Briefly

MEE Secured Transactions Practice Essay

Attachment and Priority in Secured Transactions

The facts

TechStart, Inc., a software development company, needed financing to purchase computer equipment and inventory. On January 15, First Bank agreed to lend TechStart $75,000, and on January 20, the parties executed a security agreement granting First Bank a security interest in "all equipment and inventory, whether now owned or hereafter acquired." First Bank properly filed a financing statement in the Secretary of State's office on January 25.

On February 1, TechStart purchased a CNC machine for $40,000 on credit from Industrial Metals Supply Corp. The purchase agreement between TechStart and Industrial Metals did not explicitly create a security interest, but Industrial Metals retained title to the machine "until full payment is received." TechStart took possession of the machine on February 1 and has paid Industrial Metals $10,000 toward the purchase price.

On February 10, TechStart was in financial difficulty and approached Second Credit Union for additional financing. TechStart offered the same equipment and inventory as collateral. The parties executed a security agreement on February 10, and Second Credit Union filed a financing statement on February 15. Second Credit Union has no knowledge of First Bank's prior interest or Industrial Metals' retained title.

On March 1, TechStart defaulted on its obligation to First Bank. First Bank sent notice to TechStart and began preparing to foreclose on the equipment and inventory. Meanwhile, TechStart has made no further payments to Industrial Metals and has also defaulted on its obligation to Second Credit Union.

The CNC machine is currently worth $38,000. Industrial Metals claims it retains ownership of the machine. First Bank asserts it has priority over any other creditor's claims to the equipment. Second Credit Union contends it has a perfected security interest and demands payment priority from the proceeds of the sale of the collateral.

  1. As between First Bank and Industrial Metals Supply Corp., who has priority in the CNC machine? Analyze both whether First Bank's security interest attached to the machine and whether First Bank's interest has priority.
  2. Has Second Credit Union properly obtained a perfected security interest in the equipment and inventory?
  3. In what order would the proceeds from the sale of the CNC machine be distributed among Industrial Metals, First Bank, and Second Credit Union?
Show the model answer

Does First Bank's security interest attach to the CNC machine, and if so, does First Bank or Industrial Metals have priority?

Rule. Under the UCC, a security interest attaches when three conditions are met: (1) the debtor has rights in the collateral, (2) value has been given by the secured party, and (3) the debtor has authenticated a security agreement describing the collateral. A security interest is perfected by filing a financing statement in the appropriate office. However, a secured party holding a purchase-money security interest in goods other than inventory (such as equipment) has priority over a conflicting security interest in the same goods if the purchase-money security interest is perfected when the debtor receives possession of the goods or within 20 days thereafter. A seller's retention of title to goods delivered to the buyer is limited in effect to the reservation of a security interest; the seller does not retain superior rights as an owner and must perfect like any other secured party.

Analysis. First Bank's security interest attached to the CNC machine. TechStart had authenticated a security agreement describing equipment on January 20, First Bank had given value by committing the $75,000 loan on January 15, and TechStart obtained rights in the machine when it took possession on February 1. First Bank's financing statement was filed on January 25, before TechStart received the machine. However, Industrial Metals' status requires analysis. When Industrial Metals retained title to the machine pending full payment, it created a security interest in the goods under the UCC. Industrial Metals did not file a financing statement; instead, it relied on its retained ownership. Because Industrial Metals sold the machine on credit and its interest secures the unpaid purchase price, Industrial Metals holds a purchase-money security interest, and it could have obtained priority over First Bank's earlier-filed interest if it had perfected within 20 days after TechStart received possession on February 1. A seller's retention of title does not give the seller ownership rights outside Article 9; it is simply a reserved security interest, which may qualify as a PMSI. First Bank's interest, though filed first, is not a PMSI. Industrial Metals' interest is a PMSI in the CNC machine, but retaining title did not excuse it from filing. Under the UCC, retention of title is treated as creating a security interest that requires filing to perfect, and a PMSI in equipment is not automatically perfected. Since Industrial Metals did not file within the 20-day window, or at all, it does not qualify for PMSI priority, and First Bank's perfected security interest takes priority.

Conclusion. First Bank has priority over Industrial Metals in the CNC machine because First Bank's security interest properly attached and was perfected by filing before TechStart received the machine. Industrial Metals' interest is a security interest, and it was unperfected because Industrial Metals did not file a financing statement. Industrial Metals' status as a seller retaining title gives it no special rights beyond a security interest. Because it failed to perfect within 20 days after delivery, it lost PMSI priority, and its unperfected interest is subordinate to First Bank's perfected interest.

Has Second Credit Union properly obtained a perfected security interest in the equipment and inventory?

Rule. Under the UCC, a security interest is perfected when it has attached and the secured party has taken the steps required by the UCC to give notice of its interest in the collateral. The primary method of perfection for equipment and inventory is filing a financing statement in the central filing office (typically the Secretary of State's office) of the state where the debtor is located; for a registered organization such as a corporation, that is its state of incorporation. A financing statement is sufficient if it provides the debtor's name, the secured party's name, and a description of the collateral. Filing must be in the correct name and office to perfect the security interest.

Analysis. Second Credit Union executed a security agreement on February 10 describing 'all equipment and inventory,' which satisfies the requirement that the debtor authenticate a security agreement describing the collateral. Second Credit Union gave value by committing to lend funds on February 10, and TechStart had rights in the equipment and inventory as the owner and possessor. Therefore, Second Credit Union's security interest attached on February 10. Second Credit Union filed a financing statement on February 15, five days after attachment. Assuming the filing was in the Secretary of State's office of TechStart's state of incorporation, it was in the proper office for equipment and inventory. Assuming Second Credit Union used TechStart's correct legal name and provided an adequate description of the collateral, the financing statement was sufficient. Second Credit Union's security interest was perfected upon filing on February 15. Second Credit Union's lack of knowledge of First Bank's prior interest does not affect the perfection of Second Credit Union's own interest. It also does not affect priority, because priority among conflicting security interests turns on the first to file or perfect, without regard to knowledge.

Conclusion. Yes, Second Credit Union properly obtained a perfected security interest in the equipment and inventory on February 15 when its financing statement was filed. However, Second Credit Union's interest is subordinate to First Bank's earlier perfected interest.

In what order would the proceeds from the sale of the CNC machine be distributed among Industrial Metals, First Bank, and Second Credit Union?

Rule. When a secured party forecloses and sells collateral, the proceeds must be distributed according to the priorities established by the UCC. Proceeds are applied first to the reasonable expenses of the disposition. They are then applied to the debt owed to the foreclosing secured party, and then to subordinate security interests whose holders have made an authenticated demand. Perfected security interests generally take priority over unperfected interests. A perfected PMSI creditor may have special priority. Any surplus after the secured parties are paid goes to the debtor.

Analysis. The CNC machine is worth $38,000. TechStart still owes Industrial Metals $30,000 of the purchase price ($40,000 purchase price minus $10,000 paid), so Industrial Metals has a security interest in the machine to the extent of its unpaid purchase price, though that interest is unperfected. First Bank has a perfected security interest in the machine filed January 25. Second Credit Union has a perfected security interest in the machine filed February 15. As between First Bank and Second Credit Union, First Bank has priority because its financing statement was filed first. Industrial Metals, having failed to perfect its interest, is subordinate to both First Bank and Second Credit Union. First Bank's interest was perfected before Second Credit Union's interest was perfected. Therefore, after the reasonable expenses of the sale are paid, the proceeds must be distributed: first to First Bank; then to Second Credit Union, if it has made an authenticated demand; then to Industrial Metals to the extent of its unpaid purchase price ($30,000), if it has made an authenticated demand; and any remainder to TechStart. Industrial Metals' unperfected status does not eliminate its security interest, but it places Industrial Metals last among the secured parties.

Conclusion. The proceeds of $38,000 from the sale of the CNC machine should be distributed as follows. First, the reasonable expenses of the sale are paid. Next, First Bank receives payment for its secured claim, up to the amount of TechStart's debt to First Bank. Second, Second Credit Union receives payment for its secured claim if it has made an authenticated demand. Third, Industrial Metals receives payment on its subordinate claim if it has made an authenticated demand. Any remainder goes to TechStart. Because First Bank's claim (up to $75,000) exceeds the $38,000 in proceeds, Industrial Metals will likely receive nothing. Its unperfected security interest is subordinate to both First Bank's and Second Credit Union's perfected interests, and the sale proceeds will be exhausted by the senior secured creditors.

Secured Transactions issue checklist

  • Determine whether the parties intended to create a security interest (express agreement vs. implied intent from the transaction structure)
  • Identify whether the debtor is authenticated the security agreement and whether the authentication is sufficient
  • Assess whether the collateral is adequately described under the 'reasonably identifies' standard of § 9-108 (remembering that super-generic descriptions are insufficient in a security agreement)
  • Verify that the secured party gave value (check for conditional commitments, assignments, or non-monetary consideration)
  • Confirm that the debtor has rights in the collateral (ownership, possession, or power to transfer)
  • Establish the timing of when all three elements are satisfied
  • Distinguish between attachment and perfection (is the security interest attached but unperfected?)
  • Check for partial attachment issues (does the agreement cover multiple categories of collateral with varying attachment status?)
  • Evaluate whether the security agreement includes material terms that would preclude enforcement
  • Consider whether after-acquired property language is present and whether it affects attachment analysis
  • Identify whether a security interest exists and has attached
  • Determine the debtor's location and correct filing office jurisdiction
  • Verify the financing statement is properly filed with correct debtor name, secured party name, and collateral description
  • Assess whether the filing is timely and covers the relevant collateral or proceeds
  • Identify the method of perfection attempted (filing, possession, or automatic)