Santa Clara University
School of Law

Final Examination
Secured Debt
Professors Mertens and Neustadter
Spring 2000
4 essay questions: 3.5 hours

1. This examination is limited open book. You may bring to the examination and use all assigned course materials and handouts, and any notes, outlines, or other work product that you have produced alone or together with other persons in the class, whether in hard copy or in electronic form. You may not refer to any other materials.

2. You may use your own laptop computer. Save your answers to a floppy disk frequently throughout the examination. If you are typing your answers on a computer, you may exercise the Save command after time for the examination is called.

3. There are 4 questions on the examination. Answer all of the questions (including all subparts to Questions 3 and 4). If you are writing, start each answer in a separate blue book. If you are typing, start each answer on a new page. Each of the questions is based on an initial set of basic facts. Each question modifies the basic facts.

 4. The suggested amount of time necessary to answer each question is as follows:

Question 1: 1 hour (30 points)
Question 2: 1 hour (30 points)
Question 3: 45 minutes (20 points)
Question 4: 45 minutes (20 points)

5. If you find a question or part of a question ambiguous, identify the ambiguity and explain how a resolution of the ambiguity would affect your answer.

6. Support your conclusions with analysis.

7. Where applicable, apply Revised U.C.C. Article 9. You should assume that California’s version of Article 9 is identical to the uniform version even though we have discussed some California non-uniform amendments.

8. All deeds of trust contain the standard clauses contained in the deed of trust included in the Forms Handout.

  Basic Facts

The City of San José has condemned property in the flight path of new airport runways. There are a total of five houses located on this property. The city severed them from their foundations and has put them on blocks, ready to be moved. Because of the large expense of moving houses, the city has offered them, free of charge, to any developer willing to move them. Noel Novice, a California resident, thought that this would be a good way to break into the development business and, in the process, get a home for himself. (He intended to move into one of the houses.)

Last year, Noel had purchased a large lot from Sid Seller at a cost of $1 million. Noel paid Sid $100,000.00 down and Sid carried back a note for $900,000.00 secured by a first deed of trust on the lot. Originally, Noel planned to subdivide the lot and build houses. Therefore, Noel’s agreement with Sid included a provision that Sid would subordinate his note to a construction loan if necessary.

Once Noel became aware that the city was giving the five houses mentioned above away, he decided to try to obtain the houses and move them to the lot he bought from Sid, instead of building houses from scratch. Because there were no other takers, the city agreed to give the houses to Noel.

After ascertaining that it would cost $1.5 million to obtain the permits required to move the houses, hire a company to do so, subdivide the lot, pour new foundations, and then renovate the houses once they were on the foundations, he approached Southern Bank for a loan. Southern Bank agreed to loan Noel the money for the project.

After doing some research that correctly concluded that the houses would be considered personal property governed by Article 9 until reattached to the land, the bank required that Noel execute (1) a written security agreement covering the houses that included an adequate description of the houses, and (2) a deed of trust on the land that Noel owned and onto which the houses were to be moved. This deed of trust was in second position behind Sid’s deed of trust, as the bank did not require Sid to subordinate. The security agreement and the deed of trust secured one note for $1.5 million. Southern Bank also had Noel’s Aunt Gerta, a retired real estate attorney, guaranty his note. Gerta drafted the guaranty herself and purposefully did not waive any of her rights as guarantor.

Since Noel was under a deadline from the city within which he had to move the houses, Southern Bank agreed to fund the first $500,000.00 of the loan to enable Noel to move the five houses. (The bank held the $1 million balance of the loan pending review of the plans and on-going work.) At the time Noel moved the houses onto his lot, he had not obtained the subdivision map needed to divide the lot into the five separate parcels, although he had made some initial inquiries of the city. The city had expressed some reservations about a five-lot subdivision for the parcel, but Noel decided to take the risk and move the houses anyway, hoping that the city would then see the benefits of increasing the housing stock by permitting the subdivision.

After moving the houses onto the lot, Noel proceeded to file his plans for the subdivision map, the cost of which was financed by part of the Southern Bank loan. While the map was being processed, Noel poured the foundation for the house in which he intended to live and affixed that house to the foundation. Renovation on that house began, with Southern Bank advancing the money for the foundation and work on that house pursuant to the terms of its loan.

A month later, Noel received word from the city that it would not approve a five lot subdivision of the parcel. It only approved a lot split into two parcels. Thus, three of the houses would have to be moved elsewhere. At this point Noel realized that he would not have sufficient funds to move three of the houses again and, in any event, he had no land on which to put them. Noel contacted several nonprofit organizations in the hopes of giving the houses away, and then offered them to the public at no cost but had no takers. Southern Bank refused to advance more money, as additional advances were conditioned on approval of the subdivision map. Noel abandoned the project and defaulted on his notes to Sid and to Southern Bank.

Because of the cost of moving the three houses off the lot or otherwise destroying them and removing the debris, the value of the land plus the one house that is affixed to it is now approximately $700,000.00. The value would increase to approximately $800,000.00 if another house were affixed to the second parcel that the city approved pursuant to the lot split. The $800,000.00 value takes into account the presence of the other three houses that would still have to be removed. The value of the detached houses is difficult to approximate, due to the fact that they must be moved. The balance on Sid’s note is $900,000.00 and the amount due to Southern Bank is $600,000.00.

QUESTION 1 (30 points; suggested time: 1 hour)

Sid comes into your office to seek your advice. Of course, he would like to recover his $900,000.00. Advise him as to what courses of action are available to him and which you would recommend. Explain fully.

QUESTION 2 (30 points; suggested time: 1 hour)

Assume Southern Bank paid off Sid’s loan when Southern first funded its loan and that therefore the balance on the bank’s note is $1.5 million (figured by adding the $900,000.00 it paid Sid and the $600,000.00 it advanced to move the houses, start the subdivision process, etc.). The other facts are as stated above. (Southern Bank held a first on the land plus a security interest in the unattached houses.) Southern Bank happened to have three undeveloped lots in its Real Estate Owned (REO) department onto which it could move three of the four unattached houses on Noel’s lot. Southern Bank properly noticed and advertised a public sale of the houses but nobody showed up for the sale. Southern Bank entered a credit bid of $500.00 for the three houses. You should assume the sale was commercially reasonable. The bank is still owed approximately $1.5 million.

Southern Bank hired a foreclosure company to begin a nonjudicial foreclosure on the two lots, one of which has Noel’s home attached to the foundation. The sale is scheduled for next Monday. You are Southern Bank’s general counsel and the file has now landed on your desk. You note the fact that Noel indicated on the loan application that he was planning to live in one of the houses but are uncertain as to whether he ever moved in. Noel indicated no source of income on his application. You also see the guaranty from Gerta. Your job is to figure out how the bank can recover the approximately $1.5 million owed by Noel. Therefore, you must immediately decide whether or not the bank should proceed with the scheduled sale. Analyze fully the bank’s possible courses of action, keeping in mind that it has already foreclosed on the unattached houses under its security agreement and has an imminent nonjudicial foreclosure of the real property pending.

Each of the five houses contained a turn of the century, ivory pedestal sink, each worth about $1,000. To protect them against damage during the relocation of the houses, Noel removed the sinks and stored them in a rented storage facility pending renovation of the houses. While the sinks were in storage, Noel approached Thrifty Finance, Inc., a corporation ("Thrifty"), for a $5,000 loan and offered the sinks as collateral. Noel wanted the loan to pay for taking some classes on renovating old homes. Thrifty was willing to make the loan if, in addition to taking the sinks as collateral, it obtained a guaranty of the loan by Noel's sister Claudia. You may assume that the F.T.C. Credit Practices Rule does not bar Thrifty from taking a security interest in the sinks. You may also assume that the sinks did not constitute fixtures and that the security instruments held by Sid and Southern Bank did not cover the sinks.

Noel signed a promissory note in favor of Thrifty and signed a security agreement, containing an adequate description of the collateral, in favor of Thrifty. Claudia signed a written guaranty of the note. Thrifty failed to file a financing statement.

Three months after getting the loan, Noel defaulted in payments to Thrifty. You may assume that the debt (including accrued but unpaid interest) is $5,000. Noel authorized the storage facility to turn over the sinks to Thrifty and told Thrifty that he was moving to Paris. Thrifty obtained the sinks from the storage facility. The President of Thrifty wants two of the sinks for his own home. Thrifty is considering various options to accommodate the President's wishes and to recover the amount owing.

Subpart (a)

One option that Thrifty is considering is the following: First, it will strictly foreclose on two of the sinks and credit Noel $1,500. Thereafter, Thrifty will sell those two sinks to the President of Thrifty for whatever Thrifty and the President mutually agree. After the strict foreclosure, Thrifty will sell the remaining three sinks in a commercially reasonable sale at a public auction, credit Noel with the proceeds (after subtracting permissible costs), and sue Claudia for any deficiency. Is this course of action permissible? If it is permissible, need Thrifty notify or otherwise communicate with Claudia in order to comply with Article 9?

Subpart (b)

A second option that Thrifty is considering is the following: It will sell two of the sinks directly to the President (without first strictly foreclosing on them) for $750 each, sell the other three sinks at a public auction, credit Noel with the proceeds of both sales (after subtracting permissible costs), and sue Claudia for any deficiency. Assuming proper notification, is this course of action permissible?

Subpart (c)

A third option that Thrifty is considering is the following: It will sue Noel on his note and Claudia on her guaranty, obtain a judgment against each for the full amount of the debt, execute the judgment against Noel by causing the sheriff to levy on and sell the sinks, and then execute on assets of Claudia to satisfy any portion of the $5,000 debt remaining unpaid. The President will purchase two of the sinks at the execution sale. Is this course of action permissible?

Assume the same facts as in the first paragraph of Question 3, except that Thrifty did not ask for a guaranty. All dates stated below are in the same year.

Noel signed a promissory note in favor of Thrifty and signed a security agreement, containing an adequate description of the collateral, in favor of Thrifty. On April 1, Thrifty presented a financing statement, accompanied by the appropriate fee, to the Office of the California Secretary of State. The financing statement described the collateral as "five ivory, pedestal sinks," provided the name and mailing address of the secured party, and listed the name of the debtor as "N. Novise." The financing statement gave the mailing address of the debtor and indicated that he was an individual.

The clerk in the Office of the California Secretary of State, new on the job, refused to accept the financing statement for filing because it was accompanied by a check for the filing fee that exceeded by $5.00 the amount that the Office requires for such a filing. On May 1,Thrifty re-presented the financing statement to the same office. This time the financing statement contained the same information as the first financing statement, except that it listed the name of the debtor as Noel Novice and was accompanied by the exact amount of the required filing fee. This time the office accepted the financing statement for filing.

On July 20, Noel filed a Chapter 11 petition. (Even though most Chapter 11 filings are by corporations and other business entities, an individual is also eligible for relief under Chapter 11.)

Subpart (a)

May Noel avoid Thrifty's security interest and treat Thrifty as holding only an allowed unsecured claim? In part, your analysis should consider U.C.C. 9-516.

Subpart (b)

Assume that Noel may not avoid Thrifty's security interest. Assume that the debt is $5,000 and that the value of the collateral is $3,500. What payment and payment terms must Noel's Chapter 11 plan provide for Thrifty's allowed secured claim in order to justify confirmation over Thrifty's objection?