Enforceability of consensual security

Enforceability of consensual lien in personal property and fixtures

U.C.C. 9-203(b) states three requirements for a security interest in personal property and fixtures to be enforceable by a secured party against a debtor, which I state here in a different order: (1) the debtor and the secured party must have authenticated a security agreement that contains a description of the collateral, or the collateral must be in the possession or control of the secured party pursuant to a security agreement between the debtor and the secured party, or, in the case of specified types of collateral, there must be some other evidence of an agreement to create a security interest; (2) the secured party must give value to the debtor; and, (3) the debtor must have rights in or power to transfer rights in the collateral that is the subject of the security agreement. Once the security interest becomes enforceable against the debtor it is said to attach to the collateral (unless the agreement of the parties explicitly postpones the time of attachment). U.C.C. 9-203(a).

A "security agreement" between the debtor and the secured party is a defined term (U.C.C. 9-102(a)(73)) that requires further reference both to the definition of "security interest" (U.C.C. 1-201(37)) and to the definition of "agreement" (1-201(3)). Notice that the definition of agreement includes oral bargains as well as bargains that arise from circumstances such as usage of the trade, course of dealing, or course of performance. Thus, a security agreement may be oral. However, because of the danger that a party might fabricate a claim of a security interest, the drafters have required some additional evidence of the existence of a security agreement as a condition to its enforceability. See Official Comments 3 and 4 to U.C.C. 9-203. To determine the nature of the additional evidence required, one needs to know if the security interest will be possessory or non-possessory, or, in the case of some types of collateral, whether the secured party has control over the collateral.

A security interest is non-possessory if the secured party does not have possession of the collateral. Many consensual secured transactions involving personal property or fixtures are non-possessory. Where collateral is equipment, or inventory, or car, or furniture, the debtor typically must use and therefore retain possession of the collateral. For other kinds of collateral, such as accounts or general intangibles, there is nothing physical to possess. A non-possessory security agreement will be enforceable only if it is evidenced by recorded language, authenticated by the debtor, that reflects an agreement by the debtor to grant a security interest and sufficiently describes the collateral. U.C.C. 9-203(b)(3)(A). Authentication of recorded language means the debtor's signature, use of a symbol, or other action that confirms the debtor's identity and indicates the debtor's assent to or adoption of the recorded language. See U.C.C. 9-102(a)(7) ("authenticate") and U.C.C. 9-102(a)(69) ("record"). The concept of an authenticated record, replacing the old Article 9 concept of a signed writing, accomodates electronic technology and commerce. An authenticated record of the security agreement must describe the collateral in the manner stated in U.C.C. 9-108. That section expands considerably on the more terse definition of sufficient description found in former Article 9 (former U.C.C. 9-110), a definition that had engendered much litigation concerning the sufficiency of description of collateral in a security agreement. Under the "composite document rule" adopted in some jurisdictions, the authenticated record need not be a single document. No doubt, as under former Article 9, we shall continue to see controversies about whether several authenticated records taken together will be sufficient to indicate the debtor's agreement to a security interest. See, e.g., Komas v. Future Systems Inc.

A security interest is possessory if the secured party has possession of the collateral. For example, a pawn shop may hold a ring as collateral for repayment of a loan, or a bank may hold grain to secure repayment of a loan to a farmer by holding a negotiable warehouse receipt issued by a storage facility in which the grain is stored. For all collateral other than certificated securities, if the security interest is possessory, the security agreement can be enforceable in the absence of an authenticated record if the secured party has possession pursuant to the agreement between the parties. Possession by the secured party is thought to be sufficient confirming evidencing of the existence of the security agreement. U.C.C. 9-203(b)(3)(B).

If the collateral consists of deposit accounts, investment property, letter-of-credit rights, or electronic chattel paper, the security agreement will also be enforceable if the secured party has control over such collateral pursuant to the debtor's security agreement, even if the security agreement is oral. U.C.C. 9-203(b)(3)(D). Control over these types of collateral is defined in U.C.C. 9-104, 9-105, 9-106, and 9-107. If the collateral consists of a certificated security in registered form, the security agreement will be enforceable if the security has been delivered to the secured party pursuant to the debtor's security agreement. U.C.C. 9-203(b)(3)(C).

In some cases, such as a corporate merger, a person not originally a party to a security agreement (e.g. an acquiring company) may become bound as debtor to a security agreement entered by another person (e.g. an acquired company). See U.C.C. 9-203(d), (e).

There are a few types of security interests governed at least in part by Article 9 that are enforceable even in the absence of an agreement of the parties, i.e. they are non-consensual. See U.C.C. 9-203(c). For example, under U.C.C. Article 2, a buyer of goods entitled to revoke acceptance of those goods (i.e. return the goods to the seller and cancel the contract) has a security interest in the goods in the buyer's possession to secure repayment of any portion of the purchase price already paid. U.C.C. 2-711(3). As long as the buyer retains possession of the goods, no agreement is necessary to make this security interest enforceable against the debtor. U.C.C. 9-110(1). In this Article 2 example, what is the debt? Who is the debtor?

Under U.C.C. 9-203(b), a security agreement is enforceable against the debtor only if, in addition to the requirement of a security agreement evidenced by recorded language, possession, or control, the secured party gives value to the debtor and the debtor has rights in or the power to transfer rights in the collateral.

In U.C.C. 9-203(b)(1), the drafters of the Commercial Code express the requirement of value in the passive voice, a style of writing that good writers discourage. When one thinks about a secured transaction, however, it is clear that a security interest is unenforceable unless the secured party furnishes value. In most cases the secured party advances or promises to advance funds to or sells property on credit to the person who becomes obligated to pay, but the transaction could call for the secured party to advance value to a third party. In either case we have value under U.C.C. 1-201(44)(d).

There are, however, somewhat less obvious but commercially important cases. For example, a judgment creditor may agree to accept installment payments of the judgment if secured by a security interest in some of the judgment debtor's collateral. If so, would the value requirement be satisfied? See U.C.C. 1-201(44). Such an arrangement may avoid the precipation of bankruptcy that might otherwise occur if the judgment creditor pursued its rights to execute on the judgment. See Commentary.Enforcement of judgment.

The value requirement reflects a general principle of secured debt: a lien (whether judicial, consensual, or statutory and whether on real or personal property, or on fixtures) is unenforceable absent an underlying obligation. This principle takes an unusual turn in bankruptcy, where a lien on property (in rem liability) will generally remain enforceablein the amount of the discharged obligation, or the value of the collateral, whichever is less, notwithstanding the discharge of the underlying obligation (in personnam liability) . See Commentary.Consumer Chapter 7.

We explore the requirment of rights in collateral in Central Production Credit Assoc. v. Hopkins and State Bank of Young America v. Wagener.