Chapter 4 Scope of Article 9

Part III Scope of Article 9, Classification of Collateral and Choice of Law

Chapter 4 Scope of Article 9

Working with Article 9 requires knowing whether or not a particular credit transaction is governed by Article 9. This determination, in turn, requires familiarity with the definitions found both in Article 9 and in UCC Article 1 and also the scope and exclusionary provisions in Article 9. The definitions contained in Article 9 itself were in former section 9-105 and now are found in new section 9-102. The scope and exclusionary provisions, which were sections 9-102 and 9-104 of former Article 9, are combined in new Article 9, section 9-109. It is imperative going in to have a sense of what Article 9 does and does not cover.

Generally speaking, Article 9 applies only to transactions involving a "security interest" which, as we saw in Chapter 3 (The Nature of Secured Credit under Article 9), is essentially a lien by agreement on personal property. New section 9-109(a)(1) provides that, subject to exclusions in new sections 9-109(c) and 9-109(d) (discussed below), new Article 9 applies to "any transaction, regardless of its form, that creates a security interest in personal property or fixtures by contract." Thus, John's lien by agreement in the basketball hoop in Problem 3.2, in Chapter 3, clearly is covered by Article 9.

The case of In re Wiersma, 283 B.R. 294 (Bkcy D. Idaho 2002), offers a good example of the point that substance governs over form. In that case the debtor executed an “assignment” of a cause of action for breach of contract. The court concluded that the assignment created a security interest, notwithstanding the language of the document executed by the debtor, because it was clear that the debtor did not intend to divest itself of all interest in the cause of action and rather the parties understood that the cause of action was assigned for the purpose of securing a debt evidenced by a promissory note. Of course, a debtor may intend to transfer all of its interest in property outright and if that intention is clear then the assignment is not intended as security and does not create a security interest.

Likewise, a purported sale according to which all of the debtor’s assets or ownership of its business are transferred to a lender subject to a right of repurchase for a nominal price when the debt is paid in full but the right of repurchase terminates on default will be treated as in substance serving only to create a security interest. More generally, a transfer contingent on a default as to a loan debt, even if formulated in terms of a condition subsequent, is not an outright transfer but rather the creation of a security interest. See, e.g., Chesapeake Investment Services v. Olive Group Corp., 2003 WL 369682 (Mass. Super. 2003).

Insofar as a transaction in substance creates a security interest, the creditor must proceed as permitted by the enforcement provisions of Article 9 and cannot simply take ownership of the property. Id. Enforcement of a security interest is the subject of Part VII of the CANINE materials.

Personal property, which includes both tangibles, especially goods, and intangibles, for example, accounts receivables, is to be distinguished from real property. Under new section 9-109(d)(11) the creation of a security interest in real estate is outside the scope of new Article 9. See Wells Fargo Home Mortgage, Inc. v. McCarthy, 51 UCC Rep. Serv. 2d 853 (Minn. App. 2003) (Unpublished opinion). Excepted from this exclusion is the creation of an interest in fixtures. Fixtures are goods that have attached to real estate so as to give real estate parties an interest in the goods. Security interests in fixtures are examined more closely in Chapter 20 (Perfection As To Fixtures and Other Real Estate-Related Collateral).

As is apparent only from an examination of the definition of "goods" in new section 9-102(a)(44), security interests in timber to be cut are covered by new Article 9. New Article 9 also governs security interests in notes secured by interests in deeds of trust or mortgages. The complicated questions of how a security interest in a promissory note secured by a real estate mortgage or deed of trust is created and perfected are dealt with in Chapters 8 (The Specifics of Enforceability -- A Security Agreement Authenticated by the Debtor or Its Equivalent) and 20 (Perfection as to Fixtures and Other Real Estate-Related Collateral).

It is commonplace today to market various property, including equipment and even vehicles for personal use, under what is denominated a “lease.” However, more often than not these transactions are in substance secured transactions or what are often referred to as “disguised conditional sales.” Such transactions are clearly covered by new Article 9 under new section 9-109(a)(1). Nevertheless, what is in the form of a lease may in fact and law be a lease or what is conveniently referred to as a “true” lease.

Distinguishing a true lease from a lease intended for security is frequently a difficult task at best. Section 1-201(37), now section 1-201(b)(35), went to great lengths to offer guidance to courts and others faced with making the distinction. Among the more important factors tending to support a conclusion that the transaction is for security is that the ostensible lessee has an option to acquire the property for no additional consideration or for nominal consideration. But, in the end the determination of whether a lease is a true lease or creates a security interest must be made on the facts of each case.

The multitude of factors to be considered has been moved from former section 1-201(37), now section 1-201(b)(35), to section 1-203. The Official Comments to section 1-203 are extensive and helpful, but difficulties remain. Because of the uncertainties, under new section 9-505, a “lessor” is permitted to file a financing statement and doing so is not of itself to be a factor in determining whether the property secures an obligation.

It should be noted that a lessor under a true lease may create an Article 9 security interest. To the extent that a lessor who does so is relying on the security interest it creates the lessor must satisfy the requirements of Article 9 regarding enforceability, perfection and enforcement. As noted above, the fact that a lessor has filed a financing statement does not of itself render a true lease a lease intended as security. On the other hand, if a lessor files a financing statement and the transaction is determined to be for security then the lessor will have perfected any security interest attaching to the property.

Originally, former section 1-201(37), now section 1-201(b)(35), also sought to distinguish a true consignment from a consignment intended for security. Once again, making the distinction was no mean undertaking. Section 1-201(b)(35) and new section 9-109(a)(4) state unequivocally that consignments are covered by Article 9. However, all is not what first appears and it is necessary to study the definition of “consignment” found in new section 9-102(a)(20) to even begin to understand what is intended where that term is used. What the definition appears to encompass are bailments to merchants to whom goods are delivered for the purpose of sale. See Official Comment 14 to new 9-102.

If a transaction satisfies the definition contained in new section 9-102(a)(20), then special rules found in various sections of Article 9 apply. See, e.g., new sections 9-319, 9-505 and 9-601. However, not all “true consignments” are covered. See new 9-102(a)(20)(B) and (C) and Official Comment 14 to new 9-102. And, a so-called “sale or return” as defined in Article 2, section 2-326, is not a consignment for purposes of Article 9 because the buyer becomes the owner of the goods and the seller may obtain an enforceable security interest in the goods only by satisfying the requirements of new section 9-203.

Of perhaps greatest importance, under new section 9-102(a)(20)(D), consignments intended for security are not consignments within the Article 9 scheme and the ostensible consignor must satisfy all the requirements of Article 9 applicable to security interests generally. Consequently, once again there is a need to distinguish true consignments from consignments intended as security as an initial matter and doing so may be less than easy.

For reasons associated with commercial practice former Article 9 covered sales of certain intangibles. New Article 9 does also. See new 9-109(a)(3). New section 9-109(a)(3) expands upon former Article 9 by including within its scope sales of payment intangibles, and promissory notes. By virtue of the expanded definition of “account,” new Article 9 also covers sales of (and other security interests in) “health-care-insurance receivables.” How these additional types of collateral are defined is discussed in Chapter 5 (Classification of Collateral).

As noted in Official Comment 4 to new section 9-109, although Article 9 occasionally distinguishes outright sales of accounts and other such collateral from sales that secure an obligation, how a particular transaction is to be classified is left to the courts. However, Official Comment 4 notes further that bringing sales of receivables within the scope of Article 9 “generally has been successful in avoiding difficult problems of distinguishing between transactions in which a receivable secures an obligation and those in which the receivable has been sold outright. Sales and assignments for security of accounts and other receivables are treated further in Chapter 37 (Foreclosure as to Intangibles).

Article 9 also covers security interests in the proceeds of original collateral, meaning, for the most part, property that replaces original collateral. For example, as to goods held for sale it is expected that the original collateral will be replaced and it makes sense for the security interest to continue in whatever is received when the original collateral is disposed of. Security interests in proceeds are treated at length in Chapters 9 (The Specifics of Enforceability -- After-Acquired Property, Proceeds and Future Advances), 16 (Perfecting Security Interests in Proceeds and Other Later Acquired Property) and 24 (Changes in the Use or in the Location of the Collateral or of the Debtor; Security Interests in Proceeds).

As noted in Chapter 3 (The Nature of Secured Credit under Article 9), Article 9 generally governs only consensual liens on personal property, i.e., security interests in personal property created by agreement. The creation of most other types of liens is largely outside the scope of Article 9. In particular, judicial liens -- liens obtained by litigation -- are governed by the law outside Article 9. Thus, as we saw in Problem 3.4 in Chapter 3, an attempt by John to obtain a lien by litigation on the basketball hoop is a matter outside the scope of Article 9.

Liens also can arise by law, especially by statute. Among the more common such liens are an artisan's lien, a garage lien and a landlord lien. See B & S (cited in Chapter 3), Chs. 24 and 25. How most statutory liens arise and are perfected and enforced are matters outside the scope of Article 9. See new 9-109(d)(2). New Article 9 makes a significant change here by bringing agricultural liens, as defined in new section 9-102(a)(5), within the coverage of Article 9. See new 9-109(a)(2).

Former Article 9 governed conflicts between holders of judicial liens and certain statutory liens and Article 9 secured parties. The same is true under new Article 9. See new 9-317(a), new 9-109(d)(2), new 9-333 and Chapters 26 (Secured Party Versus Lien Creditor) and 31 (Secured Party Versus Statutory Liens Including Federal Tax Liens and Agricultural Liens).

As was true under former Article 9, new Article 9, section 9-109(d)(1) excludes rights of set-off from its coverage and although a right of set-off held by a bank has sometimes been referred to as a “banker’s lien” the right of a bank to set off a debt against its debtor’s bank account is not really a lien at all because once monies are deposited in a bank account the monies no longer belong to the debtor and a debtor-creditor relationship between the bank as the debtor and the depositor as the creditor is created. See, e.g., In re Quisenberry, 295 B.R. 855 (Bkcy N.D. Tex. 2003).

New Article 9 adds a provision, section 9-340, that generally gives priority to a bank’s right of set-off as against a secured party with a conflicting claim to the bank account. In so doing, new Article 9 has resolved in favor of the set-off party a question that had split courts under former Article 9. See B & S (cited in Chapter 3), 26.04(C) and Official Comment 2 to new 9-340.

It is worth noting that a person who has a lien or right of set-off arising by statute (or even as a matter of common law) is not precluded from creating an Article 9 security interest in the property subject to the lien and, as will be discussed further in Part VI, whether a creditor is relying on a lien or a right of set-off or on a consensual security interest may affect the outcome of priority disputes regarding the property involved.

However, as explained in Chapter 8 (The Specifics of Enforceability – A Security Agreement Authenticated by the Debtor or Its Equivalent), there must be an enforceable security agreement giving the holder of the lien or right of set-off a security interest in the property subject to the lien or right of set-off and an agreement between a bank and its customer creating (or acknowledging) a right of set-off does not satisfy this requirement. See In re Quisenberry, supra.

Former Article 9 expressly excluded certain consensual liens that otherwise would be covered because they satisfy the definition of a security interest and arose by agreement. These exclusions tended to reflect historical commercial practice or the existence of specialized and separate legal regimes. New Article 9 narrows some of the more noteworthy exclusions.

Thus, security interests in insurance claims and deposit accounts were covered by former Article 9 only as proceeds. New Article 9 covers security interests in such collateral as proceeds but extends coverage to original interests in health-care-insurance receivables and, other than in consumer transactions, deposit accounts. See new 9-109(d)(8) and 9-109(d)(13).

Former Article 9 contained a broad exclusion of interests in tort claims as original collateral. New Article 9 covers security interests in "commercial tort claims" as original collateral as well as proceeds while interests in other tort claims are covered only as proceeds. See new 9-109(d)(12). Note that if a tort claim has been settled and reduced to a contractual obligation it ceases to be a claim arising in tort and becomes a payment intangible.

Consequently, an interest in a settlement of a claim for other than a commercial claim as original collateral would be within the scope of new Article 9. See Official Comment 15 to new 9-109. On the other hand, an interest in a judgment based upon a tort claim would be excluded from Article 9 coverage by new section 9-109(d)(9) unless the tort was a commercial tort. See Official Comment 12 to new 9-109.

Former Article 9 also excluded all security interests created by governmental debtors. New Article 9 has eliminated that exclusion, but some states have adopted non-uniform versions of Article 9 (or have laws outside of Article 9) that reinstate the exclusion. For example, Arizona has added to new section 9-109(d) a subsection that reads “[This article does not apply to: 14. A transfer, pledge, assignment, grant or similar action by this state, another state or a governmental unit of this state or another state.” See also, MP Star Financial, Inc. v. Cleveland State University, 2004 WL 1615067 (Ohio App. July 20, 2004) (Applying an Ohio version of new section 9-109(d) that excludes from the scope of Article 9 a transfer by a government, state or governmental unit).

As is explored further in Chapter 19 (Perfection Pursuant to Federal Law), transactions that otherwise would be covered by Article 9 may be outside the scope of the article because Article 9’s application has been preempted by federal law. See, e.g., Surgicore, Inc. v. Principal Life Insurance Co., 48 UCC. Rep. Serv. 2d 736 (N.D. Ill. 2002) (Not reported in F. Supp. 2d).

More generally, in the aggregate, the various changes to new Article 9 may be understood to manifest a purpose towards inclusion rather than exclusion. Consequently, in general, it would seem to be a safe assume that unless new Article 9 (or some law outside of Article 9) expressly so provides otherwise the creation of a consensual interest in any and all tangible or intangible personal to secure a debt is covered by new Article 9.

The expanded scope of Article 9 likely will be felt most as to various contract rights and general intangibles, including software licenses. Thus, as stated in Official Comment 4 to new section 9-408, new sections 9-408(a) and 9-408(c) render ineffective restrictions on assignments . . . “to the extent” that the assignments restrict the “creation, attachment, or perfection of a security interest,” including sales of payment intangibles and promissory notes.

As a further illustration, there was some uncertainty under former Article 9 as to whether an interest in a limited liability company to secure a debt was subject to Article 9. It should now be clear that this and related ownership interests may serve as collateral.

It must be emphasized that expanding the range of personal property an interest in which will be the subject of Article 9 does not alter such basic requirements as that, subject to specific qualifications, the interest must be given to secure a debt. See new section 9-109(a)(1), as discussed above. Moreover, certain realities that do not relate directly to question of the extent to which particular property may serve as collateral may impact the value of that property as collateral. Thus, as discussed in Chapter 10 (The Need for Value and Debtor’s Rights in Collateral), a debtor may create a security interest in property only if the debtor has rights in that property sufficient to enable the debtor to create a security interest. See new section 9-203(b)(2) and Official Comment 3 to new 9-408.

Further, as will be explained more fully in Chapter 25 (The How and Why of Priority), although restrictions on alienability, such as so-called “negative pledge covenants,” i.e., promises by a debtor not to create a subsequent security interest in favor of some other party, do not prevent a transfer from taking effect, the breach of such promises may result in a default. See new section 9-401(b) and Official Comment 5 to new 9-401.

And, in a more complicated fashion, as discussed further in Chapter 37 (Foreclosure as to Intangibles), although limitations on assignments may not be effective to prevent a security interest from being created, there may be difficulties in enforcing the security interest. See new section 9-408(d) and Official Comment 8 to new 9-408.

It should be noted that the foregoing discussion of the expanded scope of new Article 9 assumes that the subject of a transaction is property. According to Official Comment 3 to new section 9-408, what constitutes property to which an Article 9 security interest may attach is a matter that ultimately is determined by law outside Article 9.

As noted above, and as is discussed more fully in Chapter 25 (The How and Why of Priority), the intent of the drafters of new Article 9 clearly was to expand the scope of coverage of new Article 9 and, therefore, a court should use caution in concluding that something is not property for purposes of Article 9, but there may be situations in which law outside Article 9 leaves the court little choice but to do so. See, e.g., In re Chris-Don, Inc., 367 F. Supp. 2d 696 (D. N.J. 2005).

You may test your grasp of the basics of the coverage of former and new Article 9 in the next two problems.

Problem 4.1 (interactive)

Which of the following transactions are within the scope of new Article 9?

(a) A sale of a television on credit under a contract providing that the seller has an interest in the television to secure its price.

(b) An arrangement under which a retailer of widgets on credit sells to a bank the contracts arising from the sale of widgets.

(d) A lien arising by statute on crops grown by a debtor who plants and harvests the crops.

(e) An interest to secure a loan in trees the lender and borrower understand will be cut and sold.

(f) An interest in an individual's bank account to secure a loan debt incurred for personal, family or household purposes.

Problem 4.2 (interactive)

There are less common but no less important transactions that also pose the question of whether they are covered by Article 9. Which of the following transactions are within the scope of new Article 9?

(a) An interest in an individual’s ownership interest in a limited liability company to secure a loan.

(b) An interest in equipment created by a governmental debtor to secure a loan.

(c) An assignment of a cause of action for breach of contract that by its terms will be effective only if the assignor fails to pay a debt in connection with which the assignment was made.

(d) An assignment of an interest in a commercial tort claim.

CASE COMMENTARY

Condrey v. SunTrust Bank of Georgia, 431 F.3d 191 (5th Cir. 2005)

The Epicentre Strategic Corporation-Michigan v. Perrysburg Exempted Village School District, __ F.3d __, 2005 WL 3060104 (N.D. Ohio 2005)

ACG Credit Co., LLC v. Gill, 876 A.2d 188 (N.H. 2005)

Wells Fargo Bank Minnesota, National Association v. B.C.B.U, 143 Cal. App. 4th 493 (Cal. App. 2006)

IIG Capital, LLC v. Archipelago, L.L.C., 829 N.Y.S. 2d 10 (N.Y. App. Div. 2007)

Coffey v. Singer Asset Finance Co., L.L.C., 2007 WL 258962 (Tex. App. 2007)

Vars v. Citrin, 470 F.3d 413 (1st Cir. 2006)

Stockman Bank of Montana v. AGSCO, Inc., 727 N.W.2d 742 (N.D. 2007)

In re Borden, 361 B.R. 489 (B.A.P. 8th Cir. 2007)

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

2009-02-01 update