Date: May 15, 2007
To: Commercial Transactions students
From: Avery Katz
Re:  Feedback on Spring 2007 exam


Here is a summary of how I thought the exam questions should have been approached.  I have also posted on the website the top student answers to each of the questions. What made these answers the best was their coverage of arguments, detail and sophistication in use of facts, and clarity in organization and explanation. If you drew different inferences from the given facts than I did or than the top answers did, you wouldn't have lost points, unless your inferences were unsupportable. 

For your reference, here is a copy of the actual exam.

Your individual exams my be obtained via e-mail from my assistant, Amara Levy-Moore (4-0064, I did not make many written comments on the exams themselves; instead, I used a system of symbols to indicate my reaction to particular arguments and inferences. A key to these symbols is attached. If you want to discuss your individual exam, please feel free to contact me. You will find it useful, however, to read this model answer as well as the top answers before we meet.

It was a pleasure teaching the class, and I wish you all well. Please keep in touch.

Question 1: Priority in assets of Music Mart

We are told that Lester, as general lender, has a prior security interest on Music Mart’s inventory and equipment. The security interest automatically attaches to proceeds, including cash, accounts, and chattel paper received on the sale or lease of inventory.

If Lester’s financing statement is valid, his security interest is perfected, but there are two potential problems here. The first is that the financing statement listed the debtor by a nickname. Because Music Mart is a proprietorship, filing against the individual owner as debtor is proper, but 9-503 requires that the “individual name” of the debtor be used, and while individuals do not have official legal names in the way that organizations do, a nickname may not suffice. Lester has two chances to remain perfected: the first is that a court will hold (as some have) that a regularly used nickname counts as the debtor’s legal name. The other is that even if the nickname does not suffice, the filing may be saved under 9-506(c) if a search under the correct debtor’s name, Daniel Drazic, would disclose the filing. Under the most commonly used search logic, this would not be the case, but if the relevant filing office used a more sophisticated search logic, it is possible that the filing would turn up.

The second problem is that the financing statement is overbroad — the security interest covers only inventory and equipment, but the financing statement refers to “all business assets.” The overbroad financing statement will not affect perfection, however, although it may breach Lester’s duty to Music Mart. "All business assets" does include inventory and equipment.

Assuming that Lester’s filing is good, his security interest also remains perfected under 9-315 in any cash proceeds (assuming they remain identifiable), accounts, or chattel paper.

Fender, as a purchaser of chattel paper, also has a security interest in the contracts and leases she bought. Sales of chattel paper are treated as security interests under Article 9; and by taking possession, Fender both attaches (the possession substitutes for a security agreement) and perfects (the possession substitutes for a financing statement.) Under the usual first-to-file rule of 9-322, Lester would take priority, but under these facts, Fender likely qualifies for the factor’s super-priority under 9-330, assuming she satisfies the requisite statutory elements, because Lester claims the chattel paper only as proceeds. This superpriority extends to any cash that is paid out on the chattel paper, and to any repossessed or returned goods, but not to the lessor’s reversion interest in leased goods (as to those, Lester retains priority under 9-330 comment 11).

As for the instruments themselves, the buyers have priority in them under 9-315(a) (authorized disposition of collateral) and 9-320 (priority of BIOC) so long as they remain in good standing in their contracts. Lessees of instruments retain analogous priority under 9-321. On the facts given, the leases do seem to be true leases because the amount that lessees must pay to acquire title is not nominal (though this would depend on the assumption that the lease does not exceed the goods’ useful life.) Status as leases is relevant to Lester’s priority over Fender, but not to any other obvious issue.

If Fender gives up possession of the chattel paper, she loses perfection under 9-313 (and if she gives it up to Music Mart, she may lose attachment as well.) Thus she would lose priority in the paper to a bankruptcy trustee or to a subsequent purchaser. Whether she loses his 9-330 superpriority over Lester, however, is not entirely clear, since 9-330 does not explicitly make perfection a requirement for superpriority. Probably she does lose superpriority as well as perfection, but this result requires some interpretative and policy argument.

Similarly, if the chattel paper is destroyed, possession is lost as well. Photocopies would not count as possession (or as control under 9-105) because there is no unique version that would exclude others from also holding a photocopy. Nonetheless, it is possible that a court would find some common-law argument under 1-103 to allow Fender to maintain perfection and priority under such circumstances, possibly on an analogy to 9-309 on lost negotiable instruments. (Similarly, in the case where Fender gave up possession by mistake, she might be able to reclaim the chattel paper on a mistake or or restitution theory, or to claim that any third party possessor was holding it in constructive trust).

Question 2: Advice to Orange Bank on refinancing transaction

The question asked for advice on obtaining a new security interest in connection with refinancing Boscorp's outstanding loan, as well as possible guarantees from Bosco and Boscorp. Discussing these in turn:

New security interest. The most obvious risk here is that if Boscorp files for bankruptcy, any new security interest (and any payments received under the new or old loan) could be voidable as preferences under Bankruptcy Code §547. Orange Bank is looking to promote an unsecured claim to a secured one, which would count as a classic preference if it occurs within 90 days of bankruptcy and satisfies the other criteria of 547b. Specifically, the grant of a new security interest would count as a transfer of property, to a creditor, on account of an antecedent debt that would result in the creditor receiving more than if it had not been made. Note that it would not count as a preference if Orange received its security interest in exchange for new value, but refinancing an existing loan does not count as new value except to the extent that additional amounts are lent. (If Orange is refinancing someone else’s outstanding loan, the refinancing would not count as preferential toward Orange, but repayment of the existing loan to another creditor would be a preference.)

The only element of 547b that may be missing here is insolvency, but since insolvency is presumed for the 90 days prior to bankruptcy, Orange would bear the burden of proof on this issue and given the factual uncertainty regarding the value of the good will and receivablesm could probably not make it out. Thus Orange should not count on retaining its security interest unless it is confident that Boscorp can stay out of bankruptcy for 90 days. (The 1-year preference period of insiders is irrelevant here, since the grant of a security interest would not work to the benefit of Bosco on these facts.)
If Orange gets a security interest and the SI holds up, it does not need to worry about subsequent payments being voidable as preferences (because payments to a fully secured creditor are not preferential). If Orange does not have a good security interest, however, the individual payments are voidable unless they can be saved under one of the exceptions of 547c: ordinary course status is the best bet here.

Orange should make sure that any security interest it gets is promptly perfected by filing; this is so for two reasons. First, an unperfected SI can be avoided under the strong-arm powers of §544a; and second, late perfection could bring the timing of the SI into the preference period under §547e, which would make it voidable as a “false preference.”

Orange probably does not have to worry about a new security interest being treated as a fraudulent conveyance under §548 or under state law, because the pre-existing debt would count as fair value for fraudulent conveyance purposes. Due diligence would require making sure that the exchange was otherwise for fair value, however. It would also require looking into the UCC records to make sure that all assets were unencumbered and that no other creditor had a prior security interest or lien.

Orange should also be aware that even if it has a good security interest in Boscorp’s assets, enforcement of the interest will be stayed under §362; and Orange may not be able to enforce that interest in bankruptcy at all if the court deems the assets necessary to an effective re-organization. It may instead be forced to live with an ongoing priority claim enhanced by “adequate protection.” Additionally, if Boscorp’s assets depreciate over time, the security interest would be vulnerable to strip-down in bankruptcy under §506, so that Orange would only have a security interest to the extent of the remaining value of the collateral (possibly not much in the case of accounts receivable).

Guarantee from Bosco of Boscorp's loan . Obtaining a guaranty from Bosco would probably be wise, but requires Orange to undertake certain precautions. With respect to the guaranty alone, Orange needs to make sure that it is in writing (to satisfy the Statute of Frauds) and if possible, that Bosco waives suretyship defenses (to avoid an argument that Orange failed to pursue Boscorp diligently). Note that if Orange also gets a security interest in Boscorp’s assets, it will not be possible to waive the suretyship defenses entirely, since Bosco would then be treated as a debtor under Article 9, and cannot waive the rights provided in §9-602.

The real advantage of a guaranty comes in the event of Boscorp’s bankruptcy. In that case, Orange Bank would be stayed from collecting against Boscorp, but the stay would not apply to payments received from Bosco, who is a separate legal entity (assuming that there were no piercing of the corporate veil or equitable consolidation). Similarly, any discharge of Boscorp would not apply to Bosco, and payment from Bosco to Orange would not count as preference because they would not be property of the estate.

On the other hand, if Boscorp goes bankrupt, a guarantee would mean that Bosco will be treated a creditor of Boscorp for preference purposes, and any payment made by Boscorp to Orange would be a potential indirect preference (benefitting Bosco by reducing the amount she is liable to Orange). Because Bosco would count as an insider, furthermore, the period applicable to such preferences would be one year, not 90 days (although under §550c, Orange would not have to worry about having to return any payment made outside the 90-day period.) One way around this problem would be to have Bosco disclaim any right of reimbursement or subrogation under the guaranty, in which case it would no longer count as Boscorp’s creditor.

Cross-guaranty from Boscorp of Bosco’s loan. This proposal is the most risky aspect of the transaction and Orange Bank should avoid it. It would probably count as a fraudulent conveyance, because any benefit received by Bosco from the guaranty would not count as a benefit (and hence not as fair value) to Boscorp; and it increases the risk of a court later piercing the corporate veil and consolidating Bosco’s and Boscorp’s assets. If the upstream guaranty is absolutely necessary, Orange should make sure that Bosco offers an equally valuable guaranty of Boscorp’s loan, which could arguably count as fair value.

Question 3: Recommendations for new payments policy

Here there was room for you to argue in various ways, and the top student answers illustrate some of the possibilities.  Note that the question did ask you for an assessment of advantages and disadvantages of these various approaches in the setting of new payments, so that descriptions of existing law, however, thorough and accurate, received little credit.


Key to symbols used to mark exams:

good point or argument


excellent point or argument


fair point, or incompletely or unclearly expressed

weak point

point needs elaboration


point already made, repetitive, or unnecessarily restating facts




very unclear, confused, mixing together separate points


mistake of law, misstatement of fact, misuse of term


point appears mistaken


irrelevant or tangential point


point's relevance unclear


point is not applicable to this situation


non sequitur: conclusion does not follow


fighting facts: contradicting stated facts or making assumptions inconsistent with them


laundry list: throwing in relevant and irrelevant arguments alike, without distinction


lecturing: abstract discussion of conceptual material, unconnected to the problem at hand


unsupported assertion / unidentified assumption


verbose; too much space devoted to the point or points in question


discussion is overly vague or overly general


conclusory; result of argument stated without reasoning


straw argument: overly weak or caricatured argument set up for sake of rebuttal


otherwise good point is overstated or exaggerated


fails to discuss obvious counterargument