Chapter 28 Secured Party Versus Secured Party
A. Generally
New Article 9 provides a seeming maze of rules for governing disputes among secured parties claiming security interests in the same collateral. The rules largely replicate those found in former section 9-312, especially the first-to-file-or-first-to-perfect rule of former section 9-312(5)(a), but the new Article 9 rules are restructured and are more elaborate and some rules not found in former Article 9 have been added. The general rules of new Article 9 are relatively straightforward, but there are numerous qualifications that make sorting out priorities, especially as to proceeds disputes, difficult at times. The basic priority rules and those applicable to purchase money security interests are the subject of this chapter. Special rules that apply to certain collateral and to proceeds conflicts are treated in Chapter 29 (Secured Party Versus Secured Party (continued)).
Before getting to the specific rules governing priority among secured parties, a word about subordination agreements is in order. It can happen, and not infrequently does happen, that a secured party who has priority over another secured party under one or more of the priority rules about to be discussed, will agree to subordinate its security interest to a party as to which the agreeing party has priority.
Among the reasons why a secured party with priority under the Article 9 rules might enter into a subordination agreement is that the secured party who does so does not wish to extend further credit to the debtor, but understands that additional credit may be necessary to keep the debtor viable and to better assure that the subordinated debt will be paid. It is worth emphasizing subordination is a matter of contract between the parties to the contract and who has priority under the Article 9 rules will have to be decided before any such contract is executed.
The basic scheme of new Article 9 is that most disputes among secured parties with conflicting non-purchase money security interests in the same collateral are governed by the temporal priority rules found in new section 9-322(a). The most important temporal rule is the first-to-file-or-first-to-perfect rule in new section 9-322(a)(1). Under this rule, the party first to file a financing statement covering collateral or the first to perfect by whatever method, has priority.
The first-to-file-or-first-to-perfect rule is subject to the rules in new section 9-324, conferring priority under certain conditions to holders of purchase money security interests without regard to the timing of filing or perfection. The first-to-file-or-first-to-perfect rule also is subject to the special priority rules contained in new sections 9-327, 9-328, 9-329, 9-330 and 9-331. These sections, awarding priority under specified conditions to holders of security interests in deposit accounts, investment property, and letter of credit rights, and to purchasers of chattel paper and instruments and to persons with rights under Articles 3, 7 and 8, again without regard to the timing of filing or perfection, are examined in Chapter 29 (Secured Party Versus Secured Party (continued)).
The first-to-file-or-first-to-perfect rule also governs most priority disputes involving proceeds. However, the application of the rule to proceeds disputes is qualified by rules contained within new section 9-324, governing purchase money security interests, and in new sections 9-322(c), (d) and (e), which distinguish proceeds of filing collateral from those of non-filing collateral, and some of the rules applicable to specialized collateral in new sections 9-327, 9-328, 9-329, 9-330 and 9-331. Discussion of these rules also is deferred to Chapter 29 (Secured Party Versus Secured Party (continued)).
There are specific rules in new sections 9-325 and 9-326 governing disputes involving transferees of collateral and new debtors. These rules likewise will be considered in Chapter 29 (Secured Party Versus Secured Party (continued)).
B. New Section 9-322(a) and the First-to-File or First-to-Perfect Rule
1. Generally.
New section 9-322(a) actually contains three rules. Under new section 9-322(a)(2), not surprisingly, a perfected security interest or agricultural lien has priority over an unperfected security interest or agricultural lien. Under new section 9-322(a)(3), as between unperfected security interests and agricultural liens, the first to attach has priority.
The heart of new section 9-322(a) is new section 9-322(a)(1). New section 9-322(a)(1) contains the first-to-file-or-first-to-perfect priority rule found in former section 9-312(5)(a). Under this rule -- subject to the special rules for purchase money security interests now found in new section 9-324 and examined below -- as between holders of non-purchase money security interests, the first party to file or to perfect prevails.
The first-to-file aspect of the rule reflects the notice filing nature of the filing system under which, among other things, a party may file before concluding a secured transaction. See Official Comment 4 to new 9-322. Note carefully, however, that the rule is stated in the alternative. Whichever party files or perfects first prevails. If a party obtains an enforceable security interest non-purchase money security interest and takes possession of the collateral before another party files as to the collateral, then the party who took possession has priority. Note also that the first-to-file or first-to-perfect rule operates irrespective of what the parties to a dispute know or do not know. See Example 1 in Official Comment 4 to new 9-322.
New section 9-322(a)(1) is subject to a special qualification pertaining to agricultural liens. Under new section 9-322(g), the first-to-file or first-to-perfect rule would give way to a priority conferred by the statute creating the agricultural lien.
Of course, the priority rules discussed here and in the other chapters in Part VI determine priority only where the Uniform Commercial Code (UCC) applies. As explained in Chapter 6 (Choice of Law), especially in international transactions, the parties may agree that a law other than the UCC applies or choice of law rules may dictate the application of a law other than the UCC. In Usinor Industeel v. Leeco Steel Products, Inc., 209 F. Supp. 2d 880 (N.D. Ill. 2002), the court concluded that a U.S. lender with a perfected security interest in goods sold by a French seller to a buyer in Illinois and delivered to the buyer in Illinois had prior claim to goods as against the French seller.
In so doing, the court first held that the Convention on Contracts for the International Sale of Goods (CISG) governed only the rights and obligations of the buyer and seller and to determine the rights of a third party it was necessary to look to applicable domestic law. The court then determined that the applicable domestic law was that of Illinois, meaning the UCC, and not French law, and under UCC, Article 2, section 2-401(1), the French sellers retention of title gave rise only to a security interest and because the security interest was unperfected it was subordinate to the perfected security interest of the lender.
Although the court does not appear to expressly refer to new section 9-322(a)(2), as explained above, it is that provision that gives a perfected security interest priority over an unperfected security interest.
The Usinor Industeel case is a useful reminder of the desirability of including a choice of law provision in an agreement arising in an international transaction, as discussed in Chapter 6 (Choice of Law).
You may explore the essence of the first-to-file-or-first-to-perfect rule of new section 9-322(a)(1) in the next three problems.
Problem 28.1 (interactive)
On Day 1, Southern Bank files a financing statement covering a drill press owned by Debtor. On Day 10, Ready Lender lends to Donna Debtor, Donna authenticates a security agreement describing the collateral as the drill press covered by Southern's financing statement and Ready Lender files a financing statement covering Donna's equipment. On Day 15, Southern lends to Donna and she authenticates a security agreement that describes the collateral as the drill press covered by it filing on Day 1.
Who perfected first as between Southern Bank and Ready Lender?
Who has priority as between Southern and Ready Lender?
Would the outcome in the dispute between Southern and Ready Lender be different if Southern knew of Ready Lender's security interest when Southern lent to Donna?
Problem 28.2 (interactive)
Assume the facts of Problem 28.1. Assume further, however, that Ready Lender takes possession of the drill press rather than filing on Day 10.
Who has priority as between Southern Bank and Ready Lender?
Suppose Southern did not file on Day 1 but rather it filed on Day 15 when it closed the loan to Donna. Who would win now?
Problem 28.3 (interactive)
Selma Seller sells a stereo to Betty Buyer for use in her home and Selma takes a security interest in the stereo to secure the unpaid price of the stereo. Subsequently, Lenny Lender lends to Betty, takes a security interest in the stereo to secure the loan and files a financing statement covering the stereo. Betty defaults owing Selma and Lenny more than the stereo is worth.
Who has prior claim to the stereo?
2. The First-to-File Rule and After-Acquired Property.
The first-to-file or first-to-perfect rule governs disputes between non-purchase money parties with interests in after-acquired collateral. Because there can be no perfection without attachment, competing parties may perfect security interests in after-acquired collateral simultaneously. See Example 4 in Official Comment 5 to new 9-322.
You may test your understanding of the application of the first-to-file-or-first-to-perfect rule to after-acquired property in the next problem.
Problem 28.4 (interactive)
On Day 1, Southwestern Bank lends to Donald Debtor and obtains an enforceable security interest in Donald's equipment, existing and after-acquired. Also on Day 1, Southwestern files a financing statement covering Donald's equipment. On Day 10, Lisa Lender lends to Donald and obtains an enforceable security interest in D Donald's equipment, existing and later-acquired. That same day, Lisa files a financing statement covering Donald's equipment. On Day 15, Donald acquires a drill press used in Donald's business.
Who perfected first as between Southwestern and Lisa?
Who has priority as between Southwestern and Lisa?
3. The First-to-File-or-First-to-Perfect Rule and Future Advances.
In Chapters 26 (Secured Party Versus Lien Creditor) and 27 (Secured Party Versus Buyers) it was seen that priority disputes involving lien creditors (new section 9-323(b)) and buyers of goods (new section 9-323(d)) as to future advances depended on the time an advance was made (or an absence of knowledge of a sale or levy) unless the advances were made pursuant to a commitment. Disputes among secured parties regarding future advances are governed by the first-to-file-or-first-to-perfect rule of new section 9-322(a)(1).
The basic proposition is that a security interest covering a later advance has the same priority as the security interest in the initial advance. This priority obtains whether the later advance is made pursuant to a future advance clause or a new security agreement covering the same collateral. The only nexus required for a filing made in connection with a security interest created by a different security agreement to perfect a security interest created by a later security agreement is that the description of the collateral in the financing statement be sufficient to cover the collateral that is the subject of the later security agreement.
There are some qualifications to the basic rule of new section 9-322(a)(1) in new section 9-323(a) for security interests securing discretionary advances that are perfected automatically or temporarily. Under new section 9-323(a), where a security interest securing an advance is perfected only automatically under new section 9-309 or temporarily under new sections 9-312(e), (f) or (g) and the advance is not made pursuant to a commitment entered into before or while the security interest is perfected otherwise than automatically or temporarily, then for purposes of determining priority under the first-to-file-or-first-to-perfect rule of new section 9-322(a)(1) perfection dates from the time the advance is made. See Official Comment 3 to new section 9-323.
Stated differently, new section 9-323(a) indicates the limited circumstances when the time an advance is made is material to priority under new section 9-322(a)(1) and in most cases applying the first-to-file-or-first-to-perfect rule of new section 9-322(a)(1) depends on the date of a filing or the date of perfection.
You may explore your understanding of the treatment of future advance priority among secured parties under new Article 9 in the next two problems.
Problem 28.5 (interactive)
On February 1, Lisa Lender lends $5,000 to Donald Debtor and Donald signs a security agreement giving Lisa an interest in Donald's machinery to secure the loan. The security agreement provides that any advances that Lisa should choose to make in the future also will be secured by the interest in Donald's machinery. Lisa immediately files a financing statement covering the machinery. On March 1, Western Bank lends $5,000 to Donald and takes a security interest in the same machinery and on the same day files a financing statement covering the machinery. On April 1, Lisa makes another $5,000 advance. Donald defaults at a time when he owes Lisa $10,000 and Western $5,000 and the machinery is worth only $10,000.
Does Lisa get the $10,000?
If there were no future advance clause in the security agreement between Lisa and Donald and instead Donald signed a new security agreement creating a security interest in his machinery on April 1, who then would get the $10,000?
Could the secured party who loses out have avoided being subordinated? If so, how?
Assume again the original facts of Problem 28.5 but assume further that instead of filing on March 1 Western Bank took possession of the machinery pursuant to an agreement with Donald. Who has priority as to what amounts now?
If Western Bank lent to Donald on January 15 and Western took possession of Donald's machinery on that date pursuant to an agreement with Donald who would get what amounts?
Problem 28.6 (interactive)
On September 25, Lenny Lender lends $5,000 to Donna Debtor on an unsecured basis. On September 29th, Lenny decides he needs security for the loan. At Lenny's request, Donna signs a security agreement giving Lenny a security interest in a negotiable warehouse receipt to secure the earlier unsecured loan. On October 1, Southern Bank lends $5,000 to Donna and Donna signs a security agreement giving Southern an interest in the same negotiable warehouse receipt to secure the loan. Southern does not file a financing statement covering the warehouse receipt or take possession of the warehouse receipt, but the security interest in the document is perfected temporarily under new section 9-312(e). On October 5, Lenny files a financing statement covering the warehouse receipt. On October 8, Southern makes another $5,000 advance to Donna pursuant to a discretionary future advance clause in the agreement signed by Donna on October 1. The same day, Southern files a financing statement covering the warehouse receipt. Donna defaults owing Southern $10,000 and Lenny $5,000 and the goods covered by the warehouse receipt are worth $10,000.
Which of the following statements correctly states the relative priorities of Lenny Lender and Southern Bank?
(a) Southern Bank gets the $10,000 worth of the goods covered by the negotiable warehouse receipt.
(b) Lenny Lender gets $10,000 worth of the goods covered by the negotiable warehouse receipt.
(c) Southern Bank gets $5,000 worth of the goods covered by the negotiable warehouse receipt and Lenny Lender gets $5,000 of the goods covered by the negotiable warehouse receipt.
How much of the goods would Southern Bank get if it had made a binding commitment to lend the second $5,000 at the time of the first $5,000?
4. Proceeds Disputes
Under former Article 9, certain disputes among conflicting claims to proceeds were governed by the rules applicable to special types of collateral, for example, the purchase money priority rules of former sections 9-312(3) and (4). However, the first-to-file-or-first-to-perfect rule of former section 9-312(5)(a) governed most proceeds disputes. For purposes of applying the first-to-file-or-first-to-perfect rule, under former section 9-312(6), a date of filing or perfection as to the original collateral was the date of filing or perfection as to the collateral.
Under new Article 9, once again, if a security interest has priority over a conflicting interest in the same collateral under the first-to-file-or-first-to-perfect rule of new section 9-322(a)(1), then the security interest generally will also have priority as to the proceeds. New section 9-322(b) tracks former section 9-312(6) by providing that for the purposes of applying the first-to-file-or-first-to-perfect rule a time of filing or time of perfection as to proceeds is the time of filing or perfection as to the original collateral. Consequently, generally speaking, under new Article 9, as between parties holding non-purchase money security interests in most collateral, the party who files or perfected first as to the original collateral has priority as to the proceeds.
You may explore the new Article 9 rules governing basic proceeds disputes in the next two problems.
Problem 28.7 (interactive)
Central Bank and Ready Lender have non-purchase money security interests in Delia Debtor's inventory, existing and after acquired. Both Central and Ready Lender perfected by filing, but Central filed first. Who has priority as to accounts receivables generated by the sale of Delia's inventory?
Problem 28.8 (interactive)
Assume the facts of Problem 28.7. Assume further, however, that Central Bank's security interest is in Delia Debtor's accounts receivables, existing and later-acquired, rather than inventory and Central filed a financing statement covering the accounts before Ready Lender filed a financing statement covering the inventory.
Who has priority as to accounts generated by the sale of Delia's inventory?
Suppose that Ready Lender filed its financing statement covering Delia's inventory before Central filed a financing statement covering Delia's accounts. Who has priority as to accounts generated by the sale of Delia's inventory?
As will be discussed fully in subpart C below, purchase money security interests may have priority over a conflicting interest as to which the purchase money security interest would be subordinate under the first-to-file-or-first-to-perfect rule.
C. Purchase Money Security Interests
1. Generally
Purchase money security interests received special treatment under former Article 9 and the same is true under new Article 9. Under new Article 9, new section 9-324 governs. This section covers cases dealt with in former sections 9-312(3) and (4) and is expanded to reach a total of five categories of purchase money security interests. The five cases are:
(1) Conflicts between non-purchase money security interests and purchase money security interests in collateral that is other than inventory or livestock;
(2) Conflicts between non-purchase money security interests and purchase money security interests in inventory;
(3) Conflicts between non-purchase money and purchase money security interests in livestock;
(4) Conflicts between non-purchase money and purchase money security interests in software; and
(5) Conflicts between competing purchase money security interests in the same collateral.
The extent to which the priority awarded purchase money security interests in collateral in each category carries over to proceeds is explained in connection with the discussion of the priority rules governing each category of purchase money security interest. As to certain collateral, new Article 9 has added special rules governing proceeds and the discussion of these rules is deferred to Chapter 29 (Secured Party Versus Secured Party (continued)).
2. Purchase Money Security Interests in Other Than Inventory or Livestock
a. Original Collateral
The rules governing disputes between non-purchase money and purchase money security interests in other than inventory or livestock collateral are the most straightforward and we start with these rules. Under former section 9-312(4), a purchase money security interest in collateral other than inventory had priority over a conflicting security interest in the same collateral if the purchase money security interest was perfected at the time the debtor received possession of the collateral or within ten days thereafter.
As is discussed below, the special priority as to original collateral carried over to proceeds of the collateral. The rules of former section 9-312(4) thereby trumped (or "primed") the usual first-to-file-or-first-to-perfect priority rules of former section 9-312(5)(a) and former section 9-312(6). The special priority was given to encourage the infusion of new assets and credit into a debtor's business.
New section 9-324(a) basically reenacts former section 9-312(4) to create an identical priority for purchase money security interests in other than inventory. It differs in three respects. First, there is a special rule for purchase money security interests in livestock found in new section 9-324(d) and the rule of new section 9-324(a) applies to goods other than inventory or livestock. Second, the ten-day time period is extended to twenty days. Third, the extent to which the special priority carries through to proceeds is subject to new section 9-327. The livestock and proceeds rules are considered below.
Under new section 9-324(a) a purchase money security interest in collateral that is other than inventory or livestock has priority over a non-purchase money security interest in such collateral IF the purchase money security interest is perfected when the debtor receives possession of collateral or within twenty days thereafter. As with former section 9-312(4), the special priority is given to the purchase money party to encourage the infusion of new assets and credit into the debtor's business.
It should be noted that there is no negative inference in new section 9-324(a). Consequently, a holder of a purchase money security interest in other than inventory or in livestock who fails to satisfy the conditions for the special priority under new section 9-324(a) does not necessarily lose to a competing party because the dispute then is governed by new section 9-322(a) and the purchase money party could prevail under the first-to-file rule.
The operation of new section 9-324(a) is the subject of the next problem.
Problem 28.9 (interactive)
Western Bank lends to Delia Debtor and takes a security interest in Delia's equipment, existing and after-acquired. Western properly files a financing statement covering Delia's equipment. Selma Seller sells Delia a drill press and takes a security interest in the drill press sold to secure its price. Selma delivers the drill press to Delia the next day. Ten days later Selma files a financing statement covering the drill press.
Who has priority as to the drill press sold by Selma?
If Selma delayed filing a financing statement for 30 days following delivery of the drill press to Delia and Western did not file until 31 days after the delivery of the drill press to Delia, who would have priority as the drill press?
b. Proceeds
Under new section 9-324(a), subject to new section 9-327, the special priority for a purchase money security interest in other than inventory or livestock carries over to the proceeds of such collateral. As is more fully explained in Chapter 29 (Secured Party Versus Secured Party (continued)), new section 9-327 gives a holder of a security interest in a deposit account who has perfected the security interest by control priority over security interests perfected otherwise than by control.
Therefore, if a holder of a purchase money security interest in other than inventory or livestock perfects the security interest within twenty days of possession of the collateral by the debtor then the holder of the security interest has priority not only as to the original collateral but also the proceeds of the collateral, except if the proceeds are a deposit account and another creditor has perfected a security interest in the deposit account by control.
As noted above, there is no negative inference in new section 9-324(a) and if a party does not qualify for the special priority for proceeds under new section 9-324(a) the dispute is governed by new section 9-322(a).
You may explore the application of new section 9-324(a) to a proceeds dispute in the next problem.
Problem 28.10 (interactive)
Assume the facts of Problem 28.9. Assume further, however, that Delia Debtor sold the drill press and received a check identifiable as having been received for the drill press.
Who as between Selma Seller and Western Bank would have priority to the check?
If Selma delayed filing a financing statement for thirty days following delivery of the drill press to Delia who would have priority as to the check?
3. Purchase Money Security Interests in Inventory
a. Original Collateral
The priority rules for purchase money security interests in inventory are considerably more complicated than those for purchase money security interests in other than inventory and livestock. Under former section 9-312(3), a perfected purchase money security interest in inventory had priority over a conflicting security interest in the same inventory and also had priority in identifiable cash proceeds received on or before the delivery of the inventory to a buyer if the conditions spelled out in former section 9-312(3) were satisfied.
In particular, the special priority was conditioned on a requirement that other secured parties of record be timely notified of an impending sale. As is discussed below, the special priority in former section 9-312(3) carried over to proceeds to a much more limited extent than provided for in former section 9-312(4) for other than inventory.
As with former section 9-312(4), the purpose of the special priority of former section 9-312(3) was to encourage new financing. The rule put holders of outstanding inventory interests at risk in that any advances they made after the purchase money interest attaches could be subordinated. The notification requirement was intended to allow non-purchase money parties to withhold further advances. See Official Comment 3 to former 9-312.
The new Article 9 priority rules for purchase money security interests in inventory are found primarily in new sections 9-324(b) and (c). The rules are more elaborate than those in former Article 9, but insofar as original collateral is concerned the basic scheme is the same. Thus, under new section 9-324(b), a purchase money security interest in inventory has priority over a conflicting security interest if:
(1) the security interest is perfected before the debtor gets possession of the inventory;
(2) the purchase money secured party sends an authenticated notification to the holder of a conflicting non-purchase money security interest entitled to notification under new section 9-324(c);
(3) the holder of the conflicting security interest entitled to notification under new section 9-324(c) receives the notification within five years before the debtor receives possession of the inventory; and
(4) the notification states that the person sending the notification has or expects to acquire a purchase money security interest in inventory of the debtor and describes the inventory.
Under new section 9-324(b)(1) the special priority applies only if the purchase money security interest is perfected before the debtor gets possession of the inventory. Under new section 9-324(b)(3) the required notification must be received by a party entitled to notification within five years before the debtor receives possession. The five-year period is understood to correspond to the time after which a filing lapses under new section 9-515. As to lapse, see Chapter 14 (The Nitty Gritty of Filing). The question could arise as to how the requirements predicated on possession should apply where the debtor never receives possession (for example, where goods are shipped directly to a third party). Official Comment 5 to new section 9-324 answers the question as follows:
If the debtor never receives possession, the five-year period never begins, and the purchase-money security interest has priority, even if notification is not given.
This conclusion seems not to take account of the purpose of the notification requirement to protect prior non-purchase money parties, see Official Comment 4 to new section 9-324, but how the requirements predicated on possession by the debtor could be interpreted differently where the debtor does not get possession is not readily apparent. As explained below, the same questions arise with respect to the special priority for purchase-money security interests in livestock that are farm products in new section 9-324(d).
New section 9-324(c) spells out which holders of conflicting security interests are entitled to notification under new section 9-324(b). Under new section 9-324(c)(1), a holder of a conflicting security interest is entitled to notification if the holder of the conflicting interest filed a financing statement covering the same type of inventory before the purchase money party filed a financing statement.
New section 9-324(c)(2) governs where the purchase money party perfected temporarily without filing or perfection under new section 9-312(f). In such a case the holder of the conflicting security interest is entitled to notification if it filed a financing statement before the beginning of the twenty-day period for temporary perfection under new section 9-312(f).
Whether the notification scheme achieves its intended purpose of opening up new secured credit opportunities is open to doubt. Creditors who lend against inventory generally expect to have the only security interest in inventory. The parties contemplate that additional inventory will be acquired with additional loan funds from the inventory party or on open (unsecured credit).
There may well be a provision in the security agreements between such lenders and the debtors barring the creation of other inventory security interests. Under new section 9-401, as discussed in Chapter 25 (The Why and How of Priority), the security agreement prohibition will not prevent the creation of a purchase money security interest, but violation of the prohibition will be a default allowing the inventory lender to foreclose. Therefore, notification of an impending purchase money security interest could produce a default and a foreclosure by an inventory lender.
The result is that debtors generally will not grant purchase money security interests in inventory as to which there are outstanding security interests and will instead seek unsecured credit or try to work out an accommodation with the inventory lender. Ultimately, the extent to which suppliers of inventory will sell other than on a secured basis of course is dependent on how much they want the debtor's business and their risk tolerance as to the particular debtor.
To test your understanding of the new Article 9 purchase money priority rules under new sections 9-324(b) and 9-324(c), consider the next problem.
Problem 28.11 (interactive)
Lenny Lender has a security interest in Donna Debtor's inventory of appliance parts, existing and later-acquired. Lenny perfected its security interest by filing. Southwestern Bank is about to finance Donna's acquisition of new appliance parts. Southwestern is aware of Lenny's security interest and does not wish to lend to Donna unless it can be sure it will have priority over Lenny as to the new appliance parts.
Can you give Southwestern the assurance it desires?
If so, what must Southwestern do to be sure of the priority it seeks?
Does Southwestern risk putting Donna into default by sending the required notification?
What if the appliance parts the purchase of which was to be financed by Southwestern were to be shipped directly to buyers from the supplier and Donna would never receive possession. Would your answers change and, if so, how?
b. Proceeds
The special priority for proceeds in former section 9-312(3) was quite limited. It obtained only as to identifiable cash proceeds, as defined in former section 9-306(1) -- see Chapters 9 (The Specifics of Enforceability -- After-Acquired Property, Proceeds and Future Advances) and 16 (Perfecting Security Interests in Proceeds and Other Later Acquired Property) -- and did not apply to such important collateral as accounts and chattel paper.
Moreover, to be eligible for the special priority of former section 9-312(3) the cash proceeds must have been received on or before delivery of the inventory to a buyer from the debtor. Therefore, down payments received before delivery of inventory to a buyer would get the special priority, but installments received after delivery would not. And, of course, the priority as to certain identifiable cash proceeds was available only if the purchase money secured party met the requirements set out in former section 9-312(3) for priority as to the original collateral.
Priority as to non-cash proceeds and otherwise eligible proceeds where the secured party had not complied with the requirements of former section 9-312(3) was governed by the first-to-file-or-first-to-perfect priority rule contained in former sections 9-312(5)(a) and 9-312(6).
New Article 9 preserves the special limited priority for proceeds of inventory for holders of purchase money security interests in inventory. Thus, new section 9-324(b) provides a priority for identifiable cash proceeds (as defined in new section 9-102(a)(9)) received on or before delivery of inventory to a buyer from the debtor, but leaves disputes as to most non-cash proceeds to the general proceeds rules. However, there have been some changes from former Article 9.
Under new section 9-324(b), a purchase money secured party "has priority over a conflicting security interest in chattel paper or an instrument constituting proceeds of the inventory and proceeds of the chattel paper, if so provided in section 9-330." This part of new section 9-324(b) is confusing at best.
New section 9-330 provides for a special priority for purchasers of chattel paper and the proceeds of chattel paper and purchasers of instruments under specified conditions. But, it is difficult to conceive of a situation where a conflict as to proceeds of inventory implicates both the limited proceeds priority of new section 9-324(b) and the proceeds priority given by new section 9-330. Therefore, discussion of new section 9-330 as it could apply to the proceeds of a purchase money security interest in inventory is properly deferred to Chapter 29 (Secured Party Versus Secured Party (continued)).
Note further here, however, that the protection given to identifiable cash proceeds in new section 9-324(b) is subject to new section 9-327. As is explained in Chapter 29 (Secured Party Versus Secured Party (continued)), a security interest in a deposit account that is perfected by control has priority over a security interest in that deposit account perfected otherwise than by control. Consequently, if proceeds of inventory are cash proceeds in the form of a deposit account, the priority given to a purchase money security interest in identifiable cash proceeds gives way to a security interest in the deposit account that was perfected by control.
You may test your understanding of the limited extent to which the priority given to a purchase money security interest in inventory carries over to proceeds in the next two problems.
Problem 28.12 (interactive)
Assume the facts of Problem 28.11. If Southwestern Bank satisfies the conditions in new section 9-324(b) for priority over Lenny Lender as to inventory acquired with financing provided by Western, who has priority as between Southwestern and Lenny to the various proceeds referred to below:
(a) Cash down payments made by the buyers of appliance parts from Donna Debtor and received before delivery of appliance parts to the buyers?
(b) Monthly installment payments made by the buyers of appliance parts from Donna Debtor after delivery of the appliance parts to the buyers?
(c) Appliance parts traded in by the buyers of new appliance parts from Donna Debtor before delivery of the new appliance parts to the buyers?
Explain your answers.
Problem 28.13 (interactive)
Southern Bank has a purchase money security interest in Donald Debtor's inventory of automobile parts. Southern perfected by filing before Donald received possession of the automobile parts and Southern has otherwise satisfied new section 9-324(b). Following the agreement with Southern, Donald borrowed from Lisa Lender and gave Lisa a security interest in accounts generated by the sale of the automobile parts. Lisa perfected by filing as to the accounts.
Who has priority as to the accounts generated by the sale of the automobile parts, Southern or Lisa?
Would your answer be different if Lisa filed as to the accounts before Southern filed and otherwise satisfied the requirements of new section 9-324(b) as to its purchase money security interest in the automobile parts?
4. Purchase Money Security Interests in Livestock
a. Original Collateral
New Article 9 adds a special priority for purchase money security interests in livestock. More accurately, the priority is for purchase money security interests in livestock that are farm products. Recall under new section 9-102(a)(34), livestock are farm products only where the debtor is engaged in a farming operation. The new priority rules are found in new sections 9-324(d) and (e).
New sections 9-324(d) and (e) are patterned after new sections 9-324(b) and (c) providing for priority for purchase money security interests in inventory and proceeds under certain specified conditions, and discussed in subpart C(3) above. As with the inventory case, under new section 9-324(d)(1), the priority for the holder of a purchase money security interest in livestock requires that the security interest be perfected when the debtor receives possession of the livestock. Also as to the priority for livestock, there must be timely notification to the earlier filed interests defined in new section 9-324(e), as required by new sections 9-324(d)(2), (d)(3) and (d)(4). See Official Comment 10 to new 9-324.
For reasons that are not apparent the notification required by new section 9-324(d) must be received within six months before the debtor receives possession of the livestock as contrasted with the five-year period provided for in new section 9-324(b) providing for a special priority for purchase money security interests in inventory.
As is the case with inventory and as was discussed in subpart C(3) above, the question could arise as to how the perfection before possession and notification within six months of possession requirements are to be applied where the debtor never receives possession. As was noted in that subpart Official Comment 5 to new section 9-324 indicates that where the debtor never receives possession the requirements of new section 9-324(b) for inventory predicated on possession by the debtor do not apply if the debtor does not receive possession and this conclusion may well carry over to new section 9-324(d).
As discussed in the next subpart, the rules providing for a special priority for purchase money security interests in livestock departs from that for inventory insofar as proceeds are concerned.
b. Proceeds
As noted, the special priority for purchase money security interests in livestock that are farm products under new section 9-324(d) resembles that for inventory, but is broader with respect to the treatment of proceeds. First, as is the case with new section 9-324(a) (other than inventory and livestock), subject to the rule in new section 9-327 governing security interests in deposit accounts perfected by control, the special priority carries through to all identifiable proceeds and not just certain cash proceeds.
Second, the special priority extends to identifiable products of livestock in their unmanufactured states. Thus, if a security agreement covers livestock and the financing statement does also, there is a perfected security interest in the livestock and the secured party with a purchase money security interest in livestock that constitutes farm products under new section 9-102(a)(34) will have priority as provided for in new section 9-324(d) as to identifiable products of the livestock in their unmanufactured states, including calves and colts. See Official Comment 10 to new 9-324.
Note, however, that if a secured party has a purchase money security interest in specific collateral, such as a prize breeding bull, and the security agreement describes the collateral as "debtor's prize breeding bull," then there is no security interest in the products of the bull unless the security agreement so provides. By contrast to proceeds Article 9 does not give a secured party an interest in products of collateral (unless the products somehow constitute proceeds under the definition of "proceeds" in new section 9-102(a)(64), which would not be so as to offspring of livestock). In short, there must be a security interest in collateral before there can be a conflict as to which the special priority applies.
You may test your understanding of the special priority for purchase money security interests in livestock that are farm products as it applies to original collateral and proceeds and products in the next problem.
Problem 28.14 (interactive)
Central Bank lends to Donald Debtor who raises and sells beef cattle. Donald gives Central a security interest in Donald's cattle, existing and later-acquired. Central properly files a financing statement covering Donald's cattle. Subsequently, Donald purchases a prize breeding bull, Super Stud, from Bulls R Us, a wholesaler of breeding bulls. Donald signs a security agreement giving Bulls R Us a security interest in Super Stud to secure its price. Bulls R Us knows about Central's security interest and wishes to be assured of the priority of its security interest in Super Stud over that of Central.
Can Bulls R Us be given such assurance? If so, how so?
If Donald sells Super Stud will any priority as to Super Stud extend to identifiable non-cash as well as cash proceeds?
Suppose Bulls R Us also desires to have a superior security interest in calves sired by the bull. Will satisfying the conditions for priority as to Super Stud assure Bulls R Us of priority as to the calves?
The question may arise as to whether purchase money security interests in aquatic goods qualify for the special priority in new section 9-324(d) and (e). Aquatic goods are within the definition of "farm products" in new section 9-102(a)(34), but it is left to the courts to decide in a given case whether the goods are crops or livestock. See Official Comment 11 to new 9-324. If the aquatic goods, for example, shrimp raised on a shrimp farm, are livestock then they will be within new sections 9-324(d) and (e). If the aquatic goods are crops it is unclear how they will be treated. It seems that the special priority rule for other than inventory, discussed in subpart C(1) above, would apply, but where there is not timely perfection then the first-to-file or first-to-perfect rule of new section 9-322(a) governs.
The drafters have proposed for adoption, Model 9-324A, an optional provision for production security interests and where adopted that provision would govern a crops case. See Official Comment 11 to new 9-324. The model provision would replace former section 9-312(2), which was not adopted in most states and is not included in new Article 9. See Official Comment to Model 9-324A. But cf. Chapters 20 (Perfection as to Fixtures and Other Real Estate-Related Collateral) and 32 (Fixtures Priorities).
5. Purchase Money Security Interests in Software
a. Original Collateral
New Article 9 adds a priority rule for purchase money security interests in software. As we saw in Chapter 5 (Classification of Collateral), dealing with classification, and Chapter 18, dealing with automatic perfection, under new section 9-103(c), a purchase money security interest in software arises only if the debtor acquires its interest in the software for the principal purpose of using the software in goods subject to a purchase money security interest.
Under new section 9-324(f), a purchase money security interest in software has the same priority as the purchase money security interest in the goods in which the software was acquired for use. The priority of the interest in the goods is determined by new section 9-324(a), for other than inventory, and new section 9-324(b), for inventory. Subparts C(2) (other than inventory) and C(3) (inventory) should be consulted as to the operation of the special priority rules for purchase money security interests in such collateral.
b. Proceeds
Because the priority given to a purchase money security interest in software depends on whether the goods in which the software was acquired for use is other than inventory or inventory, the proceeds rules of new section 9-324(a) (other than inventory) and new section 9-324(b) (inventory) apply to conflicts involving proceeds of software subject to a purchase money security interest. Again, subparts C(2) and C(3) should be consulted.
You may test your understanding of the priority rules for purchase money security interests in software in the next problem.
Problem 28.15 (interactive)
Donna Debtor purchases a computer on which Windows software is installed from Sid Seller for use in her business. The purchase is on credit and Sid takes a security interest in the computer and the software to secure the price of each. Lisa Lender holds a security interest on Donna's equipment, existing and after-acquired. Lisa filed a financing statement covering Donna's equipment before Donna purchased the computer and software. Which of the following accurately states the conditions under which Sid's security interest in the software has priority over that of Lisa?
(a) Sid will have priority over Lisa as to the software if Sid perfects its security interest in the computer before or within 20 days after Donna gets possession of the computer and Sid timely notifies Lisa of its impending interest in the computer.
(b) Sid will have priority over Lisa as to the software if Sid perfects its security interest in the computer before Donna gets possession of the computer and Sid timely notifies Lisa of its impending interest in the computer.
(c) Sid cannot get priority over Lisa as to the software under any conditions.
(d) Sid will have priority over Lisa as to the software if Sid perfects its security interest in the computer before or within 20 days after Donna gets possession of the computer.
Assume Sid satisfies the conditions for priority over Lisa as to the computer. If Donna sells the computer with the software installed in it for cash, who has priority as to the cash, Sid or Lisa?
6. Competing Purchase Money Security Interests in the Same Collateral; Accessions and Commingled Goods
It is possible for more than one creditor to have a purchase money security interest in the same collateral. Under former Article 9 there was a difference of opinion as to what should happen in such a case. One could reasonably argue that in a case of conflicting purchase money security interests in the same collateral the holders of the interests should share pro rata, i.e., each creditor should get a percentage of the value of the collateral that corresponds to that part of the price of the collateral financed by that creditor. However, the prevailing view seemed to be that the priority should be resolved under the first-to-file-or-first-to-perfect rule. See, e.g., John Deere Co. v. Production Credit Ass'n, 686 S.W.2d 904 (Tenn. App. 1984).
New Article 9 has added a provision that specifically addresses conflicts between competing purchase money secured parties. Under new section 9-324(g)(1), if more than one security interest in the same collateral qualifies for the special priority given by new sections 9-324(a) (other than inventory or livestock), (b) (inventory), (d) (livestock) or (f) (software), then a security interest securing the unpaid price of the collateral has priority over a security interest securing a loan obligation incurred to enable the debtor to acquire rights in the collateral.
Under new section 9-324(g)(1), therefore, as between a seller and a lender, the seller is preferred. According to Official Comment 13 to new section 9-324, the rationale for this rule, which is adopted from real estate law, is that the equities favor sellers because sellers part with specific property rather than money and they would not part with property except on the understanding that the seller will have access to the property to satisfy the obligation. Under new section 9-324(g)(2), as between lenders, new section 9-322(a) governs.
To test the application of new section 9-324(g) consider the next problem.
Problem 28.16 (interactive)
Donna Debtor purchases a computer for use in her business from Selma Seller on credit. The sales price is $4,000. Donna pays $1,600 down and promises to pay the balance of $2,400 in 12 equal monthly installments. Selma takes an interest in the computer to secure the unpaid price. Selma delivers the computer the same day. The next day Selma files a financing statement covering the computer. Donna borrowed one-half the down payment from her brother, Bob, two days before the purchase, and borrowed the other half of the down payment from his mother, Mary, the day before the purchase. Bob and Mary each took a security interest in the computer to secure their loans and each filed a financing statement covering the computer the day of the loan by each. Donna defaults as to all three debts owing Selma $2,000 and Bob and Mary $500 each. The computer is worth $2,500.
Who gets what under new section 9-324(g)? Explain your answers.
Suppose that Selma Seller delayed filing until 30 days after the delivery of the computer to Donna Debtor. How would the proceeds from the sale of the computer be distributed now?
You should be aware that conflicting purchase money security conflicts can arise in situations involving accessions and commingled goods. There were special rules in former section 9-314 and 9-315 for dealing with such accession and commingled goods conflicts. New Article 9 has reenacted these rules in somewhat simplified form in new sections 9-335 and 9-336.
D. Priority Among Holders of Assigned Security Interests
The following case decided under former Article 9 offers an interesting opportunity to consider a number of points dealt with in Chapter 28 and prior chapters. The facts are somewhat complicated, but the court's analysis makes wading through the facts worth the effort.
Interbusiness Bank, N.A. v. First National Bank of Mifflintown
Problem 28.17 (interactive)
Explain why the security interest of Interbusiness had priority over that of First National but First National still prevails.
Would the analysis or outcome be any different under new Article 9?
If the facts were that First National had been assigned the financing statement filed first by Allied Capital and Interbusiness had been assigned the second security interest perfected by the later filed financing statement, who would have priority?
For a more recent case addressing some of the same issues as those involved in the Interbusiness case but applying new Article 9 provisions, see Retenbach Constructors, Inc. v. CM Partnership, 639 S.E.2d 16 (N.C. App. 2007).
CASE COMMENTARY
Borley Storage and Transfer Co., Inc. v. Whitted, 271 Neb. 84, 710 N.W.2d 71 (Neb. 2006)
Retenbach Constructors, Inc. v. CM Partnership, 639 S.E.2d 16 (N.C. App. 2007)
Genesee Regional Bank v. Palumbo, 779 N.Y.S.2d 883 (N.Y. Supreme Court 2005)
First National Bank v. Lubbock Feeders, L.P., 183 S.W.3d 875 (Tex. App. 2006)
Sunflower Bank, N.A. v. Kindsvater, 144 p.3d 81 (Kan. App. 2006)
In re Millivision, Inc., 474 F.3d 4 (1st Cir. 2007)
2009-02-01 Update