Problem 1. Pre-filing. Assignment 6 The Composite Documents Rule Cases (Understanding the Relationship/Distinction Between Attachment and Perfection)

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1 Problem 1 Assignment 6 The Composite Documents Rule Cases (Understanding the Relationship/Distinction Between Attachment and Perfection) 2012: You applied to borrow $10K from First Bank First Bank filed UCC-1 covering your wine collection (intended collateral), but you never borrowed money Mar. 2014: You borrowed $25K from Boone Bank You signed security agreement covering wine collection Boone Bank filed UCC-1 covering wine collection Sept. 2014: You borrowed $40K from First Bank to buy a car You signed a security agreement covering the wine collection and the car Who has first priority in the wine collection? Boone Bank s SI was first to attach (First Bank didn t have a SI until Sept. 2014) Boone Bank s SI was first to be perfected (First Bank had already filed its UCC-1, but a SI cannot be perfected until it has attached) [ 9-308(a)] BUT, First Bank s SI has priority, because (a) First Bank now has a SI in the wine collection, and (b) First Bank was first to file a UCC-1 covering the wine collection [ 9-322(a)(1)] Priority between conflicting SIs in same collateral based on first to file or perfect [ 9-322(a)(1)] Problem 1 demonstrates that a secured party can pre-file a UCC-1 financing statement (before a SI attaches) [ 9-502(d)]. Why do this? Convenience: there s no gap between attachment and perfection Priority: stakes out priority vs. other potential secured creditors [ 9-322(a)(1)] Pre-filing 1

2 Signature/Authentication Old Article 9: debtor had to sign a UCC-1 before secured party could file it ( paper system) New Article 9: no signature requirement; secured party can file a UCC-1, but only if debtor has authorized it to do so [ 9-509(a)] Debtor s authentication of security agreement = authorization for secured party to file a UCC-1 that covers the collateral described in the security agreement [ 9-509(b)] 9-509(a) [Person entitled to file record.] A person may file an initial financing statement, amendment that adds collateral covered by a financing statement, or amendment that adds a debtor to a financing statement only if: (1) the debtor authorizes the filing in an authenticated record or pursuant to subsection (b) or (c) (b) [Security agreement as authorization.] By authenticating or becoming bound as debtor by a security agreement, a debtor or new debtor authorizes the filing of an initial financing statement, and an amendment, covering: (1) the collateral described in the security agreement; and (2) property that becomes collateral under Section 9-315(a)(2), whether or not the security agreement expressly covers proceeds. If the secured party is going to pre-file its UCC-1, it should have debtor authorize the UCC-1 filing in an authenticated record [ 9-509(a)(1)] This is so, because UCC-1 is not effective unless authorized [ 9-510(a)] Secured party that files an unauthorized UCC-1 can be held liable for actual damages [ 9-625(b)] and a $500 statutory penalty (even if debtor suffered no actual damages) [ 9-625(e)(3)] If UCC-1 is initially pre-filed w/out authorization, but the debtor later signs a security agreement describing the collateral covered by the UCC-1, the initial pre-filing is thereby ratified Bank is going to make loan to Debtor, secured by SI in all of Debtor s inventory Bank asks Debtor to authorize filing of UCC-1 that describes the collateral as inventory, accounts, chattel paper, and instruments Why would Bank want to describe the collateral in the UCC-1 more broadly than in the security agreement? 2

3 Here, an overbroad filing may be justified Bank knows Debtor will sell some inventory on credit, producing accounts, instruments, and chattel paper in return Bank will have a SI in those proceeds [ 9-315(a)(2)] If UCC-1 covers accounts, instruments, and chattel paper too, Bank can be sure its SI in the proceeds of its collateral will also be perfected But, before Bank can file this overbroad UCC-1, Bank must have the Debtor authorize that UCC-1 to be filed, in a separate authenticated record Problem: Debtor s execution of security agreement would only authorize filing covering inventory [ 9-509(b)] If Bank files it without authorization, then Bank faces penalty for filing unauthorized UCC-1 [ 9-625(e)(3)], and UCC-1 is not effective to extent it is unauthorized (i.e., wouldn t cover anything other than inventory) [ 9-510(a)] Note: Debtor could refuse to authorize filing of overbroad UCC-1 Debtor s concern: filing vs. equipment or accounts could limit Debtor s future ability to obtain credit using those types of property as collateral If Debtor does refuse, Bank must decide whether to (1) go forward with loan with UCC-1 containing narrower description, or (2) refuse to make the loan Laminated Veneers Security agreement description: all chattels, machinery, equipment now at the plant of [Debtor] and all chattels, machinery, fixtures or equipment that may hereafter be brought in or installed on said premises [fn. 1, p. 3] Held: agreement did not attach to two cars owned by the Debtor and located at the plant Court was WRONG. Why? 3

4 Court s Reasoning Equipment isn t precise enough description to cover the two cars [T]he security agreement... is the primary source to which a creditor s or potential creditor s inquiry is directed and must be reasonably specific. [p. 4] Laminated Veneers: The Proper View All equipment is not ambiguous As long as the cars were located/used at the plant and were not held for sale/lease, the cars are reasonably identified by all equipment Financing statement, not the security agreement, is the primary source of a potential creditor s inquiry Remember Problem 1: could Boone Bank have relied on the fact that at the time of its loan, First Bank had not yet taken a SI in the wine collection? NO! Problem 3 Bubba Charles Putnam County Bank 5 Broadway, Putnam, XX Holt Alice 12 Main Street Putnam XX Putnam County Bank 5 Broadway Putnam XX All of the Debtor s restaurant equipment Alice Holt Alice Holt By itself, does this UCC- 1 constitute an effective security agreement? By itself, this signed UCC-1 cannot constitute a valid security agreement It is authenticated by Alice, and it does describe her restaurant equipment sufficiently ( all of the debtor s restaurant equipment ) But the UCC-1 form doesn t state that the form is creating a SI in the equipment, or that Alice has already granted a SI in it by some other document Plus, b/c a UCC-1 can be pre-filed, the fact Bank filed the UCC-1 can t prove Bank and Alice have already entered into a security agreement! 4

5 The Purpose of the UCC-1 The primary purpose of a UCC-1 is to notify 3d parties of the possibility that a secured party has taken a SI in the described collateral, or may take a SI in it in the future Message to 3 rd parties: the debtor may have granted a SI in the collateral already, or may do so in the future, so deal w/debtor at your own risk regarding the described collateral Problem 4 Diamond Furniture owed $258,000 to Atlantic Commercial Finance (ACF), and was in default Parties sign letter agreement [see next slide] ACF files UCC-1 covering all of Diamond Furniture s accounts, inventory, and equipment ACF prepares note, security agreement for signature, but it was never actually signed by Diamond Furniture, who is now bankrupt ACF (Creditor) and Diamond Furniture, Inc. (Debtor) conceptually agree as follows: (1) Debtor acknowledges its debt to Creditor of $258,000. (2) This indebtedness shall be evidenced by an installment note, secured by a lien on all of Diamond Furniture s accounts receivable, inventory, and equipment, now-existing or after-acquired, which shall be evidenced by a standard form security agreement and shall be perfected by the filing of a financing statement to be filed upon the signing of this letter. (3) When signed by Debtor, this letter will form the basis for Creditor to prepare an installment note and security agreement, and to prepare and file a financing statement. (4) Debtor acknowledges that this agreement is in lieu of Creditor s filing suit to obtain a judgment against Debtor. [Signatures] Does ACF have a valid SI in the accounts, inventory, and equipment of Diamond Furniture? Or does ACF s failure to obtain execution of a formal security agreement mean that ACF does not have a valid SI? Problem 4 5

6 Composite Documents Rule Problem 4 is somewhat comparable to Bollinger, in which the court found a security agreement in a set of several different documents: A promissory note (signed by debtor, which recited that the debt was intended to be secured by a formal security agreement) A UCC-1 financing statement (signed by debtor) which included a description of the collateral, and Correspondence from Debtor to lender, which identified the intended collateral [p. 8] The security agreement 9-203(b)(3): there must be an effective security agreement covering the collateral Usually, this agreement is entirely contained within the 4 corners of an integrated document entitled Security Agreement However, the agreement can be evidenced by a combination of writings, supplemented by context of the parties relationship and their course of dealing ( composite documents rule, as in Bollinger) In Problem 4, a court could say that a sufficient security agreement exists: Signed letter agreement acknowledges debt (extension of value) Signed letter agreement indicates intent to grant SI in all accounts, inventory, equipment Formal Security Agreement document was prepared with that description (but not signed) Debtor authorized filing of UCC-1, and filed UCC-1 described intended collateral Martin Grinding & Machine Works Debtor got SBA loan for $350K from Bank Most of documents (including filed UCC-1) identified collateral as: all of debtor s machinery, equipment, furniture, fixtures, inventory, and accounts Due to clerical error, the Security Agreement used description = all machinery, equipment, furniture, fixtures (i.e., it omitted inventory and accounts) After bankruptcy, Debtor argued that Bank did not have a valid SI in Debtor s inventory or accounts 6

7 Martin Grinding & Machine Works Held: Bank had no SI in Debtor s inventory and accounts Court: Bank can t introduce extrinsic evidence to enlarge the collateral description in what is an otherwise unambiguous security agreement Ostensible rationale: it s good commercial policy to facilitate certainty, and thus to protect reliance interests of subsequent creditors [I]f parol evidence could enlarge an unambiguous security agreement, then a subsequent creditor could not rely upon the face of an unambiguous security agreement to determine whether the property described in the financing statement, but not the security agreement, is subject to a prior security interest.... The examination of additional documents, which the admission of parol evidence would require, would increase the cost of, and inject uncertainty as to the scope of prior security interests into, secured transactions. Therefore, although the rule excluding parol evidence works results contrary to the parties intentions in particular cases, it reduces the cost and uncertainty of secured transactions generally. [p. 12] Is Martin Grinding s reasoning sound? Martin Grinding Court suggests that 3rd parties can rely upon the contents of the Security Agreement in its investigation, even though the collateral description in UCC-1 is broader That s WRONG (as in Laminated Veneers) 3rd parties must act based on the contents of the financing statement, NOT the security agreement (as Problem 1 demonstrates) 7