Question/Answer for Assignment 32 (Priority: Secured Party vs. Secured Party) [UPDATED November 4, 2013 at 4:55pm]

1. I have a question about a debtor granting two security interests in the same car. Suppose that the first secured party is Bank One, and it takes a security interest in the car and has that security interest noted on the car's title certificate, and then Bank One takes possession of the title certificate. Now suppose debtor grants a security interest to Bank Two, Bank Two asks Bank One to submit the certificate to the titling agency to have Bank Two's lien noted on it, and Bank One refuses, but says, "here, we'll just mark on the title certificate that Bank Two claims a second priority lien." Would that be sufficient to perfect Bank Two's security interest, or not?

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 Bank Two hasn't filed an application to have its lien noted on the certificate of title, nothing in the titling agency's records will show Bank Two has a lien. Merely having its name written as a lienholder on the actual title certificate won't be sufficient to perfect the security interest, because it isn't "compliance" with the certificate of title statute.

2. I have a question about the 20-day grace period rule for perfecting a PMSI under § 9-324(a). Suppose that on Monday, Fred buys a TV set for the waiting room at his office (Fred is a doctor), and Fred grants Seller a purchase money security interest to secure the unpaid price of the TV. Then, on Friday (four days later) Seller files a UCC-1 covering the TV set. But in the meantime, on Wednesday, Fred sells the TV to one of his patients, Sally, for $500. Sally takes possession of the TV and has no idea of Seller's security interest in it. If I'm reading § 9-324(a) right, then when Seller files its UCC-1, it is perfected and has priority over Sally? That doesn't seem right, because if Sally had searched the records, she'd have found no UCC-1 filing on it when she bought the TV.

Actually, in this case, § 9-324(a) wouldn't apply because the conflict in your question is between Seller (a secured party) and Sally (a buyer of the goods); § 9-324(a) applies to a dispute between two conflicting secured parties. In your hypo, the applicable rule would be § 9-317(e), which does reach the same result — because Seller perfects within the 20-day grace period after Fred took possession of the TV, Seller's perfected security interest in the TV is effective and takes priority over the rights of a buyer (like Sally) who bought the property between the time that the security interest attached and when it was perfected by the filing.

This is somewhat harsh for Sally — you're right that she might have been taken by surprise. If she searches the records, she won't find Seller's financing statement because it hasn't been filed yet. But under § 9-317(e), that doesn't matter. Once Seller files, § 9-317(e) gives Seller "relation-back" priority over the buyer Sally.

The drafters viewed this as a necessary consequence of allowing the purchase money secured party a grace period in which to file. Clearly, this rule operates for the benefit/convenience of purchase money sellers of goods. They don't have to "pre-file" if they sell goods on secured credit; they can file within the day grace period and they're treated as if they had pre-filed. This is convenient for the purchase money seller; it is also convenient, though, for buyers of goods. If I buy a machine from seller, I don't have to wait to take delivery of the machine until seller has had a chance to go to the UCC records and file a financing statement; I can carry it out of the store as soon as I sign the security agreement. The only person for whom the rule isn't "convenient" is a buyer like Sally.

If Sally is sophisticated, and understands the way that the system works, she can avoid this risk by asking Fred for proof that he's owned the TV for more than 20 days. If she can satisfy herself of that, then once she gets a "clean" search in the records, she can be sure that any security interest already taken in the TV cannot be perfected and that any later filing could not have "relation back" priority over her because that filer couldn't qualify under § 9-317(e).

3. Suppose that Bank A extends a line of credit to Debtor's business, and has a prior-perfected security interest in all of the Debtor's equipment, including after-acquired. Debtor then buys a bulldozer from Seller. Seller takes a PMSI and perfects within the 20 day grace period so as to get priority over Bank A under § 9-324(a). Six months later, Debtor still has a substantial balance due on the contract but the contract has a high interest rate, and Debtor gets a more favorable loan from Bank B (lower monthly payments). Debtor uses the loan to pay off Seller, and grants Bank B a security interest in the bulldozer. Second Bank files a financing statement covering the bulldozer. First Bank still has a security interest in the machine, too, under its after-acquired clause. Does Bank A have priority under first to file, or does Bank B have a way to claim priority because it paid off Seller's loan and thus stepped in to the position of Seller, which would've had priority?

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 of Debtor's contract, Seller's security interest in the bulldozer after the refinancing would still be a PMSI, and would still be entitled to priority over Bank A under the PMSI priority rule in § 9-324(a).

The question is whether the law should reach the same result where a third party lender like Bank B refinances the debt by paying off (or "taking out") the Seller. Let me start by explaining how Bank B 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 Bank B a SI in the bulldozer, Bank B could have just paid Seller directly and had Seller assign its PMSI to Bank B. After that assignment, there's no question that Bank B would have simply stepped into the shoes of Seller. Bank B's SI would be a PMSI and would still have priority over Bank A (again, assuming Seller had originally perfected within the grace period in § 9-324(a)). Bank B 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 Bank B is now the secured party rather than Seller), although Bank B doesn't even have to file that amendment 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 Bank B 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, Bank B 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 Bank B to be subrogated to Seller's priority if that will not materially prejudice Bank A or other creditors. Here, there certainly wouldn't be any material prejudice to Bank A; if Seller had refinanced the loan itself, Seller would still have enjoyed PM priority over Bank A, so why should the result be any different if Bank B refinanced the debt instead?

I think the subrogation argument is a good one, and as the judge, I would rule in favor of Bank B. But there's a risk that some courts may refuse to grant subrogation, in part because Bank B could have easily taken a direct assignment of the existing PMSI from Seller and did not do so (thus perhaps implying that Bank B wasn't counting on having the same priority as Seller did). If the court doesn't use subrogation to protect Bank B, then the court is almost certainly going to say that Bank A takes priority under first-to-file-or-perfect. Bank B doesn't have a PMSI (Bank B's loan didn't enable the debtor to acquire the bulldozer; the debtor had already acquired rights in the bulldozer), and thus doesn't qualify for PM priority without the equitable subrogation argument.

4. We didn't talk about Problem 32.8, but I have a couple of questions about it. Would the feed supplier (Weil's Feed and Seed) be able to qualify for purchase money priority over Centurion? The question says that "WFS never served a § 9-324 notification on the bank," but would the inventory notification rule even apply? Wouldn't the feed be "farm products"? Or are farm products treated as inventory for purposes of the notification rule in § 9-324(b)?

The feed would indeed be "farm products," as it is "supplies used ... in a farming operation" under § 9-102(a)(34)(C). And the categories of goods (consumer goods, inventory, farm products, and equipment) are MUTUALLY EXCLUSIVE. If the feed is farm products, it can't be inventory. And for PMSI priority purposes, the § 9-324(a) purchase money priority rule for "goods other than inventory or livestock" would mean that a PMSI in farm products would be covered by § 9-324(a). Thus, if Weil's Feed and Seed had filed a UCC-1 financing statement covering the feed within 20 days after Murray Cattle Company took possession of the feed, then Weil's Feed & Seed's perfected PMSI in the feed would have priority over Centurion Bank's conflicting security interest in the feed under § 9-324(a).

So if Weil's Feed and Seed would have priority as to the feed, would that priority extend to the cattle as either proceeds of the feed, or as "commingled goods" under § 9-336? The cattle don't seem to fit the definition of "proceeds" or the definition of "commingled goods."

I don't think there's any substantial likelihood that a court would treat the cattle as "proceeds" of the feed. The cattle may have eaten the feed, and it probably helped the cattle become bigger. But the debtor didn't receive the cattle in exchange for the feed [Murray Cattle already owned the cattle, so the cattle aren't "proceeds" of the feed under § 9-102(a)(64)(A)], and the cattle probably are not "rights arising out of the collateral" under § 9-102(a)(64)(C), either. The cattle (and their increase in size) are not attributable solely to the collateral, but to all of the other inputs that go into raising cattle (water, medicine, veterinary care, electricity, etc.). So I don't think any court would say that the cattle are identifiable proceeds of the feed.

The "commingled goods" argument may be a little stronger for Weil's Feed & Seed, but not much. The classic example of "commingled goods" would be the one described in the comments to § 9-336, where SP-1 has a security interest in the Debtor's eggs, and SP-2 in the Debtor's flour, and Debtor takes the eggs and the flour and uses them to bake 100 cakes. At that point, the eggs and the flour are gone — their identity has been "lost in a product or mass" (i.e., the cakes). Thus, the eggs and flour are "commingled goods" under § 9-336, and the security interests of SP-1 and SP-2 are instead transferred to the product or mass (i.e., the cakes) under § 9-336(c).

For Weil's argument to work in this problem, you would have to say that the feed was "commingled goods" and the (presumably bigger) cattle were the "product or mass." But the comments suggest that "commingled goods" involves "commingling" of two sets of goods in a way that renders them both no longer identifiable (such as eggs and flour into cakes, or two sets of ball bearings into one mass of ball bearings). The problem here is that the cattle have not lost their identity just because they ate the feed and got bigger. The larger cattle are not really a "product or mass" produced by commingling. There are at least two reported decisions in which the courts have held that feed fed to cattle was not "commingled goods" (and thus that the feed supplier's SI in the feed did not attach to the cattle that ate the feed under § 9-336(c)). See, e.g., Farmers Coop. Elevator Co. v. Union State Bank, 4 U.C.C. Rep. Serv. 1 (Iowa 1987); First Nat'l Bank v. Bostron, 564 P.2d 964 (Colo.Ct.App.1977).