Note: These were, in my judgment, the best answers received under examination conditions. They should not be taken as model answers, in that they all contain extraneous material as well as omitting useful information. Some even reach incorrect conclusions. However, they all take intelligent approaches to the questions, are well organized and reasoned, and make sensitive use of the facts.
Because answers were scanned from originals to prepare this page, be aware that odd characters and typos may have been unintentionally inserted into the text.
|Question #1, Answer #1||Question #2, Answer #1||Question #3, Answer #1|
|Question #1, Answer #2||Question #2, Answer #2||Question #3, Answer #2|
|Question #1, Answer #3||Question #2, Answer #3||Question #3, Answer #3|
Question 1, Answer 1
CURRENT LEGAL RISKS AND LIABILITIES
I have inferred from the problem that customers negotiate their paychecks to Cash24 by indorsement and transfer for value rendering Cash24 a holder in due course. (3-201, 3-302). The main legal risks stem from the difficulties in pursuing claims against Cash24' s customers, especially for risk of flight and insolvency, along with the inability to set off against a deposit account. Banks also retain a defense for negligence under 3-406.
If a customer presents a forged instrument, Cash24 would be unable to enforce against the drawer and would be out the amount paid to customer, unless recovery from customer. As no one is entitled to enforce a fraudulent indorsement, due to lack of proper negotiation 3-201(b), Cash24 would breach the presentment warranty. 3-301, 3-417(a). Payor Bank could recover from Cash24 as the person who took from the forger unless Cash24 could assert a defense under 4-406, 4-301/4-215, or 4-214(a).
b. Forged Checks
A forged check on the other hand, does not breach the presentment warranty as a HDC is entitled to enforce against the forger. 3-403(a), 3-301. If the payor bank dishonors the check, liability goes up the chain to the first payee.
c. Altered Checks
If Cash24 accepts a check from someone otherwise authorized to enforce, but who has raised the amount, Cash24 will be able to enforce only the amount of the original check and will lose the raised amount, unless recovery from customer.
Although less risky than the above as most employers will likely be able to cover employee checks, if a customer's employer dishonors a check, and neither payor bank nor depositary bank has breached its midnight deadline, 4-301/4-215, 4-214(a), Cash24 will be forced to recover the amount of the check from the customer through indorser's liability, 3-415(a), or if he/she is insolvent, from the employer, 3-414(b).
The only legal risks I see associated with Cash24's money orders is a possible claim arising from the transaction between customers and their payees. For example if a payee breached a contractual duty and the customer wanted to get back the money it paid for the money order. This seems to be a very rare occurrence though as most money orders will be issued to pay for services, such as electricity, cable, etc., that has already been received by the customer. In the off-chance that this isn't the case, I would suggest a money back guarantee in exchange for the money order. This would create goodwill without any significant burden, depending of course on whether or not my assumptions on money order usage are correct and whether the administrative costs would be offset by interest we could collect before exchange. As long as Cash24 keeps enough money in its deposit account to cover the money orders, there should not be any other problems.
Paycheck loans pose a considerable risk as they are unsecured, however this risk is somewhat mitigated by the low amounts and high interest rates. Cash24's ability to recall loans depends on a customer's solvency and the rights of other secured creditors, unsecured creditors and lien creditors if the customer goes into bankruptcy.
2. PROPOSED CHANGES
Cash24 provides a much-needed service to our customers, catering mainly to lowincome, unbanked customers in an area poorly served by ordinary banks with average fees similar to low-balance accounts. These facts might allow us to deflect some pressure to reform our services. Depending on the intensity of the pressure, I would propose the following changes to alleviate risks and allow Cash24 to lower customer fees.
a. CHECK CASHING
As stated above, the main problems associated with check cashing are due to the current difficulties in bringing suit against high risk customers. We can reduce our fees to the extent we are able to reduce risk.
i. Require information cards with signatures, current
Although there would be certain administrative costs, we could require each customer to fill out an information card with various data and create a record in a computerized database system. This would allow us to better monitor high risk customers and bring suit against those who break the law. The downside of course is that this would put an undue burden on good customers and unlikely reduce the risk of bad customers. If someone is willing to steal or commit fraud, they will likely give false information.
a verifiable permanent home address
This might alleviate the fraud aspects in the previous paragraph, but would put an even greater burden on good customers.
employers to pre-authorize checks
Requiring pre-authorization could greatly reduce risks with little burden on customers after an initial amount of administration, but would depend on the diversity of employers and their willingness to cooperate. Furthermore, it would only work with checks from employers.
iv. Maintain records of past
checks to prevent
Assuming most employees receive a constant wage from month to month, and depending on the cost of maintaining a database system, we could keep a statistical record of check amounts to protect against aheration.
check-cashing fees to a percentage of the check
We could change the current flat fee to cash a check to a percentage fee based on the amount of the check. This would require "high-income" customers to subsidize lower-income customers. It is not clear how this would alleviate risk and would possibly alienate "high-income" customers. Nevertheless business and regulatory bodies might view it as a step towards alleviating the burden on low-income customers.
customers to cash checks immediately
Depending on the cost of implementing such a system, we could eliminate the need to print paper checks and allow customers to immediately cash electronic transfers. Customers would then cash all their electronic-benefit checks with us and we could cut down on paper costs.
b. MONEY ORDERS
Since risks associated with money orders are low, we might offer lower rates or offer one for free after X number of checks have been cashed. As fees are based mainly on administrative burdens, after overhead costs are covered, we could reduce the cost of money orders to our customers and gain goodwill with business and regulatory bodies.
The risk from paycheck loans arise from our unsecured standing.
i. Secure loans
First we could secure the loans, but this is probably not worth the administrative costs on such low amounts. Also, customers might not have valuable collateral, or the collateral that they have might already be subject to prior secured creditors.
ii. Require guarantors
We could require all customers to provide guarantors. However, the guarantors might not be any more solvent than high-risk customers.
not increase loan amount or issue additional
loans until the original amount has been paid
We could require customers to pay prior loans in full before issuing new loans, but we want to take in as much interest as possible.
iv. Offer information and
customer service in multiple languages
Since a significant number of our customers are immigrants and minorities we could keep the loans as they are and offer customer service and information in multiple languages to ensure customers fully understand what they are doing. However, this would require administrative cost.
Question 1, Answer 2
Cash24 faces three risks with respect to its check-cashing business:
The risk that the customer has forged the indorsement on the check
The risk that the check itself is a forgery
The risk that the drawer of the check does not have sufficient funds to cover the value of the check.
First, if the customer forged the signature of the payee on the check, then Cash24 faces the risk that the check will either be dishonored, or that the check will be accepted but that the drawee bank will seek to recover the amount of the check from Cash24 for breach of its presentment warranty under §3-417. In either situation, Cash24 is unlikely to be able to recover the amount of the check from its customer who has presumably absconded.
This is a difficult risk to protect against. Naturally, Cash24 should demand identification from customers cashing checks, require that checks be signed in its presence and compare signatures, but these are common procedures that it has probably already implemented. Accordingly, there are few opportunities for cost-saving with respect to this risk.
Second, if the check were forged or the drawer had insufficient funds, Cash24 would face the same risk of having the check dishonored, in which case it would not be able to recover the disbursed money from its customer. [Though in either case, if the drawee bank paid the check, it would not be able to recover the amount from Cash24. See §§3-418, 4-301.]
Ideally, Cash24 would only pay customers for checks after the check had cleared following deposit in Cash24's account with its depositary bank. It could issue the customer a promissory note for the amount of the negotiated check, with payment conditional upon the drawee bank's acceptance of the check. Once the check negotiated by the customer cleared, Cash24 could call the customer and inform them that they could come by and pick up their cash. This arrangement would be impossible to implement effectively, however. Many low-income people live from paycheck to paycheck (or benefit check to benefit check) and would not be able to wait until the check cleared. An acceptable compromise would be for Cash24 to pay its customer 50% of the face value of the check immediately in cash, and to pay the rest upon the check clearing. As described above, Cash24 could issue its customer a promissory note for 50% of the check for the interim period between negotiation of the check and final acceptance by the drawee bank.
This wouldn't eliminate the risk to Cash24 of dishonor of the check, but it would reduce its exposure, and would permit it to provide its customer with enough cash to "tide them over" until the check cleared. This scheme would likely reduce the number of payroll loans Cash24 could make, however. If customers don't have access to the full amount of their checks at the start of the month, they are less likely to spend it all in the first half of the month and require a payroll loan. While this may benefit some customers, others are likely to view this two-step arrangement as an inconvenience that would drive them to other service providers. Cash24 may be able to entice customers by paying nominal interest on its promissory note, a feature likely to assuage the concerns of some critics.
Finally, Cash24 could implement a differentiated pricing scheme, charging less for checks from governmental entities, where the risk of dishonor is lower. (1) It could also charge less for checks cashed by customers receiving electronic benefits transfers through Cash24. If any checks from such customers were dishonored, Cash24 could exercise its right of set-off before issuing checks for subsequent electronic transfers.
Electronic Benefits Transfers to Checks
Cash24 does not face any substantial risks with respect to these transactions. It has received the money before it issues its check. There is a risk that the electronic transfer was sent by mistake, in which case the sender or the intermediary banks might be entitled to recover the amount of the transfer under the conunon law of restitution, but since Cash24 will have disbursed the amount of the transfer to its customer, such parties cannot recover the funds from Cash24.
Cash24 may face some risk in issuing money orders, depending on how its customer pays for the order. It will face the usual risks if its customer pays by check or credit card. This is unlikely to be the case, given that most of its customers are unbanked. Nonetheless, Cash24 should only accept payment in cash to minimize these risks.
It is unclear that Cash24 is significantly overcharging for money orders. The United States Postal Service charges between $0.90 and $1.25 for money orders, (2) while WesternUnion charges "around a dollar." (3) Nonetheless, Cash24's charges may be more than 50% higher than its competitors. While there are few opportunities for cost saving, Cash24 may be able to lower its fees in light of its low risk exposure. Naturally, this would entail a loss of revenue.
Cash24' s risk in such transactions is simply stated: it faces the risk that the customer will not repay his/her loan when it becomes due. The simplest way for Cash24 to minimize this risk is to transfer it to another party. Cash24 may be able to buy insurance against the risk of customer default. It is unclear whether such insurance is available, however. Moreover, purchasing such insurance would significantly reduce Cash24's profits on the loans and in any case would make it difficult to reduce the fees it charges its customers, as the premiums would likely be high. Given that Cash24 is charging $30 for a two-week loan, however, there may well be enough room for Cash24 to purchase insurance and still recognize a profit.
The most effective way for Cash24 to transfer the risk to another party would be for it to factor these loans to a party specialized in this type of risk. By using the secondary market for such loans, Cash24 might still be able to recognize significant profits while increasing efficiency, thereby allowing it to lower the fees it charges.
Similar to the solution proposed for reducing Cash24's risks when cashing checks, Cash24 could reduce the fees it charges for payday loans where the customers receive electronic benefits transfers through Cash24. If a customer defaulted on his/her paycheck loan, Cash24 could exercise its right of set-off before issuing checks for subsequent electronic transfers.
Other protections would be impractical. Cash24 could demand collateral for its loans, but its customers are unlikely to have collateral of significant value and Cash24 is presumably ill-equipped to take physical possession of and store collateral such as a television.
It might be possible for Cash24 to take a security interest in its customer's next paycheck or benefits check, but if it has to pay a $20 filing fee in addition to search fees, (4) this would just make such loans more expensive. Moreover, if the customer enters bankruptcy, the customer probably won't have a job anymore and probably doesn't have any assets worth taking, so it is unlikely that taking a security interest would help Cash24.
[Note 1: There may be other law prohibiting this scheme, but I am unaware of it.] (return ^)
[Note 2: See www.usps.gov.] (return ^)
[Note 3: Phone inquiry on December 11, 2003.] (return ^)
[Note 4: f4 See, e.g., http://www.dos.state.ny.us/corp/uccfaq.html.] (return ^)
Question 1, Answer 3
Check24 will almost invariably suffer a loss upon the dishonor a check we have cashed. The drawee bank owes us no duty, so if it dishonors a check for lack of funds or because of a stop order, our only recourse is against the customer. Because we have only a temporary relationship with most of our customers, and because many of our customers have very few assets to begin with, our likelihood of any substantial recovery is small.
One potential solution to this threat of dishonor is to hold a customer's check until we receive notice that it has cleared. Although this is option is open to us legally, from a business standpoint it would make little sense. Our customers are drawn to our service primarily because it provides them with instantaneous liquidity. If we forced customers to hand over their paychecks on Friday night, and did not provide cash until Saturday or later, they would most likely bring their business to one of our competitors.
A compromise solution could be to provide partial payment up-front for our customers immediate needs, but only provisional credit for the remainder, contingent of the check clearing. Even if the reduced risk could dramatically lower our fees, however, we would likely still lose business under this plan. Because our fee is already so low ($3.50) in comparison to the cash we are providing, it is not likely that even a substantial reduction would compensate for the value our customers place on liquidity.
Another means of risk reduction would be to increase customer screening. The effect of screening is limited, however, because the primary risk of dishonor lies with the drawer of the check who is not present during the transaction. We should focus our efforts, therefore, on screening the checks themselves. First, we could demand different fees for different types of checks. Low-risk checks like government benefits or paychecks from large employers would incur a lower fee than personal checks or small businesses checks. Although this would allow us to draw more low risk-checks from our competitors, the increased fee for higher-risk checks could seriously harm business. A large percentage of our customers likely work for small companies or individuals, often on a non-regular basis, and the loss of their business could be substantial. It might make more sense to keep all the fees the same and allow the low-risk checks to subsidize the higher risk customers. We could also increase more traditional screening processes like credit checks of payees or background research in to drawers.
Our second major concern with the check cashing operation is the threat of check fraud. Generally, we will not be liable for forged checks. When we forward a check to the drawee bank for payment, we do so under a presentment warranty under §3-4 17, not under a transfer warranty under §3-416, given the definition of transfer under §3-203. This presentment warranty makes us liable only if we had knowledge of the forged instrument, so in almost all cases the drawee bank is required to credit our account. Our only potential liability arises under §3-406 if our employees fail to exercise due care in accepting a forged check. By properly training our employees and ensuring minimal safeguards are in place, we can reduce the risk from forged checks to near zero.
Unfortunately, this same protection does not apply to checks with forged indorsements. Unlike a forged check, a forged indorsement never creates an entitlement to enforce under §3-301. Therefore, when we present a check to the drawee bank for payment, we breach the presentment warranty under §3-417. At that point, our only recourse is to go after the customer or previous transferees. As with dishonor, however, the nature of customers makes recovery in these situations unlikely.
It is uncommon today for individuals to personally give value for an indorsed check. Consequently, the chain of transferees is probably small, and it is likely that when a customer presents us with a forged indorsement, she is the forger herself or closely involved with her. It is critical, therefore, that we rigorously screen customers for risk of fraudulent indorsement. There are a number of ways to do this.
First, we should instruct employees to carefully check ID's and signatures, possibly requiring a signature test or answers to some background questions about the check's payee. This could be difficult, however, given the large number of customers who are not well established in the community and who may not have legal identification. Second, we could invest in technology to allow our employees to quickly run a criminal background check on all customers. Third, we could provide a fee discount to repeat customers. This would both encourage their loyalty and reduce the risk of forged identification. Finally, in the future when it becomes economically feasible, we could invest in high technology anti-fraud devices like electronic signature machines.
This is another very low risk area for our company. There is a small potential risk of double payment if a customer, acting as a remitter, loses a money order and attempts to receive reimbursement. This threat can be minimized if we establish stringent policies towards lost instruments and hold funds in escrow until the threat has been reduced.
This section of our business is probably responsible for most of our negative image and most of the calls for public regulation. Because our customers are poor and the credit risks they present are high, we are forced to charge extremely high rates.
To mitigate the high risk of default and reduce these rates, we could attempt to secure some kind of collateral from our customers. This seems a unworkable solution, however, given the financial situation and general lack of assets of our customers. Furthermore, outside of opening a pawn shop (which would not present a good image for the company) there would be little economic way to foreclose on collateral given the small loan amounts involved.
The only reasonable way to reduce the credit risk of our customers is to improve screening. Regular credit checks will be of limited use since most of our customers can be assumed to have bad credit, but there are other options for reducing risk. We could reward repeat customers with lower rates to incentives them to pay and increase the number of reliable users in the future. We could also contact local employers and make arrangements to receive payments directly from them on pay-day. Finally, we could work to build personal ties with our customers in order to exert social pressures towards repayment.
Question 2, Answer 1
As bankruptcy trustee I first have a duty to ensure that E-buy regains solvency in order to provide the maximum benefit to creditors and its investors. Failing that, I have a duty to ensure that the creditors proceed in an orderly fashion and receive the maximum aggregate benefits upon liquidation.
There seems to be a legitimate possibility that E-buy will survive bankruptcy proceedings and satisfy the demands of all its creditors. Its current insolvency could potentially be a symptom of short-term cash-flow problems rather than a systemic long-term failure of business structure. The going concern value of the company, therefore, is likely substantially greater than its value upon liquidation. Once the company can prove its potential, the existing creditors could be invited to a workout session to restructure debt. With the relatively small number of creditors involved, and the threat of holdouts low, this is a very real possibility. To reach this stage, there are a number of steps I would take as trustee.
First, and most importantly, I would attempt to halt Zyzyx's efforts to lift the automatic stay on its collateral under §362(d) of the Bankruptcy Code. Without the ability to sell inventory at retail prices during the holiday season, E-buy would have little chance of surviving.
Zyzyx could not
the requirements of §362(d)(2) because the inventory is essential to
restructuring, and E-buy has substantial equity in the inventory under
cross collateralization plan. Zyzyx has a stronger argument that its
is not receiving adequate protection under §362(d)(1). After Timbers
Inwood Forest, Zyzyx could not lift the stay based solely on lost
opportunity costs in the collateral, but would need to show a tangible
Zyzyx would seem to have a strong argument in this regard, given the
demonstrated devaluation of outdated technology. Even if such a loss
proven, since the inventory is critical to E-Buys survival, it might be
company's interest to provide periodic cash payments to satisfy the
of adequate protection under §361.
Another source of short term capital for E-Buy would be access to the receivables held by the credit card companies under charge back disputes. Under the Truth in Lending Act (TILA) credit card customers have limited charge back rights. First, a large number of customers would seem to be disqualified because they are not located within 100 miles of E-buy. Courts have been increasingly willing to disregard the 100-mile requirement with internet transactions, however, essentially treating the merchant's location as the customer's computer. Even so, many of E-Buy's customers would still not have a valid claim because they may never have had rights against E-Buy. This issue would be resolved with contract law and would hinge on whether the consumers were given notice of the outdated technology or whether it was buried in fine print.
As trustee I would fight aggressively to protect Zyzyx's inventory and receive payment from the credit card companies. Even if the possibility of making E-buy solvent is low, there is still a strong option value for the owners. With very little to lose, there is no reason not to take a gamble and hope that the market turns around. If this gamble fails, as option-value gambles usually do, my next step would be to resolve conflicts between the competing creditors.
Because GI has a valid security interest in all of E-buy's assets perfected by an acceptably broad filing statement under §9-504(2), it will likely receive the greatest share of the bankruptcy estate. In fact, given the large amount that the investors loaned and the meager assets of the company on liquidation, GI will probably receive nearly all the company's assets at the expense of other creditors. There are a few potential exceptions, however.
First, under the Uniform Fraudulent Conveyance Act (UFTA), E-buy's creditors could bring a suit against GI for providing inadequate capital for the company. Under corporate law, a company's shareholders must abide by the "first in last out" rule and receive dividends only out of a company's equity. There seems to be evidence on either side, but if the creditors could prove that the heavily leveraged buyout by GI was the cause of E-buys failure, they could recover any profits that the company's shareholders illegally received.
Second, any recent acquisitions of inventory could be considered a preferential transfer for purposes of §547. Because GI's position was improved on behalf of antecedent debt while the company was insolvent, the transfer could be avoided. To determine the amount to set aside, the court would apply the two point improvement test under §547(c)(5) and compare GI's aggregate inventory value 90 days before filing with GI's position today, setting aside any gains accrued.
Finally, GI may have lost perfection on some of E-buys inventory because of the company's name change. First, the name change would need to have rendered the financing statement seriously misleading. Under §9-503, this would depend on whether it could be found using the search logic of the filing office, which seems likely with a manual filing system given the similarity of the names. If the name was seriously misleading, GI would become unperfected after four months for purposes of after acquired property under §9-507. Because 8 months transpired after the name change before GI amended its financing statement, any property acquired during that four-month window would not receive priority or other secured creditors.
Zyzyx's could first claim priority based on its purchase money security interest (PMSI). Although a PMSI will normally beat an earlier filed security interest, there are special rules for inventory under §9-324. In order to have priority over GI, Zyzyx must have notified GI when it took the interest (which there is no evidence of). Even with notice, Zyzyx will only be superior for cash proceeds received on or before delivery and would need to use E-Buy's records to trace cash proceeds back to its inventory.
The fact that Zyzyx had cross collateralized its inventory would not destroy its PMSI status. Although this would be an illegal arrangement in consumer transactions, under §9-103, this would likely be considered a reasonable agreement between the parties.
Zyzyx would also have priority over the installment contracts that it received from E-Buy. Because these contracts merged a security interest with a monetary obligation they would be considered chattel paper under §9-102(a)(11). As such, Zyzyx would have a superior interest to GI under §9-330 since GI claims the paper "merely as proceeds", so long as the paper was not marked by GI.
The court would almost certainly refuse to recognize Alpha and Beta's security interest, but would instead consider it a preferential transfer under § 547(b). The security interest qualifies as a transfer under § 101(54), was made for the benefit of a creditor on account of antecedent debt, and enabled the companies to receive more than they would have as unsecured creditors. As long as the transaction took place 90 days before filling, the security interest will be set aside.
Question 2, Answer 2
Even though the description of collateral in the financing statement complies with the requirement set forth by §9-504(2), it is doubtful that the description of the collateral in the security agreement satisfies §9-203(b)(3)(A). Certainly, §9-108(a) provides that a description of personal property is sufficient if it reasonably identifies what is described.
The description on the security agreement is borderline. The question turns out into whether the description of tangible and intangible reasonably identifies what is the collateral subject to the security agreement. General Investors (GI) would argue that it is a permissible description by category, despite the generality, and that in any event it reasonably identifies the collateral. However, as trustee would let the bankruptcy court decide this issue. There is no precedent on point and the text of the statute could favor us. There is enough at stake that it merits the court to define it. In addition to being extremely generic, the description does not perform the functions it was established for: it is difficult for creditor to identify the collateral and debtor cannot limit creditor's rights in the collateral.
If a change in debtor's name is seriously misleading §9-507(c) establishes that the filing ceases to be effective as to any new collateral acquired by the debtor after 4 months, unless a new statement is filed. However, §9-506(c) provides that if a later search under the debtor's correct name, using the filing office's standard search logic, would disclose the financing statement, the mistaken name does not make the financing statement seriously misleading.
Either under a manual or a computerized search using the standard search logic—no capital letter matter-, the name of the E-Buy would come out right. So the change of name did not make the financing statement seriously misleading.
If the bankruptcy court holds that security agreement is valid, GI has a perfected security interest in equipment, inventory, cash, negotiable instruments —checks-, accounts —credit-card receipts- chattel paper —installment contracts & security interest- and general intangibles —patent-. Nonetheless, the trustee would still have a claim against GI's security interest under §544 of Bankruptcy Code. Certainly, §544 allows the trustee to avoid transfers that could have been avoided under non-bankruptcy law by actual unsecured creditor. Article 4 of the Uniform Fraudulent Conveyance Act —most likely adopted in our jurisdiction— establishes that a conveyance made by a person who is or will be rendered insolvent thereby is fraudulent as to creditors without regard to its actual intent if the conveyance is made without fair consideration.
There is precedent on point. In a leverage buyout (LBO) transaction, the court in US v. Gleneagles Investment, invalidated a lender's security interest as a fraudulent transfer since the funds used "merely passed" through Target to Venture and ultimately to the shareholders of Target. The court also held that the note given was worthless since Venture had no assets different than the stock and it constituted a gratuitous transfer. The Third Circuit upheld this decision.
Even though there are differences in these cases, the trustee could make a plausible argument that GI was aware that E-Buy was being used by the venture capital fund to transfer funds to them and milk E-Buy leaving its creditors exposed. Knowing its financial statements, it would be reasonable to conclude that GI was aware that incurring in such obligation would leave the company vulnerable to insolvency. This position would be backed by the opinion of some industry analyst which considered E-Buy's LBO as the source of current financial problems and some others who deemed that the price paid for the shares was too high. Therefore, GI's security interest could be avoided.
In the Associated Sales Contract ("Contract"), Zyzyx retained title of the goods pending full payment by E-Buy. §1-201(37) establishes that the retention or reservation of title by seller of goods notwithstanding shipment or delivery creates a security interest. Therefore, Zyzyx has a security interest over inventory. Nonetheless, it is unperfected since it did never file a financing statement -§9-308-. In consequence, the trustee is senior to Zyzyx -§9-31 7(a).
As to the chattel paper —installment contracts & security interest-, Zyzyx has a perfected security interest, since it has taken possession of those contracts -§9-313(a) allows to perfect tangible chattel paper by possession-. Therefore, Zyzyx perfected security interest would be senior to bankruptcy trustee.
Despite that it is a perfected transaction, the trustee could avoid it as a preference under §547 of the Bankruptcy Code. However, we need more information to establish if it constituted a transfer of an interest of D's property made w/in 90 days prior to filing for bankruptcy —all other requirements of §547(b) are met-, or if such prerogative was already established in the Contract v7 and it was part of their ordinary course of business-§547(c)(2) exception-. Most likely the priority of Zyzyx on chattel paper would be declared void as a preference and the exemption in §547(c)(2) would not be applicable.
Zyzyx is not a secured party, therefore, it cannot ask for a lifting of the stay.
Alpha and Beta would have a perfected security interest in inventory —since they are suppliers, I assume it was the intention of the parties to grant security interest over it, it is not clear which is the collateral-. Alpha has actually disbursed funds and Beta promised to do so; hence, both of them have given value, and the collateral attached.
Nevertheless, bankruptcy trustee could avoid this transaction as a preference -§547(b)-. It is a transfer of an interest of debtor's property, to or for benefit of a creditor, on account of an antecedent debt, made while debtor was insolvent, made w/in 90 days of filing and it would give creditor more than it would get in liquidation.
The §547(c)(1) exemption does not apply since it is not a contemporaneous exchange for new value given to the debtor. The security agreement is covering the new and the outstanding loans. The outstanding loan does not fit into contemporaneous exchange for new value substantially contemporaneous. Furthermore, recognizing the exemption in this case would contravene the purpose of the provision: don't favor one creditor over the other.
4. Disputed charge s
Since E-Buy is already in bankruptcy
court, the claims about the credit card transaction could also be
asserts that it provided its customer with the required information and
disclose relevant information regarding the products it was selling,
there is a high probability that it can be established that the claims
Since E-Buy is already in bankruptcy
court, the claims about the credit card transaction could also be
asserts that it provided its customer with the required information and
disclose relevant information regarding the products it was selling,
there is a high probability that it can be established that the claims
In conclusion, it is difficult to determine whether the company should continue in reorganization or go to liquidation. It depends on (i) how well positioned is the 11 company's name and how damage it is; E-Buy seems a pretty attractive name, however, the extent of the damage is unknown; (ii) the sales; and (iii) the success in bankruptcy proceeding.
I advice for fighting in the bankruptcy court all the aforementioned claims, specially the one against GI, and then decide what is the best course.
Question 2, Answer 3
During the profitable holiday shopping season F-Buy should maintain business. Reorganization seems useful for businesses that are solvent in cash flow terms, but not on balance sheet (eg firm mistakenly expanded long-term assets in response to temporary perceived demand, now needs to downscale).
The facts that forced E-Buy into bankruptcy make a reorganization under chapter 11 seem possible. First of all, one of the main reasons that forced E-Buy into bankruptcy was a bank policy to increase fees and to delay credit card payments due to frequent credit card charge backs by consumers. These charge backs, based on returned consumer purchases, have no merit because sufficient disclosure of relevant specifications had been undertaken. Taking these factors into account, as well as the possibility for E-buy to reduce its overexpansion, there seems to be a realistic chance for E-Buy to continue its business after restructuring.
Promissory note is defined in 9-102(65) and perfected upon attachment. 9-309. This is the case because GI is major creditor and gave value (funding E-Buy's startup operations), it can be assumed that E-Buy has rights in collateral or at least power to transfer RIC, and the note was properly executed.
With regard to SI in other assets the requirements for attachment under 9-203 are also fulfilled. Perfection follows 9-308.
In the process of filing one has to observe 9-507c. Change in debtor's name is relevant when it seriously misleading under 9-506. 9-506b refers to 9-503a requiring that a registered organization be identified by the name indicated on the public record. This is not the case. However, 9-506c provides another exception by referring to standard search method used to find a debtor. Modern search logic will probably find the name change, thus name change is not seriously misleading. FS is effective despite minor errors. Amendment to FS is still possible. 9-512.
Scope of SI: The description of collateral is not specific enough to meet the requirements of a FA under 9-108, but does suffice a FS under 9-504.
- Because deposit account is a separate type of collateral, SA covering general intangibles will not adequately describe deposit accounts. Rather, SA must reasonably identify deposit accounts that are the subject of a SI, eg by using the term deposit accounts. > SI is not effective for deposit account held by bank.
provides that an after-acquired
property clause in a SA does not reach future commercial tort claims.
In order for
SI to attach, the tort claim must be in existence when SA is
addition, SA must describe tort claim with greater specificity than
"all tort claims". 9-108(e)(1). Claim for patent infringement and
unfair competition against Destiny.com is commercial is not covered by
According to 547 BC preference includes a transfer to or for the benefit of a creditor on account of an antecedent debt made while debtor was insolvent within 90 days of filing that gives C more than it would get under chapter 7. Signing security agreement covering outstanding unsecured loans counts as "transfer". The outstanding loans are antecedent debt. E-Buy signed the security agreement covering outstanding debts "recently", thus it can be assumed that he was insolvent (according to 547f BC insolvency presumed since July). A and B receive more than they would get under chapter 7 because now they are secured. However 547b BC refers to 547c: BT may not avoid transfer to the extent that such transfer was intended to be a contemporaneous exchange for new value given to the debtor and there was in fact a substantially contemporaneous exchange. E-Buy agreed to sign security agreement in exchange for additional credit, A lent funds under this arrangement, thus contemporaneous exchange was not only intended, but in fact given by A. In contrast, B has not given actual exchange, but B could fall under the exception of 547c(2) because the transfer was closely linked to the ordinary course of business. As a result, BT may not avoid the security agreement as a preferential transfer under 547 BC.
The case does not suggest actual intent to defraud or hinder. 548a(1)(A) Neither is there a fraudulent transfer. 548a(1)(B)(i) because security agreement securing an old debt counts as receiving value, thus E-Buy received equivalent value when signing the security agreement.
The fact that A gave E-Buy new funds does not create a PMSI since we are not told that E-Buy actually used those funds to buy new goods. Furthermore, the SA only covered old outstanding loans.
Bank has SI in deposit account that is automatically perfected. 9-104. Bank's SI has priority over all other SI. 9-327. Bank can exercise recoupment or set-off. 9-340, 9-341.
Based on the fact that the counterclaim against E-Buy's claim for patent infringement and unfair competition is not likely to succeed, E-Buy might end up as a lien creditor.
Under 9-327(3) Bank's SI takes priority over all other conflicting SI in the deposit account. 9-327(4) is not effective because there is no subordination agreement between bank and another creditor. Under 9-322a(1) GI has perfected SI in promissory notes and assets. Assuming that GI was the first creditor to file, GI has priority over Z' s perfected SI in installment contracts that are in his possession. Insofar as Z has an unperfected SI, his unperfected SI is also subject to GI's SI which are either perfected or at least earlier in time. 9-322(2), (3).
A and B have a perfected SI, but were the last to file and are therefore subject to GI's and Z's perfected SI. On the other hand, A and B's perfected SI has priority over unperfected SI GI or Z might have. In the event E-Buy wins its claim against Destiny.com, F-buy has a judicial lien which is subject to perfected SI, but has priority over unsecured SI. 9-317.
Petition for lifting
Relief from stay is possible under 362d BC. Z is a "party in interest' because he is a creditor and has a reasonable interest that the stay be lifted as soon as possible to prevent his goods from further depreciation. Z petitioned lifting of stay and has thus made a "request".
For lifting of a stay under 362d(1) there must also be a cause, which includes "lack of adequate protection" (defined in 361 to include cash payments, replacements liens or other "indubitable equivalent"). Without such adequate protection there is no cause to lift the present stay. Alternatively, a stay can be lifted under 362d(2), if the debtor has no equity in the property and such property is not necessary for reorganization. Since in the present case Z retained title to all goods sold to E-Buy, E-Buy has no equity in those goods (Z has burden of proof, 362g). However, assuming that the goods delivered by Z as main supplier of consumer electronic equipment are an essential part of the bankruptcy estate necessary for effective reorganization, Z's petition for relief can not be based on this ground.
With regard to the assets BT should try to sell off a significant amount of the equipment that is not needed to run the business on a smaller basis. Inventory — especially older items — should be sold off, if necessary even with small profit margins as long as there is any value left. Cash should be left on deposit and checks deposited with bank as well to ensure necessary cash flow. Same with credit card receiveables. Value of receiveables on computer installment sales program might be distributed among creditors. Patent on business model and computer algorithm should be maintained if business keeps going. Claim for patent infringement and unfair competition is unsure and should not be distributed, but kept on reserve.
Question 3, Answer 1
THE PROBLEM — SECURED CREDITORS VS. INVOLUNTARY TORT CLAIMANTS
I suggest the subcommittee focus its attention on an aspect of the UCC based entirely on unsound justifications: the priority given to secured creditors over involuntary tort claimants arising later in time. Currently as Article 9 stands, secured creditors (SCs) have an extremely strong position that allows them to win disputes involving conflicting claims to a debtor's assets even against involuntary tort claimants (ITCs). 9-201, 9-3 17. If a tortfeasor has enough assets to pay back all secured creditors with a sufficient amount left to settle tort claims, this should not present much of a problem. However, this is often not the case, and after secured creditors, who willingly entered into contractual relationships with debtors, have taken their share, little remains for innocent parties subjected to significant harm due to a debtor's breach of duty.
The definition of a lien
creditor found in 9-102(52) has substantially the same meaning as the
definition in pre-revision 9-301. See comment 20 to 9-102.
that despite ample academic criticism, little has been done to improve
situation. Perhaps the lack of a solidified lobby has stalled effort
reform. As no ITC knows ex ante that she will become a victim, there is
incentive to advocate for her prospective rights. This problem is
exacerbated by the fact that ITCs are often very diverse from each
collective action and resource pooling near impossible. Additionally,
already monitoring debtors to a certain extent to protect against
etc., are in a much better position than ITCs to monitor against a
I would propose the following changes:
Carve out a definition
of involuntary tort claimants from 9-102(52)
There is substantial difference between ITCS and other lien creditors to have distinct definitions.
Option 1 - Tort
claimants always have priority
Depending on the willingness of SCs to lend if they know they will be subordinate to ITCs the UCC might provide absolute priority to ITCs.
Option 2 — SCs
have priority, but become liable to TCs
Perhaps a compromise would be to allow SCs priority so that they could continue to collect payments and interest during lengthy judicial proceedings, but then allow ITCs to recover from SCs as well as debtors. Of course SCs would be extremely wary of this, but it would probably incentivize monitoring of debtor's behavior.
Option 3 — 1 to
1 disbursement of funds
Neither SCs nor ITCs have priority, but take as equals with disbursement of payments on a 1 to 1 basis.
Option 4 —2 to 1, etc.
Alternatively, allow SCs to take payments at a higher rate than ITCs, e.g. 2 to 1, etc.
5- SC priority over ITC does not apply to AAP
Allow SCs to keep a priority in initial assets, but allow ITCs to have priority in any after-acquired property.
Empirical Data that would help to determine whether or not this issue requires legislative reform might include:
1. The frequency of tort
claims that recover
nothing due to prior SCs
a. Judicial records
2. The actual ability of
SCs to monitor
a. The subcommittee could survey typical secured creditors, task research groups to measure what is needed to monitor and whether or not SCs have such resources, etc.
1. Willingness of SCs to
lend if ITCs have
a. Again a survey of SCs or perhaps a test state before proposing enactment nationwide.
2. Average tort
a. Canvass recent tortfeasors to determine amounts paid. Search judicial records.
Question 3, Answer 2
In UCC § 1-103 and the accompanying comments, the drafters state their intent of making the UCC a flexible document that is adaptive to changing times without the need of frequent amending. This is accomplished partially through the structure of the document and partially through the twin fall back safety nets of liberal judicial interpretation consistent with this goal and partially by permitting the use of pplemental legal principles to support the UCC's purposes. Flexibility, of course, is not a goal in itself but has value only if it contributes to the promotion of some useful value, e.g. (a) efficiency and(b) an opportunity for equitable negotiations among commercial actors. Is the UCC efficient in the way it allocates information or monitoring costs, and does it create circumstances where parties can bargain fairly? If so, then presumably they can create value through Pareto-improving transactions and then negotiate for the gains from efficiency in an equitable manner.
While the UCC is admirable in its structure, there is one tradeoff which seems both inequitable and inefficient, and that is the fact that judicial liens are subordinate to perfected security interests. If we assume that one of the goals of tort law is to force actors to intemalize the costs of their actions, promoting efficient decision making (i.e. decision making that accurately includes the costs of a particular course of action) will promote the efficient use of resources and, ultimately, cultivate the fruits that tantalized the UCC. Under 9-317(a), however, a judicial lien is simply another security interest, one which may have no value if all of an actor's assets are already covered by a previous security interest. This scheme, while promoting certainty, carries with it a kind of perverse incentive: the cost to the debtor (for example, a corporation) of engaging in potentially harmful behavior is reduced, possibly substantially, and when the price of something drops, all else being equal, the rational actor consumes more of that thing. Other schemes have been suggested such as, for example, privileging tort victims. If the UCC elevated the priority of a judicial lien, this might encourage the commercial actor to be extra careful in his business. Of course, he or she might purchase too much safety, at the cost of capital to grow his or her business.
It might be useful first to see if this is really a problem. Is tort protection really a reason for granting security interests in one's property? The price elasticity of demand for reckless behavior is observable, at least indirectly, through the response of similar businesses in different regions to different kinds of insurance, and that might be one way to determine whether businesses, if they did engage in this behavior, would overreact or simply behave more safely. Regardless, this priority rule sticks out among the other rules as one that might warrant closer scrutiny for future revision.
It might also be interesting to have a scheme where priority was determined among similarly secured creditors randomly. In this way, arms-length dealers could bargain for the risk of leaping to the back of the queue if the debtor became insolvent while judicial lien holders would have a chance of being first in line but neither party would have much incentive to behave opportunistically since any effort spent would be lost, but the outcome of such behavior would be uncertain.
Question 3, Answer 3
The drafters of the recent amendments to Article 9 chose to maintain minimal filing requirements under §9-502, requiring only the names of the parties and an indication of collateral. Furthermore, §9-504(2) sets such a lenient standard for indication of collateral that almost any generic description is enough. The PBB needs to examine these filling requirements to determine whether they provide the most efficient level of information.
Comment 2 to §9-502 states the general policy for adopting such a lenient filing requirement. It states that the section only seeks to provide "notice filing" to creditors, at which point they would need to inquire further to learn what goods of the debtor are covered.
There are number of potential problems with the idea of notice filing. First, it can be extremely costly for creditors to find out the needed information, especially in complicated situations involving numerous secured creditors. Second, the code provides little assistance to creditors seeking information. In order to gain a detailed account of the collateral, a creditor can seek information from secured creditors directly, but these creditors will likely be unwilling to provide assistance, both for lack of time and because they have an interest in junior creditors providing capital to their debtor. A creditor's only other option is to ask the debtor herself to request information from the creditor under §9-2 10. This is not much help either. A debtor in a desperate situation could simply lie about her security agreement, or if the party seeking information holds a judicial lien and is not a potential creditor, the debtor might refuse to act at all.
Because the process of finding information is so costly even after a creditor has been put on notice, there is anecdotal evidence that many creditors have simply stopped using the filing system. I propose the PEB devise a study to determine how often creditors actually search the filing system.
If it turns out that use is very low, one option would be to eliminate the filing requirement altogether. This would eliminate much of the litigation arising from disputes about filing, and would substantially reduce the administration costs. Creditors would need to simply ask potential debtors about any superior security interests, which would not present much more risk than relying on debtors to provide information under §9-2 10.
A second option to combat low use of the filing system would be to increase the information required at filling. PEB should commission a second test to determine whether an increase financing statement information would have an effect on creditors' willingness to search. Since convenience and speed would likely be factors, this study could be combined with the new technology allowances under 9-516(a) and 9-102(a)(69). Researches could poll relevant creditors to see how receptive they would be to a searchable electronic database with full information in the filing statement. Furthermore, an empirical test could be provided on a limited scale in a willing state.
Finally, even if creditors were more likely to use a system with more information, the overall costs and benefits of the plan would need to be studied. Increased information would have a number of apparent benefits. First, creditors could lend at lower interest rates since they could be assured of accurate information about prior security interests. Second, the market as a whole will be better able to gauge a company's financial status.