Spring 1999 final exam (Secured
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 rights and obligations of the parties to these transactions are to be determined in light of Drucilla’s (hereafter "D") having filed for bankruptcy - a context that may or may not look the same as the parties rights & duties if we were not looking at a bankruptcy. Therefore, the analysis must be begin with the parties interests generally in order to determine how, if at all, those rights are to be effected by D’s insolvency and subsequent bankruptcy.
Loan from GMAC To D
The $3 mill loan from GMAC to D to finance D’s inventory of cars appears to have been correctly attached and perfected; the facts do not indicate any problems under §9-203 (GMAC gave $3M value to D, she purchased the cars to have rights in them as a collateral, a conforming security agreement was signed by D; the interest was perfected by filing and I will assume compliance with §§9-302, 9-401, and 9-402 as the facts do not suggest any issues in that regard. It is important to note at this point that §9-203 will, by default, give GMAC a security interst in the proceeds of the cars b/c the parties did not K otherwise. Proceeds are whatever "is received upon [D’s] sale, exchange, collection, or other dispostion of the cars or the proceeds of the cars. §9-306(1). Importantly, this will give GMAC an interest in the proceeds from Ethelred ("E"), the chattel paper interests, etc. See §9-105(1)(b) defining CP; these sales Ks represent both a monetary obligation and an interest in "goods" as defined (1)(h). An issue, more fully discussed below, will be whether GMAC also has an interest in the ‘proceeds’ of those proceeds - the $500,000 rec’d from Megabank ("M") for assignment of the chattel paper (Note potential problem in tracing to find "identifiable proceeds") Also, it may be implied that GMAC has an interest in after-acquried inventory (court at times imply such clauses b/c of the rapid turnover of inventory), but that is not certain.
Note also that GMAC appears to have been granted a purchase money security interest, which will be very important in terms of priority (see §9-312(3) re; PMS/in inventory) §9-107 defines a PMS/interest and appears to encompass GMAC’s interest b/c GMAC took an interest by making an advance of $ to D to enable D to obtain rights in the collateral (the cars) and D actually used the $ to purchase the cars. This PMSI interest in inventory gives GMAC priority over all conflicting SI in the cars and in indentifiable cash (may be troublesome) proceeds b/c the interest was perfected w/i 10 days of D reciving the cars (assumed). Of course, the section also has a notice req to other secured creditors; the facts do not clearly indicate if this would be met.
E Buys Car From D
D sold E a car and appears to have a good SI in the car as valid against E. D had rights in the car, advanced the car (value to E, and, presumably, has a signed K from E to that effect. §9-302(1)(d) excludes cars from PMSI definition, so this interest will not perfect automatically under §9-302(1). The facts do not indicate that D filed or perfected the coll., so, if unperfected as it appears, this interest may not hold up to other creditors or to the BR trustee. Of course, suretyship law will govern the K with Canute ("C") who has guaranteed the interest and is another source of protection for D. D’s provision to respossess and sell ‘as she sees fit’ will be limited by §1-102(3) if her methods are ‘manifestly unresonable.’
D Assigns Ks to M
D sold the chattel paper interests to M in return for $500,000. Under §9-102(1)(b), Article 9 still applies to this sale. Because this is chattel paper there are ‘extra’ perfection issues. Whatever protection D has against E will flow to M under §9-302(2)’s shelter rule, but M perfected against D as well by possessing the instruments (§9-305). M may get special priority in these intangibles as a ‘buyer’ under §9-308. M gave value to D ($500,000) and took possession in what is likely the course of business for this factor; thus, he will have priority against a mere proceeds interest under §9-306. Remember that all disputes between E and M will be governed by §9-318, which will maintain many of E’s rights against D as against M, when the parties haven’t contracted otherwise.
Default is determined by the parties’ contract, & the facts indcate that D defaulted in her agreement with GMAC, which allows GMAC to proceed as it sees fit under Part 5 of A9. This will be complicated by the fact that D was insolvent when she defaulted, perhaps limiting GMAC from acting on its interests (see §§547, 362 of BR Code)
How does bankruptcy change the analysis of the above interests? First of all, the BR trustee will step into position of a lien creditor (§544(a)) and be able to knock down our interests that are determined to be unperfected. She may also assert any defenses of actual unsecured creditor and assert all defenses they have under §544(b). Trustee also steps into D’s shoes and may assert rights and defenses if D (ex. against C as guarantor on E’s debt b/c collateral value presumably less than amnt owed only 2 mos. of payments made when E defaulted) that are mentioned above on her behalf. §§541, 365, 558.
The BR tribunal may determine that D’s ‘gifts’ and personal expenditures of the $500 from M were ‘fraudulent conveyances’ under §548, which is likely to meet the ‘interest’ requirement due to D’s fraudulent ‘elaborate system for hiding her insolvency and her payments. The trustee will also want to see what transfers by D were "preferential" to any creditor in the 90 days of presumed insolvency before filing. §547(6) Only payments on account of antecedent debts can be preferential, so the transaction wherein D exchanged interest in return for new value (ex -- factoring if sales Ks) will not be perferenitial. The subordination K b/t M and GMAC may have altered either or both of the creditors’ positions, but was not a transfer by D, so that isn’t captured under §547(b). §316 allows parties to enter subord. Ks, and doesn’t explicity alter that right in an insolvency/BR context. Perhaps BR law has something to say about such an arrangement (ex -- §362 prevents this if it meets their definition of an attempt to act in their interest), but I am not clear on that.
Question 1: Top answer #2
Parties' rights and obligations
GMAC has the first filed (perfected) security interest, assuming a signed security agreement was created to meet attachment requirements of 9-203, assuming filed properly under 9-401, interest in the inventory (cars) of Drucilla. When the car was sold to E, normally under §9-306(2) & 9-203(3), GMAC’s security interest will continue in identifiable proceeds, as will the collateral.
However, if GMAC authorizes the sale, the security interest does not continue. Thus it must be determined whether GMAC’s statement on D’s invoices stating that it had a perfected security interest negates the inference that an inventory financier has authorized the sale of inventory. I think that it does not, especially coupled with the clause saying that proceeds must be used to buy new inventory. Thus §9-306(2) cuts off GMAC’s interest in the car, as does §9-307(1) because the car is sold to a buyer in the ordinary course who takes free of a security interest (created by his seller) even if he is aware of it.
GMAC does continue to have an interest in the proceeds (after 10 days) under §9-203(3), & 9-306(3), which is the sales contract to E (& others) if the original filing covers property that is proceeds, and a filing for these proceeds would be made in the same place as the original collateral [§9-306(3)(a).]
The property constituting the proceeds is the sales contract, which may be perfected by filing (§9-304) because it is chattel paper, evidencing both a right to payment and a security interest (§9-105). The filing would likely be the same place (depends on version of §9-401 adopted). Thus GMAC retains an interest in the proceeds. However, under §9-308, this interest can be subordinated by a purchaser of chattel paper who gives new value, takes possession in ordinary course of business, if other party claims a security interest merely as proceeds (as GMAC does). Thus Megabank had a superior interest in the contracts, so GMAC got a great deal in getting paid $150,000 to subordinate its interests that it didn’t really have. (C’s can enter these agreements under 9-316). GMAC could have enforced the default clause to get the cash proceeds of the sale of the sales contracts that was not used to buy new inventory or repay the loan, because she was insolvent, but is now stayed by the bankruptcy proceeding under §362. The trustee may be able to recover the cash proceeds, as proceeds of proceeds, which GMAC has an interest in under §9-306(3)(b) because filing statement covered original inventory and assuming money is identifiable under state tracing law. T can get this cash back (with some protection for transferees) under §550. Under §9-306(4) which provides for proceeds treatment in insolvency proceedings, GMAC still has its interest in this cash under 306(5)(a) if the trustee treats these recovered proceeds as identifiable and non-commingled. Thus GMAC no longer has rights in the chattel paper, but does in the cash proceeds of these proceeds if recovered by the trustees (if meets §9-306(4) The returned car is treated under §9-306(5) which says that if the goods were collateral at the time of sale (they were as to GMAC’s loan), and the indebtedness is still unpaid, the original security interest reattaches, but an unpaid transferee of the chattel paper (M) gets priority if it had priority under §9-308. Thus, M has priority over GMAC in the car, as well as the chattel paper.
If E doesn’t pay under the contract assigned to M, C as the guarantor of the car payments from E to D, (or to M if E received notice of assignment meeting -318 requirements) will also claim an interest in the car since C is still liable on the sales contract. However, by letting M take the car, who is assigned the contract, C’s then left with the liability amount by which the debt exceeds the cars fair market value. (Assuming no valuation challenge can occur). M cannot take action to get the car because is stayed by §362, because the car is now property of the bankruptcy estate. But T(trustee) will abandon it because D has no interest in it, or because M makes a successful lack of adequate protection claim under §362(d) because car continues to depr3ciate. As for the rest of C’s liability, M, as an assignee, is subject to all of the account debtor’s defenses under §9-318. §9-206 permits clauses which waive the account debtors rights to assert defenses it may have against the assignor against the assignee. It must be determined whether the guarantor (C) can also agree to waive any suretyship rights, and whether the waiver of notice to repossess and sell made the initial sales contract unenforcable. §9-504 allows a waiver of notice after default, but not before, and §9-501 says these rights cannot be modified by the parties. Thus this is unenforcable. As for the suretyship defenses, I assume this means C waived rights to assert D defenses, which may not be enforceable. If not, C is entitled to have and proceed with sale of car in a commercially reasonable manner, and to seek a deficiency if follows 9-504, or no deficiency if under 9-505.
C can then go after E for the rest because C steps into shoes of the creditor with right of repayment. Or, M could have gone after E before C, after following §9-504 (not waived by E either because cannot under §9-501). M cannot seek money from D through the bankruptcy proceeding because D sold the sales contracts with no recourse. E and C cannot get out of contract altogether because of attempt to get waiver, unless this fits state case law on interpreting failure to comply under §9-507.
The trustee’s rights and obligations have been discussed within the above discussion.
Question 2: Top answer #1
This is a tricky question as it involves multiple questions across many Articles of the UCC. It is often difficult to know in advance whether a court will hold an arrangement to be a lease or a security agreement since they look a lot alike. Leases, however, are not covered by Article 9 (they are in 2A) and thus are a different body of law.
There are advantages to both arrangements. What makes this look more like a security agreement is that there is residual value in the tower at the end of the 10-year contract and that there is no arrangement for them to just get it. In fact, there is effectively a balloon payment at the end. This assumes that the $5,000 is greater than the monthly payments. I would advise the client if it wants this to be a lease to make that payment even bigger. For the sake of though, lets assume that it's a security agreement under Article 9.
There are numerous hazards we'll have to be aware of. The first is that KPUT will default. There is some likelihood of this because of the leverage they will have and since they believe the radio tower is less likely to be of use to my client than to them. Fortunately, Article 9 will give us lots of comfort if they outright default. We should draw a security agreement that defines default very broadly allowing Radial to declare it whenever it feels insecure. That is allowed since Article 9 leaves it to the parties to define default. Moreover, insecurity clauses are legal as long as they are only executed in good faith under 1-208. Furthermore, Radial should include an acceleration clause in the contract. It wants to be sure that it gets all of its money if there is any default.
Since this is a PMSI in equipment, Radial should be very careful to file quickly within the ten day grace period under 9-312. If it does it will be nicely setting itself up for super-priority in the event of a conflict under 9-312(4). This is a PMSI because Radial is basically financing the purchase of the collateral under 9-107.
Also in the event that there's even a need to distinguish priority under 9-312(5) you need to file ASAP. Also under 9-312 if one files within the 10-day grace period with a PMSI it dates back to the date of the security agreement.
Actually if its possible to get the signature of the debtor (KPUT) it would be advisable to file now before this lengthy negotiation begins. 9-303 explicitly allows pre-filing because it can be done before the security agreement. Pre-filing will be useful.
In the event of default, 9-503 gives Radial many powers. It will be allowed to foreclose on the tower under 9-503's self-help statute. It will also be allowed to re-sell it. Frankly, this is not a very attractive option, better it is to be able to disable it and thus pressure KPUT to pay up. Article 9 also allows the creditor to disable machinery on the land of the debtor if that is more efficient as it probably will be here. Thus in an Article 9 setting, the source code solution is an excellent one and should be fully developed. Once it is used KPUT will likely exercise its right to redeem under 9-506 which means pay Radial and be back on the air which is exactly what my client wants.
Retaining title in the hardware and software is frankly irrelevant. Some might think this will make it look more like a lease, but 9-202 specifically states that the retention of title by the creditor or debtor is irrelevant. The purpose of Article 9's scope is to elevate form over substance.
The major conflict on the horizon for Radial though will be with RTC and we should plan now to protect ourselves. RTC has filed against both KPUT and its parent company Bayshore. I recommend in our filing we do the same. A filing is valid unless it is seriously misleading under 9-402 as to render it ineffective. The courts unfortunately have been divided in whether a parent company is seriously misleading. Conflicting results in Alexander Farms and Glasco show the difficulties with this. Filing against both, which is allowed, will provide more protection.
We need to get more information about RTC's security interest. RTC is required to provide the information at the insistence of the creditor under 9-402. We should demand that in negotiations. Also, we want to know whether or not the financing statement has lapsed. Without a continuation statement under 9-403(3) they are only good for 5 years. If this one has lapsed we should file ASAP to take advantage of their error.
Now assume there is an RTC and Radial conflict. (By the way, I am assuming RTC is not the Resolution Trust Corp., a quasi government agency which has extra powers given to it by Congress.) In such a situation, RTC might go after the radio tower for its own debt. The radio tower constitutes equipment and if they have an after acquired clause under 9-204 then we will seem to be junior creditors in our radio tower. This is why it's vital to file ASAP because we want to get the super-priority accorded to PMSIs in equipment under 9-312(4). Because it's equipment and not in inventory we do not need to notify RTC that we are trumping their priority. To be very safe we could send them the letter but that seems duplicative.
Another complication is if the radio tower is a fixture. There is no hard and set definition for fixtures in the Code. All we know under 9-313(3) is that they are related to the property. Using an economic test, the Summers & White - 1 man, 1 crescent wrench, 1 hour test, or the size/mobility test it seems likely that there is a very good argument that it's a fixture. This means a whole class of interests may have a conflict with us. As I'm about to show our client should file both as an Article 9 claimant in the Secretary of State's office as well as a real estate claimant in the local recorder of deeds office.
When a claim is made by an Article 9 and another Article 9 claimant, it is covered by 9-312. If in the same collateral there are claims by 2 real estate claimants it is covered under the Real Estate law. But if there is one Article 9 claimant and one real estate claimant thy come under 9-3134. Article 9 recognizes the general validity of real estate claims under 9-313(3).
Here under 9-313, Radial is going to want to have super-priority against real estate claimants as well and can get one by filing a fixture filing. The fixture filing is defined in 9-402(5). 402-5 tells what must be recited in the fixture filing. We will follow it exactly. If this is filed in the real estate office, Radial will have a PMSI in the fixture and beat the real estate interest under 9-313(4)(a). Again, the filing must be within ten days. I recommend pre-filing the debtor must also have a real estate interest in the fixture under 9-313(4)(a). There is no problem with that.
There are two catches. If we don't do a fixture filing we are risk of losing to another filed real estate interest under 9-312(4)(b). Also, a fixture filing PMSI does not protect us against construction mortgages, but there is little we can do about that except ask KPUT.
In all, my advice is that we file early and often. We should file as a fixture holder as well as an Article 9 claimant so we establish as powerful a security interest as possible in the event this is not deemed a lease.
Finally, we should also require that KPUT to give us in writing a showing of their financial health. If its in writing and KPUT goes bankrupt right after the deal we will be able to reclaim more easily under 2-702.
Question 2: Top answer #2
Assuming that the radio tower, software, and hardware are all one unit, the first issue presented is whether this is a lease or a security agreement. Under 9-102, transactions are only governed by article nine if they are for a security interest as defined in 1-201 (37). The difference between a lease and a security agreement can be minimal. The focus has been on the substance of the agreement and not how the parties have deemed the agreement, especially in light of 9-408. Under 9-408, parties can term the agreement however they wish and an article 9 filing does not prejudice the determination of whether the agreement is a lease or security agreement.
The lease may benefit the company because under 2A-305 and 2A-307, the lease provides better priorities and rights for Radial, than a security agreement.
Courts using 1-201(37) have looked at the option to purchase with nominal consideration, the right to terminate the lease, reversion rights, the useful life of the goods, qualities of ownership and an economic realities test to determine whether an agreement is a lease or security agreement.
In this case, the option to purchase may be a significant factor. It appears that at the end of the lease the value of the tower as dismantled is less than the market value. Therefore $5,000 might be considered not nominal. Especially if it exceeds the salvage value of the tower. In fact the salvage value may equal the market value. The market value needs to be determined.
The facts presented do not explain whether a right to termination exists. If Radial makes the right to termination upon either party, this might be persuasive that the agreement looks more like a lease than like a conditional sales contract.
The reversion rights appear to remain with Radial and this further points to the creation of a lease and not a conditional sales contract (sec. agreement).
The useful life of the goods is not stated, but is probably greater than the ten years of the contract, which also favors a lease.
Radial should assume the qualities of ownership such as taxes and insurance, which would signal a retention of ownership by Radial and not KPUT, if it determines it wants a lease and not a security agreement.
Finally, under the economic reality test the question becomes whether at the end of the lease period, the only reasonable option would be to purchase the tower. Here, the facts lead to that conclusion, because the cost of dismantling is greater than the value of the tower, which points to a security agreement.
Whether Radial decides that it wants a security agreement or a lease, Radial should still do an Article 9 filing -- especially since under 9-408, such a filing is not prejudicial.
Under Article 9, the tower may be a fixture or maybe a good to protect against both, Radial should file a fixture filing and a filing in the central office.
The fixture filing is done at the local real estate (deed) office under 9-313 and 9-401. Determining whether the tower will depend on local real estate laws, although 9-313 cmt 3 gives some help. Economically, if the tower has complementary value, such that alone it has less value than together with the land, it is a fixture (under 9-313 (1)(a)).
The fixture filing must meet the requirements of 9-404(5), assuming KPUT is not a transmitting utility. As such it must have the type of collateral, must show filing at the real estate office and must show a description of the real estate.
In order to get priority over any real estate encumbrances, the fixture filing should be a purchase money security interest and must be filed before the tower becomes a fixture or within 10 days thereafter under 9-313 (4)(a).
Priority may also be gotten over the conflicting interest of an encumbrance or an owner by filing on article 9 filing. It must be shown, however, that the tower is readily removable office machinery under 9-313(4)(d).
In order to get priority over the equipment personal property owners, Radial should file centrally and perfect within 10 days of the tower’s possession by KPUT. This will give Radial superpriority as a purchase money security interest (9-107) in equipment under 9-312(4).
There may be an issue as to whether a radio tower is equipment or inventory. 9-109 seems to indicate that a radio tower in the hands of KPUT would fit in the catch-all category of equipment (9-109 (2)) rather than inventory (9-109 (4)).
The last issue is whether the software source code can have detrimental effects upon the deal. While the source code would add to argument that the agreement is a lease, because the source code gives Radial reversion rights, if the contract is determined to be a secured agreement, the source code may have detrimental effects. If the debtor defaults and the source code is enacted, this action may be viewed as repossession under 9-503. Especially under state consumer laws. Further it may be a breach of the peace which would give rise to a tort surf for conversion, lost profits, intentional contractual interference, etc. This may influence Radial’s ability to get a deficiency judgement, as it may be implied strict foreclosure.
As to the deficiency judgement, there are three views. The first is that the action of Radial does not prevent a deficiency judgement. The second, as the one adopted by the revision, is that if in violation of 9-504 or acting as an implied strict foreclosure, Radial creates a rebuttable presumption against a deficiency judgement. This comports with a strict reading of 9-504 and 9-507 and 1-106 (returning parties to their original position). The third view has actions outside 9-504/9-505 to create an absolute bar to the deficiency judgement. Depending on the court, Radial should be cautious of its use of the source code in a manner that violates 9-504.
The source code enactment may also give risk to criminal actions under FCC rules, damages if the repossession was not in accordance to 9-504, 505. Lastly even if the debtor, KPUT, was in default, it could probably get redemption by paying its arrears under 9-506, this defeating the source code.
The better action would be either to have an acceleration clause or a guarantor. The acceleration clause would allow Radial to get all its damages upon default under 9-506, alleviating is non-payment risks. The grantor would give it leverage because guarantors typically have leverage over the debtor and also would reduce Radials monitoring costs.
Question 3: Top answer #1
A) Will it work?
1) Setting or assigning financing stmts:
This seems to come down to attachment. §9-201 says a sec agmt is effective "between the ptys," and the filing associated with this agreement would seem to only give a perfected interest to one of these parties. §9-405(?) allows for assignment by a sec'd pty of all or part of his rights under a financing stmt by filing in where the orig. stmt was filed a new agmt signed by Coastal & identifying the debtor. This seems to imply Coastal can assign its rights to a priority interest against F to the client but see better interpretation in (b) "Should it work". Coastal would only need at least $500 to be persuaded to make this assignmemt, but clearly it would be worth more to the client.
2) Can client sell his contract to C, thereby giving priority to this loan amt as well as over Tidewater? The code permits assignment of sec. int's, which shifts an interest from being owed to one creditor to another, w/o requiring filing under §9-302(2), and enables the interest to remain protected as to the original D, against D's other C's. Does this apply here? No because client is unsecurd. Thus we would have to characterize client's loan in the hands of Coastal as a "future advance" provided for under the original sec. agmt between C & F. C can make advances w/o new sec. agmts that still have same priority under 9-312(7). B/c Coastal is providing no "new value" to F in this arrangement, it doesn't seem to fit the concept of future advances. Instead C would loan F $100k to pay the client, and then keep his priority portion against this loan, still oversecured b/c debt to C = $100,500 and his assets =$130k. F may go along if client is threatening ct. action, but if F knows his bankruptcy law, he will file and not care b/c he gains no benefit (sec'd C's get all his assets either way and the trustee will avoid the pymt to client as a preference or constructively fraudulent transfer). But, if F thinks he will not go into bankruptcy if he pays client, then w/some compensation to C, he will probably go along (i.e. higher interest from F, payment from clients).
B) Should it work?
1) assign fin. stmt: because C's fin. stmt was for a future advances contract, subsequent C's can find out by inquiring about the sec. agmt that they are subject to. The collateral becoming further encumbered, thus making less of D's assets available to them with this future advances agmt. The assignment of the fin. stmt. to client doesn't harm subsequent C's b/c they are aware of the possibility of later loan amounts pre-empting their rights to the collateral (as well as buyers in the ordinary course, PMSI’s etc.) Thus there really is no notice problem created by this --one creditor steps into the shoes of another. It is like refinancing which may also entitle the 2nd co. to keep priority of orig. lender. The code also imposes duties on C's to monitor debtors to some extent to make sure they aren't taking actions to put their rights at risk, so this assignment ability would just put C's on notice to find out what the D's other sec. agmts provide for--i.e. future advances, or what other unsec'd obligations exist that might make D unable to pay. On the other hand, the code tries to reduce monitoring costs and prevent unfairness to C's who cannot monitor and prevent impairment of their interests. Allowing a fin. stmt. to be assigned runs contrary to these goals if it can be done w/o a future advances sec. agmt. For this reason, it seems to be a more likely interpretation of §9-405 that the sec'd pty's rights to pmt by D the priority of this pymt can be assigned to the new C, but that the new C cannot get priority for his pre-existing obligations from D. Priority pymts of these obligations are not "rights of the sec'd pty" that is assigning the fin. stmt. The code does permit partners to subordinate their status or to give up priority by terminating a stmt b/c these are in line w/the notice and fairness objectives. Although there are economic benefits to Coastal, the client, and Fritz, these cannot outweigh Tidewater’s rights and expectations of payment.
Selling the loan contract to Coastal so C gets priority on the assets for this $100k debt also should not be permitted under the code. It presents the same notice problems as assigning the fin. stmt. (I'm treating selling & assigning fin. stmt as same thing). Even if there is a future advances clause in the sec agmt, it is not in the filing and this antecedent debt doesn't further the justification given for allowing these transactions to get priority. We want to allow a D & C to have an ongoing bus. relationship w/o new filings/sec agmts. This goal is not furthered by bringing in prior loans that don't give new value to the debtor.
Bankruptcy Code policies are also frustrated b/c we want to stop C's from taking advantageous actions when D is insolvent to the detriment of other C's. The code undoes transactions to enlarge the pool of assets and distrib. fairly. thus, giving a sec int to client is an avoidable preference b/c it improves his position to detriment of others and getting F to agree is the type of coercive creditor action the B Code also seeks to discourage. When D & some C's can manipulate the system and shifts ________ upon priorities, this prevents all C's from being willing to bear risks and leave a D alone w/hope that he can recover from financial downturn.
Coastal need only pay a small amt more than 15k to make a profit for client, so should offer a low amt. unless trustee.
Question 3: Top answer #2
1) The transaction proposed by the client will not work. Client would not be able to buy Coastal’s priority security agreement and filing. The sale of this to client would be a sale of the security agreement (chattel paper). Client can obtain rights in this paper as to the seller and Fritz under 9-308 by purchasing for value in the ordinary course of business (if it is ordinary course, which it may not be), but the interest will not be perfected as to client until he files as to the agreement, 9-302, or takes possession, 9-304, either of which would be later in time than Tidewater’s interest and junior priority under 9-312(5). A subordination agreement is of no help because Coastal can subordinate his rights as to client but not T’s which retains priority.
Coastal’s priority cannot shelter client’s claim through purchase by Coastal either. Coastal’s priority extends only to advances made to Fritz pursuant to the security agreement under 9-204. Client’s loan certainly is not one of these advances. Coastal would only get whatever rights client had under agreement by purchasing it; and that is only the same unsecured claim.
A way this could work is for Client, Coastal, and Fritz to come to an understanding for what it will take to settle client’s claim and then have Coastal advance the necessary amount to Fritz under the future advances protection of Coastal’s security interest, and then have Fritz use the money to pay off client’s claim. That way Coastal will be effectively buying client’s claim and still maintaining priority over other creditors.
2) This transaction would seem to be okay and should work as far as Article 9 is concerned. One of the overarching principles of Art. 9 is that parties should be able to contract in a manner that allows them to do what they want. This transaction is merely a mechanism to achieve the goals of the parties within the roles of Art. 9. Art. 9 also bases the granting of security interests and priority on principles of notice, allowing parties to contemplate transactions with knowledge of other claims. Here, Tidewater took a security interest and loaned money with full notice of not only a superior priority claim in the same assets as their security, but also with notice of the extension of that priority to any future advances made under that agreement. The advance made in this transaction is one that Tidewater took the risk of being subordinated to when entering into his agreement. While perhaps not completely fair, in this instance, this seems to indicate that the transaction would be okay under Art. 9.
This transaction does not, however, seem to comply under the policies of the Bankruptcy Code and likely will not work. The Bankruptcy Code seeks to fairly liquidate and distribute assets to creditors pursuant to the priority of their claims and empowers the Trustee to avoid or undo transactions that go against this principle of fairness.
Firstly, the Trustee will likely be able to avoid the advance extended to Fritz and subsequent payment to client under §548(a)(2) of the Bankruptcy Code. 548(a)(2) would render the entire transaction avoidable because the obligation to Coastal on the advance would have been made incurring debt with in one year of filing bankruptcy, would have resulted in Fritz receiving less than reasonably equivalent value because the money went straight to client to pay off a loan that would have been mostly discharged anyway, and would have been incurred while Fritz was insolvent, therefore fulfilling all the requirements of 548(a)(2).
Even if not avoidable as a fraudulent transfer, the payment of client’s unsecured claim is likely avoidable by the Trustee as a preferential transfer under 547(b). In this case, Fritz’s transfer was from himself to client, on account of antecedent debt, while Fritz was insolvent, and (assuming it was made within 90 days of filing for bankruptcy), improved client’s position relative to other creditors, because he would not have been paid in full in Chapter 7 liquidation, while Tidewater would have. Now, the positions are reversed with client getting paid in full with Tidewater getting very little as most of Fritz’s assets will go to paying off Coastal’s newly increased secured claim. Furthermore, this transaction does not fit any of the exceptions contained in 547© that make preferences non-avoidable. It just doesn’t fit any of these exceptions because Fritz’s transfer to client is not made for new value.
If I were Coastal, I would pay less than $14,500 for client’s claim because that is all the unsecured claim can hope to garner in the imminent bankruptcy. If it were worth it to client to eliminate the risk of sudden depreciation of the assets, which would render his claim close to worthless or bankruptcy, and Coastal were willing to assume this risk, then a price where these two risks cross paths would be appropriate for the purchase of client’s claim.