Chapter 22

Security Interests in Personal Property

WHAT THIS CHAPTER IS ABOUT

This chapter covers transactions in which the payment of a debt is secured (guaranteed) by personal property
owned by the debtor or in which the debtor has a legal interest. The importance of being a secured creditor cannot be
overemphasized—secured transactions are as basic to modern business as credit.

CHAPTER OUTLINE
I. THE TERMINOLOGY OF SECURED TRANSACTIONS
UCC Article 9 applies to secured transactions.

A. SECURED TRANSACTION
A secured transaction is a transaction in which payment of a debt is guaranteed by personal property
owned by the debtor or in which the debtor has a legal interest.

B. SECURITY INTEREST, SECURED PARTY, COLLATERAL, AND DEBTOR

A security interest is the interest in the collateral that secures payment or performance of an obligation
[UCC 1–201(37)]. A secured party is a creditor in whose favor there is a security interest in the debtor’s
collateral [UCC 9–102(a)(72)]. Collateral is the subject of a security interest [UCC 9–102(a)(12)]. Debtor is
the party who owes payment [UCC 9–102(a)(28)].

II. CREATING A SECURITY INTEREST

A. TWO CONCERNS
A creditor’s main concerns are, if a debtor fails to pay, (1) satisfaction of the debt through possession or
sale of the collateral and (2) priority over other creditors to the collateral.

B. THREE REQUIREMENTS
A creditor’s rights attach to collateral, creating an enforceable security interest against a debtor if the
following requirements are met [UCC 9–203].

1. Written Security Agreement

(1) It must be written or authenticated (which includes electronic media, or records), (2) describe the
collateral, and (3) be signed or authenticated by the debtor [UCC 9–102, 9–108]. Or the secured party
must possess the collateral.

2. Secured Party Must Give Value

Value is any consideration that supports a contract [UCC 1–201(44)].

3. Debtor Must Have Rights in the Collateral

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The debtor must have an ownership interest or right (current or future legal interest) to obtain pos-
session of the collateral.

III. PERFECTING A SECURITY INTEREST

Perfection is the process by which secured parties protect themselves against the claims of others who wish to
satisfy their debts out of the same collateral.

A. PERFECTION BY FILING
Filing is the most common means of perfecting a security interest.

1. What a Financing Statement Must Contain

It must contain (1) the names of the debtor and the creditor (a trade name is not sufficient), and (3) a
description of the collateral [UCC 9–502, 9–503, 9–506, 9–521].

2. Where to File a Financing Statement

Depending on how collateral is classified, filing is with a county (timber, fixtures, etc.) or a state
(other collateral) [UCC 9–301(3), 9–502(b)]. The specific office depends on the debtor’s location—

1) Individual debtors: the state of the debtor’s residence.

2) Chartered entity (corporation): state of charter or filing.
3) Other: state from which the debtor manages its business operations.

B. PERFECTION WITHOUT FILING

1. Perfection by Possession
A creditor can possess collateral and return it when the debt is paid [UCC 9–310, 9–312(b), 9–313]. For
some securities, instruments, and jewelry, this is the only way to perfect.

2. Perfection by Attachment

a. Purchase-Money Security Interest (PMSI)

A PMSI is (1) retained in, or taken by a seller of, goods to secure part or all of the price, or (2)
taken by a lender, such as a bank, as part of a loan to enable a debtor to buy the collateral [UCC
9–103(a)(2)].

b. Perfection of a PMSI
A PMSI in consumer goods is perfected automatically when it is created. The seller does not need
to do more.

c. Exceptions
Security interests subject to other federal or state laws that require additional steps are excepted.
For example, to perfect a PMSI in a car requires filing a certificate of title.

C. EFFECTIVE TIME DURATION OF PERFECTION

A financing statement is effective for five years [UCC 9–515]. A continuation statement filed within six
months before the expiration date continues the effectiveness for five more years (and so on) [UCC 9–
515(d), (e)].

IV. THE SCOPE OF A SECURITY INTEREST

A. PROCEEDS
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Proceeds include whatever is received when collateral is sold or otherwise disposed of. A secured party
has an interest in proceeds that perfects automatically on perfection of the security interest and remains
perfected for twenty days after the debtor receives the proceeds. The interest remains perfected for more
than twenty days if—

1. A filed financing statement covers the original collateral and the proceeds [UCC 9–315(c), (d)].
2. There is a filed statement that covers the original collateral and the proceeds are identifiable cash
proceeds [UCC 9–315(d)(2)].

B. AFTER-ACQUIRED PROPERTY
A security agreement may provide for coverage of after-acquired property [UCC 9–204(a)]—collateral
acquired by a debtor after execution of a security agreement.
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C. FUTURE ADVANCES
A security agreement may provide that future advances against a line of credit are subject to a security
interest in the collateral [UCC 9–204(c)].

D. THE FLOATING-LIEN CONCEPT

A floating lien is a security agreement that provides for the creation of a security interest in any (or all) of
the above. The concept can apply to a shifting stock of goods—the lien can start with raw materials and
follow them as they become finished goods and inventories and as they are sold, turning into accounts
receivable, chattel paper, or cash.

V. PRIORITIES
When several creditors claim a security interest in the same collateral of a debtor, which interest has priority?

A. SECURED PARTIES V. UNSECURED PARTIES

Secured parties (perfected or not) prevail over unsecured creditors and creditors who have obtained
judgments against the debtor but who have not begun the legal process to collect on those judgments
[UCC 9–201(a)].

B. SECURED PARTIES V. BUYERS

1. The General Rule

A security interest in collateral continues even after the collateral has been sold unless the secured
party authorized the sale.

2. Exception—Buyer in the Ordinary Course of Business

Takes goods free of any security interest (unless the buyer knows that the purchase violates a third
party’s rights) [UCC 9–320(a)].

3. Exception—Buyers of Consumer Goods Purchased outside the Ordinary Course of Business

The buyer must give value and not know of the security interest; the purchase must occur before the
secured party perfects by filing [UCC 9–320(b)].

4. Exception—Buyers of Instruments, Documents, or Securities

A holder in due course, a holder to whom a negotiable instrument has been negotiated, and a bona
fide purchaser of securities have priority over a previously perfected security interest [UCC 9–330(d),
9–331(a)].

5. Exception—Buyers of Farm Products

A buyer from a farmer has priority over a perfected security interest unless, in some states, the se-
cured party has filed centrally an effective financing statement or the buyer has notice before the sale.

C. SECURED PARTIES V. OTHER SECURED PARTIES

1. The General Rule

The first interest to be filed or perfected has priority over other filed or perfected security interests. If
no interest has been perfected, the first to attach has priority [UCC 9–322(a)(1), (3)].

2. Exception—Commingled or Processed Goods

When goods have lost their identity into a product or mass, security interests attach in a ratio of the
cost of the goods to which each interest originally attached to the cost of the total product or mass
[UCC 9–336].
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3. Exception—Purchase-Money Security Interest (PMSI)

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a. Inventory
A perfected PMSI prevails over a previously perfected security interest if the holder of the PMSI
perfects and gives the holder of the other interest written notice of the PMSI before the debtor
takes possession of the new inventory [UCC 9–324(b)].

b. Software
If software is used in goods subject to a PMSI, priority is according to the classification of the
goods [UCC 9–103(c), 9–324(f)].

c. Other Collateral
A perfected PMSI prevails over a previously perfected security interest if the holder of the PMSI
perfects before the debtor takes possession of the collateral or within twenty days [UCC 9–
324(a)].

VI. RIGHTS AND DUTIES OF DEBTORS AND CREDITORS

A. INFORMATION REQUESTS
When filing, creditors and debtors can ask the filing officer to furnish a copy of the statement with the file
number, the date, and the hour [UCC 9–523(a)]. Others (such as prospective creditors) can ask the filing
officer to provide a certificate that gives information on possible perfected financing statements [UCC 9–
523(c), 9–525(d)].

B. RELEASE, ASSIGNMENT, AND AMENDMENT

A secured party can release all or part of the collateral [UCC 9–512, 9–521(b)], or as sign part or all of the
security interest [UCC 9–514, 9–521(a)]. A filing can be amended, if both parties agree [UCC 9–512(a)].

C. CONFIRMATION OR ACCOUNTING REQUEST BY DEBTOR

When the debtor asks, the secured party must tell the debtor the amount of the unpaid debt (within two
weeks of the debtor’s request) [UCC 9–210].

D. TERMINATION STATEMENT
When a debt is paid, the secured party can send a termination statement to the debtor or file it with the
original financing statement.

1. If the Collateral Is Consumer Goods

The statement must be filed within one month after the debt is paid, or—if the debtor requests the
statement in writing—within twenty days of receipt of the request, whichever is earlier [UCC 9–
513(b)].

2. If the Collateral Is Other Goods

The statement must be filed or furnished to the debtor within twenty days after a written request is
made by the debtor [UCC 9–513(c)].

VII. DEFAULT
Default is whatever the parties stipulate in their agreement [UCC 9–601, 9–603]. Occurs most often when
debtors fail to make payments or go bankrupt.

A. BASIC REMEDIES

1. Repossession of the Collateral

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A secured party can take possession of the collateral without a court order, if it can be done without a
breach of the peace, [UCC 9–609(b)] and retain it for satisfaction of the debt [UCC 9–620] or resell it
and apply the proceeds toward the debt [UCC 9–610] (see below).

2. Execute and Levy

A secured party can give up the security interest and proceed to judgment on the debt (this is done if
the value of the collateral is less than the debt and the debtor has other assets) [UCC 9–601(a)].
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B. DISPOSITION OF COLLATERAL

1. Retention of Collateral by the Secured Party

a. Notice
A secured party must give written notice to the debtor. In all cases except consumer goods, notice
must also be sent to any other secured party from whom the secured party has received notice of
a claim.

b. If Debtor or Other Secured Party Objects within Twenty Days

The secured party must sell or otherwise dispose of the collateral [UCC 9–620(a), 9–621].

2. Consumer Goods
If the collateral is consumer goods with a PMSI and the debtor has paid 60 percent or more on the
price or loan in a non-PMSI, the secured party must sell within ninety days [UCC 9–620(e), (f)].

3. Disposition Procedures
(1) Disposition must be in a commercially reasonable manner and (2) the debtor must be notified of
the sale [UCC 9–610(b)].

a. Disposition
After default, a secured party may sell, lease, license, or otherwise dispose of any or all of the
collateral. “Commercially reasonable” means the method, manner, time, place, and other terms.

b. The Secured Party Must Give Written Notice to the Debtor

In all cases except consumer goods, notice must also be sent to any other secured party from
whom the secured party has received notice of a claim [UCC 9–611(b), (c)], unless the collateral is
perishable or is customarily sold in a recognized market.

4. Proceeds from Disposition

Must be applied to (1) expenses stemming from retaking, storing, or reselling, (2) balance of the debt,
(3) junior lienholders, and (4) surplus to the debtor [UCC 9–608(a); 9–615(a), (e)].

5. Deficiency Judgment
In most cases, if a sale of collateral does not repay the debt, the debtor is liable for any deficiency. A
creditor can obtain a judgment to collect.

6. Redemption Rights
Before the secured party retains or disposes of the collateral, the debtor or any other secured party
can take the collateral by tendering performance of all secured obligations and paying the secured
party’s expenses [UCC 9–623].

TRUE-FALSE QUESTIONS
(Answers at the Back of the Book)
1. A financing statement is not effective if it is filed electronically.

2. Attachment gives a creditor an enforceable security interest in collateral.

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3. A secured creditor’s right to proceeds exists for twenty days after receipt only if the proceeds are for-
warded to the secured party.

4. To be valid, a financing statement does not need to contain a description of the collateral.

5. When a secured debt is paid, the secured party does not need to file a termination statement in all cases.
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6. A security agreement determines most of the parties’ rights and duties concerning the security interest.

7. A secured party can release the collateral described in a financing statement even if the debtor has not
paid the debt.

8. Default occurs most commonly when a debtor fails to repay the loan for which his or her property served
as collateral.

9. After a default, and before a secured party disposes of the collateral, a debtor cannot exercise the right of
redemption.

10. When two secured parties have perfected security interests in the same collateral, generally the last to
perfect has priority.

FILL-IN QUESTIONS
(Answers at the Back of the Book)
1. Generally, in a secured transaction, the ________________________________ (creditor/debtor) files a financing
statement with the appropriate state office. When the debt is paid, the __________________________ (creditor/debtor)
may also send a termination statement to the officer with whom the financing statement was filed.

2. When two or more secured parties have perfected security interests in the same collateral, generally the
___________ (first/last) to perfect has priority. When two conflicting security interests are unperfected, the
____________ (first/last) to attach has priority.

MULTIPLE-CHOICE QUESTIONS
(Answers at the Back of the Book)
1. Alpha Credit Corporation files a financing statement regarding a transaction with Beta Company. To be
valid, the financing statement must contain all of the following except

a. a description of the collateral.

b. the debtor’s name.
c. the reason for the transaction.
d. the secured party’s name.

2. Able Transport, Inc., buys a forklift, but does not make a payment on it for five months. The seller, Baker
Equipment Company, repossesses it by towing it from a public street. Able sues Baker for breach of the
peace. Able will likely

a. not prevail because Baker did not use judicial process.

b. not prevail because the repossession was not a breach of the peace.
c. prevail because Able did not default on the loan.
d. prevail because the repossession was a breach of the peace.
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3. Dan owns Eats Café, which he uses as collateral to borrow $10,000 from First State Bank. To be effec tive,
the security agreement must include

a. a description that reasonably identifies the collateral only.

b. a description that reasonably identifies the collateral and Dan’s signature.
c. Dan’s signature only.
d. neither a description that reasonably identifies the collateral nor Dan’s signature.
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4. Great Trucks, Inc. (GTI), repossesses a truck (not a consumer good subject to a purchase-money security
interest) from Highway Trucking Company, and decides to keep it instead of reselling it. GTI sends
written notice of this intent to the debtor. GTI must also send notice to

a. any junior lien claimant who has filed a statutory lien or security interest and any secured party from
whom GTI has received notice.
b. only a junior lien claimant who has filed a statutory lien or security interest in the truck.
c. only a secured party from whom GTI has received notice of a claim in the truck.
d. none of the above.

5. Irma, a debtor, wants to confirm the amount of his outstanding secured debt with Jiffy Loan Corporation.
Irma can ask Jiffy to confirm her view of the debt, without charge, every

a. month.
b. six months.
c. year.
d. five years.

6. Kappa Credit, Inc., has a security interest in the proceeds from the sale of collateral owned by Local
Stores Company. This interest may remain perfected for longer than twenty days after Local receives the
proceeds

a. if a filed financing statement covers the proceeds or the proceeds are identifiable cash proceeds.
b. only if a filed financing statement covers the proceeds.
c. only if the proceeds are identifiable cash proceeds.
d. under none of these circumstances.

7. Nick borrows $5,000 from Modern Financial Corporation (MFC), which files a financing statement on
May 1, but does not sign a security agreement until he receives the funds on May 5. He also borrows
$5,000 from Omega Bank, which advances funds, files a financing statement, and signs a security
agreement on May 2. He uses the same property as collateral for both loans. On his default, in a dispute
over the collateral, MFC will

a. lose because Omega perfected first.

b. lose because Omega’s interest attached first.
c. win because it filed first.
d. win because its interest attached first.

8. Peak Electronics Stores sell consumer products. To create a purchase-money security interest in a com-
puter bought by Quinn, Peak must

a. assign to a collection agent a portion of Peak’s accounts payable

b. assign to a collecting agent a portion of Peak’s accounts receivable
c. extend credit for part or all of the purchase price of the computer.
d. refer Quinn to Rapid Cash Company, a third-party lender.

9. Safe Loans, Inc., wants to perfect its security interest in collateral owned by Tech Corporation. Most
likely, Safe should file a financing statement with

a. the city manager.

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b. the county clerk.

c. the federal loan officer.
d. the secretary of state.

10. United Sales Company is incorporated in Virginia, with its chief executive office in the state of
Washington. Using its equipment as collateral, United borrows $5,000 from Zip Credit, Inc. To perfect its
security interest, Zip needs to file its financing statement in

a. any convenient state.

b. Virginia only.
c. Virginia and Washington.
d. Washington only.

SHORT ESSAY QUESTIONS

1. What is the floating lien concept?

2. What are a secured party’s rights on a debtor’s default?

ISSUE SPOTTERS
(Answers at the Back of the Book)
1. Adam needs $500 to buy textbooks, and other supplies. Beth agrees to loan Adam $500, accepting as collateral
Adam’s computer. They put their agreement in writing. How can Beth let other creditors know of her interest in the
computer?

2. Central Sales Company (CSC) borrows $1,000, using its inventory “present and after acquired” as collateral,
from Delta Bank, which perfects its interest on May 1. On May 5, CSC buys from Excel Goods, Inc., new inventory in
which CSC gives Excel a purchase-money security interest (PMSI). On the same day, Excel perfects its interest and
notifies Delta. CSC takes possession of the new inventory on May 7. On June 1, CSC defaults on the loans. Whose
security interest has priority?

3. First National Bank loans $5,000 to Gail to buy a car, which is used as collateral to secure the loan. Gail has paid
less than 50 percent of the loan, when she defaults. First National could repossess and keep the car, but the bank does
not want it. What are the alternatives?