Question/Answer Memo for Problem Set 10 (Priority: Secured Party vs. Secured Party)
1. I understand how two secured parties could take and perfect a security interest in the same collateral if the collateral is regular goods, because both creditors could perfect by filing and both creditors are authorized to file a financing statement covering the collateral. But what if the collateral is a car? If First Bank already has a perfected security interest in the Debtor's car (which would be noted on the title certificate), and Debtor hasn't finished paying for the car, First Bank will have the original title certificate and won't return it to the Debtor until Debtor finishes making the payments. [I didn't get the title certificate to my car until after I'd finished paying off the car loan.]
So if Debtor wants to use the same car as collateral for a loan from Second Bank, how can Second Bank get its security interest noted on the title certificate if First Bank won't release the title certificate?
Great question. The answer is that Second Bank practically can't get its security interest in the car perfected without First Bank's cooperation. State titling agencies (like the Department of Revenue in Missouri) generally will not issue a title certificate for a car (other than a brand new car) unless the existing title certificate is surrendered. [This assumes we aren't talking about a brand new car, which we wouldn't be in this situation.] And because the Department of Revenue's records will show that First Bank is shown as the first lienholder on the outstanding title certificate, the Department of Revenue won't issue a new title certificate without the authorization of First Bank.
This means Second Bank would have to go to First Bank, and ask First Bank to file a joint application for the certificate to be modified or reissued to show both liens (both First Bank and Second Bank). After the certificate is modified/reissued, it would be returned to First Bank which would continue to hold it until its loan is paid off. So it is not impossible, but it is quite a hassle. Thus, Second Bank might realistically decide to just loan the Debtor the additional money necessary to pay off First Bank, so that First Bank would have to surrender the existing title certificate, which would then allow Second Bank to surrender the certificate and have a new certificate issued that showed Second Bank as the first lienholder.
A follow-up: Could Second Bank just ask First Bank to write down on the face of the title certificate that Second Bank has a lien?
No. Under state certificate of title laws, a creditor has to apply to the state titling agency to have its lien noted on the certificate in order to perfect its security interest. This makes sense; if a would-be buyer or lender is trying to ascertain what interests, if any, might exist against the car, the would-be buyer or lender is going to look to the records of the state titling agency. If Second Bank hasn't filed an application to have its lien noted on the certificate of title, nothing in the titling agency's records will show Second Bank's lien. Merely having its name written as a lienholder on the actual title certificate won't be sufficient to perfect the security interest.
2. I have a question based on the PMSI priority rule we talked about in class on Thursday. Assume that First Bank has a prior-perfected security interest in all of the Debtor's equipment, including after-acquired. Then assume that Debtor buys a machine from Seller, who takes a PMSI and who perfects by filing within the 20 day grace period under section 9-324(a), so Seller has first priority as to the machine. Assume that Debtor is paying for the machine on an installment contract.
Now suppose one year later, Debtor still has a substantial balance due on the contract but the contract has a high interest rate, and now Debtor gets a more favorable loan from Second Bank (better interest rate and lower monthly payments), with Second Bank taking a security interest in the machine. Debtor takes the loan proceeds, pays off Seller, and grants Second Bank a security interest in the machine. Second Bank files a financing statement. First Bank still has a security interest in the machine, too, under its after-acquired clause.
In this situation, does first-to-file or perfect apply to give First Bank priority? It seems like Second Bank should be able to claim the same priority as Seller, since Debtor was essentially refinancing a purchase-money obligation. But technically, Second Bank doesn't have PMSI, because Second Bank's loan didn't really enable the Debtor to buy the collateral since Debtor already owned it by then. So if Second Bank doesn't have a PMSI, would First Bank win under first to file or perfect?
Another good question. Your instinct that this looks like a refinancing transaction is a good one. In fact, if you look at the comments to § 9-103, comment 7a, you see this statement:
Consider, for example, what happens when a $10,000 loan secured by a purchase-money security interest is refinanced by the original lender, and, as part of the transaction, the debtor borrows an additional $2,000 secured by the collateral. Subsection (f) resolves any doubt that the security interest remains a purchase-money security interest. Under subsection (b), however, it enjoys purchase-money status only to the extent of $10,000. [emphasis added]
This makes it clear that if Seller had refinanced or restructured the existing balance, Seller's security interest after the refinancing would still be a PMSI. The question is whether the law should reach the same result where a third party lender refinances the debt by paying off (or "taking out") the Seller.
Let me start by explaining how Second Bank could have done this and could have, without question, claimed Seller's priority. Instead of loaning Debtor the money, having Debtor pay off Seller, and having Debtor grant Second Bank a SI in the machine, Second Bank could have just paid Seller directly and had Seller assign its PMSI to Second Bank. After that assignment, there's no question that Second Bank would simply step into the shoes of Seller. Second Bank's interest would be a PMSI and would still have priority over First Bank (again, assuming Seller had originally perfected within the grace period in section 9-324(a)). Second Bank could then amend the existing UCC-1 filing to reflect that the assignment had taken place (i.e., correct the UCC-1 to reflect that Second Bank is now the secured party rather than Seller), although they don't even have to do that to remain perfected. See § 9-310(c) ("If a secured party assigns a perfected security interest ..., a filing under this article is not required to continue the perfected status of the security interest against creditors of and transferees from the original debtor.").
The question is whether Second Bank should be treated the same way if it takes a separate security interest from Debtor rather than taking an assignment of the existing security interest from Seller. In this situation, a court might apply the general principle of equitable subrogation, which basically provides that a person who fully performs the obligation of another person that is secured by collateral becomes by subrogation the owner of the obligation and the collateral to the extent necessary to prevent unjust enrichment. A court might reason that by "paying off" a purchase-money obligation but taking a security interest in the same collateral, Second Bank reasonably expected to receive a security interest with the same priority as enjoyed by the creditor being "paid-off," and that there is no harm to allowing Second Bank to be subrogated to Seller's priority if that will not materially prejudice First Bank or other creditors. Here, there certainly wouldn't be any material prejudice to First Bank; if Seller had refinanced the loan itself, Seller would still have enjoyed PM priority over First Bank, so why should the result be any different if Second Bank refinances the debt instead?
I think the subrogation argument is a good one. But there's a risk that some courts may refuse to grant subrogation, in part because Second Bank could have easily taken a direct assignment of the existing PMSI from Seller and did not do so (thus perhaps implying that Second Bank wasn't counting on having the same priority as Seller did). If the court doesn't use subrogation to protect Second Bank, then the court is almost certainly going to say that First Bank takes priority under first-to-file-or-perfect because Second Bank doesn't have a PMSI and thus doesn't qualify for PM priority.
3. I'm confused about how the following priority contest would be resolved where the collateral was crops, tying together this priority stuff with what we covered in the chapter on perfecting by possession or control. Suppose Bank loans Farmer $100,000 to plant a corn crop, is granted a security interest in the Debtor's corn crop (growing), and files a financing statement covering the corn. Then, after the corn is harvested, Farmer takes it to the grain elevator which issues a negotiable document for the corn. Then, Farmer borrows $100,000 from Finance Company to buy a new combine, and grants Finance Company a security interest in the document, and Finance Company takes possession of the document.
Based on what you said in Problem Set 8, does § 9-312(c) mean that Finance Company would get priority over the Bank? That doesn't seem like it should be right, because the Farmer was first to perfect and at that time, the goods weren't covered by a negotiable document.
That wouldn't be right, and that's not what § 9-312(c) means. Section 9-312(c) says that while collateral is covered by a negotiable document, a security interest perfected in the document would take priority "over any security interest that becomes perfected in the collateral by another method during that time." [emphasis important!] In your problem, Bank has already taken and perfected its security interest in the corn before the corn was taken to the elevator and a negotiable document was issued. Bank didn't take and perfect its security interest in the corn while the goods were covered by a negotiable document. Thus, section 9-312(c) doesn't apply. Instead, the first to file or perfect rule applies, and Bank was first to file or perfect. Bank would prevail. This result makes sense. When the elevator issues a negotiable document for the corn, that document will have a date and time on it (indicating when the warehouse took possession of the corn). After that date, third parties will need to look to the document as evidence of ownership of the corn. But the document will not tell anyone anything about possible ownership claims that arose BEFORE the document was issued. For that, third parties have to look to the UCC records. So Finance Company should've searched the UCC records and, had it done so, it would've found Bank's financing statement and would've realized Bank might have a prior perfected SI in the corn.