Peter Winship (June 2014)

CURRENT ISSUES IN SECURED TRANSACTIONS LAW IN THE UNITED STATES

Three issues addressed:

1. May a debtor grant a security interest in a statutory or contractual licence?

2. How may syndicated financiers perfect a security interest in a deposit account?

3. Over what collateral should a secured party be given purchase money priority?

ISSUES ADDRESSED

US law for security interests in personal property is Article 9 of the Uniform Commercial Code:State law, not federal law

Individual states may amend so like a model law Where applicable, federal law preempts

UCC first adopted in 1951Comprehensive revision in 1998Most recent amendments 2010

Adopted except in NY and Oklahoma

UCC ARTICLE 9

Example 1. Restaurant holds liquor licence issued by State Liquor Board. State law prohibits assignment of licence without Board’s consent.Restaurant grants Bank a security interest in all its business assets, including licence, to secure repayment of bank loan. Bank duly perfects its interest.Restaurant defaults and commences insolvency proceeding. With consent of Liquor Board, business assets—including the licence—are sold as a “going concern.”Does Bank have an enforceable security interest in proceeds of this sale?

I. LICENCES

1998 revision introduced § 9-408:Overrides any term of statutory or

contractual licence that prohibits, restricts or requires the consent of licensor to creation, attachment or perfection of a security interest in the licence.

But at same time leaves the licensor’s rights unaffected in all material respects.

“one of the most intractable provisions of the Uniform Commercial Code”

LICENCE (2)

Is the liquor licence personal property?Article 9 does not answer; look to “other law”Virtually all states recognize that holder of liquor licence may grant security interest in the licence if it is transferableDepends on wording of liquor licensing lawNo difficulty articulating policy, butDifficulty articulating nature of right in licenceCrucial interest is right to what is received on

transfer of licence

LICENCE (3)

Assuming liquor licence in Example 1 is personal property, the licence is a “general intangible” (§ 9-102(a)(42))Section 9-408 has following consequences:Liquor law requirement that Liquor Board consent

to transfer ineffective; Restaurant’s grant of security interest in licence is effective

Bank may not enforce security interest but has right to whatever is received on transfer of licence made with Liquor Board’s approval

LICENCE (4)

Bank has security interest in present “ right to proceeds” not in “proceeds” received on subsequent transfer of the licenceDistinction important in bankruptcy proceeding: Security interest in existing property and their

proceeds created before commencement of bankruptcy proceeding is effective in bankruptcy proceeding (BC § 552(b))

In Example 1, before bankruptcy Bank had a security interest in right to proceeds and the proceeds of that right; when licence sold Bank has enforceable security interest in proceeds of this right; BC § 552 satisfied

LICENCE (5)

Initial proponent of § 9-408 recognized proposal is of principal value to lenders to “cash flow” businessesSuch businesses have few valuable assets other than

licence (or equivalent, such as franchise)Lender relies on payment from the cash generated by the

business rather than on security interest in tangible assetsLender has strong incentive to keep business operating,

thereby creating “good will”Lender, rather than general unsecured creditors, should be

entitled to good will realized when business is sold as going concern

Smith (1994) 28 Loy LA L Rev 335

LICENCE (6)

Example 2. Developer agrees to grant SME a non-exclusive licence of its computer software.One term of the agreement provides that an attempt by SME to assign rights in the software entitles Developer to terminate the licence.A second term prohibits SME from disclosing to anyone certain information regarding the software.If SME seeks financing secured by a security interest in the licence, what legal or practical obstacles will it face?

LICENCE (7)

Section 9-408 covers contractual as well as statutory licences (§ 9-408(a))Terminology confusing (§ 9-408, Comment 5)

Licence is a “general intangible”Developer (licensor) is “account debtor” (§ 9-102(a)

(3))SME (licensee) is “debtor”

Nature of SME’s property interest in licence may be limited to promise of Developer not to sue for SME’s use of Developer’s software

LICENCE (8)

In Example 2: 1st term: Developer ’s right to terminate if SME

attempts to grant a security interest is ineffective to the extent it impairs creation of the security interest (§ 9-408(a)(2))

2nd term: this contract restriction is not covered by § 9-408(a) so term is not made ineffective (cf. § 9-408(d)(5))

As practical matter, potential lender to SME must decide whether to make loan without full information about Developer ’s software

LICENCE (9)

Section 9-408 modeled on approach to security interests in broadcast licences issued by the Federal Communications Commission

Weise, (1999) 74 Chi-Kent L Rev 1077

FCC and UCC § 9-408 appear to differ: FCC not allow security interest in l icence; UCC allows security interest in l icence

Federal Circuit Court recently ruled that difference is semantic using concept of property as a bundle of r ights: FCC allows security interest in one right (right to proceeds on

transfer of licence) UCC allows security interest in total bundle of sticks but then takes

away rights, such as enforcement rights, that affect licensorIn re Tracy Broadcasting Corp., 696 F.3d 1351 (10 t h Cir. 2012), cert. denied , 133 S Ct 2340 (2013)

LICENCE (10)

Pre-1998 Article 9 recognized security interests in deposit accounts only when proceeds of other collateral could be traced into the account At common law creditors could take a security interest in

bank account but non-uniform Bank could not take security interest in account maintained

with it; but bank had rights of recoupment and set-off

1998 revision permits both third party and depository bank to take security interest in deposit account as original collateral

II. DEPOSIT ACCOUNTS

“Control” a key concept:Attachment: “control” pursuant to security

agreement equivalent to authenticated security agreement (§ 9-203(b)(3)(D))

Perfection: only by “control”—filed financing statement ineffective (§§ 9-312(b)(1); 9-314)

Priority: security interest with “control” usually has priority (§ 9-327)

DEPOSIT ACCOUNTS (2)

Obtaining “control” of deposit account (§ 9-104):Bank with which account is maintained deemed in control if security agreement with Debtor covers deposit account (§§ 9-104(a)(1), 9-203(b)(3)(D))Third party has control when:

it concludes Deposit Account Control Agreement with Bank and Debtor (§ 9-104(a)(2)); or

it become Bank’s customer with respect to the account (§ 9-104(a)(3))

Control not defeated if B entitled to deal with account (§ 9-104(b))

DEPOSIT ACCOUNTS (3)

Example 3. D maintains a deposit account with Bank A. To secure a loan from Banks X, Y and Z, D creates a security interest in the deposit account in favour of Bank A, as agent for the three banks. Do Banks X, Y and Z have a perfected security interest in the bank account?

Source: Query on UCC Listsev (25 September 2012)

DEPOSIT ACCOUNTS (4)

2010 Amendment to Official Comment 3 to § 9-104 (but without amending black-letter text) adds an “Example” exactly on pointAnswer given:“Because Bank A is a “secured party” as defined in Section 9-102, the security interest is perfected by control under (a)(1).”Nothing said about agency relation.

DEPOSIT ACCOUNTS (5)

Listserv participants commented:Agent/Trustee held property (perfected security interest) for

Principals, citing Restatement 3 rd Agency § 8.12, Comment bSome recommended all banks conclude a deposit account

control agreement spelling out relationship between banks on matters such as shifting control to successor agent, disclaimers of liabil ity, indemnity

If DACA concluded, one suggested adding statement that it entered into just in case court finds Bank A deposit does not perfect

Other commentators recommend agreement with Bank A subordinating its rights of recoupment and setoff

DEPOSIT ACCOUNTS (6)

Drafters discover agency and trust law:Restatement 3 rd Agency § 8.12 (Duties regarding principal’s property), Comment b (2006): “An agent’s possession or control of property on behalf of a

principal is tantamount for many purposes to possession or control of the principal [citing, inter alia, UCC § 9-104]”

Restatement 3 rd Trusts § 2, Comment i (2003):Trust res may include claim against trusteeAuthority and logic of prior restatements meager and

dubiousReporter ’s Note: contrary to prior restatements; change

supported by “practical considerations as well as [it avoids] … strained explanations of sensible results”

DEPOSIT ACCOUNTS (7)

Example 3 (var. a). D maintains a deposit account with Bank A. D creates a security interest in the deposit account to secure a loan from Banks X, Y, Z, and A. The banks appoint Bank A as collateral agent. Do Banks X, Y, Z and A have a perfected security interest in the bank account?Listserv commentators: slight hesitationBank A is a secured party as depository bankMost commentators consider all banks are perfected by

Bank A’s perfection of interestNeed for agreement between banks stressed as even more

needed

DEPOSIT ACCOUNTS (8)

Example 3 (var. b). D maintains a deposit account with Bank A. D creates a security interest in the deposit account to secure a loan from Banks X, Y, and Z. The banks appoint Bank A as collateral agent. Do Banks X, Y, Z have a perfected security interest in the bank account?Listserv commentators: greater hesitationBank A is no longer a secured partyEven if take security interest when account opened not

necessarily to secure other banks’ security interest

DEPOSIT ACCOUNTS (9)

A recent study of whether English law recognized purchase money security interests (PMSIs) notes:SMEs have difficulty attracting capitalGrowing importance of intangible assets

Study recommends:English law should recognize such an interest “in well-

defined circumstances”Legislatures are better equipped than courts to resolve the

competing economic policy issues involvedThere should be public consultation followed by legislationUrged consideration of foreign legislative models

Boadle, [2014] LMCLQ 76

III. PURCHASE MONEY SECURITY INTERESTS

From mid-19 th century the concept of the purchase-money security interest (PMSI) was recognized in federal and state common law as an interest with priority over earlier creditor with an interest in debtor ’s after-acquired propertyUCC Article 9 codified concept in 1951Pre-1998 text suggested that there could be a purchase-

money interest in “collateral” (i.e., all personal property, including fixtures)

Grant Gilmore suggested (1963) that there could occasionally be a purchase money interest with priority in general intangibles

PMSI (2)

1998 revision limits purchase-money security interests to goods and software (UCC § 9-103(b), (c)) “Goods” includes software embedded in goods “Software” is separate category: in PMSI context, seller or

third-party financer finances debtor ’s acquisition of goods and software to be used in these goods

No explanation for limiting the types of collateral in which a secured party might have a purchase money security interestUCC Article 9 also provides that later security interest in some intangible property has effective priority without being called a PMSI (e.g. § 9-330)

PMSI (3)

No explanation for limiting the types of collateral in which a secured party might have a purchase money security interestPossible explanations:There had been litt le if any practice of purchase-money

claims as to non-tangible collateralDuring drafting process there was no demand from debtors

or interested financers of other non-tangible collateralTime pressure to complete revisionSeparate uniform law projects underway to provide rules for

licences in intangible property (UCITA) Intellectual property complicated by federal law coverage

which preempted state law, such as UCC Article 9 Intellectual property practices not yet ripe for codification

PMSI (4)

Example 4. X Inc. grants SP-1 a security interest in all the corporation’s existing and after-acquired assets to secure repayment of a loan.SP-2 subsequently lends money to X Inc. to enable it to acquire Inventor's patent. X Inc. grants SP-2 a security interest in the patent to secure repayment.As between SP-1 and SP-2, which creditor has priority if X Inc. defaults on both loans?

ANSWER: SP-1. Patent is a general intangible and therefore not a good. The general priority rule—first to file or perfect (§ 9-322)—gives priority to SP-1’s prior interest.

III. PMSI (5)

Comments:SP-1 has potential windfallSP-1 has “situational monopoly” because of

information and transaction advantages so obtains monopoly rents

But intangible property may be risky therefore new intangible asset potentially dilutes SP-1’s risk assessment

SP-2 may be in better position to assess riskiness of new intangible asset

Need for empirical research into business practices

PMSI (6)