Part VI Priority

Chapter 31 Secured Party Versus Statutory Liens Including Agricultural Liens and Federal Tax Liens; Bank’s Right of Set-Off

A. Generally

You should recall from Chapter 3 (The Nature of Secured Credit under Article 9) that a lien is an interest in property to secure a debt and that there are essentially three kinds of liens: consensual liens, including Article 9 security interests, judicial liens obtained by litigation; and liens that arise by operation of law. The last category of lien includes both a lien created by judicial decision, a "common law lien," and a lien created by statute. Most liens of consequence that arise by operation of law today are statutory liens. This chapter examines only conflicts between secured parties and holders of liens created by statute.

Most states, including Arizona, have created a range of statutory liens aimed at protecting particular types of creditors who have been deemed deserving of such protection.  Among the statutory liens are landlord liens, artisan liens and garage (repair shop) liens.  Former Article 9 excluded from its coverage the creation, perfection and enforcement of statutory liens and most priority disputes involving such  liens also were outside the scope of former Article 9.  However, under former section 9-310 a creditor who had a lien arising by operation of law on goods in the possession of the creditor to secure debts resulting from the fact the creditors had furnished materials or services with respect to the goods was given priority over a holder of a security interest unless the lien was statutory and the statute expressly conferred priority on the holder of the security interest. 

As discussed in Chapter 4 (Scope of Article 9), the creation, perfection and enforcement of most statutory liens and most priority disputes involving such liens are outside the scope of new Article 9.  See new section 9-109(d).  However, as explained in Chapter 4 and later chapters, new Article 9 does apply to agricultural liens.  Thus, new Article 9 governs the perfection of agricultural liens and most priority disputes between holders of agricultural liens and Article 9 security interests (although the creation and scope of an agricultural lien are matters determined by the statute creating the lien).  New Article 9, section 9-333, also continues the special priority given by former section 9-310 to holders of certain possessory liens on goods as to which materials and services have been furnished.

In many states, including Arizona, liens on property to secure the payment of delinquent taxes are given to the state and subdivisions of the state.  Because the state tax lien schemes may differ from one state to another, these materials make no attempt to deal with state tax liens or priority disputes between Article 9 secured parties and tax lien holders.

Liens resulting from the failure to pay federal taxes also are possible.  Federal tax liens can pose serious problems for Article 9 secured parties.  The rules governing priority disputes between holders of federal tax liens and holders of Article 9 security interests, which derive heavily from court decisions as ameliorated by the Federal Tax Lien Act of 1966, are considered in subpart D below.  However, an in depth treatment of federal tax liens also is beyond the scope of these materials.  Chapter 5 of the B & S text (cited in Chapter 3) offers a detailed discussion of federal and state tax liens.  Other chapters of the B & S text discuss various types of liens arising under state law at some length.

B. Secured Party versus Agricultural Lien

As defined in new section 9-102(a)(5) a lien is an "agricultural lien" essentially if it is an interest (other than a security interest) in farm products that is created by statute, that secures payment of an obligation for goods or services furnished in the ordinary course of business to a debtor who is engaged in a farming operation and that is not dependent on possession.

As was seen in Chapter 12 (Perfection Generally) and Chapter 13 (Overview of Perfection by Filing), agricultural liens are perfected by filing a financing statement in the Office of the Secretary of State in the state where the farm products are located.  See new 9-302, 9-310(a) and 9-501(a).  As explained in Chapter 28 (Secured Party Versus Secured Party), priority disputes generally are resolved according to the first in time to file or to perfect or to attach rules of new section 9-322(a).

These rules apply to disputes involving agricultural liens except that under new section 9-322(g)  a perfected agricultural lien has priority over a conflicting security interest in (or agricultural lien on) the same collateral if the statute creating the agricultural lien so provides.  As stressed in Official Comment 12 to new section 9-322, a priority provided for in a statute creating a competing agricultural lien trumps the rules of new section 9-322(a) only if the agricultural lien is perfected.

In Chapter 9 (The Specifics of Enforceability -- After-Acquired Property, Proceeds and Future Advances) and Chapter 16 (Perfecting Security Interests in Proceeds and Other Later Acquired Property) it was noted that an agricultural lien on proceeds cannot arise or be perfected under Article 9.  The extent to which an agricultural lien reaches proceeds is determined by the statute creating the agricultural lien.  Official Comment 12 to new section 9-322 emphasizes that the rules in new section 9-322 applying to proceeds disputes, discussed in Chapter 28 (Secured Party Versus Secured Party) and Chapter 29 (Secured Party Versus Secured Party (continued)), do not apply to proceeds disputes involving agricultural lien holders.

That same comment insists that if an agricultural lien has priority under new section 9-322(g) (because the agricultural lien is perfected and the statute creating it confers priority) and the statute creating the agricultural lien gives the holder of the lien a lien on proceeds, then a court should apply the principle of new section 9-322(g) and award priority to the holder of the perfected agricultural lien.

It would seem that by enacting new Article 9 a state has made a decision to displace whatever decisional law might favor an agricultural lien over a security interest with the Article 9 scheme as set forth in new section 9-322.  It would further seem, however, that a holder of a statutory lien, whether or not it qualifies as an agricultural lien, is free to create an Article 9 security interest in the property subject to the lien.

If the lienholder does create a security interest then any dispute with another Article 9 party would be resolved according to the priority rules governing disputes between and among secured parties, as discussed in Chapter 28 (Secured Party Versus Secured Party) and Chapter 29 (Secured Party Versus Secured Party (continued)).  Cf. United States v. Globe Corp., 546 P.2d 11 (AZ 1976) (Indicating that a holder of a landlord lien could create and perfect an Article 9 security interest in property covered by the landlord lien).

The next two problems illustrate several aspects of the new Article 9 scheme for resolving disputes between agricultural liens and security interests.

Problem 31.1    (interactive)

Selma Seller sells cottonseed on credit to Dell Debtor to be used by Dell for planting and growing cotton on farmland in Marana, Arizona, leased by Dell from Strobe Corporation, the owner of the land.  Dell gives Selma an interest in the cotton grown from the seed to secure the unpaid price of the seed.  Dell signs a security agreement covering the cotton crop but Selma does not file a financing statement.  Dell borrows from Western Bank to finance his farming operations.  Dell gives Western a security interest in "the crop of cotton to be grown this coming year" and authenticates a security agreement so describing the collateral.  Western immediately files a financing statement covering the cotton crop in the Arizona Secretary of State's Office.  Dell encounters serious financial difficulties and defaults on the debts to Selma and Western and also his rental obligations to Strobe Corporation.  Arizona has enacted two statutes that could support a claim of an agricultural lien.  They are:

A.R.S. § 33-901 Lien for furnishing labor or machinery upon agricultural land (Farm Services Lien)

A person who labors or furnishes labor or machinery or equipment in improving and preparing agricultural lands for planting crops, and to whom wages or monies are due and owing therefor, shall have a lien upon the crops produced on such lands for all unpaid amounts.

A.R.S. § 33-362 Landlord's lien for rent (Remedies of Landlord)

A. The landlord shall have a lien on all property of his tenant not exempt by law, placed upon or used on the leased premises, until the rent is paid. The lien shall not secure the payment of rent accruing after the death or bankruptcy of the lessee, or after an assignment for the benefit of the lessee's creditors.

B. The landlord may seize for rent any personal property of his tenant found on the premises, but the property of any other person, although found on the premises, shall not be liable therefor. If the tenant fails to allow the landlord to take possession of such property, the landlord may reduce the property to possession by an action to recover possession, and may hold or sell the property for the payment of the rent.

C. The landlord shall have a lien for rent upon crops grown or growing upon the leased premises, whether the rent is payable in money, articles of property or products of the premises, and also for the faithful performance of the terms of the lease, and the lien shall continue for a period of six months after expiration of the term of the lease.

D. When premises are sublet, or when the lease is assigned, the landlord shall have the same lien against the sublessee or assignee as he has against the tenant and may enforce the lien in like manner.

Which of the creditors, Selma Seller, Western Bank and Strobe Corporation, has an agricultural lien?  Which of these creditors has a security interest?

Problem 31.2   (interactive)

Assume the facts of Problem 31.1.  

Does Strobe Corporation have priority over Selma Seller as to the cotton crop?  

Would your answer to the previous question be different if A.R.S. § 33-362 conferred priority on the holder of a landlord's lien?  

Who does have priority as to the cotton crop as between Selma and Strobe Corporation?  

Who has priority as to the cotton crop as between Selma, Strobe Corporation and Western Bank?

The statutes in some states make the determination of the priority between a security interest and a lien that could qualify as an agricultural lien more straightforward.  For example, the Iowa landlord’s lien statute creates a lien on crops not unlike that conferred by A.R.S. § 33-362(C) above, but the statute specifically provides that such a lien may be perfected only by filing a financing statement pursuant to new sections 9-308(a) and 9-310(a) of new Article 9 and if the lien is so perfected then the lien has priority over a prior Article 9 security interest. Moreover, according to the Iowa courts the lien applies to proceeds of crops.  See Agriliance, L.L.C. v. Runnells Grain Elevator, Inc., 272 F. Supp. 2d 800 (S.D. Iowa 2003).

In other states it may be unclear what a lienor has to do to perfect and, specifically, whether filing under Article 9 is required, and whether any priority conferred by the statute extends to proceeds. See, e.g., Stockman Bank of Montana v. AGSCO, Inc., 727 N.W.2d 742 (N.D. 2007) (concluding that substantial compliance with a statute was enough to give a supplier an agricultural lien created by the statute).

It is important to keep in mind in all cases that under new section 9-322(g), a priority over a security interest will be effective only if the priority is provided for in the statute creating the lien.   See Official Comment 12 to new 9-322.

C. Priority of Possessory Liens Arising by Operation of Law

Under new section 9-333(b), a possessory lien on goods has priority over a security interest in the goods unless the lien is created by a statute that expressly provides otherwise.  For purposes of the special priority given by new section 9-333(b), under new section 9-333(a), a "possessory lien" is an interest, other than a security interest or agricultural lien, that

(1)    secures payment of a debt incurred for services or materials furnished with respect to the goods by a person in the ordinary course of that person's business;

(2)    is created by statute or rule of law in favor of the person; and

(3)    depends for its effectiveness on the person's possession or the goods.

According to new section 9-333(b), a holder of a possessory lien on goods has priority over a holder of a security interest in the goods unless the lien is created by statute and the statute creating the lien expressly gives priority to the security interest.  Implicitly, a security interest could never have priority over a possessory lien arising under common law.  Moreover, if the lien is created by statute, the lien has priority over the security interest unless the statute expressly confers priority on the security interest.

The reality is that many statutes creating liens that would qualify as possessory liens under new section 9-333(a) were not drafted with Article 9 in mind and may use language that leaves its intent as to priority unclear.  The requirement that the statute expressly give priority to the security interest would seem to mean that doubts regarding the intent of the statute are to be resolved in favor of the lien holder.  Official Comment 2 to new section 9-333 reinforces this interpretation.

Note that to qualify as a possessory lien under new section 9-333(a) the person claiming the lien must have furnished services or materials with respect to the goods involved and must have done so in the ordinary course of the person's business.  A landlord's lien would not fall within new section 9-333.  An agricultural lien as defined in new section 9-102(a)(5) would qualify except that new section 9-333(a) excludes agricultural liens.  Actually, the exclusion seems unnecessary because under new section 9-102(a)(5) a lien can be an agricultural lien only if it is not dependent for its effectiveness on possession.

The clearest examples of liens that are eligible for the special priority in new section 9-333(b) are liens given to artisans and repair shops.  However, if the lien is not dependent on possession then the lien does not qualify as a possessory lien under new section 9-333(a).  Moreover, any statute creating such a lien must be consulted to discover whether the statute expressly gives priority to a competing security interest.

Of course, a statute may create a lien that does not qualify for priority under new section 9-333(b) and the statute may specify the priority of the lien holder over other creditors, including secured parties.  In re S.M. Acquisitions Co., 296 B.R. 452 (D. Ill. 2003).

You may consider the operation of new section 9-333 in the next three problems.

Problem 31.3    (interactive)

Delia Debtor buys a television for personal use from Sid Seller on credit.  Delia gives Sid an interest in the television to secure its unpaid price and Delia authenticates a security agreement that satisfies new section 9-203(b)(3)(A).  Before Delia has paid the full price of the television Delia takes the television to QuicFix TV Shop for repairs.  Delia fails to pay QuicFix for the cost of the repairs and Delia also defaults on the debt owed to Sid.  Sid seeks to repossess the television from QuicFix.  QuicFix refuses to give up the television.  All of the foregoing events take place in Arizona.  Arizona has enacted the following statute:

A.R.S. § 33-1021. Lien for labor or materials furnished on personal property; right to possess property (Personal Property Lien)

When an article, implement, utensil or vehicle, except motor vehicles, is repaired or cleaned, glazed or washed, with labor, with or without material, by a carpenter, mechanic, artisan or other workman, such person shall have a lien thereon for the labor or material and may retain possession thereof until the amount due is fully paid.

Does QuicFix have a personal property lien under A.R.S. § 33-1021?  

Does QuicFix have a "possessory lien" under new section 9-333

Who as between Sid Seller and QuicFix has prior claim to the television?

Note that motor vehicle situations are outside the scope of A.R.S. § 33-1021.  Consider the following problem.

Problem 31.4    (interactive)

Donald Debtor, an Arizona resident, purchases a WhirlWind fifth-wheel trailer from Sam Seller, an Arizona WhirlWind dealer.  Fifth-wheel trailers are house or recreational type trailers that are designed to connect to the bed of a pick up truck (which pulls the trailer).  The WhirlWind trailer was purchased on credit and Donald signed an installment contract giving Sam an interest in the trailer to secure its unpaid price.  Before the price of the trailer has been paid, Donald takes the trailer to Trailer Outfitter, Inc., an Arizona business specializing in customizing and otherwise modifying trailers, for some expensive modifications.  Donald fails to pay for the modifications and has defaulted on the debt owed to Sam.  Arizona has enacted the following statute:

§ 33-1022. Garages; aircraft

A.     Proprietors of garages and repair and service stations shall have a lien upon motor vehicles of every kind and aircraft, and the parts and accessories placed thereon, for labor, materials, supplies and storage for the amount of the charges, when the amount of the charges is agreed to by the proprietor and the owner.

B.     The lien shall not impair any other lien or conditional sale of record at the time the labor, materials, supplies and storage were commenced to be furnished, unless furnished with the knowledge and consent of the record lienor or vendor.

C.     If a proprietor has a lien on an aircraft pursuant to subsection A of this section, the proprietor who provides labor, materials, supplies and storage for aircraft may relinquish possession of the aircraft and retain the lien by recording the lien with the county recorder of the county in which the labor, materials, supplies or storage were provided. The lien shall be filed with the county recorder within thirty days after possession is relinquished. In addition, the proprietor may record the lien with the federal aviation administration aircraft registry. A lien filed with the federal aviation administration aircraft registry shall comply with all requirements of federal law and shall accurately describe the aircraft, list the amount of the claim, list the date on which the labor, materials, supplies or storage were last furnished, be signed by the claimant showing the title of the signer, if appropriate, and be accompanied by the recording fee

D.     A lien which is filed with a county recorder pursuant to subsection C of this section does not bind a purchaser of the aircraft without actual notice of the lien unless the lien has also been recorded with the federal aviation administration aircraft registry. A lien authorized under subsection C of this section may be foreclosed only by an action in court.

E. When an aircraft lien which has been recorded under this section has been satisfied, the lienholder within thirty days after satisfaction shall issue a release of the lien to the person against whom the lien was claimed and shall record the release of that lien in the county in which the lien was recorded and with the federal aviation administration aircraft registry, if the lien was recorded there. Failure to record a release upon satisfaction of the lien shall subject the lienholder to the penalties prescribed in § 33-712.

Who has prior claim to the WhirlWind trailer as between Sam Seller and Trailer Outfitter? 

Does A.R.S. § 33-1022 govern?  What question must be answered before you can answer the previous question?  See Western Coach Corp. v. Malibu Corp., 528 P.2d 868 (Ariz.App. 1974). 

If A.R.S. § 33-1022 does not apply does Trailer Outfitter have a lien under A.R.S. § 33-1021 and priority under new section 9-333(b)?  Be sure to read A.R.S. § 33-1021 carefully before answering. 

If A.R.S. § 33-1022 does not give Sam Seller priority and Trailer Outfitter does not have priority under A.R.S. § 33-1021 and new section 9-333(b) then which of these creditors has priority?

Problem 31.5   (interactive)

If the dispute in Problem 31.4 were over the pickup used to pull the trailer rather than the trailer itself, who would have priority as between Sam Seller and Trailer Outfitter?  Be sure to read A.R.S. § 33-1022(B) carefully before answering.  Explain your answer.

Notice that A.R.S. §§ 33-1021 and 33-1022 cover liens for work done on airplanes.  The application of the lien statute to aircraft was considered in U.S. v. 1980 Lear Jet, Model 35A, Serial Number 277, 25 F.3d 793 (9th Cir. 1994).

D.  Secured Party versus Federal Tax Lien

Debtors who default on secured debts may well have income tax problems.  The Internal Revenue Service (IRS) is a formidable adversary for taxpayers and for their creditors.  The IRS can obtain a tax lien on most of a taxpayer debtor's property simply as the result of a taxpayer's failure to pay an assessed deficiency when demanded by the IRS to do so.  26 U.S.C § 6321.  Unless specifically provided otherwise in an applicable statute, the tax lien arises at the time of the assessment and continues until the tax liability is satisfied.  26 U.S. C. § 6322.

A federal tax lien is basically a secret lien.  No recording is necessary for the lien to be effective against a taxpayer and many of the taxpayer's creditors.  Subject to important qualifications made by the Federal Tax Lien Act of 1966, 26 U.S.C. § 6321 et seq., the Doctrine of Inchoateness governs.  Under this doctrine a tax lien has priority over other interests in property subject to the tax lien unless the identity of the claimant, the property in which the interest is claimed and the amount owed are fixed at the time the tax lien arises.  See, e.g., United States v. Globe Corp.  , 546 P.2d 11 (AZ 1976).  Obviously, the inchoateness doctrine creates special difficulties for commercial financing involving after-acquired collateral.

The Federal Tax Lien Act in 26 U.S.C. § 6323(a)  offers some protection to persons who are holders of security interests prior to the time a tax lien is recorded.  However, under 26 U.S.C § 6323(h)(1), a person is a holder of a security interest within the meaning of the act only to the extent that the security interest is perfected in the sense that it cannot be subordinated by a lien creditor.

Moreover, there are special rules governing interests in after-acquired property and future advances.  Under 26 U.S.C. § 6323(c), after-acquired property interests are protected only if the collateral is "commercial financing security," meaning essentially chattel paper, accounts and inventory, and only to the extent that the collateral is acquired within 45 days after the tax lien is recorded.

Likewise, discretionary future advances are protected only to the extent they are secured by security interests in chattel paper, accounts and inventory and only advances made without knowledge of the tax lien and within 45 days after the tax lien is recorded are protected.  Obligatory advances, advances made pursuant to a commitment, are not subject to the 45-day or knowledge limitation.

Under the foregoing scheme, interests in after-acquired property other than chattel paper, accounts and inventory arising after a tax lien has arisen (after an assessment) are inchoate at the time the tax lien arises and will be subordinate to the tax lien, irrespective of whether or not the tax lien has been recorded.  Similarly, future advances secured otherwise than by interests in chattel paper, accounts and inventory will be subordinated to the extent they are made after a tax lien arises, whether or not the tax lien has been recorded.

Security interests in chattel paper, accounts and inventory acquired within 45 days after a tax lien is recorded are protected.  Future advances secured by interests in chattel paper, accounts and inventory owned by the taxpayer or acquired with 45 days after a tax lien is recorded are protected to the extent the advances are obligatory and discretionary advances are protected to a similar extent if they are made within 45 days after a tax lien is recorded and without actual knowledge that a lien has been recorded.

The message to secured parties is two-fold. First, secured parties are always at risk as to interests in and advances secured by property other than chattel paper, accounts and inventory, i.e., "commercial financing security," and secured parties must be alert to the possibility of tax problems and resulting tax liens.   Second, as to collateral consisting of chattel paper, accounts and inventory and discretionary advances secured by interests in such collateral, secured parties should examine the public records every 45 days and should take appropriate action upon discovery of a tax lien.

Appropriate action means not making any discretionary advances more than 45 days after the tax lien is recorded and may well mean treating the recording of a tax lien as a default leading to foreclosure on all collateral acquired by a debtor before the end of the 45-period after the recording of a tax lien.

Whether or not it is practicable for a secured party in a given case to act as the federal tax lien laws dictate is a nice question.  In any event, acting appropriately requires knowing where to look for a tax lien.  Under 26 U.S.C. § 6323(f), states may designate the place in which a tax lien is to be recorded.  Arizona law, A.R.S. § 33-1032(B), designates the County Recorder's Office in the county where real property subject to a tax lien is located as the place in which the tax lien is to be recorded.

As to personal property, the place for recording a tax lien depends on whether the debtor/taxpayer is an organization (a corporation or partnership) or an individual. As to an organization, under A.R.S. § 33-1032(C)(1), the place for recording is the Office of the Secretary of State.  As to individual debtor/taxpayers, under A.R.S. § 33-1032(C)(4), the County Recorder's Office in the county in which the individual resides has been designated as the place for recording a tax lien.

Federal law governs as to the form and content of a notice of a federal tax lien and state law requirements, including those of Article 9, do not determine whether a particular notice is sufficient.  See 26 U.S.C. § 6323(f)(3) and United States v. Union Central Life Insurance Co., 368 U.S. 291 (1961).  Thus, for example, new Article 9 section 9-503 does not govern the sufficiency of a name used in a notice of a federal tax lien.

Interestingly, however, the courts have employed a test of the sufficiency of the debtor’s name used that resembles that found in new sections 9-503 and 9-506.  That test is one of reasonableness, understood to mean, would notice of a tax lien have been disclosed in a search done in the office designated by the state for filing tax liens using the debtor’s legal name and the search procedures of the office so designated.

In the case of In re Spearing Tool and Mfg. Co., Inc., 302 BR 351 (E.D. Mich. 2003), the court concluded that a federal tax lien filed under the name “Spearing Tool & MFG Company, Inc.” as to a debtor whose registered name was “Spearing Tool and Manufacturing Co.” was not effective given that the Michigan Secretary of State’s Office, where the tax lien was filed, did not engage in searches using variations on the name and creditors had no independent access to the search index and the tax lien had not shown up during routine searches conducted by the creditor.

In reaching its decision, the court determined that it was not reasonable to expect a creditor to submit search requests under various spellings of the debtor’s name, but it was reasonable to impose on the IRS the burden of using the correct legal name. The court added that even though the creditor in the case had access to the debtor’s tax returns and could have learned of tax deficiencies from the IRS, creditors generally engage in such investigations only when deciding to extend credit initially and not when making future advances.

In the course of its opinion the court noted that “while the new version of the UCC, i.e., state law, does not control the content of federal tax liens, it does shed light on what is reasonable behavior for searchers in today’s environment.”

You may explore the basics of the Doctrine of Inchoateness, the Federal Tax Lien Act of 1966 and the rules governing priority disputes between Article 9 secured parties and the IRS in the next two problems.

Problem 31.6   (interactive)

On January 1, Lisa Lender lends Delta Corporation $10,000 and takes an interest in all Delta’s equipment, existing and hereafter acquired, to secure the loan.  The loan agreement contains a clause providing that the interest in Delta’s equipment shall secure all Delta’s indebtedness to Lisa, and defines indebtedness to mean any amounts presently owed to Lisa and any advances that Lisa should choose to make in the future.  Lisa properly files a financing statement.  On March 1, the IRS assesses a tax deficiency against Delta.  On April 1, the IRS properly records a notice of the tax lien.  On May 1, Delta acquires several items of new equipment.  On May 5, Lisa, without knowledge of the tax lien, lends Delta another $5,000.  Delta defaults without paying anything to Lisa.  

Which of the following accurately describes the outcome of a priority dispute between Lisa and the IRS?  It will be helpful to you to sketch the events so as to capture the timing of the various events.

(A) Lisa's security interest is prior to the tax lien as to the equipment in existence on April 1 and as to that acquired on May 1, in the amount of $15,000.

(B) Lisa’s security interest is prior to the tax lien in the amount of $15,000, but only as to the equipment in existence on March 1.

(C) Lisa’s security interest is prior to the tax lien as to the equipment in existence on April 1 and as to that acquired on May 1, but only in the amount of $10,000.

(D) Lisa’s security interest is prior to the tax lien only in the amount of $10,000 and only as to the equipment in existence on March 1.

Problem 31.7   (interactive)

Assume the facts of Problem 31.6 but that the collateral in which Lisa Lender has a security interest is existing and later acquired inventory rather than equipment. Which of the following now accurately states the outcome of a priority dispute between Lisa and the IRS?

(A) Lisa's security interest is prior to the tax lien as to the inventory in existence on April 1 and as to that acquired on May 1, in the amount of $15,000.

(B) Lisa’s security interest is prior to the tax lien in the amount of $15,000, but only as to the inventory in existence on April 1.

(C) Lisa’s security interest is prior to the tax lien as to the inventory in existence on April 1 and as to that acquired on May 1, but only in the amount of $10,000.

(D) Lisa’s security interest is prior to the tax lien only in the amount of $10,000 and only as to the inventory in existence on April 1.

E. Bank's Right of Set-Off

As was true under former Article 9, new Article 9, section 9-109(d)(1) excludes rights of set-off from its coverage and although a right of set-off held by a bank has sometimes been referred to as a “banker’s lien” the right of a bank to set off a debt against its debtor’s bank account is not really a lien at all because, as explained in Chapter 9 (The Specifics of Enforceability – After-acquired Collateral, Future Advances, Transferred Collateral and Proceeds, and the New Debtor Problem), once monies are deposited in a bank account the monies no longer belong to the debtor and a debtor-creditor relationship between the bank as the debtor and the depositor as the creditor is created.  See, e.g., In re Quisenberry, 295 B.R. 855 (Bkcy N.D. Tex. 2003).

New Article 9 adds a provision, section 9-340, subsection (a) of which generally gives priority to a bank’s right of set-off (and recoupment) as against a secured party with a conflicting claim to the bank account.  In so doing, new Article 9 has resolved a question that had split courts under former Article 9 in favor of the set-off party. See B & S (cited in Chapter 3), 26.04(C) and Official Comment 2 to new 9-340.

The priority conferred upon a bank is qualified in new section 9-340(c).  Under that subsection, the exercise by a bank of a right of set-off as to a debt owed by a debtor is ineffective against a secured party who has perfected a security interest in a deposit account by getting control of the deposit account under new section 9-104(a)(3) (by becoming a customer on the account).

The qualification to the priority given the bank comports with new section 9-327(4) which, as explained in Chapter 29 (Secured Party Versus Secured Party (continued)), gives priority to a secured party who has obtained control of a deposit account by becoming a customer on the account over a bank that also has control of the account because the deposit account is maintained at the bank.  See Official Comment 2 to new 9-340. However, the right of a bank to exercise recoupment rights is not affected by new section 9-340(c).

As noted in subpart B above, a person who has a lien arising by statute (or even as a matter of common law) is not precluded from creating an Article 9 security interest in the property subject to the lien and as also noted there whether a creditor is relying on a lien or on a consensual security interest may affect the outcome of priority disputes regarding the property involved. New section 9-340(b) makes clear that a bank may hold both a right of set-off against and an Article 9 security interest in the same deposit account and by holding a security interest a bank does not impair any right of set-off it would otherwise enjoy. See Official Comment 3 to new 9-340.

A bank might wish to create a security interest because it then would have a claim to proceeds of the bank account and the security interest might fare better in bankruptcy than the right of set-off.  However, as explained in Chapter 8 (The Specifics of Enforceability – A Security Agreement Authenticated by the Debtor or Its Equivalent), there must be a security agreement giving the holder of the right of set-off an enforceable security interest in the deposit account and an agreement between a bank and its customer creating (or acknowledging) a right of set-off will not serve to render a security interest enforceable unless it satisfies the requirements of new section 9-203(b)(3). See In re Quisenberry, supra.

It also should be noted that new section 9-340 does not apply to bank accounts evidenced by an instrument, such as a certificate of deposit, because instruments are excluded from the definition of a deposit account in new section 9-102(a)(29)See Official Comment 3 to new 9-340.

You may test your understanding of the set-off rules and their interaction with the other priority rules of new Article 9 in the next two problems.

Problem 31.8   (interactive)

Sid Seller holds a security interest created by Donna Debtor in Donna’s property described in the security agreement as “all of Donna Debtor’s inventory and accounts receivables, existing and after-acquired.”  Donna has opened a bank account at Central Bank and in the security agreement with Sid, Donna has promised to deposit in the account only proceeds from the sale of inventory and the collection of accounts.  Sid timely files a financing statement covering the inventory and accounts. Donna’s depositor’s agreement with Central Bank provides Central Bank with a right to set off against the bank account any debts owed by Donna to Central Bank and that have matured (are past due).  Donna has an unsecured line of credit with Central Bank and she has made several draws.  Monthly payments owed on the line of credit and totaling $2000 are past due.  Donna has defaulted on the secured debt owed to Sid.  At the time of the default, Donna owes Sid $1500 on this debt.  Sid is prepared to prove that the $1500 balance in the bank account maintained with Central Bank consists entirely of proceeds from the sale of inventory and the collection of accounts subject to Sid’s security interest.  Central Bank has asserted a right of set-off against the bank account.  

Who as between Sid Seller and Central Bank has prior claim to the bank account? Would your answer change if Donna, Sid and Central had agreed in an authenticated record that Central would follow Sid's instructions as to the bank account without further assent by Donna?

Problem 31.9   (interactive)

Assume the facts of Problem 31.8.  Assume further, however, (a) Donna’s line of credit with Central Bank is secured by an interest in the bank account maintained with Central Bank; (b) Sid Seller perfected its security interest in the bank account under new section 9-104(a)(2); (c) Donna acquired an item of inventory that she paid for with a check drawn on the bank account; and (d) Both Central Bank and Sid can establish that the item of inventory constitutes proceeds of the bank account.  

Who as between Sid Seller and Central Bank has priority as to the item of inventory?  Explain your answer.

CASE COMMENTARY

Planned Furniture Promotions, Inc. v. Benjamin S. Youngblood, Inc., 374 F. Supp. 2d 1227 (M.D. Ga. 2005)

Stockman Bank of Montana v. AGSCO, Inc., 727 N.W.2d 742 (N.D. 2007)

In re Borden, 361 B.R. 489 (B.A.P. 8th Cir. 2007)

 

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2011-08-22 update