Part IV Creating an Enforceable Article 9 Security Interest

Chapter 8 The Specifics of Enforceability

A. Getting A Grip

As noted in Chapter 7 (Overview of Enforceability and Attachment), under former Article 9, section 9-203(b), a security agreement attached when it was enforceable against the debtor. This coincidence of enforceability and attachment is preserved in new Article 9, section 9-203(a).  The enforceability of security interests arising in certain specialized situations, such as upon the sale of investment property or when a bank takes a check for collection, is governed by rules referred to in new section 9-203(c).

But, generally speaking, a security interest becomes enforceable when (1) one or the other of the two general conditions is met, namely, a secured party has possession pursuant to agreement of property that is capable in law of being possessed or the debtor has authenticated a security agreement that adequately describes the collateral; (2) the secured party has given value; and (3) the debtor has sufficient rights in the collateral or the power to transfer rights in the collateral.  See new 9-203(b).

Enforceability (and hence attachment) through possession occurs when the collateral has been pledged to a creditor to secure a debt.  The pledge is probably the oldest form of security involving personal property.  In civil law systems, including Mexico, arrangements under which security in personal property is given other than by pledge have not been readily accepted.  By contrast, under Article 9, because as a practical matter debtors want or need to continue in possession of collateral, pledges tend to be limited to certain special situations. 

Most of the interesting issues associated with pledges, including the question of whether or not a secured party actually has possession, arise in the context of perfection so the discussion of pledges is properly left to Chapter 15 (Perfection by Possession (Including Documents of Title)).

The requirements for enforceability in new section 9-203(b) that a secured party has given value and that the debtor has rights in the collateral are dealt with in Chapter 10 (The Need for Value and that the Debtor Have Rights in the Collateral). The need for a security agreement that is in proper form and meets the requisite formalities is the subject of the next subpart.

B. The Need for a Security Agreement

1. Meeting the "Statute of Frauds" Requirement

Former section 9-203(1)(a) provided that a security interest not involving a pledge was enforceable only if the debtor had signed a security agreement that contained a description of the collateral.  One could reasonably have understood former section 9-203(1)(a) to require a formal document labeled "Security Agreement."  However, the courts generally did not read the provision to require such a document.

In Re Ace Lumber Supply, Inc., 105 B.R. 964 (Bkcy D. Mont. 1989) provides a useful illustration.  In that case the court reviewed several decisions under former section 9-203(1)(a) and concluded that the intent requirement imposed by that section had not been satisfied.  To examine the decision and opinion, click the name of the case above.

In Ace Lumber the court noted that former section 9-203(1)(a) was understood to have both a statute of frauds and an evidentiary role. As to the former the question was whether the writings were sufficient to allow a court to conclude the parties intended to create a security interest.  As with statutes of frauds' inquiries generally, decisions as to whatever threshold demands were imposed were fact-specific and depended upon a particular courts disposition to support or resist statute of frauds' requirements.  Courts often were willing to look to a collection of writings in deciding whether the statute of frauds aspect of former section 9-203(1)(a) had been satisfied.  The willingness of courts to do so was referred to as the "composite document doctrine."

The evidentiary aspect of former section 9-203(1)(a) tended to be concerned with a creditors ability to show that particular property was subject to whatever security interest the parties had created.  As noted in Ace Lumber, parol evidence was admissible on this point but not as to the statute of frauds aspect of former section 9-203(1)(a). The question whether the collateral had been adequately described was pivotal in evidentiary determinations and is discussed at length in subpart C below.

New section 9-203(b)(3)(A) is the successor to former section 9-203(1)(a).  New section 9-203(b)(3)(A) requires that a security agreement be authenticated rather than signed.  As is discussed further below, the purpose of this change to accommodate electronic transactions.  The initial question must be whether new section 9-203(b)(3)(A) should be understood to have the meaning given to former section 9-203(1)(a) by courts in cases such as Ace Lumber.

The next three problems and the text elaborating on the problems focus on this initial inquiry.

Problem 8.1    (interactive)

What was lacking on the facts of Ace Lumber that in the court's view would have rendered the security interest enforceable under former Article 9?  Explain your answer.

Would you expect the Ace Lumber case to come out the same way under new section 9-203(b)(3)(A)?  Explain your answer.

Problem 8.2    (interactive)

Sid Seller agreed to sell equipment to ABC, Inc. on credit.  There was a bill of sale that specifically described the items of equipment.  The bill of sale made no mention of a security interest.  Some time after the sale the board of directors of ABC, Inc. passed a resolution directing corporate counsel to prepare a financing statement "on behalf of the corporation as debtor to Sid Seller as the secured party."  On the same day that the board passed the resolution, ABC, Inc. issued a promissory note to Sid in the amount of the unpaid price of the equipment.  The financing statement was prepared and filed.  There was evidence that ABC, Inc.'s attorney prepared a security agreement but none was ever produced by either Sid or ABC, Inc. 

Is the security interest in the equipment enforceable?  Cf.  In the Matter of Numeric Corp., 485 F.2d 1328 (1st Cir. 1973).

The court in Ace Lumber indicated that parol evidence is admissible to establish the scope of a security interest.  In the case of In re Invenux, 298 B.R. 442 (Bkcy D. Colo. 2003), decided under new Article 9, the court discusses the parol evidence rule and holds that it does not bar evidence that a security agreement does not express the true intent of the parties and reformation of a security agreement.  The case is considered further in subpart C(2) below.

Not surprisingly, there was some disagreement about what was enough to satisfy the statute of frauds requirement of section 9-203. Thus, in Gibson County Farm Bureau Co-op Assn v. Greer, 643 N.E. 2d 313 (Ind. 1994), the Indiana Supreme Court in a thoughtful opinion concluded that a financing statement alone was enough to satisfy former section 9-203(1) and whether the parties actually intended to create a security interest was a question of fact as to which parol evidence was admissible.

However, as is explained more fully in Part V, because a financing statement states that there may be a security interest in loosely described collateral, most courts under former Article 9 would not go so far as did the court in Gibson and it seems likely that the view expressed in cases such as Ace Lumber will prevail under new Article 9.

In the case of In re Wiersma, 283 B.R. 294 (Bkcy D. Idaho 2002), the court concluded that a document using the language of assignment, given evidence that the assignment was intended to secure a promissory note, was sufficient to satisfy former section 9-203 and render the security interest enforceable and that the security interest would continue to be enforceable under new Article 9.

The court in the case of In re Quisenberry, 295 B.R. 855 (Bkcy N.D. Tex. 2003) explored the need for a security agreement and the requisites of enforceability of any security interest created by the agreement in the interesting and important context of a bank that had a right of set-off against the deposit account of a depositor who also was a debtor on a security agreement executed by the debtor in favor of the bank.  The dispute involved a check of unknown origin deposited in the deposit account.  The debtor had given the bank a security interest in certain vehicles to secure a truck loan.

Oversimplifying somewhat, the security agreement described the collateral as two vehicles and also accessions to the trucks, products of the trucks, certain intangibles arising out of any sale or lease of the trucks and all proceeds, including insurance proceeds, from the sale or loss of the trucks.  The right of set-off was contained in the depositor's agreement between the debtor and the bank.  For reasons that are explained in Chapter 30 (Secured Party Versus Trustee in Bankruptcy), the bank's ability to reach the deposit account depended on whether it had a security interest in the deposit account.

The court concluded that the set-off agreement was not a security agreement as defined in new section 9-102(a)(73) and there could be a security interest in the deposit account only to the extent it was covered by the security agreement executed in connection with the truck loan. Because the deposit account did not fall within the description of the collateral in the security agreement and because the bank had failed to show the deposit account constituted proceeds or otherwise arose as the result of a sale or other disposition of the vehicles there was no security interest in the deposit account arising out of the security agreement executed in connection with the truck loan.

The absence of a security agreement also meant the bank could not rely on new section 9-203(b)(3)(D) under which a security interest is enforceable where the collateral is a deposit account and the secured party has control under new section 9-104, "pursuant to the debtor's security agreement." In short, the bank did not have an enforceable security interest in the bank account because the security agreement executed by the debtor made no reference to the bank account and the depositor's agreement providing for a right of set-off did not satisfy the requirements of a security agreement under new section 9-203(b)(3). Control as an element of enforceability and perfection is considered in more detail in Chapter 22 (Perfection as to Deposit Accounts, Letter of Credit Rights and Electronic Chattel Paper.

It can happen that the parties agree on the specifics of a security agreement but fail to include certain terms in the document that emerges from their negotiations. Consider the following problem.

Problem 8.3    (interactive)

Suppose a secured credit deal is closed on a day when the creditor's representative (you!) came to the meeting without a specific description of the collateral.  Suppose further that the parties agreed that the description would be added later.  If the description is actually added later -- literally entered into the writing -- is the security interest in the affected collateral enforceable?  Suppose the facts in Problem 8.3 were that the descriptions of certain items of collateral were known and entered into the writing at the closing but the description of some important collateral was not.  Could the necessary description of that collateral be added later?  The court in Longtree, Ltd. v. Resource Control Int'l, Inc., 755 P.2d 195 (Wyo. 1988) had the following to say about the matter under former Article 9:

The RCI-Pacific Star log purchase agreement described the collateral as follows:

RCI shall sell to Pacific Star and Pacific Star shall purchase from RCI, the logs which shall be made available to Pacific Star at its Star Studs Mill pursuant to the Logging Plan, a copy of which is attached hereto and made a part hereof. The parties recognize that the Logging Plan is subject to revision from time to time by RCI, with the reasonable consent of Pacific Star. The logs to be purchased and sold pursuant to the terms of this Agreement shall be delivered to Pacific Star's Star Studs Mill and stored at such location at the Mill site as Pacific Star shall designate from time to time.

The agreement was signed by Darrell Jones for Pacific Star. The logging plan attached to the agreement covered logs to be delivered between May 1983 and March 1984. The logs claimed by RCI in this action were delivered after March 1984. Although these logs were not identified in the 1983-1984 logging plan, they were identified in subsequent revisions.

[The argument against RCI's security interest is] that the revisions to the logging plan cannot serve as a description of the collateral because they were not signed by the debtor, Pacific Star. We disagree. . . .

In this case, the log purchase agreement and the revised logging plan express an internal connection with one another. As a result, the absence of a signature on the revised logging plan does not render RCI's security interest unenforceable. RCI obtained a security agreement signed by the debtor describing the collateral and its security interest.

Note carefully the language of the last quoted paragraph.  According to the court, exactly when will the necessary intent be found in documents executed at different times?

3. The Move to Electronic Transactions

It was noted above that new section 9-203(b)(3)(A) requires that a security agreement be "authenticated" rather than signed.  It also was noted that this change was made to accommodate electronic transactions.  A fuller explanation of the change is in order.  The place to start is with the definition of authenticate. Under new section 9-102(a)(7), "authenticate" essentially means to sign, or to execute or adopt a symbol or encrypt a record with present intent to identify the authenticating party and to establish the authenticity of a record or term.

The definition of "authenticate" uses the terms "record" and "encrypt. "Record," as defined in new section 9-102(a)(69), essentially means information that is inscribed on a tangible medium or which is stored in an electronic or other medium and is retrievable in perceivable form.  "Encrypt" is not defined in Article 9 but it is usually understood to refer to electronic communications that are coded so as to require the use of "keys" to open them. The purpose of encrypting of course is to make the communications secure and available only to persons holding the keys.

As the foregoing should suggest there has been a shift away from a concern with a sufficient writing to a desire to accommodate deals that are made electronically.  Official Comment 9(a) to new section 9-102 explains the substitution of the term "record" for a "writing" as follows:

In many, but not all instances, the term record replaces the term writing and written.  A record includes information that is in intangible form (e.g., electronically stored) as well as tangible form (e.g., written on paper).  Given the rapid development and commercial adoption of modern communication and storage technologies, requirements that documents or communications be written, in writing, or otherwise in tangible form do not necessarily reflect or aid commercial practices.

A record need not be permanent or indestructible, but the term does not include any oral or other communication that is not stored or preserved by any means.  The information must be stored on paper or in some other medium. Information that has not been retained other than through human memory does not qualify as a record.  Examples of current technologies commercially used to communicate or store information include, but are not limited to, magnetic media, optical discs, digital voice messaging systems, electronic mail, audio tapes, and photographic media, as well as paper.  .  .  .  Any writing is a record.

Other definitions reinforce the attempt to respond to the move away from reliance on writings.  Thus, under new section 9-102(a)(74) "send" essentially means to mail or to transmit by any other usual means of communication a record or notification, using an address reasonable under the circumstances and having paid the costs of mailing or transmitting, or to cause a record or notification to be received within the time it would have been received if properly mailed or transmitted. 

"Communicate," as defined in new section 9-102(a)(18), essentially means to send a written or other tangible record, to transmit a record by any means agreed upon by the persons sending and receiving the record, or in the case of transmission of a record to or by a filing office, to transmit a record by any means prescribed by filing-office rule.

For the foreseeable future many deals will be concluded using written documents.  Where this is true it is reasonable to expect that new section 9-203(b)(3)(A) will be given the same meaning as former section 9-203(1)(a).  However, where the parties do business electronically courts will have to decide the extent to which electronic exchanges can satisfy new section 9-203(b)(3)(A) and produce an enforceable security interest.

Insofar as the interpretations of the prior law have been driven by the concerns that underlay statutes of frauds the prior law is not clearly applicable to a case where there is no writing. On the other hand, former Article 9 has been interpreted as requiring only that there have been sufficient communication between the parties to establish some threshold level of intent to create a security interest.

This requirement is readily transported to new Article 9.  A creditor should be allowed to establish the threshold level of intent required through the use of stored and retrievable electronic communications.  The emergence under new Article 9 of a "composite record doctrine" is quite conceivable.  And, where both writings and electronic communications are involved, as is certainly possible, some amalgamation of the composite document and composite record approach could result.

There remains the problem of whether particular electronic communications are sufficiently attributable to the debtor to support a conclusion that a security interest in the property of that debtor is enforceable.  Historically, the law has looked to manual signatures to provide the necessary attribution.  There are no manual signatures in a purely electronic transaction and new Article 9 indicates it is enough that a security agreement has been "authenticated." As noted above, authentication requires that a record has been executed or encrypted with a present intent to identify the authenticating party and to establish the authenticity of the record.

Encrypted exchanges that involve the use of decoding keys seem clearly to provide the needed authentication.  What other forms of electronic attribution will suffice remains to be seen.  In particular, routine electronic mail exchanges could pose problems because even when it can be shown that a message originated from the debtor's server there may be a question of whether the debtor sent the message.

On the other hand, manual signatures do not guarantee authenticity.  Manual signatures can be forged or otherwise be unauthorized.  The law has dealt with this problem by requiring a party relying on a manual signature to prove it is the signature of the party it purports to be. Arguably, the same approach must be taken as to electronic "signatures."  Depending on the form of the electronic communication it could happen that authenticity will pose less of a problem as to such communications than it is as to written communications.

It should be noted that electronic contracting is the subject of several international (e.g., UNCITRAL) and state laws and, most recently, a federal statute.  The Uniform Electronic Transactions Act (UETA) is a model law adopted in several states that requires that contracts not be denied effect because they are in electronic form.  The federal Electronic Signatures law (E-Sign) tracks UETA and provides that the federal law has no application in states that adopt the uniform version of UETA.

Such laws tend to support an interpretation of Article 9 that facilitates the enforcement of electronic security agreements.  However, it has been recognized that there is a risk of less than deliberate action by a debtor and that fraud could increase in the electronic environment. Thus, the federal electronic signatures statute requires that for consumer parties to be bound they must previously have agreed in some more conventional manner to be bound in an electronic exchange.

UETA and E-Sign specifically exclude contracts governed by the Uniform Commercial Code from their coverage, but only to the extent that the Uniform Commercial Code has been or will be revised to accomplish the objectives of E-Sign and UETA.  New Article 1, section 1-108 provides that

This [Act] modifies, limits, and supercedes the federal Electronic Signatures in Global and National Commerce Act [E-Sign], (15 U.S.C. Section 7001, et seq.) but does not modify, limit, or supercede Section 101(c) of that act (15 U.S.C. Section 7001(c) [requiring affirmative consent from a consumer to electronic delivery of transactional disclosures that are required by state law to be in writing] or authorize electronic delivery of any of the notices described in Section 103(b) of that act (15 U.S.C. Section 103(b)).

To say the least, it will take some time to learn how and when the UCC generally and Article 9 in particular are to be reconciled with UETA and E-Sign.

The next four problems illustrate many of the foregoing points regarding the move to electronic dealings.

Problem 8.4    (interactive)

Sid Seller has long been ABC, Inc.'s primary source of materials used in ABC, Inc.'s automotive parts manufacturing operation.  ABC sends an electronic mail message to Sid in which ABC orders materials, described item-by-item, to be delivered immediately and paid for in three equal monthly payments.  The message states "Buyer agrees that Seller will have an interest in Buyer's inventory, including former and to be manufactured widgets, and the materials that are the subject of this order."  Sid sends ABC an e-mail message acknowledging receipt of ABC's order and accepting the terms stated therein.  ABC fails to pay as promised.  If ABC had signed a writing containing the terms in ABC's e-mail message there would be an enforceable security interest. 

Is the debt represented by the unpaid sales price of the materials secured?

Problem 8.5    (interactive)

If the Sid Seller and ABC, Inc. in Problem 8.4 concluded the deal set out in that problem through a series of electronic mail exchanges, rather than one exchange, would your answer to the question posed in that problem be different?

Problem 8.6    (interactive)

Most of you are familiar with the practice of or actually have purchased goods or software over the Internet.  Many, if not most, of those of you who have made Internet purchases have done so by clicking on the required buttons or links without reading the terms of the agreement made available to you online and which you have "accepted" by clicking on "I accept." 

If one of the terms in that agreement provided for a security interest in whatever you have purchased did a secured debt result? 

Suppose the purchases in Problem 8.6 were made for use in your business.  Would your analysis change?

Problem 8.7    (interactive)

ABC, Inc. and Sid Seller have had a long-standing business relationship.  Early in their relationship Sid and ABC entered into a "master agreement" that was signed by both.  This master agreement established procedures for doing business electronically, including a clause requiring encryption.  The master agreement provided that there would be a security interest in all goods sold.  It further provided that if Sid's computer system received from ABC's system an electronic order that complied with all the terms of the master agreement and included a specific description of goods ordered then Sid's computer system would automatically fill the order and send the materials and an invoice to ABC.  

Is the debt incurred when Sid Seller ships goods ordered electronically secured?

C. An Adequate Description

1. The Role of an Adequate Description

If a creditor is able to meet whatever statute-of-frauds-type threshold Article 9 imposes, the creditor still must establish an interest in particular property.  The focus then shifts to the requirement expressly stated in new section 9-203(b)(3)(A) that a security agreement describe the collateral.

As is implicit in the proposition that the creditor must establish the particular property in which it has an interest, the burden of proof as to the scope of a security interest is on the creditor.  See, e.g., In re S.M. Acquisitions Co., 296 B.R. 452 (D. Ill. 2003).  As was true under former Article 9, parol evidence generally is admissible to aid the creditors cause. Id.

Former section 9-203(1)(a) also required that the security agreement describe the collateral.  Former section 9-110 provided that a description was sufficient (whether or not it was specific) if it reasonably identified what was described. The Official Comment to former section 9-110 indicated that nothing as precise as a serial number was necessary, but courts and commentators struggled with the question of when a description was otherwise adequate.  The counterpart to former section 9-110 is new section 9-108.  Our task is to determine when a description is adequate under new section 9-108.

2. What Constitutes an Adequate Description

New section 9-108(a) reiterates the "reasonably identifies" test.  The remainder of new section 9-108 expands upon the "reasonably identifies" language both by embellishing it and expressly indicating what will not be sufficient.  Under subsection (b) of new section 9-108 anything from a specific listing to a computational formula reasonably identifies collateral.  A description by type, except as limited by subsection (e) is expressly authorized by new section 9-108(b)(3).  Interestingly, while it has long been understood that a description by type is adequate, the precise meaning of type, in the context of a description is not entirely clear.

Under former Article 9, a description of goods according to the subcategories discussed in Chapter 5 (Classification of Collateral), consumer goods (subject to the discussion below), equipment, farm products or inventory, would be an acceptable description by type.  So also would be a description of intangibles such as accounts, general intangibles, chattel paper and instruments.  What tended to make these descriptions by type was that they were separately defined in former Article 9, sections 9-105, 9-106 and 9-109.  That the foregoing would be considered sufficient descriptions by type under new Article 9 seems clear, especially insofar as there are separate definitions of such collateral in new section 9-102(a).

There is uncertainty as to the meaning of "type" because, although courts and commentators often ran together the terms type and category, new section 9-108(b)(2) specifically adds category to the embellishment of  reasonably identifies, as required by new section 9-108(a), suggesting that type and category are somehow different.  Nevertheless, it makes sense to view the use of both type and category in new section 9-108(b) as an attempt to be exhaustive and that the terms may well be used interchangeably.  Of course, this leaves the question of what constitutes a description by type or by category.  The answer would seem to be that if the collateral is specifically defined then it is a type or category of collateral.

It is important to understand, as explained in Chapter 5 (Classification of Collateral), that new Article 9 contains many more definitions than did former Article 9 and has created subsets within more generic groups or types.

Thus, for example, health-care-insurance receivable is separately defined in new section 9-102(a)(46) as a subset of account, as defined in new section 9-102(a)(2), payment intangible is defined in new section 9-102(a)(61) as a subset of  general intangible, as defined in new section 9-102(a)(42), and chattel paper, as defined in new section 9-102(a)(11), includes electronic chattel paper, defined in new section 9-102(a)(31), and tangible chattel paper, defined in new section 9-102(a)(78).  A description employing any of these definitions should pass muster as a description by type or category but, arguably, a description of the major set, for example, chattel paper, should suffice to include the subsets of electronic and tangible chattel paper.

Of course, the property sought to be reached as collateral must fit within the definition by type.  Thus, as was seen in Chapter 5 (Classification of Collateral) the definition of account in new section 9-102(a)(2) is broader than that in former Article 9, section 9-106, and some property that would have been general intangibles under former Article 9 would be accounts under new Article 9.

For example, lottery winnings would be general intangibles under former Article 9 but are expressly included in the definition of account in new section 9-102(a)(2)(viii). Consequently, a security agreement describing the collateral as general intangibles would not be adequate to subject lottery winnings to the security interest created by the security agreement so describing the collateral.

New section 9-108(b)(2) approves the use of a category of collateral. It is not entirely clear what category adds to type as in common usage both mean a class or kind or group. However, if, as just explained, type refers to defined terms then category could be intended to go beyond type to include groupings that through usage in a trade or industry or between parties have taken on an accepted meaning.

Notwithstanding the broadening of potential descriptions by type resulting from the expanded list of definitions (or by category, which arguably goes beyond type), as is explained further below, it is good practice to describe collateral with as much specificity as is practicable, including describing collateral by item, thereby avoiding disputes about the meaning of type or category.  Moreover, as also further explained below, new section 9-108(c) contains limitations on the use of what are clearly descriptions by type and one must be careful to avoid supergeneric descriptions as these are not allowed under new Article 9.

Perhaps the most revealing part of new section 9-108(b) is subsection (b)(6), which adds that any other method not precluded by subsection (c) is adequate if the identity of the collateral is objectively determinable.  "Objectively determinable" is contracts law language.  It goes to the point that security agreements are contracts and objectively ascertainable intent ultimately governs what an agreement's terms mean.

Consequently, at the root of the description requirement in new section 9-203(b)(3)(A) is the question of exactly what property the parties intended to be subject to the creditor's lien. See In re Quisenberry, supra.

However, it is objectively determinable intent that controls and what the parties actually intended is not likely to be permitted to give to the language of a security agreement a meaning that is at odds with the plain meaning of words or phrases that are defined in new Article 9.  Thus, a secured party would be hard put to make the case that a security interest created by security agreement describing the collateral as general intangibles would cover lottery winnings or a right to payment for energy provided or to be provided, both of which would have been general intangibles under former Article 9 but are expressly included in the definition of an account in new section 9-102(a)(2).

It is not uncommon for a secured party to describe collateral by reference to its location. Thus, a description in a security agreement referring to equipment located at a particular place would properly be understood to limit the security interest to equipment located at that place and not that located elsewhere. However, a reference to a location as part of a description should be distinguished from a covenant in a security agreement by which a debtor agrees to keep collateral at a particular location, also not uncommon.  See, e.g., In re S.M. Acquisitions Co., 296 B.R. 452 (D. Ill. 2003).

As noted earlier, parol evidence may be admissible to aid the court in determining the scope of a security interest.  There are limits on the admission of parol evidence, although what they are is often less than clear.  It is generally agreed that parol is not admissible to vary the terms of an agreement that is unambiguous on its face (although parol may be admissible to establish an ambiguity).

In In re Invenux, 298 B.R. 442 (Bkcy D. Colo. 2003), the court concluded that new section 9-203 does not displace the reformation of contracts doctrine and that reformation of a security agreement is possible under Article 1, section 1-103(b), providing for the application of supplementary principles of law not displaced by other provisions of the UCC.  The court further held that the parol evidence rule does not apply to an action seeking reformation and parol evidence is admissible to reform a security agreement that fails to express the intent of the parties as to what is covered by the security interest.  In re Invenux, supra.  However, the court denied relief in the case because the burden on the party seeking reformation is great (clear an unequivocal proof) and a prior agreement expressing the true intent of the parties must be proven to exist and the secured party had failed to carry its burden.  

In the last analysis, the question of what is intended by the use of a given description should be answered by reference to the consequences for the particular creditor and for other creditors that follow from a conclusion that particular property is or is not subject to a security interest.   The consequences very simply are that the putative secured party will be left in a preferred position or, alternatively, have to compete with creditors generally for that property.

3. Being as Specific as is Practicable

Given what is at stake, and despite the breadth of new section 9-108(b), it is good practice to be as precise as is practicable under the circumstances.  This rule is not always easily followed because drafting legal documents requires a combination of substantive knowledge, communication skills and experience.  Forms, especially automated forms, including document assembly programs, can be valuable aids in drafting documents.  However, these aids must be used with care in the context of security agreements because assuming that each transaction is like the next, even where a particular creditor does a high volume of the same kind of credit business, is risky. Ultimately, a secured party must determine what degree of specificity will best protect its interest in the property, taking into consideration whether the language used will achieve the secured party's intent int that it is neither too specific nor too general.

So, again, one should be as specific as is practicable under the circumstances.  Of course, cost is a relevant circumstance and a creditor may be willing to take certain calculated risks, including delegating the final decisions about descriptions to loan officers and others.  Whoever has the final responsibility should be sensitive to the above rule.  When the collateral consists of one item or a few items, being specific to the point of using serial numbers or their equivalent is advisable.

Problem 8.8    (interactive)

Endrun, Inc., an energy provider, has entered into contracts with several manufacturers to provide the energy needed by these manufacturers for a period of three years.  Central Bank finances Endruns operations and to secure the loan made to Endrun has taken a security interest in property described in the security agreement as all of Enrun, Inc.s equipment, existing and later acquired, and all general intangibles, existing and later acquired.  

Would Central Bank have an enforceable security interest in the contracts entered into between Endrun and its customers?

If the security agreement described Central Bank's collateral as "all of Endrun, Inc.'s equipment, existing and after-acquired, all of its accounts, existing and after-acquired, and all of its general intangibles, existing and after-acquired" would Central Bank have an enforceable security interest in the contracts entered in business bank accounts maintained by Endrun at Central Bank?

4. Super Generic Descriptions and the Risk of Exclusion by Specificity

A word of caution is in order. Specificity involves certain non-obvious risks. When courts interpret legal documents they often apply axioms of interpretation. One to remember is that ambiguities are likely to be resolved against the drafter.  Another risk is that the specific governs the general according to the maxim expressio unius est exclusio alterius (under which the naming of one thing may exclude another). See In re Quisenberry, supra.

If a document describes the collateral as "all of the debtor's equipment located at the debtor's place of business" and then describes certain items of equipment with particularity, a court may conclude the general description is trumped by the specific.  That a court would be so inclined is especially likely when pre-printed forms and boilerplate provisions are used.  The usual, although not always fail safe, approach to the exclusio problem is that where the goal is to be sure that certain property is covered the description should refer to it specifically but the description should add a qualifying phrase such as "including but not limited to."

The risk of excluding collateral with a specific description that trumps a more general one (the exclusio axiom) typically arises in the context of "super generic" or "omnibus clause" descriptions that purport to claim all of the debtor's property (or all of a certain type). The judicial response to such clauses under former Article 9 was somewhat mixed. To see what the court in one case, In re Legal Data Systems, Inc., 135 B.R. 199 (Bkcy D. Mass. 1991), had to say about the matter click on the case name.

New Article 9 addresses omnibus or "super generic" clauses directly.  Thus, new section 9-108(c) provides that descriptions of collateral such as "all the debtor's assets" or "all the debtor's personal property" or descriptions using words of similar import do not reasonably identify the collateral.  It will be noted that new section 9-108(c) says that a super-generic description does not reasonably identify collateral as required by new section 9-108(a).  Official Comment 2 to new section 9-108 does no more than indicate that new section 9-108(c) codifies the prevailing view under former Article 9 with regard to such descriptions.

It is helpful to know why courts disfavored super-generic clauses.  In a nutshell, these courts were concerned that allowing a secured party to tie up a debtors entire estate would severely limit the ability of a debtor to get credit from third parties and they were disinclined to find that a super-generic clause manifested a debtors intent to enter into such a disabling agreement.

Consider the next two problems.

Problem 8.9    (interactive)

Is the Legal Data Systems decision good law under new Article 9?  Explain your answer.

Problem 8.10    (interactive)

Donald Debtor is a sole proprietor who develops and markets business computer systems.  Ready Lender finances Donalds business operations.  Donald and Ready Lender have entered into a security agreement under which the collateral is described as "all Debtor's business assets."  At all relevant times, Donald's assets consisted of its inventory of computer systems on hand and in process, a checking account at Second Bank, a copyright on software installed on the computer systems it sells and a patent on the hardware design of the systems.  The security agreement satisfies new section 9-203 in all other respects. 

Does adding the modifier "business" get Ready Lender past the limitation in new section 9-108(c)? 

What description would you have advised Ready Lender to use?

5.  Variations on "All Assets"

There is another way for a creditor to reach all the assets of a business debtor.  Instead of attempting to take an interest in all of the debtors business assets as such, the creditor could take as security an interest in the business that would give the creditor control over the business assets.

As to a corporation, for example, a creditor could take an interest in a sufficient number of shares of stock representing the ownership of the corporation to give the creditor control of the corporation.  The same should be true of a limited liability company (LLC). As to a limited partnership, however, it seems that a creditor could not get control without displacing the general partner and that would seem to require an agreement by the general partner and it is not clear how that would be accomplished.

As to a general partnership, how control can be gained without dissolving the partnership presents a nice question.  As to a sole proprietorship, there may be no alternative but to confront the limitation in new section 9-108(c) on super-generic descriptions.

It should be kept in mind, as will be explored further in Part VII, that it is not possible for a creditor to simply step in as the owner in the event of a default.  The creditor is obliged to follow the enforcement provisions of Article 9 meaning, as a general rule, either selling the ownership interest or seeking to retain it in satisfaction of the debt. See Chapter 35 (Disposing of Collateral to Satisfy a Secured Debt) and Chapter 36 (Acceptance of Collateral in Full or Partial Satisfaction of a Debt).

As explained in Chapter 4 (Scope of Article 9), and also in Part VII, a purported sale of a business that is effective only on default is in substance a transfer for security and will be treated as such, meaning the creditor must foreclose on the ownership interest as permitted by Article 9.

In Chesapeake Investment Services v. Olive Group Corp., 2003 WL 369682 (Mass. Super. 2003), the creditor seems to have attempted an all assets approach that would be problematic under new section 9-108(c).  It also, however, sought to take an interest in the entire business.  The court properly denied effect to an ostensible bill of sale that did not transfer ownership unless and until the debtor defaulted.

Of course, a creditor may take a security interest in the ownership of a business without regard to getting control of the business so as to reach its assets.  Where the debtor is the owner of the business, as would be the case as to closed corporation, limited partnership or an LLC, the security interest may cover all of the ownership shares or some lesser number or percentage of shares.

Ownership interests in a corporation are represented shares of stock that are securities, as defined in Article 8, section 8-102(a)(15), and that would be investment property, as defined in new section 9-102(a)(49), under new Article 9.  See new section 9-102(a)(49) and Chapter 5 (Classification of Collateral). Creating and perfecting security interests in investment property is considered more fully in Chapter 21 (Perfection as to Investment Property).

An interest in a limited partnership could be a security as defined in Article 8, section 8-102(a)(15), in which case it would investment property and warrant treatment similar to that of shares of stock.  See Official Comment 15 to Article 1, section 8-102(a)(15).  On the other hand, shares of an LLC likely would not be securities because they are not traded within the meaning of the definition of securities in Article 8, section 8-102(a)(15). See Official Comment 15 to Article 1, section 8-102(a)(15). Rather, a share of ownership of an LLC would be classified as general intangibles and should be so described in the security agreement. See Chapter 5 (Classification of Collateral).

Related to but distinguishable from the situations just discussed would be a sale of a business secured by the assets of the business or the business itself.  The sale of a corporation entails transferring the shares of stock representing the ownership of the corporation and the seller may take an interest in stock so transferred to secure the selling price.   The same, seemingly, would be true of a limited partnership.

As to a general partnership it would appear that the partnership could not be sold without dissolution and execution of a new partnership agreement.  As to an LLC, it is more likely that a seller would want to take an interest in the assets of the business held as an LLC.  The same would be true as to a sole proprietorship because there is nothing to represent the ownership of the business other than its assets, including its good will and other intangibles.

It may be asked whether the limitation on the use of super-generic descriptions in new section 9-108(c) should apply to the sales of LLCs and sole proprietorships because such secured sales are distinguishable from the all assets situations that led to the adoption of new section 9-108(c).  It is true that a debtor/buyer in a sale of a business situation would be disabled from obtaining credit from third parties, a concern that was instrumental in the addition of new section 9-108(c), but insofar as it was a doubt about what the parties actually intended in using an all assets description, that doubt is pretty much dispelled in a sale of business transaction.

Nonetheless, to reduce the risk of litigation over the issue of whether the super-generic limitation applies to a sale of a business transaction it would be advisable to use a description such as all the assets being acquired in the sale of the business, or words to that effect.  The more conservative and safest route, of course, would be to spell out exactly what assets are to be subject to the sellers security interest and to eschew the use of super-generic descriptions.

In Chapter 13 (Overview of Perfection by Filing) we will learn that a supergeneric description, by and large, is permissible in a financing statement even though such a description is not sufficient in a security agreement.

Problem 8.11    (interactive)

Central Bank will be financing the sale of a business owned by Fix All, Inc. to General Repair, Inc. Central Bank's loan will be secured by all the assets of the sellers business. Central Bank seeks advice as to how to describe the collateral so as to avoid any difficulties that might be presented by the use of a super-generic description.

What do you advise?

6. Limitations on Descriptions by Type

As indicated above, new Article 9 explicitly authorizes the use of a description by type in new section 9-108(b)(3).  Descriptions by type were commonly employed under former Article 9.  However, courts often demanded more, for example, the debtors appliances or debtors electrical appliances or even washer or television, where consumers were involved.  They did so in the belief that consumer transactions were different than commercial transactions generally because there typically is an inequality of bargaining power and a disparity in the levels of sophistication of the parties concerning matters dealt with in a security agreement.

Under new section 9-108(d), except as otherwise provided in subsection (e), a description of a security entitlement or securities account or a commodity account is sufficient if it describes the collateral by those terms or as investment property or it describes the underlying financial asset or commodity contract. According to Official Comment 4 to new section 9-108 this section allows the use of a description of investment property that is not technically by type so that the description "securities" rather than "securities entitlements, " for example, is adequate.

New section 9-108(e)(2) rather awkwardly provides that describing collateral as "consumer goods" or as a "securities entitlement," "securities account" or "commodities account" is not sufficient in a consumer transaction.  We will look again at the limitations on the use of descriptions by type where consumers are involved in Chapter 11 (Enforceability of Security Interests Against Consumers).

Note that the application of the limitation in new section 9-108(e)(2) requires referring to the definition of a "consumer transaction." Under new section 9-102(a)(26) a "consumer transaction" essentially is one in which the debt is incurred by an individual primarily for personal, family, or household purposes and the debt is secured by an interest in collateral held for a personal, family or household purpose.

The question is what description should be used to describe the collateral subject to the limitation in new section 9-108(e)(2).  The answer is that the collateral must be described with greater specificity than is provided by a description by type and in the case of consumer goods it will usually be practicable to describe the collateral by item.

In Chapter 4 (Scope of Article 9) we saw that new Article 9 brings a security interest in a "commercial tort claim," as defined in new section 9-102(a)(13), within its scope.  Under new section 9-108(e)(1) the description "commercial tort claim" is not adequate and something more than a description only by type is necessary.  However, the description need not be specific and a description such as all tort claims arising out of the explosion of the debtors factory will suffice. See Comment 5 to new 9-108.

On the other hand, because, as will be explained in Chapter 9 (The Specifics of Enforceability After-Acquired Property, Future Advances, Transferred Collateral and Proceeds and the New Debtor Problem) under new section 9-204(b)(2) a security interest cannot attach to a commercial tort claim that is not in existence at the time the security agreement is executed, describing the claim with some specificity is quite doable.

According to Comment 5 to new 9-108, the reason for the limitations in new section 9-108(e) on the use of descriptions only by type is to prevent debtors from inadvertently encumbering property as to which the limitations apply.

You may test your understanding of the effect of new section 9-108(e) through the following problems.

Problem 8.12    (interactive)

Byron Buyer purchases from Sid Seller for use in his home a General Electric refrigerator, an Amana Washer, a Maytag dryer, a Hitachi large screen television and a personal computer.  Byron agrees to pay for these items in twelve equal monthly installments.   Byron further agrees that Sid will have an interest in all the items to secure the debt represented by the unpaid price of the items purchased. 

Would a description "consumer goods" be sufficient on the facts of Problem 8.12? 

Would the description "all the Buyer's consumer goods" be adequate?  

What description would you propose be used given the facts of the problem?

Problem 8.13   (interactive)

Byron Buyer runs a technology consulting business out of his home.  Byron owns a refrigerator, a large screen television and a desktop computer.  Only the desktop computer is used in Byron's business.  Byron also has a securities account with Broker, Inc.  Byron borrows from Ready Lender to pay some debts arising in connection with the consulting business and Byron gives Ready Lender a security interest in the foregoing items of property. 

Would a description such as "consumer goods" or "all the debtor's consumer goods" be sufficient as to the desktop computer? 

Would a description "consumer goods" or "all the debtor's consumer goods" be sufficient as to the refrigerator and television? 

Would a description such as "debtor's securities accounts" be sufficient as to the account with Broker, Inc.? 

Would "Debtor's securities" be adequate? 

Would you still recommend a description such as you proposed in Problem 8.12?

7. Descriptions of Crops, Timber to be Cut and Fixtures

As we saw in Chapter 4 (Scope of Article 9), generally speaking, transfers of interests in real estate are outside the scope of Article 9.  However, as we also saw in Chapter 4, and as is explored more fully later, as was true under former Article 9, new Article 9 covers security interests in certain real estate-related collateral, including crops, timber to be cut and fixtures.

Former section 9-203(1)(a) provided that a security interest in crops and timber to be cut was enforceable only if the security agreement described "the land concerned."  New Article 9 section 9-203(b)(3)(A) requires a description of "the land concerned" only where the collateral is timber to be cut.  A legal description of the land is not necessary and it is enough that the description of the land satisfies the "reasonably identifies" mandate of new section 9-108(a).

The next problem explores the treatment by new Article 9 of descriptions of real estate-related collateral.

Problem 8.14    (interactive)

Danielle Debtor lives on a farm in Pinal County, Arizona.  Danielle raises cotton on the farm, which is on the Pinal Parkway (Arizona Highway 77).  Danielle also owns a two-acre plot of land adjacent to the farm on which there is a stand of mesquite trees.  Danielle has entered into a contract under which the mesquite trees will be cut and sold during the next calendar year.  Danielle borrows from Second Bank and gives Second Bank a security interest in certain of Danielles assets, including an irrigation system located on Danielles farm, Danielle's current crop of cotton and the mesquite trees on the parcel of land adjacent to Danielles farm. 

Would a description in the security agreement "the irrigation system located on Debtor's farm " be sufficient to give Second Bank an enforceable security interest in the irrigation system? 

Would a description "Debtor's farm products" be sufficient to subject the cotton crop to an enforceable security interest? 

Would the description "Debtor's farm products" be adequate as to the mesquite trees? 

What description would you propose for the mesquite trees?

Later we will see that the description in a financing statement covering timber to be cut must describe the collateral as timber to be cut and a financing statement filed as a fixture filing must describe the collateral as fixtures and as to both situations the financing statements must also describe the land involved.

CASE COMMENTARY

Citicorp Leasing, Inc. v. United American Funding, Inc., 2005 WL 1847300 (S.D.N.Y. 2005) (Not reported in F. Supp. 2d)

The Epicentre Strategic Corporation-Michigan v. Perrysburg Exempted Village School District, 2005 WL 3060104 (N.D. Ohio 2005)

In re Clayson, 341 B.R. 137 (Bkcy W.D.N.Y March 24, 2006)

In re Sabol, 337 B.R. 195 (Bkcy C.D. Ill. February 6, 2006)

In re Jeans, 326 B.R. 722 (Bkcy W.D. Tenn. June 28, 2006)

First National Bank of Izard County v. Garner, 86 Ark. App. 213, 167 S.W.3d 664 (Ark. App. 2004)

Sunflower Bank, N.A. v. Kindsvater, 144 p.3d 81 (Kan. App. 2006)

Feliciana Bank & Trust v. Manuel & Sessions, L.L.C., 943 So.2d 736 (Miss.App. 2006)

Alete, Inc. v. GEC Engineering, Inc., 726 N.W.2d 520 (Minn. App. 2007)

 

 

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2009-02-01 update