CHAPTER 30
SECURED TRANSACTIONS
ANSWER TO CRITICAL THINKING QUESTION
IN THE FEATURE
CASE 30.1—CRITICAL THINKING
ETHICAL
Under the circumstances, is it ethical for GRB to enforce its security interest in the ring
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CASE 30.2—CRITICAL THINKING
LEGAL ENVIRONMENT
Why does UCC 9–332 permit transferees to take funds “free of a security interest”? How
did this provision work to benefit the parties in this case? The comments to UCC 9–332
explain that “broad protection for transferees helps to ensure that security interests in deposit
accounts do not impair the free flow of funds.” This encourages business and commercial deals
that might otherwise be impaired by extensions of credit and the existence of security interests.
So, for example, UCC 9–332 allowed the arrangement among the debtor and two
creditors in the Tusa–Expo case to work to the benefit of all of the parties, as well as the
debtor’s customers, who were not direct parties to the arrangement. The terms of the loan from
Textron to Tusa Office required the debtor to establish a bank account—the lockbox—into which
its customers made payments directly. Textron could withdraw the funds paid into the lockbox
and use them to increase the credit available to Tusa Office on its loan. Tusa Office could use
the increased credit to pay Knoll. By paying Knoll, Tusa Office kept its debt to Knoll below the
furniture maker’s limit and enabled Tusa Office to fill new orders for its customers.
ETHICAL
Office Expo, Inc., a dealer in used furniture, was, like Tusa Office, a subsidiary of Tusa–
Expo Holdings. Tusa Office operated profitably but Office Expo did not. To bolster Office
Expo, funds were transferred from Tusa Office to Office Expo on a regular basis, which
CASE 30.3—LEGAL REASONING QUESTIONS
1A. What type of property was at the center of the dispute in this case? How did that
property become involved in the dispute? At the center of the dispute in this case were
shares of stock in Sparton Corporation. The shares were owned and pledged as collateral for
loans by Bradley Smith, on his own behalf and on behalf of the John J. Smith Revocable Living
Trust. The loans consisted of borrowed funds from Firstbank Corporation.
The stock became the center of a dispute after the debtors defaulted on their obligations.
The lender took possession of the pledged shares and sold them in two private transactions to
recoup the funds lost on the loans. The creditor then released the remaining collateral to Smith
CHAPTER 30: SECURED TRANSACTIONS 3
and the trust and also remitted the excess funds collected in the private sales. The dispute
focused on the price of the stock on its sale.
2A. On what ground did the plaintiffs argue that the bank should not have been
granted a summary judgment? The debtors, Bradley Smith and the John J. Smith Revocable
Living Trust, filed a suit in a Michigan state court against the creditor, Firstbank Corporation,
alleging that the lender’s sales of the debtors’ stock in Sparton Corporation were “commercially
unreasonable.” The UCC requires that “every aspect of a disposition of collateral, including the
method, manner, time, place, and other terms, must be commercially reasonable.” Firstbank
filed a motion for a summary disposition. The court issued the judgment. Smith and the trust
appealed.
3A. Why does collateral have to be disposed of in a commercially reasonable manner?
Is price alone enough to prove reasonableness? Why or why not? When a creditor
disposes of property that has served as the collateral for a debt, every aspect of the
disposition’s method, manner, time, and place must be commercially reasonable, according to
[UCC 9–610(b). If a secured party does not dispose of the collateral in a commercially
reasonable manner, it may negatively affect the price paid for the collateral at the sale. If that
occurs, a court can reduce the amount of any deficiency that the debtor owes to the secured
party [UCC 9–626(a)(3)].
The purpose of requiring commercially reasonable conduct is to obtain a satisfactory
price, but price alone is not enough to prove reasonableness. The courts look at many factors to
determine reasonableness. Every aspect of a sale must be conducted in a commercially
reasonable manner. Under UCC 9–627(b)(3), this can happen if a sale conforms with the
reasonable commercial practices among dealers in that type of property.
ANSWERS TO QUESTIONS IN THE REVIEWING FEATURE
AT THE END OF THE CHAPTER
1A. Perfection by filing
Perfecting a security interest in the computers would require him to file a financing statement,
because the computers are classified as equipment (goods bought for use primarily in a
business). With respect to the sound system, the kayak, and the vehicle, when a seller of
consumer goods extends credit for the purchase to a person buying for household purposes, a
purchase-money security interest, or PMSI, is created and attaches automatically, without the
filing of a financing statement. In the case of the 4-Runner, motor vehicles often fall under other
state laws concerning such details as their use as collateral and encumbrances on their titles,
but these laws are not discussed in the chapter.
2A. Debtor’s name
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CHAPTER 30: SECURED TRANSACTIONS 5
30-1A. Priorities
A perfected secured party prevails over most third parties having claims to the same collateral of
the debtor. An exception, however, is a buyer who, in the ordinary course of business, “takes
free of a security interest created by his seller even though the security interest is perfected and
even though the buyer knows of its existence.” Garfield purchased a generator from Redford, a
seller who deals in goods of that kind. Thus, Garfield is a buyer in the ordinary course of
30-2A. Perfection of a security interest
The creditor has a security interest in the collateral and is a perfected secured party. To create a
security interest, the following criteria must be met [UCC 9–203]:
(a) Unless the collateral is in the possession of the secured party, a debtor
must sign a security agreement describing the collateral.
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30-3A. The scope of a security interest
No. The bank will prevail because it held a properly perfected security interest in Edward’s entire
30–4A . SPOTLIGHT ON RADIO SHACK—Priorities
Yes, the bank’s security interest has priority over Radio Shack’s claims. The Boudreauxes
30–5A. Default
A secured creditor has a variety of different of steps that it can take to satisfy a debt. Under the
UCC, these remedies are cumulative and can be exercised simultaneously. A secured creditor
can repossess and retain a debtor’s collateral in full or partial satisfaction of the debt. The
collateral does not have to be disposed of first unless the parties have agreed otherwise. If the
collateral satisfies the debt only partially, the creditor can seek a judgment for the balance due.
Of course, it would not be fair for a creditor to deprive a debtor of the possession of the
collateral for an unreasonable length of time and not apply the property, or the proceeds from its
sale, against the debt. The creditor must act in a commercially reasonable manner and take
steps to sell, lease, retain, or otherwise dispose of the collateral.
In this problem, it does not appear that the bank has failed to proceed in a commercially
reasonable manner. The bank chose to retain the collateral and seek a judgment on the debt.
The amount that OAI owes the bank might be at issue—how does the value of the collateral
30–6A. Disposition of collateral
Yes, the sale was commercially reasonable. Once default has occurred and the secured party
has obtained possession of the collateral, the secured party can sell the collateral in any
CHAPTER 30: SECURED TRANSACTIONS 7
commercially reasonable manner and apply the proceeds toward satisfaction of the debt. The
secured party must notify the debtor ahead of time about the sale. Generally, a sale would be
(1) the debtor’s signature, (2) the debtor’s and creditor’s addresses, and (3) a description of the
collateral by type or item.
In this case, all of Union’s financing statements were sufficient to perfect security
30–8A. Disposition of collateral
Yes, Barclays was entitled to collect even though it did not give Poynter ten days’ advance
notice of the sale. A loan agreement, like any contract, must be interpreted according to the
plain and obvious meaning of its terms.
In this problem, the loan agreement between Barclays and Poynter gave Barclays
multiple stand-alone options on default. One option required the lender to give ten days’
advance notice of a sale. A different option permitted the lender to avoid this requirement. When
Poynter did not repay the loan, Barclays repossessed the yacht, notified Poynter that it would be
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30–9A. Perfection of a security interest
Yes, the description in PHI’s financing statement was sufficient to perfect the creditor’s security
interest in the SURE payment. A financing statement must describe the collateral in which a
secured party has a security interest in order to provide public notice of the fact that certain
property of the debtor is subject to a security interest. The UCC permits broad, general
descriptions in a financing statement, such as “all assets.”
In this problem, G&K Farms ran a farm. G&K was insured under the federal
Supplemental Revenue Assistance Payments Program (SURE), which provides financial
assistance for crop losses caused by natural disasters. PHI loaned G&K $6.6 million, and filed a
30-10A. A QUESTION OF ETHICS—Priorities
(a) The court found that Denton knew when he signed the note for Anderson’s loan
that if Anderson defaulted and FIB repossessed the collateral, the sale proceeds would be
applied first to the SBA loan. The court ruled in FIB’s favor. Denton appealed to the Montana
Supreme Court, arguing in part that FIB failed to disclose the impact of the SBA loan
arrangements on the loan that he co-signed and that this relieved him of the obligation to pay.
FIB responded that one of its officers “fully informed” Denton about the structure of the two
loans, that Denton knew the SBA loan would have priority to the collateral on Anderson’s
default, and that Denton agreed to this arrangement. The state supreme court affirmed the lower
court’s decision. “Our review of the record confirms that significant evidence was presented that
would allow the . . . Court to conclude that Denton knew his loan would hold a second position
lien to the SBA loan.”
CHAPTER 30: SECURED TRANSACTIONS 9
(b) Denton contended among other things that the note and security agreement
constituted a contract of adhesion because FIB prepared the note and the borrowers had no
opportunity to negotiate its terms, some of which were unconscionable. FIB countered in part
30–11A. Security Interests
(a) The requirements that must be met for a creditor to have an enforceable security
interest are (1) the collateral must either (a) be in the possession of the secured party pursuant
to an agreement, or (b) there must be a written security agreement describing the collateral and
signed by the debtor; (2) the secured party must give value; and (3) the debtor must have rights
in the collateral. The first requirement is necessary to provide proof of the security agreement.
The second requirement (value) can consist of any consideration that supports a contract (as
well as an antecedent obligation or a binding commitment to extend credit). It is a necessary
element to the formation of any contract. The third requirement protects property owners from
others’ use of the property to secure interests in which the owners have no part.
(b) A security interest is not enforceable unless it attaches to the collateral. For
attachment to occur, under UCC 9–203 the debtor must have rights in the collateral, the secured
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