Ever needed a loan for your business?
You know, maybe expanding buying equipment, that kind of thing.
Yeah, we're stocking up inventory for a busy season.
Right. And you get to that point where
the lender asks, OK, what can you offer as collateral,
something valuable to back it up?
Something they can look to if you know things don't quite go
as. Planned.
Exactly. And there's this whole legal
world behind that simple idea designed to make it work, make
it safe for lenders. And actually possible for you,
the borrower to get that financing in the 1st.
Place in that system, That's what we're diving into today.
It's all about secured transactions.
Primarily governed by Article 9 of the Uniform Commercial Code,
the UCC, so. We've gathered up quite a bit of
material, articles from places like Avison, Legal Nolo, bits
from the UCC itself, study guides.
Even a peek at how law students talk about it online, trying to
get their heads around it. Our mission today is really to
unpack all that, how these security interests get created,
how they're protected, enforced. And yeah, how recent updates are
tackling things like digital assets.
We want to give you a clear handle on these rules.
OK, let's start at the beginning.
What is a secured transaction fundamentally?
At its heart, it's pretty simple.
It's a credit deal. A borrower, the law calls them.
The debtor gives a lender the secured party and interest in
some specific property. That property being the
collateral. Right.
That interest, the security interest, it's the lenders
backup, it secures the promise to repay the loan.
So the lender gets this special claim.
Why is that such a big deal? Because it gives them a huge
advantage. Legally speaking, if the debtor
defaults, can't pay. Yeah, that secured party usually
gets first shot at the collateral.
They jump ahead of most other creditors, the ones who don't
have a security interest. It really lowers the lenders
risk. Got it.
And we're talking about business assets here mainly like
equipment, inventory, accounts receivable.
Exactly. Article 9 covers security
interests and personal property. That includes goods,
intangibles, fixtures, things attached to buildings.
But not the land or the building itself.
Right. Real estate mortgages are a
whole different area of law. So if you're borrowing against
your machinery, your stock money customers owe you, you're in
Article 9 territory. OK, Key players, debtor, that's
you, the borrower, secured party, the lender and the
collateral the specific property.
And crucially, it's something you agree to.
It's a voluntary. Light unlike, say, a tax lend,
the government slaps on you. Precisely, it's based on an
agreement. All right, So what kind of
property can actually be collateral under Article 9?
Is it just physical stuff? Oh, it's much broader than that.
Article Nine groups property into categories and this is
important because the rules for how the lender protects their
interest, how they perfect it can change depending on the type
of collateral. OK, so classification matters.
What are the main buckets we should know?
First you've got goods, tangible movable items, and within goods
there are important subtypes like consumer goods, stuff
bought mainly for personal, family or household use.
Think financing a car for your family.
Then inventory. This is huge for businesses.
Goods held for sale or lease, raw materials, components,
basically your stock makes sense.
Then equipment also key for businesses goods used in the
business that aren't inventory or consumer goods machinery,
computers, delivery trucks, office furniture, the.
Tools of the trade. Exactly.
And finally, farm products, crops, livestock, things used in
farming operations. OK so goods cover most physical
assets. What about the non physical
stuff? Money owed?
Ideas. That's the next big group.
Intangibles and semi intangibles rights, basically Like what?
Well accounts, that's money owed to your business for goods sold
or services rendered on credit, your receivables, chattel paper.
This one's a bit tricky. It's a record, could be paper or
electronic. Now that shows both a debt and a
security interest in specific goods, like a car loan contract
held by the dealer. OK.
A hybrid, yeah. Then deposit accounts your
actual business, bank accounts, instruments like promissory
notes or checks, investment property, stocks, bonds,
securities accounts. Wow, lots of cat.
And the big catch? All general intangibles.
This covers things that don't fit elsewhere.
Intellectual property like patents, trademarks, copyrights,
business goodwill, even certain software rights or payment
rights that aren't accounts. So potentially my business's
brand reputation or a patent could be collateral.
As a general intangible, yes, absolutely.
So knowing the right category for your assets, inventory,
equipment accounts, general intangibles, that's step one for
figuring out the rules. Which leads us to Step 2, making
the lenders claim actually stick, making it legally binding
against you, the borrower. You call that attachment.
That's right. Attachment is the moment the
security interest becomes enforceable against the debtor.
It's the foundation. And you said there were three
things that need to happen for attachment.
Three essential requirements. Yes, they all have to be met.
OK, what's the 1st? First, the secured party, the
lender must give value. This is usually the loan money
or extending credit or even a firm commitment to lend.
So the lender put something on the line.
Right. Even agreeing to take a security
interest for an old debt counts as giving value.
OK, value given second. Second, the debtor must have
rights in the collateral. You need to own the property, or
at least have the power to transfer rights in it.
You can't pledge something you don't have any claim to.
Makes sense, Can't use my neighbor's lawnmower as
collateral. What's #3. #3 is usually an
authenticated security agreement.
Think of it as the contract. It needs to be a record,
typically written or electronic, where the debtor explicitly
grants the security interest. And it has to describe the
collateral. Yes, and it needs to be signed
or otherwise authenticated by the debtor.
How specific does that description need to be in the
agreement? Do I list serial numbers for
everything? Not necessarily.
The standard is that it must reasonably identify the
collateral, saying all inventory or all equipment located at the
main plant is usually good enough for the agreement.
But not too vague. Definitely not too vague in the
agreement, just saying all assets or all personal property.
Courts often find that's not specific enough in the security
agreement to attach the interest.
You need a bit more detail there.
OK, so the agreement needs reasonable detail.
Right, though there is an alternative for some types of
collateral if the lender takes physical possession of the goods
or gains legal control over things like deposit accounts or
certain digital assets. Like a pawn shop holding the.
Item exactly. In those cases, a written
security agreement might not be strictly necessary for
attachment itself, though it's still best practice to have one.
So recap, lender gives value, borrower has rights and there's
an authenticated agreement describing the collateral or the
lender has possession control, that's attachment.
The claim is valid against the borrower.
You got it. And that agreement can be
forward-looking too. How so?
It can include an after acquired property clause.
This means the security interest automatically attaches to
property the debtor gets later after signing the agreement.
Super common for things like inventory that turns over
constantly. So my loan secured by inventory
covers the new stuff I buy next month.
Generally, yes. If that clause is in there,
there's a limit for consumer goods, though it usually only
covers consumer goods acquired within 10 days of the lender
giving value. Protects consumers a bit.
OK, what else can the agreement cover?
Future advances The agreement can state that the collateral
secures not just the initial loan, but also any future loans
or advances made under the same agreement, like drawing on a
line of credit. Right.
And what if I sell the collateral?
Does the lender's interest just disappear?
Usually no. The security interest typically
continues in the proceeds. Whatever you receive when you
sell or dispose of the collateral cash, a check, an
account receivable from the buyer, the lender's interest
automatically attaches to that. OK.
So attachment makes the claim real between the borrower and
lender, but you said there's another big step.
Yes, perfection. This is absolutely crucial.
If attachment is about the lender's rights against the
debtor, perfection is about their rights against almost
everyone else. Other creditors.
A bankruptcy trustee. Exactly.
Perfection is what gives the secured party priority over most
other claimants to the same collateral.
It's about putting the world on notice.
So attachment first, then perfection to lock it down
against others. How do lenders perfect?
There are several ways, and the right method often depends on
the type of collateral. I feel like I've heard about
filing something like a UCC form.
But that's the most common method by far, filing a
financing statement, commonly called a UCC one.
OK, the lender files the simple form in a public office, usually
the Secretary of State's office in the state where the debtor is
located. It's like planting a flag for
everyone to see. What's on this UCC one form?
It needs the debtor's name, and getting this exactly right is
critical, especially the official registered name for a
business. Why so critical?
Because that's how others search the records.
If the name is wrong, the filing might be ineffective, basically
invisible. It also needs the secured
party's name and an indication of the collateral.
How specific does the collateral description need to be on the
filing? Same as the agreement.
No, this is a key difference on the UCC 1 financing statement.
The description can be much broader.
Something like all assets or all personal property is generally
OK for the public filing. Wow OK so super generic is fine
for the filing, but needs to be reasonably specific in the
actual agreement. Exactly the filing just needs to
put people on notice that there might be a security interest,
prompting them to inquire further about the specifics in
the agreement. And lenders can actually file
this UCC 1 before everything is finalized, even before
attachment. Really why to lock in their
priority date. If they file early, their
interest becomes perfected. The instant attachment occurs
later. First to file often wins.
OK, filing is #1 what else? Possession if the lender
physically takes the collateral. This works well for tangible
things, goods, instruments, cash, tangible chattel.
Paper the pawn shop again. Right, you can't possess an
account receivable, so it doesn't work for intangibles.
Got it. Any other methods?
Control. This is the key method for
certain assets where possession isn't practical or relevant.
Think deposit accounts, investment property, electronic
chattel paper, and now importantly, those controllable
electronic records we'll talk about later.
How does control work? It means the lender takes legal
steps to be able to dispose of or manage the asset without
needing the debtors further consent.
For a bank account, it might involve an agreement with the
bank giving the lender authority over the account.
OK. Filing possession control that.
It one more main way automatic perfection for a few specific
situations. The security interest is
perfected the moment it attaches automatically.
No filing or possession needed. By the way, the most common
example is a purchase money, security interests, PMSI and
consumer goods. When you finance a new TV for
your home directly from the store, their security interest
in that TV is usually automatically perfected.
OK. So filing possession control or
sometimes automatic, That's how lenders make their claim public
and strong against others. That's right, and it means for
you, the borrower, there's likely a public record showing
that claim on your assets. Now this leads to the big
question. What happens if two different
lenders have a perfected security interest in the same
collateral? Who gets paid first if the
borrower defaults? Priority battles the general
rule. The bedrock principle is the
first secured party to either file a financing statement or
perfect their security interests.
Whichever happens first has priority. 1st in time, first in
right. Generally yes, if neither party
perfected then the first one whose interest attached gets
priority. But usually it comes down to
that first to file or perfect rule.
OK, but you hinted there are exceptions ways to jump the
line. Absolutely.
And the most powerful one we've already mentioned briefly, the
purchase money security interest or PMSI.
Right, the loan used to buy the specific collateral, it had
automatic perfection for consumer goods.
Correct, but it's real superpower is in creating super
priority. APMSI can sometimes leapfrog an
earlier perfected security interest in the same collateral.
How does that work? Let's use that unique toys
example again. Big Bank has a loan secured by
all inventory filed years ago. Now Unique Toys needs money just
for a new shipment of action figures.
And a new lender provides that specific funding for those
specific figures, taking a security interest only in those
figures. That's a PMSI.
So new lenders interest in just those figures can beat big banks
older claim on all inventory. It can yes, but new lender has
to follow specific rules to get that super priority.
And the rules depend on whether the collateral is inventory or
something else like equipment. OK, what are the rules for say
equipment if I get a PMSI loan to buy a new machine for my
factory? For non inventory collateral
like equipment, two things are needed for super priority one,
the loan has to actually enable the purchase 2 The PMSI lender
must file a UCC 1 financing statement covering that
equipment within 20 days after the debtor receives possession
of it. 20 days? That seems specific.
It is if they file within that 20 day window, their PMSI
prime's earlier security interest in the same equipment,
miss the deadline and they just fall back into the regular first
to file or perfect order. Courts are strict on that 20 day
rule. OK. 20 days for equipment, PMS
eyes. What about for inventory?
Back to unique toys and the action figures.
Inventory PMS is are tougher to get super priority for.
First, the PMSI itself must be perfected, usually by filing at
or before the time the debtor receives the inventory.
No 20 day grace period. OK, file before the goods
arrive. What else?
And this is crucial. The PMSI lender must send an
authenticated notice to any other secured party who has
already filed A financing statement covering inventory for
that debtor. They have to tell big bank.
Yes. Big Bank and any other prior
inventory filers must receive that notice before Unique Toys
gets the new action figures. The notice has to say the new
lender expects to acquire a PMSI in inventory and describe that
inventory. Wow.
So for inventory, it's perfect immediately and give advance
notice to the existing lenders. Exactly.
It's a heads up system. It lets big bank know that
someone else is getting priority on this specific incoming batch
of inventory. It prevents hidden landings.
OK, that makes sense. So you've got attachment, then
perfection, then these priority rules with PMSI as a major
exception. It's how someone map this out.
Like is there an SI attachment, perfection, default remedies,
priority, Kind of a mental checklist?
That's a great way to visualize the whole life cycle and
understanding PMS eyes is key. If you're financing specific
assets, whether you're the borrower or the lender, it can
really impact the deal structure.
Speaking of changing realities, the world of assets isn't just
physical stuff or bank accounts anymore.
We've got crypto NFTS. How does Article 9 handle those?
Did the law need an update? Oh, absolutely.
That was a huge driver behind the most recent major amendments
to the UCC, the 2022 amendments. Technology, especially digital
assets, had outpaced the existing rules.
So using crypto as collateral was tricky before.
Very There wasn't clear guidance on how to classify many digital
assets, or, more importantly, how a lender could reliably
perfect a security interest in them.
It created uncertainty and risk. So what did the 2022 updates do?
A major focus was bringing clarity to using digital assets
as collateral. They introduced new definitions
and rules specifically for this emerging area.
Like what new concepts? A key one is controllable
Electronic records, or CE Rs. Think of these as certain types
of digital assets, maybe specific cryptocurrencies or
NFTS that meet the legal tests for unique identifiability and
control. OK, so a defined category for
these things. Yes, and the law also recognizes
related concepts like controllable accounts and
controllable payment intangibles, which are basically
payment rights tied to a CER. These are now explicitly
recognized as collateral types. So if my business hold
qualifying crypto, I can now more clearly use it to secure a
loan. That's the goal, yes.
And crucially, the amendments established perfection by
control as the primary and best way to perfect a security
interest in these new categories.
CE Rs controllable Accounts and controllable.
Payment intangibles control, again like with deposit
accounts. Similar principle, gaining
control over a CER means the lender has the practical and
legal ability to benefit from it, sell it, prevent others from
dealing with it, and achieving perfection by control gives the
lender priority over anyone who might have just affected by
filing a UCC one against those assets.
That makes sense. Actually controlling the digital
keys is stronger than just filing a form saying you have an
interest. Precisely, it aligns the law
better with the technological reality.
The updates also tweaked other definitions like clarifying that
money under the UCC is only government issued currency.
So crypto isn't money but can be collateral as a CER or general
intangible. And they updated rules for
chattel paper to better reflect hybrid electronic paper deals.
And these changes are actually happening now.
States are adopting them. Yes, they are rolling out.
For instance, Minnesota adopted these amendments effective
August 2024. It's a process, but the
framework is there now. This feels like a really big
deal for businesses in the digital economy.
Suddenly, these valuable digital assets can be more effectively
leveraged for financing. It reduces ambiguity for lenders
and potentially opens up significant new funding avenues
for borrowers holding these assets.
It's a crucial modernization. OK.
We've covered creating the claim, protecting it priority,
even digital assets. What happens when things go
wrong when the borrower is in default?
Right, the enforcement stage. Interestingly, Article 9 itself
doesn't define default. It doesn't, no.
What constitutes default is determined by the security
agreement, the contract between the debtor and the secured
party. So it's usually missed payments.
That's the most common, yes, but it could also be other
violations like failing to ensure the collateral, selling
it without permission, becoming insolvent, whatever the
agreement says is a default trigger.
OK. So a default happens according
to the agreement. What rights does the secured
lender have then? They have significant remedies
under Article 9. Primarily, they can take
possession of the collateral, they can dispose of it, usually
by selling it. Sometimes they can propose to
keep it, and they can sue the debtor for any shortfall.
Taking possession? Can they just like show up with
a tow truck for the company car? They can use self help
repossession. Article 9 gives them the right
to take the collateral after default without going to court.
But there's a huge condition. They must do it without
breaching the peace. Without breaching the peace,
what does that mean in practice? No breaking down.
Exactly. No violence, no threats, no
breaking and entering, no trickery that amounts to
trespass. They generally can't bring law
enforcement along unless they have a court order.
And importantly, if the debtor is present and clearly object
says stop, you can't take it. The repossessor generally has to
back off right then. Pushing past an objection would
be a breach of the peace. It very likely would be, yes.
Persistence over clear objection is often seen that way by
courts. So if self help is too risky or
the debtor objects, what's the lenders option?
They have to use the courts. They can file a lawsuit, often
called a RIP Levin action, to get a court order authorizing
the sheriff or Marshall to seize the property.
It's slower and costs more, but it avoids breaching the peace.
OK, so they get the collateral back one way or another, then
what usually sell it? Yes, the most common path is
disposition, usually meaning a sale.
It could be a public auction or a private sale.
Are there rules about how they conduct the sale?
Absolutely critical ones. Every aspect of the sale, the
method, manner, time, place, and all terms must be commercially
reasonable. Commercially reasonable?
That sounds important, but a bit vague.
It means the lender has to act in good faith and use procedures
that are standard and fair for selling that type of property,
aiming to get a decent price under the circumstances.
They can't just hold a quick, poorly advertised sale and
accept a lowball offer, especially if it harms the
debtor or junior creditors. So they have to try to get a
fair market value. Or at least conduct the sale in
a way that's likely to produce a fair result.
Courts look at the process. Was there proper advertising?
Was it sold in the right market? Were the terms fair?
A very low price combined with procedural flaws can definitely
lead to a finding that the sale wasn't commercially reasonable.
OK, the sale happens. Where does the money go?
Article 9 specifies the order. First, it covers the lenders
reasonable expenses for repossessing and selling the
collateral, attorney fees, storage costs, auctioneer fees.
Makes sense. Then second, it pays off the
debt owed to the secured party who conducted the sale.
OK. Third, if there are any junior
secured parties, lenders with lower priority who made a proper
demand, they get paid next from any remaining funds.
And if there's still money left after all that?
Any surplus goes back to the debtor.
What if the sale proceeds aren't enough to cover the expenses and
the main debt? That's a deficiency.
The debtor still earns the remaining amount.
The secured party can then sue the debtor personally for a
deficiency judgment to collect that shortfall.
But wait, didn't you say there are consequences if the lender
messes up the sale? Yes, and this is a huge
protection for debtors. If the secured party fails to
follow the rules, especially if they don't give proper notice
before the sale, or if the sale wasn't commercially reasonable,
they might lose their right to collect that deficiency
judgment, or at least have it significantly reduced.
Wow, so getting the process right is absolutely critical for
the lender if they want to recover the full amount.
It provides a very strong incentive for them to comply
with the rules. You mentioned they could
sometimes keep the collateral instead of selling it.
Yes, that's called strict foreclosure.
The secured party can propose to accept the collateral in full
satisfaction of the debt, or sometimes impartial
satisfaction. The.
Debtor has to agree. Yes, the debtor generally has to
consent after the default or if the lender sends a proposal, the
debtor has 20 days to object. If they don't object, they're
deemed to have consented. The lender also usually has to
notify other claimants. Can they always do this?
No, there's a key consumer protection for consumer goods.
If the debtor has already paid 60% or more of the cash price or
loan principal for a non PMSI loan, the lender cannot use
strict foreclosure. They must sell the collateral
within 90 days. Why that rule?
To protect consumers who have built up significant equity, it
forces a sale so they can potentially recover any surplus
value. Prevents the lender from just
keeping an almost paid off asset.
That seems fair and you mentioned notice before the sale
is critical. Absolutely vital.
Before disposing of the collateral, the secured party
generally must send a reasonable authenticated notice to the
debtor, any secondary obligers like guarantors and any other
secured parties who have properly notified the selling
lender of their claim. What's in the notice?
Key details identifies the debtor and secured party.
Describes the collateral. States how it will be sold.
Public Private gives the time and place for a public sale or
the date after which a private sale might occur.
Failure to give proper notice is probably the number one reason
lenders lose deficiency claims. So to sum up default, the
agreement defines it. The lender can repossess
carefully. Must sell reasonably with
notice, applies proceeds in order.
Might sue for deficiency if they followed the rules, or might
keep the collateral with consent but not usually for paid up
consumer goods. That's a great summary.
Article 9 aims for efficiency for lenders, but it builds in
these crucial procedural safeguards and fairness
requirements for debtors. It's a balance.
We have certainly covered a lot of ground.
Today feels like a comprehensive tour.
It really does, from the basic idea of a secure transaction and
what can be collateral. Through attachment, making the
claim real against the borrower. To perfection, making it strong
against the world using filing, possession or control.
And those important priority rules, especially the PMSI is
super priority for new value. Then bringing it up to date with
the 2022 amendments tackling digital assets like CE, Rs and
the importance of control there. And finally, walking through the
often complex process of default, repossession,
disposition, and the rights and responsibilities on both sides.
It really highlights that understanding Article 9 isn't
just academic, it's intensely practical for anyone touching
business finance, whether you're borrowing or lending.
It's the rule book that makes secured lending work.
It provides that predictability and structure everyone relies
on. Exactly.
And looking ahead, you know, with technology changing so
fast, here's something to chew on.
OK. We talked about how the law
adapted to digital assets with concepts like controllable
electronic records. But as technology continues to
evolve, think about AI, decentralized systems, maybe
even things we haven't imagined yet.
How might our fundamental legal ideas of what it means to have
possession or control over collateral be further challenged
and redefined in the future? That's a deep one.
How do you possess or control something that might be purely
algorithmic or distributed? A fascinating question indeed.
We'll leave you with that thought.
Catch you next time on the Deep Dive.