Part IV Creating an Enforceable Article 9 Security Interest
Chapter 11 Enforceability And Attachment Of Security Interests In Consumer Transactions
A. Generally
Secured transactions involving consumers are commercial transactions but they are different in that consumers frequently lack bargaining power and often do not fully understand the nature and consequences of whatever bargain is struck. New Article 9 does somewhat more than former Article 9 to protect consumers. However, many consumer protections are in laws outside Article 9 and these laws can affect the operation of Article 9 rules where the debtor is a consumer. The purpose of this chapter is to explore the limitations on the enforceability of security interests in consumer cases found in Article 9 and in the law outside of Article 9.
B. The Article 9 Consumer Protections
As noted in Chapter 5 (Classification of Collateral), under new section 9-102(a)(23) goods are "consumer goods" if they are used or bought for use primarily for personal, family or household purposes. In Chapter 8 (The Specifics of Enforceability -- A Security Agreement Authenticated by the Debtor or Its Equivalent) we saw that a description of consumer goods by type, i.e., as "consumer goods," was resisted by courts under former Article 9 in the belief that a more detailed description was necessary to compensate for the fact that most consumers had little understanding of secured transactions.
We also saw in Chapter 8 (The Specifics of Enforceability -- A Security Agreement Authenticated by the Debtor or Its Equivalent) that new Article 9 codifies the resistance to the use of a "consumer goods" description in a security agreement by providing in new section 9-108(e)(2) that a description only by type is insufficient as to consumer goods in a consumer goods transaction. A "consumer transaction," as defined in new section 9-102(a)(26), is one in which an individual debtor incurs an obligation for personal, family, or household purposes and the obligation is secured by an interest in collateral that is held or acquired primarily for personal, family or household purposes.
Where the collateral in a consumer transaction constitutes consumer goods the transaction will be a “consumer-goods transaction” as defined in new section 9-102(a)(24). As is made explicit in the definition in new section 9-102(a)(26), a “consumer transaction” includes a “consumer-goods transaction,” but the former is broader in that the collateral need not be consumer goods but rather need only be “held or acquired primarily for personal, family, or household purposes.”
The more inclusive definition applies to new section 9-108(e)(2) which, in addition to barring the use of a description by type as to consumer goods, provides that a description of investment property collateral as "investment property" or a "securities entitlement" or a "securities account" or "commodity account" likewise is insufficient in a consumer transaction.
The next problem gives you the opportunity to explore the limitations found in new section 9-108(e)(2) again.
Problem 11.1 (interactive)
The facts of Problem 8.11, in Chapter 8 (The Specifics of Enforceability -- A Security Agreement Authenticated by the Debtor or Its Equivalent), were as follows: Byron Buyer runs a technology consulting business out of his home. Byron owns a refrigerator, a large screen television and a personal computer. Only the personal computer is used in Byron's business. Byron also has a securities account with Broker, Inc. Byron borrows from Ready Lender to pay some debts arising in connection with the consulting business and Byron gives Ready a security interest in the foregoing items of property.
Would a description such as "consumer goods" or "all the debtor's consumer goods" be sufficient as to the personal computer?
Would a description "consumer goods" or "all the debtor's consumer goods" be sufficient as to the refrigerator and television?
Would a description such as "debtor's securities accounts" be sufficient as to the account with Broker, Inc.?
Would your answers be different if Byron borrowed from Ready Lender to finance a vacation?
In Chapter 9 (The Specifics of Enforceability -- After-Acquired Property, Proceeds and Future Advances) you learned that there is another Article 9 limitation on the enforceability of a security interest where the debtor is a consumer. New section 9-204(b)(1) provides that a security interest does not attach under an after-acquired property clause to consumer goods, as additional security, other than to accessions, unless the debtor acquires rights in the consumer goods within ten days after the secured party has given value.
The "additional security" qualification is necessary to prevent new section 9-204(b)(1) from barring enforcement of a security interest taken by a seller in consumer goods that the seller has contracted to sell but that have not yet been made or acquired by the seller or a security interest of a lender in consumer goods that the debtor has not yet bought.
As explained in Chapter 9 (The Specifics of Enforceability -- After-Acquired Property, Proceeds and Future Advances), accessions, as defined in new section 9-102(a)(1), are goods that are attached or integrated into other goods so as to become part of other goods but not lose their identity, for example, a new engine in an automobile. As will be seen in Part VI there are special priority rules for dealing with accessions.
You may explore the application of new section 9-204(b)(1) in the next problem.
Problem 11.2 (interactive)
Assume the original facts of Problem 11.1. Assume further, however, that the security agreement described the collateral as "consumer goods, existing and hereafter acquired" and also "securities accounts, existing and hereafter acquired." One month after the original loan and security agreement Byron acquired a stereo system for personal use and also opened another personal securities account with See-Trade, an online brokerage firm.
Is Ready Lender's security interest in the stereo system enforceable?
Is Ready's security interest in the new securities account enforceable?
Suppose that at the time Byron acquired the stereo system, Byron also purchased additional memory for his personal computer. Would Ready have an enforceable security interest in the computer memory?
C. Consumer Protections Outside Article 9
Consumer transactions in which after-acquired property security interests are created often involve so-called "series of sales." In these situations the debtor acquires several items on credit from the same seller. Frequently, there will be a general agreement providing that every item purchased becomes collateral for the debt associated with each item previously purchased and each previously-purchased item is collateral for the debt associated with the later-acquired items.
The following example will illustrate. Debtor purchases a refrigerator from Seller and Seller takes a security interest in the refrigerator to secure its unpaid price. Debtor signs a security agreement that provides that Seller will have a security interest in any appliances purchased later by Debtor from Seller to secure the debt owed on the refrigerator and the refrigerator will be security for the debts incurred in the purchase of the later items. A week later Debtor purchases a stove from Seller. The debt owed on the refrigerator will be secured by interests in the refrigerator and the stove and the debt owed on the stove will be secured by interests in the stove and the refrigerator.
Such arrangements are referred to as "cross collateral" security agreements. Cross collateralizing is not uncommon in the business world and there is nothing in Article 9 that directly prevents it. However, where the debtor is a consumer a cross collateral security arrangement may run into difficulty. Depending on the timing of the purchases, new section 9-204(b)(1) limiting the enforceability of security interests in after-acquired consumer goods could apply. But, law outside of article 9 also may limit the enforceability of the security interests without regard to the timing of the purchases.
Many of you will recall from contracts class the well-known case of Williams v. Walker-Thomas Furniture Co, 350 F.2d 445 (D.C. Cir. 1965). You likely will remember in general terms what happened in that case, but the opinion is worth reading again. You may do so by clicking on the case name.
Oversimplifying somewhat, the buyer-debtors in Williams had entered into series of sales agreements that provided for cross collateralizing. After having paid for many or most of the items purchased the debtors defaulted at which point the creditor repossessed every item. The court of appeals concluded that the agreements may have been unenforceable on grounds of unconscionability, especially as provided for in UCC Article 2, section 2-302, and remanded for a determination of whether the cross collateralizing arrangements were unconscionable.
The decision and opinion in Williams generated much debate. Detractors complained that because cross collateral clauses are not expressly barred and implicitly are approved by the provision authorizing after-acquired collateral arrangements (now new section 9-204(a)) and the floating lien concept discussed in Chapter 9 (The Specifics of Enforceability -- After-Acquired Property, Proceeds and Future Advances), such clauses should not be denied effect as being unconscionable. However, these objections overlooked certain important features of the contracts at issue in Williams.
The contracts in Williams consolidated the debts incurred as to each item purchased and provided for single monthly payments on the consolidated debts. Moreover, under the contracts all of the items purchased served as collateral until all of the consolidated debt had been paid. It was these features of the contract that allowed the sellers to repossess every item when the debtors failed to make a monthly payment even though the debtors had paid more than the amount of the debts incurred for some or even most of the items.
A way to avoid unconscionability challenges in series of sales contracts is to provide that each monthly payment will be applied to the debt created by each item purchased in the order of purchase and when enough had been paid to satisfy the debt associated with a particular item the security interest in that item will be released. This type of payment and release arrangement is conveniently referred to as first-in-first-out (FIFO) secured financing.
You may explore the application of unconscionability doctrine in the next problem. The problem also illustrates the possible overlap of unconscionability doctrine with the Article 9 limitations examined in subpart B.
Problem 11.3 (interactive)
Betty Buyer has entered into a contract with Sid Seller under which Sid agrees to sell furnishings and appliances "on time" and Betty signs an agreement under which each item becomes security for each item later-purchased and each later-purchased item becomes security for each earlier purchased item (i.e., there is cross collateralizing of all the items purchased). In the description of the collateral section of the agreement "consumer goods" appears. The security agreement further provides that all the debt arising from the secured sales shall be consolidated and paid in equal monthly installments. The security agreement finally provides that in the event of a default at any time before the entire debt owing is paid Sid may retake all the items purchased. Betty then makes several purchases of personal use goods from Sid. Buyer first purchases a large screen television. A week later Betty purchases a stereo system. A month later Betty purchases a dishwasher and a refrigerator.
Is the description of the collateral sufficient to support enforceability and attachment of the security interests in the television, stereo system, dishwasher and refrigerator?
Suppose the agreement describes the collateral as "an Hitachi television, serial number xyz123," and a specific description of each later-purchased item is added to the basic agreement at the time each item is purchased. As to which items is there still an enforceability difficulty under Article 9?
If all of the later-purchased items were purchased within ten days of the purchase of the television, would there be an enforceability problem under Article 9.
If all of the later-purchased items were purchased within ten days of the purchase of the television, would there be an enforceability problem under the law outside Article 9?
How might the contracts be revised to avoid whatever objections to enforceability you have identified?
Cross-collateralizing and other "blanket" security arrangements have been the target of special statutes outside Article 9. These laws were inspired by a common belief that, in the consumer setting, blanket security arrangements can be especially oppressive because the goods often are worth much more to the debtor than they are to the creditor and the result is to give creditors undue "leverage." ARS § 44-5501 is such a law. ARS § 44-5501(C) provides:
C. Neither the seller of consumer goods or services nor his assignee may take any other security for a consumer credit sale other than (1) a security interest in goods sold or as to which services have been rendered and (2) in the realty to which such goods may be affixed. If the seller or assignee elects not to retake the goods, but brings an action for the unpaid balance, the goods may not thereafter be retaken and are not subject to judicial process to enforce any judgment obtained therein.
ARS § 44-5501 is limited to consumer credit sales of goods and services. "Consumer credit sale" is not defined, but is generally understood to refer to personal, family and household credit. Under subsection (C) only security interests in goods that are the subject of a sale or as to which services have been rendered are enforceable. For reasons that are not apparent the limitation applies only to sellers and assignees and not lenders.
We will come back to subsection (B) of ARS § 44-5501 in connection with foreclosure, but here you should be aware that it applies only to transactions where the sales prices is $1,000 or less. The question has been raised whether the dollar limit also applies to subsection (C). The argument that the dollar ceiling does apply is that ARS § 44-5501 is aimed at "low ticket" sales where the goods have relatively little resale value.
Another limitation on blanket security arrangements in the consumer setting is found in the Federal Trade Commission (FTC) Fair Credit Practices Rule in 16 CFR Part 444.2. This rule makes taking a non-purchase money security interest in household goods an unfair trade practice. The difference between purchase and non-purchase money security interests is explored at length in Chapter 18 (Perfection by Doing Nothing -- Automatic Perfection). As used in the FTC rule, "other than a purchase money security interest" essentially means that the credit did not enable the debtor to acquire the household goods involved. "Household goods" is defined in 16 CFR Part 444.1(i) to include clothing, furniture, appliances and personal effects, but to exclude electronic equipment other than one television and one radio.
Security arrangements that violate the rule technically are unfair trade practices that require action by the FTC, but the practical effect of the rule is to make the proscribed security interests unenforceable.
You may test your understanding of ARS § 44-5501(C) and the Fair Credit Practices Rule in the next two problems.
Problem 11.4 (interactive)
Betty Buyer purchases an Amana refrigerator on credit from Sid Seller for $600. The refrigerator is bought for use in Betty's home. Betty signs a security agreement that gives Sid an interest in the Amana refrigerator to secure its unpaid price. The collateral is described as "one Amana refrigerator, serial number 125689, and a Maytag washer, serial number xx9210, and a Technics stereo, serial number xyz123." At the time Betty signs the security agreement, Betty already owns the Maytag washer and Technics stereo.
Are Sid's interests in the Maytag washer and Technics stereo enforceable under ARS § 44-5501?
Problem 11.5 (interactive)
Assume the facts of Problem 11.4. Assume further, however, that Betty Buyer paid Sid Seller for the Amana refrigerator with cash borrowed from Friendly Finance Company and the security agreement described in Problem 11.4 named Friendly Finance Company as the secured party.
Does ARS § 44-5501(C) bar enforcement by Friendly Finance Company of the security interests in the Maytag washer and Technics stereo?
Would Friendly Finance Company be in trouble under the Fair Credit Practices Rule as to the Maytag Washer? In answering this question be sure to check the definitions of terms used in the rule.
Would Friendly Finance Company be in trouble under the Fair Credit Practices Rule as to the Technics stereo? Again, be sure to check the definitions of terms used in the rule.
The application of ARS § 44-5501 to a series of sales agreement such as that in Problem 11.3 is clouded by the fact that ARS § 44-5501(C) provides that a seller of consumer goods may not take a security interest in other than goods sold and all the goods in Problem 11.3 were sold by the seller. The Fair Credit Practices Rule more clearly applies to the security interests in the dishwasher and refrigerator to secure the debt incurred to buy the television because these security interests seem not to have enabled the debtor to acquire rights in the television within the meaning of the FTC rule.
There also is a bankruptcy provision, BRA § 522(f)(1)(B), under which certain non-purchase money, non-possessory interests may be avoided. That complicated provision is best treated in Chapter 30 (Secured Party Versus Trustee in Bankruptcy), but it is worth noting here that the FIFO approach to consolidated debt financing referred to above is a way to preserve the purchase money status of a security interest and reduce the likelihood that a BRA § 522(f) attack will be successful.
It also should be noted that new section 9-103(f) purports to preserve the purchase money status of security interests in cross-collateral arrangements, but that section does not apply in consumer goods transaction (separately defined in new section 9-102(a)(24)). As to the intended operation of new section 9-103(f) in non-consumer-goods transactions, see Official Comment 7 to new section 9-103.