Welcome back to the deep dive. Today we are well.
We're not just wading into the pool.
I think we're swimming out to the deepest, darkest part of the
ocean. We are tackling Chapter 5 of
Secured Transactions. This is it.
This is the chapter that really separates the passing grades
from the top of the curve. It's where we leave the
comfortable, you know, the predictable world of inventory
and equipment behind. Right up until now, everything
is felt somewhat logical. You have a widget, you file a
paper, you're safe. But chapter 5 introduces what
the outline calls special collateral types.
I prefer to call it the danger zone.
That's a good name for. It because if you walk into an
exam question or you know a client meeting, assuming the
general rules apply here, you are going to get crushed.
You will absolutely get crushed. The fundamental shift we have to
make today is moving from what we know, the notice filing
system, to a completely different world, a system of
control and possession. You see the standard Article 9
rules. They're designed for things you
can touch and count, like tractors or boxes of shoes.
But Chapter 5 this deals with intangible assets, liquid assets
and well, assets that are physically bolted to the earth.
So the mission for this deep dive is to build an Is it
special checklist. The strategy is simple.
Before you apply a general rule like first in time, you have to
pause. You have to ask is this
collateral special? That is the primary analytical
framework exactly. If the answer is yes, you just
you have to discard the general rule.
You find a specific exception and we are going to cover a lot
of ground today. Deposit accounts, proceeds,
fixtures, sessions, commingled goods, electronic chattel paper,
and commercial tort claims. All right.
Let's start with the asset that every business cares about the
most cash or in our world in legal terms, deposit accounts.
Deposit accounts are the absolute domain of control.
Now to set the stage, a deposit account is you know your
standard demand savings passbook or similar account maintained
with the bank. But wait, I want to stop you
right there because there is a trap immediately at the front
door. We aren't talking about every
bank account in the world, are we?
No. And this is where students lose
points on the very first sentence of an essay.
We have to look at UCC section 91-O9OD13.
Article 9 generally does not apply to an assignment of a
deposit account in the consumer transaction.
So if I'm a law student and I go to the bank to buy a Honda
Civic, and the bank wants to take a security interest in my
personal saving account, that's not this.
That's not this. Article 9 is not the governing
body for that transaction. It's excluded.
We are talking strictly and only about commercial deposit
accounts, business accounts. OK, so we are in the commercial
world. I am a business.
I have a bank account with $100,000 in it.
I want to use that as collateral for a loan.
My instinct based on everything else we've learned is to file a
UCC 1 financing statement, right?
I file it with the Secretary of State.
I describe the collateral as all deposit accounts.
I pay my fee. Am I perfected?
You are wholly unperfected. You have done absolutely nothing
of legal value. That seems harsh.
I mean, I put the world on notice.
Why doesn't that count for anything?
Because the statute says so, plain and simple.
Section 931-B1 is what I call the control or nothing Roll for
a deposit account is original collateral filing is just it's
ineffective. OK.
Why though? What's the policy?
Well, think about the policy reason here.
If we allowed filing every time a bank teller cashed a check,
they would effectively have to search the Secretary of State's
database to see if a lender had a claim on those funds.
The banking system would grind to a halt.
It's unworkable. That makes sense.
Speed is currency, so if filing is garbage, I need control.
The source material outlines 3 methods under section 91-O four.
Let's walk through them, because this is where the exam
hypotheticals live. For sure method one is the
easiest. It's the homecourt advantage.
The secured party is the bank where the account is maintained.
So if I borrow money from Wells Fargo and my operating account
is at Wells Fargo and they just win?
Wells Fargo is automatically perfected.
They have control by virtue of being the bank.
They don't need to sign a new agreement.
They don't need to file anything.
They win. Done.
OK. But that's too easy.
In the real world, businesses often borrow from, I don't know,
private equity groups or alternative lenders, but they
keep their money at a big National Bank.
So the lender is not the bank. What now?
Now you enter the world of the DACA, the Deposit Account
Control Agreement. This is method 2 and requires an
authenticated record and a piece of paper basically signed by
three parties, the debtor, the secured party and the bank.
And what does that piece of paper actually say?
What's the magic language? The core provision is that the
bank agrees to comply with the secured party's instructions
regarding the funds and here's the kicker, without requiring
further consent from the debtor. That sounds dangerous for the
debtor. Does that mean the lender can
just drain the account whenever they want?
Legally, yes. That's what control means.
Now, in practice, the agreement usually says I, the lender,
promise not to touch the money unless the debtor defaults.
But for the purpose of perfection, the power to direct
the funds must be absolute. The bank has to agree that if
the lender calls and says freeze the account, the bank will
freeze it even if the debtor is on the other line screaming no.
Wow, I can imagine banks hate signing these.
It puts them right in the middle of a fight.
Oh, they despise them. It creates liability, but it's
the standard way to perfect. If you're not the bank, it's
just the cost of doing business. Now there's a third method.
The outline calls it the name change.
This is the nuclear option. I like that term.
The secured party actually becomes the bank's customer on
the account. You literally the name on the
account from Debtor Inc to Lender LLC.
Why would anyone go to that extreme?
It seems like an administrative nightmare.
You're messing with their operations.
You do it because of priority. This leads us right to the fight
scenario. Section 9327 lays out who wins
when multiple people claim the cash.
OK, let's play that out. We have a lender with a control
agreement that's method 2, and we have the bank where the
account is held method one. The bank lends the debtor money
later. Who wins?
The bank wins. Even though they were second in
time. Even though they were.
Second, the rule is that the bank where the deposit account
is maintained generally has priority over a conflicting
security interest held by another party, even if that
other party has a control agreement.
Wait, hold on, that sounds incredibly unfair.
You're telling me I can get a control agreement on January
1st, Lend $1,000,000 and feel? Totally safe.
Then on June 1st the bank lends them money and they
automatically jump ahead of me just because they hold the
account. Yes, that is the bank priority
rule. The banks right of set off and
their inherent priority. Trump's the third party.
The policy is that the bank sees the flow of funds.
They rely on that account balance.
They're the custodian. The law gives them the upper
hand. So how does a third party lender
protect themselves? Do they just have to accept
being second in line? No, and that is exactly why
method 3 exists. If the third party lender
actually puts the account in their own name, becomes the
customer of record, they defeat even the depository bank.
So the nuclear option is the only way to beat the house.
Precisely if you want to prime the bank, you have to take
ownership of the account. It's the only way to be
absolutely certain you're first. That is a brutal ecosystem.
OK, let's shift gears. We've been talking about cash in
the bank as original collateral, but often cash appears in a bank
account because you sold something else.
You sold inventory and you got a check.
Now we're talking about proceeds.
Proceeds one of the most intellectually interesting
concepts in commercial law, Section 91-O2 A 64 defines them
really broadly. Whatever is required up on the
sale, lease, license or disposition of collateral.
And the general rule is lender friendly Section 9.
Creative Teen says the security interest attaches automatically
to identifiable proceeds. The keyword there, as you said,
is identifiable. If I trade a car for a specific
check and I hold that check in my hand, it is clearly
identifiable proceeds of the car.
But in the real world, businesses don't hold checks,
they deposit them. Right.
They deposit the check into a general operating account.
That account also contains payroll money, a loan from an
uncle, revenue from services that aren't collateral.
It's a soup. The money is commingled.
This is the commingling problem and the question is does the
lenders security interest die because the specific dollar
bills got mixed up with other dollar bills?
Common sense might say yes, once you mix water you can't unmix
it. But the law says no.
And to solve this, the courts use an equitable tracing
principle. It's called the lowest
intermediate balance rule, or labia.
I love the labia because it forces us to imagine a narrative
about how the debtor spends money.
It's almost a cynical narrative. It is entirely cynical, but it's
also a legal fiction. The rule assumes that the debtor
acts in the best possible faith towards the creditor, even if
they aren't trying to. Here's the analogy I use.
Imagine the bank account is a water tank.
The secured creditors proceeds are blue water.
The debtors own unrestricted cash is Clearwater.
They get poured into the tank and they mix together.
OK, so we have light blue water. Now the debtor pulls the plug at
the bottom to pay the electric bill.
The lowest intermediate balance rule presumes that the debtor
drains the Clearwater first. They spend their own money
before they ever touch the secured creditors money.
The blue water stays in the tank as long as possible.
But what happens if the tank gets drained, almost empty, if
they spend a lot of money? That is the lowest intermediate
balance. Let's put numbers on it makes
more sense. Day one you have $5000 of your
own money in the account Clearwater.
Day 2 you deposit $10,000 of proceeds.
Blue water total is 15,000. Day three you spend $12,000.
The rule says you spent your 5000 first plus 7000 of the
proceeds. The balance is now $3000.
That $3000 is all that is left of the secured.
Creditors claim the blue water level dropped.
Here is the trick though. Here's the exam question.
What if on day 4, the debtor wins the lottery and deposits
$50,000 into the account? Does the blue water level rise
back up to 10,000? No.
Absolutely not, and that's the key.
Once the blue water drains out, it is gone forever.
You cannot replenish the collateral with new unrelated
money. The secured claim is capped at
the lowest balance the account hit during that interim period.
We have a case in the materials in re Qualia Clinical Services
from the 8th Circuit. What happened there?
Quali is the textbook application of this.
The bank claimed a security interest in the debtors deposit
accounts as proceeds of accounts receivable.
The debtor went bankrupt. The trustee argued that because
the money had been churned, money in, money out, the
identifiable proceeds were lost. It was all just one big soup.
And the court said. The court applied Labyr.
They looked at the daily balances.
They said no, the interest isn't lost, but it is limited to the
lowest point. It saved the lender from getting
0, which was a big win, but it prevented them from claiming all
the new cash that came in later. So for exam purposes, if you see
a fact pattern with a list of deposits and withdrawals, you
literally need to go line by line, find the lowest number in
the column, and that's your cap. Exactly.
It's a math problem masquerading as a law problem.
Now, sticking with proceeds, we have to talk about perfection.
Just because the interest attaches to the proceeds doesn't
mean you are perfected forever. Correct, there is a 20 day rule.
If you have a perfected interest in the original collateral, you
are automatically perfected in the proceeds for 20 days.
It is a grace period, a little breathing room.
What happens on day 21? Do you just fall off a Cliff?
You become unperfected unless you meet an exception, and the
most important one, the one tested all the time, is the same
office rule. OK, walk us through that.
The rule is this perfection continues indefinitely if the
financing statement covering the original collateral was filed in
the same office where you would file to perfect the proceeds.
So an example, you have a security interest in inventory,
you file with the Secretary of State.
Standard stuff. The debtor sells the inventory
on credit, creating accounts receivable.
Those are the proceeds. How do you perfect an interest
in accounts receivable? You file with the Secretary of
State. Since it's the same office, you
don't need to do anything. Your original filing on
inventory is good enough to cover the accounts.
Proceeds forever. But let's break it.
What if I trade my inventory for a piece of equipment?
Still the same office. Secretary of State for
inventory, Secretary of State for equipment.
You're good. OK, what if I trade my inventory
for a warehouse Real property? Now you're in trouble.
Now you have a problem. Real property mortgages are
recorded in the county. Land records inventory is filed
with the Secretary of State. Different offices.
The same office rule fails.
You have 20 days to rundown to the county recorder and file a
mortgage, or your security interest in that warehouse
becomes unperfected on day 21. That is a classic exam trap.
Wash the office. OK.
I want to pivot to a fascinating case study in the materials
regarding proceeds and federal law, the FCC license cases.
This feels like a clash of Titans.
It is. It's the unstoppable force of
commercial finance versus the immovable object of federal
policy. The immovable object is the
Federal Communications Act. It says basically that the
Airways belong to the public. A private company like a radio
station gets a license to use them, but they don't own the
frequency. Therefore, the statute says you
cannot place a lien on an FCC license.
Which creates a huge problem for lenders.
I mean, if I'm lending $50,000,000 to a broadcaster,
their only real asset is that license.
If I can't take it as collateral, I'm not lending the
money. Correct.
So lawyers got creative. They said, OK, we won't put a
lien on the license itself, we'll put a lien on the proceeds
of the license, the money you would get if you ever sold it.
And the courts have been, let's just say, split on whether this
clever workaround actually works.
We have Henry Tracy Broadcasting and Henry Terrace Star Networks.
Let's contrast them. In Tracy Broadcasting, we had a
radio station in bankruptcy. The lender had a security
agreement covering general intangibles and proceeds.
They claimed this covered the SEC license proceeds, but the
court looked at the timing. At the moment of bankruptcy,
there was no buyer. There's no sale pending.
It was just a hypothetical future sale.
Exactly. And the court said essentially
you can't have proceeds of a sale that hasn't happened yet
since the license itself is a public right and can't be
collateral, and no private proceeds existed yet.
The lender got nothing. The Lynn was invalid.
That is terrifying for a lender. It suggests the collateral value
is 0 until the very moment a sale closes.
But then Tarastar came along and offered a lifeline.
Tarastar involved a massive satellite network.
The stakes were much higher and the lawyers there, while they
were smarter with their drafting the court in terrorist, are
distinguished. Tracy.
They held that a lien can attach to the economic value of the
license as proceeds even without a current sale.
They reasoned that the right to monetize the license is a
private right separate from the public right to broadcast.
So it comes down to drafting. It's about the words on the
page. It absolutely does.
The take away for our listeners is this.
Don't just list FCC license in your collateral description.
That is void. It's a mistake.
You have to explicitly describe all economic rights, proceeds
and attributes associated with the license while arguably
excluding the public license itself.
You have to thread the needle to survive the Tracy versus Terror
star split. Let's move from radio waves to
digital waves. Electronic chattel paper.
First, we need to define chattel paper.
It's a weird hybrid, right? It is.
Chattel paper is a record or a set of records that evidences 2
things simultaneously. 1A monetary obligation you owe me
money and two a security interest in specific goods.
If you don't pay, I take the car.
The classic example is a car loan or an equipment lease.
In the old days, this was physical paper.
If a finance company bought a stack of car loans from a
dealer, they would physically take the papers.
They would put them in a vault. That is possession.
Possession perfected the interest.
But now I signed my car lease on an iPad.
There is no original paper. It's a PDF.
You can't put a PDF in a physical vault.
So Article 9 had to invent a digital equivalent of
possession. They call it control, but the
question is how do you control a digital file that can be copied
infinitely with a keystroke? Section 9 One O 5 sets out a
really strict 6 point test to determine if a computer system
creates what's called a single authoritative copy.
I want to actually go through these points, or at least the
essence of them, because this is where the tech meets the law.
It sounds like they were describing blockchain before
blockchain was even a thing. They essentially are.
It's about digital integrity. To have control, your system
must prove that this specific digital file is the 1 So 1 a
single authoritative copy must exist which is unique,
identifiable, and importantly, unalterable. 2 the authoritative
copy must identify the secured party as the assignee, and
three, the authoritative copy must be communicated to and
maintained by the secured party or its custodian.
OK, so points 1-2 and three create the digital vault.
What about copies? How do you handle?
That that is the rest of the test. 4 copies are amendments
that change the assignee can only be made with the consent of
the secured party. The lender holds the keys. 5
each coy of the authoritative copy, like a backup or just a
rintout, must be clearly marked as a copy.
It can't be mistaken for the original and six, Any amendment
has to be readily identifiable as either authorized or
unauthorized. There has to be an audit trail.
It's rigorous. I mean, you can't just save APDF
to a hard drive and claim you have control.
You need specialized vaulting software.
But why does this matter? Why go through this IT
nightmare? Why not just file a UCC 1
covering chattel paper? You can file a UCC, one that
works for perfection, but filing is weak, control is strong, and
the reason is there is a super priority rule for purchasers of
chattel paper. A super priority, OK.
If I buy chattel paper from a dealer and I take possession if
it's paper or control if it's electronic for new value and I
act in good faith, I win. Wait, let's unpack that Win Win
against 2. I beat a secured party who
merely filed. Let's say Bank A lends money to
a car dealer and files a UCC one on all chattel paper.
Bank A is perfected. Being safe.
The dealer then sells a car contract to finance Company B
Finance Company B pays cash and takes control of the electronic
file. The authoritative copy.
The dealer goes bust. Who owns the car contract?
Well, my gut says Bank A. They filed first.
First in time. It doesn't matter.
Finance Company B has control Control Trump's filing in
chattel paper disputes. Finance Company B takes the
asset free and clear of Bank A's land.
That is a massive trap. So if you're a lender and you're
relying on filing for chattel paper, you are vulnerable to a
purchaser who takes control. The law wants these assets to be
liquid. It wants a dealers to be able to
sell these contracts easily. Correct. the Super Priority Rule
facilitates commerce. If purchasers had to check the
UCC filings every time they bought a car loan, the secondary
market would just freeze. Let's shift from cars to
buildings fixtures. This is where Article 9 crashes
head first into real estate law. Fixtures are goods that have
become so related to particular real property that an interest
in them arises under real property law.
Think of a central air conditioning unit, A built in
furnace or industrial machinery that's bolted to the factory
floor. The confusing part is that it is
still a good It's a furnace, but it's attached to the land.
So do we file with the Secretary of State for goods or the county
recorder for land? If you want to be safe against
everyone, you need a fixture filing.
This is a special kind of UCC One, it has three extra
requirements. One it must be filed in the real
property records, the county office where deeds and mortgages
are filed. Two, it must provide a
description of the real property, and three, it must
name the record owner of the real estate if the debtor
doesn't own the land like a tenant.
We have a case in Remay that shows what happens when you get
lazy with point #2, the property description.
In remay is a great warning. The creditor filed a fixture
filing, but for the description of the real estate they didn't
use the full legal meets and bounce description.
They use something vague like a street address or partial lot
number. Not good enough.
Not nearly good enough. The bankruptcy court asked the
key question, would a title searcher looking at the land
records find this UCC filing? The answer was no.
The description was insufficient to index it properly against the
land result. The filing was worthless.
The lien was avoided by the trustee.
So 123 Main St. is not enough. You can't just put that in the
box. Never rely on a street address
in a fixture filing. You get the deed, you copy the
legal description word for word. No shortcuts.
Now let's talk about the priority battle.
This is the main event for fixtures.
We have a bank with a mortgage on the building recorded years
ago. We have a supplier who sells a
new furnace to the building owner on credit.
The furnace gets installed, the owner defaults who gets the
furnace. The general rule is first in
time. The mortgage was recorded years
ago. The furnace is installed today.
The mortgage, in a sense, eats the fixture.
The bank wins. That seems unfair to the
supplier. The bank is getting a windfall,
a free furnace. It is unfair, which is why we
have the PMSI exception. If the supplier holds a purchase
money security interest, meaning they lent the money specifically
to buy that furnace, and they make a proper fixture filing
within 20 days of the goods becoming fixtures, they went.
So the supplier can jump ahead of the existing mortgage.
They can prime a mortgage recorded 10 years earlier.
Yes, they get super priority. The rationale is that we want to
encourage modernization. We don't want an old mortgage
lender to block the debtor from upgrading their property with
new efficient equipment. But.
And there is always a But in Chapter 5 there is one lender
who beats even the PMSI supplier, the construction
lender. The construction mortgage is the
God Mode of real estate lenders. As we said, if the goods are
brought onto the site during the construction phase and the
construction mortgage is recorded, the construction
mortgage beats the PMSI fixture lender.
Why? Why do we screw the supplier of
the windows and the elevators in the furnace?
Because the construction lender is taking a massive risk,
They're funding a hole in the ground hoping it becomes a
building. If we allowed every supplier,
the toilet guy, the window guy, the elevator guy, to come in and
file superior lenses on their specific parts, the building
would be picked apart if things went wrong.
The construction lender needs a first liens on the entire
project to make the financing work.
So if you are selling elevators to a skyscraper under
construction, what do you do? You realize you are second in
line or you get the construction lender to sign a subordination
agreement, but good luck with that.
Moving on, we have two concepts that sound similar but are
legally distinct accessions and commingled goods.
What is the difference between Agps installed in a truck and
flour baked into a cake? Great example.
The GPS is in a session that's section 9335.
It is physically united with the truck but it retains its
identity. You can unscrew it.
It is still AGPS. The flower is commingled goods
section 933D6. It's identity is lost in the
product. You cannot extract the flower
from the cake. Let's start with the accession
the GPS. Who wins between the truck
lender and the GPS lender? Generally the priority follows
the normal Article 9 rules, first to file, PMSI rules,
etcetera. However, there is a massive trap
called the Certificate of Title exception.
Cars and trucks are covered by certificates of title.
The pink slip if the security interest in a hole the truck is
perfected by notation on the certificate of title that
interest Trump's the security interest in the accession.
So if Ford Motor Credit is on the title of the truck and I
sell you a $5000 stereo system on credit and file a UCC. 1 If
they repossess the truck, they take the stereo.
Your security interest in the stereo is subordinate to their
interest in the whole truck. That seems to kill the market
for aftermarket part sales on credit.
It certainly makes it very, very risky.
Now what about the cake, the commingled goods?
I supply flour, you supply sugar.
We bake a cake. The cake is the product.
Does my lean on the flour just disappear into the ether?
No, your lean shifts. It attaches to the product cake.
But now we have a problem. We have two lenders, Flower
Lender and Sugar Lender, claiming the same cake.
Who wins? Who's first?
Right, first in time doesn't make sense here.
It doesn't, so this is one of the few times the law uses pure
math. They rank equally in proportion
to the value of their contributions.
If the flower cost $10 and the sugar cost $5, the total cost of
inputs is $15.00. The flower lender gets 100 and
fifteenths or 2/3 of the cake proceeds.
The sugar lender gets a 500 and fifteenths or 1/3.
Pro rata sharing. No first in time, just math.
Correct. Since the goods are lost, we
can't say mine is on top. We just share the value.
It's the only equitable solution.
We are entering the final stretch.
Let's do a quick fire round for a few other special traps in
Chapter 5. First up, commercial tort
claims. I am a business.
I sue a competitor for patent infringement.
I expect to win $10 million. Can I use that lawsuit as
collateral for a loan? Yes, but with two huge caveats.
1 Specificity You cannot write all commercial tort claims in
your security agreement. That is invalid.
You have to describe the specific claim.
The lawsuit against X Corp, case number 12345.
And the second one. Two, no after acquired property.
The after acquired property clause does not work for these
If you sign the deal today and a new tort claim arises next year,
when someone else infringes your patent, your security interest
is not attached to it. You have to sign a new amendment
to add it. Why does the law make it so
hard? What's the policy?
It goes back to an old common law doctrine called champerty.
The law hates the idea of lenders stirring up litigation
just to make money. By requiring specificity, we
ensure the lender is financing a specific existing asset, not
just betting on the debtors general litigiousness.
Next trap Letter of credit rights.
The rule is simple control. That's the only way.
Unless it's a supporting obligation.
You need the issuer, the bank that wrote the letter, to
consent to the assignment of the proceeds.
Filing a UCC 1 is generally ineffective.
You need the bank's permission period.
And finally, a concept that confuses everyone, sales of
accounts. We usually think of Article 9 as
covering loans. If I borrow money and pledge my
accounts receivable, that's clearly Article 9.
But what if I sell my accounts receivable to a factor true
sale? I don't own them anymore.
Does Article 9 apply? Yes, it does.
This is a big one. Under section 91-O9A3, the seal
of accounts, chattel paper, payment, intangibles, and
promissory notes is treated as a secured transaction.
For perfection purposes. The buyer is treated as the
secured party. The seller is treated as the
debtor. But why?
If I bought it, I own it, it's mine.
Why do I have to file a financing statement against the
person I bought it from? It seems totally
counterintuitive. Think about the secret land
problem. If I sell my accounts to you,
but I stay in business, I still send the invoices to my
customers. To the outside world, it looks
like I still own those accounts. If another lender comes along,
they might lend me money thinking I have all these great
assets. They have no idea they've been
sold. To prevent that kind of fraud,
the law forces the buyer to file a UCC one.
This puts the world on notice. Hey, these accounts have been
sold. Don't rely on them.
We have a case in re Commercial Money Center that confirms this.
Yes, in that case, the buyer of the assets failed to perfect.
They failed to file, the seller went bankrupt, and because the
buyer hadn't filed, the bankruptcy trustee was able to
use their strong arm powers, treat the sales unperfected, and
effectively claw the assets back into the bankruptcy estate.
The buyer lost everything. The lesson is brutal.
Even if you buy the asset outright, if it's an account or
chattel paper, file the UCC one or risk losing at all.
We have covered a massive amount of ground today.
We've gone from bank accounts to radio towers to cake batter.
If you had to summarize the exceptions, mindset for our
listeners, the strategy for the exam, what is the mental map?
The mental map is this. Stop the autopilot.
When you read a fact pattern, identify the collateral first.
Don't do anything else. If it is inventory or equipment,
you can relax into the standard rules first to file.
But if it is a deposit account you have to ask do I have
control? If it is chattel paper, ask who
holds the authoritative copy. If it is a fixture ask did we
file in the real estate records? If it is proceeds ask, can we
trace it via the lowest intermediate balance rule?
It really is about recognizing that the special categories are
where the money is won and lost. The default setting of file with
Secretary of State is the wrong answer for the most valuable
assets a company might have, its cash and its contract.
Precisely the strategist, The top student, knows that the
exceptions are not just footnotes, they are the ball
game. And that is a perfect place to
wrap up. We hope this deep dive helps you
navigate the minefield that is Chapter 5.
For our listeners, here's a final provocative thought to
chew on. We talked about control for
electronic channel paper. As cryptocurrency and blockchain
assets become standard on corporate balance sheets, how
does Article 9 adapt? Is a crypto wallet a deposit
account? Is it a general intangible or is
it electronic money? The UCC is currently being
mended in many states. To answer that, look up Article
12. But until it's settled
everywhere, it is the ultimate special collateral trap waiting
to happen. That is a whole other deep dive
for another. Day.
Indeed it is. Thanks for listening and good
luck with the code. All right, everyone, welcome
back. We're diving into Article 9 of
the UCC, which you know, is a huge topic on the bar exam.
But what really separates the top scores is mastering the
exceptions. So today we're going to tackle
some of the trickiest parts of Article 9, the special
collateral types. You know, these are the spots
where the normal rules just don't apply, and frankly, where
the examiner's love to see if you really know your stuff.
So here's our game plan. We're going to start with a
quick look at why these exceptions even exist.
Then we'll get into the nitty gritty of each special
collateral type. We're talking proceeds,
fixtures, deposit accounts, the whole shebang.
And at the end, we'll tie it all together so you can see the big
picture and be ready for whatever curve balls the exam
decides to throw your way. You see, most of Article 9 is
built on this really simple, kind of beautiful notice filing
system. You file a UCC 1 financing
statement and boom, the whole world is on notice of your
security interest. But for certain kinds of
collateral, the rules completely change.
These exceptions are there for some very specific policy
reasons, and spotting them is absolutely the key to acing
these questions. OK, this slide right here.
This is your new best friend. Seriously.
Think of it as the CHEAT SHEET for this whole topic.
It lays out the key exceptions and shows how they just totally
flip the script on attachment, perfection and priority.
We're going to walk through each one of these, so don't stress
about memorizing it right this second.
Just get a feel for the landscape we're about to
explore. So what is it that makes this
collateral so special? Well, it's because these assets
just don't fit nicely into that standard filing system.
Sometimes they bump up against a completely different area of
law, like real estate law when we talk about fixtures.
Other times they're super liquid financial assets, like a bank
account, where a public filing in some state office just isn't
the best way to let people know what's going on.
OK, let's jump into our first category, proceeds.
The core idea here is really simple, but powerful.
A security interest shouldn't just disappear when the
collateral changes form. The whole point is that the
security interest is supposed to follow the value even if the
original item gets sold, traded, or whatever else happens to it.
And you'll notice the definition here is incredibly broad, and
that's on purpose. So if your debtor sells a
secured piece of inventory, the cash they get, those are cash
proceeds. If they trade in a secured
company truck for a new one, that new truck is non cash
proceeds. The key rule is that your
security interest in the original collateral
automatically continues in any identifiable proceeds.
Ah, and here it is. This is the classic 100% going
to be on the exam problem. Your debtor sells some
collateral for say 10 grand in cash.
They deposit that 10 grand into their business account which
already had five grand in it. Now the funds are commingled.
How in the world does the secured party prove which part
of that $15,000 is their collateral?
So to solve this puzzle, the law uses this really clever
accounting trick. It's called the Lowest
Intermediate Balance rule, or LIBR.
It basically works on a presumption.
We assume the debtor spends their own money first before
they spend the secured party's proceeds.
But here's the catch. If the total account balance
ever dips below the amount of proceeds you put in, that dip
permanently cuts down your claim.
So if that $15,000 account drops to $8000, your identifiable
proceeds are now capped at 8 grand, even if the debtor
deposits $1,000,000 the next day.
All right, so we've seen how a security interest can follow the
value as collateral changes form.
Now let's look at a totally different kind of
transformation. What happens when personal
property, like a furnace, gets so attached to a building that
it basically becomes part of the real estate?
This is where Article 9 has to figure out how to work with a
completely different legal universe, real property law.
The big question here is whether a piece of personal property,
what Article 9 calls a good, has become so connected to the real
estate that it's now considered a permanent part of it.
This is always a question of fact.
But the textbook example is that giant commercial furnace that's
been bolted into the basement of an office building.
And this right here brilliantly illustrates the exam trap.
A standard UCC, one that you file with the Secretary of
State, does absolutely nothing to give you priority over a real
estate mortgage. To win that battle, you need
something special. Called it, Fixed your filing.
Now, this is still a UCC one form, but it has extra
requirements like a description of the real property.
And this is the crucial part. You file it in the local land
records office, the exact same place where you'd go to record a
mortgage. So how do you actually figure
out if something's a fixture? Well, courts use A5 part test
that you can remember with the acronym Maria M is for the
method of attachment. You know, how hard is it to
remove a is for adaptability? Was this thing custom built for
this specific building? R is the relationship of the
parties. We expect different things from
a tenant than from someone selling the property.
I is for the objective intent of the person who installed it.
And finally, A is for any agreement the parties made on an
exam. You'll want to run through these
factors to build your argument. All right, let's switch gears
completely. We're moving to another type of
collateral that is a huge favorite on exams, deposit
accounts. And listen, here is the absolute
number one thing you need to know.
Forget everything you've learned about filing a financing
statement when a deposit account is the original collateral.
Filing is useless. It is all about 1 concept and
one concept only control. This is the black letter rule.
You have to write this on your exam.
If the fact pattern gives you a commercial bank account as the
original collateral and it says the lender filed to UCC one,
that filing does nothing 0 zilch.
The only way to perfect that security interest is to get
control. So how do you get control?
Well, there are three ways. The first one's the easiest.
If the lender is the same bank that holds the account, they
have control automatically. The third way is pretty rare.
It's the second option that's the real workhorse in commercial
lending, the deposit Account Control agreement or DACA.
This is just a three party contract between the lender, the
debtor and the bank where the bank says, Yep, if the lender
tells us to send them the money, we'll do it no questions asked.
OK, now here is where it gets really interesting.
This slide shows you the priority waterfall for deposit
accounts and it totally throws the normal first to file or
perfect rule out the window. Look who's at the very top, the
bank that actually holds the account.
They have what we call super priority.
They win. They win even if another lender
got a DAC assigned a year earlier.
And if you think about it, this makes perfect sense from a
policy standpoint. The bank holding the cash is in
the absolute best position to control it.
So we've seen how control is king for liquid assets like bank
accounts. Now let's see how that idea and
a few others apply to some other unique intangible assets.
Let's start with a really specific one, commercial tort
claims. The UCC is incredibly strict
about this, and the policy reason is pretty clear.
We don't want lenders making these huge blanket grabs of any
and all future lawsuits A debtor might have.
So the security agreement has to describe the specific tort
claim. A generic description, like all
commercial tort claims is totally invalid.
And this is a critical point. And after acquired property
clause does not work for these, the interest can only attach to
a claim that already exists when the agreement is signed.
Just like with deposit accounts, that word control pops up again
for electronic chattel paper. But here it means something a
bit different, a bit more high tech.
To have control, you need a system that can create the
electronic equivalent of a single unique original document.
Think of it like a digital master copy, a special file that
can't be changed without the secured party say so.
And it clearly marks all other copies as just that, copies.
It's all about preventing multiple people from claiming
they hold the original. And here is another huge exam
trap. So many students assume that if
something is a sale, it can't possibly be a secured
transaction. But for accounts receivable and
for chattel paper, Article 9 actually treats an outright
buyer as if they were a secure party.
Why? Well, because to the rest of the
world, it's impossible to tell if a company sold its
receivables or just borrowed money against them.
So the law steps in and says to the buyer, you have to file a U
CC-1 to perfect your ownership or you risk losing out to the
seller's other creditors. OK, let's pull all this
together. We've just marched through a
whole bunch of very specific rules, but what are the big
ideas, the themes that connect all of them?
Understanding the why behind the rules is what's going to help
you reason through a new fact pattern on the exam.
When you boil it all down, it really comes down to these two
core principles. For financial assets, things
that are basically cash, like a bank account, your brain should
immediately scream control of giving notice.
For physical assets that change form or get bolted onto a
building, you should be thinking coordination and following the
value. This is the mental framework
that will help you slice through the facts and spot the right
issues. And that brings us right back to
the central conflict that makes this area so tough, but also so
testable. So what's the answer?
Which law governs? Well, the answer, of course, is
that both of them do. And to get all the points on
your exam, you have to analyze the problem under both the Ucc's
fixture rules for priority against other lenders and under
real property law for priority against mortgagees, showing you
can synthesize those two worlds. That is what demonstrates true
mastery of the subject.