Chapter 32 Fixtures Priorities

Part VI Priority

Chapter 32 Fixtures Priorities

A. Generally

In Chapter 4 we saw that real estate transactions are largely outside the scope of Article 9. However, under new sections 9-109(a)(1) and 9-334(a), as was true under former Article 9, new Article 9 governs the creation and perfection of security interests in goods that are fixtures (except for ordinary building materials incorporated into an improvement on land).

In Chapter 20 (Perfection as to Fixtures and Other Real Estate-Related Collateral) it was explained that a security interest in a fixture can be perfected by the usual methods, including filing and also automatically (but not by possession). See new sections 9-309(1) and 9-312(a). The earlier discussion of fixtures anticipated the fact that a priority dispute can arise between an Article 9 party and a real estate party. The reason that disputes between Article 9 parties and real estate parties are possible is that, under new section 9-102(a)(41), fixtures are goods that are so affixed to real estate that an interest in the goods can arise under local real estate law.

It was noted in Chapter 20 that new section 9-102(a)(41) does not actually define "fixture," but rather refers the determination of whether or not goods are fixtures to real estate law outside Article 9. It further was noted that the pertinent law outside Article 9 ordinarily consists of tests devised by courts that make it difficult at times to know with certainty whether particular goods are fixtures or not. What is clear is that rules are needed to resolve disputes involving fixtures. These rules are the subject of this chapter.

It will be seen that outcomes in disputes involving real estate parties often turn on whether the Article 9 party has filed a "fixture filing." A fixture filing is made by filing in the real estate records a financing statement that contains special information, including an indication that it is a fixture filing, an adequate description of the real property to which the collateral is affixed and the name of a record owner of the real estate involved if the debtor is not an owner of record. See new sections 9-102(a)(40) and 9-502(b) and Chapter 20 (Perfection as to Fixtures and Other Real Estate-Related Collateral).

It was noted in Chapter 20 (Perfection as to Fixtures and Other Real Estate-Related Collateral) that security interests in growing crops and timber to be cut also may come into conflict with real estate interests. As will be seen below, new section 9-334 sets forth an elaborate priority scheme for dealing with such conflicts. As for growing crops, new section 9-334(i) provides quite simply that perfected security interests in growing crops have priority over a conflicting interest of an owner or encumbrancer of the real estate so long as the debtor has an interest of record or is in possession of the real estate.

Unlike disputes as to fixtures and growing crops 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.

B. Secured Parties Versus Other Parties Claiming Goods as Goods

It is important to keep in mind that fixtures are goods and disputes may arise among parties who claim the goods as goods (or "personalty"). Conflicts between a secured party and other parties with interests in collateral as goods are governed by the priority rules examined in Chapters 26, 27, 28 and 29.

You may consider the application of those rules to disputes among parties claiming interests in the collateral as goods in the next four problems.

Problem 32.1 (interactive)

Donna Debtor borrows from Western Bank and gives Western a security interest in a large drill press which is used by Donna in Donna's business and which is bolted to the floor of Donna's plant. Western files a "fixture filing" in the proper place. Thereafter, Lenny Lender lends to Donna and takes a security interest in the same drill press. Lenny files a financing statement covering the drill press with the Secretary of State's Office. Donna then defaults on both loans. Under state law a purchaser of Donna's plant would not acquire any interest in the drill press.

Who has priority as between Western Bank and Lenny Lender?

Problem 32.2 (interactive)

Assume the facts of Problem 32.1. Assume further, however, that after Western Bank and Lenny Lender file, Donna Debtor sells the drill press to Byron Buyer who gives value and receives delivery without knowledge of either Western's or Lenny's security interest.

Does Byron Buyer take free of Western Bank's security interest? Does Byron Buyer take free of Lenny Lender's security interest?

Problem 32.3 (interactive)

Assume the facts of Problem 32.1. Suppose instead of a sale Donna Debtor suffered a judgment pursuant to which the sheriff levied on the drill press after Western and Lenny filed.

Does the resulting judicial lien subordinate Western Bank's security interest? Does the resulting judicial lien subordinate Lenny Lender's security interest?

Problem 32.4 (interactive)

Assume the facts of Problem 32.1. Assume further, however, that the drill press was affixed to Donna Debtor's plant in such a way as to give a purchaser of Donna's plant an interest in the drill press under local real estate law.

Would Lenny Lender still have priority over Western Bank?

On the change in facts, would a buyer who satisfied the conditions stated in new section 9-317(b) after Western filed take free of Western Bank's security interest?

On the change in facts, would a lien obtained by levy after Western filed subordinate Western Bank's security interest?

C. Article 9 Security Interests Versus Real Estate Parties

1. Generally.

We now look at conflicts between secured parties and parties with an interest in the collateral arising under real estate law. Such conflicts arise only if the goods are fixtures as defined in new section 9-102(a)(41), i.e., goods that are so attached to real estate that under local real estate law a party who takes an interest in the real estate acquires an interest in the goods.

Real estate parties have no interest (as real estate parties) in goods that are not fixtures. A possible exception, discussed below, is that in some states a real estate mortgage can reach crops. Where the goods are fixtures special priority rules govern disputes between Article 9 parties and real estate parties.

The general rule under former Article 9 was that a security interest was subordinate to the conflicting interest of an encumbrancer or owner of the related real estate who was not the debtor. However, the general rule was subject to a number of exceptions, most of which turned on whether or not the secured party had made a fixture filing. New Article 9 retains the basic scheme of former Article 9.

Recall from Chapter 20 (Perfection as to Fixtures and Other Real Estate Related Collateral) that a fixture filing is made by filing a financing statement meeting the special requirements of new section 9-502(b) in the real estate records, as provided for in new section 9-501(a)(1)(B). Such a filing reduces the element of surprise to an owner or encumbrancer whose interest predates the affixation of the goods to the real property insofar as the fixture filing is in the chain of title and made against the debtor, where the debtor has an interest of record in the real estate, or the financing statement names a party of record other than the debtor where the debtor is in possession but has no interest of record (such as a lessee). See new section 9-502(b)(3).

2. The General Rule

New section 9-334(c) preserves the general rule of former section 9-313(7) that real estate parties prevail by providing that subject to subsections (d) through (h), a security interest in fixtures is subordinate to a conflicting interest of an encumbrancer or owner of the related real property which is not the debtor. Under new section 9-102(a)(32), an "encumbrance" is a right in real property, other than an ownership interest, and includes a mortgage or other lien on real property. An "owner" obviously is a person who has or acquires an ownership interest in real property.

Consequently, Article 9 security interests are at risk as to mortgages and deed of trust holders and other encumbrancers of real estate to which goods that are fixtures are affixed, unless the Article 9 security interest is given priority under an exception to the general rule of new section 9-334(c).

3. Exceptions Requiring Fixture Filings

a. Protection for purchase money security interests

One of the more important exceptions to the general rule in new section 9-334(c) is that in new section 9-334(d). According to new section 9-334(d), subject to new section 9-334(h) for construction mortgages, a perfected security interest in fixtures has priority over a conflicting interest of an encumbrancer or owner of the real property if:

(1) the debtor has an interest of record or is in possession of the real property;

(2) the security interest is a purchase-money security interest;

(3) the interest of the encumbrancer or owner arises before the goods become fixtures; and

(4) the security interest is perfected by a fixture filing before the goods become fixtures or within 20 days thereafter.

This exception to the general rule protects purchase money security interests that are timely perfected by a fixture filing against ownership interests in and encumbrances against real property that arose before the goods become fixtures. It is intended to prevent the real estate party from reaping a windfall from affixation of the goods to the real property.

The exception operates only where the debtor is a party of record as to the real estate or is in possession. Thus, for example, if the debt secured by the goods that have become affixed to real estate was incurred by a contractor who has no interest in the real property then new section 9-334(d) does not protect the party with the security interest in the goods.

b. Construction mortgage qualification to purchase money security interest protection

Under new section 9-334(h), a purchase money security interest in fixtures that qualifies for the special protection in new section 9-334(d) is subordinate to a construction mortgage that is recorded before the goods become fixtures and before completion of construction.

New section 9-334(h) provides that a mortgage is a "construction mortgage" to the extent that it secures an obligation incurred for the cost of the land and improvements to the land if the mortgage indicates it is a construction mortgage. A mortgage given to refinance a construction mortgage has the priority given by new section 9-334(h).

c. Protection against later recorded real estate interests

New section 9-334(e) contains several additional exceptions to the general rule that real estate parties prevail. Under new section 9-334(e)(1), a perfected security interest in fixtures has priority over a conflicting real estate interest if:

(1) the debtor has an interest of record in the real property or is in possession of the property;

(2) the security interest is perfected by a fixture filing before the interest of the encumbrancer or owner is of record; and

(3) the security interest has priority over any conflicting interest of a predecessor in title of the encumbrancer or owner.

New section 9-334(e)(1) provides a first in time of filing or recording priority rule, but requires that the filing be a fixture filing so that the filing will show up in the real estate records and provide notice to real estate parties who record subsequent to the filing. See Official Comment 6 to new 9-334. Note that the security interest in the fixture need not be purchase money.

Under new section 9-334(e)(1)(B), the first in time exception applies only if the security interest has priority over any conflicting interest of a predecessor in title of the competing ownership or encumbrancer interest. This requirement acknowledges the usual rule that a person must be entitled to transfer what is being transferred.

Thus, a fixture security interest that is subordinate to a mortgage is subordinate to an assignee of the mortgage even where the assignment is subsequent in time to the creation and filing of the security interest. Likewise, if the fixture security interest is subordinate to the rights of an owner then it is subordinate to a subsequent grantee of the owner and a subsequent mortgagee of the owner. See Official Comment 6 to new 9-334.

You may test the operation of the general rule in new section 9-334(c) that real estate parties prevail over parties with security interests in fixtures and the exceptions to it in new sections 9-334(d) and 9-334(e)(1) in the next two problems.

Problem 32.5 (interactive)

Delia Debtor owns her home. The real estate and improvements to it are subject to a deed of trust held and duly recorded by Central Bank. Delia has never owned a barbeque. Delia purchases a home gas barbecue unit from Sid Seller on credit. Delia signs an agreement giving Sid an interest in the barbeque unit to secure its price. The barbeque unit is delivered to Delia and built into a patio wall in such a way as to give a purchaser of the home an interest in the barbeque unit.

On these facts, is Sid's security interest in the barbeque unit perfected?

Is Sid's security interest prior to Central Bank's deed of trust interest? Would Sid's security interest in the barbeque be prior to the claim of Betty Buyer who purchases the home from Delia after the barbecue unit is installed and duly records the conveyance in the local real estate records?

How could Sid have assured itself of priority over Central Bank?

How could Sid Seller have assured itself of priority over Betty Buyer?

Problem 32.6 (interactive)

Ollie Owner purchases land and contracts with Bob Builder to construct a home on the land. Ollie borrows from Southern Bank to finance construction of the home. Southern secures the loan to Ollie by taking an interest in the land and the improvements and Southern duly records its interest. Bob purchases a central air conditioning system from Selma Seller on credit and gives Selma an interest in the air conditioning system to secure the unpaid price of the system. Selma immediately makes a fixture filing. Two days later, while the home is still under construction, Selma installs the air conditioning system in such a way that the system becomes a fixture under the law outside Article 9. Bob defaults on its debt to Selma. Which of the following correctly states the priority between Selma Seller and Southern Bank?

(a) Selma Seller has priority over Southern Bank under new section 9-334(d).

(b) Southern Bank has priority over Selma Seller under new section 9-334(c).

If Ollie Owner had bought the air conditioning unit from Selma Seller, would Selma now have priority over Southern Bank?

4. Other Exceptions to the General Rule

a. Exception for readily removable fixtures

Under new section 9-334(e)(2), a security interest perfected by any method before the goods become fixtures has priority over a conflicting real estate claim to a readily removable fixture that is (1) a factory or office machine or (2) equipment not primarily used or leased for use in the operation of the real property or (3) a replacement of a domestic appliance that constitutes consumer goods.

The exception to the rule of new section 9-334(c) in new section 9-334(e)(2) applies only in the limited circumstances spelled out in the provision. To the extent that the exception does apply it protects a secured party who because of the uncertainty in the law regarding what is or is not a fixture mistakenly concludes that it is taking a security interest in goods that are not or will not become fixtures and perfects otherwise then by making a fixture filing.

You may consider the operation of new section 9-334(e)(2) in the next problem.

Problem 32.7 (interactive)

Betty Buyer owns a home subject to a deed of trust interest held by Southwestern Bank who financed the purchase of the home duly recorded the deed of trust. Betty, who has never owned a microwave oven, buys a microwave oven from Sid Seller on credit and gives Sid an interest in the microwave oven to secure its unpaid price. Sid installs the microwave oven in Betty's kitchen. The microwave is built into a kitchen wall but would be readily removable. Which of the following correctly states the priority between Sid Seller and Southwestern Bank? Note that more than one choice may be correct.

Betty Buyer owns a home subject to a deed of trust interest held by Southwestern Bank who financed the purchase of the home and duly recorded the deed of trust. Betty, who has never owned a microwave oven, buys a microwave oven from Sid Seller on credit and gives Sid an interest in the microwave oven to secure its unpaid price. Sid installs the microwave oven in Betty's kitchen. The microwave is built into a kitchen wall but would be readily removable.

Which of the following correctly states the priority between Sid Seller and Southwestern Bank?
Note that more than one choice may be correct.

(a) If under law outside Article 9 the microwave oven is a fixture, Sid Seller has priority over Southwestern Bank under new section 9-334(e)(2).

(b) If under the law outside Article 9 the microwave oven is not a fixture, Sid Seller has priority over Southwestern Bank under new section 9-201(a).

(c) If under the law outside Article 9 the microwave oven is a fixture, Southwestern Bank has priority over Sid Seller under new section 9-334(c).

(d) If under the law outside Article 9 the microwave oven is not a fixture, Southwestern Bank has priority over Sid Seller under new section 9-201(a).

If the microwave were a replacement and also a fixture would Sid Seller have priority over Southwestern Bank even though Sid has made no filing - fixture or otherwise?

b. Exception for Judicial Liens on Real Property

New section 9-334(e)(3) contains an exception to the general rule of new section 9-334(c) that is more important than might first appear. Under new section 9-334(e)(3), a security interest in a fixture has priority over a lien on the real property obtained by legal process after the security interest in the fixture is perfected by any method.

As explained in Chapters 26 and 30, a trustee in bankruptcy cannot avoid a security interest under BRA § 544 if the security interest cannot be subordinated by a lien creditor under state law on the date of bankruptcy. In other words, federal bankruptcy law employs a lien creditor test of perfection. If a security interest is protected against a lien creditor under state law on the date of bankruptcy, then a trustee cannot avoid the security interest under BRA § 544.

New section 9-334(e)(3) provides that a security interest in a fixture perfected by any method before a lien is obtained on the real property has priority over the lien. It follows that a security interest in a fixture perfected by any method on the date of bankruptcy cannot be avoided under BRA § 544.

You may consider the application of new section 9-334(e)(3) in the next problem.

Problem 32.8 (interactive)

The facts of Problem 32.5 were as follows: Delia owns her home. The real estate and improvements to it are subject to a deed of trust held and duly recorded by Central Bank. Debtor has never owned a barbeque. Delia purchases a home gas barbecue unit from Sid Seller on credit. Delia signs an agreement giving Sid an interest in the barbeque unit to secure its price. The barbecue unit is delivered to Delia and built into a patio wall in such a way as to give a purchaser of the home an interest in the barbeque unit. Assume further that after the barbeque is delivered the sheriff levies on the real estate pursuant to a writ obtained by Leon Lien Creditor.

Who has priority as between Sid Seller and Leon Lien Creditor?

If the sheriff levied on the barbeque who would have priority as between Sid Seller and Leon Lien Creditor?

If instead of a levy, Delia filed bankruptcy the day after the barbeque was delivered would Sid Seller's security interest in the barbeque be avoidable by the trustee under BRA § 544?

c. Disclaimed real state priority

As was also true under former Article 9, quite logically, under new section 9-334(f), if a real estate party has formally consented to a security interest or disclaimed an interest in the goods as fixtures or the debtor has the right to remove the fixtures as against an encumbrancer or owner, then the security interest has priority.

d. Exception for manufactured homes and goods covered by certificates of title

New section 9-334(e)(4) gives priority to a security interest in a manufactured home where the security interest in the manufactured home has been perfected by compliance with a certificate of title law. The exception in new section 9-334(e)(4) applies only where a state certificate of title law provides that perfection requires compliance with the certificate of title law.

e. Special rule for crops

New Article 9 also adds a special rule pertaining to crops. Under new section 9-334(i), a perfected security interest in crops growing on real property has a priority over a conflicting interest of an encumbrancer or owner of the real property if the debtor has an interest of record in or is in possession of the real property.

Official Comment 12 to new section 9-334 notes that in some jurisdictions a mortgage on real property may cover crops and that in the event crops are encumbered by both a mortgage and an Article 9 security interest new section 9-334(i) gives priority to a perfected Article 9 security interest. The comment adds that states whose real property law includes statutes that give priority to mortgagees should adopt new section 9-334(j) and expressly subordinate those statutes to new section 9-334(i).

5. Foreclosure of a Security Interest in Fixtures

As is explored more fully in Part VII, it is one thing to have priority over conflicting claimants and another to effectively foreclose an interest in collateral. Former Article 9, section 9-313(8) provided that if a secured party had priority over all owners and encumbrancers of the real estate, then on default, subject to various limitations in the Part 5 of former Article 9 governing foreclosure, the secured party could remove collateral from the real estate, but the secured party would have to reimburse any encumbrancer or owner of the real estate who was not the debtor and who had not agreed for the cost of repair of any physical injury.

Under former section 9-313(8), a secured party was not obligated to reimburse for any diminution in value of the real estate caused by the absence of the goods removed or by any necessity of replacing them, but a person entitled to reimbursement could refuse permission to remove the collateral until the secured party gave adequate security for the performance of the reimbursement obligation. The new Article 9 foreclosure rules are moved to Part 6 of new Article 9 and are placed in new sections 9-604(b), 9-604(c) and 9-604(d).

According to Official Comment 3 to new section 9-604, the rules of new sections 9-604(c) and (d) preserve the substance of former section 9-313(8). However, new section 9-604(b) is added to make clear that an interest in fixtures may be enforced either under real property law or under any of the applicable provisions of Part 6 of new Article 9 and that the section is intended to overrule decisions such as that in Maplewood Bank & Trust v. Sears, Roebuck & Co., 625 A.2d 537 (N.J. Super. Ct. App. Div. 1993) indicating that a secured party's only remedy was to remove the fixtures from the real property.

CASE COMMENTARY

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

2009-02-01 update