Memorandum

Date: January 31, 2000
To: Sales and Secured Transactions students
From: Avery Katz
Re: Feedback on Fall 1999 exam
 

Here is a summary of how I thought the exam questions should have been approached. In addition, because I do not expect anyone to have produced as full an analysis as mine under exam conditions, I have attached copies of the top two student answers to each question. 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.

Your individual exams will be available for inspection at the registrar's office, though I have not made many marks on them; instead, I kept a score sheet for each exam containing my own notes. Attached to this memo is a key to the various markings I did use. If, after reading this memo and the top answers, you want to discuss your exam, please feel free to contact me. My phone number in New York is 212-854-0066, and my e-mail address is avkatz@law.columbia.edu. E-mail sent to my GULC address (katz@law.georgetown.edu) will also reach me, but sending directly to my new address is faster and more reliable.
It was a pleasure teaching the class and I wish you all well. Please keep in touch.

Question 1

The first place to start is with the question of whether this transaction is covered by Article 2. The horse is plainly a good under 2-105(1), and 2-105(3) states that "[t]here may be a sale of a part interest in existing identified goods." The only complication is that the parties also signed a partnership agreement, making this a mixed transaction, but the fact that there were two contracts and that the value of the horse probably predominates in the transaction makes it likely that the UCC will fully apply.

The next issue is risk of loss, starting with 2-509. There is room to argue whether the case falls within subsection 2-509(2) [goods held by a bailee to be delivered without being moved] or (3) [the general case]. Under (2)(b), risk of loss passes to the buyer when the bailee (here the seller) acknowledges the buyer's right to possession, since we are not told of any document of title. Under (3), assuming the Vogts are merchants, the risk passes when the buyer receives the goods. Neither provision seems to fit perfectly the case where a part interest is sold; one would need to make a functional argument about who is in the best position to bear the risk, and what the parties understood about who was bearing risk. I would be inclined to view (2) as the more relevant section, which would imply that the risk had passed. Under 2-510(2), however, a rightfully revoking buyer is entitled to throw the loss back on the seller, to the extent that the loss is uninsured. [When the goods are nonconforming, 2-510(1) also leaves the risk of loss on the seller until acceptance, but given the six months that passed before the Buehls complained, there was almost certainly acceptance.]

Thus, we need to figure out whether the Buehls rightfully revoked. To have the right to revoke under 2-608, the Buehls would first have to show a nonconformity that substantially impaired the value of the good to them. Such a nonconformity would have to come out of a breach of warranty. The possibilities here are express warranty (based on Mr. Vogt's statements), the implied warranty of merchantability, and the implied warranty of fitness. All are plausible claims, but none is problem-free. For express warranties, the Vogts would have to establish that the statements were part of the basis of the bargain, and also that they were violated. The most obvious difficulty here is that the statements are parol evidence and inconsistent with the language of the disclaimer, so 2-202 may prevent the Buehls from proving them, if the written contract is deemed an integrated agreement. Given that the disclaimer was a standard clause in a trade association contract, furthermore, there may be a trade usage that such statements are not to be taken as warranties. Finally, even if Vogt's statements are warranties, the only one that has clearly been breached is the one stating that Damask can attain show titles again. This, by itself, may give rise to damages under 2-714, but might not substantially impair the value of the horse.

The implied warranty of merchantability is probably part of the contact because the Vogts are merchants and because there was no effective disclaimer (there was no mention of the word merchantability). It is worth noting, however, that under 2-316(3)(c) implied warranties can also be excluded or modified by trade usage, and the disclaiming language that appears in the trade association contract might qualify in this regard. In any event, the Buehls would have to show that Damask would not pass without objection in the trade. It would be helpful here to distinguish between lameness and stomach ulcers, and to specify whether the relevant trade was for a show horse or a breeder.

Finally there is the implied warranty of fitness. On the facts, it is straightforward to argue that the Buehls were relying on the Vogts' skill and judgment. The question again would be what was the Buehl's purpose (breeding or showing) and was there a breach (i.e., would a lame horse still be fit for breeding?) Then there is also the disclaimer to deal with. To disclaim the fitness warranty, the disclaimer must be in writing and conspicuous. We know it was in writing; we do not know whether it was conspicuous.

Returning to the issue of revocation and assuming a breach of warranty, the Buehls can only revoke if the impairment was substantial to them, and if the revocation occurred before any substantial change in condition not caused by the good's defects. Both elements are arguable. It is not clear whether a lame horse is an adequate breeder, even if it cannot win show titles anymore. And it is not clear whether the stomach ulcers that caused Damask's death were themselves a breach of warranty, even if lameness was. Finally, it is not clear whether the Buehls' statements of dissatisfaction amounted to a timely revocation. In order to shift the risk of loss back on the seller, 2-510 requires the buyer actually to revoke, not just to have the right to revoke. If there was no timely revocation, the Buehls will be limited to a claim for damages for breach of warranty.

Under 2-714, the Buehls would be entitled to money damages equal to the difference, at the time of acceptance, between the horse as warranted (a fit horse) and the horse they got (a lame horse). They would not be entitled to the difference between a fit horse and a dead horse, unless they could claim this amount under the language of 2-714(2) which refers to "special circumstances show[ing] proximate damages of a different amount," or unless they could claim it as consequential damages under 2-715. Both claims are uncertain, unless the Buehls could establish that the stomach ulcers were themselves a breach of warranty and that Damask's death proximately resulted therefrom.

If there was no breach of warranty, the Buehls are probably out of luck, though they also may put forward claims based on unconscionability and the implied duty of good faith. As a general matter, a disclaimer in a commercial contract that comports with trade usage is not unconscionable, but the special circumstances of the relationship between buyer and seller and the buyer's lack of experience may make it so here. Similarly, it may have been bad faith for Mr. Vogt to have withheld information about Damask's lameness. There is also a possible claim based on the tort of misrepresentation, via 1-103.

Common errors: On this question, there were no errors that stood out as especially common. A number of people did not distinguish between (or confused the standards for) rejection (2-602) and revocation (2-608). Plainly the Buehls did not reject in a timely fashion; when it comes to revocation, however, there is room for argument. A few people discussed the buyer's right to reject independent of whether there had been any breach or nonconformity, but most people absorbed the basic point that nonconformity of some sort is a precondition for any remedy for the buyer, including rejection or revocation.

Source: This question was based on Leal v. Holtvogt, 123 Ohio App. 3d 51; 702 N.E.2d 1246 (1998), though I changed some facts and added others. In the actual case, the appellate court upheld the trial court's verdict for the buyers on theories of implied warranty of fitness and negligent misrepresentation, and remanded in order that the trial court might determine what damages would return the parties to their original positions before the agreement was entered into (a tort rather than a contract measure of damages).

Question 2

This question illustrates how complicated a priority problem can be under Article 9, even on relatively simple facts. As I explain below, I did not foresee all of the complications arising from the interaction between the UCC and the Florida title statute, and as a result this turned out to be a quite challenging question.

Deere had a perfected security interest in the Coach as of 6/97, perfected under the Florida title statute and 9-302(3)(b). Presumably it did not authorize Gramm's disposition to Sunshine, and Sunshine cannot qualify as a BIOC under 9-307(1), so its security interest carries over to the Coach in Sunshine's hands. [A perfected secured creditor beats a non-ordinary-course buyer under 9-201 and 9-301(1)(c).] Some of you made an argument that I did not anticipate; namely, that under the Florida statute Deere became unperfected when the Coach came into Sunshine's hands (because then it became inventory and the statute does not purport to regulate security interests in inventory). This argument is a loser on functional and policy grounds, I think, but as reading of a text you had never seen before it was both colorable and creative, and I gave credit for it depending on how clearly you made the point.

We are not told whether Gramm ever received the Monaco motor home she was supposed to be buying. If she did, then Deere has a proceeds interest in it under 9-306. (By the same token, Deere has a proceeds security interest in the cash that Sunshine received from Lenders upon the sale to Norman.) Both proceeds SI's became unperfected after ten days, however, since there is no filed financing statement and Deere cannot comply with any of the safe harbors listed in 9-306(3)(a)–(c) [this last point is a tricky one].

When Gramm entrusted the Coach to Sunshine, she empowered Sunshine under 2-403(2) to convey all her rights in it to Norman, a BIOC. Furthermore, if the delivery of the Coach was the consummation of a purchase, she empowered Sunshine under 2-403(1) to transfer good title to a BFP for value, which includes both the Normans and the inventory lender Citrus. Thus both Citrus and Norman take free of Gramm's interest in the Coach. They do not take free of Deere's security interest, however. §2-403(2) says that a BIOC gets "all rights of the entruster," and Deere was not the entruster. Similarly, 2-403(1) says the BFP gets good title, not that s/he takes free of a SI. The statutory text is not as clear as it could be, but 2-403(4) and c. 4 appear to defer to Article 9, and much of Article 9 makes no sense if we read 2-403(1) to allow a secured debtor to wipe out a secured creditor's interests by conveying to any BFP for value. In any event, 9-307(1) makes plain that a BIOC takes free, not of any security interest, but only of a security interest "created by his seller."

We still need to clarify the relative rights of Deere, Lenders, Citrus, and Norman. Assuming that the Coach came into Sunshine's inventory, Citrus acquired a SI in it under the after-acquired property clause of its contract with Sunshine. (And alternatively, Citrus would have an proceeds SI in the Coach if Sunshine obtained it in exchange for the Monaco, which was previously inventory. C's proceeds interest, in contrast to D's, would be perfected under 9-306(3)(a), since it had filed against Sunshine's inventory.) This SI was attached and perfected on Nov 14, but for purposes of priority among secured creditors, Citrus's status relates back to the 1996 filing. There is thus a textual ambiguity regarding whether Citrus or Deere's SI takes priority. If we follow the first-in-time rule of 9-312, Citrus's filing was first and Citrus wins. If we follow the general common-law principle of nemo dat, which says that Sunshine acquired the Coach subject to Deere's SI and can only convey it the same way, then 9-312 does not apply and Deere wins. An alternate argument for this result comes from 9-203, which provides that a SI can only attach if the debtor has rights in the collateral. The result is unsettled under current Article 9 but Deere probably has the better argument. The first in time rule of 9-312 assumes that a notice filing system is in place and that later creditors can learn the situation by checking the records. In this case, there is no way that Deere, when it lent to Gramm in 1997, could have discovered or protected itself against Citrus's 1996 filing against Sunshine. Thus the functional basis for 9-312 is not present, and we should go with basic common-law property principles. [The same argument would hold with regard to the cash that Lenders paid Sunshine on behalf of Norman, except that Deere is unperfected in the cash, and Citrus is perfected. Thus on the cash we have a conflict between the nemo dat principle, and 9-201's principle that perfected SI's beat unperfected ones.]

As between Deere and Lenders, Deere wins. We are not told explicitly whether Lenders took the necessary steps to perfect a SI (by inference they didn't, since they never got hold of the Florida title), but it does not matter. Lenders' rights are derivative of Norman's, and we have already see that Norman takes subject to Deere's SI. (In any event, even if Lenders has a perfected SI, it filed after Deere.) Both Lenders and Norman take free of Citrus's SI under 9-307(1), however, since Norman was a BIOC and the SI was created by Norman's seller, Sunshine. In exchange for giving up its SI, however, Citrus gets a perfected proceeds SI in the cash that Lenders paid Sunshine for the Coach. Similarly, assuming she actually received the Monaco and the trade-in is considered ordinary-course, Gramm takes free of Citrus's inventory security interest in it. (but not free of Deere's proceeds SI)

Thus, outside of bankruptcy, Deere has first priority in the Coach and in the Monaco if it was delivered. Second priority on the Coach goes to Lenders and Norman. Citrus no longer has any interest in the Coach, or in the Monaco if it was delivered. As for the cash that Lenders paid Sunshine on behalf of Norman, Citrus has a perfected proceeds interest and (probably) first priority. Second priority on the cash goes to Deere, who has an unperfected proceeds interest in it.

Now consider the powers of the bankruptcy trustee. (1) Under §544a, the trustee can avoid Deere's SI in the cash proceeds, since it is unperfected, but not Citrus' SI, which is perfected. (Citrus would still have to thread the needle thru 9-306(4)(d), however, which we did not discuss and for which you are not responsible). All other security interests in Sunshine's property, however, are perfected and unavoidable. (2) The payment to Sunshine's controlling shareholder, however, is plainly an avoidable preference. (3) The sales of the Monaco to Gramm and the Coach to Norman may qualify as fraudulent conveyances, but both transferees were for value and so the consumer buyers do not have to return their interests. Thus the derivative interests of their secured lenders survive as well. (4) Finally, depending on the date of bankruptcy, Citrus's SI in the Coach may technically be a preference, as an increase in inventory subject to an AAP clause. To the extent that Citrus acquired the Coach in exchange for the Monaco however, there is no preference; and the transaction may in any event be saved by the exceptions of §547(c). In summary, Deere still gets first priority in the Coach and in the Monaco if it was delivered; and Citrus still gets first priority in the Monaco if it was not delivered, and in the cash subject to 9-306(4)(d).

Note that if Sunshine had not purchased the Coach from Gramm, but merely taken it on consignment and then sold to Norman, Norman would have a good claim under 9-307(2) to take free of D's SI, since then he would be a consumer buying directly from a consumer and there is no filed financing statement. Additionally, Citrus would never have acquired a SI in the Coach, since Sunshine would have lacked rights in the collateral. Citrus would still have an estoppel claim against Gramm under 1-103, though, for investing Sunshine with apparent ownership.

Common errors: The most common error on this question had to do with the relative priority of Norman and Deere. Many people asserted that Norman as a BIOC would take free of any security interest, but this is incorrect under 9-307(1). Additionally, a number of people argued that one or the other of the parties' status as a purchase money lender would give them superpriority under 9-312. In fact, purchase money superpriority was not relevant for this problem. Although Deere was a purchase money lender, it didn't give any notice of its interest to Citrus; and although Lenders was a purchase money lender, it took free of Citrus's interest under the shelter principle

Source: This question was based on Gordon v. Hamm, 63 Cal. App. 4th 1324 (1998), though I changed some of the facts and added others.

Question 3

This was a more open-ended question that called for a fair amount of creativity. In grading, I looked for answers that both attempted to apply material from the statutory text, and that also discussed larger policy concerns. A good answer, however, would have first indicated that [subject to a minor complication mentioned below] there is no problem with existing security interests becoming unperfected. As to security interests in consumer goods, 9-302(d) states that no filing is necessary (except as to motor vehicles covered by a title statute, and these would not be affected by a failure of the article 9 filing system anyway.) As to other security interests, 9-403(1) makes clear that presentation of a financing statement to the filing officer constitutes filing. [The additional complication relates to existing financing statements that are close to five years old, since the filing will expire absent the filing of a timely continuation statement under 9-403(3). We did not cover this section in any detail and you were not responsible for knowing about continuation statements. But, in such cases, the secured creditor will lose perfected status and runs the risk of losing to a bankruptcy trustee or other lien creditor; more importantly, even if the filing is subsequently renewed after the crisis is over, priority over other secured parties and the bankruptcy trustee will date back only to the moment of renewal. As indicated below, however, this is not a problem so long as the filing office remains open to accept continuation filings. ]

Similarly, as to obtaining security interests on new loans, there is no problem for consumer loans, and no problem for business loans so long as the filing office remains open for business. So long as all filings are made in the right place, later creditors' actual knowledge is irrelevant. As a practical matter, however, it would be prudent to maintain clear evidence of all filings, in case the official records somehow get corrupted.

The real problem is that if the filing records are down, it will not be possible to check before lending whether another creditor has a prior security interest. What can be done about this is the interesting part of the question. Here there is room for you to discuss to notice function of the filing system, whether it really matters in practice, and what other types of notice or investigation might offer a substitute.

There was also room to talk about what might be done as a practical matter with respect to any debtor defaults caused by any Y2K problem. The main legal constraint here, however, is the requirement of 1-208 that there be a good faith belief that payment or performance is impaired. Else, the creditor is not entitled to declare default, and may be held liable for any damages that result from an improper foreclosure.

Not that it matters anymore, but a more detailed discussion of this issue can be found in Thomas C. Baxter and Stephanie Heller, "Commercial Law Issues Arising from the Y2K Problem," 32 Uniform Commercial Code Law Journal 3 (Summer 1999).

Key to symbols used to mark exams:

v good point or argument
! excellent point or argument
~ fair point, or incompletely or unclearly expressed
– weak point
… 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