faith could be understood to require that a purchaser inquire further when the purchaser knows facts that would lead a reasonable purchaser to do so.

It is not clear, however, what the requirement of good faith means as to a purchaser of chattel paper claimed merely as proceeds because, as explained above, the priority bestowed by new section 9-330(a) is defeated only when the chattel paper bears a legend that it has been assigned to an identified assignee other than the secured party.  Thus, Official Comment 5 to new section 9-330 states that a purchaser "who gives new value in ordinary course can rely on possession of unlegended, tangible chattel paper without any concern for other facts that it may know . . . ."

The usual meaning of "value," defined in Article 1, section 1-204 (formerly Article 1, section 1-201(44)) to mean essentially a binding commitment but also to include antecedent debt, was considered in Chapter 10 (The Need for Value and Debtor's Rights in the Collateral) in connection with the requirements of enforceability under new section 9-203(b).  "New value" is defined in new section 9-102(a)(57).  As used in new section 9-330(b) "new value" is distinguishable from "value" in that it does not include antecedent debt (but it does include release of a security interest in other property).

New section 9-330(a) refers to purchasers who obtain control of chattel paper as well as those who take possession.  The purpose of the reference is to bring within the scope of the special priority rule purchasers of electronic chattel paper, as to which possession is not possible and control under new section 9-105 is the preferred method of perfection.  See Chapter 22 (Perfection as to Deposit Accounts, Letter of Credit Rights and Electronic Chattel Paper).

Where a purchaser of chattel paper does not qualify for the special priority given by new section 9-330(b), a dispute is governed by new section 9-322(a). Thus, for example, in a dispute between a purchaser of chattel paper who does not qualify for the special priority of new section 9-330(b) and a party with a security interest in the chattel paper other than merely as proceeds of inventory who has filed as to the chattel paper, the outcome would depend on who filed first or who perfected first under new sections 9-322(a) and (b).

The court in Arcadia Financial, Ltd v. Southwest-Tex Leasing Co., Inc., 47 UCC Rep. Serv. 2d 1371 (Tex. App. 2002) was presented with the opportunity to apply new section 9-330(a) in the rather unique setting in which the creditor with an interest in inventory had such an interest by virtue of having reserved title to the goods provided to a dealer.  If the court considered the application of new section 9-330(a), then it would have had to decide whether the assignee of chattel paper qualified for the special priority given by new section 9-330(a) or whether the first-to-file or first-to-perfect priority rule of new section 9-322(a) would govern.

Instead the court focused on the passage of title to the inventory items, vehicles subject to a certificate of title law, and mistakenly concluded that because the inventory party had conditioned the transfer of the certificates of title covering the ownership of the vehicles to the dealer on payment for the vehicles title to (and, implicitly as well, no other interest in) the vehicles never passed to the dealer or to the buyers from the dealer.

You may explore the application of the merely as proceeds of inventory priority for chattel paper rule in new section 9-330(a) in the next two problems.

Problem 29.4  (interactive)

Lisa Lender perfects a security interest in Donald Dealer's inventory of automobile parts, existing and after-acquired, by filing.  Donald sells automobile parts to numerous buyers on credit in the ordinary course of Donald's business.  The buyers sign written contracts giving Donald an interest in the automobile parts to secure their price.  Western Bank lends to Donald and takes an interest in Donald's contracts, existing and later-acquired.  Western files a financing statement covering the contracts.  Donald encounters cash flow problems and defaults on the debts owed to Lisa and Western. 

Who has priority as to the automobile parts in the hands of the buyers? 

Who has priority as to the automobile parts in Donald's possession that have not yet been sold? 

Who has priority as between Lisa and Western as to the contracts for the sale of automobile parts?

Problem 29.5    (interactive)

Assume the facts of Problem 29.4.  Assume further that after borrowing from Western Bank, Donald Dealer borrows from Friendly Finance Company and assigns a large number of the contracts for the sale of automobile parts to Friendly.  Friendly takes possession of the contracts in the ordinary course of its business, in good faith and for new value.  Donald defaults on the debts owed to Lisa Lender, Western and Friendly. 

Who has priority as between Lisa and Friendly? 

Would the correct answer be different if Friendly knew about Lisa's security interest?

Would Friendly have priority over Lisa if the chattel paper bore a legend indicating that the contracts were subject to a security interest?

Would Friendly qualify for the special priority in new section 9-330(a) if the chattel paper had been assigned to Friendly to secure an outstanding unsecured debt?

If Friendly was not able to meet the conditions for the special priority in new section 9-330(a) then Lisa would have priority. Why is this so?

ii. Chattel paper claimed otherwise than merely as proceeds of inventory

New section 9-330(b) governs priority between purchasers of chattel paper and persons claiming an interest in chattel paper other than merely as proceeds of inventory.  With one notable difference, the stated conditions for purchaser priority under new section 9-330(b) are the same as those in new section 9-330(a) (the merely as proceeds situation). The difference is that to qualify for the special priority in new section 9-330(b), the purchaser must not have knowledge that the purchase violates the rights of the secured party (as contrasted with the requirement in new section 9-330(a) that the chattel paper not indicate that it has been assigned to an identified assignee other than the purchaser).

Thus, a purchaser of chattel paper has priority over a security interest in the chattel paper that is claimed other than merely as proceeds of inventory if:

(a) the purchaser gives new value;

(b) the purchaser takes possession or obtains control of the chattel paper;

(c) the purchase is in the ordinary course of the purchasers business;

(d) the purchaser acts in good faith; and

(e) the purchaser acts without knowledge that the purchase violates the rights of the secured party holding an interest in the chattel paper claimed otherwise than merely as proceeds of inventory.

As used in new section 9-330(b), knowledge means "actual knowledge," as defined in Article 1, section 1-202 (formerly Article 1, section 1-201(25)). Note that it is knowledge that the purchase violates the rights of the secured party and not simply knowledge that a conflicting security interest exists. See Official Comment 6 to new 9-330.  However, under new section 9-330(f), if chattel paper indicates that it has been assigned to an identified secured party other than the purchaser, then the purchaser of the chattel paper has knowledge that the purchase violates the rights of the secured party and the purchaser is not eligible for the special priority given by new section 9-330(b).

New section 9-330(b) requires that the purchaser take in good faith.  As noted above, in connection with the discussion of new section 9-330(a), the current definition of good faith in Article 1, section 1-201(b)(20), includes a requirement that a person observe reasonable commercial standards of fair dealing. The meaning of the good faith requirement as applied to a purchaser of chattel paper claimed other than merely as proceeds of inventory is not clear.

Official Comment 6 to new section 9-330 indicates that good faith does not require a purchaser of chattel paper to search for a filing against the paper. However, that same comment appears to suggest that a purchaser who, for whatever reason, does a search and discovers a financing statement covering the chattel paper cannot ignore the discovery and may be obliged to inquire further.  If further inquiry results in the purchaser acquiring knowledge that the purchase violates another's security interest, then the purchaser would not qualify for the special priority under new section 9-330(b).

Determining the meaning of good faith is complicated by the fact that priorities for purchasers of instruments, discussed below, also are conditioned on a requirement that the purchaser take in good faith, and good faith may mean something different for purchasers of instruments than it does for purchasers of chattel paper.  Cf. Official Comment 7 to new 9-330 and Official Comment 5 to new 9-331.

As is true of new section 9-330(a), new section 9-330(b) refers to purchasers with control of chattel paper. Once again, the purpose of this reference is to bring within the scope of the special priority rule purchasers of electronic chattel paper, as to which possession is not possible and control under new section 9-105 is the preferred method of perfection.  See Chapter 22 (Perfection as to Deposit Accounts, Letter of Credit Rights and Electronic Chattel Paper).

Where a purchaser of chattel paper does not qualify for the special priority given by new section 9-330(b), a dispute is governed by new section 9-322(a). For example, the outcome of a dispute between a purchaser of chattel paper who does not qualify for the special priority of new section 9-330(b) and a party with a security interest in the chattel paper other than merely as proceeds of inventory who has filed as to the chattel paper would depend on who filed first or who perfected first under new sections 9-322(a) and (b).

To test your understanding of the application of new section 9-330(b) to security interests in chattel paper as original collateral consider the next problem.

Problem 29.6  (interactive)

The facts of Problem 29.4 as modified in Problem 29.5 were as follows: Lisa Lender perfects a security interest in Donald Dealer's inventory of automobile parts, existing and after-acquired, by filing.  Donald sells automobile parts to several buyers on credit in the ordinary course of Donald's business.  The buyers sign written contracts giving Donald an interest in the widgets to secure their price.  Western Bank lends to Donald and takes an interest in Donald's contracts, existing and later-acquired.  Western files a financing statement covering the contracts.  After borrowing from Western, Donald borrows from Friendly Finance Company and assigns a large number of the contracts for the sale of automobile parts to Friendly.  Friendly takes possession of the contracts in the ordinary course of its business, in good faith and for new value.  Donald defaults on the debts owed to Lisa, Western and Friendly. 

Who has priority as to the chattel paper as between Western and Friendly? 

Would the answer under new section 9-330(b) be different if Friendly knew about Western's security interest in the chattel paper? 

Would Friendly have priority over Western under new section 9-330(b) if the chattel paper bore a legend indicating that it had been assigned to Western? 

If the chattel paper bore a legend that it was subject to a security interest held by Lisa, who would have priority as to the chattel paper as between Lisa, Western and Friendly?

Would you analysis of the disputes between Lisa and Friendly and Western and Friendly be different if the contracts generated by the sale of the inventory were in electronic form and Friendly had control of the contracts? Explain your answer.

Under new section 9-330(c)(1), subject to the special rule for deposit accounts under new section 9-327, a purchaser of chattel paper who satisfies the requirements of new section 9-330(b), also has priority as to the proceeds of the chattel paper to the extent that priority is provided for in new section 9-322. The extent to which there is priority under new section 9-322 is considered in subpart B below.

Where the proceeds consists of specific goods covered by the chattel paper or cash proceeds of the specific goods, there also is priority as to proceeds directly under new section 9-330(c)(2) for a purchaser of chattel paper who satisfies the conditions of new section 9-330(b), even if the purchaser's security interest in the proceeds is unperfected. The rule in new section 9-330(c)(2) governs certain complicated situations, such as that where a buyer in ordinary course of business returns goods to a dealer or where the goods are repossessed by the dealer. These situations are dealt with in Official Comments 8 to 11 to new section 9-330 and are beyond the scope of these materials.

c. Instruments

Under new section 9-330(d), a purchaser of an instrument has priority over a security interest in the instrument perfected by a method other than possession if the purchaser gives value and takes possession of the instrument in good faith and without knowledge that the purchase violates the rights of the secured party.  The rule of new section 9-330(d) tracks that in new section 9-330(b) pertaining to chattel paper, but there is no requirement that the purchaser take delivery in the ordinary course of the purchaser's business or that it give new value.  Ordinary value, as defined in Article 1, section 1-204 (formerly Article 1, section 1-201(44)) to mean essentially a binding commitment but also to include antecedent debt, see Chapter 10 (The Need for Value and Debtor's Rights in the Collateral), is sufficient.

As is the case with the special priority for chattel paper contained in new section 9-330(b), discussed above, it is actual knowledge that the purchase violates a conflicting security interest in the chattel paper that is material. But, as is true as to new section 9-330(b), new section 9-330(d) is subject to new section 9-330(f).  Under new section 9-330(f), if an instrument indicates that it has been assigned to an identified secured party other than the purchaser then the purchaser of the instrument has knowledge that the purchase violates the rights of the secured party and the purchaser is not eligible for the special priority given by new section 9-330(d).

As is true with respect to good faith as it applies to a purchaser of chattel paper, discussed above, the meaning of good faith as a requirement for qualifying for the special priority in new section 9-330(d) is unclear.  The uncertainty is again traceable to the expanded definition of good faith in Article 1, 1-201(b)(20), which imposes the objective test that a person must observe reasonable commercial standards of fair dealing.

If, for whatever reason, a purchaser conducts a search and discovers a financing statement filed by a competing party, then it may plausibly be argued that the purchaser is obliged by the good faith requirement to inquire further.  If further inquiry leads the purchaser to obtain actual knowledge that the purchase violates the security interest, then the purchaser would be denied the benefit of the special priority in new section 9-330(d). Cf. Official Comment 7 to new 9-330. However, as a general rule, good faith does not require the purchaser of an instrument to search the public records. See Official Comment 7 to new 9-330. A more interesting question is whether the observance of reasonable commercial standards of fair dealing could impose on a particular purchaser a duty to search for an Article 9 filing.

In two related decisions, Agriliance, L.L.C. v. Runnells Grain Elevator, Inc., 272 F. Supp. 2d 800 (S.D. Iowa 2003) and Agriliance, L.L.C. v. Farmpro Services, Inc., 328 F supp 2d 958 (S.D. Iowa 2003), a federal district court concluded that the observance of reasonable commercial standards of fair dealing requires asking how a reasonable person in like circumstances would behave.  Although the courts inquiry was whether the defendants were holders in due course and thereby protected by Article 3 rules despite being subordinate under the Article 9 priority rules, the test of fair dealing articulated by the court should apply as well to the good faith standard as it pertains to section 9-330(d) because, as is explained in subpart A (5) below, good faith as it applies to holders in due course is defined the same way as the good faith required of purchasers under new section 9-330(d).

It is important to keep in mind that although the effect of good faith to require a person to make such inquiry as is reasonable under the circumstances is the same for purchasers under new section 9-330(d) as for persons seeking holder in due course (HDC) status under new section 9-331(a), the ultimate question is different as to each section.  The reason is that to be denied the special priority of new section 9-330(d) a purchaser must have actual knowledge that the purchase violates a security interest whereas, as is further explained in Subpart A (5) below, knowledge of the existence of a security interest is enough to prevent a person from being a HDC.

It should also be understood that new section 9-330(d) is expressly subject to new section 9-331(a).  As explained in subpart A (5) below, new section 9-331(a) gives priority to a holder in due course (HDC) of a negotiable instrument. Therefore, if one party is entitled to the priority conferred by new section 9-330(d) and another person is a HDC as to that instrument, then the HDC will have priority.

On the other hand, because something less than knowledge that a purchase violates another's security interest can deny a person HDC status, a purchaser of an instrument could be denied the special priority of new section 9-331(a) and still qualify for priority under new section 9-330(d).  See Official Comment 7 to new 9-330.

Where a purchaser of an instrument does not qualify for the special priority given by new section 9-330(d) a dispute is governed by new section 9-322(a).

You may test your understanding of the application of new section 9-330(d) in the next problem.

Problem 29.7   (interactive)

Central Bank lends to Donna Debtor and takes a security interest in a certificate of deposit (CD) that is not negotiable but is transferred by delivery in the ordinary course of business.  Central files a financing statement covering the CD.  Later, Donna delivers the CD to Lenny Lender who takes possession of the CD without knowledge or notice of any claims against the CD, including that of Bank, and to satisfy an outstanding debt owed by Donna to Lenny.

Who has priority as to the CD? 

Suppose that Lenny was unable to satisfy the requirements of new section 9-330(d), but Central delayed filing its financing statement until after the delivery of the CD to Lenny.  Who has priority?

5. Priority of Security Interests in Negotiable Instruments, Negotiable Documents and Securities.

Under new section 9-331(a), new Article 9 does not limit the rights of a holder in due course (HDC) of a negotiable instrument conferred by Article 3, the rights of a holder to which a negotiable document has been duly negotiated provided for in Article 7, or the rights of a protected purchaser of a security given by Article 9.  The interaction between new Article 9 and Article 7 is dealt with in Chapter 15 (Perfection by Possession (Including Documents of Title)). The priority conferred by Article 8, including that referred to in new section 9-331(b), is beyond the scope of these materials. However, the priority of a HDC under Article 3, including the similarities and differences that exist between that priority and the priority conferred by new section 9-330(d), is considered below.

New section 9-331(a) provides that if a person is a holder in due course and the person would take free of a security interest under Article 3 (which it normally would), then Article 9 does not prevent that outcome.  Under Article 3, section 3-306, a holder in due course of a negotiable instrument generally is protected against a security interest in the instrument, even though the security interest has been properly perfected.

For the protection under new section 9-331(a) to be available, the instrument purchased must be a negotiable instrument within the meaning of Article 3, section 3-104. The details of when an instrument is negotiable under section 3-104 are beyond the scope of these materials but, generally speaking, the essential requirement is that the instrument be payable to bearer or to order, i.e., that the instrument includes the words of negotiability.  To qualify for the special treatment under new section 9-331(a), a purchaser must be a holder in due course (HDC) within the meaning of Article 3, section 3-302.  See, e.g., Sonic Engineering, Inc. v. Konover Construction Co. South, 51 UCC Rep Serv. 2d 844 (Conn Super Ct 2003) (concluding that a judgment creditor could not be a HDC within the meaning of new section 9-331(a) and its claim to a cashiers check was subordinate to that of a secured party who had a security interest in the deposit account that funded the check and which had been perfected by control.

When a purchaser is a HDC also is a matter that is largely outside the scope of these materials. However, two of the requirements, good faith and notice, are discussed here, especially because the discussion can inform the understanding of other priorities, specifically that in new section 9-330(d)).

Under Article 3, section 3-302(a)(2) to be a HDC of a negotiable instrument, the instrument must have been taken in good faith.  Section 3-302(a)(2) speaks of notice rather than knowledge and requires that an instrument have been taken without notice of any claim to the instrument described in Article 3, section 3-306.  As noted above, section 3-306 describes the claims a HDC takes the instrument free of and a security interest (a possessory right) is one of those claims.  Consequently, a person who takes a negotiable instrument with notice that it is subject to a security interest cannot be a HDC.

Throughout much of its history, good faith under Article 3 had only a subject component; however, the definition in Article 3, section 3-103(a)(6), has been expanded to include honesty in fact and the observance of reasonable commercial standards of fair dealing.  This is, of course, the very same definition found in Article 1, section 1-201(b)(20), and which applies throughout the UCC, including Article 9.  Indeed, subsection of Article 3, section 3-103, defining good faith is optional because in its absence the Article 1 definition will apply. See Official Comment 4 to Article 3, section 1-103.

In Agriliance, L.L.C. v. Runnells Grain Elevator, Inc., 272 F. Supp. 2d 800 (S.D. Iowa 2003) and Agriliance, L.L.C. v. Farmpro Services, Inc., 328 F supp 2d 958 (S.D. Iowa 2003), the two court decisions discussed in subpart A(4)(c), it was held that the observance of reasonable standards of fair dealing may require that a person inquire as to the actual facts, but the scope of the duty to inquire must be determined by reference to what may reasonably be expected of a party who is similarly situated.

As for the meaning of notice, except to the extent that Article 3 specifically so provides, Article 1, section 1-202 (formerly Article 1, section 1-201(25)) governs. Section 1-202, not unexpectedly, provides that a person has notice of a fact if the person has actual knowledge of it.  However, under that section a person has notice of a fact if from all the facts and circumstances known to the person at the time in question, the person has reason to know that it exists. Notice so understood is distinguishable from actual knowledge in that a person may be held to know something it does not actually know if from all the facts and circumstances the person had reason to know that something.  This reason to know aspect of notice has been understood to impose on a person a duty to inquire into the actual facts when the facts that are known and the circumstances make such an inquiry reasonable.

As just noted above, the observance of reasonable standards of fair dealing aspect of good faith similarly imposes a duty to make an inquiry that is reasonable under the circumstance.  To this extent the requirements of good faith and notice tend to merge.  The court in the two decisions referred to above, Agriliance, L.L.C. v. Runnells Grain Elevator, Inc., 272 F. Supp. 2d 800 (S.D. Iowa 2003) and Agriliance, L.L.C. v. Farmpro Services, Inc., 328 F supp 2d 958 (S.D. Iowa 2003), reached precisely that conclusion.  The court went on decide whether the defendant in each case had notice (in which case it would not have taken in good faith) that would deny it HDC status.

In Runnells the question was whether a landlord of farmland who took a cashiers check asserted to be the proceeds of crops grown on the leased land and subject to the plaintiffs security interest was under an obligation to search the filing records in which case it would have discovered the plaintiff's security interest and could not qualify as a HDC.  The court held that under all the circumstances, including the fact that the check stubs disclosed how the amount of the check had been calculated, a reasonable landlord, similarly situated, would not have knowledge of and could not be held to have knowledge of the plaintiffs security interest.

By contrast, in the Farmpro case, the court concluded that the defendant, a lender engaged in making agricultural loans, under all the circumstances, including the fact that crops often are used as collateral for such loans, the fact that the lender had entered into an agreement expressly subordinating its security interest in the debtors crops to the plaintiff's security interest in the crops, and the fact that the lender was aware of the debtors ongoing financial difficulties, was on notice of the fact that the source of a check it received in payment of its loan was crops in which the plaintiff had a perfected security interest and the lender, therefore, should be charged with knowledge of the plaintiff's security interest and could not qualify as a HDC.

It remains to be seen whether or to what extent other courts will determine that notice and good faith are the same or are distinguishable.  However, as the foregoing discussion indicates, good faith or notice requirements of holding in due course can impose a duty to inquire that could lead to knowledge of a security interest such as will deny HDC status.  An important qualification to this general conclusion is in order.

In earlier chapters, it was noted that perfection of a security interest in a negotiable instrument (or a negotiable document of title) can be perfected by filing.  Under new section 9-331(c), the fact that a financing statement covering a negotiable instrument (or a negotiable document of title or a security) has been filed does not constitute notice of a claim or defense such as will prevent a person from becoming a holder in due course (or deny a holder of a document of title to whom the document has been duly negotiated of rights under Article 7 or a purchaser of a security to rights conferred by Article 8). However, as just explained, actual knowledge of a financing statement or a conclusion that a holder of a negotiable instrument should have searched the public records and in so doing would have discovered a filing could prevent a holder from having HDC status under Article 3, section 3-302.  See Official Comment 5 to new 9-331.

It will be useful to compare and contrast the special priorities conferred by new section 9-331(a), on the one hand, and new section 9-330(d), on the other.  Good faith as to each of these special priorities is defined identically, in Article 1, section 1-201(b)(20), to mean honesty in fact and the observance of reasonable standards of fair dealing.  Thus, decisions about good faith made as to new section 9-331(a) should apply to determinations of good faith made as to new section 9-330(d).

As interpreted by the court in the Runnells and Farmpro cases, good faith requires that a person make such inquiry as is reasonable under all the circumstances.  To this extent, a person who has not acted in good faith sufficiently to qualify as a HDC for purposes of new section 9-331(a) will not be eligible for the special priority conferred by new section 9-330(d).  However, although actual knowledge or knowledge the existence of a security interest in a negotiable instrument imputed as a matter of notice or good faith of will deny a person HDC status, and hence, the ability to invoke the special priority in new section 9-331(a), that person may still be eligible to rely on the special priority in new section 9-330(d) because only knowledge that a purchase violates a security interest and not simply knowledge of the existence of a security interest is required to render a person ineligible for the protection of new section 9-330(d).  See Official Comment 7 to new 9-330.

With regard to the difference in knowledge necessary to deny a person the ability to invoke new section 9-330(d) or new section 9-331(a), it may be asked whether the court in the Farmpro case, supra, should not have stopped at having decided that the farm lender could not qualify as a HDC and have inquired further as to whether the lender was entitled to the special priority under section 9-330(d).  Insofar as the new section 9-330(d) is unavailable only to the extent that a purchaser has knowledge that a purchase violates a security interest the answer would seem to be that the court should have done so.

Although all the facts and circumstances might have imposed on the lender a good faith obligation to make such inquiry as would have given the lender knowledge of the plaintiff's security interest, it would be a separate matter to decide whether the lenders inquiry would have given it knowledge that the plaintiff's security interest had been violated.  Of course, the scope of the inquiry required, especially in light of the subordination agreement in that case, might have been such as to lead to such knowledge.

Subsection (d) is subject to Section 9-331(a), which provides that Article 9 does not limit the rights of a holder in due course under Article 3. Thus, in the rare case in which the purchaser of an instrument qualifies for priority under subsection (d), but another person has the rights of a holder in due course of the instrument, the other person takes free of the purchaser's claim. Section 3-306.

You may consider the application of new section 9-331 in the next problem.

Problem 29.8    (interactive)

Assume the facts of Problem 29.7.  Assume further that the CD is negotiable and that Lenny Lender is a holder in due course.  Who has priority as to the CD as between Lenny and Central Bank?  If Lenny did not qualify as a holder in due course could Lenny still have priority over Central?  Under new section 9-331(c), the fact that Central filed a financing statement, in and of itself, could not prevent Lenny from being a holder in due course. 

If there were circumstances sufficient to deny Lenny holder in due course status because Lenny had acted in bad faith (for example, that Lenny had done an Article 9 search and discovered Central Bank's filing), could Lenny also be denied priority under new section 9-330(d)?

B. Special Priority Rules as to Certain Proceeds Disputes

As explained in subpart A, special priority rules sometimes apply to certain collateral under new sections 9-327, 9-328, 9-329, 9-330 and 9-331.  Disputes as to the proceeds of collateral qualifying for the special priorities provided for in those sections may nonetheless be governed by the first-to-file-or-first-to-perfect rule of new sections 9-322(a)(1) and 9-322(b), discussed in Chapter 28 (Secured Party Versus Secured Party).  However, the drafters of new Article 9 concluded that the temporal priority provided for in the first-to-file-or-first-to-perfect rule is not always appropriate as to what is referred to by the drafters as "non-filing collateral."  Consequently, new section 9-322(c)(2), as qualified by new sections 9-322(d), (e) and (f), provides a special non-temporal priority rule for determining priority as to some non-filing collateral.

Non-filing collateral is collateral a security interest in which may be perfected by a method other than filing, mainly by possession or control, and possession or control is the only way to perfect or the preferable way to perfect a security interest in the collateral and parties who so perfect do not expect to have to do a search of the filing system.  Non-filing collateral includes chattel paper, deposit accounts, negotiable documents, instruments, investment property and letter-of-credit rights. See Official Comment 7 to new 9-322.

Under new section 9-322(c)(2), subject to new sections 9-322(d), (e) and (f), a security interest in proceeds of non-filing collateral has priority over a conflicting security interest if:

(1) the security interest in the proceeds is perfected;

(2) the proceeds are cash proceeds or of the same type as the original collateral; and

(3) in the case of proceeds of proceeds, all intervening proceeds are cash proceeds, proceeds of the same type as the original collateral or an account relating to that collateral.

According to Official Comment 8 to new section 9-322, new section 9-322(c)(2) provides a "baseline" priority rule for proceeds of non-filing collateral in situations where the temporal (first-in-time) rules of subsection (a)(1) are not appropriate. The condition that triggers the application of the priority provided for in new section 9-322(c)(2) is that original collateral is non-filing collateral a security interest is entitled to priority under one of the special priority rules considered above, such as the priority for a security interest in a deposit account perfected by control given by new section 9-327(1).

It is important to note that for the subsection (c) priority rule to apply the security interest in the proceeds must be perfected. Moreover, a security interest in proceeds that would otherwise have priority under new section 9-322(c)(2) will be subordinated because perfection did not continue beyond the twenty-day period of automatic perfection provided for in new section 9-315(c). As to the continuing perfection as to proceeds matter, see Chapter 24 (Continuing Perfection -- Changes as to the Use of Collateral or in the Location of the Collateral or the Debtor; Security Interests in Proceeds). To guard against this possibility a secured party who perfects a security interest in non-filing collateral (for example, a deposit account) by a method other than filing (for example, by control) could file a financing statement covering filing collateral that the secured party anticipates may be acquired using funds from the deposit account at the time it takes control of the deposit account.

The application of the section 9-322(c)(2) priority also requires that the proceeds at issue be cash proceeds, defined in new section 9-102(a)(9) as "money, checks, deposit accounts, or the like" or "of the same type as the collateral." Cash proceeds would not include ordinary goods, such as inventory or equipment, or various intangibles, such as investment property or negotiable instruments (other than checks) or documents of title. According to Official Comment 8 to new section 9-322, "of the same type" means a type of property defined in the Uniform Commercial Code, such as investment property, instrument or various ordinary goods, such as inventory or equipment. As to the meaning of "type" in classifying collateral, see Chapter 5 (Classification of Collateral). Consequently, the priority conferred by new section 9-322(c)(2) would apply to a security interest in proceeds of a investment property that are not cash but are of the same type, such as a certificated security.

Finally, if the proceeds are proceeds of proceeds, then the new section 9-322(c)(2) priority applies only if "all intervening proceeds are cash proceeds, proceeds of the same type as the collateral, or an account relating to the collateral." According to Official comment 8 to new section 9-322, "once proceeds other than cash proceeds, proceeds of the same type as the original collateral, or an account relating to the original collateral intervene in the chain of proceeds, priority under subsection (c) is thereafter unavailable."

As explained below, where new section 9-322(c)(2) does not apply because the conditions for its application are not met, the rule provided in new section 9-322(d) may apply or, on the right facts, the priority may be governed by the first-to-file-or-perfect rule.

Not surprisingly, determining when new section 9-322(c)(2) does and does not apply can be challenging. The next problem will assist your understanding of new section 9-322(c)(2) in a relatively uncomplicated fact situation.

Problem 29.9   (interactive)

Friendly Finance Company takes a security interest in a certificated security and perfects by filing.  Lisa Lender later takes a security interest in the same certificated security and perfects by control.  Delia Debtor receives cash dividends paid on the certificated security and deposits them in a general bank account in Southern Bank. 

Assuming that both Friendly and Lisa can trace the cash dividends into the general bank account, who as between Friendly and Lisa would have priority as to the general bank account in Southern Bank under the usual priority rule (the first-to-file or first-to-perfect rule)?

Who has priority as to the original collateral (the certificated security)?

Does this special priority as to the original collateral carry through to the bank account (the proceeds)?

Who has priority as to the bank account under new section 9-322(c)(2)?

As noted above, new section 9-322(c)(2) is subject to new section 9-322(f).  New section 9-322(f) provides that the rules of new section 9-322(c)(2) are subject to "the other provisions of this part."  The other provisions of this part include the special priority rules for certain collateral examined in subpart A above.

The next problem illustrates how the language "the other provisions of this part" in new section 9-322(f) qualifies the operation of new section 9-322(c)(2).

Problem 29.10   (interactive)

Assume the facts of Problem 29.9. Assume further, however, that Friendly Finance Company obtained control of the general bank account in Southern Bank?

On this change in facts, who has priority as to the general bank account as between Friendly and Lisa Lender?

The special rule for proceeds of non-filing collateral in new section 9-322(c)(2) also is subject to new sections 9-322(d) and (e).  Under new section 9-322(d), if a security interest in non-filing collateral is perfected otherwise than by filing (i.e., by possession or control), then perfected security interests in the proceeds of the collateral rank according to the time of filing. This rule is referred to by the drafters as a "new" first-to-file rule. See Official Comment 8 to new 9-322. However, under new section 9-322(e), the rule of new section 9-322(d) applies only if the proceeds are not cash proceeds and are filing collateral (i.e., are other than non-filing collateral).

Stated more directly, where the proceeds of non-filing collateral, a security interest in which was perfected by possession or control, are filing collateral, then conflicting security interests in the proceeds rank according to the time of filing.  New section 9-322(d) also is subject to new section 9-322(f), providing for priority under other provisions of this part, such as the special priority given to security interests in deposit accounts perfected by control.

The resulting brainteaser of rules may be explored in the next problem.

Problem 29.11    (interactive)

Friendly Finance Company lends to Donald Debtor, takes a security interest in Donald's general bank account and perfects its security interest in the bank account by obtaining control. Thereafter, Lenny Lender takes a security interest in Donald's equipment, existing and after-acquired, and files a financing statement covering the equipment. Subsequently to the secured loan by Lenny Lender, Friendly also takes a security interest in Donald's equipment, existing and after-acquired, and files a financing statement covering the equipment. Donald then uses funds from the bank account to acquire equipment that Friendly can trace as proceeds of its security interest in the bank account.

Who as between Friendly Finance and Lenny Lender has priority as to the equipment under the first to file or first to perfect rule of subsections 9-322(a)(1) and (b)?

However, Lenny nonetheless has priority over Friendly as to the equipment acquired with funds from the bank account. Why is this so? Hint: The bank deposit is non-filing collateral and the equipment is filing collateral.

Why can Friendly not rely on its priority as to the bank account to get priority as to the equipment under new section 9-322(c)(2)?

Suppose the facts of Problem 29.11 were that Donald Debtor sold the equipment acquired using the funds from the bank account as to which Friendly Finance has a security interest perfected by control and Donald received a check in payment for the sale of the equipment. Assuming that Friendly and Lenny both are able to establish that the check constitutes identifiable proceeds of their security interests. Who has priority as to the check?
Hint: The check is cash proceeds but not all intervening proceeds are cash proceeds (or proceeds of the same type).

C. The "Double Debtor," "New Debtor" and "Multiple Debtor" Problems

1. Generally

Understanding the complicated priority rules considered in this subpart requires also understanding the basic rules regarding the extent to which security interests continue in or attach to transferred collateral and collateral acquired by transferees or new debtors and, also, the rules governing perfection and continuing perfection of any such security interests.  These matters were considered at length in Chapters 9 (The Specifics of Enforceability -- After-Acquired Property, Proceeds and Future Advances) and 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 it would be a good idea to review of those chapters now.

2. The "Double Debtor" Problem.

To this point we have been examining conflicts among parties whose interests were created by the same debtor.  It can happen that a person (the transferee/debtor) acquires property subject to a security interest created by some other person (the transferor/former debtor/obligor) and the acquiring person (the transferee) then creates a security interest in favor of another creditor.  In such a case, there arises what has been referred to as the "double debtor" problem.  The double debtor problem was not explicitly addressed in former Article 9.

Recall from Chapter 9 (The Specifics of Enforceability -- After-Acquired Property, Proceeds and Future Advances) that under new section 9-315(a)(1), a security interest continues in transferred collateral unless the secured party authorizes the transfer free of the security interest.  The transferor remains the obligor under new section 9-102(a)(59) but the transferee becomes the debtor under new section 9-102(a)(28).

Under new section 9-507(a), if the security interest in the transferred collateral was properly perfected by a filing made against the transferor, then the financing statement continues to be effective against the transferee, without further action by the secured party and irrespective of any name change (unless and until the financing statement lapses or is terminated).  However, if the security interest in the transferred collateral was not timely or properly perfected, then a buyer/transferee may take free of the security interest under new sections 9-317(b) or 9-320(b).  If the transferee is a buyer in ordinary course, the transferee/buyer takes free of even a perfected security interest under new section 9-320(a).

The question here is what happens if a transferee who has not taken free of a security interest in transferred collateral gives a security interest in that collateral to another secured party.

If the holder of the security interest created by the transferor in the transferred collateral has priority over the security interest created by the transferee under new section 9-322(a) (first to file or perfect) or under new section 9-324 (special priority for a purchase money party), then that is the end of the inquiry.  However, if the holder of the security interest created by the transferee has priority under either new section 9-322(a) or 9-324, the holder of the security interest created by the transferor and that continued in the transferred collateral may still have priority.  This can happen under new section 9-325(a).

Under new section 9-325(a), a security interest in the transferred collateral has priority over a security interest created by the transferee if: 

(1) The transferee/debtor acquired the collateral subject to the security interest created by the transferor (i.e., the transferee did not take free of the security interest under new sections 9-315(a)(1) or 9-317(b), 9-320(a) or (b));

(2) The security interest created by the transferor was perfected when the collateral was transferred; and

(3) There is no period after the transfer when the security interest that continued in the transferred collateral became unperfected (e.g., by lapse).

The rationale for the priority given new section 9-325(a) is that the later secured party could have investigated the source of the collateral and the transferee's title to the collateral whereas the secured party holding the security interest that continued in the transferred collateral has no reason to know of or protect against the security interest created by the transferee. See Official Comment 3 to new 9-325.

Under new section 9-325(b), the special priority rule of new section 9-325(a) governs only where the security interest created by the transferee otherwise would have priority solely under new sections 9-322(a) or 9-324 (or the conflicting security interest was created under Articles 2 or 2A).

You may explore the operation of new section 9-325(a) in the next problem.

Problem 29.12   (interactive)

Western Bank has a security interest in Donna Debtor's equipment, existing and after-acquired. Western filed a financing statement covering the equipment.  Subsequently, without authorization, Donna sells the drill press to Byron Buyer who purchases a drill press with the proceeds of a loan from Lisa.  Lisa takes a security interest in the drill press and files ten days after the delivery of the drill press to Byron Buyer.

Who as between Western Bank and Lisa Lender has priority as to the drill press under the usual priority rules, i.e., those found in new section 9-322(a) and 9-324?

However, the facts present a so-called "double debtor" problem governed by new section 9-325(a). Explain how this is so.

Who has priority as between Western Bank and Lisa Lender under new section 9-325(a)?

3. The "New Debtor" Problem

As discussed in Chapters 9 (The Specifics of Enforceability -- After-Acquired Property, Proceeds and Future Advances) and 23 (Continuing Perfection -- The Need to Reperfect (Or Refile), under new section 9-102(a)(56), a "new debtor" is a person who becomes bound as a debtor under new section 9-203(d) by a security agreement created by another person.  As noted in those chapters, former Article 9 did not explicitly deal with new debtor priority problems.  New Article 9 addresses a number of new debtor problems, including those pertaining to continuing perfection.

Under new sections 9-507(a) and 9-508(c), a financing statement naming the original debtor continues to be effective as to collateral transferred to a new debtor without regard to name change concerns.  Under new section 9-508(a), the filing against the original debtor also is effective as to collateral owned by the new debtor or collateral acquired by the new debtor up to four months after the new debtor becomes bound under new section 9-203(a).  Lastly, under new section 9-508(b), the filing made against the original debtor can be effective against the new debtor as to collateral purchased more than four months after the person becomes a new debtor if the secured party files a financing statement against the new debtor before the expiration of the four-month period.

The question here is what happens if a new debtor creates a security interest in favor of a secured party other than the one to whom the original debtor gave the security interest to which the new debtor has become bound.  Under new section 9-326(a), subject to new section 9-326(b), the holder of a security interest created by a new debtor that is perfected by a filing that is effective otherwise than by the operation of new section 9-508 has priority over (subordinates) the holder of a security interest to which the new debtor has become bound under new section 9-203(d) if that security interest is perfected by a filing that is effective solely under new section 9-508. See Official Comment 2 to new 9-326.

The usual priorities obtain where the holder of the security interest created by the original debtor timely files an initial financing statement against the new debtor because its security interest is no longer perfected solely under new section 9-508. According to Official Comment 2 to new section 9-326, for purposes of new section 9-326(a), effective solely under new section 9-508 does not "encompass a new initial financing statement providing the name of the new debtor, even if the initial financing statement is filed to maintain the effectiveness of a financing statement under the circumstances described in Section 9-508(b)." Cf. Example 4 in Official Comment 3 to new section 9-326.

The rule of new section9-326(a) is less complicated than might first appear. You may consider its application in the next problem.

Problem 29.13   (interactive)

Central Bank holds a security interest in Ollie Debtor's existing and after-acquired inventory.  The security interest was perfected by filing.  Lenny Lender holds a security interest in Newton Debtor's inventory, existing and after-acquired, that also was perfected by filing.  Newton becomes bound by the security agreement entered into between Ollie and Central under new 9-203(d). 

The priority between Central Bank and Lenny Lender is determined by new section 9-326(a). Why is this so?

Who has priority as between Central Bank and Lenny Lender under new section 9-326(a) as to inventory owned by Newton at the time that Newton becomes bound to the security agreement entered into between Central and Ollie? 

Suppose that in Problem 29.13 Central Bank and Lenny Lender were fighting over an item of inventory acquired by Newton more than four months after Newton became bound to the security agreement entered into between Ollie and Central and that Central had filed an initial financing statement naming Newton as the debtor before the four month period after Newton had become bound had expired. Who has priority as between Central and Lenny as to this later-acquired item of inventory?

In the foregoing problem, the conflict was between the holder of a security interest created by an original debtor and the holder of a security interest created by a new debtor.  It could happen that a new debtor becomes bound to more than one security interest created by the original debtor and a conflict as to property owned or acquired by the new debtor could arise between the secured parties to the separate security agreements entered into by the original debtor.  If both competing parties rely on new section 9-508 to make their filings against the original debtor effective against collateral owned or acquired by the new debtor, then under new section 9-326(b) (the first sentence), priority is governed by the usual priority rules ("other provisions of this part"). See Official Comment 3 to new section 9-326.

The next problem will allow you to apply new section 9-326(b).

Problem 29.14    (interactive)

Southwestern Bank has a security interest in Oprah Debtor's accounts, existing and after-acquired.  Southwestern Bank perfected by filing a financing statement covering the accounts.  Lenny Lender also has a security interest in Oprah's accounts, existing and after-acquired.  Lenny filed as to the accounts after Southwestern filed.  Newton Debtor becomes bound by the security agreement entered into between Oprah and Lenny.  Subsequently, Newton becomes bound by the security agreement entered into between Oprah and Southwestern.

This is a new debtor case governed by the first sentence of new section 9-326(b). Why so?

Who has priority as between Southwestern and Lenny under the first sentence in new section 9-326(b) as to accounts generated from Newton Debtor's business activity after Newton became bound to the security agreements between Oprah and Southwestern and Oprah and Lenny?

Suppose Lenny had filed a financing statement naming Newton as the debtor. Who has priority now?

4. The "Multiple Debtor" Problem.

It could happen that a person becomes bound to security interests created by more than one original debtor, i.e., a person becomes a new debtor as to security interests created by different original debtors, and the secured parties as to the different security agreements could come into conflict as to collateral owned or acquired by the new debtor.  If both secured parties involved in such a conflict rely on new section 9-508 to make their filings against their original debtors effective, then the second sentence of new section 9-326(b) governs.

The second sentence of new section 9-326(b) provides that the conflicting security interests rank according to priority in time of the new debtor becoming bound to the security agreements entered into by different original debtors.  If one of the secured parties has filed against the new debtor and, therefore, is not relying on new section 9-508 to perfect its security interest, then new section 9-326(a), discussed above, governs. According to Official Comment 3 to new section 9-326, subsection (b) of new section 9-326 "reflects the generally accepted view that priority based on the first-to-file rule is inappropriate when filings were made against different debtors," but, as is true of the rules in new section 9-326(a) and the first sentence of 9-326(b), the special priority rule in the second sentence of new section 9-326(b applies only to conflicts "among security interests perfected by filed financing statements that are 'effective only under Section 9-508.'"

You may consider the application of the second sentence of new section 9-326(b) in the next problem.

Problem 29.15   (interactive)

Central Bank has a security interest in Debbie Debtor's inventory, existing and after-acquired. Central perfected its security interest by filing. Lisa Lender has a security interest in Donald Debtor's inventory, existing and after-acquired. Lisa perfected its security interest by filing against Donald before Central filed against Debbie.  Subsequently, Newton Debtor becomes bound by the security agreement entered into between Central and Debbie and later still becomes bound by the security agreement entered into between Lisa and Donald.

This is a multiple debtor situation governed by the second sentence of new section 9-326(b). Why so?

Who has priority as between Central Bank and Lisa Lender under the second sentence in new section 9-326(b) as to inventory owned or acquired by Newton Debtor? 

Would the answer to the previous question be different if Lisa Lender filed against Newton Debtor?

CASE COMMENTARY

Integrity Bank Plus v. Talking Sales, Inc., 2006 WL 212193 (D. Minn. 2006)

Madisonville State Bank v. Citizens Bank, 184 S.W.3d 835 (Tex. App. 2006)

Madisonville State Bank v. Canterbury, Stuber, Elder, Gooch & Surratt, P.C., 209 S.W.3d 254 (Tex. App. 2006)

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2011-08-22 update