Question/Answer for Assignments 8 and 9

1. On page 151, the casebook is talking about the Article 9 generic collateral types and its says "When parties use one of these terms in a security agreement, the courts usually (but not always) give the term its Article 9 [meaning] rather than its common meaning. We think the courts are often wrong in doing so; the results can easily be contrary to the intention of parties who were not even aware of the Article 9 definitions of the words they were using." I don't understand. If the court is interpreting a security agreement, and Article 9 provides the background rules for secured transactions, doesn't it make perfect sense for the court to give the term its Article 9 meaning?

I think that when the casebook authors say that "courts are often wrong in doing so," they are seriously overstating their case. Their statement suggests that more often than not, parties to security agreements are unsophisticated and unaware of the existence of Article 9 or its definitions. But that's an empirical question, and they certainly haven't provided empirical evidence to support that proposition.

My own view — and that of the Article 9 drafters — is that the majority of transactions involves "repeat players" (e.g., frequent lenders and borrowers) who are sufficiently familiar with Article 9 that it probably makes more sense to conclude that when they used the term "accounts," they meant accounts as defined in § 9-102(a)(2), not "accounts" as that term would be understood by whatever freshman English major you stopped outside of the General Classroom Building or Ellis Library. The drafters viewed these sort of "repeat players" as presumptively capable of signaling (by providing their own agreement-specific defined terms and definitions) their intention to define terms differently from the Article 9 definitions.

The authors are correct that it is possible that a particular debtor may have had a different understanding about what an "account" was. Keep in mind, though, that a "security agreement" (note the lowercase) under Article 9 doesn't necessarily mean just the document entitled "Security Agreement." If the "Security Agreement" described the collateral as "accounts," but there are contemporaneous writings or correspondence between the parties that indicated that they thought or understood this term would include "bank accounts," then the court could and should conclude that their "security agreement" covers the debtor's bank accounts — even though they are not "accounts" as defined in Article 9. In other words, under a "composite documents" approach, the extrinsic evidence that proves the parties intended a broader definition of "accounts" could come from outside of the "Security Agreement" document itself.

2. Suppose that a creditor loans money to debtor and takes a security interest in debtor's car. Debtor is a caterer, and uses the car for both business use (delivering catered goods) and for personal use (the family car). Is the car "equipment," or is it "consumer goods," 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 will decide whether the car is a consumer good or equipment. It can'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.").

However, in terms of planning and documenting this transaction, it should not matter to the creditor whether the debtor's primary use will be personal or for business. All the creditor has to do to create an effective security interest in the car is to describe the car specifically; the creditor doesn't have to use a generic description. The creditor can have the debtor sign a security agreement that says the collateral is "Debtor's 2011 Honda Accord" (assuming that's what the debtor's car is). If the security agreement describes the car specifically, it really doesn't matter whether the car is consumer goods or equipment.

Whether the car was "consumer goods" or "equipment" would only matter, for attachment purposes, if the parties had entered into a security agreement that generically described the collateral as "all of the Debtor's equipment." 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 car more frequently for business use than for personal use, a court should conclude that the car was "equipment" (and thus covered by the security agreement). If the debtor expected to use the car primarily for personal use but occasionally to deliver catered meals, then the description "all of the Debtor's equipment" would not be sufficient to cover the car. Ultimately, this would be a question of fact that would have to be determined by the court.

Following up, what if the debtor originally bought the car for business use, but then changed that use and now uses it only for personal use? Would the car cease to be "equipment" and become "consumer goods"? If the security agreement had covered "all of the Debtor's equipment," would that mean that the car was no longer collateral once the debtor's use changed? That would seem like a bad rule because the debtor could defeat the creditor's interest unilaterally by changing how it used 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. The creditor would not lose its security interest in the car just because Debtor changed its use of the car after entering into the transaction.

3. In one of the problems in the book, the creditor took a security interest in "all of the Debtor's equipment and accounts," but without specifically stating that it covered "after-acquired" equipment and accounts. In class, you suggested that courts tend to interpret a security interest in "accounts" or "inventory" to implicitly cover after-acquired, but that courts are more reluctant to interpret a security interest in "equipment" to implicitly cover after-acquired equipment. That makes sense if you look at them separately, but what if "equipment" and "accounts" are in the same security agreement? Wouldn't that make a difference? Could the lender argue that since the parties would've understood "accounts" to include after-acquired accounts, the court should also interpret "equipment" to include after-acquired equipment?

That's a very good argument on the lender's behalf, as a matter of contract interpretation. It's probably the best argument you can make. Is it good enough? Maybe it would win, maybe it wouldn't. It would certainly help your argument for the lender if there was any other extrinsic evidence that could corrobarate that the parties intended that after-acquired equipment would also be collateral.

4. I'm confused about the term "consumer transaction." Wouldn't any transaction involving a security interest in consumer goods be a "consumer transaction"?

The term "consumer goods" describes the collateral itself, and thus whether something is consumer goods depends upon how the debtor intends to use it (i.e., if it is intended to be used for personal, consumer, or household purposes, it is consumer goods under § 9-102(a)(23). The term "consumer transaction" refers to the characteristics of the loan itself. Thus, a loan transaction could involve "consumer goods" as collateral without the transaction being a "consumer transaction" under § 9-102(a)(26).

The term "consumer transaction" is defined in § 9-102(a)(26), and means "a transaction in which (i) an individual incurs an obligation primarily for personal, family, or household purposes, (ii) a security interest secures the obligation, and (iii) the collateral is held or acquired primarily for personal, family, or household purposes."

Thus, consider these three examples:

Example A. Freyermuth borrows $10,000 from Gely to pay for his child's school tuition. Freyermuth signs an agreement that purports to grant Gely a security interest in "all of Debtor's consumer goods." Because Freyermuth incurred the debt for a family purpose (his child's education), and because the intended collateral is consumer goods, the transaction is a "consumer transaction." As a result, because the collateral is described ONLY by type, the agreement does not reasonably identify the collateral, and Gely does not obtain a valid security interest in any of Freyermuth's consumer goods. [This is an example of the application of the rule in § 9-108(e)(2), which provides that in a consumer transaction, a description of the collateral using the generic descriptor "consumer goods" is not sufficient.]

Example B. Freyermuth borrows $10,000 from Gely to pay for his child's school tuition. Freyermuth signs an agreement that purports to grant Gely a security interest in "all of Debtor's consumer goods, including, among other things, Debtor's 2002 Honda Accord." Because Freyermuth incurred the debt for a family purpose (his child's education), and because the intended collateral is consumer goods, the transaction is a "consumer transaction." Because all of Freyermuth's consumer goods other than the Accord are described ONLY by type, the agreement does not reasonably identify any of Freyermuth's consumer goods other than the Accord, and thus Gely does not obtain a valid security interest in any of Freyermuth's consumer goods other than the Accord. § 9-108(e)(2). However, the Accord is not described ONLY by type; it is also described by specific listing, which is a recognized manner of description as per § 9-108(b)(1). Therefore, Gely would obtain a valid security interest in the Accord (but not in any of Freyermuth's other consumer goods).

Example C. Freyermuth borrows $10,000 from Gely to meet the payroll for his restaurant and bar, "Tar Heel BBQ." Freyermuth signs an agreement that purports to grant Gely a security interest in "all of Debtor's consumer goods." Because Freyermuth incurred the debt for a business purpose (payroll expenses of his business), the transaction is not a "consumer transaction," even though the intended collateral is consumer goods. As a result, the fact that the collateral is described ONLY by type does not trigger the applicability of § 9-108(e)(2); the agreement does reasonably identify the collateral, and Article 9 would provide Gely with a valid security interest in all of Freyermuth's consumer goods (at least all those Freyermuth owned at the time he entered into the security agreement).

So what's the difference between a "consumer transaction" and a "consumer goods transaction," and why does it matter?

There is a difference, but it is pretty subtle. Any "consumer goods transaction" will also be a "consumer transaction." A "consumer goods transaction" is essentially a consumer transaction where the collateral is "consumer goods." Sometimes, though, in a consumer transaction, the collateral could be held by the debtor for personal use but it might not be consumer goods. For example, suppose that the collateral is 500 shares of Apple stock which the debtor holds as a personal investment. The debtor may be holding that for its personal use, but the stock isn't "goods" and thus isn't "consumer goods." Instead, the stock would be "investment property." So a loan transaction in which the borrower was borrowing the money for a personal purpose (paying his son's tuition) and putting up the stock as collateral would be a "consumer transaction" but not a "consumer goods transaction."

The difference might or might not matter, depending upon the context. Some of Article 9's consumer-protective rules apply to "consumer transactions" (like § 9-108(e) and the exception to the rebuttable presumption rule in § 9-626(b)), and others apply to "consumer goods transactions" (like the enhanced notification requirements for the notice of disposition in § 9-614).

5. Why wouldn't a tractor or a combine be "farm products"? The debtor's farming operation will eventually consume all of the economic value of the combine, so wouldn't it be "supplies used ... in a farming operation"?

If you look at the definition of farm products in § 9-102(a)(34), you'll see that it is limited to property that (a) is owned by persons engaged in a farming operation and that (b) is either (i) crops, (ii) livestock, (iii) "supplies used or produced in a farming operation," or (iv) products of crops or livestock. Clearly, a tractor isn't crops, livestock, or products of crops or livestock. So it can't fit into "farm products" unless we consider a tractor to be "supplies used ... in a farming operation."

This reinforces a point about Article 9's distinction between inventory and equipment. If something used in business is a fixed long-term asset, like a machine, Article 9 treats it as equipment. If it is used up or consumed in operating a business, like paper clips, paper, copier toner, staples, coffee and bottled water in the break room, etc., it is inventory [see § 9-102(a)(48)(D)]. This distinction is further discussed in Comment 4a to § 9-102. So "supplies used ... in a farming operation" would include things like seed, fertilizer, oil and gas for the tractor, and the like, but it wouldn't include a tractor or a combine. They would be equipment, if the debtor acquired them for use in a farming operation.

6. In class, you were talking about specific vs. generic collateral descriptions. Why not always provide a specific description of the intended collateral? Wouldn't that be better than a generic descriptor?

Not necessarily. If I'm lending the debtor money to finance its entire business operation, and I'm taking a security interest in all of the debtor's business assets, providing a specific description of every intended article of collateral would be a giant pain in the butt. I'd have to sit down with an employee of the debtor and generate a comprehensive listing of each and every one of the debtor's business assets. That list may go on for dozens or hundreds of pages (depending on the size of the businsess), and compiling it may take hours or even days. Why do that if the generic description "all of the debtor's inventory, equipment, accounts, and general intangibles, presently owned and after-acquired" will work just as well?

Also, there's the Article 9 codicil to Murphy's Law — "If the parties try to list each item of intended collateral in the Security Agreement, they WILL screw it up and omit something important from the list." Where the parties intend for the security agreement to cover ALL assets of a particular type, using a generic descriptor mitigate or eliminate the risk of omitting something.

7. You didn't specifically go over some of the hypos in Problem 9.1 on page 161, specifically (d) ("all of the debtor's consumer goods") and (e) "all of the debtor's goods other than consumer goods." Would those descriptions be sufficient?

The description "all of the debtor's consumer goods" is NOT sufficient if it used in a security agreement in a consumer transaction. [This point is also made in the answer to question 4 in this Q&A memo.] Section 9-108(e)(2) says that the generic "all consumer goods" descriptor is not a sufficient description in a consumer transaction. This is a policy judgment that the drafters made that consumers might be unlikely to appreciate that a security agreement might cover all of their consumer goods if they were signing a security agreement in the context of buying a car, for example (in that case, they'd expect the agreement to cover the car, but not everything else they own).

The description in part (e), "all of the debtor's goods other than consumer goods" is a tough one. Section 9-108(c) makes clear that a "supergeneric" description such as "all of the debtor's assets" or "all of the debtor's personal property" is not a sufficient description to satisfy the section 9-203(b) requirement that the security agreement contain a description of the collateral. But section 9-108(b)(3) makes clear that a description by "type" of collateral (a mere "generic" description rather than a "supergeneric" one) is sufficient.

So is "all goods other than consumer goods" a valid generic description or an invalid supergeneric description? I think the drafters would say it was the former, because "goods" is a "type" of collateral defined in the UCC, and thus section 9-108(b)(3) would appear to validate that description. Your casebook authors think it is invalid, because it is as all-encompassing as a supergeneric description and thus is of "similar import" and thus should fail under section 9-108(c). I would tend to disagree with them, but I would also say that it would be a bad idea for a secured party to use this collateral description and run the risk that they end up in court, where opposing counsel may be able to successfully persuade the judge that the description is equivalent to a "supergeneric" and thus insufficient. It isn't worth the risk, especially where the creditor could instead describe the collateral as "all of the debtor's equipment, inventory, accounts, general intangibles, farm products, money, investment property" (naming every type of potential UCC collateral). That kind of description is clearly sufficient under section 9-108(b)(3), so the secured party would be ill-advised to use the "all goods other than consumer goods" description.

One final question --- asked by someone in last year's class, but such a good question I'll share it with this year's class too.

8. The Understanding book (p. 73) implies that the rule in § 9-108(c) about how a creditor can't use a "supergeneric" collateral description in a security agreement is a bad rule (you call it "debatable"). You seem 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, unconscionability, adhesion, mistake, etc. to invalidate overreaching agreements. I think that argument boils down this: "Let everybody have freedom of contract, and trust that courts will use existing contract doctrines to weed out the most egregious abuses." That puts WAY too much faith in the judgment of courts. Courts almost never say that a contractual provision is unconscionable. It doesn't seem like a bad policy choice for the legislature to make 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 will probably fail 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. Having said that, I think it would have made more sense for Article 9 to permit supergeneric descriptions in general, but then not allow them in consumer transactions. But the drafters of Article 9 made their policy choice, and you've made what I think is the strongest argument in support of that choice.