Priority vs. Buyer: Rules Assignment 36 Priority: Buyers vs. Secured Creditors Reference: Understanding Secured Transactions 11.01, 11.02, 11.03 9-201(a): SI enforceable unless Art. 9 says otherwise 9-315(a)(1): SI enforceable against buyer unless secured party authorized sale free and clear 9-317(b): buyer w/out knowledge of SI takes free of SI if it is unperfected 9-317(e): PMSI perfected by filing w/in 20-day grace period has priority over grace-period buyer 9-320(a): buyer in ordinary course takes free of SI created by its seller 9-320(b): buyer in consumer-to-consumer sale takes free of SI unless secured party filed UCC-1 9-323(b): buyer vs. secured party (future advances) Buyer v. Secured Party: General Rule Baseline priority rule: security interest is effective against purchasers of the collateral (which includes buyers, 1-201(b)(29), (30)), unless another section of Article 9 provides otherwise [ 9-201(a)] Derivative title: absent some basis for estoppel, buyer takes subject to prior-in-time interests Bank has a perfected SI in the inventory of Sound City, Inc. Security agreement: Sound City can make no sales on credit; only for cash Sound City sells a sound system on credit to Fried Fried was unaware of restriction vs. credit sales If Sound City defaults to Bank, Can Bank repossess sound system from Fried? Problem 36.6(a) 1
Problem 36.6(a): Can UCB Repossess the Sound System from Fried? A. No, b/c Fried took free of Bank s SI as a buyer in ordinary course of business [ 9-320(a)] B. Yes, b/c sale to Fried violated the Bank s security agreement C. Yes, b/c Fried is not a buyer in ordinary course of business No, b/c Fried took free o... 0% 0% 0% Yes, b/c sale to Fried vio... Yes, b/c Fried is not a b... Buyers of Inventory Buyers of inventory typically are protected by one (or both) of two statutory estoppel rules (1) Buyer of a good (other than farm products) in ordinary course of business takes free of SI created by its seller [ 9-320(a)] (2) Buyer takes free of SI if the secured party authorized the disposition free of the SI [ 9-315(a)(1)] (inventory security agreements typically so authorize) 1-201(b)(9). Buyer in the ordinary course means a person that buys goods in good faith, without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person, other than a pawnbroker, in the business of selling goods of that kind. A person buys goods in the ordinary course if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the seller s own usual or customary practices. A buyer in ordinary course of business may buy for cash, by exchange of other property, or on secured or unsecured credit. Problem 36.6(a) Fried is protected as a buyer in the ordinary course (BOCB) [ 9-320(a), 1-201(b)(9)] Sound City is person in the business of selling goods of that kind The sale in fact may have violated Sound City s security agreement, but Fried didn t know that Credit sales of sound equipment are common in modern retailing (e.g., consistent with usual and customary practice among such retailers) 2
Bank has a perfected SI in inventory of Sound City Sound City installs a $14,000 home stereo system into home of its lawyer, Paulos Paulos agreed to take the sound system in partial payment of his past-due legal services bill Problem 36.6(b) Problem 36.6(b): Can UCB Repossess the Sound System from Paulos? A. No, b/c Paulos took the sound system free of Bank s SI as a buyer in ordinary course of business B. Yes, b/c Paulos is not a buyer in ordinary course of business No, b/c Paulos took the... 0% Yes, b/c Paulos is not a... 0% Problem 36.6(b) Paulos not a BOCB protected by 9-320(a) Buyer is not a BOCB if Buyer acquire goods in total or partial satisfaction of a money debt [ 1-201(9)]. Rationale? This isn t a customary transaction, b/c it doesn t produce any proceeds to which the inventory lender s SI would attach Buyer in Paulos position should be suspicious and should investigate Seller s authority further Problem 36.6(b) Can Paulos qualify for protection under 9-315(a)(1)? No specific authorization of the sale (Bank didn t know about this sale) No general authorization (security agreement only authorized ordinary course sales) Note: if Bank knew Sound City had made similar sales before, and hadn t objected, Bank may be deemed to have authorized such transactions [p. 607] 3
Davis Dept. Store sold stereo to Beavis (for home use), takes PMSI, files UCC-1 Beavis later sells stereo to Butthead at a garage sale Butthead unaware of Davis SI Beavis defaults to Davis, which tries to repossess stereo from Butthead Problem 36.5 Problem 36.5: Can Davis Repossess the Stereo from Butthead? A. Yes, under the derivative title principle B. No, b/c Butthead is a buyer in ordinary course of business C. No, b/c Butthead is a garage sale buyer protected by 9-320(b) Yes, under the derivative... 0% 0% 0% No, b/c Butthead is a buy.. No, b/c Butthead is a ga... Garage Sale Exception [ 9-320(b)] In a sale transaction, buyer of a good takes it free of a SI created by seller if: The good is a consumer good in seller s hands The buyer pays value, without knowledge of SI The good will also be a consumer good in the hands of the buyer, and Secured party has not perfected its SI, either by filing or by taking possession [ 9-320(e)] Problem 36.5 Davis may repossess from Butthead Davis s PMSI is automatically perfected [ 9-309(1)], but Davis also filed a UCC-1, so Butthead doesn t qualify for protection under 9-320(b) Had Davis not filed, Butthead would have prevailed due to lack of knowledge [ 9-320(b)] Butthead should have searched UCC-1 filings before completing purchase 4
Card buys a used RV from Sunrise RV (paying $23,000 in cash) This RV was sold to Eddy 1 year ago by All Seasons RV, which took a SI in the RV 3 months ago, Eddy traded it in to Sunrise RV (without knowledge/consent of All Seasons RV) Eddy still owes All Seasons RV $17,000 Problem 36.1 Problem 36.1: Did Card Get a Clear Title to the RV? A. Yes, b/c Card was a buyer in the ordinary course of business B. No, b/c Card was not a buyer in the ordinary course of business C. No; if All Seasons SI was perfected, Card takes the RV subject to that SI Yes, b/c Card was a buyer... 33% 33% 33% No, b/c Card was not a b... No; if All Seasons SI was... Card is a BOCB, but a BOCB only takes free of a SI created by its own seller [ 9-320(a)] As a BOCB from Sunrise RV, Card took the RV free of any SI created by Sunrise RV (its own seller) But All Seasons SI was created by Eddy, not by Sunrise RV! Thus, Card took the used RV subject to that SI (assuming it was properly perfected) [ 9-201(a), 9-317(b)] Buyer v. Unperfected SI 9-317(b): Unless Article 9 provides otherwise, buyer of goods takes free of a SI in the goods if buyer gives value and takes possession of goods: Without knowledge of the SI, and Before SI is perfected Estoppel warranted vs. unperfected secured party (buyer relied on seller s ostensible ownership) If All Seasons RV s SI had been unperfected, Card would ve taken RV free of that SI 5
Problem 36.1: Rationale BOCB rule assumes that merchant s inventory lender has impliedly authorized the merchant to sell free and clear of that lender s SI Sensible to say that Sunrise s inventory lender could authorize Sunrise to sell free and clear of its lien But Sunrise s inventory lender can t authorize it to sell free and clear of another creditor s lien! What should buyer of used goods do? Used Goods: Due Diligence? To protect against this risk when buying used goods, buyer such as Card must Reconstruct the chain of title to identify all prior owner(s) of the goods Investigate to determine whether a prior owner of the goods granted a SI that has not yet been satisfied or released (i.e., UCC/title searches vs. prior owners/inquiry of prior secured parties) Buyer Hypo Fred pays $15,000 for an engagement ring from George s Jewelry Fred asks George s to hold the ring for two weeks until Fred can arrange to insure it Two days later, George s Jewelry defaults to Bank, which has perfected SI in all of George s inventory Does Bank still have a valid SI in that ring? Daniel v. Bank of Hayward [p. 600] M/M Daniel agreed w/chrysler dealer to buy a not-yet-manufactured van, made down payment Bank financed Dealer s inventory Dealer was in breach (selling cars out of trust ) Bank seized possession of dealership and vehicles, right after the dealer had taken delivery of the van that M/M Daniels had agreed to buy Court held (under prior Article 9): Daniels were BOCBs, took van free of Hayward Bank s SI 6
Revised Article 9: Only a buyer that takes possession of the goods or has a right to recover the goods from the seller under Article 2 may be a buyer in ordinary course of business. [ 1-201(9)] Under this standard, can Fred be a BOCB who took free of Bank s SI in the ring? He didn t take possession of the ring But, is the ring identified to the contract of sale to Fred? [ 2-501(1), 2-502(1)] If so, title to the ring passed to Fred, even though George s still had possession of the ring Thus, Fred may still be a BOCB If Fred is a BOCB, is there any problem with his leaving the ring in the possession of George s Jewelry? Fred has created an entrustment (bailment) by leaving George s in possession of the ring This could mislead 3d parties dealing with George s (is the ring part of the store s inventory?) Problem Entrustment Problem Problem: By leaving the ring w/george s, Fred entrusted the ring to a merchant in such goods Entrustment includes a bailment, regardless of any condition expressed by the entruster Entrustment to a merchant gives the merchant the power to convey the entruster s title to a good faith purchaser for value! [ 2-403(2), 2-403(3)] This rule would protect a buyer who bought the ring from George s w/out knowledge of Fred s rights Buyers of Collateral that Secures Future Advances For a line of credit arrangement, the collateral secures not only amounts already borrowed and not yet paid, but also future advances Suppose Buyer buys a machine from Debtor w/out consent of Bank (which has SI in the machine, securing Debtor s line of credit from Bank) At time of sale, balance to Bank = $50,000 10 days later, balance to Bank = $70,000 Which amount should Debtor have to pay Bank in order to redeem the collateral (and get clear title)? 7
9-323(d) [Buyer of goods.] Except as otherwise provided in subsection (e), a buyer of goods other than a buyer in ordinary course of business takes free of a security interest to the extent that it secures advances made after the earlier of: (1) the time the secured party acquires knowledge of the buyer s purchase; or (2) 45 days after the purchase. 9-323(e) [Advances made pursuant to commitment; priority of buyer of goods.] Subsection (d) does not apply if the advance is made pursuant to a commitment entered into without knowledge of the buyer s purchase and before the expiration of the 45-day period. Buyer took machine subject to SI, to extent of $50,000 owed to Bank on date he bought the machine [ 9-201(a), 9-315(a)(1)] B/c machine also secured future advances, it also secures repayment of advances made to Debtor (a) w/out knowledge of sale to Buyer and (b) w/in 45 days after that sale [ 9-323(d)] Thus, answer depends on whether Bank knew of sale of machine to Buyer Scenario 1: Bank knew of sale to Buyer at time of $20,000 future advance, Buyer takes machine free of SI to the extent of those future advances Thus, redemption amount would be only $50,000 This makes sense: once Bank knows of the sale, it can act to freeze credit line, repossess collateral It should not be able to get priority for future advances thereafter unless it had previously committed to make them [ 9-323(e)] Scenario 2: Bank did not know; Buyer takes subject to SI to extent of those future advances Advances are within 45-day window in 9-323(d) Redemption amount = $70,000 8