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UCC Security Interests in Proceeds of Collateral Navigating Attachment, Perfection and Priority and the Impact of a Debtor's Bankruptcy

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TUESDAY, OCTOBER 1, 2013

Presenting a live 90-minute webinar with interactive Q&A

John Lawlor, Partner, Mayer Brown, Chicago

Jim Pfau, Partner, Faegre Baker Daniels, Minneapolis

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The Outer Limits of Proceeds

John F. Lawlor Partner 312-701-7220 [email protected]

October 2013

Introduction

• Commercial Tort Claims

• Insurance Proceeds

• FCC Licenses

• Bankruptcy Considerations

• Some Other Cases

6

Commercial Tort Claims

• UCC §9-102(a)(13): “Commercial tort claim” means a claim arising in tort with respect

to which: (A) the claimant is an organization; or

(B) the claimant is an individual and the claim:

(i) arose in the course of the claimant’s business or profession; and

(ii) does not include damages arising out of personal injury to or the death of an individual.

A commercial tort claim is not a general intangible

7

• Official Comment 5.g to UCC §9-102: “A security interest in a tort claim may exist if the claim is proceeds of other collateral.”

• Proceeds definition includes “ . . . claims arising out of the loss, nonconformity, or interference with the use of, defects or infringement of rights in, or damage to, the collateral.” UCC §9-102(a)(64).

8

• Two ways that Article 9 treats commercial tort claims differently than other intangible collateral

– Under UCC §9-204(b)(2), an after-acquired property clause in a security agreement will not include commercial tort claims that are not in existence when the security agreement is authenticated.

– Under UCC §9-108(e), the description of a commercial tort claim in the granting clause cannot be by “type” (which would otherwise be a permissible way of describing the collateral). The description must be by another means specified in UCC §9-108(b) (specific listing, category, etc.)

9

• American Cartage case, 656 F. 3rd 82 (1st Cir., 2011) – Complicated facts involved suit by purchaser of all bankrupt

debtor’s assets against advisor and manager of the debtor while in bankruptcy. Claims alleged conversion, breach of fiduciary duty, interference with contractual relationships and conspiracy.

– Purchaser argued that claims were proceeds of collateral.

– Court held that proceeds of collateral can only include the right to payment from resolution of a commercial tort claim, and not the claim itself.

– Court cited language in Official Comment 15 to UCC §9-109 to support this analysis.

10

• Comment 15 relates to 9-109(d)(12), which excludes assignments of claims “arising in tort” from Article 9, but specifically states that commercial tort claims are not so excluded.

• Comment 15 provides as follows: “This Article now applies to assignments of ‘commercial tort claims’ (defined in Section 9-102) as well as to security interests in tort claims that constitute proceeds of other collateral (e.g., a right to payment for negligent destruction of the debtor’s inventory).”

• Court found that “ . . . treating commercial tort claims themselves as proceeds would blur any meaningful distinction between the two categories.”

• Comment 15 does not say that only a right to payment from a tort claim can constitute proceeds; the court’s argument is contrary to Official Comment 5.g to UCC §9-102, which says that a “tort claim” may be proceeds, not simply the right to receive payment upon resolution of a tort claim.

11

• In American Cartage the successor in interest was seeking to prosecute the tort claims against the alleged tortfeasors, which may have caused the court to conclude as it did, that only the right to payment of a resolved tort claim can be proceeds collateral, not the claim itself.

12

Tort Claims and Insurance Proceeds

• Several cases have held that tort claims seeking to recover general business losses, rather than losses attributable to a diminution in value of specific collateral, do not constitute “proceeds” of such original collateral.

– Helms v. Certified Packaging Corp., 551 F.3rd 675 (7th Cir., 2008)

– In re Ferry Road Properties, LLC, 78 U.C.C. Rep. Serv. 2d 580 (Bankr. E.D. Tenn. 2012)

• Cf. lead in language to clauses (D) and (E) of the definition of “proceeds” (referring to tort and insurance claims) “to the extent of the value of collateral . . . .”

13

• In Helms, lender’s original collateral was equipment

• Helms: – “The usual proceeds of collateral are the money obtained from

selling it. By a modest extension . . . they are money obtained in compensation for a diminution in the value of the collateral. But replacing a business loss is not restoring the value of damaged collateral. There is no necessary relation between the value of collateral and a business loss that results from its being destroyed or damaged—as this case illustrates: the business losses exceeded the impairment of the value of the collateral ninefold. The claim of a secured creditor to the proceeds of collateral cannot exceed the value of the collateral.”

14

• Would the lender in Helms have prevailed on its proceeds argument if the original collateral been all assets or had included all accounts and general intangibles?

• See MNC Commercial Corp. v. Rouse, 1992 U.S. Dist. LEXIS 22166 (W.D. Mo. 1992)

• MNC Commercial held that payments of a business interruption insurance policy were proceeds of debtor’s accounts and general intangibles.

15

FCC Licenses

• As a matter of federal law, FCC licenses are not assignable, and this includes a prohibition on the grant of a security interest in an FCC license.

• Beginning in 1994, the FCC has taken the position that a lender may take a security interest in the proceeds of an FCC license.

16

• Under §552(a) of the Bankruptcy Code, a secured party’s pre-petition lien generally does not attach to property acquired by the debtor post-petition

• There is an exception to this general rule in §552(b) of the Bankruptcy Code, which provides that the secured party’s pre-petition lien can attach to proceeds of pre-petition original collateral

• Because there can be no lien on an FCC license (other than anticipated proceeds of sale) as original collateral, courts have had some difficulty with the concept that a lender has a security interest in the proceeds of the license

17

• In Tracy Broadcasting, 696 F.3rd 1051 (10th Cir., 2012), the Tenth Circuit held that federal law permits the holder of an FCC license to grant a security interest in the proceeds of sale of that license.

• The court also held that the UCC recognizes that a security interest in the proceeds of sale of an FCC license attaches when the licensee enters the security agreement (regardless of whether a sale is contemplated at that time).

18

• The Tracy court reasoned by analogy to the anti-assignment override provisions of UCC §9-408(c) (which does not purport to override federal law)

– [Section 9-408(c)] overrides state licensing laws that would bar the creation, attachment, and perfection of security interest in state-issued licenses that are essentially identical to the security interest claimed by [SP]; and by doing so, it implicitly recognizes the propriety of creation, attachment, and perfection of such security interests in federal licenses when, as here, no federal law is thereby violated.

19

• The court cited Official Comment 7 to UCC to §9-408, Example 4 to support its analysis:

– Example 4: A debtor is the owner of a cable television franchise that, under applicable law, cannot be assigned without the consent of the municipal franchisor. A lender wishes to extend credit to the debtor, provided that the credit is secured by the debtor’s “going business” value. To secure the loan, the debtor grants a security interest in all its existing and after-acquired property. The franchise represents the principal value of the business. The municipality refuses to consent to any assignment for collateral purposes. If other law were given effect, the security interest in the franchise would not attach; and if the debtor were to enter bankruptcy and sell the business, the secured party would receive but a fraction of the business’s value. Under this section, however, the security interest would attach to the franchise. As a result, the security interest would attach to the proceeds of any sale of the franchise while a bankruptcy is pending. However, this section would protect the interests of the municipality by preventing the secured party from enforcing its security interest to the detriment of the municipality.

20

• Although the anti-assignment override in UCC §9-408(c) does not override federal law, the Tracy court found that such section “does for . . . state licenses what the FCC’s policy does for FCC licenses. Section 9-408 implicitly recognizes (and the comments to the section explicitly endorse) that a lien on the right to sale proceeds of a government license can attach when a lender extends credit to a licensee.”

21

• Tracy held that “one of the rights acquired by a licensee when it obtains a license is the right to receive money from a future transferee of the license. This right has value upon acquisition of the license, regardless of whether a prospective purchaser is in sight. And the FCC permits the licensee to grant a security interest in that right.”

• See also MLQ Investors, L.P. v. Pacific Quadracasting, Inc. 146 F. 3rd 746 (9th Cir., 1998)

22

Possible Extensions Of FCC Cases

• Consider whether the rationale of Tracy can be extended to other types of property that cannot be assigned, particularly state law rights that are subject to the anti-assignment overrides of UCC §9-408(c), such as cable TV franchises

23

Bankruptcy Considerations

• As noted above, Section 552(a) of the Bankruptcy Code generally provides that property acquired by the estate or by the debtor after the commencement of the case is not subject to any lien resulting from any security agreement entered into by the debtor before the commencement of the case.

• Section 552(b)(1) of the Bankruptcy Code provides that §552(a) will not invalidate a lien in proceeds of pre-petition original collateral, “except to any extent that the court, after notice and a hearing and based on the equities of the case, orders otherwise.”

– Thus, even if the SP has a valid security interest in proceeds, the Bankruptcy Court can invalidate it based on the equities of the case

• Section 552(b)(2) of the Bankruptcy Code provides a similar rule for rents of property that is pre-petition collateral and the fees, charges, accounts, or other payments for the use or occupancy of rooms and other public facilities in hotels, motels, or other lodging properties.

24

Other Cases

• In the Matter of Value-Added Communications, 139 F.3d 543 (5th Cir. 1998) (fees for use of pay phones held not to be proceeds of the phones)

• 1st Source Bank v. Wilson Bank & Trust, 2012 U.S. Dist. LEXIS 143024 (M.D. Tenn. 2012) (accounts arising from use of tractors and trailers held not to be proceeds of such tractors and trailers)

• In re Gamma Center, Inc., 489 B.R. 688 (Bankr. N.D. Ohio 2013) (proceeds of equipment include only proceeds of sale of equipment, not receivables generated from use of equipment)

• In re Las Vegas Monorail, 429 B.R. 317 (Bankr. D. Nev. 2010) (rider fees not proceeds of a monorail franchise)

25

Security Interests in Proceeds of Collateral

Jim Pfau Faegre Baker Daniels LLP | October 1, 2013

Proceeds: Why Bother?

Security Interests in Proceeds of Collateral 27

DEFINITIONS


“Proceeds”: Before 2001

[OA9-306(1)] “’Proceeds’ includes whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds. Insurance payable by reason of loss or damage to the collateral is proceeds, except to the extent that it is payable to a person other than a party to the security agreement.”


“Proceeds”: Since 2001

[9-102(64)] “’Proceeds’ means . . . the following property: (A) whatever is acquired upon the sale, lease, license, exchange, or

other disposition of collateral; (B) whatever is collected on, or distributed on account of, collateral; (C) rights arising out of collateral; (D) to the extent of the value of collateral, claims arising out of the loss,

nonconformity, or interference with the use of, defects or infringement of rights in, or damage to, the collateral; or

(E) to the extent of the value of collateral and to the extent payable to the debtor or the secured party, insurance payable by reason of the loss or nonconformity of, defects or infringement of rights in, or damage to, the collateral.”


Cash and Noncash Proceeds

[9-102(a)(9)] “’Cash proceeds’ means proceeds that are money, checks, deposit accounts, or the like.” [9-102(a)(58)] “’Noncash proceeds’ means proceeds other than cash proceeds.”


ATTACHMENT


Attachment: The Basic Rule

[9-315(a)] “Except as otherwise provided in this article and in Section 2-403(2):

(1) a security interest or agricultural lien continues in collateral notwithstanding sale, lease, license, exchange, or other disposition thereof unless the secured party authorized the disposition free of the security interest or agricultural lien; and

(2) a security interest attaches to any identifiable proceeds of collateral.”


Commingled Proceeds

[9-315(b)] “Proceeds that are commingled with other property are identifiable proceeds:

(1) if the proceeds are goods, to the extent provided by Section 9-336; and

(2) if the proceeds are not goods, to the extent that the secured party identifies the proceeds by a method of tracing, including application of equitable principles, that is permitted under law other than this article with respect to commingled property of the type involved.”


“Magic” Proceeds: Beyond Original Collateral

• Under 9-109, Article 9 does not apply to: • “a transfer of an interest in or an assignment of a claim under a policy

of insurance” • “an assignment of a claim arising in tort, other than a commercial tort

claim” • “an assignment of a deposit account in a consumer transaction”

• BUT • . . . “Sections 9-315 and 9-322 apply with respect to proceeds and

priorities in proceeds.”


PERFECTION


Perfection: The Basic Rule

[9-315(c)] “A security interest in proceeds is a perfected security interest if the security interest in the original collateral was perfected.”


But Wait . . .

“[9-315(d)] “A perfected security interest in proceeds becomes unperfected on the 21st day after the security interest attaches to the proceeds unless:

(1) the following conditions are satisfied: (A) a filed financing statement covers the original collateral; (B) the proceeds are collateral in which a security interest may be

perfected by filing in the office in which the financing statement has been filed; and

(C) the proceeds are not acquired with cash proceeds; (2) the proceeds are identifiable cash proceeds; or (3) the security interest in the proceeds is perfected other than under

subsection (c) when the security interest attaches to the proceeds or within 20 days thereafter.”


Perfection Examples

#1: SP perfects security interest in all assets. Debtor sells inventory for cash and buys equipment.

#2: SP perfects security interest in inventory. Debtor sells inventory for cash, uses cash to buy other inventory.

#3: SP perfects security interest in inventory. Debtor trades inventory for equipment.

#4: SP perfects security interest in inventory. Debtor sells inventory for cash, uses cash to buy equipment.


PRIORITY


Priority: The Basic Rule (Temporal Priority)

[9-322(b)(1)] “[T]he time of filing or perfection as to a security interest in collateral is also the time of filing or perfection as to a security interest in proceeds.”


Priority: Basic Examples

#1: On Monday, Allied Bank perfects a security interest in accounts. On Tuesday, Interstate Bank perfects a security interest in inventory. On Wednesday, Debtor sells inventory, giving rise to an account.

#2: On Monday, Interstate Bank perfects a security interest in inventory.

On Tuesday, Allied Bank perfects a security interest in accounts. On Wednesday, Debtor sells inventory, giving rise to an account.


NON-TEMPORAL PRIORITY


PMSI Priority in Proceeds: Generally [9-324(a)] “Except as otherwise provided in subsection (g), a perfected purchase-money security interest in goods other than inventory or livestock has priority over a conflicting security interest in the same goods, and, except as otherwise provided in Section 9-327, a perfected security interest in its identifiable proceeds also has priority, if the purchase-money security interest is perfected when the debtor receives possession of the collateral or within 20 days thereafter.”


PMSI Priority in Proceeds: Inventory

[9-324(b)] “. . . a perfected purchase-money security interest in inventory has priority over a conflicting security interest in the same inventory, has priority over a conflicting security interest in chattel paper or an instrument constituting proceeds of the inventory and in proceeds of the chattel paper, if so provided in Section 9 330, and, except as otherwise provided in Section 9-327, also has priority in identifiable cash proceeds of the inventory to the extent the identifiable cash proceeds are received on or before the delivery of the inventory to a buyer, if . . . .”


PMSI examples (Equipment)

#1: On Monday, First National Bank files a financing statement to perfect its security interest in all assets of Al’s Palace o’ Cuisine.

On Tuesday, Manufacturer sells a commercial refrigerator to Al’s and perfects a security interest in the refrigerator. Manufacturer’s interest is a PMSI.

On Wednesday, Al sells the refrigerator in exchange for a check, which he sticks in a drawer.

#2: Same facts, except that on Thursday Al cashes the check and uses the

money to buy a new refrigerator. #3: Same facts on Monday and Tuesday, but on Wednesday Al trades the

(original) refrigerator in for a new refrigerator rather than selling it for cash.


PMSI Examples (Inventory)

#3: On Monday, First National Bank files a financing statement to perfect its security interest in all assets of Bob’s Grocery.

On Tuesday, Manufacturer sells canned peas (inventory) to Bob’s and perfects a security interest in the peas. Manufacturer has sent prior notice to First National, and Manufacturer’s interest is a PMSI.

On Wednesday, Bob sells all of the peas to a single customer in exchange for a check, which he sticks in a drawer.

#4: Same facts on Monday and Tuesday, but on Wednesday

Bob sells the peas to a customer on open account, without taking back a check, note or chattel paper.


PMSI Priority in Proceeds: Livestock and Software

• Livestock: priority continues in identifiable proceeds and “identifiable products in their unmanufactured states.” [9-324(d)] • Livestock PMSI requirements are similar to inventory PMSI, but priority

extends to all identifiable proceeds as well as certain products.

• Software: priority continues in identifiable proceeds to same extent as related goods and their proceeds [9-324(g)] • Limited meaning since software is granted PMSI status only when sold

in connection with goods (9-103(c))


Chattel Paper as Proceeds

[9-330(a)] “A purchaser of chattel paper has priority over a security interest in the chattel paper which is claimed merely as proceeds of inventory subject to a security interest if:

(1) in good faith and in the ordinary course of the purchaser’s business, the purchaser gives new value and takes possession of the chattel paper or obtains control of the chattel paper under Section 9-105; and

(2) the chattel paper does not indicate that it has been assigned to an identified assignee other than the purchaser.”


Proceeds of Chattel Paper

[9-330(c)] “Except as otherwise provided in Section 9-327, a purchaser having priority in chattel paper under subsection (a) or (b) also has priority in proceeds of the chattel paper to the extent that:

(1) Section 9-322 provides for priority in the proceeds; or

(2) the proceeds consist of the specific goods covered by the chattel paper or cash proceeds of the specific goods, even if the purchaser’s security interest in the proceeds is unperfected.”


Chattel Paper: Example

On Monday, Al’s Appliances grants a security interest in all of its assets to Bob’s Bank. On Tuesday, Al’s sells a refrigerator to Don’s Diner, which signs an installment sales contract constituting chattel paper. On Wednesday, Al sells (or grants a security interest in) the chattel paper to Frieda’s Factors, which takes possession of the original chattel paper in good faith, in the ordinary course of business, for new value, and without any indication on the paper that it has been assigned to Bob’s Bank. • As between Bob’s Bank and Frieda’s Factors, who has priority in:

• The chattel paper? • Cash payments on the chattel paper? • Two new dishwashers that Al’s Appliances purchases with the cash

payments on the chattel paper? • The refrigerator, when Al changes his mind and returns it?

• Does it matter whether Bob’s Bank’s security interest in the refrigerator was a PMSI?


Priority of Party in Control/Possession: Original Collateral

• Deposit accounts (9-327) (“A security interest held by a secured party having control of the deposit account under Section 9-104 has priority over a conflicting security interest held by a secured party that does not have control.” [9-327(1)]

• Investment property (9-328) • Letter-of-credit rights (9-329) • Rights of holders in due course of negotiable instruments, holders of

negotiable documents of title, protected purchasers of securities (9-331)


Priority of Party in Control/Possession: Proceeds

[9-322(c)] “Except as otherwise provided in subsection (f), a security interest in collateral which qualifies for priority over a conflicting security interest under Section 9-327, 9-328, 9-329, 9-330, or 9-331 also has priority over a conflicting security interest in:

(1) any supporting obligation for the collateral; and (2) proceeds of the collateral if:

(A) the security interest in proceeds is perfected; (B) the proceeds are cash proceeds or of the same type as the

collateral; and (C) in the case of proceeds that are proceeds of proceeds, all

intervening proceeds are cash proceeds, proceeds of the same type as the collateral, or an account relating to the collateral.”


Possession/Control: Example

On Monday, Bob’s Bank perfects (by filing) a security interest in Company’s right to dividend payments from VentureCo, a corporate joint venture between Company and two other businesses. On Tuesday, Carrie’s Credit Union perfects a security interest in Company’s stock in VentureCo by taking possession of the stock certificates. On Wednesday, VentureCo delivers a dividend check to Company. Company puts check in a drawer. On Thursday, Company deposits check in its bank account. On Friday, Company uses the proceeds to buy: • additional equity in VentureCo, • IBM stock, and • a new laser printer.


Checks and Other Instruments

[9-330(d)] “Except as otherwise provided in Section 9-331(a), a purchaser of an instrument has priority over a security interest in the instrument perfected by a method other than possession if the purchaser gives value and takes possession of the instrument in good faith and without knowledge that the purchase violates the rights of the secured party.”


Example: Checks, Other Instruments

On Monday, Bob’s Bank perfects (by filing) a security interest in Company’s right to dividend payments from VentureCo, a corporate joint venture between Company and two other businesses. On Tuesday, Carrie’s Credit Union perfects a security interest in Company’s stock in VentureCo by taking possession of the stock certificates. On Wednesday, pursuant to an agreement between Bob’s Bank and VentureCo, VentureCo delivers a dividend check directly to Bob’s Bank.


Extra Credit: Bonus Examples

From the comments to 9-322 Example 11 (13) SP-1 perfects interest in deposit account by control. SP-2 perfects against inventory. Debtor uses traceable funds from deposit account to purchase new inventory. Inventory is sold and proceeds deposited in another deposit account (not subject to control). Example 12 SP-1 perfects interest in deposit account by control. SP-2 perfects against equipment. Debtor uses traceable funds from deposit account to purchase new equipment.


Epilogue: Cash

[9-332(a)] “A transferee of money takes the money free of a security interest unless the transferee acts in collusion with the debtor in violating the rights of the secured party. (b) A transferee of funds from a deposit account takes the funds free of a security interest in the deposit account unless the transferee acts in collusion with the debtor in violating the rights of the secured party.”


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UCC Security Interests in Proceeds of Collateralmedia.straffordpub.com/products/ucc-security-interests-in-proceeds...UCC Security Interests in Proceeds of Collateral . ... courts have