Professor Margit Livingston on Priority Between Accounts Financers and Lien Creditors Under U.C.C. Article 9

Professor Margit Livingston on Priority Between Accounts Financers and Lien Creditors Under U.C.C. Article 9

If a secured party properly perfects its security interest by filing a financing statement in the appropriate public office, it can normally be assured that it will prevail over a lien creditor (including the trustee in bankruptcy) in a fight over the debtor's accounts. In a recent bankruptcy case, however, two secured parties found their positions as accounts financers under attack from a lien creditor and barely survived.

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Secured parties often ask their debtors to give them a security interest in accounts as accounts are a relatively liquid form of collateral-unlike, say, equipment or even inventory. If the debtor defaults, the secured party may notify the account debtor to pay the secured party directly, an easy and quick method of foreclosure. U.C.C. § 9-406 (a) (Official Text 2012). If the secured party properly perfects its security interest by filing a financing statement in the appropriate public office, it can normally be assured that it will prevail over a lien creditor (including the trustee in bankruptcy) in a fight over the debtor's accounts. U.C.C. § 9-317 (a)(2). In a recent bankruptcy case, however, two secured parties (who had assigned their claims to the trustee) found their positions as accounts financers under attack from a lien creditor and barely survived. In re Delta-T Corporation, 475 B.R. 495 (E.D. Va. 2012) (hereafter "Delta-T") [an enhanced version of this opinion is available to lexis.com subscribers]. The court, however, in finding in favor of the secured parties' interests employed some arguably creative reasoning to arrive at its conclusion.

Under Article 9 of the Uniform Commercial Code, an account is, among other things, the right to payment for goods sold or leased or services rendered, whether or not it has been earned by performance. U.C.C. § 9-102 (a)(2). Consider the following situation: B goes to S's store with the intent to buy 500 widgets. S agrees to sell 500 widgets to B, but B asks if she can pay for the widgets in 60 days. S agrees and allows B to leave the store with the widgets. B's promise to pay for the widgets within 60 days creates an account, and if S were to offer that promise to pay as collateral for a loan from SP, SP should characterize the promise as an account in the security agreement and financing statement. In the transaction between S and SP, S is the debtor under Article 9, and B is the account debtor-the party that owes the obligation on the account. U.C.C. § 9-102 (a)(3), (28). When B eventually pays her obligation on the account, her cash payment is considered proceeds of the account and is also subject to SP's security interest, which automatically remains perfected in the payment as "identifiable cash proceeds." U.C.C. §§ 9-102 (a)(64), 9-315 (a)(2), (c), (d)(2).

Suppose instead of asking to defer payment for 60 days, B pays cash for the widgets as she takes delivery of the widgets at S's store. If SP's security interest extends only to accounts and not inventory, then it does not attach to B's cash payment. The cash payment does not constitute an account nor is it proceeds of an account. In cash sales, accounts are not created. But consider a slightly different situation: B sends S a purchase order for 500 widgets at a total price of $1,000. S accepts the purchase order but inserts a term that requires B to pay cash for the widgets upon delivery-in other words, a C.O.D. term. B accepts that additional term. In a few days, S sets aside 500 widgets as those pertaining to B's order. S then puts the widgets in the hands of a carrier, who delivers them to B and receives the cash payment of $1,000, which is remitted to S. S puts the cash into a bank account, and in a short while, a lien creditor seeking to enforce a judgment against S garnishes the bank account. SP steps forward and claims the $1,000 as proceeds of an account subject to SP's prior perfected security interest. The lien creditor ("LC") argues that the $1,000 is the product of a cash sale and therefore not proceeds of an account. As such, the funds are not subject to SP's security interest, and LC's judgment lien is the first and only claim to them.

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