Chapter 15 Perfection By Possession (including Documents of Title)

Part V Perfecting an Article 9 Security Interest

Chapter 15 Perfection By Possession (including Documents of Title)

A. Generally

Security interests in some collateral may or must be perfected by possession. Recall that perfection is about giving notice to third parties so as to prevent secret liens. A public filing gives such notice (at least constructively). Theoretically, a change of possession also serves to give notice of a possible interest that should lead a potential creditor to inquire further. The theory may break down in application, especially insofar Article 9 does not expressly define the meaning of possession and whether or not there is possession of collateral in particular situations has not always been clear. See Official Comment 3 to new 9-313.

Difficulties have arisen where the collateral is in the possession of some third party rather than the secured party. As will be seen below, new Article 9 distinguishes between possession by third parties generally and possession by bailees holding under a document of title. The latter cases are separately treated in subpart E. As it happens, Article 9 treats both perfection and priority issues in such cases in the same sections so priority matters that might otherwise be left to Part VI are treated in subpart E.

Fully understanding possession as a mode of perfection requires knowing when possession is an alternative to filing, when perfection by possession is not possible at all and when only possession will perfect. It also is important to understand why possession works or does not work. A review of Chapter 5 dealing with the classification of collateral would be helpful here.

Not unexpectedly, a secured party who takes possession of collateral assumes certain responsibilities with regard to the care of the collateral. Although these responsibilities do not directly impact the effect of possession to perfect a security interest, they may influence a creditor's decision to rely on possession.

In the Chapter 13 (Overview of Perfection by Filing) discussion of filing we saw that the first question to answer is which state's law governs perfection (and the effect of perfection and non-perfection and priority). There is such a choice of law issue with regard to perfection by possession as well. We begin with that question.

B. Choice of Law

As was touched on in Chapter 6 (Choice of Law) and developed more fully in Chapter 13 (Overview of Perfection by Filing), former Article 9 employed a "situs rule" as to goods and quasi-goods and under that rule the law of the state where such collateral was located governed perfection of a security interest in that collateral.

As was seen in Chapter 13 (Overview of Perfection by Filing), under new section 9-301(1), the "general" choice of law rule under new Article 9 is that the law of the state where the debtor is located governs perfection. But, as also pointed out in Chapter 13, this general rule is subject to numerous important exceptions, including the law governing perfection by possession.

Thus, under new section 9-301(2) so long as collateral is located in a jurisdiction perfection and nonperfection of a possessory security interest in such collateral is governed by the law of that jurisdiction. In other words, new Article 9 employs a situs rule as to security interests perfected by possession.

Under new section 9-316(c), if the collateral leaves a jurisdiction the law of that jurisdiction ceases to govern and a security interest will be continuously perfected in the jurisdiction to which the collateral is removed only if the security interest is perfected under the local law of that jurisdiction. What this means is that if a secured party relying exclusively on possession for perfection has perfected by possession in State A and the collateral is moved to State B then the security interest continues to be perfected in State B only if State B allows perfection by possession as to the particular collateral and the secured party has sufficient possession in State B to perfect under the law of State B.

Moreover, under new section 9-316(c) there is no "grace period" during which perfection of the security interest continues to be perfected until the secured party perfects under the law of the state to which the collateral has been moved.

The matter of continuous perfection is considered fully in Chapters 23 (Continuing Perfection -- The Need to Reperfect (Or Refile) and 24 (Continuing Perfection -- Changes as to the Use of the Collateral or in the Location of the Collateral or the Debtor; Security Interests in Proceeds).

You may test your understanding of the basics of the new Article 9 choice of law rules in perfection by possession cases in the next three problems.

Problem 15.1 (interactive)

Delia Debtor is an individual residing in Arizona. Delia gives a security interest in a valuable painting to Lisa Lender who also is an individual residing in Arizona. Lisa takes possession of the painting in Arizona. Which state's law determines whether the security interest in the painting is perfected under new Article 9?

Problem 15.2 (interactive)

Assume the facts of Problem 15.1. Assume further, however, that Lisa Lender resides in New Mexico and Delia Debtor delivers the painting to Lisa in New Mexico. Would your answer to the question posed in Problem 15.1 be the same or different?

Problem 15.3 (interactive)

Assume the facts of Problem 15.1. Assume the facts of Problem 15.1. Assume further, however, that Lisa Lender moves to California and takes the painting with her. Which state's law determines whether the security interest in the painting is perfected under new Article 9?

If the security interest were perfected under Arizona law but not under California law would Lisa have some time period within which to perfect in California?

C. Collateral as to Which Perfection by Possession is Permissible, Mandatory or Not Possible

1. Goods and Quasi Goods

New section 9-313(a) generally tracks former section 9-305 by listing negotiable documents, goods, instruments, money and tangible chattel paper as collateral a security interest in which may be perfected by possession. That only tangible chattel paper is listed reflects the fact that new Article 9 distinguishes tangible from electronic chattel paper. See Chapters 5 (Classification of Collateral) and 22 (Perfection as to Deposit Accounts, Letter of Credit Rights and Electronic Chattel Paper).

All of the listed collateral is property that the law recognizes as being possessable or pledgeable. In Chapter 5 (Classification of Collateral), such property was referred to as goods or quasi goods by contrast to pure intangibles.

2. Instruments and Money

Security interests in all the property listed in former section 9-305 also could be perfected by filing except for a security interest in an instrument, which could be perfected only by possession (except where the instrument was part of chattel paper or proceeds). See former section 9-304(1). New Article 9 makes an important change here. Under new section 9-312(a) a security interest in an instrument may be perfected by filing.

It is important to be aware that perfection by possession is the preferred mode of perfection as to instruments, negotiable documents, and certain investment property because a security interest in such property perfected by filing may be subordinated to the rights of certain transferees of such property. See new sections 9-330 and 9-331. The risks associated with filing where possession is possible are explored more fully in Part VI.

"Money" is defined in Article 1, section 1-201(b)(24) to mean "a medium of exchange currently authorized or adopted by a domestic or foreign government." Under new Article 9 a security interest in money as original collateral (as distinguished from proceeds) may be perfected only by possession. See new 9-312(a) (omitting money from the property as to which filing is possible) and new section 9-312(b)(3) (providing that a security interest in money may be perfected only by possession).

3. Certificate of Title Cases

Under former Article 9 there were doubts about whether a security interest in a vehicle covered by a certificate of title could ever be perfected by possession. New sections 9-311(b) and 9-313(b) make it clear that a security interest in collateral covered by a certificate of title may be re-perfected by possession but may not be perfected initially by possession. The difference will be clearer after Chapter 17 (Perfection as to Goods Subject to Certificate of Title Legislation), dealing with perfection of security interests in vehicles covered by certificates, has been completed.

4. When Perfection by Possession Is Not Possible

As was noted in Chapter 5 (Classification of Collateral), in certain cases perfection by possession is not permitted at all. A review of new section 9-313 will reveal that security interests in pure intangibles, property that is not in law possessable or pledgeable, such as accounts, general intangibles, deposit accounts, electronic chattel paper, health care receivables and uncertificated securities, may not be perfected by possession.

5. Certificated Securities and Delivery

New section 9-313(a) provides for perfection of a security interest in certificated securities by delivery. Perfection of security interests in investment property (and delivery as a mode of perfection as to such property) is treated separately in Chapter 21 (Perfection as to Investment Property).

You may explore the meaning of possession and when perfection by possession is possible (or not) under new Article 9 in the next problem.

Problem 15.4 (interactive)

As to which of the collateral listed below is perfection by possession possible, mandatory, advisable or not possible?

(a) Gold ingots in a safe deposit box;

(b) A general checking account in a bank;

(d) Debtor's collection of John Kennedy silver dollars;

(e) A Lexus automobile used in Debtor's business;

(f) Accounts generated by the sale of Debtor's inventory of goods.

As to that collateral as to which perfection by possession is not possible (the deposit account, the Lexus automobile and the accounts), what should a creditor do to perfect?

D. What Constitutes Possession

1. Generally

Article 9 does not directly define possession and it has not always been clear in particular situations whether or not a secured party has possession sufficient to achieve perfection by possession. See Official Comment 3 to new 9-313. The ostensible purpose of a change of possession (as with filing) has been to avoid secret liens by giving to third parties constructive notice of the possible existence of a security interest.

Theoretically, then, there must be such a change of possession -- a transfer of property to the secured party or at least a divestment of possession by the debtor -- such as will give notice to third parties. In practice, however, something less will be enough achieve perfection by possession.

If the debtor transfers physical possession of the collateral to the secured party (pursuant to an agreement) then there is possession sufficient to perfect a security interest by possession. However, transfer of actual physical possession to the secured party is not always possible or practicable. Consequently, "constructive" possession has sometimes been enough. Just when this is so has not always been apparent. Most of the litigation and commentary has dealt with agency and other such third party possession cases.

2. Possession through a third party

All agree that a debtor cannot be the secured party's agent for possession and that leaving the collateral with the debtor under an agreement by the debtor to hold the collateral for the secured party is not possession by the secured party. On the other hand, possession by a person who is a general agent of the secured party and not an agent of the debtor results in possession by the secured party.

A clear case is that where the collateral is in the physical possession of an employee of the secured party. See Official Comment 3 to new 9-313. Situations where a third party who is not the exclusive agent of either the debtor or the secured party is in physical possession of the collateral have generated the most controversy.

Former section 9-305 was understood by some courts and commentators to mean that perfection as to collateral in the possession of a third party was effected when the third party was given notice of the secured party’s security interest. As is explained in subpart E (2) below, under new Article 9, a security interest in collateral that is in the possession of a third party who has issued a non-negotiable document of title covering the collateral is perfected when the third party receives notification of the security interest. However, this is a limited and special case. Where collateral is held by a third party who has not issued a document of title covering the collateral, notice will not suffice to achieve perfection under new Article 9.

New section 9-313(c) deals with cases where collateral that is not certificated securities or goods covered by a document of title (see subpart E below) is in possession of a person other than the debtor or the secured party. New section 9-313(c) provides that a secured party has possession in the specified cases when the person in possession "authenticates a record acknowledging that it holds [or will hold] possession of the collateral for the secured party."

Recall from Chapter 8 (The Specifics of Enforceability -- A Security Agreement Authenticated by the Debtor or Its Equivalent) that "authenticate," as defined in new section 9-102(a)(7), clearly contemplates an expression of an intent to adopt a record that identifies the authenticating party. By requiring an authenticated acknowledgment, new Article 9 rejects the position of former Article 9 that receipt of notification of the secured party’s interest by a person in possession of the collateral is enough to give the secured party possession. See Official Comment 4 to 9-313.

Among the most important instances of possession of collateral by a third party is that where collateral is held in escrow, for example, where the collateral is in the possession of a title company. In the case of In re Cadiz Properties, Inc., 278 B.R. 744 (N.D. Tex. 2002), the court concluded that a security interest in securities was perfected when an escrow agent took possession of the securities. In so doing, the court relied upon In re Copeland, 531 F. 2d 1195 (3rd Cir. 1976), a case decided under former Article 9 in which the court concluded that a security interest in securities in the possession of an escrow agent was perfected under former section 9-305.

As it happens, in Copeland there was an agreement by the escrow agent that it held the collateral for the secured party, but the court did not indicate it was the agreement and not simply notice to the escrow agent of the security interest that effected perfection of the security interest. Although the facts of Cadiz Properties would support a conclusion that the escrow agent had acknowledged that it held the collateral for the secured party’s benefit, the court made no mention of new section 9-313(c) requiring such an agreement.

The next three problems allow you to explore the basic operation of new section 9-313(c).

Problem 15.5 (interactive)

Ready Lender lends to Donald Debtor and takes a security interest in Donald's equipment and a negotiable certificate of deposit (CD). Ready not only files a financing statement covering the equipment but also enters into an agreement with Donald under which Donald agrees to hold the CD for Ready and not draw on it without Ready 's written permission.

Is the security interest in the CD perfected by possession?

Would there nonetheless be perfection of Ready 's security interest in the CD under new Article 9 on the facts of Problem 15.5?

Is filing as to the security interest in the negotiable CD advisable?

Problem 15.6 (interactive)

First Bank lends to Delia Debtor. Delia gives First Bank a security interest in a negotiable promissory note that is in the possession of Title Company who is acting as a collection agent for Delia.

Can the security interest in the note be perfected by possession without Title Company transferring the note to First Bank?

How can First Bank perfect by possession without Title Company transferring possession of the note to First Bank?

Is there a way other than possession that First can perfect a security interest in the note under new Article 9?

What is the risk associated with any alternative mode of perfection?

Problem 15.7 (interactive)

Northern Bank lends to Donald Debtor. To secure the loan Northern is considering taking a security interest in a valuable coin collection that has been pledged to Lisa Lender to secure an earlier loan. Lisa is not likely to give up possession of the coin collection to Northern (at least not while Donald's debt to Lisa remains unpaid).

May Northern still perfect the security interest in the coins by possession? Would it be enough under new Article 9 that Northern notified Lisa of its security interest?

What would you advise Northern to do to perfect a security interest by possession in the coin collection pledged to Lisa? Is Lisa likely to cooperate sufficiently to make this possible?

Could Northern file a financing statement covering the coin collection under new Article 9?

Would the value of the coin collection be relevant to whatever advice you give to Northern?

Although not apparent from the language of new section 9-313(c), there remains the question of whether a person in possession of collateral is so closely associated with the debtor that possession by that person does not constitute possession by the secured party even if the required authenticated acknowledgment is given. Official Comment 3 to 9-313 indicates that when a person is in possession of collateral under an escrow arrangement and that person is acting as an agent for both the debtor and the secured party then an authenticated acknowledgment can give the secured party possession sufficient to achieve perfection of a security interest in the collateral.

However, the comment implies that it generally is for the courts to decide whether or not a person is so closely connected or controlled by the debtor that the debtor has effectively retained possession even though the person has agreed to hold collateral on behalf of the third party. In re Rolain, decided under former Article 9, presented an interesting instance of the question left to the courts by new section 9-313(c). To check out the decision, click here.

The next problem explores further the treatment of third party possession situations.

Problem 15.8 (interactive)

Assume the facts of Problem 15.5 (Ready Lender lends to Donald Debtor and takes a security interest in a negotiable certificate of deposit (CD) to secure the loan. Ready not only files a financing statement covering the equipment but also enters into an agreement with Donald under which Donald agrees to hold the CD for Ready and not draw on it without Ready's written permission. Assume further that the agreement between Donald and Ready provides that the CD will be delivered to Donald's attorney who will hold the CD for Ready. Is the security interest perfected by possession? Is the security interest perfected by possession?

The resemblance of the facts to In re Rolain set forth above is intentional. Was there enough in that case to give the secured party possession under new section 9-313(c)? What is lacking on the facts of Problem 15.8 that was present in Rolain and that is important under new section 9-313(c)?

Could perfection by possession by the secured party fail on the facts of Rolain or Problem 15.8 even if the facts are modified to satisfy new section 9-313(c)? See Official Comment 3 to new section 9-313.

As will be explored more fully in Chapter 20 (Perfection as to Fixtures and Other Real Estate-Related Collateral), the requirement that a third party authenticate an acknowledgment that it holds the collateral for the secured party is important in situations where a security interest is taken in a note secured by a deed of trust or a mortgage and the note is in the possession of a third party, such as a title company. As will be seen in the next subpart, new Article 9 separates out for special treatment in new section 9-312 cases in which goods are held by a bailee under any document of title, negotiable or not.

E. Document of Title Situations

As noted above, the perfection of security interests in goods held by a bailee under a document of title is governed by special rules. As you should remember from property class, a bailment is an arrangement whereby one person (the bailor) places goods in the possession of another party (the bailee) under a contract that specifies the terms of the bailment, such as the duration of the bailment, any charges imposed on the bailor, and the conditions under which the bailee must deliver the goods back to the bailee (or some other person designated by the bailor).

The bailment contract will be more or less detailed, and more or less formal, depending on whether the bailment is between commercial parties or between acquaintances. Whether or not the bailee issues a receipt for the goods also will depend on the degree of formality of the arrangement.

Carriers (e.g., railroads and ships) and warehouses are commercial bailees who issue documents of title covering goods in their possession. Carriers issue bills of lading. Warehouses issue warehouse receipts. Bills of lading and warehouse receipts both are documents of title that constitute both a receipt for the goods and a contract between the parties to the bailment. The documents of title may be negotiable or non-negotiable and the difference is important to perfection. Much of the law governing documents of title, including that dealing with negotiability of documents, is found in Article 7, but perfection is the subject of Article 9.

The rules governing perfection as to goods held by a carrier that has issued a bill of lading or a warehouse that issued a warehouse receipt are the same. For practical reasons, a security interest in a bill of lading covering goods often is perfected temporarily without filing or possession as to the bill of lading. See new sections 9-312(e) and (f). Consequently, it is useful to focus here on warehouse situations.

1. Negotiable document of title cases

According to Article 7, section 7-104(1)(a), a warehouse receipt is negotiable if by the terms of the receipt the goods that it covers are deliverable to a bearer of the receipt or to the order of a named person. The "bearer or order " language is basic to negotiability not only of documents of title but instruments as well.

As was seen in Chapter 5 (Classification of Collateral), a negotiable document of title may be considered quasi goods in the sense that it is possessable or pledgeable. This is so because the rights represented by the document are embodied (or "merged") into the document. A special attribute of a negotiable document is that it must be surrendered to get the goods covered by the document. For this reason, persons in control of negotiable documents also control the goods covered by the documents. To this extent, a negotiable document takes on a life of its own and persons dealing with the goods held by the issuer of the document do so by taking action as to the document.

A security interest in goods in a warehouse may be perfected by filing a financing statement as to the goods themselves. The fact that the goods are held under a negotiable warehouse receipt does not prevent such perfection. However, because a negotiable document of title becomes a surrogate for the goods themselves new section 9-312(c)(1) provides that a security interest in goods held under a negotiable document of title may be perfected by perfecting a security interest in the document.

Furthermore, under new section 9-312(c)(2), a creditor who has perfected a security interest in the document has priority over a creditor who perfects by filing as to the goods if the filing as to the goods takes place after the goods are transferred to the bailee who issues the document of title. New section 9-312(c)(2) thereby trumps the usual first-in-time priority rule that will be discussed in Part VI. Former section 9-304(2) was to the same effect.

Especially because of the special priority rule in new section 9-312(c)(2), a creditor holding a security interest in goods held by a warehouse under a negotiable warehouse receipt should perfect its interest in the goods by perfecting a security interest in the receipt and not by perfecting as to the goods themselves. But, of course, the creditor should check the records for filings that pre-date the issuance of the document of title.

The next question is how a creditor perfects a security interest in a negotiable warehouse receipt. Under former section 9-304(1), a security interest in a negotiable document of title could be perfected by filing a financing statement covering the document. New section 9-312(a) preserves this option. However, filing a financing statement is not the only way to perfect a security interest in a negotiable warehouse receipt. Consistently with the proposition that negotiable documents are quasi goods, under new section 9-313(a), as was true under former section 9-305, a security interest in a negotiable document can be perfected by taking possession of the document.

As a result, a creditor with a security interest in a negotiable document has a choice to take possession of or to file as to the document. However, the fact is that perfection of a security interest in a negotiable document of title by possession is preferable to perfection of that interest by filing. The reason that perfection by possession is preferable is traceable to new section 9-331(a) and certain provisions of Article 7. Under new section 9-331(a), a person who has become a holder of a negotiable document of title by due negotiation has "priority over an earlier security interest, even if perfected, to the extent provided in Article 3, 7, and 8."

Article 7, sections 7-501(1) and (2), provide that a negotiable document of title that was issued "to bearer " is negotiated by delivery of the document and a document of title issued "to order" is negotiated by delivery together with a proper indorsement. If the person to whom the document is negotiated takes delivery of the document for value and without notice of any claim to the document on the part of any party then, under Article 7, section 7-501(4), the document has been "duly negotiated." Under Article 7, section 7-502(1), a holder to whom a negotiable document has been duly negotiated acquires title to the document and the rights given by the document against the issuer to control delivery of the goods.

In combination, new section 9-331(a) and the foregoing provisions of Article 7 essentially give to a person to whom a negotiable document of title has been duly negotiated a claim to the document of title, and the goods it covers, that is superior to the claims of other parties. A secured party who perfects a security interest in a negotiable document of title by taking possession more likely than not will do so by due negotiation and as a result will have priority over an earlier security interest in the document perfected by filing.

That the secured party in possession will enjoy the rights and priority conferred by new section 9-331(a) and Article 7 is the more likely because new section 9-331(c) provides that filing a financing statement "does not notice of a claim or defense" to a holder under new section 9-331(a).

Under Article 7, section 7-503(1), a secured party who had perfected security interest in the goods before they were deposited in the warehouse and who did not acquiesce in the procurement of the document of title of title can defeat the rights conferred under Article 7, section 7-502(1). This means that a debtor acting alone or in collusion with another creditor cannot put goods subject to a perfected security interest into the possession of a bailee who issues a negotiable document of title covering the goods and negotiate the document so as to subordinate the claim of the secured party.

Moreover, as discussed earlier, new section 9-312(c)(2) gives priority to a secured party who has perfected a security interest in a negotiable document only against another secured party who perfected as security interest in the goods after they were delivered to the bailee.

In summary, a security interest in goods held by a bailee who has issued a negotiable document of title covering the goods may be perfected by filing a financing statement covering the goods, but a security interest in such goods also may be perfected by perfecting a security interest in the document of title. A secured party who perfects an interest in the document by possession (and to whom the document is duly negotiated) has priority over a secured party who perfects by filing as to the document. A secured party who perfects a security interest in a negotiable document of title by either filing or possession has priority over a secured party who perfects a security interest in the goods after they were delivered to the bailee.

A secured party who perfects a security interest in a negotiable document by possession (and to whom the document is duly negotiated) might gain priority over a secured party who filed as to the goods before the goods were delivered to the bailee by asserting rights under Article 7. However, a secured party in possession of a negotiable document will have priority only if the secured party who filed as to the goods somehow acquiesced in the delivery of the goods to a bailee who issued the negotiable document of title (and thereby created a risk that due negotiation of the document could produce superior rights for a holder of the document).

As explained in Chapter 12 (Perfection Generally) priority is often very much a function of perfection. The relationship between perfection and priority is especially clear as to negotiable documents of title because Article 9 treats both matters in the same section. See new 9-312(c)(2) as discussed above. However, do not lose sight of the fact that this chapter is about perfection by possession and the principal message is that a security interest in goods held under a negotiable document of title can (and should) be perfected by perfecting an interest in the document by taking possession of the document.

One last point about negotiable documents of title should be made here. Because such documents take on a life of their own and parties deal with the goods held under such documents by taking action as to the documents there is a risk that a creditor may forget that ultimately it is the goods that are the security. Some major frauds have been perpetrated through the use of documents covering empty warehouses. The message to an Article 9 practitioner is apparent. Make certain the goods are in the warehouse (as well as being sure there are no filings against the goods that were made before the goods were placed in the warehouse).

To test your understanding of the rather heady material covered in this subpart consider the next problem.

Problem 15.9 (interactive)

Southern Bank lends to Delia Debtor and takes a security interest in Delia's current crop of oats that is about to be harvested. Southern files a financing statement covering the oats. Delia, without the permission of Southern or any acquiescence on the part of the Southern, harvests the oats and delivers them to Grain Elevator for storage. Grain Elevator issues a warehouse receipt providing that the oats are deliverable to bearer. Delia borrows from Ready Lender and gives Ready an interest in the oats to secure the loan. Ready perfects a security interest in the warehouse receipt by filing a financing statement covering the receipt. Delia later borrows from Friendly Finance Company and gives Friendly an interest in the oats to secure the loan. Friendly asks for and receives delivery of the warehouse receipt. Friendly is not aware of the interests of Southern or Ready. Delia defaults on all three loans.

If the oats are worth enough to satisfy only one of the three loans who would you rather be representing, Southern, Ready or Friendly? Be sure to read the pertinent sections of new Article 9 very carefully.

Who would you rather represent if Southern filed its financing statement after the oats were delivered to Grain Elevator? Why?

If you had been representing Ready Lender or Friendly Finance Company, what steps in addition to those necessary to perfection of their security interests would you have advised them to take?

2. Non-negotiable Documents of Title

In sharp contrast to negotiable documents of title, non-negotiable documents are not quasi goods and possession of them does not confer on the party in possession any special claim to the goods they cover. Non-negotiable documents need not be surrendered to the bailee to get possession of the goods. It follows that a security interest in goods held under a non-negotiable document of title may not be perfected by perfecting a security interest in the document.

As is true in the case of negotiable documents of title it is possible to perfect a security interest in goods held under a non-negotiable document of title by filing as to the goods themselves. See new section 9-312(d)(3). However, under new sections 9-312(d)(1) and (2), it also is possible to perfect a security interest in goods in the possession of a bailee held under a non-negotiable document of title by having the document issued in the name of the secured party or by receipt of notification by the bailee of the security interest.

The occasions for use of non-negotiable documents of title are matters that are largely beyond the scope of these materials. One case deserves attention here because it exists primarily for security purposes. It can happen that a creditor does not feel comfortable relying on filing as to goods because of concerns about the debtor's trustworthiness but, for practical reasons, the creditor cannot take possession of the goods. This could be the case where the goods, for example, are inventory. In such a case a creditor may set up a "field warehouse."

A field warehouse is just what the name suggests, namely, a field warehouse that is set up "in the field," meaning on the debtor's premises. This can be done by putting a lock on a yard or room or whatever or by putting a fence around the inventory. There are companies that are in the business of setting up field warehouses. To allow the debtor access to the inventory the field warehouse company issues a non-negotiable document of title and the secured party can regulate the debtor's access to the inventory with "delivery orders."

As noted above, under new sections 9-312(d)(1) and (2), a security interest in the inventory can be perfected by having the document issued to the secured party or by receipt by the warehouse company of notification of the security interest or by filing a financing statement as to the goods. Again, perfecting a security interest in the document would serve no useful purpose (and Article 9 seems not to provide any method for doing so) because the interest in the goods is not "locked up " in the document.

Historically, creditors have used one or the other of the two methods described: they have had documents of title issued in their names or relied on notifying the bailees of their interest. However, many field warehouses are rather loosely run even to the point that the on site "custodian" may be an employee of the debtor. As a result there may be a question of whether the warehouse is "in possession " sufficiently to satisfy the predicate of new section 9-312(d). Consequently, in such cases a secured party is well advised to file a financing statement covering the goods.

The question then is why bother with a field warehouse. The answer is that such an arrangement is not really about perfection but rather about "policing the collateral."

The next problem illustrates the new Article 9 rules governing perfection of a security interest in goods held under a non-negotiable title in the context of field warehousing.

Problem 15.10 (interactive)

Northern Bank lends to Donald Debtor. Northern takes a security interest in Donald's inventory of lumber. The lumber is stacked in Donald's lumberyard. Northern contracts with Field Warehouse Co. to put up a fence inside Donald's lumberyard and at all times keep inside the fence lumber that has a value of at least twice the amount of the outstanding balance owing on the loan debt. Field Warehouse Co. issues a non-negotiable document of title covering the inventory of lumber in the name of Northern and provides Northern with blank delivery orders that may be issued to Donald allowing Donald to take and sell lumber kept in the enclosed area of the lumberyard. Field Warehouse Co. hires Donald's yard foreman as custodian of the enclosed area and give the yard foreman a key to the gate to the enclosed area.

Is Northern's security interest perfected?

What should Northern do to perfect its security interest? Why?

F. Responsibilities of a Secured Party in Possession

Under former section 9-207(1), a secured party who took possession had a duty of reasonable care as to the collateral. New section 9-207(a) imposes such a duty on a secured party in possession (other than in certain specialized cases referred to in new section 9-207(d) where there is no recourse against the debtor in the event the debt is not paid). Be aware that creditors who have gained possession of collateral by "repossession" also have the responsibilities set forth in new section 9-207. See Chapter 34 (Getting Possession of the Collateral).

Generally speaking, the duty of care requires secured parties to avoid acting so as to undermine the value of the collateral or facilitating foreseeable actions of third parties that result in a loss or damage to the collateral. See, e.g., Nevada National Bank v. Huff, 582 P.2d 1044 (Nev. 1978). The extent to which a secured party has a duty to act affirmatively to preserve the value of collateral was unclear under former Article 9 and continues to be so under new Article 9. It is true, as was the case under former Article 9, that the reasonable expenses incurred in holding the collateral are chargeable against the collateral. See new 9-207(b)(1).

Under new section 9-207(c)(2), money or funds received from the collateral must be applied to reduce the secured obligation unless they are remitted to the debtor. Under new section 9-207(c)(1), proceeds of collateral may be held as additional security unless the proceeds are money or funds in which case the proceeds again must be applied to reduce the secured debt.

As was also the case under former section 9-207, under new section 9-207(b)(4) a secured party may use the collateral for the purpose of preserving it. A secured party also may use collateral as permitted by a court order or, except as to consumer goods, to the extent the debtor has so agreed. New section 9-207(c)(3) permits a secured party to repledge the collateral.

A qualification in former 9-207(2)(e) to the effect that a secured party in possession could create a security interest in the collateral only if doing so did not impair the debtor's right of redemption has been eliminated as being implicit in new section 9-623 (the section that creates the right to redeem). See Official Comment 5 to new 9-207. The right of redemption, which is essentially the right of a debtor to recover collateral by paying the amount of the debt owing, is dealt with in Chapter 33 (A Secured Party's Options on Default).

The rights and responsibilities imposed by Article 9 may be dispensed with or changed by agreement, but only within certain limits. In particular, under new Article 1, section 1-302(b) (formerly section 1-102(3)), the duty of care imposed by new section 9-207(a) may not be disclaimed by agreement. However, the parties may determine by agreement standards of care that are not manifestly unreasonable.

New section 9-207(b)(4)(C) excludes consumer goods cases from those in which the parties may agree on the right of the secured party to use the collateral. And, new 9-602(1) appears to limit the extent to which the rules of new section 9-207(b)(4)(C) regarding use or operation of the collateral may be altered by agreement entered into in connection with a default. See Official Comment 2 to new 9-602.

You may explore some of the issues associated with the secured party's rights and responsibilities when the secured party is in possession of the collateral in the next two problems.

Problem 15.11 (interactive)

Western Bank has a security interest in a certificate of deposit (CD) owned by Delia Debtor. Western has taken possession of the CD. The interest rates on the certificate of deposit are variable and are tied to market rates of interest.

If interest rates begin to decline is Western required to act in response? Examine new section 9-207 carefully. Cf. Citibank, N.A. v. Data Lease Financial Corp., 828 F.2d 686 (11^th Cir. 1987).

May Western treat the interest paid on the CD as additional collateral? Again, examine new section 9-207 carefully.

Problem 15.12 (interactive)

Assume the facts of Problem 15.11.

May Western Bank pledge the certificate of deposit to secure a debt of its own? Examine new section 9-207 carefully. Cf. McRae v. Vogler, 536 P.2d 509 (Or. 1975).

CASE COMMENTARY

In re Clayson, __ B.R. __, 2006 WL 864299 (Bkcy W.D.N.Y March 24, 2006)

Ace Equipment Sales, Inc. v. H.O. Penn Machinery Co., Inc., 871 A.2d 402 (Conn. App. 2005)

Thompson v. First State Bank, 709 N.W.2d 307 (Minn. App. 2006)

Ronald V. Odette Family Limited Partnership v. Agco Finance, LLC, 129 P.3d 95 (Kan. App. 2005)

In re Commercial Money Center, Inc., 350 B.R. 465 (B.A.P. 9th Cir. 2006)

2009-02-01 update