Question/Answer for Assignment 3 (Proceeds)

1. A question about the problem in class involving the secured party with the security interest in the video game machines, and whether the secured party also had a security interest in the quarters in the machine as "proceeds": looking at § 9-102(a)(64)(B), which says that proceeds is "whatever is collected on, or distributed on account of, collateral," why aren't the quarters "collected on" the collateral?

This is a possible interpretation of subsection (a)(64)(B), but it would require a somewhat-uncharacteristic usage of the term "collection."

The term “collection” is a term that Article 9 uses in other contexts to describe the process by which a party receives or enforces its right to payment on an account or a payment intangible. For example, suppose that Bank has a security interest in all Plumber’s accounts, present and after-acquired. Plumber does a job for Homeowner, and bills Homeowner for the work (with payment due from Homeowner in 30 days). Plumber's right to payment is an "account" covered by Bank's security interest. Now assume that 30 days later, Homeowner pays off the account in cash. In the language of Article 9, the account has now been “collected.” Thus, the cash that the Homeowner paid would be proceeds of the account under § 9-102(a)(64)(B).

In this example, if the Plumber had been in default to the Bank, or the Plumber and the Bank had otherwise agreed, the Bank could have enforced its right to the account by notifying the Homeowner that the account had been assigned and directing the Homeowner to pay the account directly to the Bank (rather than to Plumber). Section 9-607 refers to this enforcement process by the secured party as "collection" of the account.

Because the term "collection" is customarily used in this context, a court might conclude that the term "collection" applies to the collection of rights to payments such as those arising from an account, a payment intangible, or commercial paper such as a promissory note or chattel paper (which we'll discuss in later assignments). Under that sort of narrow interpretation of the term "collected on," a court might conclude that the quarters were not "collected on" the machines within the meaning of subsection (a)(64)(B).

To reiterate the point I tried to make in class, I am not saying that no court would treat the quarters as proceeds of the machine — either by applying the "collected" language from (a)(64)(B) or by saying that the uses of the machine constitute "licenses" of the machine for which the debtor received the quarters. What I'm saying is that it isn't CERTAIN, and thus a prudent secured party who expected to take a security interest in the cash from the machines would make that explicit in the security agreement, rather than relying upon proceeds coverage.

2. In discussing Problem 3 in class, you didn't talk about whether the secured party with a security interest in Debtor's goat would also have a security interest in the prize money Debtor won exhibiting the goat at the State Fair. Would the prize money be "distributed on account of" the goat and thus "proceeds" of the goat under § 9-102(a)(64)(B)?

This is a very good question, and the answer unfortunately isn't clear. In the 1999-2000 Article 9 revisions, the drafters added the "distributed on account of" language in subsection (a)(64)(B) to make clear that the drafters disagreed with the result in the pre-revision case of In re Hastie, in which the 10th Circuit held that dividends paid on account of stock were not proceeds because there was no sale or other disposition of the stock. As reflected in § 9-102, comment 10a, the drafters felt that dividends were properly viewed as proceeds of the stock, and thus added the "distributed on account of" language to reflect this.

I'm not sure that the drafters had in mind the situation of an animal winning a prize at the State Fair when they used the term "distributed on account of the collateral," but I think there's a colorable argument that the prize winnings would fit within that phrase. However, there aren't any reported cases of which I'm aware in which a court has held that prize money won by the owner of an animal is "proceeds" of the animal. Thus, a court might argue that the "distributed on account of collateral" language in § 9-102(a)(64)(B) was only meant to apply to dividends on financial securities, not on prizes won by animals. I certainly wouldn't be prepared to give a legal opinion that courts would say the prize money was proceeds of the goat (even if I think that's a defensible result). Again, the secured party could have negated any uncertainty by specifying in the security agreement that the security interest would reach any prize money received by the debtor on account of the goats.

A bonus question from a prior year's class:

3. Suppose that a secured party had a security interest in the debtor's fruit tree. Would the secured party be able argue that the fruit on the tree is "proceeds" because it would be "collected" from the tree under § 9-102(a)(64)(B)?

There's a threshold problem with your question. A secured party couldn't really take an Article 9 security interest in a fruit tree. The tree would be part of the land, and thus isn't really a "good" within the meaning of Article 9. Timber that is grown to be cut does constitute a "good" under § 9-102(a)(44), and so you could create an Article 9 security interest in standing timber that is to be cut and sold under a contract or conveyance of timber rights. But that wouldn't cover a fruit tree that a debtor was using in a farming operation, which wouldn't fit the "to be cut" language. Thus, a lender could only really take a lien on the fruit trees by taking a mortgage on the land.

For the fruit to be "proceeds," the trees would have to be "collateral," which is defined in § 9-102(a)(12) to be "property subject to a security interest." But the term "security interest" is defined in the UCC to cover a security interest in personal property. See § 1-201(b)(35). Unless a tree is standing timber to be cut, it doesn't constitute personal property, so it couldn't be "collateral" and thus the fruit couldn't be proceeds.

Theoretically, I guess, you could have a tree that was producing fruit that hadn't yet been planted on a specific piece of land (unlikely, but maybe in a nursery that sold mature trees). In that case, the tree could be a "good." In that situation, the language "collected on ... the collateral" would appear to literally apply to the fruit. However, the problem here is one of past understanding. We've traditionally thought of fruit as "crops" [see § 9-102(a)(44)] and crops have traditionally been viewed as "products" of land rather than "proceeds" of the trees, vines, or bushes on which the crops grow. Article 9 doesn't define "products" because the term has more meaning in real estate law, as the crops were viewed as products of the land. Because the growing tree is part of the land, the crop (the fruit) is viewed as a product of the land.

So if the secured party wanted to take a security interest in the fruit, it should do so by taking a security interest directly in the fruit (either described specifically by reference to the type of fruit, or generically within the broader category of "crops" or "farm products."