Part VI Priority

Chapter 27 Secured Party Versus Buyers

A. Generally

Among the transferees who may compete with secured parties are buyers.  We have often seen references to purchasers.  A buyer is a particular kind of purchaser, namely, one who contracts to buy goods or other property.  The most important of such buyers probably is a buyer in ordinary course (BIOC), defined in revised section 1-201(b)(9) to include most buyers of goods from a seller who is in the business of selling such goods.  A BIOC generally takes free of a security interest created by the person from whom the buyer buys the goods even though that security interest has been properly and timely perfected.

The rule for a buyer not in ordinary course and a BIOC of farm products resembles that applicable to lien creditors in that priority generally depends on the timing of perfection of the security interest.

A special priority rule gives consumer buyers from consumer sellers priority over security interests of secured parties who have relied on automatic perfection rather than on filing a financing statement.

Bear in mind that these special priority rules apply only if the secured party did not authorize a sale to be made free of the security interest.  If you do not understand why this is so you should review Chapters 9 (The Specifics of Enforceability -- After-Acquired Property, Future Advances, Transferred Collateral and Proceeds, and the New Debtor Problem) and 16 (Perfecting Security Interests in Proceeds and Other Later Acquired Property).

B. BIOC Disputes

As was true under former section 9-307(1), under new section 9-320(a) a buyer in ordinary course (BIOC), other than a BIOC of farm products from a person engaged in a farming operation, takes free of a security interest created by the buyer's seller even though the security interest is perfected and even if the buyer knows of its existence.

It has generally been assumed that the BIOC rule stems from the historical notion of the market overt and is designed to protect the reasonable expectation of a buyer that the buyer will get good title to goods when buying from a person engaged in the business of selling such goods.  See Law-Glossary.com, available online at http://www.law-glossary.com/definition/market-overt.html, last visited on October 12, 2010.

It has been suggested that the rule is intended to protect a creditor's security interest, see, e.g., Foy v. First National Bank of Elkhart, 868 F.2d 252 (7th Cir. 1989), but it is not clear that this can be so except to the extent that the definition of a BIOC in Article 1, section 1-201(b)(9) circumscribes who may qualify as a BIOC in ways other than buying from a seller engaged in the business of selling such goods.

The person seeking BIOC status, and the priority over a secured party that goes with it, has the burden of proving that the requirements of such status in Article 1, section 1-201(b)(9) (formerly section 1-201(9)) have been met.  See, e.g., Agriliance, L.L.C. v. Runnells Grain Elevator, Inc., 272 F. Supp. 2d 800 (S.D. Iowa 2003); Matter of Gary Aircraft Corp., 681 F.2d 365 (5th Cir.).  The essence of BIOC status is found in the first sentence of Article 1, section 1-201(b)(9), providing as follows:

Buyer in ordinary course of business means a person that buys goods in good faith, without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course of business from a person, other than a pawnbroker, in the business of selling goods of that kind.

As for the requirement that a buyer have taken the goods without knowledge that the sale violates the rights of another, which in the Article 9 setting means violates a security interest held by another, it is important to note that it is not simply knowledge that a security interest exists but rather knowledge that the sale violates that security interest that is necessary to deny a buyer BIOC status.

A buyer is aided in establishing that the buyer is without knowledge that the sale violates another's security interest by the fact that it is actual knowledge, and not simply knowledge of facts that could put the buyer on notice of a violation, that is material.  See Article 1, section 1-202 (formerly Article 1, section 1-201(25)).  It is unlikely that non-consumers and many merchants will actually know the sale violates the rights of the secured party (as distinguished from knowing about a security interest).  However, a buyer who is experienced in the ways of commercial financing may well wish to examine any security agreements executed by its seller.  Cf. Matter of Gary Aircraft Corp., 681 F.2d 365 (5th Cir.) (in which an experienced buyer did in fact examine a security agreement by which the seller created a security interest in the goods sold).

There is authority under former Article 9 indicating that the date of the sale controls as to whether the buyer has knowledge that could prevent the buyer from qualifying as a BIOC and knowledge acquired after that date is not relevant.  Matter of Gary Aircraft Corp., supra.  The language of section 1-201(b)(9) certainly supports such an interpretation and one would not expect decisions under new Article 9 to differ on this point.

The other major requirements for qualifying as a BIOC, namely, taking in good faith and in the ordinary course of business are relatively less straightforward and require fuller explanation.  Courts under former Article 9 were in disagreement about the meaning of these requirements.  See, e.g., Brashers Cascade Auto Auction v. Valley Auto Sales and Leasing, 15 Cal. Rptr. 3d 70 (Cal. App. 2004) (and the cases discussed therein).  The disagreement was largely traceable to the fact that "in ordinary course," as used in what was then Article 1, section 1-201(9) (now Article 1, section 1-201(b)(9)), was not defined in Article 9 or elsewhere in the UCC and good faith was defined in various sections of the UCC in different ways.

Good faith was defined in Article 1, section 1-201(19) (now Article 1, section 1-201(b)(20)) to mean honesty in fact.  Under this definition a person acted in good faith so long as the person did not actually know that something was amiss or did not act with an ulterior motive.  More particularly, a person could be a BIOC, insofar as the requirement of good faith was concerned, even though the facts and circumstances were such as would lead a reasonable person to inquire further and in so doing discover the seller was acting improperly.

Not surprisingly, especially for those courts that believed a buyer should not benefit from blissful ignorance at the expense of a secured party whose security interest would be lost if the buyer qualified as a BIOC, the question was how to impose upon the buyer a degree of responsibility that took greater account of the fact that the ultimate need was to properly allocate the loss resulting from a seller's misdeeds between the buyer and the secured party who were, to a greater or lesser extent, innocent. See, e.g., Brashers Cascade Auto Auction v. Valley Auto Sales and Leasing, 15 Cal. Rptr. 3d 70 (Cal. App. 2004) (and the cases discussed therein); Foy v. First National Bank of Elkhart, 868 F.2d 252 (7th Cir. 1989).

A few courts were able to achieve the desired goal by importing into the Article 9 determination of when a buyer qualified for BIOC status the definition of good faith in Article 2, section 2-103(b)(1) (since replaced), that required a merchant buyer not only to act honestly in fact, but also "in the observance of reasonable commercial standards of fair dealing."  See the review of such cases in Brashers Cascade Auto Auction v. Valley Auto Sales and Leasing, 15 Cal. Rptr. 3d 70 (Cal. App. 2004).  Under this definition, good faith took on an objective dimension that could impose upon a buyer a duty to inquire whenever the facts and circumstances would lead a reasonable buyer to do so.  Id.

Other courts were less inclined to read the Article 2 definition of good faith into Article 9, but were not disposed to allow a buyer to qualify as a BIOC provided only that the buyer acted honestly in fact and bought from a seller engaged in selling goods of the kind that were the subject of the sale.  For these courts it was necessary to find in the "in ordinary course of business" language of the definition of a BIOC the objective element of reasonable behavior they deemed appropriate.  See Brashers Cascade Auto Auction and Foy, supra.

Whatever the means by which a court was able to read the definition of a BIOC to impose an objective standard of reasonable behavior the net result, as are all determinations of reasonableness, was to require an inquiry into the particular facts and circumstances in each case.  A further consequence of the demand for an inquiry into particular facts and circumstances was that the ultimate determination of BIOC status became a question of fact subject to the limited scope of review accorded to fact finders and to the variations in outcomes from case to case that necessarily result from such a process.

This lengthy dissertation on the meaning of BIOC status has focused on the state of affairs under former Article 9 and, therefore, serves only as a prelude to the discussion of BIOC status upon the adoption of new Article 9 and changes made to the definitions governing BIOC status made in conjunction with the adoption of new Article 9.

A major change, one that as will be seen in later chapters impacts matters other than BIOC status, is that made to the definition of good faith itself. Initially in new section 9-102(a)(43) and then in a proposed revision to Article 1, section 1-201(b)(20), the definition of good faith was expanded to include the observance of reasonable commercial standards of fair dealing.

The quoted language imparts to the meaning of good faith, and thence to the definition of a BIOC in Article 1, section 1-201(b)(9), the objective element and concomitant duty of reasonable inquiry that courts struggled to impose under former Article 9.  Cf. Official Comment 20 to Article 1, section 1-201 (tracing the evolution of the definition of good faith).

Unfortunately, insofar as giving meaning to the requirement of good faith is concerned, not all states have adopted the proposed revision of the definition of good faith in Article 1. Several states have retained the more limited, honesty in fact, definition. A review of which states have adopted the expanded definition and which states have retained the narrower definition may be found at: http://www.law.unlv.edu/faculty/rowley/ra1_updates.htm.

To make matters worse, a state retaining the narrower definition in Article 1 may nonetheless have adopted and have retained new section 9-102(a)(43) containing the expanded definition of good faith. Arizona is one such state. In states that have adopted the narrower "honesty in fact" definition of good faith in Article 1 but the broader "honesty in fact" and "the observance of reasonable commercial standards of fair dealing" in Article 9 the question arises as to which definition governs determinations of when a buyer qualifies as a buyer in ordinary course.

Where buyer in ordinary of course status is material in resolving priority disputes according to the Article 9 rules, such as that contained in new section 9-320(a), it would seem that the broader Article 9 definition of good faith controls. However, since buyer in ordinary course is defined in Article 1, section 1-201(b)(9), it might be argued that the narrower definition applies.

To the extent that the proposed change to the definition of good faith is adopted or the expanded definition of good faith contained in new section 9-102(a)(43) is held to control determinations of buyer in ordinary course status, decisions under former Article 9, in which courts required as a condition of qualifying as a BIOC that a buyer behave reasonably under all the circumstances, should inform determinations of BIOC status under new Article 9 and new section 9-320(a).

Two useful examples of such decisions may be found in Brashers Cascade Auto Auction v. Valley Auto Sales and Leasing, 15 Cal. Rptr. 3d 70 (Cal. App. 2004) and Foy v. First National Bank of Elkhart, 868 F.2d 252 (7th Cir. 1989).  In Foy the debtor's inventory of vehicles was financed by a loan from a lender who took a security interest in the vehicles.  The lender retained the certificates of title to the vehicles and would turn over a certificate only when the debtor paid for the vehicle it covered.

The debtor sold several vehicles to another dealer under an arrangement whereby the debtor would repurchase the vehicles from the buyer if the vehicles did not sell within some agreed upon period of time.  The debtor told the buyer that it had the certificates of title for the vehicles and would make them available when a vehicle was resold.  The debtor's explanation for keeping the certificates of titles was that if a vehicle were resold the debtor would need the certificate of title.  The debtor did not pay the loan debt from the sales of the vehicles and never obtained the certificates of title to the vehicles.  When the debtor defaulted a dispute arose as to whether the buyer or the lender had prior claim to the vehicles.

The buyer argued that it had priority because as a BIOC it took free of the lenders security interest.  The trial court held in favor of the buyer, essentially because it believed the buyer's testimony that the buyer that it did not know that the debtor was failing to pay the lender and that there was nothing unusual about the fact that the debtor kept the certificates of title, both as a matter of local practice and because of the repurchase arrangement.

On appeal the trial court's decision was upheld.  In its opinion, the court of appeals, without clearly specifying the source of the requirements, concluded that to be a BIOC a buyer had to have acted honestly in fact and also reasonably under all the circumstances, but whether the buyer satisfied the requirements were questions of fact and the court of appeals was obliged to defer to the trial courts answers to the questions.

The facts and the dispute in the Brashers case were quite similar to those in Foy.  Once again, a debtor who sold vehicles to another dealer for resale failed to pay its lender when the vehicles were sold.  Again, the buyer from the dealer did not receive certificates of title for the vehicles it bought.  The trial court concluded that the buyer qualified as a BIOC who took free of the lenders security interest.  In a very lengthy opinion, the appellate court reversed and remanded.  It did so because the trial court had failed to apply legal standards that required a buyer to act in a commercially reasonable manner as well as honestly in fact.

As in Foy, the source of the commercially reasonable standard was not clearly identified, but the court expressed the belief that a sale, at least one to a merchant buyer, could not be in ordinary course unless the buyer acted in a commercially reasonable manner.  Its belief was based very much on the court's assertion that such BIOC disputes are largely between two relatively innocent parties and that a rule that allocates the loss between the parties by looking to all the facts and circumstances is needed.

The court also was concerned that if a commercially reasonable standard were not imposed, there would be an inconsistency as between the Article 9 analysis of when a buyer qualified as a BIOC and the analysis under Article 2 of when a buyer was a BIOC for purposes of Article 2, section 2-403(2) (protecting a BIOC in an entrustment of goods situation).

Decisions as to BIOC status may also be informed by those made by courts inquiring into the meaning of good faith and notice as conditions on qualifying for holder in due course status and for the special priority given to certain purchasers of chattel paper and instruments under new sections 9-330 and 9-331(a).  See, e.g., Agriliance, L.L.C. v. Runnells Grain Elevator, Inc., 272 F. Supp. 2d 800 (S.D. Iowa 2003).  See generally, Chapter 29 (Secured Party Versus Secured Party (continued)). It should also be noted that decisions under former Article 9, see, e.g., Matter of Gary Aircraft Corp., 681 F.2d 365 (5th Cir. 1982), indicated that the good faith requirement did not impose on a person asserting BIOC status a duty of care and decisions thus far under new Article 9 appear to agree.

A possible expanded definition of good faith, either by virtue of adoption of the proposed revision to the Article 1 definition or adoption of the definition in new section 9-102(a)(43) containing the broader notion of good faith, is not the only change made in connection with adoption of new Article 9 that can affect BIOC status.

Article 1, section 1-201(b)(9) (revising an earlier version of Article 1, section 1-201(b)(9)), purports to define buying in ordinary course.  See Official Comment 9 to Article 1, section 1-201(b)(9) (stating that "the second sentence [of the section] explains what it means to buy in ordinary course"). Thus, section 1-201(b)(9) provides that:

A person buys in the ordinary course if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the sellers own usual or customary practices. (Emphasis added.)

By this language the determination of when a sale is in ordinary course is made with reference to the usual and customary practices of sellers engaged in the same business or by reference to the particular sellers selling practices.

It may be that the requirement of ordinary course does little more than excluding sales that are outside ordinary course in the sense that they are made under terms that depart from the usual terms of sale, such as a fire or liquidation sale and sales that are made to a buyer to whom the seller customarily would not sell. So understood, the ordinary course requirement will be relatively easily satisfied in most cases.

It should be kept in mind that to be a BIOC under Article 1, section 1-201(b)(9), a buyer must buy in good faith and without knowledge that the sale violates a security interest held by another party and in ordinary course. Consequently, it seems that an independent inquiry must be made as to each of the conditions and a buyer could buy in ordinary course but still not qualify as a BIOC because the buyer did not buy in good faith or bought with knowledge that the sale violated the rights of a secured party.

There can be difficulties in applying new section 9-320(a) apart from the determination of whether a particular buyer qualifies as a BIOC.  As indicated above, under new section 9-320(a) a BIOC takes free only of a security interest created by the seller from whom the buyer buys.  There is no ready explanation for this limitation, but it must be kept in mind when applying the section.

Note, however, that a BIOC protected by new section 9-320(a) "takes free" of a security interest created by the buyer's seller. Therefore, a transferee from the BIOC acquires the goods free of that security interest.  This result is traceable to the so-called "shelter principle" found in Article 2, section Article 2, section 2-403(1).  Under that principle, a transferee by purchase of goods acquires all title that the transferee's transferor had or had power to transfer. See Official Comment 9 to former 9-301.

The fact that a transferee from a person who took free of a security interest also takes free of that security interest illustrates an important difference between taking free of a security interest and subordinating a security interest (as provided for in new section 9-317(a) (governing lien creditor disputes)). Additionally, it is possible for a secured party to "acquiesce" as to a particular sale and in so doing "entrust" the goods under Article 2, section 2-403(2).  In such a case a buyer who is a BIOC can take free of a security interest even though the security interest was created by someone other than the seller from whom the BIOC buys.

Although decided under former Article 9, the case of Matter of Gary Aircraft Corp., 681 F.2d  365 (5th Cir.) offers what is perhaps the most complete explanation of the interaction between the buyer's seller limitation in new section 9-320(a) and the shelter principle in Article 2, section 2-403(1).  In Gary Aircraft, a dealer created a security interest in an airplane in favor of a lender who properly perfected its interest in the airplane by recording the interest with the FAA (see Chapter 19 (Perfection Pursuant to Federal Law)).  Then, without the knowledge or consent of the lender, the dealer sold the airplane to a buyer who subsequently sold the airplane to another buyer.

It was held over the lender's objection that the buyer from the dealer met the burden of proof required for it to qualify as a BIOC and that although the second buyer could not take free of the lender's security interest under former section 9-307(1) the second buyer nonetheless was not subject to the lender's security interest because the second buyer took free of that security interest under the shelter principle of Article 2, section 2-403(1).

In the course of its opinion, the court dealt with the troublesome problem of the extent to which the Article 9 priority scheme could be altered by Article 2 provisions.  It explained that the second buyer could not rely on the rule in Article 2, section 2-403(1), that a bona fide purchaser for value from a person who has voidable title gets good title because to do so would negate the buyer's seller limitation in former section 9-307(1), but applying the shelter principle to protect the second buyer served only to give full effect to the taking free rule in former section 9-307(1) and the title acquired by the buyer from the dealer.

Although Gary Aircraft was decided under former Article 9, the court's reasoning in that case readily applies to the new Article 9 priority scheme created by new section 9-320(a) and Article 1, section 1-201(b)(9), and that priority remains subject to the shelter principle in Article 2, section 2-403(1).  This is not to say that courts will always get it right.

Thus, in Leasing One Corp. v. Caterpillar Financial Services Corp., 776 N.E. 2d 408 (Ind. App. 2002), the court properly acknowledged the buyer's seller limitation in new section 9-320(a), but seems not to have applied the shelter principle. That the shelter principle should have protected the subsequent buyer is not entirely clear because rather than a simple buyer from a buyer from a dealer situation, the case involved an assignee of a commercial lease through which a buyer had acquired equipment from a buyer from a dealer.  The assignee of financing contracts situations poses the question of the extent to which a financer of a buyer who takes free of a security interest may stand in the shoes of the buyer as against the holder of that security interest and the answer to that question is unclear.

The facts of Leasing One also raised the question of whether the transaction between the transferor and the transferee of the equipment was a true lease or a lease intended as security.  The court concluded that it was unnecessary to decide the question because in its view the outcome would be the same whether the transaction was a true lease or a lease intended as security. However, to the extent that an outcome turns on the application of new section 9-320(a), the answer to the question does matter because that section applies only if the transaction creates a security interest within the scope of Article 9. See Chapter 4 (Scope of Article 9).

 In Arcadia Financial, Ltd v. Southwest-Tex Leasing Co., Inc., 47 UCC Rep. Serv. 2d 1371 (Tex. App. 2002), the court appears not to have understood that under the UCC, Article 1, section 2-401(1) (see Chapter 4 (Scope of Article 9)), conditioning a transfer of title to goods on payment operates only to create a security interest, and consequently failed to consider the distinct possibility that the buyers of vehicles at retail in that case would qualify as BIOCs and would take free of the security interest of the creditor from whom the dealer obtained the vehicles.

Curiously, the court did discuss Article 1, section 1-201(b)(9) in considering whether an assignee from the dealer of contracts arising from the sale of the vehicles could qualify as a BIOC.  It concluded that the assignee was not a BIOC because it had knowledge that the terms of the agreement between the dealer and the creditor from whom the vehicles had been obtained had been violated.

Insofar as the assignment was considered independently of the sales giving rise to the contracts that were assigned, a shorter, more accurate, explanation would seem to be that only buyers in ordinary course of goods qualify for BIOC status under Article 1, section 1-201(b)(9).  However, there would remain the question suggested above of whether the assignee of the contracts could stand in the shoes of a buyer who takes free of a security interest and knowledge of the assignee regarding a violation of the terms of a security agreement should not be attributed to the buyer so as to deny the buyer BIOC status.

On the other hand, as alluded to in Chapter 17 (Perfection as to Goods Subject to Certificate of Title Legislation), some certificate of title statutes provide that a transfer of a vehicle covered by a title issued under such a statute is not effective unless the certificate of title is transferred and where such a statute applies, unless the statute is expressly subject to Article 9, where a certificate is not transferred there may be no transfer of the vehicle such as would allow a buyer in ordinary course to take free of a security interest under new section 9-320(a).  Cf., Vibbert v. PAR, Inc., 224 S.W.3d 317 (Tex. App. 2006).

As noted above, under new section 9-320(a), a buyer in ordinary course of farm products from a person engaged in a farming operation does not take free of a security interest created by the buyer's seller.   The reason for the farm products exclusion very simply is that agricultural lenders were able to get an exception. Application of the exclusion obviously requires knowing when goods are farm products.  See Chapter 5 (Classification of Collateral).  A BIOC of farm products gets some protection against unperfected security interests in new section 9-317(b), discussed below.

More importantly, Congress stepped in to confer protection of a BIOC of farm products in the Food Security Act (FSA) of 1985, 7 U.S.C. ยง 1631.  Under subsection (d) of the act, except as provided in (e) of this section, and notwithstanding any other provision of Federal, State, or local law, a buyer who in ordinary course of business buys a farm product from a seller engaged in farming operations shall take free of a security interest created by the seller, even though the security interest is perfected; and even though the buyer knows of the existence of the security interest.

Thus, the FSA substitutes a federal law scheme for determining when a BIOC of farm products takes free of a security interest for the Article 9 rule. Subsection (e), to which the general rule of the FSA is subject, provides that if a state's filing system has been certified by the Secretary of Agriculture as meeting the requirements of the FSA, then a secured party who has filed an effective financing statement may give notification, the contents of which are spelled out in the act, to potential buyers of farm products that will prevent the buyers from taking free under subsection (d) of the act.  See, e.g., Agriliance, L.L.C. v. Runnells Grain Elevator, Inc., 272 F. Supp. 2d 800 (S.D. Iowa 2003) (discussing the operation of the FSA).

It must be stressed that the notification scheme of the FSA is applicable only to the extent that the Secretary of Agriculture has certified that a states filing system satisfies the requirements of the act.  In states whose filing systems have not been certified, the rule of subsection (d) of the act applies and BIOCs take free of security interest essentially on an equal footing with BIOCs of other than farm products under new section 9-320(a).  Of course, even in a state whose filing system has been certified and in which the notification scheme is applicable, if a secured party fails to give the required notification then the BIOC takes free of the security interest.

The rule of new section 9-320(a) is subject to an exception found in new section 9-320(e). That section provides:

(e) Subsections (a) and (b) do not affect a security interest in goods in the possession of the secured party under Section 9-313.

The exception in new section 9-320(e) is intended to overrule the decision in Tanbro Fabrics Corp. v. Deering Milliken, Inc., 350 N.E.2d 590 (N.Y. 1976).  In Tanbro, a buyer from a seller had left goods in the possession of a creditor for security.  The court held the buyer to be a BIOC who was entitled to take free of the security interest of the creditor who was in possession.  The second to last sentence of revised section 1-201(b)(9) reinforces the effect of new section 9-320(e) to deny protection under new section 9-320(a) to a buyer where goods are in the possession of a creditor other than the seller for purposes of perfecting a security interest under new section 9-313.

However, the change to section 1-201(b)(9) and the addition of new section 9-320(e) do not appear to alter decisions under former Article 9 holding that a buyer could be a BIOC and could take free of a security interest created by the seller even where the buyer had not taken possession of the goods at the time of the seller's default so long as the buyer had a right to possession as against the seller. 

The Daniel v. Bank of Hayward, 425 N.W.2d 416 (Wis. 1988) case offers a good illustration. The decision warrants careful reading.  You may do so by clicking on the case name.

In Daniel a consumer buyer purchased a new van from a dealer, trading in an older RV and entering into a secured installment sales contract. Before the new van was delivered to the buyer, the dealer defaulted on a debt owed to a bank that had financed the dealer's inventory, including the van sold to the buyer.  The bank took possession of the new van and insisted that the buyer had to pay the amount owed on the van without any credit for the trade in (which had been sold by the dealer) or give up the van.

The Daniel court held that the buyer had become a buyer in ordinary course even though the buyer had not gained possession of the van.  It reasoned that the buyer had a special property interest under Article 2, section 2-501(1) at the time the new van was delivered to the dealer and this interest gave the buyer rights against the dealer sufficient to make the buyer a buyer in ordinary course.  In other words, it is enough that a buyer have a right to possession rather than have taken delivery to allow the buyer to qualify as a BIOC.

The court in Daniel did not follow its earlier decision in Chrysler Corp. v. Adamatic, 208 N.W.2d 97 (1973). In that case, the court denied BIOC treatment to a buyer who had a right to possession against the debtor.  However, in Adamatic  the buyer and the seller both were merchants and the court in Daniel stressed that as between the bank and the consumer buyer the bank was in a better position to protect itself.

A word about the consequences to a buyer who does not qualify for protection under new section 9-320(a) or the Food Security Act (FSA) or the shelter rule is in order.  The most obvious result is that if the buyer does not take free under the new section 9-317(b), discussed below, then the buyer is subject to the security interest. But, what it means to be subject to the security interest needs further discussion.

To begin with, it means that the security interest is enforceable against the buyer -- that the secured party may recover the collateral from the buyer.  See Part VII below. This right to enforce the security interest would extend to any proceeds of the collateral in the possession of the buyer.

But, there may be further consequences.  If, for example, the collateral or its proceeds are no longer in the possession of the buyer, then the secured party may have an action for conversion.  It is uniformly agreed that a security interest involves a right to possession that can be converted.  The specific elements of conversion differ from state to state, especially on the matter of the extent to which the interference with the secured party's right of possession must have been "intentional."  

In Agriliance, L.L.C. v. Runnells Grain Elevator, Inc., 272 F. Supp. 2d 800 (S.D. Iowa 2003), the secured party had brought an action for conversion against a buyer of farm products who had been given the notification required by the FSA.  The court concluded that the actions of the buyer were sufficiently intentional to subject the buyer to damages for conversion unless the buyer was able to establish an affirmative defense.

You may explore the BIOC rules in the next several problems.

Problem 27.1     (interactive)

Tractors & More, Inc., a distributor of farm equipment, sells equipment on credit to Danny Dealer who sells farm equipment at retail.  The sale is in ordinary course and Byron takes in good faith. Tractors & More takes a security interest in the equipment and files a financing statement covering the equipment.  Lucy Lender has a security interest in Tractors & More's inventory of farm equipment that was timely perfected by filing.  Danny Dealer sells a tractor to Byron Buyer on credit.  The sale by Danny to Byron is in ordinary course.  Danny takes an interest in the tractor to secure its unpaid price and files a financing statement covering the tractor.  Byron is aware of the security interest held by Tractors & More but not that of Lucy Lender.  In answering the questions that follow you will find it useful to create a sketch or outline of the various transactions. 

Which security interests does Byron take free of under new section 9-320(a)? If Byron does not take free of Lucy's security interest under new section 9-320(a) does Byron nonetheless take free of Lucy's security interest? If so, why?

Suppose the security agreement between Tractors & More and Lucy Lender required that Tractors & More obtain at least 30% down and Tractors & More sold to Danny Dealer for only 10% down. Would this change in the facts change the outcome under new Article 9? What further change in the facts would be necessary to prevent Danny from taking free of Lucy's security interest?

If Danny knew of the violation of the security agreement between Tractors & More and Lucy, would Byron take free of Lucy's security interest? Would your answer be different if Danny learned about the violation after he acquired the farm equipment?  Who has the burden of proving when Danny learned of the violation?  

If Danny knew of the violation of the security agreement between Tractors & More and Lucy at the time he acquired the farm equipment would Byron nonetheless take free of the security interest of Tractors & More?

Problem 27.2    (interactive)

Assume the original facts of Problem 27.1. Would your analysis and answers be different if the sale to Danny Dealer was not made on terms that are usual or customary in the farm equipment sales industry or with Tractors & Mores usual or customary terms?

Suppose the sale to Danny Dealer had comported with industry practice but the sale to Danny violated the express terms of the agreement between Tractors & More and Lucy Lender. Suppose further that at the time of the sale Danny did not know of the violation, but Danny had knowledge of facts that would have lead a reasonable buyer in Danny's circumstances to inquire further and if Danny had made such an inquiry he would have learned about the violation. Would your analysis and answers be different now?

Problem 27.3    (interactive)

Assume the basic facts of Problem 27.1.  Assume further, however, that Danny Dealer defaulted on its debt to Tractors & More before Byron Buyer had taken possession of the tractor but after the farm equipment had been delivered to Danny Dealer and identified to the contract with Byron. 

Would this change in the facts prevent Byron from taking free of the security interest of Tractors & More under new section 9-320(a)?

Problem 27.4  (interactive)

Assume the facts of Problem 27.1.  Assume further, however, that rather than farm equipment, Tractors & More sells supplies used in farming operations and what Byron Buyer buys from Danny Dealer is fertilizer. Would the farm products exception in new section 9-320(a) prevent Byron from taking free of the security interest of Tractors & More under new section 9-320(a)?

Problem 27.5  (interactive)

Donald Dell grows cotton on his farm in Pinal County, Arizona. Donald's cotton crop is subject to a perfected security interest held by Southwestern Bank.  Donald sells cotton from the crop subject to Southwestern's security interest to Fluffy Cotton Gin, Inc.  Fluffy buys in the ordinary course of Donald's business and on terms authorized by the security agreement creating the security interest held by Southwestern.  

Does Fluffy take free of Southwestern's security interest?

On what does the decision as to whether Fluffy takes free of Southwestern's security interest or not depend?

Suppose (as appears to be the case) that Arizona's filing system has not been certified by the Secretary of Agriculture pursuant to the FSA.  Does Fluffy take free of Southwestern's security interest?

If Fluffy did not take free of Southwestern's security interest could Fluffy be liable for damages for conversion?

C. Other Than BIOC Disputes

Under former section Article 9, a buyer other than a BIOC and a BIOC of farm products could subordinate a security interest to the extent that the buyer gave value and received delivery of the property without knowledge of the security interest and before the security interest was perfected.  New section 9-317(b) provides that a buyer, other than a secured party, who buys tangible chattel paper, documents, goods, instruments, or a security certificate, takes free of a security interest (or an agricultural lien) if the buyer gives value and receives delivery of the collateral without knowledge of the security interest or agricultural lien before it is perfected.

New section 9-317(c) extends the protection given in new section 9-317(b) to lessees that give value and take delivery without knowledge of an unperfected security interest.  New section 9-321(c) protects a lessee in ordinary course against a security interest created by a lessor even if the security interest is perfected and even if the lessee knows of its existence.  New section 9-317(d) protects licensees of general intangibles and buyers, other than secured parties, of accounts, electronic chattel paper, general intangibles and investment property other than a certificated security against unperfected security interests where the licensee or buyer gives value without knowledge of the security interest.  Under new section 9-321(b), a licensee in ordinary course, as defined in new section 9-321(a), takes free of a security interest created by a licensor even if the security interest is perfected and even if the licensee knows of its existence.

Recall from Chapter 26 (Secured Party Versus Lien Creditor) that new section 9-317(e) protects purchase money security interests against intervening lien creditors to the extent that the secured party files a financing statement within twenty days after the debtor gets possession of the collateral.  In an especially important change from former Article 9, new section 9-317(e) extends the special protection provided purchase money parties to all other than buyer in ordinary course situations.

You may explore the other than BIOC rules in the next two problems.

Problem 27.6   (interactive)

Sid Seller sells a stereo to Donna Debtor for use in her office.  Donna pays 10% down and agrees to pay the balance in twelve equal monthly installments.  Sid takes an interest in the stereo to secure its price.   Donna takes delivery of the stereo the same day. The next day, Sid files a financing statement covering the stereo. Two weeks later, without having made a single payment, Donna sells the stereo to Byron Buyer for use in his office and Donna then leaves town. Byron gives value for the stereo and takes delivery of it without knowing of Sid's security interest. A diagram of the transactions will be useful in answering the following questions.

Does Byron take free of Sid's security interest under new section 9-320(a)?

Would Byron take free of Sid's security interest under new section 9-317(b)?

Problem 27.7    (interactive)

Assume the facts of Problem 27.6.  Assume further, however, that Donna Debtor sold the stereo to Byron Buyer one week after delivery of the stereo to Donna and that Sid Seller did not file a financing statement covering the security interest created by Donna until after the sale of the stereo to Byron Buyer. 

Does Byron take free of Sid's security interest?  Be sure to refer to new section 9-317(e) before answering this question. 

Suppose that Sid did not file within 20 days of delivery of the stereo to Donna.  Suppose further that Byron sold the stereo to Betty Buyer who gave value and took delivery of the stereo without knowledge of Sid's security interest after Sid filed a financing statement.  Would Betty be subject to Sid's security interest?

D. Buyers of Consumer Goods from Consumers

As was true under former Article 9, under new Article 9 a secured party who relies on automatic perfection under new section 9-309(1) (see Chapter 18 (Perfection by Doing Nothing -- Automatic Perfection) risks losing out to certain consumer buyers.  Thus, under new section 9-320(b) a consumer buyer who buys from a consumer seller takes free of a security interest perfected automatically (and as to which no filing had been made).  New section 9-320(b) makes clear that there must be both a consumer seller and a consumer buyer.

A typical case for the application of new section 9-320(b) would be that of a person who bought goods for personal use and created a purchase money security interest in the goods and then sold the goods to a neighbor or other such person who bought for personal use.  To assure priority against a consumer buyer in such a case the secured party must file a financing statement before the buyer satisfies the conditions of new section 9-320(b).  Recall that under new section 9-311(b), compliance with a certificate of title law is the equivalent of filing.

As was discussed in subpart B above, under new section 9-320(e), new section 9-320(a)'s protection for a BIOC does not extend to a security interest of a secured party who is in possession and whose security interest is perfected by possession.  New section 9-320(e) operates to limit the effect of new section 9-320(b) as well.

You may explore the new Article 9 rules governing disputes between secured parties and consumers buying from consumer buyers in the next two problems.

Problem 27.8   (interactive)

Sid Seller sells a stereo to Donna Debtor, an architect, for use in her home.  Donna pays 10% down and agrees to pay the balance in twelve equal monthly installments.  Sid takes an interest in the stereo to secure its price.  Donna takes delivery of the stereo the same day.  Two months later, without having made a single payment, Donna sells the stereo to Donald Dealer who deals in used electronic equipment and who plans on reselling the stereo.  Donald gives value for the stereo and takes delivery of it without knowing of Sid's security interest. 

Is Sid's security interest in the stereo perfected? 

Is Donald subject to Sid's security interest?

Problem 27.9    (interactive)

Donald Dealer in Arizona sells to Betty Buyer in Arizona a new cabin cruiser boat and boat trailer that are bought by Betty for personal use. Betty gives Donald security interests in the boat and boat trailer to secure the unpaid prices of the boat and trailer.

Is Donald's security interest in the boat perfected? 

Could a consumer buyer from Betty nonetheless take free Donald's security interest in the boat

What must Donald do to eliminate the risk of a consumer buyer from Betty from taking free of Donald's security interest in the boat? 

What must Donald do to perfect its security interest in the boat trailer and prevent a buyer from Betty from taking free of Donald's security interest under new section 9-317(b? Will this action prevent a consumer buyer from Betty from taking free of Donald's security interest in the boat trailer under new section 9-320(b) even though that section provides that a consumer buyer will take free of a security interest if the buyer takes delivery "before the filing of a financing statement covering the goods" What language of new section 9-311(b) supports your answer?

E. Buyers and Future Advances

Under former Article 9, buyers other than buyers in ordinary course were protected against discretionary future advances made with knowledge of a sale or more than 45 days after a sale.  New section 9-323(d) protects buyers other than buyers in ordinary course against discretionary advances to the same extent.  The rule for buyers differs from that for lien creditors, considered in Chapter 26 (Secured Party Versus Lien Creditor), in that knowledge on the part of a secured party can shorten the 45-day period of protection given secured parties.

New section 9-323(e) excludes from the rule of new section 9-323(d) advances made pursuant to a commitment entered into without knowledge of a sale and before the expiration of the 45-day period.

New sections 9-323(f) and (g) give lessees other than lessees in ordinary course the same protection that is given to buyers other than buyers in ordinary course.

The rules governing disputes between buyers and secured parties regarding future advances are considered in the next two problems.

Problem 27.10    (interactive)

Lisa Lender has a security interest in a drill press owned by Donna Debtor to secure a loan of $5,000.  The security agreement provides that the interest shall secure such future advances as Lisa may choose to make to Donna.   Lisa files a financing statement covering the drill press.  Donna sells the drill press, which is worth $10,000, to Byron Buyer for $10,000.  Thereafter, Lisa lends Donna an additional $5,000.  Donna defaults.  Which of the following accurately states the extent to which Lisa may satisfy the $10,000 in loans to Donna out of the drill press and why?

(a) Lisa may satisfy only $5,000 of the $10,000 in debt because the second $5,000 was not advanced pursuant to a commitment.

(b) Lisa cannot satisfy any of the $10,000 debt out of the drill press because Lisa's security interest in the drill press was not perfected.

(c) Lisa may satisfy $10,000 of the $10,000 debt out of the drill press if the second $5,000 was advanced within 45 days after the sale (even if Lisa had knowledge of the sale).

(d) Lisa may satisfy $10,000 of the $10,000 debt out of the drill press if the second $5,000 was advanced without knowledge of the sale and within 45 days after the sale.

Problem 27.11    (interactive)

Lisa Lender has a perfected security interest in Donald Debtor's inventory, existing and after-acquired.  The security agreement provides that the interest shall secure such future loans as Lisa may choose to make to Donald.  Donald sells an item of inventory to Byron Buyer in the ordinary course of Donald's business and Byron otherwise qualifies as a BIOC under Article 1, section 1-201(b)(9).  Thirty days after the sale to Byron, without knowledge of the sale to Byron, Lisa makes another advance to Donald. 

May Lisa reach the item of inventory to satisfy the later advance?

May Lisa reach the item of inventory to satisfy the original advance?  

Would your answers change if the future advance clause committed Lisa to make the later advance?

CASE COMMENTARY

Ace Equipment Sales, Inc. v. H.O. Penn Machinery Co., Inc., 871 A.2d 402 (Conn. App. 2005)

Ronald V. Odette Family Limited Partnership v. Agco Finance, LLC, 129 P.3d 95 (Kan. App. 2005)

Integrity Bank Plus v. Talking Sales, Inc., 2006 WL 212193 (D. Minn. 2006)

Genesee Regional Bank v. Palumbo, 799 N.Y.S.2d 883 (N.Y. Supreme Court 2005)

In re Jeans, 326 B.R. 722 (Bkcy W.D. Tenn. June 28, 2005)

First National Bank v. Lubbock Feeders, L.P., 183 S.W.3d 875 (Tex. App. 2006)

Vibbert v.PAR, Inc., 224 S.W.3d 317 (Tex. App. March 23, 2006)

Feliciana Bank & Trust v. Manuel & Sessions, L.L.C., 943 So.2d 736 (Miss.App. 2006)

 

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2011-08-22 update