Question/Answer for Assignments 10 and 11 (Proceeds)

1. § 9-102(a)(64)(B) says that proceeds is "whatever is collected on, or distributed on account of, collateral." How could something be "proceeds" under this section without it already being proceeds under subsection (A) (what is received upon "sale, lease, license, exchange or other disposition")?

The term “collection” is a term that Article 9 uses in other contexts to describe the payment of an account or a payment intangible. Take this example. Suppose that Bank has a security interest in all of Doctor’s accounts, present and after-acquired. Doctor treats Patient, and bills Patient for the work (with payment due from Patient in 30 days). Doctor's right to payment is an "account" covered by Bank's security interest. Now assume that 30 days later, Patient pays off the account in cash. In the language of Article 9, the account has now been “collected.” Thus, the cash that the Patient paid would be proceeds of the account under § 9-102(a)(64)(B).

In this situation, there really hasn’t been any sale, lease, license, exchange of the account that would be covered by subpart (A). [Subsection (A) would be explicitly implicated, for example, if the Doctor had sold the account (before Patient had paid it) to a "factor" for cash or some other property, with the factor thereafter collecting the account directly from Patient.] But, the underlying account has been satisfied now that the Patient has paid — the Patient is no longer indebted to Doctor — and thus the money should be viewed as proceeds of the account. So subparargraph (B) would clearly apply in this case. You could argue that subsection (A) applies too — you could argue that the payment of the account was an "exchange" (the Patient swapping payment for satisfaction of the debt) or a "disposition." But the language of subparagraph (B) just makes it even clearer that the payment is "proceeds" of the account.

Likewise, take the example of a dividend paid on stock that is subject to a security interest in favor of Bank. When the corporation declares the dividend, there is no "sale" or "disposition" of the stock itself — the recipient of the dividend still owns the same shares they did before. So paragraph (A) doesn't fit. But the dividend is "distributed on account of" the stock, and therefore the dividend would be "proceeds" of the stock under § 9-102(a)(64)(B).

2. The comments to section 9-102 say that the phrase "distributed on account of collateral" is broad enough to cover "cash or stock dividends distributed on account of securities or other investment property that is original collateral." In the problem we discussed in class about the racehorse (whether the first prize from the horse winning a race constituted "proceeds" of the horse), why wouldn't the horse be "investment property" within the meaning of that language? People are pretty clearly making an investment decision buying racehorses, like they would buying risky stocks. So wouldn't the prize money be "proceeds"?

The problem with this argument is that the term "investment property" is defined by Article 9, and it means "a security" — in other words, a stock, a bond, a securities account, or the like. While a horse may be an "investment" in an economic sense and in that way analytically similar to an investment in stocks, I doubt a court would characterize a horse as a security. As we mentioned in class, if I were taking a security interest in the horse, and I expected for my security interest to also reach the horse's race winnings, I would make this explicit in the security agreement rather than relying solely upon any argument that the race winnings were proceeds of the horse.

3. We didn't finish problem 10.6 in class (the problem where Golan paid the $32,000 to buy a new copier). If I understand the lowest intermediate balance rule right, at the time of that payment, the deposit account contained $3,000 of nonproceeds and $35,000 in proceeds (the insurance funds from the damaged copier). So after this $32,000 payment, the account would have only $6,000 left (all proceeds), meaning that $3,000 of the price was nonproceeds and $29,000 of the price was paid using proceeds. That would seem to imply that the new copier is, at least in part, proceeds of the insurance money (which was proceeds of the old copier).

If that's right, then here's my question: Does the secured party have a security interest in the entire copier? Or only 29/32 of the copier?

The former. Golan didn't buy "shares" of a copier, it bought an entire copier. Golan paid over $29,000 of the secured party's collateral and, in exchange, received a copier. Thus, the entire new copier is now the secured party's collateral as second-generation proceeds of the original copier. [This makes good sense as a matter of policy; it wouldn't make sense to say that the secured party's interest is only in 29/32 of the copier; the secured party would be unlikely to sell a 29/32 interest in the copier for a price that reflected 29/32 of its actual value; people interested in copiers want entire copiers, not 29/32 interests in copiers!]

If the secured party has a security interest in the new copier as proceeds, does it still have a security interest in the $6,000 of cash proceeds left in the deposit account?

Yes. Under the lowest intermediate balance rule, that $6,000 in the account is still proceeds of the original copier.

What if Golan then took that $6,000, along with $20,000 in other cash, and bought a car? Would the car be "proceeds" and thus would the secured party have a security interest in the entire car?


4. A question about the lowest intermediate balance rule and Problem 10.5, where the debtor paid $32,000 to the IRS for taxes. Under the lowest intermediate balance rule, you said that left $6,000 in the deposit account, all of which was proceeds of the original collateral (the copier). What if, the next day, the debtor gets other cash (say debtor wins the lottery) and puts the $32,000 back in the deposit account. Does that restore the secured party's interest back to $35,000, like it was before the payment to the IRS?

No. Whatever money debtor puts into the account keeps its basic character. If the debtor gets $32,000 in lottery winnings, that wouldn't have been "proceeds" of the secured party's collateral, so it would be nonproceeds both before and after it went into the account. By contrast, if the debtor gets another $20,000 from the insurance company because the insurer realizes that it should have paid $55,000 for damages to the copier (and that it wrote the original $35,000 check in error), and the debtor puts that $20,000 into the deposit account, it would increase the "proceeds" balance in the deposit account up to $26,000.

To give you the benefit of questions posed by students in the class before, I'm also including two other questions that came up from prior year's classes:

5. 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. 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. 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.

6. Suppose that Debtor owns a museum, and grants Bank a security interest in all of the artwork on display in the museum. The museum charges $25 admission. Is the admission fee "proceeds" of the artwork? Is this money "collected on account of ... the collateral" within the meaning of § 9-102(a)(64)(B)?

The Bank could try to make the argument, but I think Bank would probably lose. While §§ 9-102(a)(64)(B) and (C) are a little ambiguous, I don't believe a court would stretch them this far. The problem is that there is no transaction that is specific to the sculptures. There’s no lease, license, etc. that could be covered by (A). [By contrast, if the Debtor loaned one of the paintings to another museum for a price of $10,000, that $10,000 would be proceeds under paragraph (A).] There's no disposition of any rights in the artwork (a license to enter the museum to see the art doesn't give me any right in the art itself, it just means I'm not trespassing on the museum's land), so paragraph (A) wouldn't apply. It's also hard to say that the admission fee is clearly related to any particular item of collateral, or even to all of the collateral, so as to say it was "collected" on account of the art. Lots of museums in major cities charge $20 or $30 for admission not because of the value of the art (though the collection may have significant value), but because of the cost of having a museum located on pricey urban land. The admission fee is in part because of the collection, but it is in part because of the docents, the building, the utilities, the janitorial staff, etc.

So because there’s been no transaction in which any interest in the collateral has been exchanged, and no event that has had the effect of diminishing the value of the collateral, and since the admission fees are not purely a return upon the economic value of the collateral, I think a court might more likely say that § 9-102(a)(64)(B) does not apply.

I suppose that if the museum separately charged you $5 to view one particular piece of art, and Bank had a security interest in that particular piece of art, you could make a stronger argument that the $5 additional charge was proceeds of the artwork within the meaning of § 9-102(a)(64)(B). But that's a pretty unlikely scenario.