Class 12 Secured Transactions Spring 2021 Priority Purchase

Class 12 Secured Transactions Spring 2021 Priority: Purchase Money SIs Randal C. Picker James Parker Hall Distinguished Service Professor of Law The Law School The University of Chicago Copyright © 2001 -21 Randal C. Picker. All Rights Reserved.

Subsequent SIs? Corp 2/1: $10 K 1/1: $10 K USC 3/1 SA: EQ FS: EQ USC 8/1: EQ worth $10 K: Who gets it? Bank December 16, 2021 2

Answer n Answer u. Under Article 9, secured creditor takes ahead of unsecured creditor n Other Law? u. Bankruptcy preferences (but 8/1, so not here) u. Fraudulent Transfer? December 16, 2021 3

Knowledge and Textured-Priority Rules Debtor 2/1: $100 SA, FS: EQ With K 3/1: $100 SA, FS: EQ No K Finco December 16, 2021 1/1: $100 SA: EQ Bad FS: EQ Creditco TTYN Bank Who has priority? Should actual knowledge matter? 4

Knowledge and Textured-Priority Rules n With Knowledge Rule, Circular Priority Possible u. B > F: Knowledge u. F > C: First to make good filing u. C > B: No knowledge, Bank as unperfected December 16, 2021 5

Knowledge and Textured-Priority Rules n n Article 9 generally rejects use of knowledge to avoid situations like this Meaning u. Bank should be unperfected u. Finco has priority over Creditor who has priority over Bank December 16, 2021 6

TTYN 4 -16: Negative Pledges Corp 1/1 $10, 000 USC Creditco December 16, 2021 2/1: $20, 000 w/negative pledge Finco 3/1: SA: All Assets FS: Same $30, 000 “Corp promises that it will not grant a security interest in any of its assets” Bank 3/1: $40, 000 in assets: Who has priority? 7

NP: Try This Separate property rights from purely contractual rights n Step 1: Distribute $30, 000 to Bank on its security interest n December 16, 2021 8

NP: Try This n Step 2: Distribute remaining $10, 000 pro rata to Credito and Finco as unsecured creditors ($3, 333/$6, 667) December 16, 2021 9

NP: Try This n Step 3: Treat the negative pledge as a contractual right of parity between Finco and Bank, so reallocate their funds ($36, 667) pro rata ($14, 667 to Finco and $22, 000 to Bank) December 16, 2021 10

Mudge Redding 7/31/81 Financed Sale Mudges December 16, 2021 9/81: $100 K Bank SA: INV, EQ ? FS? How does the Bank do? Negative Pledge 3(f). It is agreed that the assets of M & M Welding, & Stock Inc. , a Wyoming corporation, or its successor Escrow corporation shall not be mortgaged for more than the presently existing indebtedness without Sellers[’] consent until the total purchase price herein agreed to be paid shall have been paid in full. Such consent shall not be unreasonably withheld. 11

Tortious Interference with Contracts n Restatement (Second) of Torts, Sec. 766 u“One who intentionally and improperly interferes with the performance of a contract (except a contract to marry) between another and a third person by inducing or otherwise causing the third person not to perform the contract, is subject to liability to the other for the pecuniary loss resulting to the other from the failure of the third person to perform the contract. ” 12

9 -401: Alienability of Debtor’s Rights n (a) [Other law governs alienability; exceptions. ] u. Except as otherwise provided in subsection (b) and Sections 9‑ 406, 9‑ 407, 9‑ 408, and 9‑ 409, whether a debtor’s rights in collateral may be voluntarily or involuntarily transferred is governed by law other than this article. December 16, 2021 13

9 -401 (Cont. ) n (b) [Agreement does not prevent transfer. ] u. An agreement between the debtor and secured party which prohibits a transfer of the debtor’s rights in collateral or makes the transfer a default does not prevent the transfer from taking effect. December 16, 2021 14

Comment 5 to 9 -401 n 5. Negative Pledge Covenant. u. Subsection (b) is an exception to the general rule in subsection (a). It makes clear that in secured transactions under this Article the debtor has rights in collateral (whether legal title or equitable) which it can transfer and which its creditors can reach. It is best explained with an example. December 16, 2021 15

Comment 5 to 9 -401 n Example 2 u. A debtor, D, grants to SP a security interest to secure a debt in excess of the value of the collateral. D agrees with SP that it will not create a subsequent security interest in the collateral and that any security interest purportedly granted in violation of the agreement will be void. Subsequently, in violation of its agreement with SP, D purports to grant a security interest in the same collateral to another secured party. 16

Comment 5 to 9 -401 u. Subsection (b) validates D’s creation of the subsequent (prohibited) security interest, which might even achieve priority over the earlier security interest. See Comment 7. However, unlike some other provisions of this Part, such as Section 9‑ 406, subsection (b) does not provide that the agreement restricting assignment itself is “ineffective. ” Consequently, the debtor’s breach may create a default. 17

Fraudulent Transfers Debtor $100 K Creditor Insolvent debtor gives assets to Sister December 16, 2021 What should the creditor do? 18

Fraudulent Conveyance Law n Protects creditors from these types of transfers u. Creditor can follow assets into the hands of sister here u. This can arise in bankruptcy under BC 548 and outside of bankruptcy under various state laws December 16, 2021 19

Preferences Corp USC 2 $100 debt Corp has only $50 and pays all of it to USC 1. What should we do? USC 1 December 16, 2021 20

Preference Law n Outside of Bankruptcy u. Some n state laws address this, but not generally Inside of Bankruptcy u. BC 547 deals with this in elaborate fashion u. If the terms of that are met, the payment will be undone—avoided—and returned for pro rata distribution December 16, 2021 21

SI Grants to Preexisting Creditors Corp USC 2 $100 debt USC 1 December 16, 2021 22

SI Grants to Preexisting Creditors Corp USC SP 3/1: FS, SA: Collateral $100 debt USC 1 December 16, 2021 $100 debt 3/1 Who has priority? Is the 3/1 transaction a fraudulent transfer? Suppose Corp files for bankruptcy on 4/1? 8/1? 23

SI Grant to Preexisting Creditors n Not a Constructive Fraudulent Transfer under BC 548 u. Value definition under 548(d)(2)(A) covers this But a preference if within 90 day pre bankruptcy window n Actual fraudulent transfer? n December 16, 2021 24

The Mona Lisa Again Corp SP 1/1: FS, SA: Mona Lisa Louve December 16, 2021 Debtor has no rights as to Mona Lisa; what does SP get? 25

Answer n Answer u. Debtor has no rights in the collateral? u. SP gets nothing December 16, 2021 26

Grede (CA 7 2016) n Which, alone or together, of these are Grede? December 16, 2021 27

F 9 -107 n A security interest is a “purchase money security interest” to the extent that it is u(a) taken or retained by the seller of the collateral to secure all or part of its price; or u(b) taken by a person who by making advances or incurring an obligation gives value to enable the debtor to acquire rights in or the use of collateral if such value is in fact so used. 28

9 -103(a) n (a) [Definitions. ] In this section: u(1) “purchase-money collateral” means goods or software that secures a purchase-money obligation incurred with respect to that collateral; and 29

9 -103(a) u(2) “purchase-money obligation” means an obligation of an obligor incurred as all or part of the price of the collateral or for value given to enable the debtor to acquire rights in or the use of the collateral if the value is in fact so used. 30

9 -103(b) n (b) [Purchase-money security interest in goods. ] u. A security interest in goods is a purchase-money security interest: w (1) to the extent that the goods are purchasemoney collateral with respect to that security interest; 31

9 -103(b) w (2) if the security interest is in inventory that is or was purchase-money collateral, also to the extent that the security interest secures a purchase-money obligation incurred with respect to other inventory in which the secured party holds or held a purchase-money security interest; and 32

TTYN (1 of 2) 4 -23: Cross Collateralization: Equipment 3/3 $10 K Eq 3/3 $10 K Debt 4/1 $10 K Eq 4/1 $10 K Debt “Debtor hereby grants a security interest in equipment, now owned or hereafter acquired, to secure all obligations, now owed or subsequently owed, of Debtor to Supplier. ” 33

TTYN (2 of 2) 4 -23: Cross Collateralization: Inventory 3/3 $10 K Inv 3/3 $10 K Debt 4/1 $10 K Inv 4/1 $10 K Debt “Debtor hereby grants a security interest in inventory, now owned or hereafter acquired, to secure all obligations, now owed or subsequently owed, of Debtor to Supplier. ” 34

4 -23: Cross Collateralization: Equipment Std PMSI Status 3/3 $10 K Eq 3/3 $10 K Debt Ordinary SI Status 4/1 $10 K Eq 4/1 $10 K Debt Std PMSI Status “Debtor hereby grants a security interest in equipment, now owned or hereafter acquired, to secure all obligations, now owed or subsequently owed, of Debtor to Supplier. ” 35

4 -23: Cross Collateralization: Inventory Std PMSI Status 3/3 $10 K Inv 3/3 $10 K Debt Special PMSI Status: 9 -103(b)(2) 4/1 $10 K Inv 4/1 $10 K Debt Std PMSI Status “Debtor hereby grants a security interest in inventory, now owned or hereafter acquired, to secure all obligations, now owed or subsequently owed, of Debtor to Supplier. ” 36

MBank Alamo Howe < 1/10/83 SA: AR, INV FS: AR, INV MBank < 1/10/83 SA: AR FS: AR Sale AR Customer Dupont Does Raytheon have priority in AR? > 1/10/83 Assignment of AR FS: AR Raytheon 37

Understanding the Deal n Raytheon Claims PMSI in AR u. Howe sells x-ray machine on credit to customer creating AR 38

Understanding the Deal u. Raytheon says its extension of credit enable Howe to acquire AR: w “Raytheon, by agreeing to extend credit on its equipment, enabled Howe X-Ray to enter into subsequent contracts of sale with its customers, thereby acquiring rights in the contract accounts which, upon the specific advance and delivery of equipment, blossomed into a right to the collateral accounts receivable. ” 39

Understanding the Deal Why didn’t Raytheon claim PMSI priority in inventory in Howe’s hands? n Answer n u. Failed to give the notice required under 9 -324(b) 40

Understanding the Deal Suppose Raytheon had given the notice: What result? n Answer n u. Note that priority in inventory does not extend to priority in the AR as proceeds of the inventory (9324(b)) u. Need to track the progress of the collateral and possible changes in priority 41

Understanding the Deal n Couldn’t Raytheon have just sought subordinations from MBank and Du. Pont? 42

Alt Deal: Howe As Agent Howe Arranges Sale M Bank Makes Howe Agent Dupont Pay Commission Guarantees AR Customer Raytheon Financed Sale AR 43

PMSIs and Consumers Debtor 2/1 Sale $, int pmt, pmt atty fees 2/6 FS: Collateral Seller 1/1: $ SA, FS: Collateral Bank What is Seller’s status as to the purchase price? The interest obligation? The contingent debt for attorney’s fees? Does it matter whether this is a consumer-goods transaction (9 -102(a)(24))? 44

PMSI Consumer Definitions n 9 -102(a)(23): “Consumer goods” means ugoods that are used or bought for use primarily for personal, family, or household purposes. December 16, 2021 45

PMSI Consumer Definitions n 9 -102(a)(24): Consumer-goods transaction” means a consumer transaction in which: u(A) an individual incurs an obligation primarily for personal, family, or household purposes; and u(B) a security interest in consumer goods secures the obligation. December 16, 2021 46

Answer n Non-Consumer-Goods Transaction u. New statute is clear that all of these charges are part of the purchase-money obligation under 9 -103(a)(2); see comment 3 n Consumer-Goods Transaction u. Left open under 9 -103(f), (h) 47

PMSIs and Refinancing Debtor 2/1: Sale $ SA, FA: Collateral Bank 1/1: $ SA, FS: Collateral 3: 1 Lends new $ to pay off 2/1 loan Seller What is Seller’s status? 48

9 -103(f) n (f) [No loss of status of purchase-money security interest in non-consumer-goods transaction. ] u. In a transaction other than a consumer-goods transaction, a purchase-money security interest does not lose its status as such, even if: w (1) the purchase-money collateral also secures an obligation that is not a purchase-money obligation; 49

9 -103(f) w (2) collateral that is not purchase-money collateral also secures the purchase-money obligation; or w (3) the purchase-money obligation has been renewed, refinanced, consolidated, or restructured. 50

9 -103(h) n (h) [Non-consumer-goods transactions; no inference. ] u. The limitation of the rules in subsections (e), (f), and (g) to transactions other than consumer-goods transactions is intended to leave to the court the determination of the proper rules in consumergoods transactions. 51

9 -103(h) u. The court may not infer from that limitation the nature of the proper rule in consumer-goods transactions and may continue to apply established approaches. 52

Answer n Non-consumer-goods transaction u. Refinancing doesn’t cause 3/1 loan to lose PMSI status (9 -103(f)(3)) n Consumer-goods transaction u. Answer December 16, 2021 open; see Billings 53

Billings The Billings Financed Sale PMSI Refinancing: Cancel Note & SA Pre –Refinance Debt: $1087. 86 New Note & SA After Refinancing: + $103. 28 $89. 61 for credit life and accident and health insurance Is AVCO’s $4. 00 for a filing fee SI a PMSI? $9. 67 for cash advanced to debtors Factory Outlet Assignment Avco 54

BC 522(f) n (f)(1) Notwithstanding any waiver of exemptions but subject to paragraph (3), the debtor may avoid the fixing of a lien on an interest of the debtor in property to the extent that such lien impairs an exemption to which the debtor would have been entitled under subsection (b) of this section, if such lien is – 55

BC 522(f) u(B) a nonpossessory, nonpurchase-money security interest in any – w (i) household furnishings, household goods, wearing apparel, appliances, books, animals, crops, musical instruments, or jewelry that are held primarily for the personal, family, or household use of the debtor or a dependent of the debtor; 56

BC 522(f) w (ii) implements, professional books, or tools, of the trade of the debtor or the trade of a dependent of the debtor; or w (iii) professionally prescribed health aids for the debtor or a dependent of the debtor. n Household goods defined in BC 522(f)(4) 57

Two Approaches n Transformation Rule u. Refinancing n eliminates PMSI character Dual Status Rule u. Allows PMSI to maintain that character to extent that PMSI debt survives refinancing 58