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TRANSITIONING TO NEW ARTICLE 9: LEARNING THE REVISIONS BY APPLYING THE TRANSITION RULES

William E. Boyd

James E. Rogers College of Law

University of Arizona

April 11, 2000

2000. All rights reserved.

 

I. Introduction

 

There is much that is good about new Article 9. It broadens the coverage of Article 9, undertakes to simplify decisions as to which state's law governs and where in a state to file, seeks to accommodate the emergence of electronic commerce, could make creating and perfecting security interests and unraveling priority disputes easier and might produce a better balance among the interests of various parties affected by attempts to enforce a security interest. However, existing Article 9 has been with us in its current form for a long time (the last major revision was in 1972) and most practitioners have no small amount of both learning new Article 9 and unlearning existing Article 9 to do.

 

From now until new Article 9 is effective on July 1, 2001 the immediate task for Article 9 practitioners is to anticipate new Article 9 and understand how it impacts transactions entered into prior to the effective date of new Article 9. The primary focus of such anticipation must be the transition rules in Part 7 of new Article 9. But, the transition rules require understanding the substantive differences between new and existing Article 9. Consequently, an exercise directed to anticipating new Article 9 presents a good opportunity to learn some of the essential changes made by new Article 9.

This paper presents a series of problems involving familiar and important security interests that have been properly created and perfected (or not) under existing Article 9 and considers how these security interests would fare under new Article 9 (and the reasons for their fate under that law). The resulting understanding of both the differences between existing and new Article 9 and the application of the transition rules to specific examples can inform decisions about actions that may or should be taken in anticipation of new Article 9.

 

It should be noted that the transition rules of new Article 9 are based very much on a major assumption, namely, that all states will have adopted new Article 9 by July 1, 2001 and all will make that the effective date of new Article 9. As stated in Official Comment 1 to new section 9-701:

 

If [existing] Article 9 is in effect in some jurisdictions, and [new Article 9] is in effect in others, horrendous complications may arise.

 

This assumption seemed reasonable early on, but because of repeated changes to the proposed law it now may not be realistic. However, realistic or not the same assumption is made in the discussion that follows (and for the same reason).

 

II. Some Familiar but Telling Illustrations

 

Problem 1

 

Debtor, Inc. is incorporated in Arizona. Debtor manufactures widgets at a plant in Tucson, Arizona where Debtor, Inc.'s chief executive office is located. Debtor, Inc. sells widgets from retail outlets in Tucson, Arizona, San Diego, California and Albuquerque, New Mexico. On April 11, 2000, Debtor, Inc. borrows from Lender. Debtor, Inc. signs a security agreement giving Lender an interest in collateral described as "accounts, existing and later-acquired" to secure the loan. Debtor, Inc. also signs a financing statement naming the debtor as "Debtor, Inc." and describing the collateral as "accounts." Lender immediately files the financing statement in the Secretary of State's Office in Arizona.

 

Is Lender's security interest perfected on April 11, 2000?

 

The answer is "yes." Under existing section 9-103(3)(b) the law of the state where the debtor is located governs perfection and existing section (3)(d) provides that a debtor who has more than one place of business is located where the debtor maintains its chief executive office. On the given facts, Debtor, Inc. maintains its chief executive office in Arizona and, therefore, Arizona law governs perfection, meaning that Arizona is the state in which Lender should file. As for where in Arizona to file, existing section 9-401(1)(c) (Second Alternative) requires filing with the Secretary of State to perfect a security interest in accounts.

 

The next question is: How long will Lender's security interest continue perfected?

 

The answer to this question is more complicated. Suppose first that new Article 9 had not been adopted. The security interest would be perfected for six years (until April 10, 2006) at which time the filing would lapse and perfection would cease under existing section 9-403(2) unless Lender filed a continuation statement within six months prior to April 10, 2006. If Lender timely filed a continuation statement then the filing would be effective and perfect the security interest for another six years after April 10, 2006 -- not from the time the continuation statement is filed.

 

However, new Article 9 will be effective on July 1, 2001. How does its intervention affect Lender's security interest? On the facts of Problem 1 the answer is "not that much." The primary reason this is so is that the filing in Arizona perfects Lender's security interest in the accounts under new Article 9 as well as existing Article 9, albeit for somewhat different reasons. New Article 9 section 9-301(1) tracks existing section 9-103(3)(d) by making the law of the state where the debtor is located the law that governs perfection of a security interest in accounts. Thus, new section 9-301(1) provides:

 

Except as otherwise provided in Sections 9-303 through 9-306, the following rules determine the law governing perfection, the effect of perfection or nonperfection, and the priority of a security interest in collateral:

 

(1)     Except as otherwise provided in this section, while a debtor is located in a jurisdiction, the

local law of that jurisdiction governs perfection, the effect of perfection or nonperfection, and the priority of a security interest in collateral.

However, the new Article 9 "location of the debtor" rules are more extensive and differ from those in existing section 9-103(3)(d) in significant ways. Under new section 9-102(a)(70), Debtor, Inc. is a "registered organization." New section 9-307(e) provides that:

 

(e) A registered organization that is organized under the law of a State is located in that State.

 

Under this provision a registered organization is located where it is organized. Debtor, Inc. is incorporated in Arizona, so Debtor, Inc. is located in Arizona and Arizona law governs perfection (i.e., Arizona is the state in which to file). As seen earlier, Debtor, Inc. also is located in Arizona under existing section 9-103(3)(d), but the reason is that Debtor, Inc.'s chief executive office is located in Arizona. The rule that a registered organization is located where it is organized and, in particular, that a corporation is located where it is incorporated, is an major change made by new Article 9.

 

As for where in a state to file, it turns out the filing in the Secretary of State's Office in Arizona is proper under new Article 9 section 9-501(a)(2) just as it is under existing Article 9. Indeed, new section 9-501(a) requires "central" filing as to most collateral and it eliminates "local" filing except for fixture filings and certain other real estate-related collateral. New section 9-501(a) is as follows:

 

(a) Except as otherwise provided in subsection (b), if the local law of this State governs perfection of a security interest or agricultural lien, the office in which to file a financing statement to perfect the security interest or agricultural lien is:

 

(1) [the real estate records in the county where a mortgage would be recorded for fixture filings and timber to be cut or as-extracted collateral]

 

(2) the office of [the Secretary of State], in all other cases, including if the collateral is goods that are or are to become fixtures and the financing statement is not filed as a fixture filing.

 

So, Lender's security interest is perfected under both existing Article 9 and new Article 9. Not surprisingly, the perfection continues under new Article 9. However, documenting this conclusion by reference to new Article 9 takes some doing. New section 9-703(a) provides:

 

(a)     A security interest that is enforceable immediately before [new Article 9] takes effect and would have priority over the rights of a lien creditor is a perfected security interest under [new Article 9] if, when [new Article 9] takes effect, the applicable requirements for enforceability and perfection under [new Article 9] are satisfied without further action.

This provision makes clear that a security interest that is perfected (by any method) under both existing and new Article 9 remains perfected after the effective date of new Article 9. However, new section 9-703(a) says nothing about how long after July 1, 2001 perfection continues. New section 9-703(b), which will be considered more fully in Problem 2, speaks to continuation but it deals with situations where pre-new Article 9 actions that perfect a security interest under existing Article 9 would not do so under new Article 9. The next section, new section 9-704, governs cases in which actions taken pre-new Article 9 would not perfect a security interest under existing Article 9 but would do so under new Article 9. That is not the situation in Problem 1 so we move on to new section 9-705.

New section 9-705(a) is not helpful because it deals with perfection other than by filing cases. However, new section 9-705(b) provides:

The filing of a financing statement before [new Article 9] takes effect is effective to perfect a security interest to the extent the filing would satisfy the applicable requirements for perfection under [new Article 9].

This section thereby essentially reiterates new section 9-703(a) but for cases involving filing. So, we know that Lender's security interest, which is perfected under existing Article 9, remains perfected under new Article 9. But, we still do not know for how long. The answer to that question is in new section 9-705(c). That section is as follows:

[New Article 9] does not render ineffective an effective financing statement that, before [new Article 9] takes effect, is filed and satisfies the applicable requirements for perfection under the law of the jurisdiction governing perfection as provided in [former Section 9-103]. However, except as otherwise provided in subsections (d) and (e) and Section 9-706, the financing statement ceases to be effective at the earlier of:

(1) the time the financing statement would have ceased to be effective under the law of the jurisdiction in which it is filed; or

(2) June 30, 2006.

 

Under this provision a filing that satisfies both existing and new Article 9 continues to be effective until the earlier of the date the filing would have lapsed under existing Article 9 as enacted in Arizona or June 30, 2006. The June 30, 2006 date is specifically directed at states such as Arizona that have a "non-uniform" period after which a financing statement will lapse (a financing statement cannot be good beyond five years after the effective date of new Article 9). However, as noted above, even under Arizona's version of existing section 9-403(2) (under which a filing is good for six years), Lender's financing statement would lapse on April 10, 2006 and that is the earlier date.

 

The important points are as follows:

A filing in the Secretary of State's Office in Arizona would perfect Lender's security interest in Debtor, Inc.'s accounts under both existing and new Article 9;

 

Under new section 9-703(a) (perfection generally) and new section 9-705(b) (perfection by filing), Lender's security interest is perfected after the effective date of new Article 9;

 

Lender's perfection by filing is not limited to one year under new section 9-703(b) but rather continues until the filing lapses under Arizona's version of existing section 9-403(2), April 10, 2006, as provided for in new section 9-705(c).

 

Of course, Lender may wish to continue perfection beyond the date its filing lapses under new section 9-705(c) (April 10, 2006). The question is how may Lender do so. New section 9-705(d) offers an answer as follows:

 

The filing of a continuation statement after [new Article 9] takes effect does not continue the effectiveness of the financing statement filed before [new Article 9] takes effect. However, upon the timely filing of a continuation statement after [new Article 9] takes effect and in accordance with the law of the jurisdiction governing perfection as provided in Part 3, the effectiveness of a financing statement files in the same office in that jurisdiction before [new Article 9] takes effect continues for the period provided by the law of that jurisdiction.

 

The first sentence of the forgoing section indicates that a continuation statement filed after July 1, 2001 - even one that complies with new Article 9 section 9-515 governing continuation statements -- does not continue the effectiveness of a financing statement filed properly before July 1, 2001. That is the general rule. However, a careful reading reveals that there is an exception to the general rule in the second sentence of new section 9-705(d). The exception is that if the original filing was made in the office and in the state mandated by new sections 9-301 and 9-501 then a continuation statement continues the effectiveness of a financing statement filed before July 1, 2001 for the period provided by the law of the state where the original filing was made.

 

Consequently, on the facts of Problem 1, where the pre-new Article 9 filing was properly made in the same office and in the same state required for such a filing under new Article 9, Lender may continue the effectiveness of the financing statement by filing a continuation statement that satisfies new section 9-515 (under which the filing must be made six months before the filing lapses). Moreover, although the language of new section 9-705(d) could certainly be clearer, it seems that the continuation statement will render Lender's filing on April 11, 2000 effective for six years from the time it would lapse under existing section 9-403(2) as enacted in Arizona (April 10, 2006).

 

It should be noted that under new section 9-708[1] there is no need to get the debtor's signature (or, in the new Article 9 scheme, the debtor's "authorization"). The fact that a continuation statement is effective to continue a pre-new Article 9 filing for six years presents a bit of a trap for unwary searchers.

 

There is another question that should be addressed here. Recall that Lender's security interest includes after-acquired accounts (as normally would be the case). Does the above analysis apply to after-acquired accounts as well as those in existence on April 11, 2000. The answer seems to be that it does and Lender is perfected as to the accounts generated after April 11, 2000. The uncertainty arises from Official Comment 1 to new section 9-705. That comment states:

 

This section addresses primarily the situation in which the perfection step is taken under

former Article 9 or other applicable law before the effective date of [new Article 9] but the

security interest does not attach until after that date.

 

Technically, Lender's security interest in accounts generated after July 1, 2000 has not attached prior to that date. Indeed, the security interest in those accounts is not perfected under existing Article 9 section 9-303 until the accounts are generated. However, new section 9-703 employs a lien creditor test of perfection. Since a lien creditor could not get ahead of Lender (the instant an account is generated the security interest is perfected) and because new section 9-705 refers to the effectiveness of financing statements, Lender should be protected as to the later-acquired accounts. Under this analysis Lender also would be able to prevent avoidance of its security interest by a trustee under Bankruptcy Reform Act (BRA) 544(a) because that section of the bankruptcy law employs a lien creditor test. Of course, depending on the date of any bankruptcy, Lender might still have to contend with BRA 547 (the avoidable preference section) and BRA 552 (under which a security interest is not enforceable as to collateral -- other than proceeds -- acquired after bankruptcy).

 

Problem 2

 

Assume the facts of Problem 1. Assume further, however, that Debtor, Inc. is incorporated in Delaware.

 

Is Lender's security interest perfected on April 11, 2000?

 

The answer is "yes." As noted in Problem 1, existing sections 9-103(3)(b) and (3)(d) provide that the law of the state where the debtor maintains its chief executive office (Arizona) governs perfection and existing section 9-401(1)(c) requires central filing (filing with the Secretary of State).

 

For how long will Lender's security interest be perfected?

As in Problem 1, the answer to this question is more complicated. Again, were it not for new Article 9, the security interest would be perfected for six years (until April 10, 2006) at which time the filing would lapse and perfection would cease under existing section 9-403(2) unless Lender filed a continuation statement within six months prior to April 10, 2006. However, new Article 9 will have intervened on July 1, 2001. How does its intervention affect Lender's security interest? The answer is "not as much as might at first be thought." The path is different but we will end up in much the same place in as Problem 1.

To begin with, and by contrast to Problem 1, Lender's security interest is not perfected under new Article 9. Under the new Article 9 choice of law rules Lender should have filed the financing statement in the Secretary of State's Office in Delaware because Debtor, Inc. is a registered organization that is located in Delaware.

Our question then is how does the fact that Lender's security interest is not perfected under Article 9 affect the perfection achieved under existing Article 9. Again, we must turn to the transition rules of Part 7 of new Article 9. The rule that is likely to jump out first is that in new section 9-703(b), the section we passed over in Problem 1. New section 9-703(b) provides as follows:

 

Except as otherwise provided in Section 9-705, if, immediately before [new Article 9] takes effect, a security interest is enforceable and would have priority over the rights of a lien creditor at that time, but the applicable requirements for enforceability and perfection under [new Article 9] are not satisfied when [new Article 9] takes effect, the security interest:

(1)     is a perfected security interest for one year after [new Article 9] takes effect;

(2)     remains enforceable thereafter only if the security interest becomes enforceable under Section 9-203 before the year expires; and

(3)     remains perfected thereafter only if the applicable requirements for perfection under [new Article 9] are satisfied before the year expires.

 

Under the rule given by new section 9-703(b)(1) a security interest that is perfected under existing Article 9 but not new Article 9 is perfected for only one year after July 1, 2001. But, new section 9-703(b) is explicitly subject to new section 9-705. Neither new section 9-705(a) nor new section 9-705(b) applies to the case in Problem 2 where Lender's filing is effective under existing Article 9 but would not perfect under new Article 9. So, we again are back to new section 9-705(c), the section that controlled in Problem 1.

 

As also quoted above, new section 9-705(c) provides:

 

[New Article 9] does not render ineffective an effective financing statement that, before [new Article 9] takes effect, is filed and satisfies the applicable requirements for perfection under the law of the jurisdiction governing perfection as provided in [former Section 9-103]. However, except as otherwise provided in subsections (d) and (e) and Section 9-706, the financing statement ceases to be effective at the earlier of:

(1) the time the financing statement would have ceased to be effective under the law of the jurisdiction in which it is filed; or

(2) June 30, 2006.

 

As can be seen from the somewhat cumbersome language, under new section 9-705(c) an otherwise effective financing statement that was filed in the correct state under existing section 9-103 but the wrong state under new section 9-301 continues perfection for the period of time provided for in new sections 9-705(c)(1) and (c)(2). In other words, new section 9-705(c) continues the effectiveness of a filing that is proper under existing Article 9 whether or not the filing would perfect under new Article 9. Further, as we saw in our discussion of the section in Problem 1, a filing that is proper under existing Article 9 but not under new Article 9 is effective until the earlier of the date the filing would lapse under existing section 9-403(2) or June 30, 2006. So, under the facts of Problem 2, Lender's financing statement, which was filed in the correct state (Arizona) under existing Article 9 but the wrong state under new Article 9 (should have been Delaware), continues to perfect Lender's security interest until April 10, 2006, which is the earlier of the date the filing would have lapsed under existing Article 9 as enacted in Arizona or June 30, 2006.

 

The important points made about Problem 2 so far are:

 

Lender's filing is proper under existing Article 9 but not under new Article 9;

Under new section 9-705, Lender's financing statement continues to perfect Lender's security interest after the effective date of new Article 9 even though the filing would not perfect the security interest under the new Article 9 filing scheme;

 

The perfection is not subject to the one-year limitation in new section 9-703(b)(1) because new section 9-705(c) provides an exception for filing cases;

 

Lender's perfection continues until the filing lapses under Arizona's version of existing section 9-403(2), April 10, 2006, because that is the earlier of the date of lapse under Arizona law and June 30, 2006, as provided for in new section 9-705(c).

The transition scheme we have just examined imposes a not-obvious burden on third parties. Third parties must search in Arizona as well as in Delaware. If Lender's financing statement had been filed at an earlier time, for example, on April 11, 1997, then it would continue to be effective only until the six-year period expired or until April 10, 2003. As a result the risk of not searching in both states would be lessened. However, such a change in the facts would not affect the period during which a search should be conducted in Arizona because a third party cannot know how long a financing statement will be good unless the third party knows the filing date. Practically speaking then, a third party would be wise to search in Arizona until June 30, 2006.

 

As in Problem 1, Lender may wish to know how it can continue the effectiveness of its pre-new Article 9 filing beyond April 10, 2006. Here, the fact that Lender's filing was not proper under new Article 9 matters more. Lender may not simply file a continuation statement that satisfies new section 9-515 within the six-month period prior to the time the pre-Article 9 filing lapses. New section 9-705(d) governs. It states:

 

The filing of a continuation statement after [new Article 9] takes effect does not continue the effectiveness of the financing statement filed before [new Article 9] takes effect. However, upon the timely filing of a continuation statement after [new Article 9] takes effect and in accordance with the law of the jurisdiction governing perfection as provided in Part 3, the effectiveness of a financing statement files in the same office in that jurisdiction before [new Article 9] takes effect continues for the period provided by the law of that jurisdiction.

 

 

As seen in Problem 1, the general rule stated in the first sentence of the foregoing section is that a continuation statement will not work to continue a pre-new Article 9 filing. On the facts of Problem 2 Lender's filing is not within the exception stated in the second sentence of that provision. The exception requires that filing have been in the proper place under both existing and new Article 9. Lender's filing was in the right office but in the wrong state under the new Article 9 scheme.

 

So, what must Lender do? All we know at this point is that a continuation statement will not work. The answer to our question is in new section 9-706. That section provides:

 

(a) The filing of an initial financing statement in the office specified in Section 9-501 continues the effectiveness of a financing statement filed before [new Article 9] takes effect if:

(1) the filing of an initial financing statement in that office would be effective to perfect a security interest under [new Article 9];

(2)     the pre-effective-date financing statement was filed in an office in another State or another office in this State; and

(3)     the initial financing statement satisfies subsection (c).

(b)     The filing of an initial financing statement under subsection (a) continues the effectiveness of the pre-effective date financing statement:

(1)     if the initial financing statement is filed before [new Article 9] takes effect, for the period provided in [former Section 9-403] with respect to a financing statement; and

(2)     if the financing statement is filed after [new Article 9] takes effect, for the period provided for in Section 9-515 with respect to an initial financing statement.

(c)     To be effective for the purposes of subsection (a), an initial financing statement must:

(1)     satisfy the requirements of Part 5 for an initial financing statement;

(2)     identify the pre-effective-date financing statement by indicating the office in which the financing statement was filed and providing the dates of filing and file numbers, if any, of the financing statement and of the most recent continuation statement filed with respect to the financing statement; and

(3)     indicate that the pre-effective-date financing statement remains effective.

 

According to the foregoing provision, to continue the effectiveness of the pre-July 1, 2001 filing beyond April 10, 2006, Lender must file an initial financing statement in lieu of a continuation statement under new section 9-706. The financing statement must satisfy the requirements of Part 5 of new Article 9. Part 5 of new Article 9, in turn, requires Lender to file a financing statement in the Secretary of State's Office in Delaware. In addition, under new section 9-706(c), the new financing statement must identify the pre-effective-date financing statement and indicate that the pre-effective-date financing statement has not ceased to be effective.

 

As noted in Problem 1, Lender's task is eased somewhat in that Lender need not get Debtor, Inc. to authenticate the new financing statement. See new section 9-708[2]. Moreover, because it is an initial filing and not a continuation statement, the financing statement may be filed at any time before the earlier filing ceases to be effective.

 

To summarize what is learned from Problem 2, Lender's filing in the Secretary of State's Office in Arizona is proper under existing Article 9 but not under new Article 9. Nevertheless, the filing operates to perfect Lender's security interest after July 1, 2001 until the filing lapses on April 10, 2006. To prevent lapse and continue perfection Lender must file an initial financing statement (not a continuation statement) that satisfies new sections 9-301 and 9-501. The initial financing statement may be filed at any time prior to the lapse of the pre-new Article 9 financing statement and, presumably, it will be effective for five years from the date it is filed as provided in new section 9-515(a).

 

Problem 3

 

Assume the facts of Problem 1. Assume, however, that Lender takes a security interest in Debtor, Inc.'s inventory, existing and after-acquired. Lender's filing in Arizona is improper as to the inventory located in California and New Mexico under existing Article 9 but it is proper under new Article 9. The inventory would be "ordinary goods" under existing section 9-103(1) and under existing section 9-103(1)(b) the law of the state where the goods are located governs perfection and Lender should have filed in California and New Mexico as well as Arizona. Under new Article 9 the law of the state where the debtor is located governs perfection of a security interest in the inventory as well as accounts. New section 9-301 employs a location of the debtor rather than a "situs rule" for most collateral. As noted in Problem 1, this is a major change made by new Article 9.

 

The question is what happens when a filing that is not effective to perfect under existing Article 9 would perfect under new Article 9. Interestingly enough, a filing that is proper under new Article 9 can operate to perfect a security interest that was not perfected under existing Article 9. New section 9-704(3)(A) controls. That section is as follows:

 

A security interest that is enforceable immediately before [new Article 9] takes effect but which would be subordinate to the rights of a person that becomes a lien creditor at that time [i.e., is not perfected at the time new Article 9 takes effect];

 

. . . .

 

(3) becomes perfected:

 

(A) without further action, when [new Article 9] takes effect if the applicable requirements for perfection under [new Article 9] are satisfied before or at that time;

 

New section 9-704(3)(A) also means that a financing statement containing a description that is not adequate under existing Article 9 but is sufficient under new Article 9 perfects a previously unperfected security interest. The section further permits a creditor to anticipate new Article 9 by filing in compliance with new Article 9 prior to July 1, 2001. However, in cases where a filing is proper under new Article 9 but not under existing Article 9 the security interest is perfected on the effective date of new Article 9. This means that there will have been a period during which the security interest was not perfected and would be vulnerable to a lien creditor or a trustee in bankruptcy under BRA 544(a) or even a preference challenge under BRA 547.

Consequently, a creditor who wishes to anticipate new Article 9 should satisfy both existing and new Article 9 filing requirements.

 

The next question is how long perfection by operation of new section 9-704(3)(A) lasts. Although it is far from obvious the answer to the question would seem to be that the duration and lapse rules of new Article 9 kick in and the filing is good under new section 9-515(a) for five years after July 1, 2001. At first glance it might appear that Lender's security interest is perfected for a longer period of time than it would be if its filing were proper under existing Article 9. However, recall that Lender is not perfected during the period between April 11, 2000 and July 1, 2001 and Lender's security interest is vulnerable both in and out of bankruptcy during that period.

 

If Lender's security interest survives intact until July 1, 2001 and Lender wishes to continue the filing beyond five years, Lender should file a continuation statement in the six-month period before five years after July 1, 2001. What happens if a dispute arises before July 1, 2001 but is not be resolved until after that date is a question that is considered in Problem 5.

 

If the facts in Problem 3 were as stated in Problem 2 (Debtor, Inc. was incorporated in Delaware), then Lender's filing in Arizona is not proper under either existing or new Article 9. There is nothing in the transition rules of Part 7 of new Article 9 to save such a filing. New section 9-704(3)(B) governs in such a case. It is as follows:

 

A security interest that is enforceable immediately before [new Article 9] takes effect but which would be subordinate to the rights of a person that becomes a lien creditor at that time [i.e., is not perfected at the time new Article 9 takes effect];

 

. . . .

 

(3) becomes perfected:

 

. . .

 

(B) when the applicable requirements for perfection are satisfied if the requirements are satisfied after that time [i.e., after the effective date of new Article 9].

 

Therefore, if the requirements of new Article 9 have not been satisfied on the effective date of new Article 9 then the security interest is not perfected unless and until the new Article 9 requirements are met. As one might expect and as will be explored further in Problem 5, new section 9-704 has implications for resolving priority disputes. Incidentally, there is no counterpart in new Article 9 to existing section 9-401(2) (filing effective as to searcher who sees improperly filed financing statement).

 

Problem 4

 

Assume the facts of Problem 1. Assume, however, that the widgets are crops that Debtor, Inc. raises and sells. Here the widgets are farm products under existing section 9-109(3). Existing section 9-401(1)(a) provides that a filing as to accounts generated by the sale of farm products must be made locally, i.e., in the personal property records of the county where the debtor resides. So, Lender's filing in the Secretary of State's Office in Arizona would be in the wrong place under existing Article 9. A filing in the Secretary of State's Office is proper as to accounts generated by the sale of farm products under new Article 9 (filings other than those for fixtures and certain other real estate-related collateral are to be made centrally under new section 9-501) so Lender's filing in Arizona would be proper under new section 9-301. Consequently, we have another case of a filing that fails to perfect under existing Article 9 but would perfect under new Article 9 as of the effective date of new Article 9. See Problem 3. The intervention of new Article 9 has the effect of perfecting Lender's security interest as of July 1, 2001. New section 9-704(3)(A).

 

If, as in Problem 2, Debtor, Inc. were incorporated in Delaware, Lender's filing in the Secretary of State's Office in Arizona would be improper under both existing and new Article 9. Again, there is nothing in the transition rules of new Article 9 that will save a filing that is improper under both existing and new Article 9. Lender may make a filing after July 1, 2001 that satisfies new Article 9, but the date of the filing would be the date that Lender satisfied new Article 9. See Problem 3 and new section 9-704(3)(B).

 

Under new Article 9 section 9-507(b)(1) an individual debtor is located where the debtor resides. If the debtor in Problem 4 were an individual residing in Arizona then Lender's filing in the Secretary of State's Office in Arizona would have been proper under new Article 9 (but still improper under existing Article 9 because of the requirement for local filing as to accounts generated by the sale of farm products). The change in facts (making the debtor an individual) would present another instance of a security interest that is not perfected under existing Article 9 but is perfected under new Article 9 as of the effective date of new Article 9.

Problem 5

 

In June of 2001, Lender begins discussions with Debtor about a loan. Lender files a financing statement that meets the requirements of existing Article 9 on June 2, 2001. The financing statement describes the collateral as "Debtor's Equipment." On June 15, 2001, Bank lends to Debtor and takes a security interest in Debtor's equipment under a security agreement that satisfies existing section 9-203(1)(a). On the same day Bank files a financing statement that meets the requirements of existing Article 9 and describes the collateral as "Debtor's Equipment." On June 30, 2001 Lender lends to Debtor and Debtor signs a security agreement that meets the requirements of existing section 9-203(1)(a). Earlier that day the sheriff seized Debtor's equipment under a writ of execution obtained by Lien Creditor. It is now July 2, 2001. Both Lender and Bank are attempting to recover the equipment from the sheriff and the sheriff has resisted. Who gets the equipment?

 

The first step is to decide whether the priority rules of existing or new Article 9 apply. Under new section 9-709(a)[3] the priority rules of new Article 9 apply except where the "relative priorities of the claims were established before [new Article 9] takes effect." On the facts of Problem 5, the priority positions of all the parties were established before July 1, 2001, the effective date of new Article 9. Therefore, the priority rules of existing Article 9 apply. The application of these rules produces a circular priority, to wit: Lender is ahead of Bank as the first to file under existing section 9-312(5), Lien Creditor can subordinate Lender under existing section 9-301(1)(b); and, Bank is ahead of Lien Creditor under existing section 9-201 (and is not subordinated to Lien Creditor under existing section 9-301(1)(b) because Bank was perfected at the time of the levy).

 

If any of the parties' claims were established after July 1, 2001 then the priority rules of new Article 9 would apply. The new Article 9 rules have eliminated the circular priority problem and Lender would be ahead of both Lien Creditor and Bank under new sections 9-317(a)(2) and 9-322(a)(1). These sections, respectively, are as follows:

 

(a) An unperfected security interest or agricultural lien is subordinate to the rights of:

. . .

(2) a person that becomes a lien creditor before the earlier of the time the security interest or agricultural lien is perfected or a financing statement covering the collateral is filed. [Emphasis added.]

 

(a) Except as otherwise provided in this section, priority among conflicting security interests and agricultural liens in the same collateral is determined according to the following rules:

(1) Conflicting perfected security interests and agricultural liens rank according to priority in time of filing or perfection. Priority dates from the earlier of the time a filing covering the collateral is first made or the security interest or agricultural lien is first perfected, if there is no period thereafter when there is neither filing nor perfection.

 

For completeness, suppose Lender had filed improperly under the existing Article 9 scheme but properly under new Article 9. Now what? This is a case within new sections 9-704 (considered in Problem 3) and new section 9-709(b). The latter section provides:

 

For purposes of section 9-322(a), the priority of a security interest that becomes enforceable under section 9-203 of [new Article 9] dates from the time [new Article 9] takes effect if the security interest is perfected under [new Article 9] by the filing of a financing statement before [new Article 9] takes effect which would not have been effective to perfect the security interest under [existing Article 9]. This subsection does not apply to conflicting security interests each of which is perfected by the filing of such a financing statement.

 

Under the foregoing section Lender's filing dates from the effective date of new Article 9 and that would put Bank ahead as the first to file. The last sentence of new section 9-709(b) does not change this outcome. This sentence states that "[new section 9-709(b)] does not apply to conflicting security interests each of which is perfected by such filing of a financing statement." While the language could certainly be clearer it appears to mean that if the holder of each conflicting security interest has filed improperly under existing Article 9 and must rely on new Article 9 section 9-704(3)(A) to achieve perfection then the party that is first to file under existing Article 9 has priority. Thus, if both Lender and Bank filed improperly under existing Article 9 then Lender would have priority as chronologically the first to file.

 

Problem 6

 

In the problem situations considered so far the question could arise as to how a pre-new Article 9 filing that is effective after July 1, 2001 should be amended or terminated. New section 9-707[4] governs: It provides as follows:

 

(a) In this section, "pre-effective-date financing statement" means a financing statement filed before [new Article 9] takes effect.

 

(b) After [new Article 9] takes effect, a person may add or delete collateral covered by, continue or terminate the effectiveness of, or otherwise amend the information provided in, a pre-effective-date financing statement only in accordance with the law of the jurisdiction governing perfection as provided in Part 3. However, the effectiveness of a pre-effective-date financing statement also may be terminated in accordance with the law of the jurisdiction in which the financing statement is filed.

 

(c) Except as otherwise provided in subsection (d), if the law of this State governs perfection of a security interest, the information in a pre-effective-date financing statement may be amended after [new Article 9] takes effect only if:

 

(1) the pre-effective-date financing statement and an amendment are filed in the office specified in Section 9-501;

 

(2) an amendment is filed in the office specified in Section 9-501concurrently with, or after the filing in that office of, an initial financing statement that satisfies Section 9-706(c); or

 

(3) an initial financing statement that provides the information as amended and satisfies Section 9-706(c) is filed in the office specified in Section 9-501.

 

(d) If the law of this State governs perfection of a security interest, the effectiveness of a pre-effective-date financing statement may be continued only under Section 9-705(d) and (f) or 9-706.

 

(e) Whether or not the law of this State governs perfection of a security interest, the effectiveness of a pre-effective-date financing statement filed in this State may be terminated after this [Act] takes effect by filing a termination statement in the office in which the pre-effective date financing statement is filed, unless an initial financing statement that satisfies Section 9-706(c) has been filed in the office specified by the law of the jurisdiction governing perfection as provided in Part 3 as the office in which to file a financing statement.

 

These rules are anything but clear. It helps to keep in mind that the filing system is designed to aid searchers and, for the most part, the rules of new section 9-707 try to anticipate where a searcher will be looking. The reference to the law of the state that "governs perfection" reflects this premise. However, as with choice of law rules generally, distinguishing "the law of the state that governs perfection" from the law of "this state" and determining when they are the same or different often is difficult and is best done in the context of specific facts. Consequently, we will use the situations presented in the previous problems in considering the rules of new section 9-707.

 

New section 9-707 distinguishes amendments from terminations. We will look first at termination. Both new sections 9-707(b) and (e) speak to termination. New section 707(b) requires that a termination be filed according to the law governing perfection under new Article 9 Part 3 (the choice of law rules, including especially new section 9-301). However, new section 707(b) also permits filing a termination statement under the law of the state where the pre-new Article 9 financing statement actually was filed. [Why?] And, new section 9-707(e) permits such a filing irrespective of which state's law governs perfection under new Article 9 unless an initial financing statement has been filed under new section 9-706(c) in lieu of a continuation statement.

 

In Problem 1, Lender filed in the Secretary of State's Office in Arizona. That filing was proper under existing Article 9 and would be proper under new Article 9 (Debtor, Inc. is located in Arizona). Consequently, filing a termination statement anywhere but in Arizona would not make sense. In new section 9-707 terms, Arizona law is the law that governs perfection under new Article 9 and Arizona also is the state where the pre-new Article 9 financing statement actually was filed. The first sentence of new section 9-707(b) points to new section 9-707(c) [why (c)?] as enacted in Arizona and the second sentence of new section 9-707(b) points to new section 9-707(e) as enacted in Arizona.

 

The facts of Problem 2 present a somewhat more difficult situation. The first sentence of new section 9-707(b) indicates that a termination statement should be filed in Delaware as the state whose law governs perfection (Debtor, Inc. is located in Delaware). However, the second sentence of new section 9-707(b) points to Arizona's version of new section 9-707 because Arizona is the state where the pre-new Article 9 financing statement actually was filed. Therefore, a termination statement also may be filed in Arizona. As we saw in Problem 2, Lender could continue the effectiveness of its pre-new Article 9 filing beyond the date it would lapse under Arizona law (April 10, 2006) only by filing an initial financing statement in lieu of a continuation statement in Delaware. If such a filing has been made then new section 9-707(e) requires that a termination statement be filed in Delaware. Under this scheme a searcher must look for a termination statement in more than one place, namely, in the state where the pre-new Article 9 filing actually was made and in the state whose law governs perfection under new Article 9. [why this scheme?]

 

In Problem 3 Lender was given a security interest in inventory sold in Arizona, California and New Mexico. Lender's filing in Arizona did not perfect the security interest in the inventory located in California and New Mexico because under existing Article 9 a "situs rule" applies as to such collateral and Lender should have filed in California and New Mexico as well as Arizona. However, the security interest in the inventory located in California and New Mexico was perfected under new section 9-704(3)(A) as of July 1, 2001. The sensible place for filing (and searching for) a termination statement in such a case is Arizona. New section 707(b) indicates that Arizona is the place to file a termination statement because Arizona is the state whose law governs perfection under new Article 9 and it also is the state where the filing actually was made. Under new section 9-707(e) it makes no difference that Arizona law does govern not perfection. On the facts of Problem 3, to extend perfection beyond the five years from the effective date of new Article 9, July 1, 2001, Lender would have to file a continuation statement in Arizona, and Arizona still would be the place to file a termination statement.

 

Although generalizations are risky given the complexity of the new Article 9 transition rules, it would seem that it is always proper to file a termination statement in the state whose law governs perfection under new Article 9. However, searchers are not safe in looking only in the state whose law governs perfection because a termination statement may be filed in the state where the pre-new Article 9 filing actually was made (properly or not?). Consequently, a prospective creditor should search the records in the state whose law governs perfection under new Article 9 and the state where the pre-Article 9 filing actually was made [how does it know that state if misfiled? Why such a scheme?]

 

The rules governing amendments are more restrictive than those for termination statements. Thus, the first sentence of new section 9-707(b), as set out above, provides:

 

After [new Article 9] takes effect, a person may add or delete collateral . . . or otherwise amend the information in a [pre-new Article 9] financing statement only in accordance with the law of the jurisdiction governing perfection as provided for in [Part 3 of new Article 9].

 

Under this rule, an amendment must be filed in the state whose law governs perfection under new Article 9 irrespective of where the original filing was made. In Problems 1 and 3 the place to file an amendment would be Arizona. In Problem 2 the place to file an amendment would be Delaware even though the pre-new Article 9 financing statement was filed in Arizona.

 

New section 9-707(c), as quoted above, provides three methods of amending depending on whether a financing statement has already been filed in the state where the amendment must be filed. On the facts of Problem 1 and 3 Lender may file an amendment under new section 9-512 in the Secretary of State's Office in Arizona because the pre-new Article 9 financing statement is filed there. However, on the facts of Problem 2, Lender should file in Delaware (1) an initial financing statement that satisfies new Article 9 and refers back to the Arizona filing and (2) also file an amendment, concurrently or subsequently to filing the initial financing statement. Alternatively, Lender could file in Delaware an initial financing statement that contains the amended information. [What is this about?] [bottom line? Rationale?]

 

Problem 7

 

In the previous problems the focus was on perfection of a security interest in original collateral (including after-acquired collateral). We should look also at the effect of the intervention of new Article 9 on security interests in proceeds. If Debtor, Inc. in Problems 1 or 2 collected some accounts and deposited the monies in a general bank account then under both existing and new Article 9 Lender would have a claim to the bank account as proceeds. Identification problems could be overcome using a "lowest intermediate balance of proceeds" analysis. See existing section 9-306(2) and new sections 9-315(a)(2) and (b)(2). Because the bank account would be identifiable "cash proceeds" under existing section 9-306(1) and new section 9-102(a)(9), the security interest in the bank account would be perfected from the time of the filing on April 11, 2000 until the financing statement lapsed or was terminated. See existing section 9-306(3)(b) and new sections 9-315(d)(2) and (e)(2). Bankruptcy or other insolvency proceedings could complicate the analysis under existing section 9-306(4)(d), but that troublesome provision has been eliminated by new Article 9.

 

Our question is whether there is any effect on the foregoing analysis of the intervention of new Article 9 on July 1, 2001. It would seem that the status of Lender's security interest in the bank account (or other proceeds) is the same as the security interest in the accounts. On the facts of Problem 1, the security interest in the accounts is perfected after July 1, 2001 and will continue until the financing statement filed on April 11, 2000 lapses on April 10, 2006 (unless Lender files a continuation statement within six months prior to the date of the lapse) or is terminated before that time. The same should be true as to any proceeds, including any bank accounts in which monies from collected accounts have been deposited. As we saw earlier, the perfection of the security interest in the accounts in Problem 2 also would continue until April 10, 2006 and the only effect of the intervention of new Article 9 is that Lender would have to file an initial financing statement in lieu of a continuation statement to continue perfection after April 10, 2006. The same should be true as to proceeds of the accounts.

 

As was seen in our discussion of Problem 3, the security interest in the inventory sold in California and New Mexico would be perfected as of July 1, 2001 (the filing in Arizona was improper under existing Article 9 but proper under new Article 9), but there would be a gap in perfection between April 11, 2000 and July 1, 2001. Would the same be true of accounts generated by the sale of inventory in California and New Mexico? The answer is "no." The law of the state where the debtor is located governs perfection as to security interests in accounts under both existing and new Article 9. Debtor, Inc. is located in Arizona under both existing and new Article 9 (its chief executive office is in Arizona and it is incorporated in Arizona). Consequently, a filing in Arizona would be proper under both existing and new Article 9 and there would be continuous perfection from April 11, 2000 until the financing statement lapsed under Arizona law, on April 10, 2006, or was terminated.

[compare to after-acquired?]

 

Problem 8

 

The previous problems have focused on filing as the most common mode of perfection. There are, however, situations where perfection will have been (or should have been) perfected in some other manner. At the risk of confusing whatever has been learned to this point, a few such situations are considered in this problem.

 

Suppose Lender in Problem 1 was given a security interest in a negotiable certificate of deposit (CD) and to perfect the security interest Lender took possession of the CD. The security interest is perfected under existing Article 9 section 9-305 and would be perfected under new Article 9 section 9-313 and would continue so long as Lender remained in possession. Under new section 9-703(a), the security interest is perfected on July 1, 2001 and continues perfected under new section 9-705(a) as long as Lender keeps possession of the CD.

 

The situation is more complicated if Lender relies on possession of the CD by a third party. Under existing Article 9 section 9-305 Lender's security interest could be perfected by notice to the third party of Lender's security interest. New section 9-313(c) provides that there is perfection only where the third party acknowledges that it holds the CD for the Lender. If the facts were that Lender had given notice to the third party in possession of the CD on April 11, 2000 then the security interest would be perfected under existing Article 9 but not under new Article 9. However, under new sections 9-703(b) and 9-705(a), Lender's security interest is perfected on July 1, 2001 and remains perfected for one year from that date. To achieve continuous perfection beyond one year after July 1, 2001 Lender must get the third party's acknowledgment within the one-year period. New section 9-705(a).

 

A negotiable CD is an "instrument" under both existing Article 9 section 9-105(1)(i) and new Article 9 section 9-102(a)(47). Under existing Article 9 section 9-304(1) perfection of a security interest in an instrument, other than as proceeds or as part of chattel paper, can be perfected only by possession. New Article 9 makes an important change here. Under new section 9-312(a) perfection of a security interests in an instrument may be achieved by filing a financing statement. Suppose in an effort to perfect its security interest in the negotiable CD Lender filed a financing statement on April 11, 2000 rather than taking possession of the CD. The security interest is not perfected under existing Article 9 but it would be perfected under new Article 9. Under new section 9-704(3)(A) the security interest in the CD would be perfected effective on July 1, 2001. As with the inventory in Problem 3, the security interest remains perfected for five years after that date and the perfection can be continued thereafter by filing a continuation statement under new Article 9 section 9-515. But, as was also true as to the inventory there is a gap in Lender's perfection between April 11, 2000 and July 1, 2001. Beyond this, filing as to a negotiable instrument is risky because the instrument may be negotiated to a holder-in-due-course and under existing section 9-309 and new section 9-331 the holder-in-due-course would have priority. [new 709?]

 

Problem 9

 

New Article 9 makes another important change that can pose transition questions. Security interests in deposit accounts (general bank accounts as distinguished from certificates of deposit) other than as proceeds are outside the scope of existing Article 9. Existing section 9-104(l). By contrast, new Article 9 covers security interests deposit accounts both as proceeds and (except in consumer transactions) as original collateral. See new section 9-109(d)(13). However, a security interest in a deposit account as original collateral can be perfected only by "control." New section 9-314 and Official Comment 5 to new section 9-312. A secured party has control of a deposit account under new section 9-104 when:

 

(1) the secured party is the bank with which the deposit account is maintained;

(2) the debtor, secured party, and bank have agreed in an authenticated record that the bank will comply with instructions originated by the secured party directing disposition of the funds in the account without further consent by the debtor; or

(3) the secured party becomes the bank's customer with respect to the deposit account.

 

Suppose Lender in Problem 1 is given a security interest in a deposit account owned by Debtor, Inc. Creation and perfection of such a security interest is outside the scope of existing Article 9. What Lender should do to perfect the security interest in the deposit account is a matter of uncertainty. Suppose on April 11, 2000 Lender enters into an agreement with the bank where the deposit account is located under which Lender is able to direct the disposition of the funds in the account. What happens after July 1, 2001 depends on whether Lender's actions are sufficient to perfect the security interest either under the law outside Article 9 or under new Article 9 or under both the law outside Article 9 and new Article 9 or under neither law.

 

If, for example, the agreement is effective to perfect both under the law outside Article 9 on April 11, 2000 and under new section 9-104 then we have a case under new section 9-703(a) and the security interest is perfected from April 11, 2000 and continues after July 1, 2001 so long as Lender has control. If instead Lender's actions perfect under the law outside Article 9 on April 11, 2000 but would not give the Lender control under new section 9-104 then the case is governed by new section 9-703(b) and the security interest is perfected from April 11, 2000 until one year after July 1, 2001 unless Lender acts to get control under new section 9-104 within the one-year period. If the security interest is not perfected under the law outside Article 9 on April 11, 2000 but there is control under new section 9-104 then the security interest is perfected under new section 9-704(3)(A) as of July 1, 2001 and it remains perfected so long as Lender has control. However, in the last case there is a gap in perfection between April 11, 2000 and July 1, 2001. If the Lender's actions were not sufficient to perfect under the law outside Article 9 on April 11, 2000 and would not give Lender control under new section 9-104 then the security interest is unperfected from April 11, 2000 and remains unperfected after that date.

 

Investment property?

License fees?

Advice???



[1] In ?? of ??? a section dealing with termination and amendment was added to Part 7. This section is numbered 9-707 and what was section 9-707 is now section 9-708 and what was section 9-708 is now section 9-709. The official comments were moved to correspond to the changes.

[2] See supra note 1 as to the insertion of a section dealing with termination and amendment and the effect on the numbering of sections 9-707, 9-708 and 9-709.

[3] Id.

[4] Id.