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The Basic Checking Relationship and the Banks Right to Pay Checks
a. General
i. The Basic Relationship
1. 3-103(a)(2), 4-104(a)(8), 4-105(3): Definition of drawee or payor bank
2. 3-103(a)(3), 3-105(c): Definition of drawer or issuer
3. 4-105(2): Definition of depositary bank
4. 4-105(4): Definition of intermediary bank
ii. Promulgation of Rules
1. Both Federal and State law makes rules. 4-103(b) acknowledges the preemptive
effect of rules that are promulgated by the federal rules over state rules
iii. The UCC
1. Article I is general principles that apply to all substantive topics covered by the
a. Definitions in 1-201(b)
b. Obligation of Good Faith in 1-304
2. Article III is negotiable instruments
3. Article IV is Bank Deposits and Colllections
b. The Banks Right to Pay
i. When is it proper for the Bank to Pay?
1. 4-401(a): A Bank can pay only when the check is properly payable
a. It is properly payable if the customer has authorized the payment. 4401comment 1
2. If a check is given to an intermediary bank, then the intermediary becomes a
person entitled to enforce the check. 1-201(b)(25), (27)
3. If a check is stolen through no fault of the payee, the bank does not have the right
to pay the check. 4-401 comment 1, sentence 5-7.
c. Overdrafts
i. The payor bank can charge the account, but (absent some specific agreement) it is also
free to dishonor the check and refuse to pay it. 4-401(a), 4-402(a)
ii. McGuire v. Bank One, Louisiana, N.A.
1. Man representing himself as investment broker offers to sell woman bonds. She
writes him $200,000 check, says not to cash it until later date. He cashes right
away, and money has not transferred from her investment account into another
account, creating an overdraft of $188,000. He does not buy bonds with her
money, but keeps it for himself (conversion). She believes bank failed to exercise
ordinary care. Held, Bank had the right to cash the check. (1) The check was
properly payable under 4-401. (2) 4-401 permits a bank to charge a properly
payable check against a customers account even if an overdraft results. (3) Under
4-103 the bank must exercise ordinary care. (4) B/c the check was properly
payable under 4-401(a), this is ordinary care under 4-103. (5) Case law has shown
that it doesnt matter how big of an overdraft that is caused, it does not affect
ordinary care.
iii. Rationale for Overdraft Acceptance
1. Rule that required banks to pay overdraft would be unduly burdensome for banks
that would have to deal w/holding the bag if nobody reimbursed them

2. Rule that required banks not to pay overdrafts would be unduly burdensome on
customers who would have bad credit and bounced checks
iv. Banks can agree to pay overdrafts, and thus become obliged to do so. 4-402(a) states
that a bank may dishonor an item that would create an overdraft unless it has agreed to
pay the overdraft and 4-103(a) states that the effect of the provisions of this Article
may be varied by agreement.
1. The UCC does not regulate how much banks can charge in overdraft fees.
However, some state courts have found that a huge charge violates the banks
obligation of good faith if charge was not in the reasonable contractual
obligations of the parties and some courts have found them unconscionable.
v. Banks are allowed to pay checks in ANY order they choose. 4-303(b)
d. Stopping Payment
i. Customer must give the payor bank timely and adequate notice of the stop payment. 4403
ii. Bank cannot charge account over a stop payment order. 4-403 & Comment 7
iii. Three considerations limit the practicality of the customers right to stop payment:
1. The customer must act promptly to exercise the right. 4-403(a)
a. Received at a time and in a manner that affords the bank a reasonable
opportunity to act on it before any [final] action by the bank with respect
to the item.
i. Unlikely to work if stop payment comes more than a few days after
check has been written
2. The duration of the stop payment order is six months, and can be revived by the
payee after that. 4-403(b)
3. The underlying obligation for which the check was written.
a. Payee has two separate rights on the check:
i. The right to enforce the check
ii. The underlying obligation
b. To handle these two rights, UCC provides two rules:
i. 3-310(b): UCC suspends the payees right to pursue the customer
on the underlying transaction when the payee accepts the
customers check.
ii. 3-310(b)(1): The statute provides that the suspension ends if the
check is dishonored.
e. Remedies for Improper Payment. 4-401
i. Bank must reverse the improper transaction. B/c item was not properly payable, the bank
cannot sustain the charge on the customers account. Bank must thus recredit.
1. Statute also provides for consequential damages in cases which the charge to the
account leads the bank to dishonor other checks. Must pay damages to the
customer for all things proximately caused. 4-402(b)
ii. 4-407 sharply limits the recredit issue. 4-407 subrogates the banks rights to the rights
of the payee so that the bank can assert the payees rights against the drawer as a defense
to the banks obligation to recredit the account.
1. Case: McIntyre v. Harris


The Banks Obligation to Pay Checks

a. When are funds available for payment
i. The bank has the option to pay any item that is properly payable from the customers
1. When the account has funds available the bank has an affirmative duty to pay
the account
ii. Two questions must be answered:
1. When is the determination made?
2. What is the balance in the account at that time?
b. Time of Evaluation
i. The statute essentially chooses the moment that the payor bank evaluates the check as the
the point in time when the account must have sufficient funds
ii. Under 4-402(c), the bank is free to determine whether the account has sufficient funds
at any time between the time the item is received by the payor bank and the time that the
payor bank returns the item.
1. Dishonor remains appropriate notwithstanding new credits to the account after the
bank has evaluated the sufficiency of the funds in the account.
c. Availability of funds
i. Reg CC establishes a framework of deadlines within which a depositary bank must
release funds that its customers deposit by check.
1. Unlike UCC 4-215, those deadlines apply even if the depositary bank does not
determine by the deadline if the payor bank will honor the check in question.
ii. First, distinguish among four separate dimensions:
1. General
a. Customer deposited in the form of local check
b. Customer deposited non-local check
i. Non local check is any check drawn on a bank located outside the
check-processing region of the bank at which the check is
c. Customer wishes to use funds indirectly (writing checks against them)
d. Customer wishes to use funds directly (withdrawing cash).
2. Noncash withdrawls from local checks
a. The bank must make $100 available on the first business day after the
banking day on which the funds are deposited.
b. The rest must be available for withdrawal no later than the second
business day
3. Noncash withdrawls from nonlocal checks
a. The bank has to make $100 available on the first business day after the
banking day on which the funds are deposited.
b. The rest must be made available for withdrawal no later than the fifth
business day after the . . .
4. Cash withdrawals from local checks
a. The bank must make $100 available on the first business day after the
banking day of deposit
b. Must make an additional $400 available the second business day
c. Must make remainder available on third day








5. Cash withdrawals from non-local checks

a. Must make $100 available on the first business day
b. Must make additional $400 available on the fifth business day
c. Must make remainder available on the sixth business day.
Banking v. Business Day
1. Banking Day: Those business days on which the bank is open for carrying on
substantially all of its banking functions
2. Business Day: All calendar days except Saturday, Sunday, and Federal Holidays
Seven ways you can get all available funds the next day. However, you must be (a) the
original payee of the instrument and (b) personally deposit the item (no ATM):
1. Cash Deposits
2. Checks drawn on a local branch of the bank where they are deposited
3. US Treasury Checks
4. USPS money orders
5. Checks drawn on a federal reserve bank or federal home loan bank
6. Checks drawn on a local governmental entity
7. Cashiers Checks or similar items drawn on banks
Low-risk items that are not deposited with a teller in the payees own account:
1. A treasury check or Postal Service money order deposited by somebody other
than the original payee is treated as if it were a typical local check
2. If a Federal Reserve Check, local government check, or cashiers check is
deposited by somebody other than the original payee, the check is processed
under the standard rules, with the availability of funds depending on whether the
check is a local or non-local check
Low Risk items deposited in an ATM:
1. If Cash, Postal Service Money Order, Federal Reserve Checks, Local Government
Checks, or Cashiers Checks are deposited at an ATM into an account owned by
the payee of the check, the availability is deferred a single day, to the second
business day.
a. So, customer cant get shit until 2nd business day ($100 then)
Justification for prompt funds availability
1. First, Reg CC doesnt unconditionally obligate the bank to release funds
2. Second consideration is convenience
3. Third, the likely long-term effects of giving banks the risk of loss that they face if
deadlines force them to release funds without determining whether a check will
4. First National Bank v. Colonial Bank (Check Kiting Scheme/Risk of Loss)
Wrongful Dishonor: What happens in a bank refuses to pay
1. If a bank doesnt pay a check it was obligated to pay, it has wrongfully dishonored
the check
2. Customer is entitled to all of the damages proximately caused by the wrongful
dishonor. UCC 4-402(b)
a. Maryott v. First National Bank

Collection of Checks

a. The Payor Banks Obligation to the Payee

i. Although the payor bank might be liable to the drawer for wrongful dishonor, the payee
itself can usually do nothing to force the payor bank to pay the check
1. Illustration: Outdoor Technologies v. Allfirst Financial, Inc.
a. H gave a $700g check to Outdoor for outstanding payments. The check
stated it was drawn on an account at FNB, but it was actually drawn on
Omni Bank. Outdoor wanted to get the check cashed as quickly as
possible because H was about to institute bankruptcy proceedings.
Outdoor sent someone to drive to a branch of FNB to cash it. They said it
was an Omni check, that Omni was owned by BankCorp. and to call the
lawyer of Omni/BankCorp. Lawyer says neither bank has to cash it however, he says that if the guy goes to the closest Omni branch and
presents proper authorization they will cash it. When he got to the
branch, the lawyer said a letter wasnt proper authorization, that he
needed board approval. He couldnt get it in time, and H filed
bankruptcy, freezing the accounts. (1) There is no fraud by the lawyer. (2)
No negligent Misrepresentation.
ii. If the payee is concerned that the payor bank wont pay, it can protect itself:
1. Payee could refuse to accept an ordinary check
2. Ask for a special check that offers an assurance the bank will pay it
a. Payee can ask for a certified check under 3-409(d)
b. Ask for a cashiers check or tellers check. 3-104(g), (h)
i. These require inconvenience to get
b. The Process of Collection
i. Payee has two options to collect on a check:
1. Go directly to the payor bank and Obtain Payment Itself
a. Cash the check, by presenting it for immediate payment over the counter
i. If payor bank cashes, payment is final. 4-215(a)(2), comment 4 p 5
b. If payee has account at same bank as drawer
i. The bank sees this as an on us item
ii. Will give the depositor a provisional credit on the day it receives
the item
iii. As long as the payor bank provides that provisional settlement on
the day it receives the item, the payor bank has until its midnight
deadline midnight of the next banking day to decide whether
to honor the check. 4-301(a), (b).
1. If honored, it adds to payees account and deducts from
2. If dishonored, notice is sent to payee/customer.
a. Then, can charge back payees account
3. If bank does nothing by midnight deadline, it loses its right
to dishonor the check. 4-214(c), 4-301(b).
2. Obtain payment through intermediaries: Two Steps
a. Payee Depositary Bank

i. First, an agency relationship is set up between the bank and the

customer. 4-201.
1. Thus, the depositary bank becomes the collecting bank
2. Also, comes with a duty of ordinary care. 4-202(a)
ii. Second, bank gives provisional settlement, reserves its charge back
right if the payor bank doesnt honor the check. 4-214
b. Depositary Bank Payor Bank
i. Depositary Bank has broad discretion on how to collect
1. Must move quickly to meet funds availability rules
ii. Typically, the check (paper) is transmitted to the payor bank, who
pays it
3. Methods of transmission
a. Clearinghouse Arrangements
i. See p. 347 for a clearinghouse hypo
ii. Note: If bank doesnt follow clearinghouse rules regarding a
provisional settlement, it can lose its right to dishonor under the
1. Cant recover from depositary bank, clearinghouse, or
payee after that
iii. See: Kimberly Allen Trust p. 348
iv. Trust deposited into its account with Lakewood a $110g check.
Lakewood presented to the payor bank the check the day after it
was received, and placed a hold on trust account pending payment
of the check. Lakewood received a provisional credit. After payor
bank notified Lakewood the check had cleared, the hold was lifted
from the account. Five days later, the payor bank said it was
returning the check for insufficient funds, and Lakewood charged
back the account and a fee. Trust filed action seeking its funds
from Lakewood. (1) Under 4-214, a bank loses its right to charge
back when payment becomes final. (2) Under 4-215(d), after
payment becomes final, the bank is accountable to the customer for
the item and any provisional credit when it becomes final. (3) 4215(a) tells when something is finally paid. (4) Pursuant to 4302, if an item is presented to and received by a payor bank, that
bank is accountable for the amount of the demand item if it
retains the item beyond midnight of the banking day of receipt
without settling for it or, whether ot not it is also the depositary
bank, does not pay or return the item, or send notice of dishonor
until after its midnight deadline (midnight of the next banking day
after receipt.
b. Bilateral Arrangements (Direct Send and correspondents clearing)
i. A pair of banks that have a relationship a lot of checks drawn on
them each day - will enter into this type of relationship
contractual, where they give provisional credits and then send the
checks to the bank.
ii. Cheaper and Faster than the Federal Reserve method

c. Collection Through the Federal Reserve System

i. System of last resort because it is most expensive and slower
ii. Send to Federal Reserve Bank, who sends it to Payor bank
must honor or notify by midnight deadline
iii. If the payor wants to dishonor, go to Reg CC:
1. The Reg CC return deadline:
a. Payor bank must return the check in an expeditious
manner in order to meet one of two deadlines:
i. Two Day/Four Day Rule:
ii. Requires the dishonoring payor bank to send
the check so that the check would normally
be received by the depositary bank not later
than 4pm on the deadline: the fourth
business day for nonlocal checks; the second
business day for local checks. CC 229.30(a)
2. Reg CC and the UCC midnight deadline
a. Whereas the UCC deadline requires the payor bank
to put it in the mail by midnight of the next banking
day, Reg CC allows them to wait until the next day
if they use a mode of delivery that results in a faster
return than the midnight deadline
b. First extension, deadline is waived if you return the
check to the transferor (Fed Reserve Bank) by the
day after the midnight deadline
c. Second extension waives the midnight deadline if
the payor bank uses a highly expeditions meas of
transportation, even if this means of transportation
ordinarily would result in delivery after the
receiving banks next banking day.
3. Reg CC notice of non-payment deadline
a. A payor bank that dishonors a check for $2500 or
more must get notice of its determination to the
depositary bank by 4pm on the second business day
after the banking day on which the payor bank
received the check.
i. Whether non-local or not
ii. Allows depositary to release funds the
second business day after the banking day
d. Difference between failure to meet the Reg CC rules and failure to meet
the midnight deadline:
i. Failure to meet the deadline affects the settlement process:
1. Payor bank becomes accountable for the item under 4302, payment becomes final under 4-215, and depositary
bank loses any right of charge back under 4-214
ii. Failure to meet Reg CC:

Midnight Deadline
Reg CC return

Reg CC notice

Action Required
Send the item by midnight on UCC 4-301(a), 4-104(a)
the next banking day unless
(10), 1-201(38); Reg CC
Reg CC extends the deadline
Return the Item to the
Reg CC 229.30(a)
depositary bank either by the
two-day/four-day rule or by
the forward collection rule
If the item is for $2500 or
Reg CC 229.33
more, give notice to the
depositary bank by 4pm on the
second business day
1. Generally limited to damages CC 229.38
e. Common Practice: Return notice over the Electronic Earns System(359)


Risk of Loss in the checking System The Basic Framework

a. There are two tiers that address the issues of risk of loss in the Checking System
i. Tier One: A Basic Framework that distributes losses based on generalized assumptions
about the relative abilities of parties to prevent certain types of losses
ii. Tier Two: Several situation-specific exceptions to the general first-tier rules
b. Basic Tier One Problems
i. Nonpayment
1. General
a. Two fundamental elements of the system make nonpayment losses
relatively common:
i. (1) The payees inability to know when it takes a check whether
the payor bank will honor it
ii. (2) The relatively long delay between the time that the payee
accepts the check and the time that the payee finds out whether the
check will be honored
b. UCC 3-415 is the principal indorser liability statute
2. Endorsements
a. 3-204: Endorsement itself need be nothing more than a signature by the
person selling the check
b. 3-205(b): This is a blank indorsement has the legal effect of making
the check bearer paper so that the any party in possession of the
check can enforce it
c. Or, endorsement can be a special endorsement payable to a specified
person, entity, etc.
i. 3-205(a): This makes the check order paper which can be
enforced only by the identified party
d. Or, the party can endorse the check for deposit only or for collection.
i. 3-206: This is called restrictive endorsements which restrict the
right of later parties to transfer the check except in accordance with
the endorsement.
3. UCC rules on indorsements and indorsement liability
a. 3-415: each party that indorses a check makes an implied contract with
subsequent parties that acquire the check. That contract obligates the
indorser to pay the check if the payor bank dishonors it.
b. The rule results in a chain of liability under which each party can pass
a dishonored check back up the chain to the last person in the chain
that is able to pay (the earliest indorser)
c. 3-414(b): Liability on the drawer of the insolvent check
4. Protecting the indorser from liability on stale obligations
a. 3-415(e): The indorsers liability is conditioned on the checks being
deposited or presented within 30 days of the indorsement or the indorser
has no liability
b. 3-415(c): Any person seeking to enforce a claim of liability on an
indorsement to give prompt notice of the dishonor to the indorser.
c. 3-503(c): If the person giving the notice is a collecting bank (both
depository and intermediate banks (4-105(5)), it must give notice by

midnight of the banking day after it learns of the dishonor. In all other
cases, the notice must come within 30 days.
5. Avoiding indorsement liability
a. 3-415(b): All the indorser must do to disclaim the liability is to add the
phrase without recourse to the indorsement. If an indorsement is
made without recourse, subsequent owners of the check cannot sue the
indorser even if the check is dishonored.
ii. Forged Signatures
1. General
a. Responses from the system
i. The first response of the system is the obvious one that the
unauthorized signer the thief should be responsible for all
losses caused by the forgery
ii. The difficult task is to determine who is liable in the event that the
unauthorized signer cannot be located
b. Forged Drawers Signatures and the Rule of Price v. Neal
i. The check is a complete forgery
ii. The allocation of losses from that kind of forgery depends on
whether the payor bank (a) is duped into paying the check or (b)
notices the forgery and dishonors the check
c. Payor Bank Pays the Forged Check
i. Price v. Neal: Payor Bank bears the loss if it fails to notice the
forgery and honors the check (check was not properly payable
because the drawer never authorized it)
ii. 4-401(a): payor bank has no right to charge the account if drawer
doesnt authorize it
d. Two exceptions that allow a shift in liability
i. 3-418(a)(ii): payor bank can seek recover from the person to
whom or for whose benefit payment was made.
ii. 3-418(c): Does not apply against a person that took the instrument
in good faith
iii. 4-208: series of implied presentment warranties in favor of the
payor bank. If any of those warranties if false, the payor bank can
recover from the party that presented the check to the payor bank
or from any previous transferor in the chain of collection of the
iv. 4-208(a)(3): Warranty liability if the transferor had knowledge that
the signature of the drawer was unauthorized
1. 1-202: Distinguishing between knowledge and notice
v. It makes some sense to leave the responsibility of loss with the
payor bank. A legal rule that puts the losses from forged checks on
payor banks gives payor banks every incentive to work to develop
institutions that limit losses from forged checks
e. Payor Bank Dishonors the Check
i. If the payor bank notices the check is forged and dishonors it, then
the collecting bank is left holding the uncollectible check

ii. UCC contains two legal rules on which the presenting bank can
1. (1) Creates a special set of warranties that limit claims
about forged drawers signatures;
a. 3-417(a)(3) & 4-208(a)(3): Step 1 appears in the
qualification of the warranty regarding the drawers
signature that permits a payor bank to complain
only if the warrantor had knowledge that the
drawers signature was unauthorized
b. 3-416(a)(2) & 4-207(a)(2): The analogous transfer
warranty includes an absolute avowal of the
authenticity of the drawers signature
2. (2) it limits payor banks to pursuing that limited set of
a. 3-416(a) & 4-207(a): Step 2 appears in the rule that
the parties that can pursue transfer warranties must
be parties to whom an instrument has been
b. Because an instrument is presented to the payor
bank, not transferred to it, the payor bank cannot
pursue the broader transfer warranties
f. One twist on the warranty rules is the interaction between articles 3 and 4
i. The article 4 transfer warranties provide liability only against
banks and their customers. Accordingly, a party seeking to pass
liability to a party that handled the check before it got to a bank
would have to rely on the Article 3 transfer warranties (3-416)
1. The only significant difference is the rule in 3-416(a) that
Article 3 transfer warranties can be enforced by remote
transferees only against entities that indorsed the check
iii. Forged Indorsements
1. General
a. The drawer actually signs the check in the first instance, but some other
party subsequently forges an indorsement on the check
i. These rules are more favorable to the payor bank
b. Generally, the payor bank can even if honor was mistaken pass the loss
back to the earliest solvent person in the chain after the forgery
2. Payor Bank Dishonors the Check Because of Forged Indorsement
a. The presenting bank is left with the bad check, but can recover its losses
through transfer warranties.
b. 4-207(a)(1 & 2) or 3-416(a)(1 & 2): Because neither the forger nor any
party after the forger in the process of collection is a person entitled to
enfordce the instrument, and because the indorsement itself is forged, each
of those parties has breached its transfer warranty under one of these
3. Payor Bank pays the Check despite the forged indorsement

a. It is no more proper to charge the drawers account in this instance than in

the forged signature area
i. 4-401(a) & comment 1: payor bank had no right to charge drawers
account because they werent authorized to cash the check
b. 3-418: (payment by mistake) payor bank cannot recover under this theory
either if the prior parties took the instrument in good faith and for value
c. 4-208(a)(1): payor bank can recover for a breach of presentment warranty
the presenting bank warrants that it is a person entitled to enforce the
draft or is collecting the check on behalf of a person entitled to enforce
the draft
i. 3-301: Absent a valid indorsement by the payee, nobody other than
the payee can become a person entitle to enforce a check
ii. Therefore, payor bank can recover its loss from the presenting
iii. 4-207(a)(1 & 2): The presenting bank, in turn, would be entitled to
pass the loss to parties earlier in the chain of collection b/c those
earlier parties would have breached the transfer warranties in these
d. The loss should pass to the earliest solvent person after the forger
iv. Conversion
1. The payee of a stolen instrument is barred from enforcing the underlying
obligation under 3-310(b)(4)
2. First, payee has a common law right to pursue the thief for conversion
3. 3-420(a): grants the victim a statutory action for conversion against parties that
purchase the check from the thief. The victim can pursue a bank that cashes the
check for the thief or a payor bank that honors the check over the forged
a. However 3-420(a) is limited by 3-420(c) which prohibits any action
against nondepositary representatives in the collection process. The
comment 3 explains that the statute is designed to bar a suit against an
intermediary bank that does nothing but process the check for collection as
a representative of the depositary banks customer.
4. 4-407(2): The payor bank is protected by this subrogation provision, which allows
the payor bank that pays the payee under 3-420(a) to charge the drawers account
just as if the item had been properly payable.
v. Alterations
1. Two main types:
a. A change in some relevant aspect of the check as originally written
i. Treat just like the treatment for forged indorsements
ii. If payor bank honors the check, it cannot charge the drawers
account for the amount that it paid out on the check
iii. 3-407(c): Payor bank in this instance can enforce the check only
according to the original terms of the check
iv. 4-208(a)(2): Payor bank can recover any loss by pursuing earlier
parties in the chain of collection for a breach of the presentment

v. 4-207(a)(3) & 3-416(a)(3): Any party against whom the payor

bank recovers is entitled, in turn, to pursue earlier parties based on
a breach of a similar transfer warranty
vi. Thus, the loss will rest with the earliest solvent party to handle the
check after the alteration
b. An addition to an instrument that was incomplete when written
i. 3-407, Comment 2: The payor bank can enforce the instrument as
completed, even if the instrument was stolen from the issuer and
completed after the theft.
ii. 4-401(d)(2): The bank is entitled to charge the drawer for such an


Risk of Loss in the Checking System Special Rules

a. Negligence
i. General
1. Loss is on the drawer if the drawers negligence substantially contributes to the
forgery. 3-406(a)
a. Precludes a party whose failure to exercise ordinary care substantially
contributes to . . . the making of a forged signature . . . from asserting
the . . . forgery against a person who, in good faith, pays the instrument.
2. Illustration: HSBC Bank USA v. F&M Bank Northern Virginia
a. Written check had lots of blank, and someone inserted new numbers. (1)
3-406 provides no claim if a thief who is not the payee indorses the check
in the thiefs name rather than the payees name. (2) UCC also imposes
ordinary care on banks which means general banking usage. (3) If a
bank can show that most banks have not yet adopted a new procedure that
would have prevented a loss, then the banks potential liability if it keeps
the old procedure is low. (4) Also, the UCC recognizes comparative
negligence, under which any party should bear the portion of the loss
attributable to its failure to exercise ordinary care. 3-406(b).
b. Bank Statements
i. General
1. Rests on the assumption that customers can stop forgery schemes if they would
just look at their fucking bank statements!
2. When a drawer fails to discover a forgery evident from its monthly bank
statements, the UCC normally transfers ensuing losses from the payor bank to the
drawer by precluding the drawer from challenging the payor banks decision to
honor future checks by the same forger. 4-406(d)(2)
ii. The UCC does not make the bank wholly responsible for losses, but would call for each
party to bear a portion of the loss based on the extent to which its shortcomings
contributed to the loss. 4-406(e)
1. Illustrative Case: Stowell v. Cloquety Co-op Credit Union
a. Dude steals guys check and then steals his banks statement mail. Man did
not receive bank statement from December 92 to September 93, and he
notified the bank in December 92 that he hadnt received one. (1) The
draft agreement with the bank defines reasonable promptness as thats
used under the UCC [under the UCC, you have 30 days from the mailing
date of the statement to object to the check 4-406(d)(2). (2) The man is
at fault the risk is on him to take measures the bank cant bear such a
iii. Although 4-406(e) exposes the bank to a risk of responsibility for comparative negligence
much like 3-406, 4-406(f) removes that risk if the customer fails to examine the statement
sent by the bnak w/in one year.
c. Theft by employees
i. General
1. Most common case is when an employee forges the employers indorsement on a
check payable to the employer

2. In many cases, the general negligence rule or the bank statement rule will place
this loss on employers
ii. When the loss is caused by a responsible employee, the UCC placesthe loss on the
employer even if those more general rules dont apply. 3-405
iii. However, employer will try to shift the loss back to the bank:
1. First, under comparative negligence: Here, 3-405(b)
2. Second, a claim that a banks willingness to allow an employee to obtain funds
from an employers account amounts to participation in the employees breach of
fiduciary duty: 3-307
a. Illustrative Case: Cable Cast Magazine v. Premier Bank
i. Employee had been stealing checks, was confronted, and admitted
it. Cable claims bank violated 3-307 by accepting checks with
knowledge that employee was breaching fiduciary duty. Bank
claims only employer liable under 3-405 and 3-406. Held, the
bank is not liable. (1) The employer must bear the loss under 3-405
upon a showing that an employee with responsibility commits a
fraudulent endorsement. However, Cable seeks to default 3-405 by
asserting that Bank was not in good faith when it took the check
from employee. 1-201(19) defines good faith as honesty in fact in
the conduct or transaction concerned. (2) There is nothing here
that indicates that the Bank knew the employee wasnt the
company, or was a fiduciary of the company. (3) Even so, Bank
had to exercise reasonable care here they did.
3. The employer may have no substantial claim b/c the check will not appear
sufficiently unusual. The question then, is: can the employer pursue a claim
directly against the depositary bank for losses the employer sustained from a
a. Illustrative Case: Gina Chin & Assoc. v. First National Bank
i. Employee wrote checks to suppliers, forged the drawers signature,
then forged the payees signature for indorsement purposes. The
sole cause of action is against drawee banks for charging her
accounts in the amount of the forged checks. (1) 3-404 and 405
change the law by allowing comparative negligence. Court holds
that these provisions ARE TRIGGERED IN A DOUBLE
d. Impostors
i. General
1. Checks procured by impostors or payable to fictitious persons.
2. General rule is that the person victimized should bear the loss. 3-404
a. Illustrative Case: Meng v. Maywood State Bank
i. Person has check made payable to himself and fictional person. (1)
The fictitious payee rule completely absolves a bank from any
liability for payment over a forged endorsement. (2) It states in 3404(b) that when something is made out to a fictitious payee, an
indorsement in the name of the payee is effective as the
indorsement of the payee. (3) This rule is effective over the rule

that places the loss on the bank for payment of a forged

indorsement. (4) As a matter of law, the designation of two payees
on a cashiers check is ambiguous where no directives are stated on
the checks to determine the manner of payment (payment can be
made to either of the named payees). (5) Here, Ps cant
demonstrate the bank failed to exercise ordinary care.


Issuer-Cardholder Relationship
a. Four Major Participants
i. Purchaser that holds the card
ii. The issuer that issues the card
1. Agrees to pay the purchases that the cardholder makes in accordance with the
agreement between the issuer and the cardholder
iii. Merchant that makes the sale
iv. Acquirer who collects payment from the merchant
b. Universal Cards
i. Visa and Mastercard, basically
c. Statutes
i. No UCC generally applicable to credit cards
ii. Must use Federal Truth in Lending Act (TILA) & the Federal Reserves Regulation Z
1. TILA is limited to Consumer Transactions
2. Limited to Credit Cards extended to individuals
a. Exception: TILA 104(1), Reg Z 226.3(a)(2):
b. Also does not apply to transactions of more than $25,000. TILA 104(3)
d. Definitions
i. Credit Cards: TILA 103(k): any card . . . or other credit device existing for the
purpose of obtaining money, property, lavor, or services on credit.
e. General Rules
i. Cannot issue credit cards without a request or application. TILA 132, Z 226.12(a)
ii. Must provide customer a clear and conspicuous written disclosure that summarizes the
applicable legal rules. Z 226.5(a)(1)
1. Closely resemble model disclosures provided by the Federal Reserve in
Appendix G of Reg Z. Can be enforced in federal court.
f. Overview of System
i. Exactly the opposite of the checking relationship
ii. Credit cards and Checkign accounts at same bank: Pursuant to agreement, Credit card
issuer can periodically deduct an amount from the funds to pay a prearranged portion of
the charges. TILA 169(a), Z 226.12(d)(3)
iii. Because credit cards cant invest funds as banks can, they make their money off of
interest rates
iv. Convenience users are those people that pay their bills every month and some issuers
have responded to these people by imposing annual fees limited to convenience users
v. TILA 169 deals with the ability of issuing bank to offset charges against other accounts
(checking) of customer held at the bank
vi. Fraudulent transactions are judged by algorithms and such
g. The mechanics of collection
i. Merchant has an agreement with a member of the applicable network (VISA, etc.), the
acquiring bank
ii. Was once a ban on allowing merchants to offer discounts to people who pay cash. TILA
167 now prohibits those agreements and leaves merchants free to offer any cash
discounts they find appropriate. Z 226.12(f)
iii. Merchant, after process, receives 95-98% of the amount charged; merchant bank gets
about 2.5%; issuer gets about 1.5%; holder pays 100%

iv. Note, acquirers charge higher rates for people who make sales over the phone, b/c of
bigger risk of fraud
h. Finality of payment
i. Right to cancel payment by consumers is much greater than in other competing systems
ii. The issuing banks obligation to pay does not become final at the time of the initial
payment to the acquirer.
1. TILA 170(a) grants a cardholder the right to withhold payment on the basis of
any defense that it could assert against the original merchant. Therefore, if you get
bad goods, you have the right to assert a goods dont conform to contract
defense on the credit card people.
iii. Qualification on cardholders right to cancel payment:
1. TILA 170(a) is only a right to withhold payment from an issuer, it does not
include a right to seek a refund from the issuer or the merchant
2. Accordingly, the right dissipates as the cardholder pays off the credit card balance
generated by the transaction in question
a. TILA 170(b) and Z 126.12(c): limits challenge right to the amount of
credit outstanding with respect to the transaction
3. TILA 170(a)(1): the cardholder must make a good faith attempt to obtain
satisfactory resolution of the disagreement . . . from the merchant honoring the
credit card.
4. TILA 170(a) prevents cardholders from withholding payment on transactions
that occur outside the state where the cardholder resides and more than 100 miles
from the cardholders billing address
a. Cases by telephone have had mixed results
iv. Card issuing network has rules that pass risk back to the merchant
1. TILA 170(a) the issuer can charge back the challenged credit slip to the


Erroneous Charges
a. General
i. First, cardholder has the right to withhold payment under TILA 170
ii. TILA 161 sets out detailed provisions of resolving alleged billing errors related to
credit cards. SEE Z 226.13
1. Under TILA 161(a), the cardholder must provide written notice to the issuer
within 60 days after the date on which the creditor sent the relevant statement to
the cardholder
a. Billing Error under 161(b) and Z 226.13(a) includes not only claims
that the cardholder did not make the charge in question, but also claims
that the merchant failed to deliver the goods and services covered by the
charge in question, and eve requests for additional clarification about the
2. The issuer must send a written statement of the notice within 30 days and must
resolve the issue within two billing cycles
3. If the holder claims the merchant didnt deliver goods, the issuer must conduct a
reasonable investigation and determine that the property or services were actually
delivered. Z 226.13(f) & TILA 161(a)(B)(ii)
4. If the issuer doesnt accept holders accusation, the issuer must give the
cardholder a written statement of the issuers reason for not correcting the charge.
Z 226.13(c)(2), (f) & TILA 161(a)
5. The creditor is barred from closing or restricting the cardholders account for
failure to pay the disputed amount during the pendency of the investigation. TILA
161(d), Z 226.13(d)
a. Issuer can accrue a finance charge against the disputed amount, which is
due only if the dispute is resolved against the cardholder. Z 226.13(d)(1)
n. 30 & Z 226.13(g)(1)
6. The statute provides only a $50 penalty against the creditor for failure to follow
these procedures. TILA 161(e)
7. Illustrative Case: Belmont v. Associates National Bank (Deleware)
iii. If a charge is erroneous, it gets passed back to the acquirer, who in turn passes it back to
the merchant
b. Unauthorized charges
i. Very strong cardholder protection
1. TILA 133(a)(1)(B) limits the cardholders liability to $50, regardless of how
much is charged, even if no notice is sent. Z 226.12(b)(1)
a. However, prompt notice can help a cardholder. Once notice is received by
the issuer, the cardholder is immune to all other charges. TILA 133(a)
b. Also, VISA and MASTERCARD have provisions where, if you send
notice within (2) business days following the theft of the card, you are
immune from all liability
2. Although you are only charged $50 or less, the cardholder should be wary b/c
some courts will say that your conduct was so negligent that you should have to
pay beyond the $50 amount of TILA.
3. Illustrative Case: Minskoff v. American Express

ii. There is an unusual aspect of TILA that states the provisions that protect cardholders
from paying unauthorized charges apply not only in consumer transactions, but also in
business and commercial transactions
1. However, in the business context, the issuer and cardholder can contract out of the
statutory allocation of loss from unauthorized charges.
2. TILA 135 permits any business that issues credit cards to at least ten of its
employees to accept liability for unauthorized charges without regard to the
provisions of TILA 133, so long as the business does not attempt to pass on to
the individual employees any liability greater than the liability under 133. Z
226.3(a) n.4, Z 226.12(b)(5) (explanation of TILA 135).
iii. Liability
1. In face to face transactions, the issuer bears the loss from unauthorized charges as
long as the merchant followed the requisite procedures (verified the signature and
obtained the appropriate authorization for the transaction).
2. In remote transactions (phone, internet) the risk of loss is left with the merchant.
iv. Issues
1. Identity theft is an issue; also, never received cards that are stolen from a thief are
an issue (this has been cut back because of phone verification)


General Debit Things

a. Payment with a Debit Card
i. The primary difference between credit and debit is that a debit card always serves as an
adjunct to a checking or savings account
ii. There is no reason why credit and debit features cannot be combined, and thus this has
become common. Reg E, 12 CFR 205.12
1. In this situation, it depends on whether customer pays with the credit or debit
2. Debit functioned governed by debit rules, credit governed by TILA and Reg Z
iii. The use of an impulse to obtain funds directly from an account qualifies it as an
electronic funds transfer, and is regulated by the Electronic Funds Transfer Act (ETFA)
1. Title IX of the Consumer Credit Protection Act (TILA is Title I)
iv. EFTA 903(6): ETFA applies to transfer of funds . . . initiated through an electronic
terminal so as to order . . . a financial institution to debit . . . an account
b. Establishing the Debit Card Relationship
i. EFTA imposes two significant restrictions on banks ability to update its checking account
relationship with debit cards:
1. First, EFTA 911 generally allows a bank to send an unsolicited debit card to a
customer only if the card is sent in an unvalidated condition.
2. Second, there are disclosure requirements that require the bank to provide the
consumer a detailed up-front disclosure of the terms and conditions that will
govern use of the card. Reg E 205.7(a)
a. Keep in mind nearly nobody will read this.
c. Transferring funds with a debit card
i. Debit card allows a person to go to an electronic machine (ATM) and do any of the
functions it could have done at a bank teller in person
ii. EFTA 906 requires that a customer be given written documentation of each transaction
that they inititate.
d. Collection by the Payee
i. A merchant must enter into a contract, either directly with the bank that issued the card or
indirectly through a network that processes debit-card transactions for the card-issuing
ii. Two major types of networks
1. Pin Based
a. Characterized by the requirement that the customer enter a PIN number
b. Under the typical network rules, the payor banks obligation to pay
becomes final at the moment that it transmits the electronic message back
to the merchant
c. The actual payment is usually made be a single daily deposit ot an account
designated by the merchant, giving it credit for all of the days debit
d. The payor bank becomes obligated to honor the payment request before
the customer leaves the counter. Thus, risk to merchant is limited to payor
bank insolvency or failure of the processing system
2. Pin Less
a. This system does not clear and settle transactions immediately

i. Rather, there is an authorization transaction while the cardholder is

at the terminal, which confirms the availability of funds in the
account to cover the transaction
ii. Then, over the next few days, the merchant obtains funds from the
transaction in the same way as it would obtain funds for a standard
credit-card transaction
1. These are called offline debit; PIN based are called
online debit
b. This system costs the merchant as much as standard credit-card
transactions (1 2 %)
i. PIN based transactions cost the merchant must less (7 cents per
c. The key difference is finality; under the PIN less system, you have the
rights of TILA in collection
iii. Error and Fraud in Debit Card Transactions
1. Erroneous Transactions
a. Two types (these have not caused significant losses)
i. Improper withdrawal (withdrawal of the wrong account or of the
wrong amount)
1. If they charge the wrong account, they recredit the wrong
one and charge the other one
ii. Could fail to make a withdrawal that it should have made
b. The system might fail in such a way that the merchant believes that it is
receiving authorizations when it in fact is not communicating with the
payor bank.
i. The POS network rules protect the merchant and pass the loss back
to payor bank; they can mitigate losses from this easier
c. Insufficient Funds
i. Bank can pay or not pay and pursue customer on overdraft
2. Fraudulent Transactions
a. General
i. Several features of Debit minimize loss
1. The rules preventing unsolicited mailing of activated cards
2. Both the authorization request from the merchant to the
bank and the banks reply are encrypted
ii. 99% of fraud on debit cards resulted from card usage by a close
acquaintance of the cardholder
iii. Consumer faces much bigger problem with unauthorized
transactions on debit than on credit
b. Who bears the loss between merchant who accepts stolen card and bank
on which the card draws?
i. Network rules allocate the loss to the bank; much better position to
mitigate these losses
c. Who bears loss between customer and bank?
i. Positive law provides an answer that protects the cardholder
considerably even apart form the parties own agreements

ii. Federal law provides two separate protections related to

unauthorized transactions, as well as a set of specified procedures
for determining whether a particular transaction was authorized
1. First set of rules: establishes threshold requirement that a
card have some minimal security feature (PIN, signature,
picture, etc.). EFTA 909(a)
a. In the absence of feature, no consumer liability
2. Other is 909(a) provisions, discussed next
3. Lost of Stolen Debit Card
a. EFTA 909(a) establishes a rule limiting customers loss from each
unauthorized transfer
i. These rules apply to any series of related unauthorized transfers.
Reg E 205.6
1. Thus, if thief used card 10 times before caught, the dollar
limits in 909(a) describe the consumers exposure for the
entire incident, not the individual transactions
b. This rule allows the bank to hold the consumer liable for up to $50 of
unauthorized transfers that occur before the financial institution learns of
the consumers loss of the card. In no event . . . EFTA 909(a)
i. Applies w/o regard to fault or diligence on the part of the consumer
c. Fault-based notice rule: allows the bank to charge the customer for losses
if the consumer does not promptly notify the bank after it discovers that
the card has been stolen. In addition . . . EFTA 909(a)
i. Operates on the assumption that customer should notify within two
business days after he knows of the theft
ii. All charges after the two day limit can be charged to consumer,
with maximum at $500.
1. This $500 includes the $50 that could have been charged
the consumer from the first rule
d. Consumer has 60 days to review the statements of the bank. If consumer
fails to report an unauthorized transaction within that 60 day period, the
consumer bears responsibility for any subsequent unauthorized
transactions that would have failed had the consumer identified the
transaction on the statement. EFTA 909(a); Reg E 205.6(b)(3)
4. Limiting Liability even futher
a. States can limit the consumers share of the loss more narrowly. This is
allowed under EFTA 919.
b. The PIN less networks (VISA and MASTERCARD) have altered their
network rules to limit the consumers exposure to losses.
i. Both networks voluntarily agreed that the banks issuing their cards
will limit customer liability for unauthorized transactions to $50,
even if the consumer fails to notify the issuer of the theft of the
card and fails to ID any fraudulent trasaction within the 60-day
EFTA period.
5. Resolving Disputes about whether a transaction was authorized

a. Customer must give bank notice within 60 days after bank mails
statement. EFTA 908(a)
b. Bank must respond within 10 days or give customer a provisional credit.
i. VISA and MASTERCARD lower this to 5 days
c. Then, bank proceeds with investigation, which it must complete within 90
days after receiving customer notice.
i. Federal court can impose treble damages on any bank that (a) fails
to recredit an account within the 10-day period when required to
do so o r (b) unreasonably rejects a customers claim of error.
EFTA 908; Reg E 205.11(c)(3)
6. Illustrative Case: Heritage Bank v. Lovett


Negotiable Instruments
a. Negotiability and Liquidity
i. General
1. Liquidity refers to the ease at which an asset can be sold at a price that reflects its
proper economic value
2. The lack of a market makes sale difficult b/c it makes the seller expand its effort
to locate a buyer and educate the buyer about the value of the asset
3. Rules that relate to negotiability enhance liquidity:
a. First, negotiable instruments offer an easy way for verifying a partys
power to transfer an enforceable interest in the instrument (the info is on
the instrument)
b. Second, there is a defense stripping rule that makes a negotiable
instrument more valuable in the hands of a purchaserthan it was in the
hands of the payee that sold it.
i. A person that becomes a holder in due course takes the
instrument free from all personal defenses
ii. Basic Framework of Negotiable Instruments
1. A typical transaction
a. Bookseller in St. Louis is buying books from distributer in London.
Businessman goes to his bank to purchase the draft. The draft somewhat
says that it wants Barklays bank in London to pay this man for the books.
Business gives to distributer, who can present the draft to Barclays bank or
sell it to his own bank. American bank notifies Barclays of the draft so
that it will recognize it when presented. Barclays, upon receiving the
draft, deducts from an account the American Bank has at Barclays for such
a purpose. If a person did a lot, the bank could give them software that
allowed them to do the drafts, and notifies the bank when he does one,
which in turn notifies Barclays.
2. The terms
a. The party that directs the payment (American bank) is the drawer or the
b. The person who caused the draft to be issued (the businessman) is called
the remitter
c. The person to who the draft is being paid (the London guy) is the payee
d. The person on whom the draft is drawn (Barclays Bank London) is the
iii. The Two Stage Framework

The obligation must be a written promise
or order
The obligation must be unconditional
The obligation must require the payment
of money
The amount of the obligation must be
The obligation must be payable to bearer
or order
The obligation must be payable on
demand at a definite time
The obligation must not contain any
extraneous undertakings

Statutory References
3-104(a); 1-201(43); 3-103(a)(2), (3), (5), (6),
(9); 3-104(e), (f), (g), (h)
3-104(a); 3-106
3-104(a); 1-201(24); 3-107
3-104(a); 3-112(b)
3-104(a)(1) & (c); 3-109; 3-115 comment 2
3-104(a)(2), 3-108

1. General Definition of Negotiable Instruments

a. General
i. UCC 3-104(a)
ii. If an instrument misses any of the requirements, the rules of article
III dont apply
b. The Promise or Order Requirement
i. Order: 3-103(a)(6): An instruction by one person (the drawer)
directing some other party to pay (the drawee)
1. An instrument that contains an order is called a draft
2. Three most common kinds of drafts:
a. A check draft on a bank: 3-104(f)
b. Cashiers Check drawer and drawee are the same
bank: 3-104(g)
c. Tellers Check A draft by one bank on another
bank: 3-104(h)
ii. Promise: 3-103(a)(9): A direct commitment to pay
1. The party that makes a promise is a maker
2. The instrument that contains the promise is a note
iii. All negotiable instruments must be in writing
c. The Unconditional Requirement
i. UCC 3-106
1. Limits negotiability to instruments that are absolute and
include on their face all of the terms of payment
a. Cant Include Conditional Payment Obligation
ii. Case: DBA Enterprises v. Findlay
1. Promissory note contained a statement that Makers
obligation under this note is subject to the conditions
recited in that Bill of Sale and Covenants not to Compete
between the parties of even date. (1) This makes the note
iii. 3-106(a)(ii) and (iii) states that a document is non-negotiable if it
states that it is subject to or governed by another writing or if it
states that rights or obligations with respect to the document are
stated in another writing.
iv. Two Exceptions 3-106(b):
1. In a note for which a maker gives collateral that includes
reference to other writings (security agreement, loan
agreement, mortgage) that describes rights related to the
collateral and to the payees remedies upon default, these
terms do not undermine negotiability. 3-106(b)(i)
2. If a document contains a statement that payment is limited
to a particular fund or source this does not undermine
negotiability. 3-106(b)(ii)
a. E.g. a nonrecourse real-estate note
d. The Money Requirement

i. The promise or order must be for the payment of money

1. Includes domestic and foreign currency
e. The Fixed amount requirement
i. The amount of the obligation must be FIXED
1. This does not exclude statements with interest or other
a. Also, interest can be variable or fixed
2. Just cant be: Ill pay you half of what I get for the sale of
my books.
ii. Case: Nagel v. Cronebaugh
1. Note doesnt contain a fixed amount, and thus isnt
negotiable so you go to basic contract principals to
interpret the note
f. The Payable to Bearer or Order Requirement
i. 3-104(a)(1)
ii. Must be payable to bearer or order
iii. Bearer two ways:
1. It must state:
a. Payable to Bearer
b. Payable to the order of Bearer
c. Or, if it otherwise indicates that the person in
possession of the promise or order is entitled to
payment. 3-109(a)(1)
2. Not payable to identified person:
a. Doesnt state a payee
b. Made payable to cash
iv. Order two ways:
1. Payable to an identifiable person
a. Pay to the order of Dan Keating
2. Payable to an identifiable person or order
a. Pay to Dan Keating or Order
b. Must include both order and an identifiable
person in the statement
c. If misses one, it is not an instrument
v. Exception:
1. A check that fails the bearer-or-order requirement, but
satisfies all of the remaining negotiability requirements
qualifies as an instrument
g. The Demand and Definite Time Requirement
i. 3-104(a)(2)
ii. Must be payable on demand or at a definite time
iii. Can be payable on demand or at no time
iv. Includes times that allow the holder to extend the time for payment
v. Includes times that allow acceleration and prepayment
vi. The only obligation that would fail the rule would be a document
giving the issuer either a completely unqualified option to extend

or a qualified option to extend that did not state a date to which

the extension would run
h. The No Extraneous Undertakings Requirement
i. 3-104(a)(3): Forbids inclusion of a promise calling for something
other than the payment of money
ii. Cannot be negotiable if it includes any non-monetary promises
1. To deliver wheat, etc.
iii. Three exceptions:
1. An undertaking or power to give, maintain, or protect
collateral to secure payment.
2. An authorization or power to the holder to confess
judgment or realize on or dispose of collateral
3. Conditions in which the borrower waives laws intended for
the benefit or protection of the borrower or obligor
a. Waivers of the Requirements of presentment,
dishonor, notice of dishonor, and the like


Transferring a negotiable Instrument

a. General
i. A transfer of a negotiable instrument never requires anything more than delivery of the
instrument and a signature by the transferor
b. Negotiation and Status as a Holder
i. Two concepts central to the transfer
1. Holder has a right to enforce the instrument. 3-301(i)
a. No person can be a holder w/o possession of the instrument
b. Bearer paper
i. If an instrument is bearer paper, possession is determinative. Any
person isn possession of bearer paper is a holder. 1-201(b)(21)
even a thief
c. Order paper
i. Order paper must be payable to some identifiable person. This is
the only person that is the holder. 1-201(b)(21)
ii. Payable to more than one person
1. If Husband or Wife than either one; if husband and
wife then both must be present
iii. Payable to account number
1. Holder of the account is the identified person
2. The act of negotiation by which it is transferred to a new holder
a. Negotiation is any transfer of possession, even an involuntary one, by a
person other than the original issuer that causes the transferee to become
holer. 3-201(a)
ii. Special and Blank Indorsements
1. To make the purchaser of an instrument the indentified person, the seller must
make an indorsement
a. As simple as a signature,unless the circumstances unambiguously
indicate that the signature was made for purpose other than indorsement.
b. Courts recognize signature in bottom right of instrument as the signature
of the issuer. 3-204 comment 1 paragraph 2. Signature in any other
place is treated as an indorsement
2. Special Indorsements
a. Identifies the person to who the check is to be paid
b. Transfers the identified person to the indorsement person. 3-205(a)
c. If you have bearer paper, the special indorsement changes it to bearer
paper. 3-109(c), 3-205(a)
3. Blank Indorsement
a. Any indorsement made by a holder that does not indicate an indentified
i. A blank indorsement transforms order paper to bearer paper, so
that anyone in possession can enforce it. 3-109(c), 3-205(b)
ii. A blank indorsement on bearer paper has no effect on the character
of the instrument, but it does create liability for the indorser under

4. Bank rules that depart from abovementioned rules

a. First, Article 4 generally dispenses with the requirement of indorsements
for transfers of checks in the check-collection system
i. Depositary bank automatically becomes a holder of a check
deposited by its customer. 4-205(1)
ii. Bank need not indorse a check when it transfers to another bank. 4206
b. Reg CC provides that no party other than a bank can become the holder of
a check once it has been indorsed by a bank
i. The only way a different party can become the holder is if the bank
specially indorses the check to a nonblank party or returns the
check to the depositor (dishonored checks). Reg CC and 4-201(b)
iii. Restrictive and Anomalous Indorsements
1. Restrictive Indorsements
a. Putting a condition other than for deposit only or for collection
b. 3-206(a), (b) invalidates almost all other restrictive indorsements
c. If an instrument bears one of the allowable restrictive indorsements, a
party who pays or purchases the instrument commits conversion unless the
proceeds of the instrument are received by the indorser or applied
consistently with the indorsement. 3-206(c)
2. Anomolous Indorsements
a. Indorsement made by a person that was not a holder at the time it made
the indorsement. 3-205(d)
b. If a person who is not the holder signs order paper, it remains payable to
the person it is payable to.
c. Article 3 assumes that these indorsements are made for accommodation
so that the anomalous indorser becomes a guarantor of the instrument. 3419
c. Enforcement and Collection of Instruments
i. The right to enforce an instrument
1. Any person that holds an instrument is a person entitled to enforce the
instrument under 3-301(i)
2. You can sell an instrument, and than that person has all of your rights under the
instrument. 3-203(b)
3. 3-203 also allows the purchaser a right to make a party sign the instrument after
the sale
ii. Presentment and Dishonor
1. Two step approach:
a. Presentment
i. A demand for payment made by a person entitled to enforce an
instrument. 3-501(a)
1. If a note, demand is made to the maker of the note.
2. If a draft, made to the drawee. 3-501(a)
b. The response of the party to whom presentment is made
i. In most cases, the system assumes that a party intends to dishonor
the instrument if it does not take an affirmative action to honor it.

1. In most cases, it is considered dishonored if it is not paid at

the time of presentment. 5-502(a)(1), (b)(2)
iii. Defenses to enforcement
1. As long as the person entitled to enforce the instrument is not a holder in due
course, Article III allows the obligor to impose a wide bariety of defenses, which
include not only any defense cereated by Article III, but also any claim the obligor
has against the payee with respect to the original transaction. 3-305(a)(2), (3)
2. Case: Turman v. Wards Home Improvement (failure ot provide the goods or
services for which the instrument was given).
d. Liability on an instrument
i. First, 3-401 articulates a general rule of exclusion. Except for the transfer and
presentment warranty liability, no party is liable on an instrument unless it has signed the
1. Two major problems:
a. Some authorizing mark other than a signature: extremely broad definition
which includes markings in 3-401(b); see 1-201(b)(37)
b. Individual acting as an agent or representative:
i. Signing party is the representative and the person they are agent
for is the represented person
ii. Is represented person liable:
1. Bound by the same principles as contract and agency law.
iii. Representative liable:
1. Is not liable if (a) the signature shows unambiguously that
he is signing on behalf of the represented person and (b) the
instrument identifies the represented person. If either of
these tests is failed, representative is liable unless he can
prove that the original parties did not intend for him to be
bound. 3-402(b)(1), (b)(2)
c. Determine the liability of the parties that have signed the instrument, there
are four rules (TABLE 40.1, p. 647)
i. The party that issues the note is directly and unconditionally liable
on the instrument. 3-412
ii. Drawee has no liability on a draft at the time it is issued. 3-408. If
it accepts the draft (just a signature) the drawee is liable for the
draft. 3-413
iii. Drawer of a draft is not liable on the draft unless it is dishonored.
1. Drawers liability if discharged if the bank accepts the draft.
iv. Indorser liable only if the instrument is dishonored. 3-415(a). The
indorsers liability is dishcharged if the bank accepts the
instrument after it has been indorsed. 3-415(d). An indorser can
limit its liability by indicating that it is signing the instrument
without recourse. 3-414(e), 3-415(b)
e. The effect of the instrument on the underlying obligation

i. General
1. When a party issues a negotiable instrument, it incurs liability that is completely
separate from its liability on the underlying obligation
ii. 3-310 sets out the rules governing the relation between liability on the instrument and
liability on the underlying obligation.
iii. Two Classes
1. Near-cash instruments. 3-310(a), (c)
a. Certified Checks, Cahiers checks, and tellers checks.
b. Cashiers and Tellers Checks are checks on which a bank is the drawer, so
the bank has liability under 3-412 and 3-414(b) respectively
c. 3-310(a) and (c) provide that the underlying obligations is dischared when
the obligee takes one of the near-cash instruments
2. Ordinary Instruments. 3-310(b)
a. The statute does not immediately discharge the underlying obligation
b. It is suspended, instead. 3-310(b)(1), (2).
i. In the instrument is paid, the underlying obligation is discharged.
3-310(b)(1), (2).
ii. If the instrument is dishonored, the suspension terminates, and the
oblige has the option to enforce either the instrument or the
underlying obligation. 3-310(b)(3). So, you can sue on the check,
or on the obligation.
iv. A discharge of the underlying obligation under 3-310 is effective only to the extent of the
amount of the instrument. 3-310(a), (b)
v. Resolving disputes, and paid in full clauses. 3-311 generally supports that use of
instrument to resolve disputes
1. A paid in full clause will discharge an underlying obligation if (a) the instrument
is tendered for full satisfaction of a disputed claim, or (b) the payor conspicuously
notifies the payee that it intends the instrument to constitute full satisfaction of the
claim, and (c) the payee successfully obtains payment of the instrument. 3-311(a),
a. Illustrative Case: McMahon Corp. v. Burger Dairy Co. (Paid in Full


Holder in Due-Course Status

a. General
i. Holder in due-course status implements the idea that enhancing the ability of transferees
to enforce instruments increases the liquidity of negotiable instruments by making
negotiable instruments more attractive investments
b. The requirements for holder in due-course status
i. Must satisfy two sets of rules
1. First, it must obtain the instrument through the process of negotiation described in
the previous section so that it becomes a holder
2. Second, there are special qualifications that must be satisfied to elevate an
ordinary holder to a holder in due course
a. Set out in two stages:
i. General definition: 3-302(a)
ii. Section with definitions that describe the terms in 3-302(a)
ii. Must satisfy three requirements:
1. Must take the instrument for value
a. Ordinary payment qualifies as value, as does the release by the purchaser
of a pre-existing claim against the seller. 3-303(a)(3)
b. Promise of future performance DOES NOT count as value until
performance has occurred. 3-303(a)(1).
2. Must take the instrument in good faith. 3-302(a)(2)(ii)
a. Requires honesty in fact and the observance of reasonable commercial
standards of fair dealing. 1-201(b)(20), 3-103(a)(4)
i. Need not establish that potential holder acquired the instrument
dishonestly, just failed to conform to reasonable standards of fair
b. Most common claims challenge long-term relationships between lenders
purchasing negotiable instruments, on the one hand, and their clients, on
the other. The issuers of those instruments have had considerable success
arguing that their relationship with the client has become so close that the
lender acts in bad faith when it tries to use holder-in-due-course status to
insulate itself from defenses that would have been valid against its
longtime client.
3. Must take the instrument w/o notice of certain problems with the instrument. 3302(a)(2)(iii) (vi)
a. Notice is when you have actual knowledge of a fact and when you have
reason to know of the fact based on all the facts and circumstances known
to you and the time. 1-202(a)
b. It is not enough to prove that the holder had notice that something was
wrong in the abstract with the instrument, the maker, or the payee. Rather,
the maker must prove notice of one of the four problems listed in that
clauses that close 3-302(a)(2)
i. The instrument is overdue (3-304), has been dishonored, or is in
default. 3-302(a)(2)(iii)
1. Demand instruments are overdue if not paid on the day
after demand is made

2. checks automatically become overdue 90 days after their

3. Instruments payable at a definite time become overdue
upon any failure to make a scheduled payment of principal
or upon any other event that results in acceleration of the
date of maturity of the instrument
ii. The instrument has a forgery or alteration. 3-302(a)(1), 3-302(a)(2)
iii. A third party claims to own all or part of the instrument. 3-302(a)
iv. One of the obligors has a defense or claim that would limit or bar
enforcement of the instrument by the original payee. 3-302(a)(2)
c. If notice does not fall in one of the four categories, the notice is relevant
only if it is sufficiently damaging to undermine the holders good faith in
acquiring the instrument.
d. Holder in due course status rests on the paradigm of an anonymous
unknowing purchaser that knows nothing about the underlying transaction
and thus cannot fairly be charged with problems in that transaction
c. Rights of the Holder in Due Course
i. Free from most significant defenses to payment
1. Holder in due course is immune from most ordinary contract claims or defenses
a. If thief stole bearer paper and sold instrument to Bank, Bank as holder in
due course is immune from any attempt by person who thief stole from to
recover from bank. Person must go after thief. 3-306
ii. Only defenses are the four real defenses in 3-305(a)(1)
1. Infancy: cannot enforce an instrument issued by a minor with no capacity to sign
it. 3-305(a)(1)(i)
2. Duress, Lack of legal capacity, and illegality: cannot enforce if original obligation
would have been void. 3-305(a)(1)(ii)
3. Fraud that induced issuance of the instrument with neither knowledge nor
reasonable opportunity to learn of its character or essential terms. 3-305(a)(1)(iii).
a. Courts interpret this narrowly
4. Discharge of the obligor in insolvency proceedings. 3-305(a)(1)(iv)
d. Payment and Discharge
i. Two step solution to the problem where one party discharges, and the holder-in-due
course can still enforce the instrument:
1. First, the holder in due course status is not precluded by notice of payment of
discharge. 3-302(b)
2. Second, any whole or partial discharge is effective against a person that takes w/o
the notice of discharge. 3-302(b)
ii. A discharge is not binding on a holder in due course that takes w/o notice of the
discharge. 3-601(b)
1. This is a pain for obligors, who would have to keep paying after they are
dishcharged by a previous holder. Several alternatives by the UCC:

a. The discharged party can make the discharge effective by acquiring the
note and destroying it at the time of payment.
i. Holder must surrender when obligor makes payment. 3-501(b)
1. Doesnt really work in practice
b. If discharge is partial, the statute offers the maker the ability to protects
itself by forcing the holder to indicate on the instrument that the payment
has been made. 3-501(b)(2)(iii)
c. UCC is a bit of a pain b/c states that payment is only valid if it was made
to a person entitled to enforce the instrument. 3-602(a)(ii)
e. Transferees w/o holder in due-course status
i. Position of a party without holder in due-course status isnt so bad: the worst problem
such a holder faces is its exposure to defenses that would have been effective against the
original payee of the instrument
ii. Two rules that make the position of the purchaser w/o holder in due course status better
than the purchaser of a non-negotiable instrument
1. First rule applies only when purchaser failed to have it indorsed. 3-203(c)
obligates the seller to sign the instrument at a later date
2. Second, the shelter rule.
a. Purchaser that fails to obtain its own holder in due course status can assert
any holder in due course rights the seller had before the sale. 3-203(b)


Remedies of Unsecured Creditors Under State Law

a. Who is an Unsecured Creditor
i. Anyone owed a legal obligation that can be reduced to money judgment is a creditor of
the party owing the obligation
ii. Unless a party contracts with the debtor for secured status or is ranted it by statute, the
party is an unsecured creditor
1. These are general and ordinary creditors that populate state collection proceedings
2. Tort victims, incautious creditors, uninformed creditors, creditors who didnt or
couldnt negotiate for security
iii. If the creditor has received a judgment, they are a judgment creditor, but this doesnt
undermine their unsecured status.
iv. These remedies are the minimum collection requirements owed to anyone who has an
obligation that can be reduced to a money judgment
b. Unsecured Creditors Getting Paid
i. General Issues
1. Cant do self-help seizure of the debtors property this constitutes conversion
a. Additionally, they may be charged with larceny
2. Also, if you demand payment, you must do so in a reasonable manner to avoid
wrongful collection practices
3. Case: Vitale v. Hotel California, Inc.
a. Basically, you can levy on the property and get the sheriff to go collect it
i. Remedy is levy under writ of execution
ii. Writ of garnishment: Requires the third party to pay the judgment
creditor rather than the debtor
ii. Limitations on Compelling Payment
1. General
a. It is the judgment creditors responsibility to use discovery to locate assets,
and only then will a sheriff go get it
i. If you accidentally locate a third parties property:
1. Could be liable for damages
2. Could be liable for conversion
ii. Creditors cant conduct fishing expeditions by showing up at a
debtors place with an officer
b. Discovery
i. Must find the debtor and have them sit through examination
1. If debtor lies: perjury
ii. May not keep assets in predictable forms
iii. Sale to bonafide purchasers exempt the property
iv. Can only enforce in the state the person is in
c. Debtors can preference one debtor over another as long as the payment to
that debtor is fraudulent
2. Exemption Statutes
a. Prevetn sheriff from seizing certain property under a writ of execution
this property is exempt
b. Wisconsin Statute p. 707

i. A creditor can not seize:

1. Provisions for burial
2. Business and Farm Property, not to exceed $7500 in value
3. Consumer Goods, not to exceed $5000 in aggregate value
4. Motor Vehicles, not to exceed $1200 in aggregate value
5. 75% of debtors income in a one week pay period
6. Depositary accounts in the aggregate value of $1000
ii. Homestead Exemption
1. Home is exempt up to $40g, except certain liens
2. Home is building and land
c. Federal law exempts a minimum of 75% of debtors earnings from
personal services
i. Some states exempt all earnings (Texas, Pennsylvania)
iii. Is the Law Serious About Collecting Unsecured Debts?
1. Legal Mechanisms:
a. Courts can order those subject to their jurisdiction to meet their legal
obligations and imprison them if they refuse to comply
i. Do include obligations regarding:
1. Alimony or Child Support
2. Respecting the property of others by not trespassing or
3. Performing under a contract to sell real property
ii. Dont include obligations regarding
1. Personal Injuries
2. The Wages of working people
3. Breaches of most kind of contracts


Security and Foreclosure

a. The Nature of Security
i. The more effective collection right is known as a lien
1. A charge against or an interest in property to secure payment of a debt or
performance of an obligation. BC 101
2. A relationship between particular property and a particular debt or obligation
3. The general nature of the relationship is that ifthe debt is not paid when due, the
creditor can compel the application of the value of the collateral to payment of the
a. This is foreclosure
ii. There are two types of non-consensual liens:
1. liens obtained by statute, such as mechanics liens (statutory liens)
2. liens obtained by unsecured creditors through judicicial processs (judicial liens)
iii. The security interest has effect only in the event of a debtors default
iv. Unsecured creditors get only what is left after provisions have been made for secured
v. Why be an unsecured creditor
1. Can charge higher interest rates
2. Thrown into it without the opportunity to negotiate
3. Some agree to a contract that leaves them unsecured w/o realizing it
vi. Story of the History of Security
1. Parties who wish to do so can easily construct the security relationship using the
everyday conventions of sale and option to purchase
2. The story shows that in the hands of clever parties, or their clever lawyers,
existing legal forms can be employed in ways unanticipated by the lawmakers
3. Third, in determining which transactions are in the nature of security and must be
foreclosed, one cant rely on the documents.
a. A transaction is in the nature of security if the intent is to provide one
party with an interest in the property of another, which interest is
contingent upon the non-payment of a debt. It is the substance of what is
going on that matters, not the form.
i. Basile v. Erhal Holding Company: The Supreme Court erred in
declaring that the P waived her right of redemption in the demised
premises. A deed conveying real property, although absolute on its
face, will be considered a mortgage when the instrument is
executed as security for debt.
ii. The intended as security doctrine applies to personal property
transactions as well as those involving real property. 9-109(a)(1)
1. Form does not matter
b. Foreclosure Procedures
i. General
1. The procedure for real estate foreclosure differ widely from state to state
2. Article 9 provides a uniform procedure for personal property foreclosure that can
be very quick and easy, but it also permits secured parties to use judicial
foreclosure methods of they prefer
ii. Judicial Foreclosure

1. A foreclosure process is judicial if it is accomplished by the entry of a court order.

a. In most states, a creditor holding a mortgage or security interest typically:
i. Files a civil action against the debtor
ii. In complaint, debtor details the terms of the loan and the nature of
default, and requests that the equity of redemption be foreclosed
iii. The complaint is served on the debtor and any subordinate lienholder, who then have a period of time in which to raise defenses
iv. Only after the P has established that it is entitled to foreclose will
the court enter a final judgment of foreclosure
b. Foreclosure sale:
i. Usually by statute (conducted by sheriff or county clerk)
1. Usually a particular time of day in a particular place
2. Advertised (1-6 weeks in advance)
3. Upon receipt of money, sheriff certifies a person to be the
highest bidder
4. Foreclosure sale must be confirmed by the court
c. Deficiency:
i. If the amount realized from the sale is less than the amount owed
the foreclosing creditor, the foreclosing creditor can request a
judgment for the deficiency
ii. In many jurisdictions, anti-deficiency laws prohibit the granting of
deficiency judgments in particular kinds of cases or give the court
discretion to deny them
d. Possession after sale:
i. Debtor usually remains on premises up to sale.
ii. If the debtor wont surrender the premises, the purchaser is entitled
to a writ of assistance, or a writ of possession, which will direct the
sheriff to remove the debtor fro mthe premises and put the
purchaser in possession.
2. Wisconsin Statute, p. 724
a. Foreclosure: you have to wait 12 months to put judgment on any house
that is foreclosed and owner occupied
b. Foreclosure w/o Deficiency: Plaintiff has the right to waive a deficiency
judgment and consent that the mortgager can stay on the property, unless
he or she abandons it, and remain entitled to all rents, etc. from the
property until the confirmation of the sale by the court.
3. Cooperation from the debtor:
a. If the debtor cooperates, and there are no other liens or interest in the
collateral, the debtor can simply transfer the property to the creditor by
means of a deed in lieu of foreclosure.
b. Sometimes creditors do this by saying its better to lose the house now than
lose it later and be liable for a deficiency
iii. Power of Sale Foreclosure
1. General
a. This is in about 25 states
b. Include in the security agreement a power of sale

c. The security agreement might be in the form of a deed of trust

i. The deed of trust states that the collateral will be held in trust by
the creditor or a third party such as a bank or title company. The
borrower agrees that in the event of default, the trustee can sell the
property and pay the loan from the proceeds of the sale.
2. Foreclosure can be accomplished w/o a lawsuit (E.g. California):
a. California: Upon default under a mortgage or deed of trust containing a
power of sale, the creditor can record in the public records a notice setting
forth the nature of the debtors default and the creditors election to sell
the property. If the debtor doesnt cure the default w/in 90 days, the
creditor can set a time and place for sale, advertise it for 20 days, and then
sell the property at an auction
b. Still, if debtor wont leave, youd have to sue for ejectment, unlawful
detainer, or eviction.
i. If wrongful to foreclose, the debtor can bring a tort action for
wrongful sale
c. UCC Foreclosure by Sale
i. Personal Property
1. UCC Art 9 governs foreclosure for security interest in personal property.
2. After default, the secured party may sell, lease, license, or otherwise dispose of
any or all of the collateral. 9-610
3. That sale or disposition itself forecloses the debtors right to redeem the property.
4. It extinguishes the creditors security interes in the collateral and transfers to the
purchaser all of the debtors rights in the collateral. 9-617(a)
5. Alternatively, if the creditor so chooses, it may foreclose by any available judicial
procedure. 9-601(a)


The importance of possession pending foreclosure

a. General
i. Why the secured creditor wants it
1. A debter may have little incentive to preserve and maintain the property
2. The use of the collateral between the time the right to foreclose accrues and the
time it becomes final may have substantial economic value.
3. If the debtor is in possession of the property in the period leading up to the sale, it
may be difficult or impossible for prospective purchasers to evaluate the property,
thereby depressing the resale price
ii. Why the debtor wants it
1. Needs a place to live, sentimentality, functionality, etc.
iii. The creditor who can make a credible threat to dispossess the debtor has extraordinary
leverage over the debtor
1. Interest, etc.
iv. Many security Agreements provide that the creditor has the right to possession
immediately upon default, but such a provision is only the starting point of legal analysis
b. The Debtors right to possession during foreclosure
i. General
1. Only the purchaser at the foreclosure sale is entitled to dispossess the mortgagee
2. By receiving a writ of assistance, or writ of possession after filing an ejection or
eviction action, the purchaser can have the sheriff on the scene in 10 to 20 days.
c. Appointment of a receiver
i. Interested party can apply for the appointment of a receiver
ii. Receiver is officer of the court with fiduciary obligations to all interested parties
iii. He has the right to collect the rents and use the money to maintain the building, as well as
the authority to rent them out as necessary
iv. The receiver will retain any rents collected in excess of the amounts necessary to
maintain the property, pending the outcome of the foreclosure action
v. Usefulness
1. Debtor and mortgager dont get access to the cash flow
2. However, cash flow will be used to maintain the building, so it helps the
vi. Courts are reluctant to appoint receivers
1. Only in rare circumstances will the court appoint a receiver to take care of owner
occupied real estate
2. a debtor can nearly always be sure he will retain possession of a family homestead
3. Receivers are appointed for owner-occupied commercial real estate more often,
but if someones business is being run out of it, this is unlikely
vii. Check out the code provisions for appointment of receivers on 732
d. Assignment of Rents
i. If the parties contemplate that the debtor will rent the collateral to others during the term
of the mortgage, the mortgage is likely to include a provision by which the debtor assigns
the rents from the property to the mortgagee as additional security
ii. Because collecting the rents from mortgaged property that has been rented to third
parties, like appointing a receiver, is functionally the equivalent of taking possession,
some courts are reluctant to give effect to the assignment of rents clause

e. The right to possession pending foreclosure Personal Property

i. Article 9 governs nearly all security interests in personal property
ii. Article 9 favors the secured creditor in very strong terms
iii. The secured party has a right to take possession immediately upon default. 9-609
iv. Need not involve courts or officials if they can get possession without a breach of the
1. If debtor resists repossession, the secured party must obtain a writ of replevin.
a. Does this by filing an action for replevin
b. Any party entitled to possession of tangible personal property is entitled to
the writ
c. Writ directs sheriff to take possession of the property
2. Immediately upon filing, the creditor can move for an order granting immediate
possession pending the outcome of the case.
a. Typically takes no more than 10 days to accomplish
3. Most states require P to give notice of the hearing to the debtor
4. If the secured creditor proves it is likely to prevail in the action, the creditor gets
the writ of replevin
a. Usually also has to post a bond in case the debtor wins in the action
5. The debtor can post a bond to retain the property
6. Typically, a creditor can get ahold of personal property through the court in a
matter of weeks
f. The Article 9 right to self-help possession
i. The right is derived from 9-609, providing that fafter default a secured party may take
ii. There are collection repossession agencies, etc.
iii. 9-609(2) gives the creditor the option to leave equipment temporarily in the
possession of the debtor but render it un-useable
1. Take the engine out, etc.
g. The Limits of self-help breach of the peace
i. 9-609(b)(2) prevents the creditor from doing a breach of the peace
ii. For examples, look at cases on 742-744
h. Self-Help against accounts as collateral
i. This just means you collateral the persons incoming accounts
1. Examples of typical arrangements on 745
ii. In the event of default, 9-607 and 9-406 proved a self-help remedy to the party
holding a security interest in the accounts
1. 9-607 allows the secured creditor who knows the identity of the accocunt
debtors to send them written notices to pay directly to the secured creditor
a. If they dont, they can be sued, and this works


Judicial Sale and Deficiency

a. General
i. Keep in mind that Article 9 security interests can be foreclosed judicially. UCC 9601(a)(1).
b. Strict Foreclosures
i. Strict foreclosures do not require a sale of the collateral
ii. Most common is the foreclosure of a contract for deed, or installment land contract
1. This is a contract for the sale of real property that provides for the payment of the
purchase price in installments over many years, with the deed to be delivered only
after the last installment has been paid
iii. In most states, if the debtor does not pay the full purchase price in accord with the
contract or at least by the end of a statutory grace period, the debtors interest in the
property is forfeited and the the court confirms that the title remains with the seller.
c. Foreclosure sale procedures
i. In most states, statutes specify
ii. The high bidder wins, must usually place a deposit, and pay the rest in a set amount of
time (hours or days). If he doesnt, he may lose his deposit and be liable for any damages
in contract
iii. Sale Proceeds
1. The money goes first to reimburse the foreclosing creditor for the expenses of
2. Next, the proceeds are distributed to the foreclosing creditor up to the amount of
the debt secured by the foreclose lien
3. Any remaining surplus goes to the debtor
iv. While the foreclosure is in progress, the mortgage debtor has the right to redeem the
property from the mortgage by paying the full amount due under the mortgage, including
interest and attorneys fees.
v. In more htna half the states, the debtor also has a statutory right to redeem the collateral
from the buyer after the sale
vi. Statutory redeeming rights usually ranger from 6 months to 3 years, with one year being
the most common
vii. Statutory rights of redemption are freely transferable.
d. Problems with Foreclosure Sale Procedures
i. Sometimes the debtor is sufficiently outraged to bring a lawsuit asking the court to set
aside the sale b/c of the inadequate sale price.
1. Armstrong v. Csurilla: Two instances when it can be set aside: (1)When the
disparity is so great as to shock the courts conscience; (2) When, in addition to
the inadequate price, there are circumstances which would make it inequitable to
allow the sale to stand. The judge in this case looks to a 10-40% of market value
e. Advertising
i. Forclosure sale advertising may be fixed by statute
1. See Wisconsin Statute on 758 and Advertisement on 759 for example
ii. Advertising is usually in small circulation magazine in order to keep costs down






iii. The legal notices rarely attract buyers interested in owning the property. To the extent
they bring in bidders at all, the bidders are usually professional bargain hunters who plan
to resell the property at a profit.
i. The mortgage contract usually grants the foreclosing creditor the right to inspect the
collateral in preparation for bidding at the sale. Such a provision ordinarily will be
specifically enforced.
ii. Others who wish to bid at the sale can observe the property from adjacent public places,
but they have no right to enter the property to inspect.
iii. Buyers who want the property for their own use are unlikely to be willing to purchase
without looking inside the building
Title and condition
i. Buyers take subject to any defects in the title that they could have discovered through a
search of the public records or an inspection of the property.
1. Marino v. United Bank of Illinois: Guy buys property, has several outstanding
liens, he is screwed. Generally the doctrine of caveat emptor applies in judicial
sales, and the risk of a mistake or defect of title is to be borne by the purchaser
unless there is fraud, misrepresentation, or mistake of fact.
Hostile Situations
i. In foreclosure sales, often there is no one with either a motive or an obligation to furnish
information to prospective purchasers.
ii. In fact, a debtors strategy for retaining its property often calls for preventing third parties
from obtaining the information they need to bid
iii. Foreclosing creditors may not be able to furnish information b/c they dont themselves
have access to it.
iv. Typically the officer has no obligation or incentive to furnish information, but the officer
may have liability for furnishing incorrect information
Antideficiency Statutes
i. Typical problem is that very low buying price reflects all the problems with foreclosure
mentioned above, and then the debtor also has to pay the deficiency costs
ii. Antideficiency statutes either prohibit the court from granting deficiency judgments in
particular circumstances, give the court the discretion to refuse to grant them, or limit the
amount of the deficiencies to be granted
1. See good example on p. 765
2. California Antideficiency statute on 766
Credit Bidding at Judicial Sales
i. The creditor will know of the sale even though it is poorly advertised, may be familiar
with the title and condition of the property already, and may have an enforceable
contractual right to inspect it.
ii. The creditor can bid on credit up to the amount of the debt. Such a bid is called a credit
1. Typically, the creditor has no incentive not to bid this high.
a. Minimizes the likelihood that the sale will be set aside for inadequacy of
b. Minimizes the likelihood that debtor will exercise his right to redeem
c. Avoids the undervalued purchase price problem

d. Doesnt have to pay, just buys it on credit

XVI. Article 9 Sale and Deficiency

a. General
i. As with real property foreclosures, the requirement that the collateral be offered for sale
as part of the personal property foreclosure process cannot be waived or varied in the
initial lending contract. 9-602(10)
b. Strict Foreclosure under Article 9
i. After a default has occurred, the debtor can consent ot the secured party retaining the
collateral in full or partial satisfaction of the obligation.
ii. 9-620(c)(2) imples consent if the secured party sends the debtor a proposal for retention
of the collateral in full satisfaction of the debt and does not receive notification of the
objection to the proposal within 20 days.
iii. Right to consent subject to three conditions:
1. There must be no objection from others holding liens against the collateral. 9620(a)(2)
2. If the collateral is consumer goods, the debtor can consent, in writing or by
silence, to strict foreclosure only after repossession. 9-620(a)
3. Strict foreclosure is not permitted if the debtor has paid 60% of the cashs price of
the consumer goods purchased on credit or 60% of the loan against other
consumer goods. The debtor may waive this right after default, but this kind of
waiver requires a writing. 9-620(a)(4) and (e), 9-624(b)
a. The implicit assumption is that consumer who have paid less than 60
percent dont have an equity, and anyone other than a consumer will be
sophisticated enough to protect its equity by making the objection
described in 9-620(c).
c. Sale procedure under Article 9
i. 9-610 governs the sale of collateral when Article 9 applies
ii. The secured creditor, and not a public official, conducts the sale and distributes the
iii. The foreclosing creditor has a duty to the debtor to choose a procedure for sale that is
commercially reasonable. Every aspect of the disposition, including the method,
manner, time, place and terms must be commercially reasonable. 9-610(b)
iv. 9-611(c)(1) also requires that the creditor give the debtor prior notice of the sale
1. Purpose is to enable the debtor to observe the sale, participate in it, or otherwise
protect its rights
v. 9-623 incorporates the common law right to redeem. Redemption is accomplished by
paying the full amount of the debt, including the secured creditors attorneys fees and
expenses of sale.
1. No additional statutory right to redeem after the sale exists under the UCC
vi. Debtors right to set aside a defective or irregular sale is more constructed under the UCC.
If the sale was commercially unreasonable, the debtors only right is often to sue the
creditor for damages.
1. If, however, the collateral is consumer goods, the debtor has the right to recover a
statutory penalty. 9-625(c)(2)
2. The good faith purchaser at a UCC sale can buy with confidence that it will not
lose its bargain b/c the sale is set aside. 9-617(b)

vii. When collateral is sold for an insufficient price, the injury to the debtor may come in
either of two forms.
1. Where the debtor has an equity in the collateral, the insufficient price may forfeit
all of part of this equity.
2. There may also be an entry of a deficiency judgment in an amount larger than is
d. Debtors defenses to deficiency judgments
i. Failure to sell the collateral
1. 9-610(a) provides that a secured party may sell the collateral after default, but
there is not specific provision that says the creditor must sell the collateral.
2. If the secured creditors delay in selling is not commercially reasonable, the
secured creditors deficiency will be limited to the amount that would have been
left owing if the sale had been commercially reasonable. 9-626(a)
ii. Requirement of Notice of Sale
1. 9-611 requires that the secured party send notice to the debtor, guarantors, and
some lieners.
2. The failure to give this notice does not invalidate the sale. 9-617, but it is a
defect that can have the effect of reducing the amount of the deficiency the
secured party can recover.
3. Illustrative Case: FDIC v. Lanier
a. Although the goods were sold at a private sale, the banks letter did not
indicate the type of sale at which the goods would be sold. This was not a
fatal defect. For a private sale, the creditor only need provide notice of
the time after which any private sale or other intended disposition os to be
made. At a minimum it must be sent in such time that persons entitled to
receive it will have sufficient time to take appropriate steps to protect their
interests by taking part in the sale of after notice is sent, giving the debtor
interests by taking part in the sale or other disposition if the so desire
iii. The Requirement of a Commercially Reasonable Sale
1. The reasonableness requirement of 9-610(b) is purposefully vague. The
purpose is to bring the knowledge and ingenuity of the secured party to bear in
determining a reasonable way to dispose of the particular kind of collateral.
2. Illustrative case: Chavers v. Frazier
a. Failure to procure the best price for collateral does not in and of itself
make a sale commercially unreasonable. 9-627(a). However, (1) the
hasty sale for this type of equipment wasnt reasonable, (2) The
advertising was not adequate, (3) A distress sale auction was not
reasonable, (4) Aircraft maintenance was not properly addressed prior to
the sale, and (5) the purchase price was not reasonable.
3. Contrast Chaverz between judicial sale issues
a. Chavers court says that sixty days was a grossly inadequate time ofr
advertising and marketing the aircraft, but judicial sale rarely allows that
much time, even for complex collateral worth millions of dollars
b. Chavers court is disappointed in advertising that ran only briefly in the
Wall Street Journal and Trade-a-Plane, but under judicial sale procedures,

the aircraft could have been sold in exactly the condition in which it was
c. Chavers says that a distress auction was not reasonable, yet nearly every
judicial sale is precisely that.
d. Chavers complains about the maintenance of the aircraft, but in a judicial
sale, the aircraft could have been sold in exactly the condition in which it
was repossessed.
e. Chavers court sets aside a sale for almost sixty percent of the fair market
value, a price that would easily pass muster in most judicial sale
4. The appropriate remedy for failure to five notice of sale or failure to conduct the
sale in a commercially reasonable manner
a. Majority hold that there is a a rebuttable presumption that the value of the
collateral was at least equal to the amount of the debt, with the
consequence that, if the consumer debtor objects, the court ends up
determining what the sale price should have been.
b. Minority holds that any significant irregularity in the sale procedure is
sufficient to deny the deficiency altogether a view that relieves the court
of the necessity to guess what the price would have been absent the defect.
i. If confused, see e.g. on 783

XVII. Bankruptcy and the Automatic Stay

a. Filing a Bankruptcy Case
i. You file a form
1. Chapter 7 liquidation
2. Chapter 11 Reorganization
3. Chapter 12 Reorganization only for owners of family farms
4. Chapter 13 Reorganization for individuals
ii. Bankruptcy Clerk stamps it: Two things happen
1. A bankruptcy estate is created (all of the property of the debtor)
2. Stay against any collection activities is automatically imposed. BC 362(a),
iii. Who is in control after the filing?
1. Under Chapter 7
a. The US Trustee appoints a trustee to administer the estate
b. Trustee liquidates the estate
c. If the debtor is an individual, he can exempt certain property from the
estate. Every individual debtor is entitled to keep the property of the
bankruptcy estate that would have been exempt from creditors remedies
on a judgment under state law. BC 522(b)
d. After liquidation, trustee distributes money pro rata to general creditors
i. If an individual, debts are discharged
ii. If a corporation, it is a corporate shell w/no assets that still owes its
2. Chapter 11, 12, or 13
a. Debtors are left in control of their own estates
b. Trustees are appointed (dont take possession of property) to examine the
debtors, review their repayment plans, receive payments from the debtors
after their plans are confirmed by the court, distribute the money they
receive to the appropriate creditors, and collect their fees.
c. Under Chapter 13
i. the debtor files a proposed budget, with a plan to devote all
disposable income to the payment of the debt for at least three
years. BC 1325(b).
ii. The plan must also promise to pay creditors at least as much as
they would have received in a Chapter 7 liquidation. BC 1325(a)
iii. Trustee examines the budget and appears at the court hearing to
consider the confirmation of the plan. BC 1302
iv. If the plan is confirmed, the trustee receives the payments form the
debtor and distributes them pro rata to the general creditors over
the life of the plan. The plan lasts from 3 to 5 years, and the debtor
is discharged from most remaining debt when the last payment is
made. BC 1328
d. Under Chapter 12
i. Basically the same pattern
e. Under Chapter 11

i. See p. 791
b. Stopping Creditors Collection Actions
i. Once the case is filed, the claims against the debtor are stayed, and you cannot violate the
rules of a stay. You cannot pursue your debt.
ii. Courts take stay violations VERY seriously. Thy usually hold deliberate violators in
contempt of court and impose a fine sufficient to make them regret their transgression. In
some circumstances, a party injured by the stay violation can sue for damages. BC
iii. While the stay is broad, it is not unlimited.
1. Only actions to collect pre-filing obligations are stayed.
2. Does not halt criminal proceedings against the debtor
3. Does not halt regulations from agencies
c. Lifting the stay for secured creditors
i. Bankruptcy proceedings permit each secured creditor the right to participate individually
in the bankruptcy case rather tna forcing on them the collective treatment forced on the
unsecured creditors.
ii. Grounds for lifting the stay are in BC 362(d):
1. The stay must always be lifted if the trustee or the debtor does not provide the
creditor with adequate protection. BC 362(d)(1)
a. Adequate Protection is defined in 361
b. A secured creditors interest is adequately protected when provisions that
the court considers adequate have been made to protect the secured
creditor from loss as a result of a decline tin the value of the secured
creditors collateral during the time the creditor is immobilized by the
automatic stay.
c. The court recognizes that a cushion of equity of sufficient size may alone
adequately protect the secured creditor against loss
i. How large, depends on:
1. The nature of the factors that might change the value of the
2. The volatitlity of the market in which the creditor might
have to sell it, and
3. The rate at which the secured debt is likely to increase in
2. Or, the stay must be lifted if:
a. There is not equity in the collateral that the trustee or debtor might realize
for unsecured creditors; and
b. The collateral is not necessary to an effective reorganization
iii. Illustrative Case: In re Craddock-Terry Shoe Corp.
iv. Motions to lift the stay receive high priority: the stay is automatically terminated, unless
within 30 days after a secured creditor moves to lift it, the court enters an order
continuing it in effect. BC 362(e)

XVIII. The treatment of Secured Creditors in Bankruptcy

a. The vocabulary (the important ones at least)
i. Debts can be discharged in bankruptcy. A discharged debt still exists, but the discharge
permanently enjoins the creditor from attempting to collect it. BC 524(a)(2)
1. The discharged debt is then referred to as nonrecourse, meaning that it cannot be
enforced against the debtor
2. Note the problems with not paying a nonrecourse secured debt on 807
ii. Under Article 9, Secured creditors have security interests, and unsecured creditors have
liens. People with realty have mortgages.
iii. Bankruptcy Code groups Article 9 security interests together with real estate mortgages
and deeds of trust under the term security interest. Then, the Code lumps security
interests together with all other secured statuses, including judicial and statutory liens,
under the term lien. 101(51),(37)
iv. A creditors claim is the amount of the debt owed to the creditor under nonbankruptcy
law at the time the bankruptcy case is filed. BC 101(5) and (12)
1. It is nearly always the amount of the claim that is important during bankruptcy,
and afterwards it is the amount of the debt that is important
b. The Claims Process
i. General
1. The bankruptcy system determines the 502 amounts of all creditors claims the
amounts those creditors were owed under non-bankruptcy law as of the date of
2. Chapter 7: amounts are determined by selling the assets
3. Chapter 11: determined by negotiations or by the court
ii. Early Process
1. Once bankruptcy is filed, the creditor files a proof of claim, describing the debt
and stating that it remains outstanding. If nobody objects to the claim, it is
deemed allowed
a. Claim is for the full amount of debt and fees if allowed. They are
accelerated as a result of the bankruptcy filing. BC 502(b)(1)
2. Chapter 11: Debtor must file a list of its creditors with the amounts owing to each.
If the debtor schedules the debt correctly and doesnt dispute it, the creditor
doesnt even need to file a proof of claim.
3. If claim is questioned, it may go to dispute resolution process. If the ultimate
resolution of a claim threatens to delay the bankruptcy case or distribution, the
court can estimate the amount of a claim, allow it in the estimated amount, and
proceed. BC 502(c).
4. If the debtor outside bankruptcy had a legal defense to payment, the bankruptcy
estate will have the same defense. BC 558.
5. The BC gives some groups of unsecured creditors priority over others. SEE
iii. Calculating the amount of an unsecured claim
1. The amount of an unsecured claim in bankruptcy is essentially the amount owed
on the debt under nonbankruptcy law as of the moment the bankruptcy petition is
filed. BC 502(b)





a. If the creditors contract provides for the debtor to pay the attorneys fees
of the creditor or to reimburse for other fees, those amounts are included
in 502(b), provided that they were incurred prior to the time the
bankruptcy was filed. 502(b)(1).
2. Unsecured claims
a. Do not grow with interest
b. Traditionally, courts havent allowed unsecured creditorst to include
postpetition attorneys fees in the amounts of their claims. However, some
recent cases have if the contract originally provided for it.
Payment on Unsecured claims
1. The data from certain studies leads to two conclusions:
a. The fate of most unsecured creditors in bankruptcy is not a happy one.
b. However, there are many cases in which unsecured creditors manage a
substantial if not full, recovery.
c. Sometimes, debtors with substantial assets, an allowed claim can yield
substantial dividends.
Calculating the Amount of Secured Claims
1. First, you must bifurcate the claim as require under BC 506(a)
a. The claim of a secured creditor can be a secured claim only to the extent
of the value of the collateral. The remainder of the creditors claim is an
unsecured claim.
2. Second, you must determine whether the creditor is entitled to accrue postpetition
interest, attorneys fees, or costs on its claim.
a. 506 says that they creditor can do so if, and only if:
i. Attorneys fees and costs must be reasonable
ii. Payment of the attorneys fees and costs by the debtor must be
provided for under the agreement under which the claim arose
iii. Interest, attorneys fees, and costs can be accrued only to the extent
that the value of the collateral exceeds the amount of the claim
secured by it. (If the claim is oversecured)
Selling the collateral
1. When the trustee liquidates the property of the estate, the trustee ordinarily sells
only debtors equity in property subject to a security interest, b/c that is all the state
has succeeded to under the Bankruptcy Code 541(a). Therefore, if there is a
$10,000, the buyer takes the boat subject to the creditors lien
a. This terminates the automatic stay with respect to that item.
2. 554(a) of the BC authorizes the trustee to abandon property of the estate that is
burdensome or of inconsequential value to the estate. When this happens, the
property ceases to be property of the estate and reverts back to the debtor. This
terminates the automatic stay with respect to this property
3. Finally, under some circumstances, the trustee can sell the collateral free and
clear of liens under 363(f).
Who pays the expenses of sale by the trustee?
1. Bankruptcy Code 506(c) authorisez a trustee who has incurred reasonable,
necessary costs and expenses of preserving, or disposing of property securing an
allowed security claim to recover from the property.

2. The language limits the trustees right to deduct the proceeds to the extent of any
benefit to [the secured creditor.] Thus, absent benefit to the secured creditor from
the trustees expenditures, the trustee cannot deduct anything from the proceeds of
3. The result is that a trustees sale of an under-secured creditors collateral will
ordinarily benefit that creditor and be deducted from its recovery, but the trustees
sale of property when the debt is sufficiently over-secured will not. Read 817-818.
c. Chapter 11 and 13 reorganizations
i. The confirmation of a Chapter 11 plan discharges the old secured debts and payment
schedules and substitutes new ones. BC 1141(d)(1)(A)
1. The plan must specify that the creditor retain its lien under BC 1129(b)(2)(A)(i)
(I), but after confirmation, the lien secures only the new debt. The confirmation
plan to which the creditor has not agree is referred to as a cramdown
ii. The statutory standards of cramdown:
1. Practically the same under Chapter 11 and 13 (Compare 1129(b)(2)(A) and
2. Unless the secured Creditor accepts (agrees to its treatment under) the plan, the
debtor must either:
a. Surrender the collateral to the secured creditor in satisfaction of the
secured claim; or
i. Most debtors want to avoid this
b. Distribute to the creditor, on account of the secured claim, property with a
value as of the effective date of the plan that is not less than the amount of
the allowed secured claim
i. Nearly always the property here is a promise of future payment
iii. Valuing future payments
1. Think of the time value of money ($1 will not buy what it will today tomorrow)
2. So, establish the present value, and then add on the market rate of interest, which
must be determined (it is difficult, there are lots of markets).
a. Illustrative Case: In Re E.I Parks (p. 821)

XIX. Creation of Security Interests

a. Formalities for Attachment
i. A Prototypical Secured Transaction
1. See pages 827-829
2. Pablo signs a financing statement on the form set forth in UCC 9-521
3. Bank sent the financing statement to the Secretary of State for filing in the filing
a. Provides Public Notice
4. Bank also ordered a search of the UCC filing system for other financing
statements filed against the person Pablos buying from
a. The bank wanted a security interest in the assets prior to all others; only
through such a search would the bank know whether there were already
other security interests in those assets
5. At closing, previous owner delivered a bill of sale for the restaurant property, an
assignment of her rights under the lease, and the keys to the restaurant
6. Bank walked to courthouse where it recorded the assignment of mortgage and
checked the records to make sure Stella had not conveyed an interest in it to
anyone else since the date of the banks title search.
ii. Formalities for Article 9 Security Interests
1. UCC 9-203(b) lists three formalities for the creation of a security interest
enforceable against the debtor:
a. Either the collateral must be in the possession of the secured creditor or
the debtor must have authenticated a security agreement which contains a
description of the collateral
b. Value must have been given
c. The debtor must have rights in the collateral
2. Only when these are accomplished does the security interest attach to the
collateral and become enforceable against the debtor. UCC 9-203(a) & (b)
iii. Possession or Authenticated Security Agreement
1. Article 9 ratifies two different kinds of security agreements
a. A Security agreement can be made effective by possession of the collateral
i. E.g. Pawnshops
ii. However, the most common arrangement is to rely on a written
security arrangement and leave the debtor in possession of the
b. Prototypical security transaction is based on a writing:
i. Security Agreement, which contains:
1. Description of the Collateral
2. Description of the obligations secured
3. Provisions defining default
4. Specifying the rights of the secured creditor on default
5. Requires that the debtor care for the collateral and keep it
6. Imposes other obligations on the debtor

ii. When the debtor has signed such an agreement, UCC 9-203(b)(3)
(A) requirement of an authenticated security agreement is fulfilled.
UCC 9-102(a)(7)
c. Neither oral or written arrangement can also fulfill the requirement of
UCC 9-203(b)(3)
i. This must be inscribed on a tangible medium in which it can be
stored and from which it can be retrieved
1. Computer disk.
2. This is referred to as a record. 9-102(a)(69)
ii. To constitute a security agreement of the third kind, that record
must be authenticated by processing it with the intention to
identify the authenticator and adopt or accept the record. 9102(a)(7)(b)
2. In re Ace Lumber Supply, Inc.
a. The debtor signed a financing statement to be filed in the public records to
put other creditors on notice, but the parties did not otherwise document
the transaction. When the debtor later filed for bankruptcy, the secured
creditor needed to prove that it had a valid security interest in order to
have an allowed security claim. Held, under Montana Law the composite
document rule is available to provide evidentiary support to create a
security interest in collateral. That rule, however, does not allow only a
financing statement signed by the debtor to satisfy 9-203(b)(3)(A)
3. Justification for the requirement of an authenticated security agreement:
a. Preventing Fraud
b. Minimizing Litigation
c. Cautioning Debtors
d. Channeling Transactions
e. Discouraging Secured Credit
4. The competing policy is expressed in the doctrine of equitable mortgages. Under
that doctrine, the courts can enforce an oral security agreements where to do so
would be equitable.
a. This is impliedly repudiated in the text of 9-203(b)(3)
5. Cases in which the security agreement did not contain a description of the
collateral at the time it was authenticated have divided the courts.
iv. Value has been given
1. The drafters of the UCC defined value in 1-201(44) so broadly that the
requirement is virtually always met in a commercial transaction
2. The definition of value used in Article 9 not only encompasses all forms of
consideration that would support an ordinary contract, it even includes one form
of consideration that does not pass muster in common law contracts: past
a. 1-201(44)(b) provides that a person gives value for rights if he acquires
them . . . as security for . . . a pre-existing debt.
v. Debtor has rights in the collateral
1. You cant grant a security interest in someone elses property. Three significant

a. First, it is read to mean that if the debtor owns a limited interest in

property and grants a security interest in the property, the security interest
will generally attach to only that limited interest.
b. Second, owners who acquired their rights in property by fraud have the
power to transfer to bona fide purchasers ownership rights they themselves
do not have.
c. Finally, you can transfer property to someone which you dont have rights,
and then if you eventually have rights in the collateral, then the security
interest (only then) becomes enforceable.
vi. Formalities of Real Estate Mortgages
1. Differs from State to State
a. Most states require the mortgage be in writing and signed by the debtor in
the presence of one or more witnesses
b. Some require acknowledgment as well, although most require that step
only as a prerequisite to recording the mortgage


Proceeds, Products, and other Value Tracing Concepts

a. General
i. One way to assure that a security interest will follow the value is to include express
language in the description of the collateral in the security agreement that covers all
forms the value is likely to take
ii. A more practical solution is to employ value-tracing concepts terms of art that indicate
that in certain kinds of transformations of the collateral the security interest should follow
from the value in prescribed ways.
b. Proceeds
i. Definition
1. 9-102(a)(64): Right arising out of the collateral are proceeds
a. Can be used to argue that virtually any property is proceeds
2. If the debtor sells the collateral, the security interest will attach to the price paid,
whether it is in the form of an account, a promissory note, or cash. If the debtor
leases the collateral, the security interest will attach to the rents received.
3. Courts will infer:
a. When the parties have done a poor job of expressing their desire that the
security interest follow the value of the collateral, some courts are quick to
infer it, even if the inference does violence to the definition of the terms
b. Proceeds are collateral within the definition of collateral in 9-102(a)(12)
4. Proceeds are Automatic
a. Even if the security agreement makes no mention of proceeds, a security
interest automatically covers them. 9-203(f) and 9-315(a)
ii. Termination of Security Interest in the Collateral after Authorized Disposition
1. Secured creditors sometimes allow their debtors to dispose of collateral free of the
security interest
a. Might be in security agreement inventory of a store
b. Might be given by creditor at a later time car dealership
c. Might be implied by the circumstances and conduct of the parties
2. In this instance, 9-315(a)(1) gives effect to the authorization: the buyer takes
free of the security interest and the secured creditor can look only to the debtor
and the proceeds
iii. Continuation of Security interest In Collateral after Unauthorized Disposition
1. In some arrangements, the parties contemplate that the debtor will sell the
collateral only pursuant to further arrangement
a. Often w/expensive items of collateral
b. Allows the bank to pass on the nature and adequacy of the consideration
the dealer will receive for the sale
2. Some security agreements prohibit the sale of collateral
a. Such a clause doesnt mean the buyer cant sell the car at all
b. When the debtor pays the debt, the interest terminates and the debtor can
3. The way to handle a problem where three people are involved (Creditor, Debtor,
and Purchaser) is to arrange for a simulataneous exchange of the security interest,
the car, and the money

a. Set up an escrow
4. Many states have enacted statutes making conduct. where a debtor sells the
collateral against a prohibition and doesnt use the money to pay the debt,
a. Illinois Statute (865): Cant sell it and not account to the creditor
b. New York Statute (865): Cant sell it at ALL
5. Even if the security agreement expressly prohibits sale of the collateral, 9-401
gives the debtor the power to transfer ownership to a buyer (may be a breach of
the security agreement or a crime)
a. To understand 9-401, it must be read together with 9-315(a)(1): When a
buyer purchases the collateral, the security interest is still there
i. Unless the secured party authorized the debtor to sell the collateral,
free of the security interest, the security interest continuesin the
original collateral and also in the proceeds
1. Is a windfall, but thats the way it goes
b. Creditors usually only bring these proceedings when their relationship
with a debtor sours (courts arent helpful to them)
i. Also, the waiver cases (waiving your rights) usually occurs w/the
sale of livestock, where sales by debtors are pretty much
continuous and the buyers are not protected by the UCC 9-320(a)
iv. Limitations on the Ssecured Creditors Ability to Trace Collateral
1. Security Interest encumbers proceeds so long as they are identifiable. 9-315(a)(2)
a. Commingling: Putting several pieces of collateral together; usually in a
bank account
i. How to commingle. Think of oil and water. Use the lowest
intermediate balance rule
1. Take the lowest balance between the time of the deposit of
the proceeds and the present balance
b. The money in a commingled account:
i. 9-322(b): a transferee of funds from a deposit account takes the
funds free of a security interest in the deposit account unless the
transferee acts in collusion with debtor in violating the rights of the
secured party
ii. However, anything the debtor purchased with that cash may be
1. You have to be able to trace the value with specificity
2. In re Oriental Rug Warehouse Club, Inc.
a. The secured party has the burden of proving with
specificity must have arose directly from the sale
or other disposition of the collateral and that these
alleged proceeds cant have arisen from any other
b. The intermediate balance rule assumes that a debtor
who spends money from a commingled account
spends first from his own funds. Once the balance
fo the commingled account drops below the amount

of the deposited proceeds, then the secured

creditors interest in the proceeds abates
c. Other value tracing concepts
i. Product: What the collateral produces
1. Usually agriculture: wool is product of sheep, milk of cows, maple of trees
a. These may also be proceeds, but we are unclear
ii. Profit: The excess of revenues of a business over the expenses where the business itself
is the collateral
1. Under 9-315, applied to real-estate, a profit may not be proceeds: the former is a
right ot remove; the latter typically is a thing received in exchange
iii. Rents: money paid for the temporary use of collateral
iv. Offspring: what the animal produces baby, etc.
v. All of these are arguably proceeds b/c they are rights arising out of collateral.
d. Non-Value tracing concepts
i. Main types
1. After-acquired property
2. Replacements
3. Additions
4. Substitutions
ii. These are non-value tracing in the sense that they can pick up property acquired by the
debtor with value not derived form the previously existing collateral

XXI. The prototypical Secured Transaction

a. General
i. This part will break down a prototypical transaction. We will discuss the strategies and
motivations of both sides. The legal doctrine governing secured credit is best understood
in relation to those strategies and motivations
b. The Parties
i. Deutsche Bank is a lender that specializes in floorplanning buying the inventory that
people use on the showroom floor of businesses
ii. Bonnies Boat World is a corporation that owns a spot near a lake on a commercial
c. Deutsche approves Bonnies loan
i. Bonnie goes and discusses with loan officer Paul Kaplan. She takes an application form,
which asks for information about Bonnie and her business, including current balance
sheets, income statements, and income tax returns for both herself and the corporation.
ii. Paul receives the application, and orders a credit check. After computer analysis and
Pauls own check, Paul decides to recommend authorization of the loan.
iii. He presents the loan to his branch manager. Branch manager approves the loan, and Paul
calls Bonnie to let her know the transaction has been approved.
d. Deutsche and Bonnie document the loan
i. Bonnie Presents to her lawyers the Security Agreement Arbitration she will have to
sign, and then has a meeting with Deutsche. Prior to the meeting, Richard, a Deutsche
employee, searches the Article 9 filing system to verify the name and address of the
company. He goes to Bonnies Boat World and makes a list of all the boats currently in
the companys possession. While there, he examines the books and records of the
company. Satisfied with what he has seen, he recommends to Paul that the loan is ready
for closing.
ii. When Bonnie arrives at Pauls office he presents four documents that are important to the
transaction, which will be discussed in a moment:
1. Security Agreement
2. Sample form Statement of Transaction
3. Financing Statement
4. Personal Gaurantee
iii. Security agreement and Statement of Transaction
1. Security Agreement (full text) is highlighted on pp. 927-935
2. At the time she signs this agreement, Bonnie has not yet purchased any boats for
Deutsche to finance, Deutsche disburses no money at this closing and there is
no Statement of Transaction for Bonnie to sign.
a. However, an example of a statement of transaction is presented on p. 935
iv. The Financing Statement
1. Bonnie also must sign a financing statement for filing in the UCC filing system of
the state. The purpose of the financing statement is to give public notice that
Deutsche claims a sexurity interest in Bonnies inventory
2. An example of a financing statement is on p. 936
v. The Personal Gaurantee
1. Although all of the loans go to the business, Deutsche requires bonnie to
PERSONALLY guarantee all of the loans.

2. Rationale:
a. First, if the borrower cant repay the loan, the owners might. The
guarantee gives the lender the right to obtain a udgment against the owners
and proceed against their assets just as though the owners were the ones
that had borrowed the money. In addition, personal guarantees can be, and
sometimes are, secured by interests in property owned by the guarantors.
b. Second, this assures, insofar as possible, that in the event of default, the
lender will have the cooperation of the owners. When a corporate debtor
becomes insolvent, the owners interest in the business often becomes
worthless. Unless the owners are personally liable for debts of the
business, they may not care how much of the debt is repaid. Even if the
owners have all of their wealth in the corporation and the corporation is
insolvent, if the owners are personally liable, they will continue to have an
incentive to cooperate with the lenders that hold personal guarantees. In
the event of competition for the assets of the corporation, the owners are
likely to be on the side of the creditor to whom they have given their
personal guarantee.
e. Bonnie Buys Some boats
i. The Floorplan Agreement
1. The floorplan agreement provides that if Deutsche finances purchase of Shoreline
Boats by deales such as Bonnies Boat World and then has to repossess those
boats, Shoreline will buy them back and the full invoice price.
a. A copy of a floorplan agreement is on pp. 938-940
2. Advantage to Deutsche:
a. Shoreline buys all boats repossessed at full invoice price
3. Advantage to Shoreline:
a. With the Floorplan Agreement in place, Shoreline can offer qualified
dealers nationwide 100 percent financing on the boats they buy from
Shoreline, making the boats more attractive to dealers.
b. If Shoreline had to finance the boats itself, it would bear much of the risk
of boats being lost, stolen, or destroyed through dealer fraud. Under the
Floorplan Agreement, Deutsche bears these risks
4. Advantages to Bonnie:
a. Because the repurchase agreement reduces Deutsches risk of loss on
resale after repossession, Deutsche can offer Bonnie a larger line of credit
and finance a larger portion of each purchase than a bank typically could.
b. Bonnies may benefit from time to time from subsidies offered by
Shoreline to Deutsche to provide dealers such as Bonnies with periods
when little or no interest accrues.
ii. The Buy
1. Bonnie buys 5 boats from Shoreline, total: $55,000.
2. Shoreline contacts Deutsche to obtain approval of the purchase.
3. Deutsche verifies that both Bonnies and Shoreline are in compliance with their
agreements and that the purchase wont overdraw Bonnies line of credit.
4. Deutsche gives Shoreline an approval number (like a visa number). Shoreline
ships the five boats to Bonnie and sends the invoice to Deutsche.

5. Deutsche pays the $55,000 to Shoreline, recording it on their books as a loan to

f. Bonnie Sells a Boat
i. Bonnie paid $15,566.58 for a boat from Shoreline. She is selling it to the Homers for
$20,000. Bonnies will have a gross profit of $4,333.32.
ii. Bonnie has an arrangement with First State Bank in which it will finance 90% of
Bonnies customers purchases. The Homers qualify for the loan.
iii. The Homers write Bonnies a check for $2,000 (10%), sings a security agreement and
financing statement for First State.
iv. On receipt of the Security agreement and fiancing statement, First State gives Bonnie
v. Because Bonnie financed with Deutsche bank on a pay as sold basis, Bonnies payment
for the boat is now due. In accord with this provision, Bonnies sends Deutsche a check
for $15,566.68 that same day.
vi. At the beginning of the next month, Deutsche will bill Bonnies for the finance charges
that accrued during the brief time this $15,566.68 was outstanding.
g. Monitoring the existence of the Collateral
i. In case of fraud, Deutsche will continually monitor its collateral
ii. Duetsche will send a person, in this case Feynman, to Bonnies boat world every 30-45
days to verify the continuing existence of the collateral and check its condition
iii. Feynman has a list of all the boats Deutsche has security interests in, and he goes around
and finds them based on their ID numbers on plates.
iv. When Feynman is finished, two boats are missing he asks Bonnie about them. She tells
him that one is out on the water, and one is sold yesterday. Feynman inspects the
bookkeeping and verifies the truth of the second boat. When he returns to the bank, he
will verify that check is received and the date it was postmarked. Bonnie tells him the
other boat will be back in an hour. He demands to drive out and see the boat on the
water. He verifies that it is the correct boat, and all is well.
v. The reason he verifies and checks all of the inventory at one time is b/c he wants to make
sure that no fraudulent actions occurred, and none of the boats have had their name plate
changed in his absence.

XXII. Personal Property Filing Systems

a. What is priority?
i. A lien with a priority higher than another is referred to as the senior or prior lien and the
other is referred to as the subordinate or junior lien.
ii. Regardless of social equity or principals of unjust enrichment, society feels comfortable
with following the established filing system based on priority and secured v. unsecured
1. See e.g. Peerless Packing Co. v. Malone and Hyde, Inc.
b. How do creditors get priority?
i. Central to the system of lien priority is the idea that liens rank in the chronological order
in which they were created
ii. Because the liens it will rank behind are already in existence, the prospective lender can
obtain information about them and, if necessary, contract with the holder regarding their
iii. The taking of certain required steps is known as perfecting a lien. The steps that must be
taken differ with the type of lien, but nearly all include acts in one of four categories.
1. Filing notice in a public records system established for that purpose
2. Taking possession of collateral
3. Taking control of collateral by means of the stake holders agreement to hold for
the secured creditor, or
4. Posting notice on the property or where it will be seen by persons dealing with the
iv. The type of lien is unimportant. Except for the time of their perfection, one perfection is
the same as one another.
c. The theory of the filing system
i. The filing system is the principal means used to communicate the possible existence of a
lien from a creditor who has one to a creditor who is thinking of acquiring one.
ii. For an Article 9 security interest (which is a lien), one must file a financing statement,
also known by its form number, a UCC-1
iii. Unsophisticated lenders often fail to discover a lien that is on the public record before
they obtain their own; the result is that the lien they take will be subordinate to the lien
already recorded.
d. Multiplicity of Filing Systems
i. With a few exceptions, each county in the United States maintains a real estate recording
system in which not only real estate mortgages, but also Article 9 fixture filings are filed.
ii. Many counties also maintain separate systems for property tax liens, local tax liens, and
money judgments.
1. All but La. And Ga. Have these systems
iii. Case: National Peregrine, Inc. v. Capital Federal Savings
1. Generall, whether a copyright has to be filed in the US Copyright office or in
another system.
2. Held, the comprehensive scope of the federal Copyrights Act recording
provisions, along with the unique federal interests they implicate, support the
view that federal law preempts state methods of perfecting security interest in
copyrights and related accounts receivable.

3. Notes:
a. Thus, when a federal statute provides for a national system of recordation
or specifies a place of filing different from that in Article 9, the methods of
perfection specified in Article 9 are supplanted by that national system;
compliance with a national system of recordation is equivalent to the filing
of a financing statement under Article 9. UCC 9-311(b).
iv. With regard to security interest in trademarks, however, one case specifies that a federal
filing isnt necessary to perfect, a state filing will do.
1. Joseph v. 1200 Valencia, Inc.
e. Methods of Cost and Searching
i. In most searches, the lender pays two fees: that of the filing officer and that of the service
ii. The typical fee for searching a single name is about $50.
iii. Book suggests that the issue of where to search and file is one that requires both a
thorough knowledge of the law and the exercise of judgment in light of the likely cost
and the amounts involved.

XXIII. The concept of Priority: State law

a. General
i. First doesnt necessary mean first in time. The holders of subordinate liens are often paid
earlier in time than is the holder of the first lien.
ii. To say that one creditor hasd priority over another is to say that if the value of the
collateral is insufficient ot pay only one of them, the law requires that value be used to
pay the one who has priority.
b. Priority in foreclosure
i. Two principals govern the timing of the enforcement of competing liens against the same
1. First, absent an agreement to the contrary, any lien holder may foreclose while the
debtor is in default to that lien holder.
a. The existence of a prior lien generally does not block the exercise of rights
of a subordinate one.
2. Second, no lien holder is compelled to foreclose.
a. Each has the option to extend the debtors time for payment or dimply
forbear from exercising its remedy.
ii. See Hawaii statute on how to apply proceeds on p. 1076
iii. The procedure for foreclosing varies with the type of lien
iv. The following principals govern most judicial or foreclosure sales.
1. The sale discharges from the collateral the lien under which the sale is held and all
subordinate liens. It does not discharge prior liens. UCC 9-617(a)
2. The sale transfers the debtors interest in the collateral to the purchaser, subject to
all prior liens. 9-617(a). the holder of the prior lien cannot enforce the debt
against the person who purchases at the foreclosure sale. But the holder of the
prior lien can enforce the lien against the purchaser. Unless the debt underlying
the prior lien is paid by the purchaser or someone else, the holder of the prior lien
can foreclose.
3. The proceeds of sale are applied foirst to the expeses of sale, then to payment of
the lien under which the sale was held, then to payment of subordinate liens in the
order of their priority. UCC 9-615(a). The remaining surplus, if any, is paid to the
debtor. UCC 9-615(d)(1). Unsecured creditors do not share in the distribution;
their remedy is to get paid by the debtor.
4. The debt underlying each lien is reduced by the amount paid to the lien holder
from the sale, but the balance remains owing. The lien holder is then entitled to a
judgment against the debtor for the deficiency, unless there is a statute providing
otherwise. UCC 9-615(d)(2).
5. Example on 1076-77
c. Reconciling Inconsistent priorities
i. While the rules of the proceeding section are typical, they arent universal.
ii. In some sale proceedings, a purchaser takes free of all liens against the property and
proceeds of sale are distributed first to the holder of the first lien.
1. Two reasons this is rare:
a. They deprive the holders of senior lines of their option not to foreclose.

b. A procedure that required payment of the first lien first would require
some mechanism for identifying and giving notice to the holder of that
lien so that the holder could protect its rights by bidding at the sale
iii. Rules governing priority between execution liens or security interests and federal tax
liens are beyond the power of the state legislature altogether, b/c those rules are enacted
by Congress as part of the Internal Revenue Code.
iv. Court fuse diverse sets of state and federal priority laws together to resolve conflicts
1. In the resulting system, all the schemes of foreclosure and distribution have one
feature in common:
a. Those creditors whose liens are discharged by the sale share in the
proceeds of sale in the order in which liens have priority
v. Mortgages usually have priority over judgment liens for the simple reason that when a
debtor has judgment liens against his or her property, no one will make a mortgage loan
to the debtor.
vi. Case: Bank Leumi Trust Company v. Liggett
1. Liggett got a judgment; a year later, Bank Leumi took out a mortgage; then
Cosden got a judgment after Bank Leumi. Statute said that judgment creditors get
paid first. Court disregards the statute and remands to consider as between the
two. Likely, the court realized how the system was supposed to work.
d. The right to possession between lien holders
i. General
1. Most courts require that the junior lien holders surrender possession to senior lien
holders in the event that two foreclose at the same time
ii. The Grocers Supply Co. V. Intercity
1. Has to do with the fact that a subordinate creditor levied the property and didnt
want to pay to he secured creditor the proceeds first
2. Notes
a. Florida court has held that UCC 9-401 does not exempt collateral from
execution and that it may be seized and sold by the judgment creditor,
subject to the secured partys lien
i. Altec Lansing
ii. First National Bank of Glendale v. Sheriff of Milwaukee County
b. Texas version of UCC provides that unless otherwise agreed, a secured
party has on default the right to take possession of the collateral. UCC 9609
c. With the exception of Wisconsin, other states considering the issue have
consistently held that the right of a prior perfected creditor to take
possession of its collateral is superior to any right of a judgment creditor
and that the prior perfected secured creditor may regain possession of the
collateral from an officer who has levied on the property at the direction of
a judgment creditor.
d. Both the Oregon CofA and the Utah SC have held that a secured creditor
whit a right of possession of the collateral after default may maintain an
action for conversion against one who exercised unauthorized acts of
dominion over the property to the exclusion of the creditors rights

iii. Issue with Grocers Supply is that if a junior leinholder cant collect until a senior
lienholder lets it, then the junior lien is worthless
1. CASE: Frierson v. United Farm Agency, Inc.
a. Merchants cannot refuse to exercise its rights under the security
agreement, thereby maintaining UFA as a going concern, while it impairs
the status of other creditors by preventing them from exercising valid
liens. This would fly in the face of UCC 9-401
iv. UCC 9-401 doesnt say that an unsecured creditor who has obtained a judgment against
the debtor can levy on collateral encumbered by another creditors security interest, it just
says that the issue is governed by applicable law other than this article.
v. Two ways to reconcile Grocers Supply and 9-401:
1. Reasoning in Frierson: The right of the senior to possession is not the right to
possession for the purpose of leaving the debtor in business and frustrating
collection by junior line holders.
a. The senior lienholder must foreclose or stand aside so junior holders can
do so.
2. The observation that Grocers Supply requires the junior lien holder to surrender
possession to the senior, but it doesnt bar the junior from continuing with the
a. Under some sale procedures, property can be sold even though it isnt
physically present.

XXIV. Bankruptcy and Priority

a. Three main difference in Bankruptcy
i. The secured creditor cant foreclose until the stay is terminated. BC 362(a)
1. Secured creditor can seek relief from the stay, but no saying whether it will be
granted. 362(d)
ii. The trustee or debtor in possession can sell the secured creditors collateral free and
clear of liens, effectively foreclosing the secured creditors lien on the trustees or
debtors own timetable.
iii. The bankruptcy isnt concerned with giving money immediately, it is concerned with
maximizing the value of the estate for everyone, including the debtor.
b. Bankruptcy Sale Procedure
i. Trustee or debtor in possession can sell the collateral
1. These sales may be judicial sales, pursuant to oa court order and confirmed
afterward bythe court, or they may be nonudicial sales held pursuant ot the
powers verted in the debtors in possession or trustees by statute. BC 363(b)(1)
and (c)(1).
ii. In bankruptcy sales the collateral may be sold subject to the liens of secured creditors.
Once such a sale is complete, the collateral ceases to be property of the bankruptcy estate,
the automatic stay expires, and, if the debt is in default, the secured creditor will be free
to foreclose BC 362(c)
iii. If the property is burdensome to the estate, b/c the liens encumber it so nobody is likely
to buy it, then the estate will abandon it. BC 554
1. Abandonment removes the property from the estate, revests the property in the
debtor, terminates the automatic stay, and allows lienholders to foreclose.
iv. Bankruptcy law provides an alternative procedure under which a trustee or DIP can sell
free and clear of the liens. BC 363(f)
1. Works like the sale by the first lien holder in foreclosure. The buyer takes it
unencumbered in title and presumably pays its full value of the purchase price.
The liens are transferred to the purchase price, with the ultimate outcome that the
proceeds are applied to the liens in the order of their priority.
v. CASE: In re Oneida Lake Development, Inc.
1. Debtor wins the right to sell collateral over a secured creditors objection.
2. 363(f) authorizes a debtor to sell its property free and clear of liens and
encumbrances, so long as it can satisfy any one of the five subsections.
a. Here, at issue is subsection (f)(3) and (f)(4)
3. (f)(3): sale by debtor free and clear of liens and encumbrances only when the sale
price is greater than the aggregate value of all liens on the property.
a. Dont look to face amount of lien, you look to the value of the creditors
interest in the estates interest in such property.
vi. Notes
1. One circumstance in which the bankruptcy power to sell free and clear of liens
can achieve greater economic efficiency than the non-bankruptcy foreclosure sale
procedure is where the amounts and priorities of competing liens against the
collateral are in doubt and the collateral is depreciating in value
a. By selling free and clear, whatever their priority and amount, to the
proceeds of sale, the debtor or trustee can prevent further losses.

2. In a bankruptcy case, a debtor or trustee can effect a sale free and clear of the two
mortgages. 363(f)(4).
3. Just as in non-bankruptcy sales, secured creditors in bankruptcy are allowed to bid
into the amount of their liens. 363(k)
c. The Power to Grant Senior Liens
i. Under state law, liens often rank in priority in the order in which they are created and
ii. In bankruptcy, the above first come priority doesnt hold
iii. In limited circumstances, the trustee or DIP can borrow additional money from a postpetition lender, secured by a lien prior to existing liens. 364(d)
1. Must notify the holder of the first lien before doing so.
2. If holder objects, court holds a hearing
a. Determine:
b. (1) if the estate is unable to borrow money without granting the prior lien,
i. May incur unsecured debt as an administrative expense with first
priority status under 11 USC 507(a)(1)
ii. It may acquire a loan that is either unsecured but senior to all
administrative expenses, secured by a lien on property that is not
secured, or secured by a junior lien on property already secured.
c. (2) there is adequate protection of the interest of the secured creditor
whose lien is being displaced
i. If value is going to increase, this is probably sufficient
3. Rationale for this is on 453: business needs it to survive
iv. Why arent secured creditors happy about this?
1. Usually gets nothing from the transaction
a. Would have come out fine in a foreclosure
2. The adequate protection dispensed by the court is no guarantee against loss
a. If the property declines in value, and there isnt enough to pay the claims,
then the old lenders unpaid claim turns into an unsecured debt, and while
it has priority over other types of claims ( 507(b)), it is still unsecured.
d. Protection of Subordinate Creditors
i. Bankruptcy shifts what would be common in foreclosure, postiting essentially that the
collection efforts of senior line holders should be stayed if (1) the senior lien holders are
adequately protected against loss, and (2) the stay is likely to facilitate the collection
efforts of subordinate creditors
1. See analogy to medicine on 460

XXV. Lien Creditors v. Secured Creditors: The Basics

a. General
i. This deals with three situations, all involving lien creditors:
1. Lien creditors v. lien creditors
2. lien creditors v. secured creditors
3. lien creditors v. mortgage creditors
b. How creditors become lien creditors
i. Prototypical lien creditor: won a judgment, obtained a writ of execution, and then
obtained a lien by levying on specific debtor property.
ii. 9-102(a)(52) defines lien creditor
1. Any creditor who has acquired a lien on the property involved by attachment, levy
or the like
iii. Attachement is a legal process in which the P in litigations obtains a writ and delivers it
to a sheriff, marshal, or other law guy, who then levies on property of the debtor.
1. In a few jurisdictions, attachment is virtually a synonym for execution.
2. In most, the distinction between attachment and execution is that an attachment
occurs before judgment is entered, and an execution occurs after
iv. Two other important lien types:
1. Garnishment: the process by which a judgment creitor in most states reaches debts
owing from a third party to the debtor or property of the debtor that is in the hands
of the third party.
a. In many jurisdictions, an unsecured creditor can garnish before obtaining a
judgment in certain kinds of cases, subject to numerous statutory and
constitutional restrictions. However, garnishment of wages held by an
employer is prohibited prior to judgment in all states and even after
judgment in a few.
2. Recordation of a judgment for money damages:
a. In nearly all states, recordation of a mony judgment in the real property
recording system creates and perfects a lien against all real property
owned by the debtor within the country
b. In a minority of states, the judgment creditor can record in the UCC filing
c. See California Code on Real Property (1090-91)
3. A trustee in bankruptcy, including a debtor in possession under Chapter 11, has
the rights of a hypothetical ideal lien creditor essentially a lien creditor with no
debilitating history or knowledge who obtained a lien on all property of the
ebtor on the date of the filing of the bankruptcy case.
a. Even if none of the debtors creditors could prevail over an unrecorded
mortgage b/c all knew about it, the debtors trustee, given its status, could.
BC 544(a).
c. Priority among lien creditors
i. Governed by state statutes, usually on a first-come, first-served system.
ii. Laws generally award a lien priority on one of four dates:
1. Date of levy:
a. Some states honor only actual physical possession by the sheriff; others
consider various kinds of symbolic or constructive possession adequate.

2. Date of delivery of the writ to the sheriff (after issued by court):

a. In a large minority of states, writs of execution rank in the order in which
they are delivered to the sheriff w/ instructions for levy on the property in
b. In all or nearly all of these states, the lien comes into existence only on
levy and may then be said to relate back to the date of delivery to the
i. Thus, only the one levied is a lien. If the second one is levied, it
has priority b/c of relation back.
3. Date of Service of Writ of Garnishment
a. This is the delivery of the writ by the sheriff to the garnishee, which is
typically a bank or an employer
4. Date of recordation of judgment:
a. This is the date the judgment is delivered to the filing or recording officer
(in large majority, this only gives liens in real estate).
iii. In a competition between writs of execution, the majority rule gives priority to the first to
levy on the particular property.
iv. The minority rule states that priority depends on the order in which writs were delivered
to the sheriff.
d. Priority between lien creditors and secured creditors
i. General
1. Priority between a lien creditor and a nonpurchase-money Article 9 secured
creditor depends on whether the lien creditor becomes a lien creditor: before the
secured creditor does either of two things: (1)perfects its security interest or (2)
files a financing statement and complies with UCC 9-203(b)(3).
ii. Article 9 Perfection (9-308(a)):
1. Perfected only after it has been attached and the steps required for perfection are
iii. Date on which lien creditor becomes a lien creditor 9-317(a)(2).
1. Majority: at the time of levy
2. Minority: Delivery of writ to the sheriff
e. Priority amoung lien creditors and mortgage creditors
i. Priority between liend and mortgage creditors is governed by real estate law.
ii. Real estate law generally gives priority to the first lien created, and then reverses the
result only if the failure to perfect offends the states recording statute.
f. Purchase money priority
i. When a second-in-time interest takes precedence over an earlier interest, the
congnoscenti describe the second secured creditor as priming the first.
ii. Occurs often with purchase-money security interests (PMSIs)
iii. Under the rule stated in UCC 9-317(e), a PMSI can prime a lien creditors interest only
if the PMSI comes into existence and attaches to the collateral before the creditor obtains
its lien against that collateral
1. If the PMSI attaches first, the holder of the PMSI has a 20-day grace period in
which it can perfect and thereby defeat a lien that came into existence between the
dates of attachment and perfection of the PMSI.

2. The effect is that a PMSI secured creditor that went public later can defeat a lien
creditor who went public up to 20 days earlier.
iv. Lien creditors who are concerned about he possibility of secure PMSI liens might choose
to dealy their levies for 20 days after the debtor acquires new property to see if a PMSI
shows up on the public record.
1. However, most will levy and wait to see if a PMSI files later.
a. Lien creditors usually hurry to establish priority.

XXVI. Lien Creditors v. Secured Creditors: Future Advances

a. Priority of Future advances: Personal Property
i. General
1. Secured creditors often continue to disburse money to their debtors after the initial
loan transaction.
2. Most of the secured parties who make these advances would be unwilling to do so
if their interest securing them might be subordinate to a lien creditor who levied
on the collateral before the secured creditor made the advance.
a. Could protect itself by repeating its search for lien creditors before making
each new advance and refusing to make the advance if one has intervened.
ii. Exceptions in favor of the secured creditor making advances
1. 9-323(b) gives several exceptions:
a. future advances have priority over the lien, provided the creditor making
the advance does not have knowledge of the lien.
b. Every secured advance made within 45 days after the levy is entitled to
priority over the lien, even if the secured creditor making the advance
knows of the liens existence.
c. Every advance made pursuant to a commitment entered into without
knowledge of the lien is similarly protected.
i. 9-323(b)(2)
iii. Rationale for exceptions
1. Reason for giving the exception within 45 days, even with knowledge of the lien:
a. Only by giving unconditional priority over lien creditors to secured
creditors future advances made during the 45-day period could the drafters
qualify those future advances for the maximum priority over IRS tax liens
available under the Tax Lien Act.
2. Reason for giving the exception after 45 day w/o knowledge of the lien:
a. Debate on 1099-1100 (Should note rationales on both sides)
b. Priority of Nonadvances: Personal Property
i. Question is whether the debtors contract fees, or nonadvances (attorney fees, costs of
collection, etc.) in the event of default qualify for priority over lien creditors under 9323(b)?
ii. Case: UNI Imports v. Exchange National Bank of Chicago
1. Facts: Exchange and Apracor entered security agreement on Apracors assets, and
revolving line of credit up to 7.2 million. After the note expired, Exchange
continue to make advances. 1mo8days later, UNI obtained $66,000 judgment,
had it enforced by marshal. Exchange refused to turn over the assets, saying they
had priority. Exchange continued to advance money (2 million or so). They
added to Aprocors balance credit collections, attorney fees, etc. DC granted
UNIs petition for the turn over of assets.
2. Issue: Whether other secured obligations such as interest and collection expenses
qualify for priority under 9-323(b)?
3. Rationale:
4. 9-323(b) rests on the assumption that each advance gives rise to a new security
interest which arises when the creditor extends value.
a. When this security interest is perfected

5. Only other case: Dick Warner Cargo says that those obligations are not treated as
advances those obligations give rise to their own security interests, at least some
of which arose with the execution of the financing agreement.
a. Language: common use of advance are sums put at the disposal of the
borrower not expenditures made by the lender for its own benefit.
b. Court holds that creditor that perfects its interest with respect to such
obligations is entitled to protection against subsequent lien creditors.
c. Therefore, as long as these are taken care of, they should be protected.
d. Not plain language of 9-323(b), but any other result would be inconsistent
with drafters intent.
6. Dick Warner Cargo isnt wholly convincing.
7. However, giving the holding of the 2nd Cir and the UCC Boards approval, we
conclude that non-advances are not advances for purposes of 9-323(b).
8. Must distinguish between nonadvances relating to advances made before the levy
(which have priority) and nonadvances relating to advances made after the levy
(which have only the priority of the future advance).
iii. Drafters reworded 9-323(b) to endorse the UNI Imports holding. The rewording does not
address the issue of non-advances relating to advances made after the lien.
iv. It is also worth noting that the accruing non-advances have priority even when the nonadvances do not contribute value to the debtors estate and the secured creditor forbears
from foreclosure until the debtor has predictably dissipated all value from which junior
creditors might have recovered.
c. Priority of Future Advances and Non-advances: Real Property
i. General
1. The law governing real estate transactions is even more tolerant of future
advances made after a lien creditor perfects an interest in the collateral.
ii. Case: Shutze v. CreditThrift of America, Inc.
1. Facts: Beneficiary of first deed of trust is Deposit Gaurantee Mortgage on
property owned by Hobart Gentry. Lien was a conventional first mortgage.
Gentrys entered second mortgage for $23,500 with Creditthrift of America, and
Gentrys entered second deed of trust to Hendrix (trustee for Creditthrift), and this
was duly recorded. The second deed of trust contains a future advance clause
(1106). However, nothing in the advance clause obligated CreditThrift to make
future advances.Shutze received a judgment on Sept 20, 1984 against Gentry for
$4,500. It was enrolled in Forest county, and acquired the power of law. 11
months later, Gentrys refinanced with CreditThrift for an additional $2,750
(CreditThrift regarded this as within their advance clause). Gentrys bail out in
1988, and creditors resort to property to fulfill the obligations. CreditThrift and
Shutze argue about CreditThrifts $2750 lien.
2. Held: Our case law holds that future advances relate back to the original deed of
trust, and although we find the UCC rule for personal property indistinguishable
from real estate law, CreditThrift had no actual notice and thus would prevail
under the UCC in any case.
3. Rationale:
4. Precedent consistently holds that Future Advance Clauses are perfectly fine; they
should be upheld according to Contract law, and subject to Contract defenses.

a. This is a convenience and accommodation to borrowers

5. All agree that creditThrifts first lien comes before Shutzes 1984 judgment lien.
We only consider the $2750 future advances of CreditThrift in 1985.
6. For priority purposes, the lien securing the future advance takes its date from the
recording of the original deed of trust and by operation of law reaches forward to
secure the advance made after intervening rights became perfected.
a. Shutze had notice of such a clause.
7. The UCC as originally enacted treated this issue the same as our cases have
they allow future advances to relate back to the original deed.
8. The new UCC stops at 45 days unless you didnt know, but this 9-323(b) does not
reach real estate transactions. 9-109(a) and 9-109(d)(11).
9. Although it seems indistinguishable from personal property issues, if we
important 9-323(b) into our law of real estate secured transactions, we would cut
back the reach of the dragnet clause. We need not take that step today, for
CreditThrift prevails under the UCC b/c they didnt have notice of the lien.
iii. The usual means of obtaining a lien against personal property is for the sheriff to levy the
property and take possession, thus everyone is on notice.
iv. The usual method for obtaining a judicial lien against real estate is for the creditor to
record its judgment in the real estate records.
1. Unless the lien creditor thereafter conducts a search, he wont know whether its
lien attached to any property of the debtor.
2. Look at 1110
v. Not all courts follow Shutze
1. Other jurisdictions refuse priority to such optional advances made by the
mortgagee with knowledge of a subsequent lien, but give priority to obligatory

XXVII. Trustees in Bankruptcy Against Secured Creditors: The Strong Arm Clause
a. General
i. Unperfected security interests do not retain their priority when the debtor goes into
bankruptcy. BC 554(a)
ii. A bankruptcy trustee or DIP has the power to avoid most kinds of security interests that
remain unperfected as of the time of filing of the bankruptcy case under 554(a) the
Strong Arm Clause
1. In this situation, the creditor becomes unsecured.
b. The purpose of 554(a)
i. A policy against secret liens
1. If creditors havent perfected, they havent given public notice on their rights to
the collateral
ii. Trustees will inspect security documents, check the secured creditors compliance with
filing requirements, and bring actions in bankruptcy court to avoid the security interests
they discover are unperfected.
iii. If a trustee is successful in avoiding the security interest, the interest is preserved for the
benefit of the estate. BC 551.
c. The text of 554(a)
i. The complexity comes from the variance in state statutes relating to what it means to be
ii. Drafters invented three hypo persons, each of whom might compete with those holding
less than perfect liens; the trustee can step in to any of their shoes and defeat the liens The ideal line creditor is the overall hypothetical: Federal law leaves it to the states to
determine what rights these ideal lien creditors have against others.
d. The three hypothetical creditors:
i. The judicial Lien Creditor of 544(a)(1)
1. Def: creditor that extends credit to the debtor at the time of the commencement
of the case, and that obtains, at such time and with respect to such credit, a
judicial lien on all property on which a creditor on a simple contract could have
obtained such a judicial lien.
a. This would be impossible for a real creditor
b. Why did the drafters use this guy?
i. They wanted to test perfection as of the filing of the bankruptcy
ii. Giving the hypothetical lien creditor its lien only as of the
commencement of the bankruptcy case prevents the trustee from
challenging a security interest for being unperfected at some earlier
iii. Allowing the hypothetical lien creditor ot be other than a simple
contract creditor would have done the same, b/c other kinds of
creditors are sometimes accorded rights that relate back to some
earlier time.
2. Lien on Motor Vehicle for Damages (Example)
3. In cases where the interest under attack is a lien on security interest, the only
characteristics of the hypo lien creditor that seem to make any difference are

a. That the hypo lien creditor obtains its rights through the exercise of
judicial remedy such as execution, attachment, garnishment, levy, and the
like; and
b. That the hypo lien creditor obtain its rights at the moment of the filing of
the case.
4. When the competing claim is a security interest, the applicable state law will be
9-317(a)(2) and 9-323(b).
a. Under it, ideal lien creditors defeat unperfected security interest for which
no effective financing statement exist, but lose to other security interests.
ii. The creditor w/an Execution Returned Unsatisfied ( 544(a)(2))
1. Def: Creditor that extends credit to the debtor at the time of the commencement
of the case, and obtains, at such time and with respect to such credit, an execution
against the debtor that is returned unsatisfied at such time.
a. 544(a)(2) is beyond the scope of this book prevents fraudulent
iii. The Bona Fide Purchaser of Real Property (
1. Must be real property other than fixtures
2. Def: Can step into the shoes of a purchaser who paid for the property(perfected
such transfer) at the time of the commencement of the bankruptcy case.
a. Must be one against whom applicable law permits such transfer (the lien
under attack) to be perfected.
b. Another way to see it: The trustee gets the rights of a bona finde purchaser
only in circumstances where the competing transfer was capable of
3. Courts allow the trustee to prevail:
a. Where the competing creditor was supposed to do something to perfects
its lien and
b. The competing creditor failed to do so.
e. The rights of a bona fide purchaser of real property are generally greater than those of a lien
i. Midlantic National Bank v. Bridge
1. Bridge got first mortgaged. Then, got second for same amount and paid off the
first. The first was pronounced satisfied, but second, unbeknownst to the parties,
remained unrecorded.
2. Trustees powers are limited to the law of the state where the property is held;
3. By operation of N.J. law, Midlantic retains an equitable lien although the lien
remained unrecorded this would trump the strong arm powers of the trustee
4. N.J. law also shows that a bona fide purchaser of real property takes over a person
with an equitable lien
5. Therefore, Midlantic loses, b/c the trustee under 544(a)(3) prevails
a. This might be different if it were personal property
f. The implementation of 544(a)
i. Does not require the trustee to avoid certain transactions (discretion to do so)
ii. Exercise of discretion by Chapter 7 trustees
1. In Chapter 7, trustees are paid after secured creditors, and have an incentive to
boost the pot they are above unsecured creditors

2. Usually the trustee gets VERY LITTLE ($60)

3. If he can avoid some liens, then that money goes into the estate. 541(a)(3) & (4)
iii. Secured creditors - proofs of claim in bankruptcy cases
1. The creditor doesnt file a proof of claim
a. If the creditor ignores the bankruptcy and nobody comes after them,
secured creditors liens pass through bankruptcy unaffected. The
debtors obligation to pay the underlying debt is discharged, but the
secured creditor can still foreclose on the lien.
2. The creditor does file a proof of claim:
a. The creditor must attach evidence of his security interest
b. The trustee is likely to examine this carefully and even conduct a search of
the public records to verify that the financing statement was filed.
i. If no proof is filed, the trustee will demand it
3. The trustee has up to two years, 546(a), to bring an action challenging the claim.
iv. Exercise of discretion by Chapter 11 trustees
1. Ordinarily, no trustee, just a DIP who exercises his discretion to bring or not
bring actions
2. If DIP does bring claims and succeeds, he changes the debtors status from secured
to unsecured
a. Will reduce creditors leverage in reorganization plan
3. Often, there are reasons (family, key supplier) not to avoid the liens in Chapter 11
4. The DIP is a fiduciary, and must exercise in the best interests of the estate.
a. If he wont bring an action, several courts allow for the unsecured
creditors committee to sue in place of the DIP
5. When converted to Chapter 7 case, the dynamic changes as long as the
conversion happens w/in 2 years of the filing of the Chapter 11 case, the trustee
has plenty of time
g. Recognition of Grace Periods
i. Grace periods allow for a creditor to have some time to perfect the lien thorugh public
1. E.g. 9-317(e) gives 20 days for PMSIs to file
2. If the creditor files, it has priority over a lien creditor who becomes such between
the time of attachment and the time of filing
3. If the debtor goes into bankruptcy, it doesnt matter you still get the grace period
to file and then the trustees rights are subordinated to yours
a. Result flows form a combination of 362(a)(4), 362(b)(3), and 564(b).
ii. Resistance to BC 544(a)
1. The changes to Article 9 that allow defectively filed security interests to prevail
over judgment lien creditors:
a. 9-338 & 9-520(c): allow security interests perfected by the filing of
incorrect financing statements to prevail over lien creditors
b. 9-515(c): a security interest that is no longer perfected b/c the financing
statement has lapsed can prevail over creditor that became a lien creditor
while the security interest was perfected.

XXVIII. Secured Creditors against Secured Creditors

a. The general rule
i. The basic rule: first to file or first to perfect
1. The basic rule is UCC 9-322(a)(1): Between the holders of two security interest
in the same collateral, the first to file or perfect has priority
2. The holder who gains priority by first filing or perfecting retains it so long as the
holder remains continuously filed or perfected. 9-322(a)(1)
ii. The explanation is that the drafters sought by this rule to protect the filing system.
1. One problem is that it doesnt necessarily reflect the first to file or perfect rule, b/c
it is most likely a first to file rule. This changes if the creditor has it in his
iii. The drafters intend that the first to file or perfect have priority even if the first knows that
the debtor intended that another creditor have priority and even if the first believed itself
to be subordinate at the time it filed or perfected.
iv. Exception to the rule: 9-325
1. The security interests perfected against a transferee are subordinate to those
perfected against a transferor.
a. Example on 1114
2. Works because article 9 security interests rank in order of perfection so that
lenders can discover the security interests to which they will be subordinate.
b. Priority of Future Advances
i. General rule
1. Provided only that the secured creditors financing statement covers the
collateral, all advances made by the secured creditor to the debtor have priority
as of the filing of the financing statement. Implicit in 9-322(a)(1).
ii. Justification
1. The same given for the priority of future advances in real estate law.
2. Bank 1s filing put Bank 2 on notice of the possible existence of security interest
that might secure future advances, so Bank2 should not be heard to complain if
such advances are made.
3. The understanding is that one who takes a second security interest agrees to take
subject to the amount outstanding under the first filing and any future advances
the holder of the first may later make.
iii. Function
1. An important function is to relieve the lender who will make future advances
from the necessity to file and search in conjunction with each advance. The same
is true w/the real estate system.
iv. Who would take a second security interest in a system in which the first can increase w/o
1. Lenders who do not understand the future-advance rule;
2. Creditors who hope to benefit from their second interest but do not advance funds
in reliance on it; and
3. Lenders who protect themselves against future advances by contract with the
holder of the first interest. 9-339.
v. Can a single financing statement secure more than one such interest?

1. A single financing statement is adequate to perfect any number any number of

security interests, to the limits of the description of collateral in the financing
statement. 9-322(a) and 9-502(d).
c. Priority in After-Acquired Property
i. If the debtor later acquires property that fits the description in the security agreement, the
security agreement attaches. UCC 9-203(b).
ii. If the dexcription of collateral is broad enough to cover the after-acquired property, the
filing covers it. As against other Article 9 secured creditors of the debtor, the afteracquired lenders priority dates from the time of its filing. 9-322(a)(1).
iii. The most common commercial use of after-acquired property clauses is in inventorysecured financing.
1. The lender perfects its interes in both currently owned and after-acquired
inventory by the filing of a singling financing statement.
2. See hypothetical on 1117.
d. Priority of Purchase Money Security Interests (PMSI)
i. Generally
1. 9-324(a) - a PMSI in collateral other than inventory has priority over a
conflicting security interest in the same collateral if the PMSI is perfected not
later than 20 days after the debtor receives possession of the collateral.
2. Justification
a. PMSI is first in an important sense: it either supplied the collateral or
made advances to enable to debtor to acquire the collateral. 9-103(a) &
b. Purchase-money priority can be understood as recognizing that, in the
sense described here, the purchase-money lender has a relationship with
the collateral beforethe after-acquired lender does.
c. It enables PMSI to sell and deliver immediately w/o having to check the
public record. Provided the PMSI files w/in 20 days of the day the debtor
receives possession, it will have priority over any earlier filings against the
debtor that might exist.
3. Anyone lending against noninventory collateral in the possession of the debtor
msut cfonsier the possibility that (1) the debtor obtained possession of the
collateral in the past 20 days and (2) the holder of the one or more PMSIs in the
collateral has not yet filed a financing statement, but will before 20 days is up.
a. Searcher can remedy the problem is by verifying the debtors possession
of the collateral and then wait 20 days beyond the basket period before
ii. PMSIs in inventory
1. The 20 day grace period for the filing of a PMSI in 9-324(a) does not apply when
the property sold will be inventory in the hands of the buyer. This exception is
designed to accommodate the customs and practices in inventory financing.
a. See 1120 for this explanation
2. The inventory-secured lender may or may not require the debtor to use the loan
proceeds to pay for the inventory, but the understanding is that the debtor will
grant no PMSIs in it.

3. The special needs of inventory financiers are reflected in the special rules in 9324(b): The rules permit purchase money priority in inventory only on these
a. The purchase-money financier msut perfect no later than the time the
debtor receives possession of the collateral, and
b. The purchase-money financier msut give advance notice t othe inventory
lender that it expects to acquire a purchase-money security interest in
inventory. To give this notice the purchase-money lender first searches the
filing system for the names and addresses of all secured parties with a
filing against inventory of the type it plans to sell. The lender then sends
the notice, typically by certified mail, to each of the inventory lenders.
Like a financing statement, the notice expires at the end o f five years.
The purchase-money supplier can avoid expiration by repeating the notice
at intervals of less than five years.
4. Most important, the protection comes without necessity for the inventory lender to
search the filing system before each advance.
5. If the security agreement prohibits liens against inventory other than the lien of
the inventory lender, a notification pursuant to 9-324 is a notification to the
inventory lender that the debtor is about to go into default. To avoid that, debtors
typically refuse to grant purchase-money security interest to their suppliers.
e. Purchase Money Priority in Proceeds
i. If a seller acquires purchase money priority in property of the debtor, and the debtor
exchanges the collateral for proceeds, the seller will have purchase money priority over a
competing security interest perfected by an earlier filing against eh debtor naming those
proceeds as original collateral.
1. Purchase money priority under 9-324 extends to collateral or its proceeds.
ii. The exception
1. 9-324(b) purchase-money status in inventory flows only into chattel paper,
instruments, and cash proceeds.
a. Not accounts
b. The flow through of purchase money status into chattel paper, instruments,
and cash deposits are themselves limited by the provisions of 9-327 and
9-330. Those provisions protect purchasers of the chattel paper or
instruments and secured parties with control of the deposit account into
which the cash proceeds are deposited.
iii. Later purchase-money inventory lender can protect itself against the possibility of a
priority account lender: the inventory lender would know of the account lender from the
outset, b/c the account lender would have filed a financing statement before the inventory
lender entered the picture. The inventory lender can refuse to lend unless the debtor
arranges to pay the inventory lender upon sale of the inventory.
f. Priority in Commingled Collateral
i. Two situations
1. Where the identity of the collateral is lost by commingling as the collateral
becomes part of a product or mass.
a. The security interest continues in the product or mass 9-336(c).

2. Where the identity is not lost, as where a replacement part is installed in a

a. The replacement part is an accession
b. If the secured party has taken a security interest in only the replacement
part, 9-335 will apply: The secured partys interest will continue to be
perfected, and will have priority over later-perfected interests in the whole.
i. But the accession secured parties remedies may be severely
impaired by 9-335(e).
1. Under that section, any secured party with priority over the
accession-secured party is entitled to prevent removal of
the accession from the whole
ii. If more than one security interest attaches to a product or mass as a result of
commingling, the interests rank equally and share in the proportion that the cost of each
partys contribution bears to the total cost of the product or mass.

XXIX. Buyers against Secured Creditors

a. Introduction
i. There are two common characteristics in all of these settings:
1. The secured creditor recognizes that the debtor has the right to sell the collateral.
Security does not interfere with the free alienability of property.
2. The secured creditor expects to be protected as to the value of its interest. The
protection may take the form of a lien on the proceeds the debtor receives from
the buyer, a continuing lien on the collateral in the hands of the buyer, payment of
the loan, or some combination of these protections.
b. Buyers of Real Property
i. The general rule resolves the competition between buyer and mortgagee on the basis of
first in time.
1. If the mortgage was created before the debtor sold the property to the buyer, the
buyer takes subject to the mortgage.
2. If the sale takes place first, it will be free of a later mortgage granted by the
ii. A recording statute may reverse either of the above results
1. One who buys in good faith, for value, without notice of an unrecorded mortgage
may take free of it under the recording statute.
2. One who takes a mortgage, in good faith, for value, without notice of the recorded
deed may have priority over the rights of the buyer pursuant to the recording
iii. All purchasers of real property are expected to search the public record, are deemed to
have notice (constructive) of duly recorded mortgages, and take subject to them.
iv. The applicable statute may be:
1. Race statute: first to file regardless of notice
2. Notice-race statute: first to file with notice of competing lien.
c. Buyers of Personal Property
i. General
1. The general rule is that buyers take subject to encumbrances of record.
a. 9-201: A security agreement is effective . . . against subsequent
b. 9-315(a): A security interest continues in collateral notwithstanding
ii. The authorized disposition exception: 9-315(a)(1)
1. General
a. The security interest does not continue in the collateral if the secured
party authorized the disposition free of the security interest.
2. The exception doesnt depend for its operation on equities in favor of the buyer.
a. It can apply in favor of a buyer who did or did not search the public
record. It can apply in favor of a buyer who knows or does not know of
the security interest or the secured creditors authorization to sell
3. The authorization to sell need not be express
a. Many cases hold that a secured creditor who knew that the debtor was
making sales of collateral in violation of provisions of the security

agreement thereby waived the provisions and authorized the sale so that
the buyer took free of the security interest.
4. The authorization must be to dispose of the collateral free of the security interest.
This element can also be express or implied.
5. There is a split as to conditional authorization (you can sell it if you do this (pay
me something, etc.))
a. Some treat the disposition as authorized
b. Some do not
c. Courts are more likely to treat the disposition as authorized if the buyer
knows of the condition, though this is not determinative.
iii. The buyer in the ordinary course exception: 9-320(a)
1. The ordinary course of whose business?
a. 1-201(9): Buyer in the ordinary course of business: Buying is in the
ordinary course of business only if it is from a person in the business of
selling goods of that kind.
b. 9-320(a) is not limited to consumer buyers
2. The buyers knowledge
a. UCC 9-320(a) protects a buyer in the ordinary course of business even
though the buyer knows of the security interests existence.
b. 1-201(9) seems to contradict this, b/c one cannot be a buyer in the
ordinary course of business if one knows that the sale to him is in
violation of a . . . security interest of a third party.
c. Comment 3 to 9-320(a) states: Reading the definition together with the
rule of law results in the buyers taking free if the buyer merely knows that
a security interest covers the goods but taking subject if the buyer knows,
in addition, that the sale violates a term in an agreement with a third
d. Therefore, if the customer knowingly buys in violation of the condition,
the customer takes subject to the banks security interest.
e. It is important to note that a buyer in the ordinary course of business
ONLY takes free of the interest of her seller, not the interests of the sellers
predecessors in interest.
3. The farm products exception
a. 9-320(a) affords no protection to people who buy farm products.
b. However, the federal Food Security Act protects those buyers, so it is
really a worthless exception
4. When does a buyer become a buyer
a. There are people, at the moment a bankruptcy petition is filed, who have
contracted to buy some of the collateral but have not yet completed their
b. If such a person is a buyer under 9-320(a), the person will take free of
the inventory lenders security agreement and be able to keep what was
c. If the person has paid part, the person will get credit for that part, and owe
the balance.

d. If the person is not yet a buyer, the person is merely an unsecured

creditor of the seller for any part of the purchase price paid and for the
benefit of the bargain the person has lost
e. Illustrative Case: Daniel v. Bank of Hayward
i. Question is When does a retail purchaser who makes a down
payment on a motor vehicle but does not take title to the vehicle
become a buyer in the ordinary course of business to prevail over
the security interest of the motive vehicle dealers floor plan
ii. Answer: When the vehicle is identified in the contract.
f. Daniel and a revision to UCC
i. After Daniel, the drafters revised 1-201(9) to add that only a
buyer that takes possession of the goods or has a right to recover
the goods from the seller under Article 2 may be a buyer in
ordinary course of business
5. Sales of goods in the possession of the secured party
a. Tanbro Fabrics v. Deering Milliken
i. Court holds that a buyer who purchases goods (just like the
purchasers in Daniel) that are in the possession of the secured
creditor, take free of security interest
b. This case IS OVERRULED by revision:
i. 9-320(e): Subsections (a) and (b) do not affect a security interest
in goods in possession of the secured party under 9-313.
ii. Comment 8: rejects the holding of Tambro Fabrics . . . and,
together with 9-317(b), prevents a buyer of collateral from taking
free of a security interest if the collateral is in the possession of a
secured party.
iv. Buyer not in the ordinary course exception: 9-323(d) & (e) and 9-317(b)
1. Those who buy goods outside the ordinary course of business have no exemption
from the search-and-file game.
a. They are expected to search and are charged with constructive notice
2. The buyer not in the ordinary course of business takes subject to any security
interest that is perfected, but has priority over unperfected ones.
v. Consumer to Consumer Sale Exception: 9-320(b)
1. When a sale is outside the ordinary course of business, even consumer buyers are
expected to play the search-and-file game
2. We refer to the exception in 9-320(b) as the consumer to consumer sale exception
b/c the exception applies only if the goods are consumer goods in the hands of the
seller before the sale and consumer goods in the hands of the buyer after the sale.
a. The requirement that the goods be held for personal, family, or household
purposes of the seller prior to the sale is contained in the main part of
section (b);
b. The requirement that they be held for personal, family, or household
purposes of the buyer after the sale is contained in subsection (b)(3).
3. The buyer in a consumer-to-consumer sale is protected from an automatically
perfected PMSI in consumer goods

a. Secured creditor cant rely on PMSI protection in 9-309(1).