The ABCs of: Secured Transactions
Here is a collection of 26 important concepts, from A to Z, you need to know about Secured Transactions for the bar exam:
A - Attachment: Unless a question states that the secured party properly attached a security interest in the collateral, attachment is always an issue in the question. This is because no one can have a security interest in collateral unless it has attached to the collateral. Attachment requires three elements: an agreement, value given by the secured party, and the debtor's rights in the collateral.
BONUS: A - After-Acquired Property: A security agreement may provide that the secured party has a security interest not only in the property that the debtor currently owns, but also in property that the debtor will acquire in the future. Exception: An after-acquired property clause is ineffective as to consumer goods other than accessions (i.e., goods that are physically attached to other goods), when given as additional security, unless the debtor acquires rights in the goods within 10 days after the creditor gives value.
B - Buyer in Ordinary Course: A buyer in the ordinary course of business is a person who buys goods in good faith and in the ordinary course of business from a seller who is engaged in the business of selling goods of the kind purchased. A BIOC generally takes free of a nonpossessory perfected security interest created by the seller of the inventory even if the buyer knows of it, unless the buyer also knows that the sale is in violation of the terms of the security agreement.
C - Collateral: Collateral is the property subject to a security interest. There are four types of tangible collateral: consumer goods; farm products; inventory; and equipment. The category into which tangible collateral is placed does not depend on the nature of the collateral, but rather on the primary use to which the debtor puts the collateral at the time the security interest attaches. There are eight types of intangible or semi-intangible collateral: instruments; documents; chattel paper; accounts; deposit accounts; investment property; commercial tort claims; and general intangibles (e.g., software, patent and trademark rights, copyrights, and goodwill. (See also “E - Equipment,” “G - Goods,” and “I- Inventory.”)
D - Default: Article 9 doesn’t define the events that will trigger a default. Instead, the security agreement will usually provide that upon certain events (e.g., failure to make timely payment, failure to keep the collateral insured, unauthorized transfer of the collateral, etc.) the secured party may exercise default remedies. In the absence of such a provision, “default” has been restricted to mean the failure to perform or pay.
E - Equipment: Equipment is a type of collateral. Goods that aren’t consumer goods, farm products, or inventory are equipment (e.g., durable goods used in a business, such as machinery used in a factory or a painting on an office wall).
F - Fixtures: Fixtures are goods that become so attached or otherwise related to real property that an interest in them arises under real property law (e.g., a built-in oven). However, ordinary building materials (e.g., bricks) aren’t considered to be fixtures. Generally, in a contest between a holder of a security interest in a fixture and a holder of an interest in the real property to which the fixture is attached, the first party to file a fixture filing or record its real property interest prevails.
G - Goods: Consumer goods is a type of collateral. Goods used or bought for personal, family, or household purposes (e.g., a tractor used to mow the grass at home) are consumer goods.
H - Holder in Due Course: A holder in due course of a negotiable instrument (or a holder to whom a negotiable document of title has been negotiated, or a protected purchaser of a security) takes priority over any security interest in the negotiable instrument.
I - Inventory: Inventory is a type of collateral. Goods that are held by a person for sale or lease, or to be furnished under a contract of service, are considered inventory. Inventory also includes raw materials, work in progress, and materials used or consumed in a business.
J - Judicial Lien Creditor: A judicial lien creditor (i.e., a person who has acquired a lien on the collateral through judicial attachment, levy, or the like) prevails over the holder of a security interest in collateral if the lien creditor becomes such before the security interest is perfected.
K - Kind: A buyer will not qualify as a buyer in the ordinary course unless the seller is in the business of selling goods of the kind that the buyer buys. (See “B - Buyer in Ordinary Course of Business.”)
L - Lease: In several previous MEE questions, the transaction between two parties was characterized as a “lease.” Don’t be fooled! Even though the parties might have expressly denominated their transaction as a “lease,” they may have, in fact, simply disguised a security interest. Whether a lease of goods is intended as security is determined on a case-by-case basis. However, a transaction will be deemed to create a security interest rather than a lease if the rental obligation isn’t terminable by the lessee and either: (i) the lease term is equal to or greater than the remaining economic life of the goods; (ii) the lessee is bound to purchase the goods at the end of the lease or to renew the lease for the remaining economic life of the goods; or (iii) at the end of the lease, the lessee has an option to purchase the goods or renew the lease for the remaining economic life of the goods for no or nominal consideration.
M - Methods of Perfection: On the bar exam, most security interests are perfected by the filing of a financing statement or by control (i.e., taking possession of the collateral), although automatic perfection, temporary perfection and perfection through possession may be tested.
N - Notice of Sale: After default, the secured party may sell, lease, or license collateral either in its condition when taken or after commercially reasonable preparation or processing. Notice of the sale must be given to the debtor, any secondary obligors on the debt, and any other secured parties who have perfected by filing a financing statement. Content of the notice must include a description of the debtor and the secured party, a description of the collateral, the method of sale, a statement that the debtor is entitled to an accounting, and the time and place of the sale. If notice lacks any of the elements, its sufficiency is a question of fact. (See also “D - Default.”)
O - Overview: You should begin every Secured Transactions question with s short sentence identifying the applicable law: “Because this question involves a security interest, it is governed by Article 9 of the Uniform Commercial Code.”
P - Perfection: It is important to understand the difference between attachment and perfection. Attachment gives the creditor rights in the collateral as against the debtor. Perfection serves as constructive notice and gives the creditor rights in the collateral as against third parties who might also have an interest in the same collateral. If the question is asking only about the secured party’s rights against the debtor, there is no need to talk about perfection—except perhaps to point out that it isn’t relevant, if the facts mention that the interest wasn’t perfected. However, if a question involves a third party who wants to claim the collateral, you must discuss perfection and, in most cases, attachment too, because a security interest cannot be perfected in collateral unless it has attached to the collateral. (See also “M - Methods of Perfection.”)
BONUS: P - Priority: The following hierarchy of interests governs:
A buyer in the ordinary course of business (“BIOC”) and in certain cases, a garage sale buyer. (A purchaser of goods acquires whatever rights in the goods his transferor had the power to transfer, to the extent of the interest purchased. This is known in Secured Transactions law as the “shelter principle.”)
PMSIs that have been properly perfected.
Perfected security interests and judicial liens that have attached, including the lien of a trustee in bankruptcy: as between conflicting perfected security interests, the first to file or perfect generally has priority; as between a perfected security interest and an attached judicial lien, whichever occurred first—perfection of the security interest or attachment of the judicial lien—generally has priority.
Ordinary buyer of the collateral (non-BIOC).
Unperfected security interests (including unperfected PMSIs).
The debtor.
BONUS: P - PMSI: It is important to recognize when a PMSI arises because, if properly perfected, PMSIs can give their holder superpriority over other creditors who perfected security interests in the same collateral before the PMSI holder. A PMSI arises if: (i) the creditor sells the collateral to the debtor on credit and retains a security interest in the collateral; or (ii) the creditor advances funds which are used by the debtor to purchase the collateral. A PMSI in consumer goods (e.g., goods for personal or household use) is automatically perfected upon attachment, and it gives the secured creditor priority over most other creditors with an interest in the same collateral.
Q - Quasi-Tangible Property: Property that is neither purely tangible nor intangible, such as electronic chattel paper or electronic documents.
R - Rights in the Collateral: This is an important requirement for attachment of a security interest—the debtor must have rights in the collateral or the power to transfer rights in the collateral to a secured party. (See "A - Attachment.")
S - Self-Help: The secured party may take possession by self-help without judicial process if she can do so without a breach of the peace. Without removal, the secured party may also make equipment unusable and dispose of it on the debtor’s property if she can do so without a breach of the peace. This latter right is directed toward the problem of taking possession of heavy, bulky equipment that isn’t easily movable. When a secured party breaches the peace, she loses the UCC’s authorization to repossess and may be sued for conversion and is liable for actual (and frequently punitive) damages. (See also “D - Default” and “N - Notice of Sale”.)
T - Transferee for Value: A secured party’s disposition of collateral after a debtor’s default transfers the debtor’s rights in the collateral to any transferee for value, and also discharges the secured party’s interest in the collateral and any subordinate security interest.
U - Unperfected Secured Parties: Generally, a perfected security interest prevails over an unperfected security interest, even if the perfected secured party takes her security interest with knowledge of the earlier unperfected security interest. (If both security interests are unperfected, the first to attach has priority. However, this rule has little practical application because either secured party can easily get priority by perfecting.)
V - Value: Value must be given by the secured party (or on his behalf) before a security agreement will be effective to create a security interest. Any consideration sufficient to support a simple contract is value. (See “A - Attachment.)
W - Where (Choice of Law): The law of the state where the debtor is located generally governs perfection of the security interest.
X - eXtensions of Attachment: Extensions of attachment allow a secured party to secure an interest not only in a debtor's current property but also in property the debtor will acquire in the future. They include after-acquired property (e.g., security interest may attach to property acquired in the future, often outlined in an after-acquired property clause in the security agreement); future advances (e.g., security agreements may cover future financial advances or loans, making them secure against present and future collateral under the terms of the original agreement); and supporting obligations (e.g., security interests in certain types of collateral automatically extend to supporting obligations, such as guarantees or suretyships, related to that collateral). (See also “A - After-Acquired Property.”)
Y - Years: A financing statement is generally effective for five years. Continuation statements may be filed during the last six months of the effective period of a prior filing and will continue the effectiveness of the filing for five more years. The debtor need not authorize the continuation statement; only the secured party needs to authorize it.
Z - Zero-Balance Account: A Zero-Balance Account (ZBA) is typically used for efficient cash management, where its balance is maintained at zero by automatically transferring funds to cover transactions. A secured party may have an interest in a ZBA if their security interest extends to the debtor's bank accounts, making it part of the collateral in the transaction.
