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Apr 3, 2024
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Assignment 8: Formalities for Attachment
Now, we have seen the general rights of both secured and unsecured creditors under state law
and how they can be affected by the debtor’s bankruptcy, so we look at the steps necessary for a
person to become a secured creditor. Generally, secured creditors are consensual creditors
—the
debtor agreed at one time to give the creditor a security interest in some of the debtor’s property.
Today, we look at how a creditor obtains a security interest in personal property under Article 9.
As the last part of the assignment notes, the law as it relates to real property is usually more
formal—every state has a series of detailed statutory requirements for obtaining an enforceable
mortgage on real property. We won’t spend any time on the real estate issues today.
There is a very, very, very important distinction in the law of personal property security interests
—the difference between a security interest attaching
and a security interest that is perfected
.
What does it mean when we say that a security interest has attached
to some personal property?
It means that the creditor can enforce the security interest against the debtor. If the
security interest has not attached, the creditor cannot enforce the security interest against
the debtor—in other words, the creditor is treated as an unsecured creditor.
What does it mean if the security interest is perfected
?
If it is perfected, it can be enforced, not only against the debtor, but also against third
parties (including other creditors) who might claim an interest in the collateral. The law
of “perfection” of security interests is covered in Part 3 of revised Article 9.
If a security interest is unperfected
, many people can acquire an interest in the collateral that is
superior to the interest of the secured party. We’ll talk about all this later in the semester.
It might be helpful to make an analogy to the law of real estate mortgages, where a similar issue
arises. Generally, a mortgagee has enforceable rights against the mortgagor in the property when
the mortgagor signs a mortgage granting the mortgagee a security interest in the property.
However, to make the mortgage enforceable as against others (purchasers, lienors, other
mortgagors, etc.), the mortgagee must record
the mortgage in the real estate records. That gives
notice
to third parties of the mortgagee’s interest in the property.
Likewise, a secured party has an enforceable security interest against the debtor when the
security interest attaches
under section 9-203, a section we will spend a lot of time with today.
However, just because the security interest attaches does not mean that the security interest is
enforceable with respect to third parties (purchasers, lienors, or other secured parties)—to make
it enforceable with respect to these third parties, the security interest must be perfected
—this is
the subject of later assignments, but right now it usually requires the filing of a document called
a financing statement
in a public office—usually the Secretary of State’s office. This public
filing gives notice
to third parties of the secured party’s interest in the collateral.
What does section 9-203(b) require for a security interest to attach?
1. value [defined in § 1-204] has been given [and everyone understands that this is “value
given by the secured party”]; 2. the debtor has rights in the collateral;
AND
3.a. the debtor has “authenticated” a security agreement that provides a description of the
collateral . . . ; OR
3.b. the collateral is collateral other than certificated securities and is in the possession of the
secured party pursuant to the debtor’s security agreement.
3.c. and d. there are also provisions about types of collateral known as “certificated
securities,” “investment property,” “deposit accounts,” “electronic chattel paper,” and “letter-of-
credit rights”—we will not deal with any Article 9 rules relating to those unusual types of
collateral—and you are not responsible for attachment of security interests with respect to those
unusual classes of property.
Section 9-203(a) says the security agreement is enforceable against the debtor with respect
to the collateral once it attaches and for attachment ALL THREE of those things must
occur.
Let’s think a little about attachment by possession. How common do you think this is?
Not very. Most debtors do not want to defer possession of the collateral until the
obligation secured by the security interest has been satisfied. For example, when you buy
a new car on credit, you want to be able to drive it before you pay it off. And, most
secured parties do not want possession of the collateral. For example, the bank would
rather not rent a secure parking facility to house all the cars it finances—it is happy for
you to use the car (as by going to work to make money to pay off the bank’s loan).
The overwhelming majority of secured creditors have their security interest attach by agreement.
What are the requirements for the “agreement” under section 9-203(b)(3)(A)?
1. Must be “authenticated” by the debtor—this effectively means it must be in a “record,”
which is either a writing or an electronic (digital) agreement.
“Authentication”—§ 9-102(a)(7)
“Record”—§ 9-102(a)(69)
2. It must “provide” a description of the collateral. We’ll talk about what descriptions are
“adequate” in class tomorrow.
This is not a hard requirement to meet, but it is amazing how many secured creditors screw this
up. For purposes of planning, you always require the debtor to sign a standard-form security
agreement and nothing else should be allowed. However, when your clients act without prior
legal advice, they frequently screw up, as did the creditor in the Ace Lumber
case who merely
had the debtor sign a UCC-1 financing statement
, not a security agreement. [Remember the
words of the great English Enlightenment poet, Alexander Pope, “A little learning is a dangerous
thing.”] The material in the text shows that courts have struggled with this requirement and many say a
security agreement can be found by reading a number of documents together, so long as one of
them is signed and so long as another of them contains a description of the collateral. This is
known as the composite document
rule.
So much for the first requirement (possession or writing).
Let’s turn to the second requirement, value having been given. When does a person give “value”
for a security interest?
“Value” is defined in section 1-204 very broadly. Anything that would be consideration
for an ordinary contract is value. So is an antecedent debt (in other words, “past
consideration” is “value”). So is a promise to extend credit or the extension of
immediately available credit. In fact, when an unsecured loan is in default, one of the
ways to work it out is for the debtor to provide some collateral to the lender as security
for the loan, thus converting the unsecured loan into a secured one.
“Value” is always given, although sometimes (as we will see later) the security interest
will attach only at the time that value is given and that may be important.
Let’s turn to the third requirement, the debtor has rights in the property. For our purposes right
now, we need to think about this requirement as a matter of timing
. For reasons we will see later,
most secured parties would prefer to have their security interests attach at the instant the debtor
acquires an interest in property. One way to do this is to have the debtor sign the security
agreement before she becomes the owner of property, so that as soon as she gets the interest in
the property, the secured party’s security interest attaches.
Let’s now turn to our Problem Set for today.
Problem 8.1:
8.1. a. Your client, First State Bank, loaned $150,000 to Coyote Laboratories, Inc. Coyote
fell on hard times and filed bankruptcy. R.K. Maroon, the bank’s president, told you that
the loan was to be secured by certain laboratory equipment, and the only documentation is
this email:
From: Coyote, Wile E., wecoyote@coyotelabs.com
Sent: Thursday, February 12, 2015 4:35 PM
To: R.K. Maroon, President, First State Bank
Subject: Loan Collateral
Thank you for the delightful lunch today. As we discussed, I grant to First State Bank a first security interest in our laboratory equipment to secure the bank’s $150,000 loan.
You filed a secured proof of claim in the bankruptcy case, and attached a printed copy of the email. The bankruptcy trustee objected to your proof of claim, citing “the lack of an authenticated security agreement.” The case is likely to pay ten cents on the dollar to unsecured creditors. Maroon wants to know whether you think it is worth contesting this objection. What do you tell him? U.C.C. §§9-102(a)(7), (a)(70), (a)(74), 9-203(b).
We tell Maroon the Bank should contest this objection. We have a strong case, $135,000 is at
issue, and the procedure is easy – show up at the hearing on our claim and contest the objection.
The email contains language that clearly grants a security interest. The language is in the present
tense and indicates a present intent to to make the grant immediately. Although Coyote didn’t
sign the email, Coyote “authenticated” it under § 9‐102(a)(7). That provision says that in
addition to signing, a record is authenticated if “with present intent to adopt or accept a record, to
attach to or logically associate with the record an electronic sound, symbol, or process.” What’s
the thing that is logically associated? Well, ah . . . We don’t know, but there no doubt it is
something because the drafters intended to authorize email security agreements. Maybe it is
Coyote’s name in the “from” field? In the context of a contract for the sale of goods governed by
Article 2, a court has held an automatically generated signature block authenticates an email.
Princeton Indus. Prods. v. Precision Metals Corp.
, 120 F. Supp. 3d 812 (N.D. Ill. 2015).
b. If instead of sending the email, Coyote had called Maroon and told him exactly the same
thing, would First State have a security interest in the equipment?
We are confident that First State doesn’t have a security interest based on this oral grant. Section
9‐203(b) is a statute of frauds. The entire point of a statute of frauds is to distinguish between
oral and written agreements. (Oops! We aren’t supposed to say “written” anymore.)
c. What if Coyote had been unable to reach Maroon and left a voicemail message saying
exactly the same thing? Does it matter if Maroon deleted the voicemail message
immediately after listening to it?
We think First State has a security interest based on the voicemail message. That voicemail
message is probably on the same disk drive as the email message –how could anyone make a
principled distinction between them? When the bank president deletes the email message, that is
unfortunate from an evidentiary point of view. But what if the security agreement had been a
forty‐page signed and notarized writing and the secured party inadvertently burned it? You can’t
get out of your home mortgage by destroying all the copies. The law has rules for dealing with
this sort of thing. Proponents must furnish the “best evidence” of the written agreement. If that
best evidence is oral testimony, then the oral testimony is admissible. The legal issue is whether a
valid security interest was created, not whether it continued to exist after creation.
Problem 8.2:
You are working as a law clerk for Judge Heather Clifford. Judge Clifford has given you
the exhibits from a recently completed bench trial and asked you “whether they meet the
authenticated security agreement requirement of U.C.C. §9-203(b)(3)(A).” The first is a
promissory note for $50,000 that was signed by the debtor but not by the secured party.
The note recites that it is “secured by collateral described in a security agreement bearing
the same date as this note.” The second is a financing statement that describes the collateral
as “all of the inventory and equipment of [the debtor’s] business.” Although the financing
statement was not signed, it was accompanied by another writing that was signed by the
debtor: an authorization for the secured party to file such financing statements and
amendments as the secured party may deem necessary or expedient to protect its existing
and future rights in collateral. The third is a letter from the debtor’s attorney to the
creditor that states, “Enclosed are the promissory note and financing statement which give
you a security interest in my client’s inventory and equipment.” No other writings were
introduced. What do you tell the judge? Is this a question that can be answered from the
documents alone, or do you need to read the testimony? U.C.C. §9-102(a)(7).
We think it is unclear whether the documents meet the authenticated security agreement
requirement. None of the documents alone meets the requirement, but together they might do so
in a jurisdiction that recognizes the composite document rule and doesn’t require that each
document be signed by the debtor to be considered.
The student needs to read the testimony to resolve uncertainty as to the meaning of the
documents and to determine whether the parties intended a security interest. Students usually
want to cite the composite document rule and jump to a solution without analysis. The trick here
is to get them to see that even though the elements of U.C.C. §9‐203(b) are vague, that is not a
license to ignore them.
We start by asking whether any of the documents, standing alone, might be a sufficient writing.
Does the lawyer’s letter alone create an enforceable security interest? First, the lawyer is not the
debtor but merely represents the debtor. Whether the lawyer’s signature is that of the debtor
depends on the lawyer’s actual and apparent authority, neither of which is clear merely from the
documents. Lawyers ordinarily do not execute security interests on behalf of their clients.
Second, the letter does not purport to be a security agreement; rather, it refers to the other two
documents.
The promissory note, like the letter, does not purport to be a security agreement; rather, it refers
either to the financing statement or to a document that apparently does not exist. The financing
statement has an adequate description of collateral and the debtor signed an authorization to file
it. But, financing statements don’t play very well as security agreements. In addition, the
signature is on the authorization to file the financing statement, not the financing statement itself.
Considered individually, none of these documents would seem to qualify as a security
agreement.
But under the composite document rule, the court can consider all of them together. Aside from
the problem of the lawyer’s authority, the facts given here are very similar to those in In re
Bollinger Corp.
, 614 F.2d 924, 926 (3d Cir. 1980), where the court found that the requirement of
a security agreement signed by the debtor was met. The Bollinger case was decided under the
pre‐1998 U.C.C. where the debtor also signed the financing statement. Here, the signed
authorization to file a financing statement could serve the same evidentiary purpose as a signed
financing statement as both provide an authenticated writing from the debtor.
Problem 8.3:
You recently joined the legal department at First National Bank and work under the direct
supervision of Scott Pryor. To begin your training, Friedman took you to the Kettering
closing. While you are driving back to the bank from the closing, Pryor asks you at
precisely what point in time First National Bank’s security interest attached to the
Fisherman’s Pier restaurant. What do you tell him? See
U.C.C. §§ 1-204, 9-203(b)(3)(A), 2-
501(1).
Let’s think back to the Kettering illustration. There were about six events that occurred there:
1. Kettering signs the note and security agreement;
2. Stella delivers the bill of sale, assignment of lease, and the keys;
3. Friedman delivered the First National check to Valley State Bank;
4. Valley State gives Friedman the termination statement;
5. Friedman delivered the check for the balance of the price to Stella; and
6. Kettering pays the balance of the purchase price to Stella with the cashier’s check.
What are the three requirements under section 9-203(b) for a security agreement to attach?
Written security agreement signed by the debtor and containing a description of the
collateral.
This was met when Kettering signed the written security agreement at
closing. This happened at [1] above.
Value.
Value was given no later than when Friedman delivered the first check at the
closing. [3] above. It may have been earlier if First National made a legally binding
promise to make the loan. Ordinarily, however, banks avoid making such “commitments”
in advance of the actual “closing” (signing and exchanging the documents).
Rights in the collateral.
Kettering certainly had rights in the collateral at the time Parker
delivered the bill of sale to the restaurant property. [2] above. Kettering may have had
rights in the collateral at an earlier time, as soon as he and Parker signed the agreement
for sale. Section 2-501(1) provides that “identification” of the goods occurs when the
contract is formed, with respect to goods that are identified and existing at the time the
contract is made and that such identification gives the buyer an insurable interest in the
goods. However, a security interest attaching at that time would only extend to the
interest he had then—a limited property interest and not title to the property.
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