Question/Answer Memo for Assignment 6

1. I have a question about Bollinger case. The original security agreement between Bollinger and ICC didn't have a "future advances" clause in it, apparently. If it had contained a future advances clause, would that have mooted the need for the court to apply the "composite documents" rule to conclude that there was a separate "security agreement" securing the additional loan?

Yes, it would have. If the ICC/Bollinger security agreement had covered future advances, then ICC could've loaned Bollinger an additional $85,000 and it would've had a security interest in the equipment to secure repayment of a total debt of $150,000, and that security interest would have been perfected. No question.

When ICC assigned its security interest to Zimmerman & Jansen, it no longer had any interest in the loan or in the collateral — it had transferred all of its rights to Zimmerman & Jansen, which "stepped into the shoes" formerly occupied by ICC. That ICC/Bollinger security agreement essentially became a Zimmerman & Jansen/Bollinger security agreement, once the assignment occurred. Thus, if the ICC/Bollinger security agreement had contained a future advances clause, then Zimmerman & Jansen could've loaned Bollinger the additional $85,000, and the entire debt would've been covered by the security interest in the equipment created by that agreement. No new security agreement would've been necessary.

Because the ICC/Bollinger security agreement did not have a future advances clause in it, Zimmerman & Jansen couldn't just loan the additional $85,000 without taking another security interest in the equipment to secure the additional $85,000 loan. Thus, Zimmerman & Jansen had to demonstrate that it entered into a new security agreement with Bollinger to have the same equipment serve as collateral for the additional loan. That's why the court had to find a new "security agreement" to secure the additional loan, and thus that's why there was a discussion about the "composite documents" rule.

2. Isn't the explanation for Martin Grinding the fact that it is a bankruptcy court deciding the dispute, and the bankruptcy court is more likely to "punish" the sloppy secured party so that the debtor's accounts and inventory would be available for paying bankruptcy expenses and unsecured creditors (rather than going to pay the secured party alone)?

I don't think that is a legitimate explanation, but it might be a practically relevant explanation.

We'll talk more about bankruptcy as we go through the course. But generally speaking, bankruptcy law doesn't change the substance of the secured creditor's state law rights unless a section of the Code explicitly pre-empts state law. For example, in evaluating whether the trustee or debtor-in-possession can set aside a creditor's security interest using the trustee's strong-arm power under BC § 544(a)(1), bankruptcy law presumptively takes the rights of the secured party and a lien creditor as it finds them under state law. Thus, if the secured party has a properly perfected pre-bankruptcy security interest, the secured party gets priority over the trustee (who has the status of a lien creditor) because state law [UCC § 9-317(a)(2)] confirms that a security interest has priority over the rights of a lien creditor if that security interest is perfected at the time the rights of the lien creditor arise.

In this regard, the bankruptcy court is supposed to apply state law as it finds it. So I suppose that if the state supreme court in that state had decided a similar case to Martin Grinding two years earlier, and had basically refused to apply the composite documents rule (and had instead concluded that the parol evidence rule prohibited the creditor from introducing extrinsic evidence that the omission of "inventory" and "accounts" in the Security Agreement had been an accidental oversight), then the bankruptcy court should do the same thing because the court should be faithful to the underlying state law.

By contrast, a bankruptcy judge should not just "punish" the secured party so as to make the collateral available to other creditors if under the applicable state law, a court would have concluded that the secured party did in fact have a validly perfected security interest in the collateral. Some bankruptcy judges may very well view it as legitimate to "punish" the sloppy secured party if it means that setting aside the secured party's interest facilitates either the debtor's ability to reorganize or enables a broader distribution of the debtor's assets to other creditors. But nothing in the Bankruptcy Code authorizes the bankruptcy judge to act this way.

Having said this, it is practically the case that some bankruptcy judges do act this way, whether that is appropriate or not. And as a result, it places a premium on the secured party not screwing up in the first place, and instead documenting the transaction correctly.

There might be some value to "punishing" a secured party that messes up if you believe it will actually cause fewer secured parties to mess up in the future. But that's an empirical question, and I'm not sure punishment solely for its own sake — i.e., saying to a secured party, "We believe you and the debtor really did agree that you'd have a security interest in inventory and accounts, but since you inadvertently omitted it from your 'Security Agreement,' we're going to punish you by saying you don't have a security interest in inventory and accounts" — really deters future sloppiness. Whether that sort of punishment "trickles down" to influence the behavior of future secured parties is not clear. Bollinger takes the view that there's no good reason to punish the sloppy would-be secured party, if the debtor's intent is still clear from a composite of authenticated records. There's good reason to believe that that approach is more consistent with the probable intent of Article 9's drafters.

The one thing that I hope is clear from class is that if a court wants to justify punishing the sloppy would-be secured party, it can only do that legitimately by saying that approach is necessary to encourage future would-be secured parties not to be sloppy — i.e., that creditors should be clear because that way it is more likely that future security agreements will be clear and thus it will be easier for courts to identify and carry out the intent of the debtor and the secured party. But that's not what the court did in Martin Grinding; in that case, the court said it was punishing the sloppy would-be secured party because it was necessary to protect the interest of subsequent purchasers and creditors. That's absolutely wrong; the issue in these cases is about the scope of the security agreement, and that's a two-party, debtor vs. secured party issue. The interests of third parties are irrelevant to the resolution of that issue. Third parties can't rely upon the contents of the security agreement; intelligent third parties make their decisions based upon the contents of the filed financing statement.