Overview of UCC Article 9;

What is a Security Interest?

CLASS #2
PROFESSOR RULE - SPRING 2018
SANDRA DAY O’CONNOR COLLEGE OF LAW
 Assets (liquidation value) & Liabilities

Assets Liabilities

 Franchise Rights ($25,000)  Bank ($50,000)

 Equipment ($8,000)  Equipment Seller ($10,000)

 Inventory ($1,000)  IRS ($5,000)

 Landlord ($5,000)
 Cash ($1,000)

TOTAL: $35,000 TOTAL: $70,000

[$35,000 more than
value of assets!]
 How should the $35,000 be divided?

 Pro rata?
 Four-way even split?
 First-in-time?
 Equal Loss Rule?
 Lottery/winner-take-all?
 Race-to-the-assets?
 Special priority for certain types of creditors?
UCC Article 9 is a permissive structure that allows parties to
agree ex ante on allocation and priority rules for a debtor’s assets.
 UCC Article 9 in Arizona

 The legislature of a state must separately enact UCC

provisions for those provisions to be enforceable law
within that state.

 In Arizona, UCC Article 9 is codified in:

A.R.S. §§ 47-9101 through 47-9709

 In May 2014, the Arizona legislature adopted the 2010

amendments to UCC Article 9.

 All 50 states have now adopted those amendments in

some form.
 Interpreting UCC Provisions

1. Read the statutory language

2. Find and read any word definitions (e.g., 1-201;
9-102); look at cross-references
3. Look at the Official Comments
4. Consider the purposes of the statute (e.g., 1-103)
5. Consider the language’s context within the statute
6. Consult secondary sources
 The Language of UCC Article 9

 Debtor*  Priority
 Creditor  Financing Statement*
 Unsecured Party  Purchase Money
 Secured Party* Security Interest
 Collateral  Control
 Personal Property  Proceeds*
 Fixture*
 Security Interest*
 Security Agreement*
 Attachment
 Perfection
*expressly defined in UCC
 Scope of Article 9

 9-109(a)(1): Article 9 applies to transactions “that

create a security interest in personal property or
fixtures by contract.”

 1-201(b)(35): definition of “security interest”

 9-102(41): definition of “fixtures”

Creditors vs. Secured Parties

Creditors

Secured
Parties
 In-Class Problem

Justin gets a $10,000 loan from Bailout Bank and signs

a promissory note promising to repay the loan within 30
days.
Justin’s mother does not sign the promissory note, but
she does pledge a valid security interest in her car as
collateral for Justin’s loan obligation.

Is Justin an obligor?
Is Justin a debtor?
Is Justin’s mother an obligor?
Is Justin’s mother a debtor?
 In-Class Problem

Justin gets a $10,000 loan from Bailout Bank and signs

a promissory note promising to repay the loan within 30
days.
Justin’s mother does not sign the promissory note, but
she does pledge a valid security interest in her car as
collateral for Justin’s loan obligation.

Is Justin an obligor? YES.

Is Justin a debtor?
Is Justin’s mother an obligor?
Is Justin’s mother a debtor?
 In-Class Problem

Justin gets a $10,000 loan from Bailout Bank and signs

a promissory note promising to repay the loan within 30
days.
Justin’s mother does not sign the promissory note, but
she does pledge a valid security interest in her car as
collateral for Justin’s loan obligation.

Is Justin an obligor? YES

Is Justin a debtor? NO
Is Justin’s mother an obligor?
Is Justin’s mother a debtor?
 In-Class Problem

Justin gets a $10,000 loan from Bailout Bank and signs

a promissory note promising to repay the loan within 30
days.
Justin’s mother does not sign the promissory note, but
she does pledge a valid security interest in her car as
collateral for Justin’s loan obligation.

Is Justin an obligor? YES

Is Justin a debtor? NO
Is Justin’s mother an obligor? NO
Is Justin’s mother a debtor?
 In-Class Problem

Justin gets a $10,000 loan from Bailout Bank and signs

a promissory note promising to repay the loan within 30
days.
Justin’s mother does not sign the promissory note, but
she does pledge a valid security interest in her car as
collateral for Justin’s loan obligation.

Is Justin an obligor? YES

Is Justin a debtor? NO
Is Justin’s mother an obligor? NO
Is Justin’s mother a debtor? YES
 Secured v. Unsecured Creditors

 Creditors who negotiate for special collateral rights

in the assets of a debtor are secured parties.

 In our ice cream example, all of the creditors were

unsecured parties.

 Under the Bankruptcy Code, unsecured parties

generally share an insolvent debtor’s available assets
on a pro rata basis.

 9-201(a): Secured parties “beat” unsecured parties

 Assets (liquidation value) & Liabilities

Assets Liabilities

 Franchise Rights ($25,000)  Bank ($50,000)

 Equipment ($8,000)  I.C.E., LLC ($10,000)
 Inventory ($1,000)  IRS ($5,000)
 Cash (in a deposit account)  Landlord ($5,000)
($1,000)

TOTAL: $35,000 TOTAL: $70,000

Suppose that Bank held a security interest in all of the LLC’s assets.
How would the assets be divided up?
 Example #1: Secured vs. Unsecured Creditors

What if only the Bank had been a secured party,

having a security interest as to all of the LLC’s assets?

Pro Rata multiplier = Liquidation value of available assets

Total of unsatisfied debts
=$0/35,000 = 0.000

Allocation:
Bank: $35,000
I.C.E., LLC: $ 0
IRS: $ 0
Landlord: $ 0
TOTAL: $35,000
 General Characteristics of UCC Article 9

 Article 9 is a permissive set of rules

 Article 9 allows parties to agree ex ante on priority of

rights in a debtor’s assets (before the debtor is insolvent)

 Article 9 is a reified system (ties rights not only to

particular parties but also to particular assets they own)
 Having “dibs” (i.e., a security interest) as to one asset (e.g.,
equipment) creates no rights as to other assets (e.g., inventory)
 Assets (liquidation value) & Liabilities

Assets Liabilities

 Franchise Rights ($25,000)  Bank ($50,000)

 Equipment ($8,000)  I.C.E., LLC ($10,000)
 Inventory ($1,000)  IRS ($5,000)
 Cash (in a deposit account)  Landlord ($5,000)
($1,000)

TOTAL: $35,000 TOTAL: $70,000

What if the IRS and I.C.E., LLC, had held a
security interest in ALL of the LLC’s assets?
 Calculating Distributions to Unsecured Creditors

The unsecured creditors share only whatever assets

are left over after the secured creditors’ claims are
satisfied.

Pro Rata multiplier = Liquidation value of available assets

Total of unsatisfied debts
 Example #2: Secured v. Unsecured Creditors

What if the IRS and I.C.E., LLC were secured parties with
respect to all of the LLC’s assets?
$35,000
Pro rata multiplier = $20,000/55,000 = 0.3636 -$15,000
$20,000
Allocation:
Bank (owed $50,000): $ 18,181.812 $70,000
-$15,000
I.C.E., LLC (owed $10,000): $10,000.00
$55,000
IRS (owed $5,000): $ 5,000.00
Landlord (owed $5,000): $ 1,818.18
TOTAL: $35,000.00

What happens to the amount ultimately allocated to unsecured

creditors as the amount of secured debt increases?
 Assets (liquidation value) & Liabilities

Assets Liabilities

 Franchise Rights ($25,000)  Bank ($50,000)

 Equipment ($8,000)  I.C.E., LLC ($10,000)
 Inventory ($1,000)  IRS ($5,000)
 Cash (in a deposit account)  Landlord ($5,000)
($1,000)

TOTAL: $35,000 TOTAL: $70,000

What if the I.C.E., LLC, had held the only security
interest, and it only covered the LLC’s equipment?
 Enforcing a Security Interest in
only a part of the debtor’s assets

What if only I.C.E.,LLC had been a secured party, but only

as to the equipment ($8,000 liquidation value)?

Pro Rata multiplier = Liquidation value of available assets

Total of unsatisfied debts
= $27,000/62,000 = 0.4355

Amount to I.C.E. = $8,000 + pro rata share of unsatisfied debt

= $8,000 + (0.4355)($2,000) = $8,871
 Example (continued)

Allocation if only I.C.E., LLC were a secured party, and

only as to the ice cream equipment:

Allocation:
Bank (owed $50,000): $21,775.00*
I.C.E., LLC (owed $10,000): $ 8,871.00
IRS (owed $5,000): $ 2,177.50*
Landlord (owed $5,000): $ 2,177.50*
TOTAL: $35,000.00

*Calculated by multiplying amounts owed by 0.4355

Pro Rata Allocation of Debtor’s Assets

Pro Rata multiplier = Liquidation value of available assets = 0.5

Total of unsatisfied debts

Allocation:
Bank (owed $50,000): $25,000
I.C.E., LLC (owed $10,000): $ 5,000
IRS (owed $5,000): $ 2,500
Landlord (owed $5,000): $ 2,500
TOTAL: $35,000
 Problem 1.1

Ed to Alexandra:
“Here’s the deal: If you make the loan to me,
I’ll let you have this watch with the
understanding that you can hold onto it
until I fully repay you.”
 Problem 1.1(a)

Note;
SI: Watch
(possession)

Ed Alexandra
(Debtor/Obligor) (Secured Party)

$20,000
 Problem 1.1(b)

Note;
SI: Watch
(Agreement)

Ed Alexandra
(Debtor/Obligor) (Secured Party)

$20,000