Fall 1999 final exam (Sales and Secured Transactions)
Top student answers
Note: These were among the best answers received under examination conditions.
They are not model answers, in that they all contain extraneous material as well as
omitting useful information. Some even reach incorrect conclusions. However, they all
provide intelligent, organized, approaches to the questions.
Question 1: Top answer #1
The transaction between the Vogts (V) and Buehls (B) is a sale of goods and therefore is
subject to Article 2 of the UCC. While the use of Damask as a stud may be a service
contract, the transaction between V and B is for the sale of the horse or an interest in
the horse. A horse is a "movable" thing which is identifiable and therefore is a
good under 2-105(1 ). 2-105(3) states that a sale may be of a "part interest"
and so the sale for one-half interest is subject to Art. 2.
The Vogts should be considered merchants with regard to the sale of a one-half interest in
the horse, Damask, according to the definition of a merchant as supplied by 2-104(1). They
were experienced in breeding and selling horses and held themselves out as such. The B's
are not merchants. It is questionable whether or not the B's are merchants. They are just
entering a business and are obviously novices with regard to the equine industry. It may
be argued that while they may not be held to merchant standards with regard to the sale
and breeding of horses, they may be given merchant status with regard to certain
procedural requirements which do not require special knowledge as to horses, but only to
general business practices. Since the B's are novices, and there is no evidence that they
have other outside business or business V experience, I will treat them as non-merchants.
This status will affect the terms of the contract between the two parties and their
interaction.
The V's offered to sell a one-half interest in Damask. B accepted. The parties obviously
intended a contract. Since the agreed price of the horse is over $500, there must be a
writing to meet the Statute of Frauds and the parties signed a partnership agreement. Both
writings contain the elements of the bargain and should be used together to determine the
terms of the contract.
Five months after the contract, the B wanted to get out. To get an remedy at all, B must
be able to show that the horse was non-conforming. To non-conform, the horse would have to
not meet the warranties either expressly or impliedly included in the contract for sale.
The contract for sale attempted to disclaim "all warranties express or implied,
except the wwarranty of title." Since we are not given any more information, I will
assume that this is the language as it is found in the actual contract. The issue is
whether this language is an effective disclaimer .
Disclaimer of warranties is governed by 2-316. Express warranties can not be disclaimed,
one can only work to not create one. Implied warranties may however be disclaimed.
It is likely that all three warranties - express, merchantability and fitness for a
particular purpose apply here.
Express:
The only evidence of an express warranty in the contract is the warranty of title. That
is not at issue here. . We are more concerned with the use of the horse as a stud. The B
would want to be able to introduce the statements made by V regarding the horse's
abilities for winning competitions generation of stud fees and producing valuable foals.
Since the parties put the contract in a writing (actually two) it is arguable that these
statements are parole evidence and should not be admissable. There is no evidence of an
integration clause stating that the writing embodies the final expression of the parties.
Since it is a fom contract, however, it is likely that it is included and so we must work
to get around it. We are give no information that the contract makes any representations
about the horse, V's statements prior to the sale can not be contradictory. The only thing
according to our available facts that the statements may contradict is the disclaimer of
an express warranty. 2-316 states that negation of limitation of express warranties is
inoperable to the extent that such construction is unreasonable. B would have to prove
that these statements in fact created express warranties. That they were affirmation of
fact which were made a part of the basis for the bargain. The B are unknowledgabel
regarding horses. Although reliance is not necessary for an express warranty, proof of
reliance may be used to show that the statements were in fact a basis of the bargain.
Merchantability:
Since V is a merchant, there is an implied warranty of merchantability under 2-314. 2-314
lists ways in which the horse may not conform. The way that best fits here is "pass
without objection in the trade under the contract description" or "fit for an
ordinary purpose." It is likely that a lame and ill horse would not pass in the
trade. The disclaimer was not effective because it does not mention the words
"merchantability" and since it is in writing, it is required to be conspicuous.
We are given no information to that effect so I assume that it was not conspicuous and did
not include the term "merchantability" both of which would be required under
2-316.
Fitness for a Particular Purpose:
V had knowledge that B was purchasing an the horse to be used as a stud. V owned the barn
where the horse was being housed and had been schooling B in the care of horses. V also
knew that B had little knowledge with regard to horses and was relying on the skill of V
in purchasing Damask. B had previously relied on V's advice in not buying Prolix. Since V
had knowledge of both these things, there is an implied warranty of fitness for a
particular purpose under 2-315. This warranty may be disclaimed but must be in writing and
must be conspicuous under 2-316. The disclaimer was in writing but we are given no
information that it V was conspicuous so I will assume that it was not and has not
effectively been disclaimed. Certainly, a horse that is lame and dies shortly thereafter
breaches the express warranty that he was a champion that was capable of winning national
titles again and was capable of earning stud fees of $20,000. (B should have been on
notice that this was unreasonable and this could possibly be considered puffing given the
price paid by B for the horse - only $16,000. However, since B is only buying a 1/2
interest - it is arguable that this price is an accurate reflection of his interest of a
horse with those capabilities and therefore should not be considered puffing but actual
warranties to a buyer with such limited knowledge. )
A horse that is lame at the time of sale, is likely to not be merchantable and would
therefore be non-conforming. While a lame horse could probably technically still do the
activities necessary of a stud horse, he would still be ineffective because stud horses
are chosen because of their reputation for health and other things. A lame horse is not
good to anyone and would be evidence of disease and bad bloodlines and would therefore not
be a suitable stud. So the horse would also breach the warranty for a particular purpose -
stud horse.
To determine what remedies are available, we must first determine whether the B accepted
the goods (the horse ). The horse continued to be boarded with the V so B never actually
took the horse anywhere. We are not given facts to tell us if the B did acts which would
be inconsistent with V's one-half interest. Since both V parties have equal interests in
the horse and share the costs of upkeep and we are given no evidence stating that B
refused to pay for upkeep or that B rejected the horse upon inspection prior to this
point, it is likely that B accepted the horse.
B would have to reject within a reasonable time under 2-602. It is likely that 5 months is
not a reasonable time for rejections. B's best argument would be that because he is a
novice, he could not effectively inspect the horse (which he is guaranteed under 2-513)
until the 5 month period because he did not have the wherewithal to make a valid
inspection until he dealt with the horse regularly. This argument will probably not be
accepted though and so B will not be able to reject the horse now. If B could reject, he
could return his 1/2 interest (in a not dead horse) and get his money back. This is not a
likely outcome.
Because the V are merchants, they are held to a higher standard under the UCC. 1-203
requires all parties must bargain and act in good faith when engaging in transactions
subject to the Art. 2. Good faith for a merchant requires honesty in fact and reasonable
commercial standards (2-103( 1 )(b ) ). V's failure to disclose Damask's prior medical
problems is evidence that V did not act with honesty in fact in the transactions with the
Bs. This may be another reason for B to be able to recover. And if B can not reject, may b
e a reason for B to revoke acceptance under 2-608 as an inducement to accept based on the
seller's assurances. If B can revoke acceptance, he can get back the money paid under the
contract the $16K.
If B can not revoke or reject, he can argue money damages. The difference between the
horse as warranted - a health champion - as compared to a sickly lame horse and collect
the differences. 2-714. B may also be able to recover his incidental damages under
2-715(1) for the amounts he paid for the upkeep when the horse was alive but will probably
be unable to recover consequential damages like lost stud fees and possible fees for foals
which are difficult to prove.
There is another issue as to who should bear the risk of loss. Generally, the buyer does
not bear the risk of loss until the goods have been delivered to him. Here the goods are
in the hands of a bailee - the farm and delivery is made without moving the goods. We are
not given evidence as to whether a negotiable document was transferred evidencing the
change of title. It is likely that the B and V both realized that the goods and the title
was in both person's names now. Both parties as owners could be responsible for the loss.
It makes more sense for V to bear the risk of insurance and for B to have to pay him for
1/2 the cost of insurance. Since V has several horses and is knowledgeable, it will be
easier for him to get the insurance than for B who has only one other horse and no
knowledge about the trade.
Recommendations for B - sue and try to get V on a breach of warranty. Be realistic and
don't expect the full contract price. If the horse had been insured, he may have been
worth more than $32k (the value of the horse - 1/2 interest = $16K). B should be entitled
at minimal to the difference between a healthy horse and the lame horse he got, plus any
incidental expenses he paid for upkeep and medical care. He could sue and try to get
completely out of the contract though.
Given V's bad faith in the deal, the court may be more likely to consider this option. I
don't think it is possible to argue that this is unconscionable since there are no extreme
terms or hardships. One should note that the horse did not die from anything that was
obvious when the horse was sold, and V should not be held liable for the complete loss of
the horse - only the differences as warranted .
The sales contract was a standard form contract.
Question 1: Top answer #2
First, before I can give the Buehls any concrete advice, I must determine whether the
contract falls within Article 2 of the UGG, so that application of those rules to the
issues will be proper. For years, the Buehls and Vogts seemed to have a service contract,
in which the Vogts provided the services of teaching the Buehls how to ride and handle
horses. Those services would not be covered by the UCC. The contract at issue, however, is
somewhat of a mixed contract, involving both goods and services. It involves services
because, under the agreement, the Vogts continued to board Damask (and presumably, to feed
and generally care for him). The contract also involves the sale of goods, however, as
Article 2-105 says that goods include all things movable at time of identification to the
contract for sale, and which can include animals, such as Damask here. Under the
predominance test, although services involved, this is primarily a sale of goods. The sale
of a share of Damask was the reasont the Buehls entered the contract and made up the
majority of the deal. Thus, Article 2, in fact, applies to the transaction.
I would advise the Buehls that, indeed, the Vogts have a number of defenses on their side,
though probably not enough to defeat the Buehls' claims. To understand why that is the
case, however, it is important to carefully examine the claims and the defenses that would
go to support the Vogts, and any counterclaims they may have.
To begin with, the Vogts will claim that the express terms of the written contract control
the agreement, and that, under those express terms, they have a valid term that disclaims
all warranties, express or implied (except the warranty of title ). As support for their
argument, the Vogts will claim that, as the situation is described in section 2-202, the
writing was intended as a complete and exclusive statement of the agreement. They will
also claim, that even though it was intended as a complete and exclusive statement of the
terms, in any event, the contract can be explained by trade usage (any practice or method
of dealing having such regularity of observance in a place or trade as to justify
expectation that it will be observed with respect to the transaction in question, see
1-205).
They will claim that, clearly, the trade usage is to disclaim all warranties except for
the warranty of title. Their proof of this trade usage is the fact that the disclaimer
itself is printed on a form provided by an Ohio trade oraanization.
Anyone involved in this organization would use the disclaimer. Additionally, the
disclaimer was used for a deal made in Ohio--the place of the trade usage. Furthermore,
the Vogts will claim that the Buehls should have been aware of this V trade usage because
they had been involved in the trade for over two years--plenty of time to familiarize
themselves with the common bases of deals in the industry (and under 1-205(3), even if the
Buehls did not in fact know of the trade usage, if they should have been aware of it, that
is enough to hold them to the standard).
Once the Vogts have laid out their claim that the express terms control the agreement, and
that the express disclaimer was a valid usage of trade explaining the agreement, they will
further claim that the Buehls accepted the terms of the agreement. They will claim that
they accepted (as that term is defined in section 2-606) by signifying to the Vogts that
they accepted and by failing to reject the goods (i.e. Damask). The Vogts will also
demonstrate acceptance by showing that the Buehls took on some of the responsibilities
that arise as effects of acceptance under 2-607. Specifically, the Buehls paid the $16,000
for the goods.
Because the Buehls accepted the agreement, the Vogts will claim, also as provided in
2-607, they were barred from rejected them. Thus, their statement that they were
"dissatisfied with the partnership" served no legal purpose. The agreement
stood, and the Buehls remained joint owners of Damask when neither owner renewed his
insurance, and when he died. As joint owners, the Vogts will claim that the Buehls were
jointly liable for not having renewed the insurance and, in fact, the Buehls owe them
money for their loss.
Although many of these claims by the Vogts may seem plausible, I would advise the Buehls
that they can probably defeat most, if not all, of the Vogts' arguments. To begin with,
the contract on which the Vogts rely, and which they claim is a complete integration of
the agreement, in fact, is not a complete integration. Proof of that is the fact that
there were 2 writings involved in this agreement--the one with the disclaimers, and the
partnership agreement. Because both were essential to the transaction, by definition,
neither could have been intended as a complete and exclusive writing. Also, as to the
Vogts' arguments about trade usage (which, I agree, in most situations can supplement the
transaction whether or not the writing is intended as a complete and final integration),
in this context, it is inappropriate for the trade usage to explain the transaction. Under
section 1-205, it is true that trade usage applies to all parties who should know about
it, but here, the Buehls had no reason to know of such a practice in the trade. They were
novices to the industry, and two years can hardly be considered long enough to become
familiar with such a specified practice. This was there first sale in the industry, and as
such, they had never encountered such a disclaimer before. The Buehls had always relied on
the Vogts for knowledge in the trade, and with the Vogts not bringing to their awareness
such a trade usage, they did not, and had no reason to, know if its existence.
Second, even if the writing had been a complete integration, the disclaimer contained
within it was not valid to disclaim the implied warranty of merchantibility and implied
warranty of fitness that accompanied this transaction. Clearly, the Vogts are merchants,
as "merchant" is defined in section 2-104(1 ) (a person who deals in goods of
the kind or otherwise byoccupation holds himself out as having knowledge or skill peculiar
to practices or goods involved in the transaction). Even if the Vogts did not regularly
deal with horses (i.e. they didn't normally sell a half share in their horses ), they had
extensive experience in horse v training, breeding, boarding, and showing, and they are
even members of a horse breeders association. As merchants, under section 2-314, a
warranty of merchantability (which states that the goods must be fit for the ordinary
purposes for which they are used) is implied in every contract for sale, unless properly
disclaimed.
According to section 2-316, for an implied warranty of merchantability to be properly
disclaimed, if the disclaimer is in writing, it must be conspicuous and must mention the
word "merchantability." The disclaimer here simply disclaimed "all
warranties express or implied," but did not specifically mention the warranty of
merchantability. It is also questionable, even if it had mentioned merchantability,
whether the disclaimer was conspicuous. Thus, the disclaimer as to merchantability was not
valid, and the implied warranty of merchantability underlying this transaction still
applies.
Also, even if the Vogts somehow succeed in convincing a court that they are not merchants,
an implied warranty of fitness underlies this transaction and also was not properly
disclaimed. Under section 2-315, an implied warranty of fitness is create where the
seller, at the time of contracting, has reason to know of any particular purpose for which
the goods are required and that the buyer is relying on his skill or judgement in the
sale. Here, the Buehls had been relying on the Vogts for their knowledge and judgement
about horses for two years. The Buehls had even relied on the Vogts' judgement just a
little while earlier in deciding not to purchase a different horse. In that previous
context, the Buehls had talked to the Vogts about the horse they wanted to buy for
breeding purposes, and it was in that context that the Vogts offered the sale of Damask.
Because the context can supplement and explain the agreement (under 2-202, this is not a
complete integration, and the context, as an additional term, is consistent with the
agreement), it can be presumed that the Vogts made the offer for sale knowing that the
Buehls wanted to buy Damask for breeding purposes, and that the Buehls were relying on the
Vogts judgement that Damask would sufficiently serve the purpose.
Like the requirements for disclaiming an implied warranty of merchantability, section
2-316 requires that a warranty of fitness be disclaimed in writing and conspicuously.
Although the disclaimer was indeed in writing, it is questionable whether it was
conspicuous, and as the Buehls never took explicit notice of it, we can presume it was not
conspicuous. Thus, the Vogts also did not disclaim their implied warranty of fitness, and
that warranty still underlies the transaction.
In this situation, both the implied warranties were breached, and as such, the Buehls are
entitled to appropriate damages under 2-714 and 2-715.
The warranty of merchantability was breached because the usual Damask was not fit for the
ordinary purposes for which he would be used. That is, he was not fit to be in shows or
win show titles. The warranty of fitness was breached because, as discussed above, Damask
was clearly not in the shape necessary for breeding purposes.
Before calculating damages, however, it is necessary to recognize the Buehls' further
counters to the Vogts' claims. The Vogts claimed that the Buehls accepted all the terms of
the agreement, accepted the goods, and as such, could not reject them. On the contrary,
however, the Buehls did not accept. Under 2606(b), the Buehls did not fail to reject the
goods--that is what they did when they said they were unhappy with the partnership, and
stopped living up to their part of the bargain (i.e. by not getting more insurance for
Damask). A few months was definitely reasonable time for the Buehls to wait to reject
under these circumstances of the horse residing with the Vogts, and their (the Buehls) not
having as much contact with him (or as much experience to understand his true condition)
as the Vogts.
Furthermore, even if the Buehls had accepted the goods, they legitimately revoked their
acceptance under section 2-608. Because Damask could not be used for breeding purposes,
his non-conformity substantially impaired his value to them. Also, they had good reason
for not rejecting in the first place, as they had relied all along on the Vogts' advice,
and the Vogts' assurances that Damask would conform to their needs. Second, revocation was
within a reasonable time. It is reasonable that it took a few months for th Buehls to
discover the problems with Damask and to realize that he would not meet their needs. Thus,
under 2-608, because at a minimun the Buehls properly revoked their acceptance, they had
the same rights they would have had as if they had rejected Damask in the first place.
Furthermore, underlying all of these problems is bad faith on the part of the Vogts. Under
section 2-103(1)(b), good faith in the case of a merchant means honesty in fact and
observance of reasonable commercial standards of fair dealing in the trade. Here, the
Vogts were neither reasonable nor honest.
They knew all along that the statements they made about Damask, which went into the
Buehls' decision to form the agreement (therefore forming an express warranty, which may
or may not have been properly disclaimed) were false. Whether or not they constituted
express warranties, the Vogts had bad faith in entering this agreement, and should be held
accountable for that conduct.
Under section 2-714, the Buehls are entitled to damages for the breach of warranties.
Specifically, they are entitled to the difference between what Damask would have been
worth if he had been as warranted ($16,000 cost + $10,000 for each of the foals he could
have produced) and what he was actually worth at acceptance ($0, as he soon died
thereafter without bringing in any money). Additionally, the Buehls are entitled to any
incidental and consequential damages, which may include what they spent on care and
feeding of Damask, possibly what they will lose for having to go out and cover (buy a new,
possibly more expensive horse for breeding), and any reasonable attorneys fees.
Question 2: Top answer #1
Deere is probably going to come out the winner here, depending on how rapidly the value of
motor homes depreciates. Deere has a perfected S/I in the Coach as of June 1997 because of
its compliance with the FL statute under 9-302(3)(b). When Gramm transferred the Coach to
Sunshine, Deere retained its interest in the Coach because it did not consent to the
transfer and Sunshine is not a BIOC (because Gramm is not a motor home dealer). Deere also
obtained a continuously perfected S/I in Gramm's new motor home as "proceeds" of
the transfer. Deere will run into trouble here, though, because of the action of the FL
statute. It will not be allowed to file a financing statement (within the ten-day grace
period) to continue its perfection after the ten-day period. However, because no one else
has a claim against the new motor home in Gramm's hands, the fact that Deere's S/I becomes
unperfected might not stop it from declaring Gramm in default and repossessing the new
motor home.
Also, Deere probably maintains its perfected S/I against the Coach in Norman's hands.
Ordinarily, Deere would lose to CS Bank in a priority battle because CS Bank's S/I in
Sunshine's inventory (of which the Coach was a part) was perfected in 1996, before Deere's
was in June 1997. Deere's Purchase Money status might defeat CS Bank's interest in the
Coach if it were still in Sunshine's inventory (although that seems to go against the
purpose behind giving PMSI's "super-priority," Deere's financing of Gramm didn't
help Sunshine's business), but the Coach is in the hands of Norman, a BIOC. Norman's BIOC
status (good faith purchase from a merchant, exchanged value for title) defeats CS Bank's
S/I, but it does not defeat Deere's S/I under 9-307(1)(b). Because Sunshine was not a
BIOC, Norman's BIOC status is irrelevant as far as Deere's S/I is concerned. The S/I
follows the collateral into his hands. So, unless Norman can come to an agreement with
Deere, Deere can foreclose on the Coach and use the proceeds from its sale to satisfy the
loan. Deere can therefore satisfy its loan from both Norman and (probably) Gramm. If one
or the other is insufficient to satisfy the $144,000, it can probably foreclose and sell
both motor homes, returning whatever surplus proceeds there may be (though how they would
be divided I have no idea).
The one thing that could get Deere into trouble is its acquiescence to the sale of the
Coach to Norman. Silence may be seen by a court as consent, but because its S/A was with
Gramm and not Sunshine, perhaps Deere didn't feel that it was in a position to object to
the sale. There is no indication that it knew Gramm had sold the Coach to Sunshine until
it discovered the sale by Sunshine to Norman, at which point it would have been fruitless
to attempt to recover from Sunshine. However, if a court finds Deere's silence to equal
consent, it would lose its S/I in the Coach once it was transferred to Norman.
However, it would still have a perfected S/I in the identifiable cash proceed that was
paid to Sunshine. But, again, it would lose this battle to CS Bank because of the first to
file or perfect rule unless it can establish that it retains its Purchase Money
super-priority over the identifiable cash proceeds received by Sunshine at the time of the
sale. I'm not sure which rules would apply in this situation because the Coach started out
as non-inventory, but became inventory after the unconsented transfer. I think the court
should deny the PM super-priority, because the policy behind giving PM super-priority
would not be served in this case.
The trustee will lose a battle for the costs to Norman because the transfer was made
contemporaneously for new value, and it would lose to CS Bank or Deere because of their
perfected security interests. However, it will defeat the controlling shareholder and be
able to avoid the transfer of funds to him because it was on account of an antecedent
debt, etc. under §547(b).
Norman is probably the big loser here because he is likely going to end up owing money
to both LC Credit and Deere. His claim is against bankrupt Sunshine and will only get a
priority share of what the trustee can collect, which won't include Sunshine's inventory,
which is subject to CS Bank's perfected S/I.
Question 2: Top answer #2
Attachment and Perfection
Deere (D) attached in regard to Gramm (G) signing a security agreement and a consumer loan
(9-203). In fact, Deere has a Purchase Money security interest under 9-107 and perfected
under 9-302(3)(b) since state statute says he can perfect by putting home on certificate
of title. (9-302(1)(d) does not apply here since there is a state statute exception.)
When Gramm entered into agreement with Sunshine Motors (SM) and delivered the Coach to
SM, SM became a debtor to Gramm, since there are no facts as to whether SM delivered the
new coach to G. In any event, it can be safely said that Gramm at least entrusted her
interest in the Coach to SM (a dealer of goods of that kind) under 2-403. (At least as to
her interest, not Deere's interest in the car since she cannot give what she doesn't
have.)
Lender's attachment under 9-203 will depend on Norman's status with the good because
although it signed a security agreement with Norman, and value was given, Norman's right
on the collateral is somewhat dubious: 1.) Norman wins against Gramm under 2-403 because
she entrusted the goods but as to value of car with security Norman is a buyer in ordinary
course, that is, it was bought from the dealership; 2.) Under 9-306(2) Norman loses to
Deere's claim on the security interest, and Deere can still go for collateral; 3.) Norman
loses against D under 9-307(1), since SM didn't create the security interest; 4.) Norman
loses against D under 2-403(2) since GMAC didn't entrust the car to SM; 5.) Norman wins
against D under 2-403(1) but security interest might still be there since SM couldn't give
what it didn't have (a car free of security interest).
So as to Lender's attachment it did attach to G's interest in the Coach, but was
subject locally to D's security interest. Moreover Lender didn't perfect
didn't even bother to investigate. The presence of a lien-holder's name on
certificate of title is likely to be enough notice (and UCC thinks so under 9-302(3)(b)).
Thus because Lenders never perfected, Lenders (L) is an unsecured creditor as to its
position with D.
Citrus Bank obtained a security interest in and filed a financing statement for
Sunshine's current and after acquired inventory. Now is the Coach inventory? Under 9-109,
it is. 9-204(7) determines priority (which is this case doesn't apply since security is
already perfected and no future advances). Nonetheless, let's remember that Deere has a
perfected security interest (PMSI) under 9-302(3)(b). (The part where it says that the
perfection provisions of the article 9-302 applies when collateral held in inventory
doesn't apply since Gramm is not the person who is holding the Coach for sale). Since the
PMSI was on consumer goods, not in inventory (it was for Gramm's household or personal
use), 9-312(4) imposes a super-priority on D's claim. Thus D trumps over Citrus.
Bankruptcy
Can BT avoid any of the transactions under §547? The strong arm BR statute 541 and 551
could give the bankruptcy trustee some leeway in getting back some property in the
bankrupt statement. Bankruptcy trustee (BT) can avoid the transfer to the unsecured
shareholder if such transfer was made within one year of the filing for bankruptcy
shareholder is an insider (they are given info about the company on a quarterly basis).
All element of §547(b) are present.
Since BT acts as a lien creditor (541 and 551) BT will not be able to avoid D's
security interest claim. Only claim is from Lenders, at least it seems, since Lenders is
unsecured, they will have to get money from the state pro rata. Can SM BT avoid transfer
of property to Norman? No, they were properly paid for Coach, even though they were not
the owners.
If SM actually gave a Monaco Home to G, can it avoid the transfer? If it was within 90
days of bankruptcy, yes, although I believe that G will become a creditor who will also be
paid pro rata. Deere will most likely have a security interest in the Coach now owned by
Norman.
It wouldn't make a difference whether it were a consignment under 2-403; there was an entrustment of goods on the part of G, not D. Yet, 9-104(f) might get it out of Act 9 scope.
Question 2: Top answer #3
In order to determine who has priorities in what, first we need to figure out what status
each of the parties has. First, Norman, under 9-307(1) is a BIOC and takes free of a
security interest created by his seller. Citrus holds perfected securities interest in the
Coach because, although 9-302(3)(b) says that when collateral is held as inventory for
sale by a person in business of goods of that kind (and Sunshine is), the filing
provisions apply to the collateral, Citrus would have filed because of their S/I in
after-acquired property (inventory) and it would state inventory as collateral. That would
cover this motor home that Gramm traded in to them. Deere holds a perfected S/I in the
Coach under 9-302(2)(d) which states that you must file a PMSI in consumer goods if it's a
motor vehicle and 2-302(3)(b) says you don't have to file if state law compliance requires
something else to perfect. Here the state law says putting name on title as lienholder is
the only way to perfect and Deere put their name on the title in compliance with state
law. Thus Deere is perfected. Lenders Capital Corp is unsecured as to the motor home. The
facts only state that lenders gave the money for Norman's purchase to Sunshine and didn't
investigate any other S/I in the Coach, but the facts don't say that Lenders took an S/I
in the Coach from Norman. Sunshine has an interest in the coach also since it sold the
Coach to Norman via conditional sale. Since a Purchase Money S/I in consumer goods
perfects automatically (9-302(d)) except for motor vehicles and Sunshine didn't file or
comply with state law by getting on the title (Deere is still lienholder on title) they
are unperfected. Now, to determine who has priority in the Coach. Norman as a BIOC would
have priority in the Coach over anyone his seller (Sunshine) created an S/I with. Thus,
Norman has priority over Citrus (as AAP inventory lender). Norman also has priority over
Lenders because they did not take back a security interest when they financed it. As
between Deere and Citrus both secured parties 9-312(3) controls because
Citrus has a PMSI in inventory. Under 9-312(3) Citrus was perfected at the time debtor got
the collateral (filed his statement in 1996 re: AAP/inventory) but he did not give notice
to the holder of conflicting S/I (Deere) at all. The section 312(3)(b) requires the holder
of prior interest to have filed covering the same inventory, but as discussed earlier,
9-302(3)(b) relieved the filing requirement. So, because Citrus didn't notify Deere, Deere
wins the priority battle between Deere and Citrus under 9-312(3). Thus, between Deere and
Norman, since Norman is a BIOC 9-307 controls again. 9-307(1) states that a BIOC takes
free of a S/I created by his seller even if perfected and BIOC knows of its existence.
Here, the S/I held by Deere was not created by Norman's seller Sunshine. It already
existed before Norman's seller ever got possession of the Coach. Since the statute does
not address S/I created by those other than the seller, we must assume the BIOC doesn't
take free of those S/I, otherwise the statute would not limit itself to S/I created by his
seller it would just say takes free of security interests the code doesn't
have specific words for no reason; therefore, we must assume that the BIOC doesn't take
free of all S/I. Paragraph 2 of Comment 2 supports this conclusion. When it says "if
a secured party authorizes the sale in the security agreement or otherwise, the buyer
takes free without regard to the limitations of this section." The fact that there
are times when the limitations don't apply indicates that there indeed are limits to the
security interests which a BIOC takes free of. Thus in the language of 9-307(1) Deere has
the priority over Norman and thus the ultimate priority in the Coach. The next item
the parties are concerned with is the money Lenders paid to Sunshine for the Coach Norman
bought. Citrus would have a perfected S/I in the money as proceeds of inventory (the
Coach) as under 9-306(3)(b). However, because Sunshine has gone into bankruptcy, the
trustee will get priority over the money. At least to the unsecured shareholder who had
his loan repaid. The payoff of the shareholder is a preference under §547(b). First, the
payment was to or for a creditor (the shareholder with the outstanding loan); was for an
antecedent debt (the facts don't say when loan was made, but I am assuming it was for
startup capital since it was the controlling shareholder); it was made while debtor was
insolvent (insolvency assumed at filing and 90 days); the transfer occurred within 90 days
of filing (says they filed after paying the loan off, also shareholder was an insider so
that extends the period for the transfer to one year); and the creditor got more than he
would have in bankruptcy because he was unsecured and unsecured creditors share pro rata.
One transfer cannot be saved under any of the §547(c) safe harbors either thus it
is a preference and the trustee has priority in the money over the shareholder. However,
perfected S/I holders can beat the trustee and thus Citrus would have ultimate priority in
the money as proceeds over the trustee and could have the judge lift the stay under 362(d)
and give them their money. (At least to the point that the cash proceeds can be identified
in the accounts of the estate.)
Question 3: Top answer #1
The UCC filing problems that Y2K might create with the computerized records kept in our jurisdiction will be nonexistent as to our loans to consumers for goods, other than vehicles, because security interests in those perfect automatically under 9-302(d). As for our being able to perfect security interests which need to be filed, §9-403(1) states that a filing occurs once the financing statement and filing fee are presented to the clerk's office not when they go into a computer database. Thus when we present them for filing we will be perfected. As for searching files to find other security interests or for others to be on notice of our security interests, the crash of a computer database should not pose a problem because 9-403(4) requires the filing office to mark the statements with a filing time and to hold the statement on microfilm or other photographic copy for public inspection. Thus the statute requires paper back-up. The database would be in addition to the paper copies kept by the office. We would want to call and make sure our jurisdiction has these, but if they don't they are violating the statute and in any court case over an unfound statement against us we would win because they are all supposed to have searchable paper copies. Also, our current S/I would not become unperfected because under 9-403(2) a financing statement is good for five years. Thus, although there would be major inconvenience in having the database knocked out, our S/I would be protected against anyone who filed subsequently because they didn't want to search the paper files. In addition we would be inconvenienced but could search the paper files to check for prior interests before making loans. We may want to get some kind of backup copy or printout of the filed statements on record as of now to make searching easier in case of a problem but that may not be possible given the volume of filings likely contained in the database. As to equipment collateral loans as PMSI holders we would be in priority to other secured creditors as long as we perfect within ten days of debtor receiving collateral so we could require our debtors not to get the stuff until we see the computer problems all clear up, although we can present the documents for filing and the office and be perfected anyway. For inventory debtors, since we have to notice before we file to perfect, maybe we could check with our major accounts and see if they are planning to acquire any new inventory for search now so we can use the database before its possible crash since we have to notice before we file for perfect anyway under 9-312(3)(a). As to the problems with late payments because of Y2K, we cannot call in all the loans for technical default unless there is something making late payments a default. However, with regard to the debtors on the "watch list" under Karner v. Willis if the loans have a clause stating we can accelerate debt collection when we feel insecure, as long as we feel we are insecure in good faith subjectively (i.e. an honest belief that we are insecure) we could accelerate and call in those loans. The Karner v. Willis test is controlled by our honest belief of insecurity re: Y2K, not if that insecure belief about Y2K is reasonable. Our belief would be honest since you are worried that people who are on the "watch list" may use Y2K as an excuse for late or non-payment even if they have no Y2K problems. Thus I think that Y2K shutdown would not affect our perfection status, merely inconvenience our ability to search until the problem is corrected. We may be able to prevent problems by communicating with our clients and doing some searches now if we see that they would be needed in a few weeks or attempt to get a backup copy of the files or hire people and search manually. Accelerating some loans, the watch list, seems sensible to protect ourselves.
Question 3: Top answer #2
To: Memorandum Superior Officer of Small Credit Union, Inc.
From: Assistant General Counsel
Date: 12/10/1999
Re: Article 9 aspects of the Y2K crisis
I received your memorandum regarding the various issues raised by the impending Y2K crisis
on our current affairs. And, after considering the issue under Article 9, I have come up
with several answers to your concerns. I am now presenting those answers to you in this
memorandum.
The first concern you raised entailed the problems raised if the filing registry gets
knocked out temporarily. Since the official registries of Article 9 filings in our
jurisdiction are computerized, it is possible that they will be affected and, at least
temporarily, taken off-line after midnight on the first of January, 2000. Specifically,
you raised two issues: 1) how can we get perfected Security Interests in the event this
occurs, and 2) will the security interests we currently hold become unperfected.
To address your question regarding our obtaining perfected security interests if the
registries are off-line, the answer seems clear. Under 9-302 and 9-303(1) of the UCC, in
order to perfect a security interest, we merely have to attach it to the collateral (which
will not be affected by the Y2K crisis, I trust) and then file with the proper filing
office. 9-403 discusses the filing process. In 9-403(1 ), filing occurs when 1) we a
Financing Statement for filing and 2) either a) we tender the filing fee or b) the Filing
Officer accepts the Financing Statement.
Thus, as long as we submit financing statements to the proper authorities and they are
accepted by officers or we tender the proper fee, we will have satisfied this provision.
Since nothing in 9-403 requires that the financing statement be entered into the record by
that filing officer, the Y2K problem should not affect our business practices in this
aspect at all.
Likewise, even if the registry is knocked off line, our current security interests will
not become unperfected. Again, under 9-304(1), we can perfect by filing. And, according to
9-403(2), a filed financing statement is effective for five years from the date of filing
(subject to certain limitations found in 9-403(6), none of which apply to us I assume). As
such, no matter what happens to the registry, the fact that we properly filed a filing
statement means that we should be protected and that our perfection will remain
continuous. Of course, if any of our security interests were filed more than four years
and six months ago, we may want to file a continuation statement as per 9-403(3) to allow
our security interests to continue without interruption (just in case the financing
registries are off-line for a while and some of our filings expire during that time).
Also, another precautionary measure we might wish to take is to seek copies of the filings
we have made from the filing office. Under 9-407(1) [Note: I am assuming that 9-407, an
optional provision, has been adopted by our jurisdiction.], upon request the Filing
officer shall give the person filing a financing statement (i.e. us) a copy of it, with
the filing time and date stamped on it. As such, if we get one of these copies for each of
our outstanding security interests, we will be able to prove that we have a perfected
interest in the collateral in the event that some of the records of the filing registry
are knocked out by the Y2K crisis.
You also raised some questions as to searching for other interest. I understand that there
may be a problem if we are unable to locate a prior security interest against anyone
applying for credit. However, there are several options open to us. We may ask the debtor
if there are any outstanding security interests against him, for example. And, we may be
able to compel him under 9-208 to obtain certified statements of account from any prior
creditors. However, this is not ideal, since it is possible the debtor will lie to us in
order to retain credit.
If this a great concern, then perhaps we should stick to obtaining Purchase Money Security
Interests only for the time when the registry is unreliable. By having a PMSI, we will
have a greater priority over other creditors under 9-312(3) and 9-312(4). Thus, this would
solve our problem of failing to find other secured creditors.
As to whether or not we will have difficulties if another creditor fails to locate our
security interest, as long as we are able to prove that we had a security interest prior
to the second creditor's arrival, we should be protected. Look at 9-312(5) of the UCC -
anyone who files or attaches first has the priority over other secured creditors. Thus, we
will be able to defend our security interests against other later creditors.
Finally, you raised the issue of whether or not we should declare the debtors in default
if they are unable to pay us due to problems with their assets created by Y2K. I think
that we should be able to declare them in default under 9-501 if they miss a payment.
There is no technical definition of "default" in the UCC. But, under 9-501,
whenever a debtor does default on an obligation, we have the right to either reduce the
claim to judgement, foreclose, enforce the Security Interest by any judicial process, etc.
Likewise, if we wish, upon default, we may accelerate the payments of the debtor, calling
them all in at once.
However, although we would be within our legal rights to call in any debtors, we should
consider the policy of doing so. Understandably, there is the danger of the assets
disappearing. But, if we start calling in all of our security interests, then people may
be unwilling to borrow from us in the future, substantially hurting our business. Thus, in
the interest of continued goodwill, I would recommend that we notify those debtors who are
on our "watch list" that we may foreclose if they are unable to pay us, grant a
grace period (based on the level of risk of the debtor), and continue business as usual.
By doing so, we will be able to protect ourselves fairly sufficiently, as the grace period
for dangerous debtors could be very short and we could then move to foreclose or seek our
remedies. And, we will also earn the reputation of being a fair creditor, thus likely
giving us increased goodwill and more customers in the future.
This concludes my analysis of the concerns you raised about the Y2K crisis and its impact
on our business. I don't think that our business will be substantially affected.
Furthermore, as detailed above, by taking certain precautionary measures and by
implementing the policies recommended in this document, we should be able to limit any
damage suffered by our business to a minimum.