Those calves are mine: toward a Uniform Commercial Code definition of "rights in the collateral".

Author:Thompson, Michael B.

    Article 9 (1) of the Uniform Commercial Code (UCC) governs in large measure relationships between debtors (2) and secured parties. (3) Section 9-203 of South Dakota Codified Laws, by requiring attachment of a security interest prior to its perfection, usually serves as the starting point of an enforceable relationship. (4) Generally, 9-203's procedures for security-interest attachment precede perfection (5) and are necessary in most instances to elevate a creditor from also-ran unsecured status (6) to collateral-clad secured status. (7) The requirements of 9-203(b)(1) and (b)(3) (8) are fairly straightforward: A creditor must give value and satisfy one of four acceptably clear steps.

    Section 9-203(b)(2)'s mandate that the debtor have "rights in the collateral" (9) (RIC) has, however, caused the courts some consternation; understandably, court-fogginess tends to antagonize practitioners, who must, with their advice, craft legal relationships based upon these precedents. (10) Ideally, then, the UCC should define this phrase. In reality, a definition is rendered only after examining several cases and resorting to some pre-existing UCC provisions.

    This article commences with a short rendition of the history of Article 9 and its avowed purposes, with an eye toward exploring how section 9-203 reached its present form. After a brief aside to discuss germane property-law principles and select property relationships, the article proceeds next with an examination of some cases in which courts tried to define RIC and also provides insight into certain UCC sections, as well as other law to which reference can be made to provide a definition for RIC. In its conclusion, the article proposes a redrafted section 9-203(b) and a definition of RIC.



      Consider the following scenario: Jimmy, a sixty-five-year old, owns a construction company-we will call it Cranes-employing about fifteen people, including his younger brother, Duane, who is in his mid-fifties. Jimmy and Duane communicate only infrequently, despite the fact that they occupy offices across the hall from each other. Duane runs a business engaged in excavation on the side.

      Jimmy has a line of credit with Long-History Bank. As collateral for the line, Bank has a security interest, complete with an after-acquired-property clause, (11) in all of Jimmy's equipment. Duane, with regard to his excavation-business equipment, has a similar relationship with New-Town Bank.

      Jimmy is well-versed in cranes, bridge construction, and how to determine the safest way to hoist an oversized air conditioner to the top of a large building. He wants nothing to do with excavation. He is, though, very generous and caring, and, as the oldest child, now motherless, feels obliged to help Duane succeed. Enter Duane's buddy Kevin, a nomad who attends equipment auctions to purchase equipment for later resale to earn a profit.

      Kevin owns a nearly-new backhoe that Duane has had his eyes on. Duane has exceeded his line of credit, though, so he goes to Jimmy for assistance. Jimmy agrees to buy the backhoe and allow Duane to use it until Duane amasses enough cash to reimburse Jimmy. Duane approaches Kevin with Jimmy's check in hand. Duane signs the purchase agreement and gives Kevin the check; in exchange, Kevin gives Duane a bill of sale designating Jimmy as the buyer of the equipment. Duane loads the backhoe onto his flatbed trailer and drives gleefully back to the equipment yard, which is a plot of real estate to which Jimmy has title but which Duane and Jimmy share.

      Jimmy and Duane agree that if Duane has to use the backhoe on any of Jimmy's jobs, Jimmy will credit the cost of each job towards Duane's purchase price. The duo makes no distinction between retail and wholesale cost, nor do they discuss computation of cost. In addition, they agree that Jimmy can use the backhoe when needed. To understate the matter, issues abound in this budding relationship.

      Duane uses the backhoe for both his and Jimmy's jobs, and Jimmy uses it himself for some of his own jobs. Neither Duane nor Jimmy keeps good records of this usage, and Jimmy pays little if any attention to the backhoe's location. Jimmy depreciates the machine and records it on equipment lists used for capital and insurance purposes. Duane, due to his inexperience, does not insure the backhoe, but he has placed it on the equipment list he shows New-Town, unaware that Jimmy has done the same thing with Long-History. Both banks conduct annual inspections, albeit at different times. Each time, bank officers see the backhoe in the yard or on a job. That is the extent, however, of each bank's investigation.

      Duane's business begins to deteriorate. He misses several line-of-credit payments. One morning when he arrives at work before Jimmy, Duane sees several trucks parked in the yard, one of which is set to haul away the repossessed backhoe. New-Town takes the backhoe to the auction lot, hoping to recoup from the sale some of its loan monies.

      Jimmy learns of the repossession when he asks Duane to help him dig a foundation for a commercial building. Now, Jimmy is incensed. His sense of injustice compels a call to his lawyer, who informs Jimmy that if New-Town's security interest "attached" to the backhoe, New-Town most likely has the right to its possession and subsequent resale.

      New-Town will argue that because Duane works for Jimmy, it achieved RIC enabling it to clutch the backhoe as after-acquired property. (12) Long-History will alternatively argue that Jimmy, as the owner of the backhoe, is entitled to its possession, thus leaving New-Town with only an unsecured interest because of the failure of New-Town's security interest to attach. The battle lines are thus drawn: Did Duane posses RIC?


      Article 9, as part of the UCC, is intended to unify personal property security law. (13) One of the drafters of Article 9 fixes 1950 as the date of its inception. (14) Article 9's draftsmen began with the premise

      [T]hat the system of independent security devices had served its time; that the formal differences which separated one device from another should be scrapped and replaced with the simple concept of a security interest in personal property; that all types of personal property, whether held for use or for sale, should be recognized as available for security. (15) The Article 9 security interest, arising as it does "bay contract," (16) is voluntary and not the result of the breach of another obligation. (17) This security interest covers debtors' grants of security interests in personal property to secured parties to ensure the repayment of debts.

      For example, Jimmy, in exchange for Long-History's loan to him, granted Long-History a security interest in his equipment. As long as Jimmy had RIC-the collateral being Jimmy's equipment-and Jimmy "authenticated" (18) a security agreement, Long-History's security interest would "attach" (19) to Jimmy's equipment. Long-History would then, in most cases, have to take additional steps to perfect, or give (as against other security interests) priority to, its security interest. If it did, its security interest would be deemed perfected and would be accorded a higher priority than if the security interest was attached, but unperfected. (20) In a perfect world, Long-History could, if Jimmy breached his security agreement, sell the securitized equipment and receive reimbursement for some, if not all, of its loan proceeds.

      It follows then, that attachment is vitally important not only to the relationships covered by Article 9 but also to the economics of credit provision. If a party's security interest never attaches, it cannot be perfected. Although the drafters of Article 9 sought to trumpet the "functional" over than the "formal" when it came to security devices (21) (and thereby ease the procedures for the grant of credit), it is understood that the more certain the attachment, the less costly the credit. In other words, as informal but unsuccessful attempts at attachment increase, the costs of capital lead to a less-robust commercial economy.

      As originally drafted, Article 9's attachment provision (22) required the debtor to own the collateral or acquire rights in it, and the section specifically excluded certain property:

      "For the purposes of this section" [i.e., with reference to the date of attachment of the security interest] the debtor has no rights: (a) in crops until they are planted or otherwise become growing crops, in the young of livestock until they are conceived; (b) in fish until caught, in oil, gas or minerals until they are extracted, in timber until it is cut; (c) in a contract right until the contract has been made; (d) in an account until it comes into existence. (23) The exclusions appear to have done no more than re-emphasize that a debtor has rights only in something when it becomes property, and not at any time before such occurrence.

      When "some thing" becomes a person's "property" is a complicated matter. (24) Courts have generally recognized that a person's relationship with a thing is comprised of several components that make up a "bundle of rights." (25) These rights include the right to exclude, (26) the right to transfer, and the right to possess and to use. (27) In South Dakota, ownership of property is either absolute or qualified. (28) A person enjoys a nearly unconditional relationship with her property when her ownership is absolute, when she "has the absolute dominion over it, and many use it or dispose of it according to [her] pleasure, subject only to general laws." (29) An example of a general law impeding this ownership is the law of nuisance. (30) With this ownership level, one person enjoys the entire tree of the "bundle of rights."

      Qualified ownership under South Dakota law is ownership that is shared with others, that suffers from a deferred or limited "time of...

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