Date: March 4, 2002
To: Secured Transactions students
From: Avery Katz
Re:  Feedback on Fall 2001 exam


Here is a summary of how I thought the exam questions should have been approached. Pending permission from the authors, I will also post on the website the top three 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 will be available for inspection at the office of my assistant, Nadine Baker (600/1 JG, 4-7594). 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: Refinancing Lemon

This was a difficult question that called for creativity in your application of the applicable doctrine. Different students provided different analyses; and I gave credit depending upon how well-explained and argued your answer was, as well as how well it was grounded in the text of the statute. What follows is one possible analysis of the problem. Many of its suggested conclusions are arguable, however, and I did not expect anyone to have provided this elaborate of an answer on the exam, or to have considered many of the complications it discusses.

Article 9 presents no barrier to taking a security interest in an asset of contingent value, including a lawyer's fee receivable. Specifically, the receivable would most likely be an account under 9-102(a)(2), because it is a right to payment for services rendered or to be rendered, even if not yet earned by performance. [Some students suggested that the receivable would be classified as a commercial tort claim. This is possible, but would require that the clients actually conveyed to Lemon a property interest in their claim against Chemtron, and also that they qualify under the definition of 9-102(a)(13). A regular contingent fee agreement would be unlikely to include an actual conveyance of a part interest.)

There may be an issue of rights in the collateral, if under the applicable law of partnership L does not have an individual property interest in the receivable. Additionally, the local rules of professional responsibility may limit a lawyer's power to convey an ownership stake in a fee receivable, but that issue is dealt with below.

The main risk for a lender in such a transaction is that the asset will turn out to be without value. If the suit against Chemtron settles at the expected amount of $3 million, there will be more than enough to pay off the senior creditor First Bank (1B), L's partners, and Second Bank (2B) as well. On the other hand, if the case goes to trial, it is a roll of the die and 2B could come up with nothing. Under 9-404, L's clients will not be liable to pay us anything they do not owe her under the underlying representation agreement.

Additionally, making the loan could change L's incentives with regard to the litigation, making her more likely to take risks. In general, there is a potential incentive problem whenever one makes a fixed loan to the holder of a risky asset. Because L gets all the upside from a high settlement or recovery, but a low return renders her insolvent and imposes the downside on of her creditors, she may have an incentive to behave in an excessively risk-seeking manner in litigation and negotiation with Chemtron (e.g., by turning down a reasonable settlement that would provide enough to repay her secured loans, but no more.) Thus we may need to monitor the manner in which she handles the case to protect against such risk-seeking on her part. On the other hand, the prospect of such supervision may create problems from the point of view of professional responsibility law.

The second most important risk for 2B is posed by the suit by L's partners, since damages awarded following a finding of breach of the partnership contract could be substantially larger in amount than the $300K lent by either 1B or 2B. On the given facts, MN are unlikely to get a lien fast enough to beat a timely perfected SI by 2B. The problem here, rather, is rights in the collateral (RIC). Does L have sufficient rights in the fee receivable to grant a SI that will defeat the interests of his partners, or is the receivable the property of the partnership? If the latter, 2B can't get a SI and may have to look to other ways of protecting itself.

It seems likely that L has at some RIC in the receivable, though, if only through his one-third share in the assets of the partnership. The term in the partnership agreement that purports to restrict Lís ability to alienate partnership assets is unenforceable under 9-408(a) to the extent that it applies to the grant of a SI. [Lís rights under the partnership agreement qualify as a general intangible under 9-102(a)(42), so the partners have the rights of the associated account debtors.] Any SI thus created would not be enforceable against the other partners, however [see 9-408(d)], so they would be able to collect the fee and apply Lís share of it against their other claims against him. On the other hand, the Chemtron plaintiffs have the right under the law of professional responsibility to terminate their representation agreement with the partnership, which they have apparently exercised. Lís subsequently agreeing to represent them may be a breach of his obligations toward his former partners, but this breach may merely have the effect of leaving him open for damages, rather than giving the partners a property claim (e.g., under a theory of constructive trust) in Lís rights under his new agreement with the clients. If the partners are merely entitled to damages, 2Bís SI would give it priority over their claims under 9-201. The answer to this last question, unfortunately, turns on local partnership law augmented by the law of professional responsibility, not on Article 9, so some additional research will be necessary before giving advice.

Third and finally, any SI acquired by 2B would take subject to 1Bís earlier SI under the first-in-time rule of 9-322, assuming 1Bís SI is still attached and perfected. The question of attachment turns on some of the same issues raised above; if the partnersí rights under the original contingent fee contract do not extend to receivables arising under the second fee contract, then 1Bís rights may not extend either. On the other hand, if the two receivables are judged to be the same, or if the second is deemed proceeds of the first, then 1Bís SI follows the property into the hands of L under 9-315(a).

After attachment one must consider perfection. 1B filed a FS against the partnership; we are not told of any filing against L individually. Under 9-507, the original FS remains effective with respect to collateral that is exchanged or otherwise disposed of, so if the receivable under the second fee contract is deemed to be the same as the original collateral, then 1B is still perfected.

All this suggests that 2B should proceed with caution in lending against the receivable. On the other hand, the claim against Chemtron is a valuable asset that is worth preserving. It does not make sense to pull the plug on litigation with an expected value of $4 million, and that can be maintained at a cost of only an additional $300,000. Both 1B and the partners stand to gain from a successful resolution of the Chemtron litigation ó 1B because it increases its chance of repayment on its loan, and the partners because they may be entitled to a share of the resulting contingent fee, and because they are personally on the hook with respect to their guaranties on the loan from 1B.

In order to protect 2Bís interests, you will need to get the partners to agree to whatever financial arrangement you work out, so that 2B can be sure of having an enforceable SI in the fee receivable if it materializes. This does not require the partners to be liable on the second $300K loan, but it does require that they agree to subordinate their interest in the receivable to you, by waiving or modifying their rights under the partnership agreement. For the above reasons, they may well have an incentive to do this.

It would also be desirable from 2Bís perspective for 1B to subordinate all or a portion of its SI under 9-339, but this is less essential since their claims against the receivable are limited to less than $300K. Another possibility would be for 2B to acquire 1Bís interests under the first loan contract, thus eliminating any conflict.

Some students suggested that 2B make sure that any funds received from the clients be deposited in an account at 2B. If carried out, this precaution would give 2B the superpriority of a depositary bank under 9-327, enabling it to take ahead of 1B, but it would not be effective with regard to any priority battle with MN, and it would not address the question of RIC.

Question 2: Commercial, Zippo, and Dragonfly


Zippo has a perfected security interest in Dragonflyís inventory, both new and used (assuming the SA or FS is not restricted to the motorcycles that D acquired from Z.) Z also has purchase money status as to the motorcycles that D acquired with Zís funds (probably all new Z motorcycles), but not to the rest of inventory.

Similarly, Commercial has a perfected security interest in Dragonflyís inventory, both new and used, since the SA and FS were not restricted to used motorcycles. C has PM status as to any used motorcycles that D acquired with Cís funds.

As to the motorcycles that are still part of Dís inventory, Z has priority under 9-322 because it was first to file. Because C was a PM lender, it could have gotten super-priority in the used motorcycles under 9-324, but it failed to send notification of its interest to Z as required by 9-324(b). Cís possession and Zís lack thereof of the title certificates is irrelevant to priority or perfection, even if there is an applicable title-certificate statute, because the goods are still inventory. [See 9-311(d).]

Lease and installment sales contracts

The lease and installment sales contracts that D obtains from its retail customers are classified as chattel paper under 9-102(a)(11). Both Z and Cís SIís carry over into the CP under 9-315(a), and both SIís remain perfected under 9-315(d)(1) (because a SI in CP can be perfected by filing under 9-312.)

Zís first-to-file priority under 9-322 also applies to the CP; however, D may be able to qualify for super-priority under 9-330(a) if it can make out all the requisite elements. Here, Z claims a SI in CP merely as proceeds, C took possession of the CP, and there is no indication that the CP indicated Zís interest in it. New value is trickier, since C did not advance additional funds to D upon receiving the CP; however, 9-330(e) provides that a PM inventory lender is deemed to have given new value for CP derived from the inventory. Thus, C could have super-priority only in CP that derived from the sale of used motorcycles, not from all CP. The outcome would depend on whether C could show that it took the CP in good faith and in the ordinary course of its business. If C knew that its arrangement with D violated Dís negative pledge to Z, this might negate good faith. Depending on local law, it might also form the basis of a tort claim for interference with contractual relations.

Motorcycles in the possession of the Wolfpack

C and Zís rights in these motorcycles and against W are derivative of Dís rights. To determine Dís rights, we must first determine whether the Wolfpack acquired the motorcycles by sale or by lease. The mere fact that there is an option to purchase for 85% of the remaining lease payments is not enough to make the transaction a sale; this price is not so low as to ensure that W will exercise the option. None of the specific tests of 1-201(37) apply either. Thus we would need to know more about the details of the contracts ó the term of the lease, who bears the risk of depreciation, who pays upkeep, etc. Under 1-201(37) it depends on the facts of the case overall.

If the contract is a sale, it is unclear whether Dís SI in them is perfected. It did not file, and because the Wolfpack is a registered organization, not an individual, the purchase-money consumer-goods exception of 9-309(1) does not apply. The only remaining possibility is under 9-310(b)(3), which states that filing is not necessary for property subject to a title-certificate statute of the sort described in 9-311. Thus, if there is a local title-certificate statute that provides that control of the certificates constitutes perfection, 9-310(b)(3) would defer to it. Otherwise, Dís SI is unperfected and is thus voidable under Bankruptcy Code ß544(a) by the Wolfpackís trustee. This result would leave D (and hence Z and C standing in Dís shoes) with a mere unsecured claim against Wís estate. Even if the SI is perfected, however, the trustee might argue that the motorcycles are necessary to an effective reorganization under ß362, and thus could keep them in the estate until the end of the bankruptcy proceedings.

If the contract is a lease, however, the motorcycles would not become part of Wís bankruptcy estate, and Wís trustee would have to comply with the lease contract in order to maintain possession. If W failed to make required lease payments, accordingly, D (and hence Z and C standing in Dís shoes) could reclaim the motorcycles pursuant to the contract.

As between Z and C, the motorcycles and any payments made under the lease contract would be proceeds of the CP, so priority in these proceeds would follow priority in the CP under 9-330(c).

Question 3: Dagwoodís Tanning Center

Claims against CFC:

First, was the SI perfected? If not, the trustee can avoid it under BC ß544(a).

There are several possible issues with regard to CFCís FS. First, the way in which it listed Dís name. Although it substantially clarifies the question of what name to use for an organizational debtor, Revised Article 9 still leaves room for confusion when the debtor is an individual. ß9-502 states that the FS must provide the Dís name to be sufficient. 9-503(a)(4) provides that in cases where the D is not a registered organization, a decedentís estate, or a trust, the FS must provide the "individual or organizational name of the debtor." Trade names are neither necessary nor sufficient. Then 9-506 provides that an error in the debtorís name is not seriously misleading (and thus makes the FS effective notwithstanding the error) if a standard search under Dís "correct name" would disclose the defective FS.

This all begs the question of what the debtorís "correct name" is. Organizations such as corporations have unique authoritative documents stating their name; individuals do not. Do we use the name on a birth certificate, marriage license, social security card, tax returns, etc., or just the name that D ordinarily uses in representing herself to the world? The answer was perhaps not so critical under the former version of Article 9, which used a more contextual standard for what counted as seriously misleading, but Revised Article 9's test is more formal and rigid. If Dís "correct name" is "Derwood P. Dagwood," then the use of "Derwood Dagwood" with no middle initial is seriously misleading under 9-506, given the local search logic, and so the FS is invalid. If Dís "correct name" is "Derwood Dagwood," conversely, then a FS listing this name together with the trade name ("d/b/a/ Coney Island Tanning Salon") would seem to suffice under 9-503, even though a standard search under "Derwood Dagwood" alone would not unearth the FS. [Section 9-503 does not state that additional information (such as a trade name) beyond the Dís name is prohibited, only that it is not necessary or sufficient. Additionally, Comment 2 states that "the actual or organizational name of the debtor on a financing statement is both necessary and sufficient, whether or not the financing statement provides trade or other names of the debtor." Thus, there would be no error in the name, and thus we do not need to go to 9-506.]

Other potential problems with the FS include the overbroad description (it listed equipment and inventory as collateral, but the SA only covered equipment); the use of Dís home address, and the failure to update the FS to reflect CFCís merger with Vulture. None of these problems would render the FS ineffective, though. Since the FS was accepted by the filing office, all it must do is comply with 9-502. Dís address is not an essential element under 9-502, and even under 9-516, any address will do. As to the list of collateral, 9-504 explicitly sanctions overbroad FSís, and comment 2 to 9-504 states that indication by general category is sufficient. As for CFCís takeover, while there are various sections in part 5 that govern the consequences of changes in the Dís name or organizational status, there is no requirement that the FS be updated to reflect similar changes for the creditor. See 9-507(b), 9-511.

Thus, the trusteeís best claim is that the FS fails to provide Dís name. It is a picky argument, but because you were told that "DPD" was Dís full legal name, I would judge there to be a reasonable chance that a bankruptcy court would find the FS invalid and thus the SI unperfected.

Second, there were various problems with VCís repossession and foreclosure. These problems could give D a claim for damages against VC under 9-625, and perhaps also a defense against a deficiency judgment under 9-626. Under BCE ßß541 and 558, the estate and trustee succeed to any claims and defenses that D could have asserted.

The repossession was probably invalid under 9-609, even though it was accomplished without violence. There is substantial case law holding that fraudulent claims of state authority vitiate debtor consent. Itís unclear what damages D suffered from this breach, though. Maybe D can claim exemplary damages in tort on a theory of trespass.

The notice that VC sent to D may also be insufficient. 9-611(b) requires the SP to send the D reasonable notification before disposing of the collateral. The three weeks between notice and disposition would ordinarily be a reasonable time under 9-612(b) [providing a 10-day safe harbor]. Here, though, there is a question whether it was reasonable for SP to send the notice to Dís former home address. The fact that D never got the notice would tend to indicate that it was not reasonable, but it would be useful to know whether D made reasonable efforts to update his address information with SP. This issue would turn on the facts, but again itís unclear what damages D suffered by virtue of not having notice (especially since we are told he did not have access to other funds). Maybe he could have gotten other people to bid at the auction, thus driving up the price.

There is also a factual question whether the sale was reasonable, given that no one showed up and that V bought at an apparently low price. 9-610 allows the SP to bid at a public sale, but requires a commercially reasonable disposition. 9-627 gives standards for commercial reasonableness and makes it a contextual issue. We do not have sufficient information to determine the outcome. According to 9-627 comment 2, a low price is not itself sufficient to establish commercial unreasonableness, but is evidence thereof.

Finally, for purposes of defending against a deficiency claim, D has two plausible arguments, Under 9-615(f), D may that the sale proceeds would have been significantly higher if someone other than V had bought at the sale. This will be hard to show if the sale was otherwise reasonable, given that there were no other bidders. More important is the rule of 9-626, which provides that if a SP has failed to comply with the requirements of part 5, the SP cannot recover any deficiency unless it can establish that the deficiency would still have resulted with full compliance on its part.

Third, Dís transactions with his brother-in-law Arnie may be fraudulent conveyances under ß548 or preferences under ß547. The sale of the trade name may be a FC if it was intended to prevent Dís creditors from collecting against a reorganized business, or if the value of the name was worth more than $500. The outcome will turn on the facts. The two months rent payment is either a FC (if the rent was not due) or a preference (if it was due). Because two months are being paid at once, the ordinary course of business exception of ß547(c)(1) will not apply. In either event, the trustee will be able to recover this latter payment.

(On the exam you would not have needed to discuss the 9-503 issue at such length but I have provided a thorough analysis for the sake of completeness.)

Key to symbols used to mark exams:

v good point or argument
! excellent point or argument
~ fair point, or incompletely or unclearly expressed
Ė weak point
Ö point needs elaboration
" point already made, repetitive
? unclear
?? very unclear, confused, mixing together separate points
x mistake of law, misstatement of fact, misuse of term
x? point appears mistaken
# irrelevant or tangential point
#? point's relevance unclear
ns non sequitur: conclusion does not follow
ff fighting facts: contradicting stated facts or making assumptions inconsistent with them
ll laundry list: throwing in relevant and irrelevant arguments alike, without distinction