Part V Perfecting an Article 9 Security Interest
Chapter 20 Perfection As To Fixtures And Other Real Estate Related Collateral
A. Fixtures
Under new section 9-109(d)(11), new Article 9 does not apply to the creation or transfer of an interest in or lien on real estate except to the extent that provision is made for the treatment of fixtures. The same was true of former Article 9. See Chapter 4 (Scope of Article 9). Recall from Chapter 5 (Classification of Collateral) that under new section 9-102(a)(41) fixtures are goods that have been affixed to real estate so that under real property law a person who has or acquires an interest in the real estate also has an interest in the goods.
Because fixtures are goods, under new section 9-501(a)(2), a security interest in a fixture may be perfected by filing a UCC 1 in the Article 9 records and as to a purchase money security interest in a fixture that constitutes consumer goods perfection is automatic. Perfection achieved in either of these ways will protect a secured party against other Article 9 secured parties, most buyers, lien creditors and trustees in bankruptcy according to the priority rules governing disputes with such parties under Article 9. See Official Comment 4 to new 9-501 and Chapter 32 (Fixtures Priorities).
However, because fixtures are goods in which real estate parties acquire an interest by taking an interest in the real estate to which the goods are attached to gain the most protection possible against real estate parties as to goods that are fixtures, a secured party must make a "fixture filing." See new 9-334 and Chapter 32 (Fixtures Priorities).
As defined in new section 9-102(a)(40), a "fixture filing" means a financing statement that in addition to satisfying the usual requirements for sufficiency discussed in Chapter 13 (Overview of Perfection by Filing) also contains information necessary to facilitate filing in the real estate records and to give notice to real estate parties. Specifically, under new section 9-502(b), a fixture filing is a financing statement that satisfies new section 9-502(a) (for a regular filing) and, in addition, indicates that it covers fixtures and that it is to be filed in the real estate records, provides a description of the real estate to which the collateral is related sufficient under local law to give constructive notice of a mortgage and, if the debtor does not have an interest of record, provides the name of a record owner of the real estate.
As for the place of filing, under new section 9-301(3)(A), the law of the state where the fixtures are located, necessarily meaning where the real estate is located, and not the state where the debtor is located, governs perfection and is the state in which to file. Under new 9-501(a)(1)(B), if a financing statement is filed as a fixture filing "and the collateral is goods that are or are to become fixtures," then the filing must be made in the office designated for the filing or recording of a mortgage on real property.
The quoted language from new section 9-501(a)(1)(B) in the previous paragraph is very important. It means that a fixture filing is effective to perfect a security interest in goods that are fixtures and such a filing will protect the Article 9 party against other secured parties, buyers, lien creditors and a trustee in bankruptcy. See 9-308(a), 9-310(a) and 9-501(a)(1)(B). It also means, however, that a fixture filing does not perfect a security interest in goods that are not fixtures. Cf. Official Comment 4 to new 9-501.
Deciding whether particular goods are affixed to real estate so as make them fixtures under local law outside Article 9 can be difficult at best. In Gomez v. Dykes, 359 P.2d 760 (Ariz. 1961), the court applied a three-part test in deciding that a trailer house located on a farm sold pursuant to a real estate sales contract was not a fixture.
The test offered is as follows:
(1) There must be an annexation to the realty or something appurtenant thereto;
(2) The chattel must have adaptability or application as affixed to the use for which the real estate is appropriated; and,
(3) There must be an intention of the party to make the chattel a permanent accession to the freehold.
The court in Gomez noted that the modern tendency is to give the intention of the parties the greatest weight. Since the trailer house belonged to a hired hand of the seller and not the seller, there could not have been an intention to make the trailer house part of the real estate. The emphasis on the parties' intent is somewhat odd given that whether or not goods affixed to real estate are fixtures can impact the rights of persons who are not parties to an agreement. But, since the dispute in Gomez was between the parties to the sales contract it was convenient to look to the intent of the parties.
The court in Gomez also had to decide whether manure located on the farmland was a fixture or not. The court concluded that manure dropped by animals fed off the land constituted fixtures but manure brought onto the land or dropped by animals not fed off the land was personalty. According to the court, "the reason for this rule is the strong public policy to keep that which has never become a true part and parcel of the land freely alienated from same. By the same token, if the animals have not been fed with the products of the land, the land has not been impoverished, and consequently, the animals' owner owes no duty to leave the manure to replenish the land."
The uncertainty as to when goods are fixtures clouds decisions about how to perfect an Article 9 security interests in goods that might not be or might not become fixtures. The result is that it can be risky to rely exclusively on a fixture filing because goods may turn out not to be fixtures.
You may test your understanding of the matter of perfecting security interests in fixtures under new Article 9 in the next two problems.
Problem 20.1 (interactive)
Donna Debtor is a sole proprietor doing business in Tucson, Arizona. Sid Seller sells a drill press to Donna to be used by Donna in her manufacturing operations. Sid takes an interest in the drill press to secure its price. The drill press will be welded to the floor of Donna's plant located in Pima County, Arizona in such a way as to give a purchaser of the plant an interest in the drill press.
How may Sid file to be perfected under new Article 9?
How should Sid perfect? Will a fixture filing protect Sid's security interest in the drill press against Article 9 (personal property) parties?
If Sid files only a fixture filing and the drill press turns out not to be a fixture is Sid's security interest perfected under new Article 9?
Problem 20.2 (interactive)
Assume the facts of Problem 20.1. Assume further, however, that Donna Debtor bought the drill press for use in her home and Sid Seller did not file anywhere.
Is Sid's security interest perfected under new Article 9?
Is the security interest perfected given the change in facts if the drill press is not a fixture?
What is the downside of relying on automatic perfection where the drill press is a fixture?
If the drill press is not a fixture need Sid worry about real estate parties?
B. Notes Secured by Deeds of Trust or Mortgages
When a person lends to another and takes an interest in real estate to secure the debt there will be a promissory note (typically negotiable in form) that names the lender as the payee and also an agreement creating an interest in the real estate to secure the note. In many states the agreement creating the interest in the real estate will be a mortgage. In such a case, the borrower is a mortgagor and the lender is a mortgagee. In most western states, the agreement creating the interest in the real estate will be a deed of trust and the lender will be the beneficiary on the deed of trust.
The mortgagee or beneficiary on a deed of trust has a right to payment secured by an interest in real estate. The secured right of payment has value and may be used as collateral by the mortgagee or beneficiary on a deed of trust when the mortgagee or beneficiary on the deed of trust becomes a borrower. The person taking an interest in the secured right to payment will require the mortgagee or beneficiary on the deed of trust to assign the promissory note and the mortgage or deed of trust. The use of the interest of a beneficiary has been referred to as "a collateral assignment of a beneficial interest in a deed of trust."
Under former Article 9 there was some disagreement as to whether such security arrangements were governed by Article 9 or by real estate law and, more specifically, whether the lender's interest in the collateral, consisting of the right to payment embodied in a promissory note secured by an interest in real estate, had to be perfected under Article 9 or under real estate law. The consensus view under former Article 9 was that the interest of beneficiary on a deed of trust or mortgagee on a mortgage was personal property and perfection of a security interest in such property required compliance with Article 9. Rodney v. Arizona Bank, 836 P.2d 434 (Ariz. App. 1992), offers a good illustration of that view.
In Rodney the beneficiary on a deed of trust borrowed from Arizona Bank and gave the bank a security interest in the borrower's interest as the beneficiary on a deed of trust and subsequently borrowed from Rodney and gave Rodney an interest in the borrower's interest as the beneficiary on a deed of trust. Arizona Bank proceeded under Article 9 on the assumption that the collateral was personalty and Rodney proceeded under real estate law on the assumption that the collateral was realty. The question on the borrower's default was whether Arizona Bank or Rodney had properly perfected. The court concluded that Article 9 governed the perfection of a security interest in the secured right to payment of a beneficiary on a deed of trust.
New Article 9 adopts the prevailing view under former Article 9. See new 9-109(d)(11)(A) and Official Comment 6 to new 9-308. New section 9-308(e) provides that "perfection of a security interest in a right to payment or performance also perfects a security interest in a security interest, mortgage, or other lien on personal or real property securing the right." In other words, the note is primary and the security follows the debt.
In an attempt to minimize the "separation" of the mortgage or deed of trust from the note, new section 9-203(g) provides that "the attachment of a security interest in a right to payment or performance secured by a security interest or other lien on personal or real property is also attachment of a security interest in the security interest, mortgage, or other lien."
Together, new sections 9-203(g) and 9-308(e) mean, for example, that a creditor who takes a security interest in a note secured by a deed of trust gets an enforceable interest in the deed of trust and if the creditor perfects its interest in the note the creditor is automatically perfected as to the beneficial interest in the deed of trust.
The question then is what may or must a creditor do to perfect its security interest in a promissory note. A promissory note almost certainly will meet the definition of an instrument in new section 9-102(a)(47) (essentially requiring a writing that is transferred in the usual course of business by delivery). In earlier chapters, it was pointed out that under new sections 9-312(a) and 9-313(a) a security interest in an instrument can be perfected by filing and it is no longer the case, as was true under former Article 9, that a security interest in an instrument can be perfected only by possession. It follows that a security interest in a promissory note may be perfected by filing or by possession.
However, perfection by possession of a security interest in a promissory note is preferable. The reason is that notes typically are negotiable and negotiation of a note to a holder-in-due-course could result in subordination of the interest of a secured party who perfects by filing as to the note. See new section 9-331(a). Therefore, a creditor who takes a security interest in a note secured by a deed of trust or mortgage may perfect its interest in the note by filing but should perfect the interest by getting possession of the note.
The meaning of possession, especially as to collateral in the possession of a third party was considered at length in Chapter 15 (Perfection by Possession (Including Documents of Title)) and it would be a good idea to review that material now. As explained in Chapter 15, in cases where no document of title has been issued it no longer is enough for a secured party to notify a third party in possession of collateral of the secured party's interest and under new section 9-313(c) the third party must authenticate a record acknowledging that it is holding for the secured party.
Article 9 does not speak directly to the resolution of disputes involving creditors of the obligor on the secured note (the mortgagor on a mortgage or grantor on a deed of trust). To get as much protection as possible against creditors of the mortgagor or grantor under a deed of trust (the obligor on the secured note) a secured party should record an assignment of the interest of the debtor in the real estate records as well as perfect a security interest in the note secured by a deed of trust or mortgage. Certain matters clearly are outside the scope of Article 9. For example, the questions of who an obligor on a note must pay to discharge the obligation (and the security) is governed by Article 3 and the who has the power to release the real estate security is left to local real estate law. See Official Comment 6 to new 9-308.
You may test your understanding of the Article 9 scheme for perfecting a security interest in the beneficial interest in a deed of trust on real estate or a real estate mortgagee's interest in the next two problems.
Problem 20.3 (interactive)
Southern Bank is about to lend to Donald Debtor. Donald is the payee on a negotiable promissory note secured by a deed of trust on real estate. Southern Bank is taking Donald's interest in the note and deed of trust as collateral.
What should Southern do to perfect its security interest? How may Southern perfect its security interest in the note under new Article 9? What should Southern do to perfect its security interest in the note?
Problem 20.4 (interactive)
Assume the facts of Problem 20.3. What should Southern Bank be advised to do to perfect its security interest where the note is held by a title company for collection?
C. Standing Timber and As-Extracted Collateral
As explained in Chapter 5 (Classification of Collateral), standing timber is real estate unless it constitutes “goods” within the meaning of new section 9-102(a)(44). To acquire a “perfected” interest in standing timber that does not constitute goods a creditor must obtain a mortgage or deed of trust on the real estate and have the mortgage or deed of trust properly recorded in the office where real estate records are kept. Standing timber constitutes "goods" under new section 9-102(a)(44) if "is to be cut and removed under a conveyance or contract of sale."
As explained in Chapter 8 (The Specifics of Enforceability -- A Security Agreement Authenticated by the Debtor or Its Equivalent), a security interest in timber to be cut is enforceable and attaches only if the security agreement includes "a description of the land concerned" as required by new section 9-203(b)(3)(A). Moreover, standing timber is expressly excluded from the definition of "farm products" under new section 9-102(a)(34). See Official Comment 4(a) to new 9-102. Therefore, the collateral should be described in the security agreement as standing timber or standing timber to be cut (or as particular trees).
Timber to be cut is the opposite of fixtures in that it is realty that qualifies as goods rather than goods an interest in which arises under real property law. However, a financing statement filed to perfect a security interest in timber to be cut must meet the special content requirements of new section 9-502(b) for a fixture filing, discussed in subpart A above.
The requirements of new section 9-502(b) are that the financing statement indicate that it covers timber to be cut and that it is to be filed in the real estate records and there must be a description of the real estate on which the timber is standing that would be sufficient to give constructive notice of a mortgage under the law of the state where the trees are located if the description were contained in a record of a mortgage and, if the debtor does not have an interest of record, the name of a person with an interest of record must be provided.
The reason for these special requirements as to the contents of the financing statement is that under new section 9-501(a)(1)(A), a security interest in timber to be cut can be perfected only by filing a financing statement "in the office designated for the filing or recording of a mortgage on the related real property."
Under new section 9-301(3)(B) the law of the state where the trees are located (which will be the state where the real estate on which the timber stands is located) governs perfection and is the state within which to file.
The reason that perfection of a security interest in timber to be cut requires filing or recording in the real estate records is that parties with interests in real estate can have interests in timber and timber to be cut. Unlike disputes as to fixtures and growing crops, as to which specific Article 9 rules apply, see new section 9-334 and Chapter 32 (Fixtures Priorities), there are no new Article 9 rules dealing with conflicts involving timber to be cut as such.
That courts will struggle with fashioning outcomes for such conflicts is illustrated by the case of Feliciana Bank & Trust v. Manuel & Sessions, L.L.C., 943 So.2d 736 (Miss.App. 2006), in which the court never really recognizes that new Article 9 priority rules should be consulted.
As explained in Chapter 5 (Classification of Collateral), once timber has been cut it no longer is timber to be cut but rather constitutes "goods" pure and simple within new section 9-102(a)(44) because it constitutes "things that are moveable when a security interest attaches." As to cut timber, filing a UCC 1 that does not include a description of the real estate will suffice. Moreover, the filing should be made in the Secretary of State's Office in the state where the debtor is located, as required by new sections 9-301(1) and 9-501(a)(2).
This means the choice of law and place of filing rules for ordinary goods apply once the timber to be cut has been cut. Consequently, a filing made as to the timber as timber to be cut ceases to be effective once the timber has been cut and there is no time within which to refile under new sections 9-316(a) and (b). See Official Comment 3 to new 9-501.
You may explore the new Article 9 rules for perfecting a security interest in timber to be cut in the next problem.
Problem 20.5 (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 removed during the next calendar year. Danielle borrows from Second Bank and gives Second Bank a security interest in Danielle's current crop of cotton and the mesquite trees.
What must the security agreement include to make the security interest in the mesquite trees enforceable?
How should Second Bank perfect its security interest in the in the mesquite trees?
Would a financing statement that is sufficient as to contents and filed in the right office to perfect the security interest in the mesquite trees also perfect the security interest in the cotton crop?
Would perfection as to the security interest in the mesquite trees achieved by a filing properly as to these trees continue after the trees are cut?
2. As-extracted collateral
Under new Article 9, oil, gas, and other minerals that have not been extracted from the ground are treated as real property to which Article 9 does not apply. Upon extraction, minerals will become personal property (goods) and are eligible to serve as collateral under new Article 9. The definition of "as-extracted collateral" in new section 9-102(a)(6) is intended to capture this distinction. See Official Comment 4(c) to new 9-102.
Under the definition in new section 9-102(a)(6), accounts arising out of the sale of minerals at the wellhead or minehead also are "as-extracted collateral." There is a parallel to timber to be cut in that as-extracted collateral is minerals (and certain accounts) only to the extent removal from the ground is contemplated. If removal is not contemplated, then the minerals are part of the real estate.
Financing involving as-extracted collateral is complicated and largely beyond the scope of these materials. The examples offered by Official Comment 4(c) to new section 9-102 are helpful in deciding what is (and what is not) as-extracted collateral. Under new section 9-301(4), the law of the state where the wellhead or minehead is located governs and that is the state in which to file. Under new section 9-501(a)(1)(A), the filing must be made locally in the real estate records.
As explained above, the choice of law and place of filing rules for goods apply once the timber has been cut and a filing made as to the timber as timber to be cut ceases to be effective. By contrast, a security interest in as-extracted collateral attaches only when the collateral has been extracted and a filing made properly before extraction is effective after extraction.
Case Commentary
Feliciana Bank & Trust v. Manuel & Sessions, L.L.C., 943 So.2d 736 (Miss.App. 2006)
2009-02-01 Update