Welcome back to the Deep Dive. Today we are just looking at,
you know, a set of rules. We are really getting into the
central nervous system of the entire credit economy.
That's a good way to put it. We are tackling Chapter 4 of
secured transactions, priority rules and competing claims.
Yeah, this is the topic that keeps bank general counsel's
awake at night, and it's the one that makes or breaks a secured
transactions exam. It really is.
You know, in our previous conversations when we were
talking about attachment or perfection, we were living in
relatively small world, right? It was almost binary.
It was just debtor versus creditor.
Did we sign the paper? Did we file the form?
Exactly. A1 on one dispute, but Chapter
4. This is where the camera pulls
back. We're suddenly seeing the whole
battlefield. That is the perfect analogy
because in the real world, when a business fails, it rarely
defaults on just one loan. Oh, it never.
It's never that clean. When the shit goes down,
everyone is scrambling for the lifeboats.
And who's on the ship? You've got the bank with the
main line of credit. You've got the equipment
supplier, maybe the credit card company.
The bankruptcy trustee suddenly appears out of nowhere.
And maybe some guy who just bought a forklift from the
debtor on Craigslist last week. Exactly.
And Chapter 4 answers the brutal question, who gets a seat on the
lifeboat and who, well, who drowns?
And the answer is definitely not everyone shares nicely, is it?
Absolutely not. This is a cold, hard
hierarchical system. There is no participation trophy
in article mount. So we're moving away from these
sort of equitable feelings. Oh, completely.
That's the biggest mental shift students have to make.
You have to get rid of the idea that I lent the money so I ought
to get paid. That feels fair though it.
Feels fair, but it's not the law.
We are moving into the coal mechanical Gears of statutory
priority. It's about diligence, notice and
strict compliance with the statute.
Which is why this is probably the make or break section for
law students and, you know, anyone prepping for the bar.
It is. I feel like this is where the
confusion between attachment and priority really bites people.
Talk about that, what's the error you see?
It's. The number one error, year after
year, students think I have a security agreement, the debtor
signed it, I gave value, I have rights, and I mean, they're not
wrong. They do have rights.
They do. They have rights against the
debtor. That's attachment.
You can sue your debtor and get a judgement.
But that's not the whole story. Not even close.
Priority is your right against the rest of the world.
It's your place in line. You can have a perfectly valid
attached security interest, but if someone else has priority,
the pot of money is empty before you even get your spoon out.
So our mission today is to map out that hierarchy, that entire
system. We have to, we're going to be
using Chapter 4 priority rules and competing claims as our
primary road map. We'll start with the baseline
rules, then get into the terrified struggle against the
bankruptcy trustee, always terrified, then the Super
priority of PMSI, and then, and I know you love this one,
circular leans. Help us.
But yeah, we have to cover it. And we should probably weave in
some of the deeper scholarship too.
Well, professors like Planck, Harris and Mooney have done some
fascinating work on why these rules exist.
They really dig into the tension with the old Nemo Dat principle
from property law. You can't give what you don't
have. Exactly, and understanding that
tension helps explain the logic behind what seems like madness
sometimes. OK, let's do it.
Let's start right at the bedrock.
The general rule? UCC section 9322A1 If a listener
remembers nothing else from this hour, what is the mantra?
1st to file or perfect. Just that First to file or
perfect. Say it in your sleep.
It sounds deceptively simple. It does, but it drives the
entire behavior of the commercial lending market.
The statute says priority ranks according to whichever happened
earliest, filing a financing statement or perfection.
So usually you file in order to perfect.
So in what 90% of cases isn't it just first to file wins?
In practice, yeah, that's often even how it shakes out.
It creates A literal race to the Secretary of State's office or
to the online filing portal. But the rule includes or perfect
for a reason. It does.
It has to account for those times when you perfect by other
means, like taking possession of the collateral or establishing
control over a bank account. But the real nuance, the thing
that trips up even the smart students, is how that first to
file prong interacts with the timing of the deal itself.
This is what creates the pre filing phenomenon.
I really want to push on this because it feels so counter
intuitive. We established in previous deep
dives that you cannot have a security interest until it
attaches correct? And it can't attach until you
give value, until you actually lend the money.
Right value rights in the collateral and an agreement, the
three pillars of attachment. But you're telling me I can file
the financing statement before I've lent a single penny?
Before I even have a deal. Yes.
In fact, if you are a diligent lawyer for a lender, you must
file before the money moves. Article 9 explicitly allows you
to file a financing statement before the security agreement is
even signed and long before value is given.
OK, let's run a scenario here to see if I truly get the
implications of this. Yeah, it's wild.
I'm lender A. On January 1st, I file a
financing statement against the debtor.
We're still negotiating the long terms.
I haven't lent them a dime. OK, so on January 1st, you have
no security interest. You just have, let's call it a
placeholder, a spot on the public list.
Right then on February 1st, Lender B comes along.
They're faster, more aggressive, They lend money to the debtor.
The debtor signs their security agreement and they filed their
financing statement that very same day.
So Lender B is fully perfected on February 1st.
Correct. Lender B has real skin in the
game. They have attached and perfected
their interest. They have a real enforceable
security interest. And me, Lender A, I'm still just
sitting there with my filing from January.
Just a piece of paper in the system.
Then on March 1st, my deal finally comes together.
We sign the papers, I wire the money.
I become perfected on March 1st, but my filing was back in
January. The debtor defaults.
Who wins? You do Lender A wins.
Wait, really? Even though Lender B was the
first one to actually perfect the first one to lend money.
Yes, under 9322, your priority date relates back to your filing
date of January 1st. Even though you had no security
interest at that time, your place in line was reserved.
That feels incredible unfair to lender be from their
perspective, they were the first real perfected creditor.
When they lent the money, I didn't even have a deal.
And you have just hit on the exact tension that Professors
Plank, Harris and Mooney write about.
It is a direct conflict between the ancient property law concept
of Nemo that could non have it. You cannot give what you do not
have and what they called the filing priority principle.
Because normally property law says if I don't have a right in
something, I can't grant a claim against it.
On January 1st, the debtor hadn't given me any rights at
all. Exactly.
So how can they grant me priority?
Article 9 makes a conscious choice to override that ancient
property concept, and the reason is pure policy, which is
certainty. It's all about the certainty of
the filing system. The drafters wanted a system
where a potential lender can look at one public record and
know exactly where they will stand in the hierarchy.
So when Lender B went to check the records on February 1st
before they lent their money. They would have seen your
January 1st filing. I see they were on notice.
They knew, or they should have known that if they went ahead
and lent money, they would be sitting behind you effectively
waiting to see if your deal went through.
The filing system is a scoreboard.
You check the score before you step onto the field.
So it prevents secret liens. It forces everyone to show their
cards publicly, even if the hand hasn't been fully dealt yet.
That's the perfect way to describe it.
It turns the filing office into the sole source of truth.
If we relied on a rule like who lent the money first, that's a
private fact. Lender B would have no way of
knowing about your quiet negotiations with the debtor
just by checking the public record.
That would create uncertainty, and uncertainty kills the
availability of credit. OK, so that's the battle between
two perfected parties. The first to file or perfect
rule governs. What about the other
combinations? What if it's a perfected party
versus an unperfected 1? That's what I call the Super
status role. It's an absolute knockout.
A perfected interest always beats an unperfected one, no
matter what. Doesn't matter if the
unperfected party attached first.
Doesn't matter if the unperfected party lent 10 times
more money. If you filed and perfected and I
just stuck the signed contract in my desk drawer and forgot
about it, you win every time. No mercy for the lazy or the
careless. None.
Now you know there is that tiny garage sale exception for
certain consumer goods, but that's a niche rule we can leave
for another day. For commercial purposes,
perfection is everything. OK.
So what about the most interesting scenario and what
you said is a classic exam trap, unperfected versus unperfected?
Yes, the tiebreaker. This is a great fact pattern for
an exam. Neither of us filed, neither of
us perfected by taking possession.
We both just have signed security agreements from the
debtor. Maybe we're both tricked, or
maybe we're both just incompetent.
The debtor defaults. Who wins?
What does students usually guess?
Their first instinct is to look for who filed first, but of
course nobody filed then. They often guess it should be
pro rata. You know we share the pain.
Both are wrong. Under section 9 Death 302-A3.
If neither party is perfected, priority goes to the first to
attach. So the system reverts to the
private timeline. Exactly because there is no
public notice for anyone to rely on, the law falls back to the
old common law idea of first in time, 1st and right, but applies
it to the creation of the interest itself.
When did you give value? When did the debtor sign the
agreement? That's what matters.
But really, if you're a commercial lawyer and you find
yourself in a priority dispute where nobody has perfected.
You should probably be calling your malpractice carrier.
You've already lost, even if you technically win the dispute.
Pretty much much you've exposed your client to a massive
unnecessary risk. All right, let's shift gears.
Section 2, we're moving to the collision that is probably the
most terrifying for any lender. It's not with another bank, it's
with the lean creditor and specifically the bankruptcy
trustee. The ultimate predator in the
Article 9 ecosystem. First, let's just define a lean
creditor in the classic sense. OK.
So a lean creditor is someone who acquired a lean on the
property through the judicial process.
They sued the debtor, they wanted judgement and then they
got the sheriff to go out and levy on the debtors assets.
They physically seized the property to satisfy the
judgement. But as you said, in law school
exams and frankly in most real world scenarios, the most common
and powerful Lynn creditor isn't some guy who won a lawsuit, it's
the trustee in bankruptcy. Right.
And this brings us to the strong ARM clause of the Bankruptcy
Code, Section 5, four to four a. This is a legal fiction, but it
is an incredibly powerful one. Explain the fission.
The moment a debtor files a bankruptcy petition that exact
second the trustee puts on a mask, they are legally
transformed. They step into the shoes of a
hypothetical in creditor who has just levied on all of the
debtors assets at that exact moment.
Hypothetical is the keyword there.
They don't actually have to go to court and get a rid of
execution. Correct.
They get that status automatically by statute.
They just raise their hand and say as of the petition date, I
am now a creditor who has seized everything and they use that
powerful status to try to kill off any security interests that
isn't absolutely perfect. So what's the rule of engagement
here? Section 9317 lays it out secured
party versus this super powered lien creditor.
It is a brutally simple timeline test.
If the secured party is perfected before the lien
arises, so before the bankruptcy petition is filed, the secured
party wins. And what does winning mean in
bankruptcy? It means your security interest
survives the bankruptcy. You are a secured creditor in
the bankruptcy case, which is a very, very good place to be.
You get paid first from your collateral.
But if the lien arises first. Then the trustee wins, and this
is what we call the EA Danger Uose.
You, as a lender, have attached your interest.
You've lent the money. The debtor has signed the
security agreement, but you haven't filed the financing
statement yet. Maybe you're waiting for a
signature to be notarized, or the Courier is slow, or your
paralegal is out sick. And in that gap, that little
window of time, the debtor files for bankruptcy.
At the moment of the petition you are unperfected.
You are unperfected, which means the trustee who has the status
of a Lynn creditor as of that moment beats you.
They use the strong ARM clause to avoid your security
interests. What does that mean to avoid it?
It means your security interest is erased.
It's nullified. You are stripped of your
collateral. You go from being a secured
lender at the front of the line to being just another general
unsecured creditor at the very back of the line fighting for
pennies on the dollar with everyone else.
That transition from secured to unsecured in a bankruptcy is
basically a death sentence for the loan.
It absolutely is. You're lucky to get anything
back, and this brings us to a case that I think illustrates
the sheer brutality of this rule better than any other in re
General Coffee Corps. I love this case.
It reads like a crime novel. It involves a massive
international fraud or a. Classic.
So the short version is this General Coffee Corporation
wanted to buy the assets of another company, Chase and
Sanborn. To get the cash to do it, they
ran a very complex scam involving a certificate of
deposit and a bank in Panama. We don't need to get into the
weeds of the wire transfers. Bottom line is they got money
they shouldn't have. Yes, they essentially
misappropriated stole money from a place called City National
Bank. So City National Bank is the
victim here. Their money was stolen and then
used by General Coffee to buy inventory, in this case coffee
beans. Right.
So eventually the whole scheme collapses and General Coffee
files for bankruptcy. City National Bank shows up in
the bankruptcy court and says, hey, huge pile of coffee
inventory sitting in the warehouse that was bought with
our stolen money. We demand a constructive trust.
OK, let's define. That a constructive trust is an
equitable remedy. It's a tool a court can use to
prevent unjust enrichment. It's basically.
The court saying, look, fairness demands that we treat this
property as belonging to the victim, not the thief.
So the. Bank is arguing this isn't
really the debtors property to begin with, they're just holding
it in trust for us because they stole the funds to buy it.
It's an argument based on pure fairness and morality.
A very. Compelling argument.
So you have city. National Bank, on one side
arguing equity and fairness and on the other side you have the
bankruptcy trustee who is arguing.
Statutory rigor. The trustee pulls out the strong
arm clause and they looked at Florida law, which was the
controlling state law in the case, and what did?
Florida law say Florida law. Like the law in many states said
that a constructive trust isn't a pre-existing property right.
It doesn't actually exist until a court declares that it exists.
It's a remedial device that a court imposes after the fact,
and since the. Bank court sue was filed before
any court had declared this trust the trustee.
Made the killer argument. They said at the exact moment of
the bankruptcy filing, I, the trustee, became a hypothetical
lien creditor on all assets. At that moment, no trust had
been declared yet. Therefore my lien attaches to
the coffee beans free and clear of the bank's later asserted
equitable claim. And the court agreed.
With that, the court agreed. The trustee won the strong arm
of the statute out muscled the equitable claim of the
constructive trust that is. Incredibly harsh.
The bank was the victim of actual fraud.
They could trace their stolen money directly to the Coffee,
but because the trustee had the statutory status of a perfect
lien creditor as of the petition date, the fairness argument lost
to the priority timeline. It is the.
Ultimate exam take away from this whole area of law.
Do not rely on fairness or equitable principles to save an
unperfected or otherwise flawed security interest against a
trustee. It's a strict liability.
System. It's a strict.
Liability statute regarding perfection.
If you aren't perfected when the gavel drops on the bankruptcy
petition, you lose the court in general, Coffee essentially
said, We feel bad for you, City National Bank, you were clearly
wronged. But the statue is the statue,
so. Diligence is everything.
You cannot sleep on your rights for a single second, not for a.
2nd but. Surely there have to be some
exceptions. What if I'm not just some
general lender? What if I'm a lender who is
coming in specifically to help the debtor by the very
collateral in question, I'm the one making the purchase
possible. Now we are entering the realm of
the Super priority. This is Section 3, the purchase
money security interest or as everyone calls it, the PMSI.
OK, let's. Start with the policy.
Why does this exist? If first to file is the golden
rule, why does the law let certain people cut the line?
It's all about. Preventing what economists call
situational monopolies. Break that down.
For us. OK, imagine.
Lender A has a standard blanket line on a debtor's assets.
The security agreement says it covers all equipment now owned
and hereafter acquired. Very standard.
Clause right after acquired property clause right now.
If that Lin was absolutely unbreakable, the debtor could
never get financing from anyone else to buy a new piece of
equipment. The second that new machine hit
the debtor's factory floor, Lender A's lien would
automatically attach and they'd have first priority.
So Lender. A would just swallow up every
new asset the debtor ever acquired.
Exactly. Lender A would have the debtor
in a chokehold. They could charge whatever
interest rate they wanted on future loans because no other
lender would ever touch the debtor, knowing they'd always be
second in line. So the.
PMSI acts as a kind of monopoly busting mechanism.
It allows a new lender, Lender B, to come in, finance a
specific new piece of equipment and take first priority just on
that new piece of equipment, jumping ahead of lender A's
prior blanket lane. Exactly.
It promotes commerce and keeps the credit market competitive.
But, and this is a huge but for any exam because you are jumping
the line, you have to follow the rules absolutely perfectly when
rules are different. Depending on the type of
collateral, drastically. Different.
And that's where students get into trouble.
OK, let's start. With the easy rule then a PMSI
in goods but non inventory goods.
So think equipment or consumer goods.
I'm a lender financing the debtors purchase of a new
printing press. If you are.
Financing a piece of equipment? Article 9 gives you a bit of a
break. It's a practical rule.
You get a 20 day grace period, a 20 day window.
To do what you must. Perfect your interest, which
usually means filing your financing statement within 20
days after the debtor receives possession of the collateral.
Wait, wait, say. That again, 20 days after
possession, not 20 days after the loan is signed or the
purchase order is issued, correct?
Possession is the trigger. The clock starts ticking the
moment the delivery truck drops off that printing press at the
debtors factory, not a day before and if you file.
Within that 20 day window if you file within.
That 20 day window, your priority relates back to the day
the debtor got the machine. You magically jump ahead of
lender A's pre-existing blanket land, but only with respect to
that new printing press. OK.
That seems manageable. It acknowledges that sometimes
paperwork lags behind the physical delivery of goods.
It's a common. Sense rule for equipment, but
now let's talk about inventory. This is.
The hard rule APMSI in inventory.
What are we talking about here? Think of a.
Car dealership financing its floor plan of new cars, or a
Best Buy stocking its shelves with TV's from Sony, or a
clothing store buying its spring collection it's goods held for
sale. Why is this so much?
Harder Why does the law treat inventory differently?
Because inventory. Is different.
It's not supposed to sit there for 10 years like a printing
press. It's meant to turn over to be
sold. It's liquid.
Existing lenders, like lender A with the blanket lien, are often
lending against the value of that inventory.
They rely on it for their cash flow models.
They need to know immediately if someone else is claiming a first
priority right to the new cars that just showed up on the lot.
They can't wait. Base to find out their
collateral base just changed precisely the risk is much.
Higher so the rules are much stricter.
So no 20 day grace. Period.
None. Zero.
To get PMSI super priority and inventory you must complete 2
critical steps and both must be done before the debtor receives
possession of the inventory. OK, what's step one?
First you. Must be perfected.
That means your financing statement must already be on
file before those widgets arrive at the warehouse.
And Step 2. This sounds like the important
one. This is where people fail.
On exams, all the time you must send an authenticated
notification to the other conflicting security interest
holders. You have to send a letter.
To who? Yes.
You have to. Actively search the UCC records,
find lender A, the one with the blanket leaner, and send them a
formal written notice. And what does this notice say?
It essentially says. Dear Lender A Just so you know I
am acquiring or expect to acquire a purchase money
security interest in the debtors upcoming inventory of widgets
and this notice has to. Arrive before the widgets
arrive, yes. That's the key.
The other lender has to receive it before the debtor receives
possession of the inventory. If you fail to send that notice,
or if you send it but it arrives one day after the inventory is
delivered, you lose your super priority.
And what happens then? You just lose.
You fall back into. The general priority rules you
fall back to first to file or perfect, which means the.
Existing blanket lender Lender A wins because they filed years
ago. Exactly you.
Just financed a lovely donation of inventory to Lender A's
collateral pool. Your client will not be happy.
This feels like a major. Exam strategy point If the fact
pattern on my screen mentions inventory or car dealership or
floor plan, I should immediately be looking for that notice step.
Your antenna should go. Up instantly.
The moment you read the word inventory in a priority dispute,
your brain should be screaming. Notice, notice, notice.
Did they send the letter? When did they send it?
The Dykema guide on PMSI points out this common misconception
among business owners. I paid for it so I should be
first, but that's not the rule. False.
You paid for it, but if you didn't send the notice for the
inventory, you are second Article 9 rewards process and
public notice, not just the fact that you provided the purchase
money. It's a procedural minefield.
It is, but it's. A necessary one to protect the
stability of inventory financing.
OK, that makes sense. Let's move on to Section 4.
The collateral has been sold. The car is driven off the lot.
The TV is in someone's living room.
Now we have a pile of cash or a check or maybe a trade in
vehicle. We're talking about proceeds
right section. 9315 The general rule here is continuity.
It's a sensible rule. If you had a perfected security
interest in the original collateral, say the inventory,
you automatically have a perfected security interest in
the identifiable proceeds. When that inventory is sold, the
cash, the. Checks the accounts receivable
as long as you can trace. It back to your original
collateral, your security interest continues in it, and
crucially, the priority date for the proceeds relates back to the
priority date you had in the original collateral.
That makes perfect sense. You don't lose your place in
line just because the form of the collateral changed from a
car to a check. Exactly.
Otherwise, a security interest in inventory would be worthless.
OK, but let's talk. About a trickier concept in this
section. Future advances.
This is where you see a lot of issues with lines of credit.
This is the standard. Revolving credit scenario.
It comes up every day in business.
Let's paint the picture. Lender A lends $10,000 on day
one and files a financing statement.
The security agreement has a standard dragnet clause, meaning
it says. This collateral secures this
loan and any and all future loans or advances made to the
debtor, right? It's a forward.
Looking clause. Then lender B comes in on day
five. They do a lien search, they see
lender A's filing. They lend $10,000 and file their
own statement. They know they're in second
place. OK, so far so.
Good A is first, B is second, but then on.
Day 10, the debtor needs more money.
They go back to lender A and draw down another $50,000 under
that original line of credit agreement.
So now the question. Is who has priority on that new
$50,000? Is it lender A who made the
loan, or lender B who was already on file before that new
money was handed over? Logic might tell.
You it should be Lender B, right?
Because Lender B was on the record on day five.
That new money from lender A didn't even appear until day 10.
From B's perspective, they were there first with respect to that
new advance. But Article 9.
Says Article 9 Says. Lender A wins.
The priority for the future advance relates back to the
original filing on day one. Lender A beats Lender B for
priority on all amounts advanced, even the money lent
after Lender B arrived on the scene.
Why does the law allow? This it seems to put Lender B in
a very precarious position. They can't be sure how much debt
is actually senior to them. It's about commercial.
Efficiency. Imagine if Lender A had to do a
brand new UCC search and file a new financing statement every
single time the debtor drew another $100 on a revolving line
of credit. Commerce would grind.
To a halt it would the. Transaction cost would be
insane. So the first to file rule also
serves as a notice to the world. It puts lender B on notice and
says hey lender A is here, they filed first.
Their security agreement might cover future advances.
Be warned if you're going to lend you need to talk to lender
A and figure out the situation. Maybe get a subordination
agreement. It puts the burden.
On the second lender to do their due diligence exactly.
However, there is a nasty little exception here when a lend
creditor shows up. Specifically, think of the IRS
with a tax lend or a judgment creditor who has levied.
This is the 45 day rule. OK, this sounds technical.
Section 9323 It is. It creates.
A limit on that future advanced superpower.
The rule says that if a person becomes a land creditor, say the
sheriff levies on the debtors assets on behalf of a judgment
winner, the secured party is protected for future advances
they make within the next 40-5 days.
Why 45? Days seems arbitrary.
It is a bit. Arbitrary, but it's designed to
mirror the federal tax land rules to create some
consistency. It gives the bank a reasonable
window of time. The law basically assumes the
bank can't possibly know about a judgement loan instantly.
They need some time to discover the lien exists, but after 45.
Days. What happens to advances made on
day 46 after 45? Days, any new money you lend is
subordinate to the lien creditor.
There's a small exception if you can prove you made the advance
without any knowledge of the lien, but that's a tough
standard. Generally, this rule effectively
caps a revolving line of credit. So if I'm a bank.
Loan officer and I get a notice that my borrower just got hit
with a massive judgement lien. You have 45.
Days to cut off their credit line or at least stop making
new. Advances or you risk losing.
Priority on any new cash you hand out after that window
closes, you're throwing good money after bad and you're
throwing it behind the lien creditor.
All right, let's get even. Deeper into the weeds, Section
5, we've been talking a lot about filing versus filing first
in time, but the Picker article from the Chicago Kent Law Review
that you mentioned introduces a different idea of perfection
hierarchy. He talks about control versus
filing. This is where we move.
Away from a purely temporal system, who was first in time?
And we look at the method of perfection.
Picker argues, and I think he's right, that Article 9 implicitly
creates classes or tiers of perfection.
Filing is good, it's the standard.
Possession is better, and control is best.
Control is best. How does that actually play out
in a priority dispute? Let's take the classic.
Example, a deposit account, a business's bank account, Now you
can perfect a security interest in a gross con if it constitutes
proceeds of your other collateral like inventory.
And you do that just by having a financing statement on file that
covers inventory and proceeds. So that's the filing method.
Right, but. Someone else, usually the bank
where the account is actually held, can perfect their interest
by control. They have control because, well,
they're the bank. They can refuse to pay out funds
without your consent. So if I have control.
Because I'm the bank holding the money and you just have a UCC
one filing that claims the account as proceeds I win a.
Security interest perfected by control has priority over a
security interest perfected merely by filing, even if I
filed. Five years ago and you only got
control today even then. This is what pick a call is, a
non temporal priority rule. Time is irrelevant.
The method Trump's the timeline. And what's the policy?
Behind that, why reward control so heavily?
Because control is a more. Robust form of perfection.
It actually prevents the debtor from dissipating the collateral.
If you have control over the bank account, the debtor can't
just write a check and spend the money.
A financing statement on the other hand, is just a piece of
paper. It gives public notice, but it
doesn't stop the debtor from draining the account.
The law rewards the method that best reduces risk and provides
the most tangible real world grasp on the asset.
The fist beats the. Claim ticket the fist beats.
The ticket every time. Speaking of complex.
Puzzles that make your head hurt.
We absolutely have to talk about the circularly.
And I remember reading the Caterpillar case, Caterpillar
Financial Services versus People's National Bank, and
feeling like my brain was melting.
It is the stuff. Of law school nightmares, but
it's actually a beautiful little logic puzzle once you see how
it's solved, it's very elegant. Okay layout.
The setup for us, the paradox. The setup is this.
You have 3 creditors, AB and C, and based on the normal filing
rules, A has priority over B, A filed first.
OK, AB. And B has priority.
Over C because B filed before C, so ABC.
It's a simple straight line. First come first served right,
but then. A and C get together for a side
deal. A signs a subordination
agreement, a contract in which A agrees to let C have priority
over A. So now A beats.
BB beats C, but C beats A. It's rock, paper, scissors.
It's a circle. If the debtor goes bankrupt and
there's not enough money to go around, who gets paid first?
You can't just go in circles. Forever.
The court has to cut the knot somehow.
And the majority rule, the one used in the Caterpillar case, is
the partial subordination rule. OK, walk us through the.
Math. Let's use a hypothetical.
There's a pot of money, say $100,000, and AB and C are each
owed $40,000. Perfect.
So. Step 1.
You ignore the subordination agreement for a moment.
You look at a. A has the first priority
position under the statute. So you set aside the amount of
A's claim from the pot. We take $40,000 out of the
$100,000 and we put it in a separate pile.
We can call that A's slot. OK, so we have A's.
Slot with $40,000 and a remaining general pot of
$50,000. Step 2.
Now we look at the subordination agreement.
Because A subordinated its position to C we take that
$40,000 that we set aside in a slot and we pay C first from
that money. So C gets paid.
With A's money, correct C. Essentially gets to jump into
A's shoes, but only up to the amount of A's claim.
C is owed $40,000. There's $40,000 in a slot, so C
gets paid in full. OK, C is happy.
A gets nothing from that slot because C took it all.
What about B? B wasn't part of this side deal
between A and C and that is the. Absolute key B is the innocent
bystander, so B's rights cannot be helped or hurt by a deal they
weren't a party to. So step 3B gets paid from the
remaining general pot, the $60,000 that's leftover.
B is owed $40,000, B takes their $40,000, so B gets paid.
In full, just as they would have if the subordination never
happened. Ghee.
Is totally unaffected. B gets exactly what B would have
gotten if A had simply kept its priority, so C is paid.
B is paid. That's $80,000 out of the pot.
There's $20,000 left. What happens to A?
A gets whatever. Is leftover.
In this case, A gets the remaining $20,000.
A started at the front of the line, but because they
voluntarily subordinated their claim to C, they effectively
gave away their seat at the table.
That's brilliant, actually. It resolves the logical paradox
by essentially treating the subordination as a private
transfer of A's priority rights to C, but only to the extent of
A's claim and without harming the rights of the non consenting
creditor B. Exactly it.
Prevents C from leapfrogging over B just because A was nice
to see. B's position in the hierarchy is
absolutely preserved. One last technical.
Area before we shift to pure strategy Fixtures section 9334
the great clash of. The Titans real estate law
versus the UCC A fixture is something that starts as goods,
as chattel, but becomes a fix to real estate like a commercial.
Oven bolted to the floor of a restaurant or an HVAC system
installed in an office building? Exactly.
It's goods, but it's also now sort of part of the building.
So who wins A? Priority Dispute the bank with
the mortgage on the building or the equipment lender who
financed the oven. This is all about.
Where you give notice, it's a filing rule to beat the mortgage
holder. The Article 9 creditor usually
needs to make a fixture filing, and that's different from a.
Standard UCC one filing. It is a standard.
UCC one is filed essentially with the Secretary of State.
A fixture filing has to be filed in the real property records of
the county where the building is located.
The same office where you'd file a deed or a mortgage, you have
to file it in the. Chain of title for the land
itself, yes. Because a mortgage lender is
only expected to search the land records, they're not going to be
searching the statewide UCC database for chattel filings.
So if you file in the wrong office, if you just send a
standard UCC one to the capital, the mortgage lender wins.
You have to shout in the room where the person you're trying
to warn is actually listening. OK, we.
Have covered a massive amount of ground.
Let's try to synthesize all of this into Section 6 Exam
strategy. If I am a student staring at a
complex Chapter 4 fact pattern on an exam, how do I survive?
OK, first and most. Important rule.
I cannot stress this enough. Draw a timeline.
Do not try to do it in your. Head never you will fail.
I promise you, you will fail. Priority is almost entirely A
temporal concept. You need to see the sequence of
events visually laid out in front of you.
What key events or dates? Need to go on the timeline for
every single. Party in the dispute you need to
mark 4 potential points in time 1 the precise state of filing 2
the precise state of attachment and remember 3 things value
rights and an agreement 3 The recise date of erfection, which
is the later of filing or attachment four and the precise
date of notice, but only if you're dealing with an inventory
PMSI. OK, I've drawn my.
Timeline it's beautiful what the next step in the analysis step
one is to. Identify the status of each
party before you even start applying rules.
Label everyone. Write it next to their name on
your scratch paper. Lender A Perfected SP Lender B
Unperfected SP Trustee Lynn Creditor Frank Buyer.
Get your cast of character straight once everyone has a
label. What's Step 2?
Step 2 is. To check for special rules
before you jump to the general rule, you have to scan for the
exceptions. Ask yourself, is there a PMS I
involved here? Does anyone have control over
the collateral? Is this a fixture dispute?
Is there a bankruptcy trustee triggering the strong arm
clause? And if the answer to all.
Of those is no, then and. Only then do you move to step
three. If no special rule applies, you
revert to the baseline. You go back to section 9322
first to file or perfect. And what are the most?
Common errors you see students make the tramps they fall into
the biggest 1 is. Assuming that new money always
wins, they see a PMSI fact pattern.
They see that a lender provided the money to buy the collateral,
and they just assume that lender wins.
But they don't. Unless they follow the rules,
they only win if. They meet the strict compliance
rules for perfection and notice. Another big one is forgetting
that filing can happen before attachment.
Students see a filing date of January 1st and a loan date of
February 1st and their brain gets confused.
They try to start the priority clock on February 1st.
No, the priority date is the filing date.
January 1st and the last one. Thinking that knowledge.
Matters but your honor, he. Knew about my unperfected linen.
He's acting in bad faith. It doesn't matter.
With very, very few exceptions for actual fraud, Article 9 is a
pure race statute. Knowledge of a prior unperfected
security interest is irrelevant for priority purposes.
You can know all about my unperfected deal, race to the
filing office, file 1st, and beat me.
It's cold, it's brutal, but it's the law.
It rewards diligence above all else, Which brings us to our.
Outro, I think the grand philosophy of all this, if
there's one. Theme that runs through every
rule we've discussed. It has to be commercial
certainty, certainty over everything.
Else over fairness, over knowledge, over everything.
It is the. Entire system is designed to
reward those who use the public notice system and to penalize
secret liens. It's constructed so that a
lender in New York can feel comfortable lending to a
borrower in California-based solely on checking a public
database and then filing their own notice.
That's what oils the Gears of the economy.
But here's a provocative. Thought to leave you with as we
wrap up. We rely on this first, a file
system. But the system itself is kind of
blind, isn't it? What do you mean by blind?
The financing statement. On file the UCC one, it doesn't
tell you how much money is owed, it doesn't tell you the interest
rate. It just says a lien might exist
on these types of assets. You still have to pick up the
phone and call the other lender to get the details.
All right, it's a. Notice filing system, not a
transactional one. It's just a red flag that tells
you to investigate further. But we live in a world of.
Blockchain technology and instant Ledger verification.
Exactly. So the question for the future
is, is this system archaic? Could we or should we move to a
transaction filing system where the filing itself contains the
real time data of the actual debt, where priority is absolute
and transparent based on a public Ledger that would
eliminate the PRE? Filing ambiguity we talked about
it would eliminate the problem of future advances not being out
of the record. You know, the exact amount of
the senior debt at any given moment.
It would. But it might also destroy the
flexibility of the floating, lean and revolving lines of
credit that are the lifeblood of so many businesses.
It's a huge debate for the future of commercial law, but
for now, for the. Exam you're about to take.
These are the rules and they are the traffic lights of a multi
trillion dollar credit economy. Without them, commerce crashes.
So Dr. Carefully. And file early.
Thanks for listening to this. Deep dive.
We'll see you in the next chapter.
All right, everyone. Let's talk about what happens
when things go South. A business defaults and suddenly
you have a pack of creditors all fighting over the same assets.
It gets messy fast. UCC Article 9's priority rules?
Well, that's the playbook. It's the set of cold, hard rules
that decides who gets paid 1st and who gets nothing.
If you're going to master commercial finance, or more
importantly, ace your secure transactions exam, you
absolutely have to know these rules inside and out.
So let's dive in. So here's our game plan.
We're going to build this analysis from the ground up.
We'll start with a fundamental baseline rule, the 1st in time
principle. Then we'll get into the really
interesting stuff, the powerful exceptions that can completely
flip the outcome, like the special super priority for
purchase money lenders and the protections we give to everyday
buyers. We'll also see how the entire
game changes when a bankruptcy trustee walks onto the field.
And finally, we'll layer in a couple of advanced concepts to
really fine tune your understanding.
OK, let's start at the beginning.
We're talking about the foundational principle here.
This is the rule that's going to govern, I don't know, 90% of the
priority disputes you'll ever see.
If you get this right, you are well on your way.
Now, before we get into the actual rules, let's just be
crystal clear on what we mean by priority.
This isn't about what seems fair or who deserves it more.
Article 9 is a system of mechanical, almost brutal rules
that are designed to create commercial certainty.
It answers one simple question. When the music stops and there's
not enough money to go around, who is first in line and this is
it. This is the big one.
UCC section 9322. It's the first to file or
perfect rule. You can think of this as the sun
in the Article 9 solar system. Almost every single problem
starts and often ends right here.
It's your default rule that always applies unless you can
find a specific statutory exception that tells you to do
something else. OK, so this table breaks it all
down into the three basic scenarios you're going to face.
The main event, the one that causes the most confusion, is
the top row, a battle between two perfected creditors.
Who wins? It's simple.
The first one to either file their financing statement or
perfect their interest, whichever happened first.
The next two are easy. A perfected creditor will
always, always beat an unperfected creditor.
No contest. And if you have two unperfected
creditors duking it out, well, the tiebreaker is just whose
interest attached 1st. And this little timeline here
shows you just how powerful this rule is.
Let's walk through it. Look closely.
Bank A files way back on day one, before they've even lent a
dime. Then Bank B comes along, lends
money files, and actually perfects its interest before
Bank A does. You'd think Bank B would win,
right? But it doesn't matter.
Because Bank A filed first. Its priority relates all the way
back to day one. This is what we mean by the race
to the filing office. The system rewards whoever gives
public notice first. OK, so now that we have that
baseline rule firmly in our minds, let's talk about its most
critical exception. This is the purchase money
security interest, or PMSI as we call it, and it's a huge deal.
It's a tool that allows a new lender to get what we call super
priority, letting them jump to the very front of the line even
ahead of a bank that filed years earlier.
So what exactly is a PMSI? It's a special type of security
interest that happens when the loan you're making is used to
buy the very thing that's going to serve as collateral.
The classic example is a car loan.
The bank gives you money, you use that exact money to buy the
car, and the car is the collateral.
The law loves these because they help the debtor that new assets,
which in theory makes the whole pie bigger for all the
creditors. Now this is a huge exam point
folks. The rules for getting PMS I
super priority are completely different depending on what kind
of collateral we're talking about.
For equipment, the rule is pretty generous.
You get a 20 day grace period to perfect your interest after the
debtor gets the stuff. But for inventory?
Whoa. The rules are incredibly strict.
You have to perfect before the debtor ever touches the goods,
and you have to go out of your way to notify any earlier
lenders. Why the difference?
We'll think about it. A bank with a floating lien on
all inventory is constantly relying on that changing stock
of goods. The law protects them from being
surprised when new PMSI financed inventory shows up and suddenly
jumps ahead of them in line. Let's be really, really clear
about this. For your exam to get that
coveted super priority for an inventory PMSI, you have to nail
all four of these steps. It's a checklist, and you have
to hit every single item perfect before possession.
Send a formal, authenticated notice to the other filers.
Make sure the notice says what it's supposed to say, and they
have to get that notice within the right time frame.
If you miss even one of these steps, poof, your super priority
is gone. You fall right back to the
normal first to file rule, and you're almost certainly going to
lose to that bank with the earlier blanket lien.
And there's one more special PMSI rule you need to have in
your back pocket. APMSI in consumer goods.
Think a sofa bought on store credit perfects automatically.
The second it attaches, it's perfected.
No filing needed, it just happens.
This makes consumer credit a lot simpler, but be careful, there
are traps. This doesn't work for things
that have a certificate of title, like a car.
And there's the famous garage sale exception.
If your consumer debtor sells that sofa to their neighbor for
the neighbor's personal use, that neighbor actually takes it
free of your security interest. Unless you went ahead and filed
A financing statement anyway. All right, let's shift gears.
So far we've been talking about creditors fighting with other
creditors. Now we're going to look at a
rule that isn't about protecting lenders at all.
It's about protecting the free flow of commerce.
It's the reason you can go to Best Buy and not have to worry
that some bank is going to come repossess the TV you just
bought. So a buyer in the ordinary
course of business or a BIOC gets to take goods completely
free of a security interest that was created by their seller.
Even if it's a perfectly perfected security interest.
To get this special protection, the buyer has to meet all of
these criteria. And that last one, the one in
bold, that's the one that gets tested all the time.
The buyer only loses their protection if they know the sale
violates the bank's rights. Just knowing the store's
inventory is financed, that's not enough, not even close.
So. Let's test that.
Here's the classic hypo You walk onto a car lot.
Of course you know the dealership has a loan from a
bank to finance all those cars. Does that mean the bank can come
take your new car? Absolutely not.
The key isn't knowing a lien exists.
The key is knowing the sale itself is prohibited by the loan
agreement. You, as a customer, have no
reason to think that selling cars is what they do.
The bank expects them to sell the cars, so you take that car
free and clear of the bank's interest.
End of story. OK, now let's turn to a totally
different kind of competitor, the lien creditor.
This is where things get really serious.
A simple failure to perfect your security interest can have
catastrophic consequences, especially when the debtor files
for bankruptcy. So a lien creditor is just a
creditor who started out as unsecured, but they went to
court, they got a judgement, and they had the sheriff seize the
debtor's property. But for exam purposes, the most
important, the most powerful, the most fearsome lien creditor
in the universe is the bankruptcy trustee.
And here's why the trustee is so powerful.
It's right here in the Bankruptcy Code, section 544 A.
We call it the Strong Arm clause, and for good reason.
The law basically says that the moment a bankruptcy petition is
filed, the trustee magically gets the rights of a perfect
hypothetical lien creditor who just levied on every single
piece of the debtor's property. So what does this mean for you,
the secured creditor? The take away for your exam is
brutally, beautifully simple. If your security interest is not
perfected when that bankruptcy petition hits the clerk's desk,
you lose to the trustee. Period.
Your security interest gets wiped out, avoided is the
technical term, and you get knocked down to the level of a
general unsecured creditor, which means you'll be lucky to
see pennies on the dollar. Perfection is your only shield
against the trustee. OK, to wrap this all up, let's
hit on two final, more advanced topics that add a nice layer of
sophistication to your analysis. We're talking about proceeds and
future advances. These are things that happen all
the time in the real world. So think about this.
When a debtor sells a piece of collateral, like a piece of
equipment, does your security interest just vanish into thin
air? No, of course not.
It automatically attaches to whatever the debtor got in
return. We call that proceeds.
And what's more, if you are perfected in the original
collateral, you stay perfected in those proceeds, at least for
a little while. 20 days to be exact.
After that, you might have to take another step to stay
perfected, unless one of the special exceptions like the same
office rule applies. Now for a classic future advance
problem. You see this one all the time.
Bank A files early on day one, then Bank B comes in and
perfects on day 30. Then way later on day sixty,
Bank A makes a second loan to the same debtor.
The question is, for that second loan, does Bank A's priority
date from day 60 or does it get to go all the way back to day
one? And the answer once again shows
you just how powerful that initial filing is.
Bank A wins. The priority for its future
advance relates back to its original day one filing date.
This is the whole point of a notice filing system.
When Bank B came along and did its search on day 30, it saw
Bank A's filing. That put Bank B on notice that
Bank A might make future loans that would also be secured by
that collateral. But, you know, there has to be
an exception. There's always an exception.
A lien creditor can sometimes jump in line and beat a secured
party's future advance, but it's a very specific situation.
It only happens if the secured lender makes the advance more
than 45 days after the lien attached and the lender knew
about the lien when they made the advance.
It's a technical rule, but it's a good one to have in your
toolbox. And that brings us to our final
thought. We've gone through all these
very specific mechanical rules, but they're all built on one big
idea. The UCC filing system is just
that, a notice system. A financing statement doesn't
tell you the whole story. It just tells you that someone
might have a claim. It's a flashing yellow light.
So the question I want to leave you with is, what does that mean
for a real world lender? What does that tell you about
the kind of homework, the kind of diligence you need to do
before you actually put your money on the line?
Think about that. Good luck on your exams.