Scope of U.C.C. Article 9
General: With some exceptions discussed below, U.C.C. Article 9 applies to "a transaction, regardless of its form, that creates a security interest in personal property or fixtures by contract." U.C.C. 9-109(a)(1). "Security interest" is defined in 1-201(37); for now, you should notice but need not focus on the extensive portion of that definition that distinguishes a security interest from a lease. Fixtures are defined as "goods that have become so related to particular real property that an interest in them arises under real property law." U.C.C. 9-102(a)(41). Carpeting is a good example. We explore the application of Article 9 to fixtures in Problem.Fixtures. By process of elimination, personal property consists of anything other than real property or fixtures.
Article 9 defines a large number of different types of personal property. Those definitions are critical because Article 9 rules often turn on the type(s) of personal property in which the secured party takes a security interest. As a rule of thumb, when using Article 9, always first identify the type of personal property serving as collateral. We give you some practice in doing so in Problem.Identifying Collateral.
Receivables: Most students have little difficulty understanding the concept of a security interest in tangible personal property such as a security interest in equipment, in inventory, farm products, or in consumer goods. If you have purchased an automobile on credit, or know someone who has, you likely understand that the automobile served as collateral for the deferred payments or for the loan that enabled its purchase. But commercial financing often involves the taking of a security interest in collateral that consists of or includes the debtor's right to be paid by third parties. A right to be paid by a third party is often referred to as a "receivable." The statutory text of Article 9 does not use the term "receivable;" instead, it uses terms for and defines particular types of receivables, because some Article 9 rules (e.g. rules governing the method of perfecting a security interest) differ depending upon the type of receivable. Official Comment 5 to U.C.C. 9-102 lists the various types of receivables The concept of a security interest in receivables is somewhat less intuitive than a security interest in goods. Some elaboration may therefore be helpful.
There is both common law contract vocabulary and Article 9 vocabulary to describe receivables financing. We start with the more familiar contract vocabulary. One party, the obligor, becomes obligated to pay another party, the obligee. The obligee, desiring funds immediately and unwilling or unable to await payment from the obligor, transfers the right to payment to another. The transfer is typically referred to as an assignment and the obligee is therefore also referred to as an assignor and the party to whom the assignment is made is referred to as the assignee. It will be useful for you to diagram these relationships and label the parties both with this contract vocabulary and with the Article 9 vocabulary that follows.
In very general terms, the obligee's transfer of the right to payment may take one of several forms. It may take the form of an assignment for security: loan me some money and take this obligation as collateral to secure repayment. It may take the form of an outright sale: buy this obligation from me for value. Or, the transfer may have attributes that make difficult the determination of whether the assignment is for security or is an outright sale. Article 9 applies to the transfer no matter what the form of the transaction. U.C.C. 9-109(a)(1), (a)(3), and Official Comment 4 to U.C.C. 9-109.
We offer a few examples to illustrate. In these examples we focus only on assignments for purpose of security. Elsewhere we consider transfers that are outright sales of receivables. See Commentary.Sales of receivables. With respect to the following examples, and for others, see generally Official Comment 5 to U.C.C. 9-102 ("Receivables-related Definitions").
Example 1. A retailer often sells large ticket consumer goods (e.g. automobiles, furniture, appliances) on credit under the terms of a retail installment sales contract (sometimes referred to as a conditional sale contract). Under the terms of such a contract, the consumer promises to pay the retailer for the goods in installments, over time, with interest and also grants the retailer a security interest in the goods being purchased. In bulk, these secured obligations of all of the retailer's consumer credit purchasers constitute valuable collateral for the retailer's own financing, collateral that the retailer can assign to a financier for purpose of security. The contracts evidencing these secured obligations are defined in Article 9 as "chattel paper." U.C.C. 9-102(a)(11). (To review: in common law contract parlance, the consumer would be referred to as an obligor, the retailer as an assignor, and the financier as an assignee.) In the parlance of Article 9, the consumer is the "debtor" and the retailer is the "secured party" in the context of the relationship between them. U.C.C. 9-102(a)(28), U.C.C. 9-102(a)(72). In the context of the retailer's relationship to its own financier, the retailer is the "debtor," the consumers obligated under the contracts are "account debtors," and the financier is the secured party. U.C.C. 9-102(a)(3).
Example 2. A manufacturer of goods, pens for example, will sell to distributors or retailers on unsecured credit typically payable without interest in 30-90 days. The accountant will call the payment obligations from distributors and retailers accounts receivable. Article 9 calls them "accounts." U.C.C. 9-102(a)(2). These accounts constitute a valuable source of collateral for the manufacturer's own financing, collateral that the manufacturer can assign to a financier for purpose of security. As in Example 1, above, the manufacturer is the "debtor," the financier is the "secured party," and the distributor or retailer obligated on the account is the "account debtor." The same conceptual framework and terminology apply to the software developer that licenses its software and uses the royalties as collateral, to the lawyer that provides her services to clients and uses her accounts receivable as collateral, to the hospital or medical group that provides its services to patients and uses its rights to reimbursement under health insurance plans as collateral ("health care insurance receivables," U.C.C. 9-102(a)(46)), and even to the winner of a lottery that uses its prospective lottery winnings as collateral.
Example 3. A seller of a business, a restaurant business for example (see Lovelady v. Bryson Escrow, Inc.), may take a promissory note stating the terms of a buyer's obligation to pay the balance of the purchase price of the business. If, as in Lovelady, the promissory note is secured by equipment of the business being sold, the note and security agreement taken together will constitute "chattel paper." U.C.C. 9-102(a)(11). But if the note is secured by an interest in real property, or is unsecured, the promissory note is called "an instrument" (not an account or chattel paper). The buyer of the business is called a person obligated on the note, or obligated on the collateral, rather than an account debtor. U.C.C. 9-102(a)(2), 9-102(a)(3), 9-102(a)(47), 9-102(a)(65). If the seller of the business prefers or requires immediate funds that will not otherwise be forthcoming from the buyer of the business until the time specified in the promissory note, the seller may assign the note for security to a financier. The seller of the business will be a "debtor" and the financier will be a "secured party."
In addition to security interests in tangible personal property and in the types of receivables described above, Article 9 applies to security interests taken in other types of receivables: deposit accounts, commercial tort claims, general intangibles, letter-of-credit rights.
Some contracts between an obligor and an obligee, or common law or statutory or regulatory law, may prohibit or restrict assignments. For example, a recording artist might agree in her contract with a recording company not to assign her right to receive royalties on the sale of records, or not to assign them without the prior written permission of the recording company. U.C.C. 9-401(a), portions of U.C.C. 9-406, and U.C.C. 9-407, U.C.C. 9-408, and U.C.C. 9-409, address the effectiveness of such restrictions or prohibitions. To facilitate financing, these provisions of Article 9 in large measure make such restrictions or prohibitions ineffective. Consideration of the details of these provisions is beyond the scope of these materials.
(1) Article 9 does not apply at all to some transactions that could be characterized as creating a security interest in personal property or fixtures. U.C.C. 9-109(d). We offer one example rather than repeating the long list you will find in that subsection. In Jonathan Harr's A Civil Action, a dramatic and riveting account of a toxic waste suit in Massachusetts, plaintiff's lawyer Jan Schlichtman and his firm turn repeatedly to their bank for credit to finance the litigation. (For a short and informative article on the extent to which lenders finance plaintiff's personal injury litigation, see Justice on Loan, California Lawyer 39 (July 1999)). The credit to Schlictman and his firm is secured, at least in part, by law firm equipment (including furnishings), by Schlichtman's car, by Schlictman's home, and by the contingent fee recovery.
The lien on Schlictman's home, whether by mortgage or deed of trust, is not covered by Article 9 because the collateral is real property. The security interests in the law firm's equipment and in Schlictman's car are covered by Article 9 without exception, although we learn in Commentary.Certificate of title that perfection of the security interest in the car will be governed by state law other than Article 9. However, the transaction giving the lender an interest in the contingent fee recovery is not subject to Article 9. "This article does not apply to: . . . (12) an assignment of a claim arising in tort, other than a commercial tort claim . . ." U.C.C. 9-109(d)(12). The toxic waste tort claim in A Civil Action was not a commercial tort claim. U.C.C. 9-102(a)(13).
Where Article 9 does not apply, other state statutory or common law will govern. Consider a hypothetical case in which Schlictman assigns the contingent fee recovery in A Civil Action to more than one lender. Which lender has priority? One would first have to resolve a choice of law question: which state is the state who's law should resolve the priority dispute? Assume for purposes of discussion that the Massachusetts common law rule on the priority of competing assignees governs. Under the Massachusetts common law rule (adopted by section 342 of the Restatement 2d of Contracts), the first assignee's claim to the recovery would prevail over a subsequent assignee's claim to the recovery except in specified circumstances such as "the subsequent assignee in good faith and without knowledge or reason to know of the prior assignment gives value and obtains payment . . . of the obligation." Id. Rules in other jurisdictions differ, or are sometimes uncertain, and the preliminary choice of law issue may be difficult. See, for example, the statutory rules in Cal. Civ. Code 954.5. Revised Article 9 significantly expanded the scope of Article 9 (although not to cover tort claims other than commercial tort claims and not to cover other transactions identified in U.C.C. 9-109(d)). In large part, this expansion enables a more efficient, certain, and less expensive means of structuring commercial finance because it supplants the divergent and sometimes uncertain statutory and common law concerning notification of assignment and priority among competing assignees with the uniform rules of Article 9.
(2) In some cases, identified in U.C.C. 9-109(c), Article 9 will apply only to a certain extent. For example, the Federal Aviation Act provides for a system of recordation of security interests in aircraft and certain aircraft engines and parts with the Federal Aviation Administration and makes a security interest not so recorded ineffective against third parties. 49 U.S.C. 44107, 44108. Those provisions of the federal act pre-empt Article 9 provisions on the method of perfecting a security interest in such collateral. However, the Federal Aviation Act does not include provisions on priority, default or foreclosure. On those topics, Article 9 governs. See Aircraft Trading and Services, Inc. v. Braniff, Inc.
Disparate language in federal law concerning intellectual property is less clear on the pre-emption issue and has prompted litigation. See, e.g., In re Peregrine Entertainment, Ltd., 116 B.R. 194 (C.D. Cal. 1990) (the Copyright Act pre-empts Article 9 as to the method of perfecting a security interest in a copyright); Aerocon Engineering Inc. v. Silicon Valley Bank, 244 B.R. 149 (Bkry N.D. Ca. 1999) (the Copyright Act does not pre-empt Article 9 as to the method of perfecting a security interest in an unregistered copyright); In re Cybernetic Services, Inc., 239 B.R. 917 (9th Cir. BAP 1999) (the Patent Act does not pre-empt Article 9 as to the method of perfecting a security interest in a patent); In re Roman Cleanser, Co., 43 B.R. 940 (Bankr. E.D. Mich. 1984), aff'd 802 F.2d 207 (6th Cir. 1986) (Lanham Act does not pre-empt Article 9 as to the method of perfecting a security interest in a registered trademark). Congress has not acted on American Bar Association recommendations in the early 1990's for modernization and harmonization of federal statutes on the issue of pre-emption of Article 9.