Sales and Secured Credit Transactions
Georgetown University Law Center
Prof. Avery Katz
March 24, 1995
Questions 1-9 are based on the following set of facts.
In 1993, Monolith, Inc., a close corporation owned and controlled by Nigel, gave First Bank a security interest in its existing and after-acquired equipment to secure a loan of $800,000. The loan contract provided that Monolith would be in default if it ever went insolvent or if it granted any security interest to any other creditor without First Bank's approval. At the same time, First Bank obtained a financing statement from Monolith, which it filed. On February 1, 1994, Monolith lacked the cash to pay its suppliers. Nigel, hoping to keep this fact quiet, secretly lent Monolith $200,000 from his personal funds, and took a security interest in Monolith's equipment and inventory, but never filed any financing statement or notified First Bank. Later in the month, Monolith's cash flow was improved and Nigel took the opportunity to repay himself the $200,000. On May 1, the same situation arose and this time Nigel lent Monolith $100,000, which was again used to pay suppliers. This time, however, Monolith's cash flow did not recover and Monolith was forced to file for bankruptcy on June 15. This was the first that First Bank learned of Monolith's troubles, since Monolith had been making regular loan payments to First Bank throughout this period. Monolith's equipment was worth over $1 million throughout this period.
1. The trustee can avoid Nigel's security interest using her strong-arm powers under §544. T: Nigel never perfected.
2. The trustee can avoid First Bank's security interest using her strong-arm powers under §544. F: First Bank perfected.
3. Had First Bank known about Monolith's situation before June 15, it would have been entitled to
call the loan and, if necessary, repossess Monolith's equipment. T: Monolith was in default;
there is no apparent problem with good faith.
4. Now that First Bank knows about the situation, it is entitled to call the loan and, if necessary, repossess Monolith's equipment. F: First Bank is now stayed from enforcing its security interest without leave of the bankruptcy court
5. When Nigel repaid himself the $200,000 at the end of February, it was a fraudulent conveyance. F: It was for fair value on account of an antecedent debt. (There might be a colorable argument that this was part of a scheme to hinder creditors.)
6. When Nigel repaid himself the $200,000 at the end of February, this was within the period for measuring preferences. T: Nigel is an insider, so the preference period goes back one year.
7. When Nigel repaid himself the $200,000 at the end of February, this was a preference under §547b. T: On account of an antecedent debt, and more than Nigel would have received in a liquidation. (I was assuming here that Monolith was insolvent all along; one could fairly argue that on the facts given, this issue is ambiguous).
8. The regular payments to First Bank are voidable as preferences. F: They don't give FB more than it would have gotten in a liquidation, and in any event they were in the ordinary course.
9. The trustee can avoid First Bank's security interest under §544b, by standing in Nigel's shoes. F: There is no basis for such an argument.
Questions 10-18 are based on the following set of facts.
Moe Schwartz manufactures ladies' coats in lower Manhattan. He applied for loans with both Chase Manhattan and Manufacturers Hanover, offering his inventory and equipment as collateral. Both banks asked him to sign a security agreement and a financing statement as part of the application process. Chase Manhattan filed its financing statement on October 1, 1994, but did not lend Moe any money (or commit to doing so) until November 1, when it lent $100,000. Manufacturers Hanover filed its financing statement on October 15 and lent Moe $250,000 the same day. On December 1, Moe borrowed $20,000 from his brother-in-law Sheldon to buy some new sewing machines, and granted Sheldon a security interest in the sewing machines. The sewing machines arrived on December 3 and Sheldon filed a financing statement covering "equipment" on December 12. As of today, Moe's inventory and equipment (aside from the sewing machines) is worth $150,000; and he has not paid anything to either bank or to Sheldon.
10. Both banks have perfected security interests in Moe's inventory and equipment. T: Both attached and filed.
11. As of today, Chase Manhattan would need a subordination agreement to get priority in the inventory and equipment over Manufacturers Hanover. F: Chase Manhattan filed first; it already has priority.
12. On October 20, Manufacturers Hanover had priority in the inventory and equipment over Chase Manhattan. T: It had a perfected security interest, and Chase Manhattan had nothing.
13. If Chase Manhattan decides tomorrow to lend additional funds against Moe's inventory and equipment, it will have priority over Manufacturers Hanover, even as to those additional funds. T: Up to $150,000 worth, since the additional funds will relate back to the original financing statement..
14. Sheldon has a purchase money security interest in all of Moe's equipment. F: Only in the sewing machines he financed.
15. Sheldon will lose priority in the sewing machines to the two banks, since he never notified them of his security interest. F: No notification is necessary for equipment, in contrast to inventory.
16. Sheldon will lose priority in the sewing machines to the two banks, since he did not file in time. F: He has ten days after delivery to file under 9-312(4) [R 9-324(a) extends this grace period to 20 days].
17. Had Sheldon waited till December 26 to file, he would have lost his security interest in the sewing machines. F: He would have lost his purchase money super-priority, but not his security interest.
18. Had Sheldon lent against a new shipment of cloth rather than sewing machines, his interest would be junior to those of the two banks. T: To get the purchase money super-priority for inventory, a lender must notify prior secured parties and file before delivery.
Questions 19-27 are based on the following set of facts.
On January 1, Reliable Finance lent $500,000 to Tricia's Video Mart and took a perfected security interest in Tricia's present and after-acquired inventory. On September 1, Tricia received a shipment of VCR's on credit from Goldstar, who kept a security interest in the VCR's to secure payment. On September 2, Goldstar filed a financing statement and notified Reliable of the transaction via registered mail. Over the next two months, Tricia sold off most of the VCR's to retail customers. Some of these customers paid cash; others bought on their charge accounts, others on six-month credit. Under Tricia's written six-month credit contract for consumer goods, Tricia keeps a security interest until all outstanding balances are paid by the consumer. Under Tricia's written charge account contract, payment is due at the end of the month and no security interest is taken. On November 1, Tricia received a second shipment of VCR's from Goldstar, also on credit and also subject to Goldstar's security interest. Finally, on November 10, Tricia factored her outstanding charge accounts and consumer credit contracts to Fast Finance for 85 cents on the dollar, signing a written contract. She failed to use this cash to repay either Reliable or Goldstar. Instead. it was deposited in a bank account, where it was commingled with other funds. As part of the factoring arrangement, Fast Finance took physical possession of the consumer credit contracts, but it never filed anything.
19. Reliable has a purchase money security interest in the VCR's. F: Reliable's funds were not used to obtain the VCR's.
20. Goldstar has priority over Reliable in any remaining VCR's from the September 1 shipment. F: To qualify for a PM super-priority in inventory, a lender must file and notify prior secured parties before delivery.
21. Goldstar has a security interest in any charge accounts deriving from sales of its VCR's. T: They're proceeds of inventory.
22. Goldstar has priority over Reliable in any charge accounts deriving from sales of the second shipment of VCR's. F: Reliable was first to file; the purchase money priority does not extend to non-cash proceeds.
23. Reliable has a security interest in the cash received from Fast Finance, if it can still be identified. T: It's proceeds of proceeds.
24. Fast Finance has a security interest in the accounts it purchased from Tricia. T: Purchasing accounts and chattel paper gives it a security interest.
25. Fast Finance has a perfected security interest in the consumer credit contracts it purchased from Tricia. T: Perfected by possession.
26. Reliable has first claim on the consumer credit contracts in Fast Finance's possession. F: Under 9-308 [R 9-330] Fast Finance took possession in ordinary course of its business, so it gets priority.
27. The cash that was deposited in the bank account is no longer identifiable, since it has been commingled with other funds. F: Not necessarily; under state law (for instance, the lowest intermediate balance rule) commingled funds may still be identifiable. [R 9-315(b)(2) explicitly refers to state law in this regard.]
Questions 28-36 are based on the following set of facts.
Federal Realty Trust, a real estate developer, built a new apartment building in downtown Bethesda, Maryland. It borrowed $15 million from Nations Bank to buy the land and to construct the building, and gave Nations Bank a mortgage in both. Nations Bank properly filed its mortgage in the Montgomery County real estate records. During construction, Federal bought 300 refrigerators, ovens, and dishwashers from Buskin, an appliance dealer, and had these appliances installed in the apartment units. Buskin financed 70% of the purchase price and retained a security interest in the appliances; it filed a financing statement in the Secretary of State's office in Annapolis before delivering the appliances.
Federal also installed 300 individual furnaces and water heaters which it purchased on credit from Hutzel, a
heating-and-cooling contractor. Hutzel took a security interest in the heating equipment and filed a financing
statement in the Montgomery County records office.
After construction was completed, Federal needed additional funds to cover startup costs, so it borrowed $250,000 from Bethesda Savings and Loan (BSL), giving BSL a security interest in the rental payments owed by its residential tenants. No tenants were ever notified of this, though. The occupancy rate turned out to be lower than Federal had expected, however, and operating costs were higher than expected, so Federal cut back on maintenance and on administrative staff. As a result, one tenant was injured when slipping on an icy walk, and others began withholding rent.
28. Buskin failed to make a proper fixture filing. T: A fixture filing must be made in the local records.
29. If the appliances are held to be fixtures, Buskin's security interest will be unperfected. F: No fixture filing is required for perfection.
30. If the appliances are held to be fixtures, Nations Bank will have priority in them over Buskin. T: Buskin may be perfected, but it is not perfected by a fixture filing. The exception under 9-313(4)(c) [R 9-334(e)(2)(C)] for domestic appliances covers only replacement appliances, not an original installation. See comment 4d [comment 8] .
31. If the appliances are held not to be fixtures, Nations Bank will have priority in them over Buskin. F: If the appliances are not fixtures, Nations Bank has no interest in them at all.
32. Assuming the furnaces and water heaters are fixtures, Nations Bank will have priority in them over Hutzel. T: Hutzel has purchase money status under 9-313(4)(a) [9-334(d)], but Nations Bank is a construction mortgagee under 9-313(6) [9-334(h)].
33. Even if Buskin has priority over Nations Bank in the appliances, Buskin may not remove them without reimbursing Nations Bank for any physical injury caused by the removal. T: Under 9-313(8) [R 9-604(d)].
34. The tenants are not entitled to withhold rent, since Federal has assigned their rental payments to BSL. F: Any defense against payment of rent that the tenants have against Federal is good against the assignee, under 9-318(1)(a) [9-404(a)].
35. The tenants may continue paying rent to Federal notwithstanding the assignment of their payments to BSL, until they are notified to the contrary. T: Under 9-318(3) [R 9-406].
36. In the event that Federal goes insolvent, the injured tenant may have an unsecured tort claim, but he will still have to pay back rent to BSL. F: Under 9-318(1)(b) [R 9-404(a)(2)], the rights of an assignee are subject to tort claims of an account debtor that arise before the account debtor is notified of the assignment.