Professor Margit Livingston on Article 9 Secured Parties vs. Lien Creditors Post-Default

Professor Margit Livingston on Article 9 Secured Parties vs. Lien Creditors Post-Default


Secured parties under U.C.C. Article 9 have a love-hate relationship with the cash proceeds of their collateral. On the one hand, a security interest in original collateral (inventory or accounts, for example) will remain attached and perfected in all identifiable cash proceeds of that collateral. U.C.C. § 9-315 (a), (c), (d)(2) (Official Text 2013). In addition, cash proceeds do not require a foreclosure sale—one simply collects them. On the other hand, cash proceeds are elusive. If they are commingled with nonproceeds in the debtor's bank account, they may lose their "identifiability," and the secured party may have to resort to tracing fictions such as the lowest intermediate balance principle to capture them. U.C.C. § 9-315 (b). Furthermore, if the debtor transfers cash proceeds to a noncollusive transferee, they are unreachable—the transferee takes them free of even a perfected security interest. U.C.C. § 9-332. In a recent case involving garnishment of accounts receivable by a lien creditor (i.e., cash transfers), the secured party was able to prevail over the lien creditor by persuading the court to adopt the "trace and recapture" approach to the transfers that were made post-default. Davis v. F.W. Fin. Servs., 2013 Ore. App. LEXIS 1507 (Ore. Ct. App. Dec. 26, 2013) (hereinafter Davis) [an enhanced version of this opinion is available to subscribers].

In Davis, the secured party, F.W. Financial Services, Inc. (FWFS) had a long-standing lending relationship with the debtor, Dryer Electric, Inc. (Dryer). Beginning in 2002, FWFS made a series of loans to Dryer and maintained a perfected security interest in Dryer's accounts receivable. Davis, 2013 Ore. App. LEXIS 1507, at *3-5. In 2009, Dryer defaulted to FWFS, which issued a written notice of default to Dryer. Dryer, which owed FWFS over $500,000 at that time, assured FWFS that it would get back on track, and FWFS refrained from accelerating the entire obligation. 2013 Ore. App. LEXIS 1507, at *5-6. In 2010, an unsecured creditor, Davis, obtained a judgment for $113,000 against Dryer based on Dryer's failure to contribute to a fringe benefit trust for unionized electrical workers. Between April 8 and May 11, 2010, Davis issued writs of garnishment to Dryer's accounts receivable debtors and obtained payments of over $67,000. 2013 Ore. App. LEXIS 1507, at *6-7.

In late 2010, FWFS learned that Davis had garnished funds from Dryer's account debtors, and on February 15, 2011, FWFS made written demand on Davis for the garnished funds. Davis, 2013 Ore. App. LEXIS 1507, at *7. Davis refused to remit any money and then sought a judicial declaration that Davis's interest in the funds had priority over FWFS's security interest in them. FWFS counterclaimed for conversion. 2013 Ore. App. LEXIS 1507, at *7-8. Both parties moved for summary judgment. The trial court granted summary judgment in favor of FWFS, holding that its perfected security interest in the garnished funds had priority over Davis's interest in them as a judgment lien creditor. 2013 Ore. App. LEXIS 1507, at *11. Davis appealed.

On appeal, Davis argued that the secured party, FWFS, had waived its rights as a prior perfected secured party by failing to pursue its remedial options against the debtor after the debtor's default but before Davis began collecting the debtor's accounts receivable. Davis, 2013 Ore. App. LEXIS 1507, at *11-12. Davis was therefore entitled to retain the amounts collected. FWFS, on the other hand, essentially argued that it had not waived its rights as a prior perfected secured party, that perfected secured parties have priority over lien creditors under Article 9 (U.C.C. § 9-317 (a)), and that the "trace and recapture" approach allows secured parties to trace their proceeds into the hands of subordinate parties and to then recapture them. 2013 Ore. App. LEXIS 1507, at *20-21. Under FWFS's reasoning, it was clearly entitled to restitution of the funds collected by Davis.

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