The Limits of Liens in Proceeds Under Article 9

If a secured party perfects in non-filing collateral through a method other than filing, the proceeds of such collateral will have the same priority only if: 1) the security interest in proceeds is perfected; and 2) the proceeds are cash proceeds or of the same type as the collateral (such as a promissory note and a draft, both of which are instruments); and 3) “in the case of proceeds that are proceeds of proceeds, all intervening proceeds are cash proceeds, proceeds of the same type as the collateral, or an account relating to the collateral.” U.C.C. ' 9-322(c)(2)(C).

Thus, if the security interest in proceeds is perfected, there are two cases in which the secured party with priority in non-filing collateral will not automatically have priority in the proceeds: 1) when the proceeds of proceeds end up in filing collateral; and 2) when the proceeds end up in non-filing collateral, but they went through filing collateral in their journey to the current form of non-filing collateral.

Article 9 summarizes the rule as follows: If the original security interest was in non-filing collateral and was perfected other than through filing and the proceeds are currently not cash proceeds or non-filing collateral except for a deposit account (basically filing collateral), priority in the proceeds will be based upon the first to file, not the first to file or otherwise perfect. U.C.C. ' 9-322(d) and (e). This is scenario (1) immediately above. Under scenario (2) immediately above, priority reverts to the first to file or perfect. U.C.C. ' 9-322(a) (1), (c), (d) and (e).

In other words, the secured party that perfected in non-filing collateral through a method other than filing retains its priority in the proceeds of its collateral ' if the ending collateral is non-filing, the security interest in the proceeds is perfected, and all intervening collateral was cash proceeds, proceeds of the same type as the original collateral, or an account relating to the collateral. But if the proceeds of the non-filing collateral are ultimately found in the form of filing collateral, priority is according to priority at the time of filing, not filing or perfection. U.C.C. ' 9-332(a) and (b).

Indeed, even if the proceeds of the non-filing collateral are ultimately found in the form of non-filing collateral and are cash or collateral of the same type or an account relating to the collateral, the non-filing secured party retains its priority in the proceeds only if no non-cash proceeds, proceeds of a different type or filing collateral intervened in the chain. In that case, the “first to have filed or perfected” rule governs. U.C.C. ” 9-322(a)(1), 9-322(2)(c), 9-322 (d) and 9-322 (e).

This complicated priority scheme for battles between filing secured creditors and non-filing secured creditors can perhaps be best understood when one reviews the architecture of ' 9-322. Subsection (a) provides that priority will be based upon the first to file or perfect. Subsection (b) provides that the time for perfection in proceeds is the time of perfection in the original collateral. Subsection (c) provides that under certain circumstances, subsection (a) is superseded and the non-filing secured creditor will have priority in proceeds, regardless of who perfected first (e.g., when the ending proceeds are non-filing collateral and in their journey the proceeds wer never in filing collateral).

Subsection (d) provides that in certain circumstances, subsection (a) is superseded and the filing secured creditor will have priority regardless of who perfected first (e.g., where the proceeds are filing collateral). Subsection (e) provides that under certain circumstances, a battle between a non-filing secured creditor and a filing secured creditor will not be governed by subsections (c) or (d), but will revert back to subsection (a) where the first to file or perfect wins. (e.g., where the ending proceeds are in non-filing collateral but in their journey they went through filing collateral). Finally, under subsections (f) and (g), liens accorded priority under the rules stated above are trumped by the following:

(i) A perfected agricultural lien on collateral has priority over a conflicting security interest in or agricultural lien on the same collateral if the statute creating the agricultural lien so provides; U.C.C. ' 9-322(g).

(ii) Section 4-210 with respect to a security interest of a collecting bank; U.C.C. ' 9-322(f)(2).

(iii) Section 5-118 with respect to a security interest of an issuer or nominated person; U.C.C. ' 9-322(f)(3). and

(iv) Section 9-110 with respect to a security interest arising under Article 2 or 2A. U.C.C. ' 9-322(f)(4).

One notable exception to the complicated priority scheme discussed above relates to chattel paper. U.C.C. ' 9-330 (c) (1) and (2). A purchaser of chattel paper automatically has priority in proceeds of the chattel paper. U.C.C. ' 9-330 (c) (1) and (2).

The priority scheme in filing versus non-filing collateral proceeds under 9-322 can be best understood through a review and analysis of Examples 6, 9, 11, 12 and 13 included in the Official Comments to U.C.C. ' 9-322. While a review of all referenced Examples is beyond the scope of this article, a review and analysis of Example 6 is insightful and illustrative. Example 6 reads as follows:

Example 6. SP-1 perfects its security interest in investment property by filing. SP-2 perfects subsequently by taking control of a certificated security. Debtor receives cash proceeds of the security (e.g., dividends deposited into Debtor's deposit account). If the first-to-file-or-perfect rule of subsection (a)(1) (All references to subsection (a)'(e) are to subsections (a)'(e) of U.C.C. ' 9-322) were applied, SP-1's security interest in the cash proceeds would be senior, although SP-2's security interest continues perfected under Section 9-315 beyond the 20-day period of automatic perfection. This was the result under former Article 9. Under subsection ' 9-322(c), however, SP-2's security interest is senior.

Note that a different result would occur if SP-1 were to obtain control of the deposit account proceeds. This is so because subsection (c) is subject to subsection (f), which in turn provides that the priority rules under subsections (a) through (e) are subject to “the other provisions of this part.” One of those “other provisions” is ' 9-327, which accords priority to a security interest perfected by control. See U.C.C. ' 9-327(1).

Note also that a still different result would occur if the dividend was not cash, but a stock certificate. In such case, SP-2 would lose to SP-1 because the proceeds are not cash, and SP-2's lien will lapse after 20 days. U.C.C. ' 9-315 (d). If, however SP-2 had filed, it would have prevailed even though it filed after SP-1, See U.C.C. ' 9-315 (3). Thus, non-filing secured parties should consider filing even though it is not necessary for priority in the original collateral, as it may be determinative of priority in a battle over proceeds.

Special rules also govern claims to proceeds of a purchase money security interest (PMSI). Due to a successful lobby by the factoring industry, PMSI superiority in inventory does not extend to all proceeds. Rather, PMSI superiority in inventory only extends to proceeds as follows: 1) chattel paper or an instrument arising from the sale of the inventory and the proceeds of the chattel paper if so provided in U.C.C. ' 9-330; and 2) in identifiable cash proceeds, except as otherwise provided for a deposit account, but only if received on or before the delivery of the inventory to a buyer. U.C.C. ” 9-324(b), 9-330(e).

There may be some room for debate on what constitutes received on or before delivery of the inventory to a buyer. Kunkel v. Sprague National Bank, 128 F. 3d 636, 33 U.C.C. Rep. 2d 943 (8th Cir. 1997) (payment “two or three days” after delivery held to be sufficient because statute designed to distinguish between cash and credit sales); Sony Corp. of Am. v. Bank One, 85 F.3d 131 (4th Cir. 1996) (check received from buyer one day after delivery of inventory deemed “reasonably contemporaneous”).

A PMSI in livestock proceeds is far broader than a PMSI in inventory proceeds, extending to all identifiable proceeds, except as otherwise provided for deposit accounts, including even identifiable products in their unmanufactured states. U.C.C. ' 9-324(d).

A PMSI in software has priority over identifiable proceeds to the extent the PMSI in the goods in which the software was acquired for use has priority in the goods and proceeds, except, again, as otherwise provided for deposit accounts. U.C.C. ' 9-324(f).

In the event of conflicting PMSIs, a PMSI on the part of the vendor securing all or part of the purchase price has priority over of a PMSI of a lender that enables the debtor to finance the purchase. U.C.C. ' 9-324(g)(1). Otherwise, the general rule of first to file or perfect governs. U.C.C. ' 9-324(g)(2).

Proceeds of a letter of credit may be “proceeds” of some other collateral if the letter of credit was a secondary obligation. So long as the proceeds remain identifiable as cash proceeds, the secured party with a perfected lien in the original collateral also has a lien in the letter of credit proceeds. U.C.C. ” 9-109(c)(4), 9-329 cmt. 3.

Finally, a PMSI in goods other than inventory and livestock, such as equipment, has priority over identifiable proceeds, again, except as provided for deposit accounts. U.C.C. ' 9-324(a).

The third and final article in this series will discuss the interplay of liens in proceeds and bankruptcy law.

Frank Peretore, a member of this newsletter's Board of Editors, is a founding partner of the law firm of Peretore & Peretore, P.C. with offices in New Jersey and New York. He may be reached at 973-729-8991.