Question/Answer Memo for Assignment 2

After-class or e-mail questions on Assignment 2 materials:

1. Suppose that the Bank takes a security interest in Debtor's car. Debtor uses it both for business (say Debtor is a caterer and uses the car to make catering deliveries) but also for personal use (family vacations, taking the kids to soccer practice, etc.). Is the car "consumer goods," or is it "equipment," or is it both?

It can't be both. The categories of goods are mutually exclusive, and are defined by the debtor's primary intended use. Ultimately, if there's a dispute, a judge would have to decide whether the car's primary use was as a consumer good or equipment. It couldn't be both. This is explicit in Comment 4a to § 9-102 ("The classes of goods are mutually exclusive. For example, the same property cannot simultaneously be both equipment and inventory.").

This sort of ambiguity could be present whenever the debtor is using an item for both personal and business use. But, in terms of planning and documenting the transaction, Bank can easily avoid any problem by having the security agreement describe the car specifically. If the security agreement describes the car specifically (e.g., by make, model, and VIN number), it doesn't matter for attachment purposes whether the car is consumer goods or equipment. [It could matter if the Debtor has defaulted and now the secured party is repossessing the car and selling it; as we'll see later in the course, there are some rules governing Article 9 foreclosure sales that would apply if the collateral was consumer goods that would not apply if the collateral was equipment. But all in good time! We'll get there later in the course.]

Whether the car was "consumer goods" or "equipment" would really only be relevant if the parties had entered into a security agreement covering one classification but not the other, e.g., if Bank had taken a security interest in all of the Debtor's "equipment" but not "consumer goods." In that case, the classification of the car would be critical, and classification would be governed by the collateral's primary use at the time the security interest attaches. If the Debtor expected to use the violin more frequently for business use than for personal use, a court should conclude that the violin was "equipment" (and thus covered by the security agreement). Ultimately, this would be a question of fact that would have to be determined by the court. But it couldn't be both.

2. What if Debtor originally bought the car for business use, but then after six months decided to get a different company car and started using the collateral only for personal use. Would the car now become "consumer goods"? And if the security agreement had covered the car because it covered "all of the Debtor's equipment," would it cease to cover the car after the change, so that the creditor would no longer have a security interest in the car?

The key is the Debtor's primary use at the time of attachment. What happens after that doesn't matter for attachment purposes — once the security interest attaches, it remains attached until the secured obligation is repaid (satisfied) or until some other provision of Article 9 extinguishes the security interest. Bank does not lose its security interest in the car just because Debtor changed its use of the car after entering into the transaction.

3. In several of the problems in class, you suggested that a court might end up interpreting a term in a security agreement a particular way based upon extrinsic evidence such as the context of the agreement or the nature of the debtor's business (like the example where the debtor sold farm implements and was not a farmer, but the security agreement described the collateral as "farm equipment" rather than inventory, and you said that in context the court might well interpret the agreement to conclude that the parties meant "inventory."

My question is how that meshes with the parol evidence rule? Could the debtor argue that the court would have to exclude that extrinsic evidence under the parol evidence rule?

No, that would be a big misunderstanding of the parol evidence rule. The parol evidence rule would permit the court to exclude extrinsic evidence where the extrinsic evidence conflicts with the terms of the parties' written agreement, where the writing was clearly intended to be a complete integration of their entire agreement, and where the writing is unambiguous. But on the facts in the Hawley Implement Co. problem (the one you refer to in your question), that isn't the case. If the parties describe the collateral as "farm equipment" when the debtor doesn't actually engage in farming at all, one might reasonably argue that the agreement is ambiguous on its face (otherwise, it is nonsensical; why would we assume that the parties would have consciously signed a security agreement that covered none of the debtor's property?). In that case, the court could probably consider extrinsic evidence.

Following up, then, is there a meaningful limit to the nature of the extrinsic evidence that the court will allow? It seems to me that this could open the door for abuse by the secured party. The example I was thinking of was one where the security agreement describes "the debtor's TV set," but the debtor in fact owns two TV sets. One of them is a 90-inch HDTV worth thousands, and the other is a 25-year old color console TV worth maybe $50. How would a judge figure out which TV the agreement was meant to cover? Of course the secured party is going to argue that it covers the more valuable one, but what if the secured party is lying?

Good question. This is certainly a risk. It's not one that justifies concluding that the court should never consider extrinsic evidence to help interpret an ambiguous security agreement. However, it does justify a court exercising some care regarding the nature of the extrinsic evidence that it relies on to interpret the agreement, and ensuring the reliability of that evidence.

Here's another example. The security agreement states that the collateral is "Debtor's car." If Debtor only owns one car (and it was the same car Debtor owned at the time of the agreement), then there's no identifiability problem. But if Debtor owns two cars: a Bentley and a Ford Focus, which car was covered? If the only extrinsic evidence that the secured party can offer is the testimony of its own loan officer — i.e., evidence that is NOT authenticated by the Debtor — then that extrinsic evidence should be rejected and the court should conclude that the security agreement does not reasonably identify the collateral (and thus no security interest attached, to either car).

But suppose that the secured party can offer evidence in the form of the debtor's loan application, when the debtor was applying for a loan, in which the debtor filled in the blank for "Collateral" with the words "my Bentley" — and that application was signed by the debtor. That's contemporaneous extrinsic evidence, authenticated by the debtor, about the debtor's intent that the agreement would cover the Bentley. There's no reason the court ought not consider that evidence (authenticated as it is by the debtor), and (if there is no evidence to the contrary) conclude that the parties' "Agreement" (in other words, the Security Agreement as supplemented by the extrinsic evidence) adequately describes the Bentley.

In some cases, the parties may offer conflicting extrinsic evidence, in which case, a court might appropriately conclude that the secured party had not carried its burden of proof and thus no attachment occurs for want of a description that reasonably identifies the collateral. But the court ought to reach that result by considering (and being unpersuaded by) the extrinsic evidence rather than excluding it altogether.

4. We didn't address the last discussion question in the Problem Set in class. In that Problem, is it correct to conclude that because section 9-204(c) doesn't say anything about how future advances have to be "related" to prior advances, whether the loans were for the same purpose is irrelevant? And, as a result, that the security agreement in the car would secure both loans?

Let's take the second question first. The problem with Problem 8 is that the facts of the problem don't say whether the security agreement that Bowman signed actually has a future advances clause in it. If it didn't, then all that the security interest in the car can secure is the $10,000 original loan. For the later loan to be secured by virtue of the original security agreement, the security agreement would have to have had a future advances clause in it. But the facts don't say. You'd need to look at the security agreement itself and see. If it didn't have one, then the later $15,000 loan to Bowman would be unsecured, because (a) the original security agreement didn't cover future advances and (b) Bowman didn't sign another security agreement granting another security interest in the car to secure the second loan at the time of the second loan.

Now, the first question. Let's assume that Bowman's security agreement DID cover future advances. If so, then the answer to your first question should be YES, it shouldn't matter that the first loan was personal and the second one was for a business purpose. The comments to section 9-204 make this clear: "This Article rejects the holdings of cases decided under former Article 9 that applied other tests, such as whether a future advance ... was of the same type or a similar type or class as earlier advances ... secured by the collateral." U.C.C. § 9-204, comment 5.

Prior to the adoption of Article 9, and even for the first two decades or so after Article 9 was adopted, some courts ruled that a future advances clause should be understood as reflecting the parties' intent that future advances would only be secured by the collateral if they were related to or of a similar character as the prior advances. Such an interpretation might make sense if the clause explicitly said something like "the collateral secures future advances of the same type or character," but most modern future advances clause explicitly cover future advances of any character. For example, look back at the form agreement in Problem Set 1: that security agreement states that the security interest granted thereby "secure[s] payment of the following obligations of Debtor to Secured Party (all hereinafter called the“Obligations”): (i) All obligations and liabilities of Debtor to Secured Party (including without limitation all debts, claims and indebtedness) whether primary, secondary, direct, contingent, fixed or otherwise, heretofore, now and/or from time to time hereafter owing, due or payable, however evidenced, created, incurred, acquired or owing and however arising, or by oral agreement or operation of law or otherwise." There's no reason to interpret that explicit of an agreement not to cover ALL future advances for any purpose. This is especially so because of the efficiency purpose that "future advances" coverage is designed to facilitate. By using a future advances clause, the lender and borrower can set up one agreement to secure a business line of credit under which the borrower will be making repeated borrowings and repayments, and the borrower doesn't then have to execute a new security agreement each and every time it takes an advance on the line of credit.

5. You said in class that a house is not "goods" because it is not movable. Are all things that are not movable barred from being goods even if they appear to be goods?

Understand that the definition of "goods" is using the term "movable" in a legal sense rather than a practical one. That is to say, a 200-ton block of cut granite sitting on top of the earth's surface may be difficult or impossible to move, but it is still "movable" in the sense that it is not physically part of the earth (and thus theoretically could be moved — perhaps by someone in a blue suit and a red cape who happens to be able to fly.

By contrast, my house could theoretically be picked up and physically moved, but it is treated under the law as not being "movable" because the house became part of the land when it was constructed on a permanent improvement to the land (a foundation or a slab). Thus, it became real estate (and thus is not personal property and thus is not goods).

[Also, you could have a house that is goods, such as for example a trailer or manufactured home that hasn't been sold to a buyer yet and is sitting on the sales lot of the trailer dealer, not yet permanently attached to land. At that point, the house would be "goods" (and it would be "inventory" in the hands of the dealer).]

Later in the course, we'll talk about the concept of fixtures — what happens if a good is attached to the land so that it becomes part of the land under real estate law, but which could still be removed. Something that is a fixture is also a good — while something is a fixture, it is simultaneously covered by both real estate law and Article 9. But again, all in good time!

6. [Here's a bonus question from someone in last year's class. It was such a good question, I'm sharing it with this year's class too.] In class, it was clear that you don't think much of the rule in § 9-108(c) about how a creditor can't use a "supergeneric" collateral description in a security agreement. You seemed to be arguing that it would be better if supergenerics were allowed, because then (1) commercial parties who needed to put up all of their personal property as collateral could do so efficiently, and (2) courts could still protect unsophisticated consumers who unwittingly put up all their personal property as collateral by applying existing contract doctrines like duress, adhesion, mistake, unconscionability, etc. to invalidate overreaching agreements.

That sounds like "Let everybody have complete freedom of contract, and trust courts will use existing contract doctrines to weed out the worst abuses. That puts WAY too much faith in the judgment of courts. Courts almost never say that a contractual provision is unconscionable. Isn't it a better policy choice for the legislature to force commercial parties to use an extra paragraph or two (using a longer list of generic descriptors rather than the supergeneric "all assets"), rather than open the door to abuses that courts may not be able to regulate consistently?

That's a great statement of the policy in support of § 9-108(c) and its decision not to permit supergeneric descriptions in security agreements. But on that theory, I still think it would have made more sense to permit supergeneric descriptions in general, but then specifically NOT allow them in "consumer transactions." But the drafters of Article 9 made their policy choice. You've made what I think is the strongest argument in support of that choice.