Chattel Paper Priorities Under U.C.C. Article 9

Chattel Paper Priorities Under U.C.C. Article 9

In this Expert Commentary, Professor Margit Livingston explains what chattel paper is and the special priority rules that apply to it under the Uniform Commercial Code.
 
Professor Livingston writes: The principal architect of original Article 9 of the Uniform Commercial Code, Professor Grant Gilmore once observed: “‘Chattel paper’ is a novel term coined by the Code draftsmen to describe a species of property which had previously managed to exist without a name.” 1 Grant Gilmore, Security Interests in Personal Property § 12.5, at 378 (1965). Although novel in its day, the term “chattel paper” has now been part of Article 9 for over forty years and comprises an important category of collateral, particularly in floor planning arrangements. Thus, it is necessary to understand both what chattel paper is and the special priority rules that apply to it.
 
Chattel paper is primarily “a record or records that evidence both a monetary obligation and a security interest in specific goods … or a lease of specific goods.” U.C.C. § 9-102 (a) (11) (Official Text 2007). In addition, if the parties creating the chattel paper also utilize an instrument such as a promissory note to evidence the obligor’s obligation, then “the group of records taken together constitutes chattel paper.” In the typical chattel paper transaction, there is a first generation secured or leasing transaction, followed by a second generation transaction in which the first generation paper serves as the collateral. For example, suppose Car Dealer sells an automobile on an installment basis to Customer, reserving a security interest in the vehicle until Customer’s debt is paid in full. Dealer then takes the installment contract/security agreement executed by Customer and offers it as collateral to Bank. The collateral in the second generation transaction between Dealer and Bank is chattel paper. Chattel paper differs from other receivables such as instruments and accounts in that it must always evidence a security interest in or lease of specific goods. Instruments such as promissory notes and accounts will typically be unsecured and unconnected with a lease transaction.
 
To create and perfect a security interest in chattel paper, the secured party must follow the usual steps of attachment and perfection. To achieve attachment of its security interest, the creditor must (1) give value to the debtor, such as a loan or an available line of credit, and (2) ensure that the debtor has rights in the chattel paper collateral. To satisfy the third step in attachment, the secured party either should have the debtor authenticate a security agreement describing the chattel paper or should take physical possession of the paper pursuant to a security agreement with the debtor. U.C.C. § 9- 203 (a), (b). If the chattel paper is not tangible—i.e., electronic, then the secured party will not able to take physical possession of it. In that case, the creditor should insist that the parties execute a proper security agreement covering chattel paper, or the creditor should achieve “control” of the paper under U.C.C. § 9-105.