Chapter 5 Classification Of Collateral

Part III Scope of Article 9, Classification of Collateral and Choice of Law

Chapter 5 Classification Of Collateral

A. Generally

The way collateral is classified impacts essentially every aspect of Article 9 from creation and perfection to priority and foreclosure. Proper classification of collateral is especially important in deciding how to describe property in security agreements and financing statements, matters considered in detail in Chapters 8-11 and 12-14.

Grappling with classification offers an early opportunity to engage in the statutory interpretation activity that is central to Article 9 law and practice and drives home the critical importance of definitions in working with statutory law. Working through the definitions can be tedious, but doing so provides an essential foundation for dealing with such important matters as adequately describing collateral, as discussed in Chapter 8 (The Specifics of Enforceability -- A Security Agreement Authenticated by the Debtor or Its Legal Equivalent) and perfection and priority, as considered in Parts V and VI.

It is useful to separate property that may serve as collateral under Article 9 into essentially three major categories. The first is "tangibles," including especially goods. The second category consists of "pure intangibles," including choses in action, ranging from rights to payment or performance to claims to special protection or privilege. The third category is "quasi goods," made up of intangibles that have taken on a certain tangible or goods-like quality because of the merger of some right or claim into a document or record, with the paradigm being a negotiable instrument.

You should be alert to the way that pledgeability -- or the lack thereof -- distinguishes property in the first and third categories from that in the second. Thus, collateral such as goods and negotiable instruments can be possessed or pledged, but pure intangibles cannot.

The next problem introduces the Article 9 classification scheme.

Problem 5.1 (interactive)

To secure a loan, Ready Lender is about to take an interest in Danielle Debtor's accounts receivables (unsecured rights to payment for goods or services sold on credit), a drill press used in Danielle's business and a negotiable promissory note payable to Danielle. Without consulting the code, into which of the three general categories of classification (goods, quasi goods and pure intangibles) would you put the following collateral?

(a) A Negotiable Promissory Note

(b) Accounts Receivables

Which of the foregoing items of collateral can be pledged?

B. Goods

1. Generally

As was true under former Article 9 "goods" are defined, in new section 9-102(a)(44), to mean all things that are movable when a security interest attaches, including fixtures, standing timber that is to be cut and removed under a conveyance or contract for sale, the unborn young of animals, crops grown, growing, or to be grown, even if the crops are produced on trees, vines, or bushes, and manufactured homes.

An important addition to the definition of goods made by new Article 9 is that under new section 9-102(a)(44) a computer program constitutes goods if the program is integrated with a computer in such a manner that it customarily is considered part of the goods or if by becoming the owner of the computer a person acquires a right to use the program in connection with the computer. The definition of goods in new section 9-102(a)(44) explicitly excludes pure intangibles and quasi goods and minerals before extraction (which do not qualify as "as-extracted collateral" under new section 9-102(a)(6)).

The next two problems will allow you to test your general understanding of the definition of goods.

Problem 5.2 (interactive)

Ready Lender is about to take a mortgage on land owned by Donald Debtor. On the land is a stand of virgin oak trees.

Which of the following statements is true:

(a) The land constitutes goods but the stand of virgin oak trees does not constitute goods.

(b) The land does not constitute not goods but the stand of virgin oak trees constitutes goods.

(d) Both the land and the stand of virgin oak trees constitutes goods.

Suppose that there is an outstanding contract of sale under which the oak trees are to be cut and removed. Are the oak trees now goods? What language of new section 9-102(a)(44) supports your conclusion?

Problem 5.3 (interactive)

Computer Depot sells a large computer system to Byron Buyer on credit. A Microsoft XP operating system is installed on the computer and under the contract of sale Byron is licensed to use the operating system on the computer.

Should the operating system be classified as "goods"? What language of new section 9-102(a)(44) supports your answer.

Former Article 9 subdivided goods into "consumer goods, "equipment," "farm products " and "inventory." New Article 9 adopts the same breakdown in new section 9-102, the general definitional section. Although the intent could be stated more clearly, the classifications are intended to be mutually exclusive. See Official Comment 4(a) to new section 9-102.

As will be seen later, an item of property can be collateral for more than one security interest (i.e., more than one party may have an interest in the same property to secure a debt). When this happens the same item of property may be classified differently for one security interest than it is for the other. For example, what constitutes consumer goods as between a seller and a buyer may be inventory as between the seller and the seller's lender.

Circumstances affecting the classification of collateral (such as the use to which it is put) may change during the time that property serves as collateral. However, as between any particular creditor and debtor, what the property is as to this debtor determines how the property should be classified and the classification is fixed at the time the security interest attaches as to this debtor.

To illustrate, if property is properly classified as consumer goods when the security interest of one creditor attaches but circumstances change so that the property is properly classified as equipment at the time the same debtor creates a security interest in the property in favor of another creditor, then the property continues to be consumer goods as between the debtor and the first creditor.

2. Consumer Goods

Under former section 9-109(1), goods were "consumer goods" if they were used or bought for use primarily for personal, family or household purposes. New section 9-102(a)(23) adopts this definition by providing that "consumer goods" means goods that are used or bought for use primarily for personal, family, or household purposes. Former Article 9, section 9-109(1), required that particular goods to be consumer goods had to be used or bought for use primarily for personal, family or household purposes. New section 9-102(a)(23) is to the same effect.

The next two problems allow you to explore the new Article 9 definition of "consumer goods."

Problem 5.4 (interactive)

Six Star Electronics, an appliance retailer, sells Byron Buyer a television on credit and takes an interest in the television to secure its unpaid price. Byron buys the television for the personal viewing pleasure of Byron and his family.

Does the television constitute consumer goods as between Six Star and Byron?

Suppose that one month after buying the television, Byron takes the television to his office and places it in the waiting room of his office for the enjoyment of clients.

Does the television continue to be consumer goods (given that the television is no longer used for personal, family or household purposes) as between Six Star and Byron?

Is the television consumer goods as between Byron and a subsequent creditor, Ready Lender, who is contemplating taking an interest in the television to secure a loan to Byron?

Problem 5.5 (interactive)

Danielle Debtor offers as collateral a computer that Danielle uses for personal electronic mail and to play various computer games. Danielle also uses the computer extensively in a consulting business that Danielle runs out of her home.

Does the computer constitute consumer goods?

In Chapter 27 (Secured Party Versus Buyers) we will learn that Second Bank's security interest likely does not continue in the television sold to Byron but this happens because of a special priority rule and the classification analysis is not affected. Here we are focusing on the meaning of inventory.

Consider the next two problems.

Problem 5.9 (interactive)

Sid Seller is a retailer who both sells and leases automobiles to businesses and to consumers.

Are all of the automobiles inventory in Sids hands. What of an automobile leased to Lisa Lessee? Is that automobile inventory irrespective of the use made of it by Lisa?

Suppose Betty Buyer bought an automobile from Sid for personal use and then Betty put the automobile up for sale. If Betty seeks to borrow from Friendly Finance Company and offers the automobile as collateral should Friendly treat the automobile as consumer goods or inventory?

Problem 5.10 (interactive)

On the facts of Problem 5.6, Donald Debtor sold pigs it fattened on its feedlot to wholesalers.

Do you wish to reconsider the earlier conclusion that the pigs were farm products in Donalds hands?

Hint: Read the definition of inventory in new section 9-102(a)(48) carefully.

What language of new section 9-102(a)(48) supports the conclusion that goods cannot be inventory and farm products at the same time?

The new Article 9 definition of inventory in new section 9-102(a)(48) specifies that "raw materials, work in process, or materials used or consumed in a business" are inventory. Such language also appeared in former section 9-109(4). Former section 9-109(4) further provided that "inventory of a person is not to be classified as equipment."

Under former Article 9, courts grappled with the question of whether materials used or consumed in a manufacturing operation but not technically themselves held for sale or lease should be classified as equipment or as inventory. Official Comment 3 to former section 9-109 asserted that the answer depended on how long the goods were held before being used or consumed. The question for us is whether the new Article scheme gives courts any greater guidance. At this point we should turn to the definition of "equipment. "

5. Equipment

Former section 9-109(2) defined equipment essentially as goods used or bought for use primarily in the debtor's business. In doing so it employed a use test much like that for consumer goods. The use test led to the question referred to above of whether certain goods used in a manufacturing operation are properly classified as equipment or inventory.

New section 9-102(a)(33) provides very simply that "equipment" means goods other than inventory, farm products, or consumer goods. The use test is gone. In its place is the proposition that whatever does not fit into any of the other three classifications of goods is equipment. Note that the definition does not directly answer the question whether certain goods used in a manufacturing operation are properly classified as equipment or inventory. Official Comment 4(a) to new section 9-102 tracks the comment to former section 9-109 referred to above by asserting that how long goods are held is what distinguishes equipment from inventory.

The new Article 9 definition of "equipment" is explored in the next two problems.

Problem 5.11 (interactive)

ABC, Inc. manufactures and sells newspaper printers.

How should the printers be classified?

The manufacturing process employs several computerized presses. Are these presses equipment or inventory?

Large amounts of lubricant are used in the manufacturing operation. Is the lubricant inventory or equipment?

What of metal used in the newspaper printers? Should the metal be classified as equipment or inventory?

Problem 5.12 (interactive)

Assume the facts of Problem 5.9 (Sid Seller is a retailer of automobiles who sells and leases automobiles to businesses and to consumers).

Should an automobile that Sid uses as a "demo" but intends to sell or lease be classified as equipment or inventory?

6. Fixtures

As noted in Chapter 4 (Scope of Article 9), transfers of interests in real property to secure debts are outside the scope of Article 9. However, goods can become affixed to real property in such a way as to give parties who have or acquire interests in the real property an interest in the goods. Such goods are "fixtures." Thus, under former section 9-313(1)(a) goods that had become so related to particular real property that an interest in them arose under real property law were fixtures. New section 9-102(a)(41) is to the same effect.

Note that new section 9-102(a)(41) does not really define fixtures. Rather it sends you to local real estate law to learn when goods have become so related to particular real property that an interest in them arises under real estate law. We will have much more to say about fixtures in Chapter 20 (Perfection as to Fixtures and Other Real Estate-Related Collateral).

You can get the basic idea of when goods are or are not fixtures in the next problem.

Problem 5.13 (interactive)

You are about to buy a house. The house has a nice swimming pool that is heated with a solar heating system that is welded to the roof of the house.

Would you expect to acquire the solar heating system under the contract providing for the sale of the house?

Suppose that the person who installed the solar heating system sold the system on credit and took an interest in the system to secure its price.

Does the seller of the solar heating system have an interest in the system as goods? As fixtures?

New Article 9 includes in the definition of goods "as-extracted collateral," as defined in new section 9-102(a)(6). The sometimes complex issues associated with such collateral are best deferred to Chapter 20 (Perfection as to Fixtures and Other Real Estate-Related Collateral).

C. Quasi Goods

The description quasi goods is intended to capture the idea that an intangible can be merged into a document or record so that parties who deal with the right or claim do so by dealing with the document or record. In the case of a simple contract, there may or may not be a paper in which the rights under the contract are embodied. Any writing that does exist is only evidence that a contract was entered into. The rights under the contract can be transferred by an assignment that does not require transfer of any writing evidencing the contract.

By contrast, the rights associated with certain intangibles may have merged with the paper evidencing the rights. The classic example is a negotiable instrument, such as a check or a negotiable promissory note. Under the "merger doctrine," developed in negotiable instruments law, a negotiable instrument is a promise to pay in a certain form that is merged so completely into a piece of paper that the piece of paper comes to embody the promise. Transferring the piece of paper is necessary to transfer the promise to pay.

Negotiability adds the important consequence that a transferee of the instrument can acquire greater rights than were enjoyed by the transferor. This happens pursuant to the "holder in due course" doctrine. But, there can be merger even where an instrument is not negotiable. And, there can be what amounts to merger as to intangibles other than instruments, such as documents of title and tangible chattel paper.

The challenge is deciding when merger has occurred. If parties treat a right or claim as being so embodied in a document that they insist upon a delivery of the document when dealing with the right or claim then merger has occurred and the document takes on a goods like quality (i.e., is "quasi goods").

As will be explained more fully in Part V, the principal reason it matters whether property constitutes quasi goods or is simply a pure intangible is that the choice between the two impacts whether a security interest in the property can be perfected by possession. Thus, for example, a security interest in a negotiable instrument may be perfected by possession but pure intangibles are not possessable and hence a security interest in them cannot be perfected by possession. Some examples of more commonly encountered quasi goods are considered below.

1. Instrument

New section 9-102(a)(47) defines "instrument" to mean "a negotiable instrument or any other writing that evidences a right to the payment of a monetary obligation, is not itself a security agreement or lease, and is of a type that in ordinary course of business is transferred by delivery with any necessary indorsement or assignment." Thus, as was true under former section 9-105(1)(i), instruments are quasi goods.

As seen in Chapter 4 (Scope of Article 9), new Article 9 encompasses interests in electronic records and documents as well as those that are in writing. However, to be an instrument there must be a writing. Moreover, the writing cannot itself be a security agreement. Not surprisingly, the definition includes negotiable instruments. Checks, promissory notes and certificates of deposit generally, although not always, are negotiable under Article 3 and are instruments under Article 9. Investment property, letters of credit rights, and writings arising out of the use of a credit or charge card are not instruments under new section 9-102(a)(47).

A useful discussion of the meaning of "instrument" under former Article 9 appears in the In re Latin Investment Corp. case. To visit the opinion, click on the name.

Latin Investment was decided under former Article 9. You may consider the continuing viability of the decision and opinion under new Article 9 in the next problem.

Problem 5.14 (interactive)

Danielle Debtor owns a certificate of deposit issued by Second Bank. The particular CD is in writing and bears a conspicuous legend that it is "Non-Negotiable."

Would the CD be an instrument under former Article 9 as applied in Latin Investment?

If a CD bore a legend "non-transferable" as well as "non-negotiable," would the CD more clearly not have been an instrument under former Article 9 as applied in the Latin Investment case?

What language of new section 9-102(a)(47) suggests Latin Investment would be decided the same way under new Article 9 as it was under former Article 9?

The actual holding in Latin Investment was that whether the particular item was an instrument or not could not be decided on a motion for summary judgment. In McFarland v. Brier, 850 A.2d 965 (R.I. 2004), the court agreed that a writing labeled non-negotiable and non-transferable could be an instrument and that the controlling question was whether the writing was of a type transferred by delivery. But, it went on to determine that the question of whether a writing was of a type transferred by delivery was a question of law for the court.

The court in Latin Investment touched on the question of how a CD that is not an instrument should be classified. We will consider that question further below.

2. Investment Property

As seen above, investment property is excluded from the definition of "instrument." Security interests in investment property pose complicated questions, many of which are attributable to how such property is held and traded today. The subject is best deferred to Chapter 21 (Perfection as to Investment Property).

3. Tangible Chattel Paper

Historically, goods have sometimes been referred to as chattels. Under former Article 9 "chattel paper" was paper that was goods-like and under former section 9-105(1)(b) meant essentially a writing or writings that evidenced both a monetary obligation and a security interest. The classic example of chattel paper historically has been a conditional sales contract, for example, a contract under which a vehicle is sold on installment credit that is secured by an interest in the vehicle.

New Article 9 defines chattel paper essentially as property evidencing a monetary obligation that is itself secured. The complete definition is in new section 9-102(a)(11). Note the definition omits the reference to a writing or writings and refers rather to a record or records. The definition of a "record" in new section 9-102(a)(69) includes both tangible mediums and "an electronic or other medium [that is] retrievable in perceivable form."

What this means is that under new Article 9 chattel paper can be intangible as well as tangible. As discussed below, Article 9 separately defines electronic chattel paper. However, only tangible chattel paper, as defined in new section 9-102(a)(78), constitutes quasi goods that may be possessed or pledged.

A final, non-obvious, but important point about chattel paper is that under the last sentence of the definition in new section 9-102(a)(11) if a transaction is evidenced by a records that qualify as chattel paper or lease and by an instrument or series of instruments, then the items together constitute chattel paper.

Under the specific language of the last sentence of new section 9-102(a)(11) ("If a transaction is evidenced by records that include an instrument or series of instruments, the group of records taken together constitutes chattel paper.") a transaction could consist of both electronic chattel paper, as discussed below, and an instrument (which must be in writing) and the electronic chattel paper and instrument would together constitute chattel paper but, presumably, not tangible chattel paper and, therefore, not quasi goods.

You may test your understanding of chattel paper in the next problem.

Problem 5.15 (interactive)

Sid Seller sells a vehicle to Byron Buyer. Byron signs a promissory note in which Byron agrees to pay the unpaid price of the vehicle in 24 equal monthly installments. In the sales contract Byron repeats the promise to pay over time and gives to Sid an interest in the vehicle to secure the promise to pay. Which of the following statements are true (more than one may be true)?

(a) The promissory note is tangible chattel paper.

(b) The sales contract creating an interest in the vehicle to secure the unpaid sales price of the vehicle is tangible chattel paper.

(c) The sales contract creating an interest in the vehicle to secure the unpaid sales price of the vehicle and the promissory note together constitute tangible chattel paper.

4. Documents of Title

Security interests often are taken in warehouse receipts and bills of lading. A warehouse receipt is a document of title issued by a warehouse that is both a receipt evidencing a bailment of goods and a contract in which the terms of the bailment are spelled out. A bill of lading is a document of title issued by a carrier and it also is both a receipt and a contract. Documents of title are referred to in both former and new Article 9 simply as "documents."

Documents of title are the subject of a separate UCC article, Article 7. They may be negotiable or non-negotiable in form. Only negotiable documents of title are quasi goods security interests in which can be perfected by possession. Security interests in documents of title are treated in Chapter 15 (Perfection by Possession (Including Documents of Title)).

D. Pure Intangibles

1. Generally

Pure intangibles are neither goods nor goods-like. Stated differently, the defining characteristic of a pure intangible is that in law it cannot be possessed or pledged. This means that a security interest in such property cannot be perfected by possession.

Former Article 9 divided pure intangibles into accounts and general intangibles. Under former section 9-106, an "account" meant any right to payment for goods sold or leased or for services rendered which was not evidenced by an instrument or chattel paper, whether or not it had been earned by performance. Any personal property (including things in action) other than goods, accounts, chattel paper, documents, instruments, investment property, rights to proceeds of written letters of credit, and money was a "general intangible." New Article 9 significantly alters this scheme.

2. Accounts

"Account " is defined in new section 9-102(a)(2). A significant change from former section 9-106 is that the new definition expands the meaning of account to include a right to payment of a monetary obligation resulting other than from a sale of goods or services. Consequently, many things that likely were general intangibles under former Article 9 -- including especially license fees, credit card charges and lottery winnings -- are accounts under new Article 9.

However, the most common account continues to be an account receivable, i.e., an unsecured right to payment for the sale of goods or services. As with former section 9-106, under new section 9-102(a)(2) a right to payment is an account whether or not it has been earned by performance (that is the debtor's performance may still be executory).

The definition of account also includes a "health-care-insurance receivable." Under the new definition, chattel paper, instruments, commercial tort claims, investment paper, letter of credit rights, and rights to payment for money or funds advanced or sold, other than rights arising out of the use of credit or charge cards, are not accounts.

3. General intangibles

"General intangible" is defined in new section 9-102(a)(42). Under the definition, "general intangible" includes things (choses) in action other than accounts. As was true under former section 9-106, what is an account cannot be a general intangible, but because the definition of account in new section 9-102(a)(2) has been expanded beyond rights to payment for sales of goods or services greater care must be used in deciding whether or not a particular pure intangible is a general intangible (and in describing the collateral in a security agreement or financing statement).

Instruments, chattel paper, commercial tort claims, deposit accounts, documents, investment property, letter of credit rights, money and minerals to be extracted are not general intangibles. Thus, under new Article 9, as was true under former Article 9, general intangibles is largely a "residual" category. See Official Comment 5d to new 9-102.

It should be noted that the definition of "general intangibles" in new 9-102(a)(42) expressly includes "payment intangibles" and "software." The former is defined in new section 9-102(a)(61) as a general intangible as to which the principal obligation is a monetary obligation. Consequently, property that does not meet the definition of other separately defined property can be a general intangible even though a payment obligation is involved. Where there is no payment obligation involved then a pure intangible most likely falls into the general intangibles category. Various forms of intellectual property, such as copyrights, are general intangibles. See Official Comment 5d to new 9-102.

The question in the case of In re E-Z Serve Convenience Stores, Inc., 299 B.R. 126 (Bkcy MDNC 2003), affirmed, 318 B.R. 637 (M.D. NC 2004), was how to classify a debtors right to the unpaid and unearned portion of a security retainer (a retainer given to secure the payment of future services any unearned portion of which was to be returned to the debtor) provided to a law firm in connection with a Chapter 11 bankruptcy and deposited by the law firm in a trust account. The court concluded that the debtors interest should be classified as a general intangible and, as such, was subject to a properly perfected security interest created in a security agreement that covered "general intangibles."

In reaching its conclusion the court invoked the proposition that general intangibles is a residual category and the particular interest was a general intangible because it was not money or a deposit account. According to the court, the debtors interest was not money because it did not fall within the definition of money in Article 1, section 1-201(b)(24) providing that money means a medium of exchange currently authorized or adopted by a domestic or foreign government and rather was a right to payment of money. The court reasoned that although the trust account might have been a deposit account as to the law firm it was not a deposit account as to the debtor because it was not a demand, time savings, passbook, or similar account maintained with a bank as required by new section 9-102(a)(29).

The court might have added that the debtor's interest was not an account under the expanded definition of account in new section 9-102(a)(2), discussed above, because as noted in that discussion, the definition expressly excludes "rights to payment for money or funds advanced or sold, other than rights arising out of the use of a credit or charge . . . card." The debtors interest would to seem meet the definition of a payment intangible, as defined in new section 9-102(a)(61) but, as explained above, a payment intangible is a general intangible and would be covered by a security agreement describing the collateral as "general intangibles."

It should be noted that the security agreement at issue in the case was executed prior to the effective date of new Article 9 and, therefore, it could be argued that the meaning of general intangible as used in that security agreement should be determined by reference to the definition of general intangibles in former Article 9, section 9-106. But, even if that argument succeeded, it would not affect the courts analysis because the debtors interest would be a general intangible under former Article 9 as well.

The court in E-Z Serve Convenience Stores also decided that the debtors rights as to the unearned retainer arose before and not after the debtor filed bankruptcy. As will be explained in Chapter 9 (The Specifics of Enforceability After-acquired Collateral, Future Advances, Transferred Collateral and Proceeds, and the New Debtor Problem), had it rather concluded that the rights arose after the bankruptcy petition was filed the secured partys security interest in the unearned retainer would not have been enforceable under BRA § 552 unless the unearned retainer constituted proceeds of original collateral.

A cause of action for breach of contract is a general intangible, even if the breach results from the negligence of the breaching party, so long as the negligence relates to performance of the contract. In re Wiersma, 283 B.R. 294 (Bkcy D. Idaho 2002).

If the cause of action is for negligence, or some other tort, not arising out of a contract, then it would be a tort claim and it must be determined whether it is a commercial tort claim or not because under new section 9-109(d)(12) security interests in commercial tort claims as original collateral are covered by new Article 9 while security interests in other tort claims are covered only as proceeds. See Chapter 4 (Scope of Article 9). Moreover, a commercial tort claim is defined separately in new section 9-102(a)(13) and is excluded from the definition of a general intangible under new section 9-102(a)(42) and would not be covered by a security agreement describing the collateral as general intangibles. See Wiersma, supra.

After having determined that a breach of contract claim was a general intangible and not a commercial tort claim, the court in Wiersma, supra, goes on to conclude that even if its analysis of the matter does not hold up the cause of action is a thing in action and for that reason is a general intangible. This conclusion is questionable because the category of general intangibles is residual and if a thing in action falls within a specific category, here a commercial tort claim, then it is not properly classified as a general intangible. See new 9-102(a)(42) (excluding, inter alia, from the definition of general intangible accounts, commercial tort claims, and deposit accounts).

Apparently in an effort to cover all the bases, the court also concludes that the cause of action is proceeds of the debtors cows and milk that were expressly covered by the security agreement. Discussion of this conclusion is best left to Chapter 9 (The Specifics of Enforceability After-acquired Collateral, Future Advances, Transferred Collateral and Proceeds, and the New Debtor Problem).

"Software" is a general intangible as defined in new section 9-102(a)(42) but is separately defined in new section 9-102(a)(75). The definition of software excludes a computer program that meets the definition of goods in new section 9-102(a)(44), as discussed earlier.

As is clear from the discussion of Wiersma, supra, commercial tort claims are not general intangibles. The definition of general intangible in new section 9-102(a)(42) also excludes such important collateral as deposit accounts and instruments. These and other exclusions affect the important questions of how collateral must be described in a security agreement or financings statement, matters that are dealt with in Chapter 8 (The Specifics of Enforceability After-acquired Collateral, Future Advances, Transferred Collateral and Proceeds, and the New Debtor Problem) and Chapter 14 (The Nitty Gritty of Filing). As is explained in Chapter 37 (Foreclosure as to Intangibles), the exclusions also affect enforcement of security interests in intangible collateral, especially where the collateral has been the subject of an assignment.

The definition of general intangibles also excludes investment property, defined in new section 9-102(a)(49) to mean a security, whether certificated or uncertificated, security entitlement, securities account, commodity contract, or commodity account. Were it not for this exclusion many types of investment property, other than certificated securities, might well be considered general intangibles. The exclusion leaves open the question of when property is investment property. In many cases the answer to the question will be clear. However, there are types of property as to which the answer is not entirely free of doubt.

For example, an interest in a limited liability company (LLC) may be offered to secure a debt. See, e.g., Chesapeake Investment Services v. Olive Group Corp., 2003 WL 36682 (Mass. Super. 2003). Unless the interest is "a medium of investment and by its terms expressly provides that it is a security governed by [Article 8]", and [the obligation] by its terms satisfies the other requirements of the definition of a security in Article 8, section 8-102(a)(15), in which case it would be investment property, then the interest would be a general intangible.

An interest in a limited partnership, on the other hand, could satisfy the requirements of the definition of a security, especially that it "is of a type, dealt or traded on securities exchanges or securities markets" and constitutes investment property and not general intangibles. As noted earlier, security interests in investment property pose special problems that are considered more completely in Chapter 21 (Perfection as to Investment Property). See generally, Coleman, Cowan & Forbes, Pledges of Partnership Interests: Panacea or Pandoras Box?, 368 PLI/Real 121 (1991).

You may explore the basics of the accounts and general intangibles classifications in the next two problems.

Problem 5-16 (interactive)

ABC, Inc. manufactures and sells toys on credit on an unsecured basis. Second Bank takes a security interest in the contracts that are generated by the sale of toys by ABC. As of the time of the creation of the security interest ABC has delivered only some of the toys that ABC has contracted to sell and some of the toys ABC has contracted to sell have not yet even been manufactured.

Are the contracts for the sale of toys that have been manufactured and delivered goods, general intangibles, accounts or chattel paper?

How should the contracts for the sale of toys that have been manufactured but not delivered be classified under new Article 9?

Are the contracts for the sale of toys that have not yet been manufactured also accounts?

What language of new section 9-102(a)(2) supports your answer to the last question?

Can a security interest in any of the contracts be perfected by possession?

Problem 5.17 (interactive)

First Bank is considering financing the acquisition of a tavern by Debbie Debtor in Arizona. Debbie is offering as collateral the liquor license that will be transferred to Debbie as part of the acquisition.

How should the liquor license be classified?

A word of caution about liquor licenses is in order. There has been some disagreement about the extent to which restrictions on the transfer of a liquor license may prevent them from the license from being property as is required for a security interest to attach. The dispute upon which this caveat is based was alluded to in Chapter 4 (Scope of Article 9) and is discussed more fully in Chapter 25 (The How and Why of Priority).

As with accounts and other pure intangibles, general intangibles cannot be possessed and a security interest in general intangibles cannot be perfected by possession.

4. Deposit Account

Pure intangibles also include "deposit accounts," defined in new section 9-102(a)(29) to include a demand, time, savings, passbook, or similar account maintained with a bank and to exclude investment property or an account evidenced by an instrument. In short, a deposit account is a general bank account. The definition generally tracks that found in former Article 9, section 9-105(1)(e). However, under former section 9-105(1)(e) a bank account evidenced by a certificate of deposit was not a deposit account. Under new section 9-102(a)(29), a bank account evidenced by a certificate of deposit may be a deposit account so long as the certificate of deposit is not an instrument.

As noted in the discussion of instruments and the Latin Investment case above, a certificate of deposit is an instrument only if it is transferred by delivery in the ordinary course of business. Moreover, to be an instrument there must be a writing. Consequently, an electronic certificate of deposit cannot be an instrument but it can be an deposit account. See Official Comment 12 to new 9-102.

The definition of a deposit account takes on greater importance in new Article 9 than it had under former Article 9 because, as was noted in Chapter 4 (Scope of Article 9), new Article 9 covers security interests in deposit accounts as original collateral, other than in the case of a consumer transaction, whereas former Article 9 covered security interests in deposit accounts only as proceeds.

The treatment of deposit accounts under new Article 9 is considered in the next problem.

Problem 5.18 (interactive)

Donald Debtor has a certificate of deposit issued by Western Bank. The CD is labelled "non-negotiable." Donald offers an interest in the CD to Lenny Lender as collateral for a loan.

How should the CD be classified?

If the CD is in electronic form (i.e., it is not evidenced by any writing) is it an instrument or a deposit account?

If the CD is in electronic form, and hence is not an instrument and rather is a deposit account, is any security interest taken by Lenny governed by new Article 9?

5. Commercial Tort Claim

A commercial tort claim is another pure intangible. As we saw in Chapter 4 (Scope of Article 9), the creation of security interests in tort claims was outside the scope of former Article 9, but proceeds interests in tort claims and interests in commercial tort claims as original collateral are covered by new Article 9. Under new section 9-102(a)(13), a tort claim is a "commercial tort claim" if the claimant is an organization or the claimant is an individual and the claim arose in the course of the claimant's business or profession and the claim does not include damages arising out of personal injury to or the death of an individual.

It should be noted that commercial tort claims are expressly excluded from the definitions of account and general intangible. Consequently, a description of a commercial tort claim as an account or general intangible in a security agreement would be improper. However, if a commercial tort claim has been settled and reduced to a contractual obligation to pay then the tort claim becomes a payment intangible as defined in new section 9-102(a)(61) and also falls within the definition of a general intangible in new section 9-102(a)(42), as discussed above. See Official Comment 15 to new 9-109.

In the case of In re Wiersma, 283 B.R. 294 (Bkcy D. Idaho 2002), also discussed in subpart D (3) above and in Chapter 4 (Scope of Article 9), the court concluded that a cause of action for breach of contract is a general intangible, and not a tort claim, even if the breach results from tortuous behavior.

Problem 5.19 (interactive)

Donna Debtor owns and operates a gift shop. Central Bank holds a perfected security interest in Donnas accounts, deposit accounts and general intangibles. Donna recently filed a lawsuit against one of her suppliers alleging fraud on the part of the supplier. Does Central Bank have a security interest in Donna's claim against the supplier?

Would your answer be different if Donna's claim against the supplier had been settled?

If Donna's claim against the supplier alleged a breach of contract involving fraud would the claim be covered by Central Banks security interest?

6. Health-care-insurance receivable

Recall from Chapter 4 (Scope of Article 9) that interests in insurance claims, other than as proceeds, were not covered by former Article 9. New Article 9, section 9-109(d)(8) contains a similar exclusion but under this provision new Article 9 covers health-care-insurance receivables as original collateral. "Health-care-insurance receivable" is defined in new section 9-102(a)(46) essentially as a right to payment of a monetary obligation for health-care goods or services provided.

Although separately defined, a health-care-insurance receivable still is either an account or a general intangible. Deciding which it is requires careful reading of the definitions of account and general intangible as discussed above. As seen in the discussion of commercial tort claims, the decision can be important because exactly how property is classified affects decisions about descriptions and ultimately determinations as to perfection. These matters get much fuller treatment in later chapters.

As has been noted, pure intangibles cannot be pledged or possessed so perfection of a security interest in such property cannot be accomplished by possession. In later chapters we will discover that perfection of a security interest in pure intangibles is usually accomplished by filing but as to some intangibles, in particular deposit accounts, perfection may require getting "control" of the property.

The next three problems allow you to revisit many of the points made above.

Problem 5.20 (interactive)

Southern Bank wishes to lend to Virus Detect, Inc., a software developer. Virus Detect has offered as collateral an interest in a negotiable certificate of deposit, a general business bank account and its storeroom full of software products. How should each item of property be classified? You should have no difficulty with the negotiable certificate of deposit and the general bank account. The software is trickier. Consider new section 9-102(a)(75) (defining "software"). Later we will explore the difficulties posed by the fact that software ordinarily is copyrighted and federal law must be consulted.

May a security interest in any of the items be perfected by possession?

Problem 5.21 (interactive)

As noted, the proper classification of collateral affects such important matters as the adequacy of a description. Would a security agreement drafted after the effective date of new Article 9 and describing the collateral as general intangibles cover a right to payment of lottery winnings? Before answering you may wish to consult new section 9-102(a)(2).

Problem 5.22 (interactive)

Northern Bank is contemplating lending to Joe Jones and taking an interest in Joe's share of a limitedpartnership to secure the loan. How should the collateral being offered be classified?

CASE COMMENTARY

The Epicentre Strategic Corporation-Michigan v. Perrysburg Exempted Village School District, 2005 WL 3060104 (N.D. Ohio 2005)

Mackela v. Bentley, 614 S.E.2d 648 (S.C. App. 2005)

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

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

Coffey v. Singer Asset Finance Co., L.L.C., 2007 WL 258962 (Tex. App. 2007)

Madisonville State Bank v. Canterbury, Stuber, Elder, Gooch & Surratt, P.C., 209 S.W.3d 254 (Tex. App. 2006)

Vars v. Citrin, 470 F.3d 413 (1st Cir. 2006)

Stockman Bank of Montana v. AGSCO, Inc., 727 N.W.2d 742 (N.D. 2007)

In re Commercial Money Center, Inc., 350 B.R. 465 (B.A.P. 9th Cir. 2006)

2009-02-01 update