We have noted the three immediate exceptions to the general rule that “the firstest with the mostest” prevails. There are some other exceptions.
Think about how these other exceptions might arise: who might want to take property subject to a security agreement (not including thieves)? That is, Debtor gives Creditor a security interest in, say, goods, while retaining possession. First, buyers of various sorts might want the goods if they paid for them; they usually win. Second, lien creditors might want the goods (a lien creditor is one whose claim is based on operation of law—involuntarily against Debtor, and including a trustee in bankruptcy—as opposed to one whose claim is based on agreement); lien creditors may be statutory (landlords, mechanics, bailees) or judicial. Third, a bankruptcy trustee representing Debtor’s creditors (independent of the trustee’s role as a lien creditor) might want to take the goods to sell and satisfy Debtor’s obligations to the creditors. Fourth, unsecured creditors; fifth, secured creditors; and sixth, secured and perfected creditors. We will examine some of the possible permutations but are compelled to observe that this area of law has many fine nuances, not all of which can be taken up here.
First we look at buyers who take priority over, or free of, unperfected security interests. Buyers who take delivery of many types of collateral covered by an unperfected security interest win out over the hapless secured party who failed to perfect if they give value and don’t know of the security interest or agricultural lien. 1 A buyer who doesn’t give value or who knows of the security interest will not win out, nor will a buyer prevail if the seller’s creditor files a financing statement before or within twenty days after the debtor receives delivery of the collateral.
Now we look at buyers who take priority over perfected security interests. Sometimes people who buy things even covered by a perfected security interest win out (the perfected secured party loses).
- Buyers in the ordinary course of business. “A buyer in the ordinary course of business, other than [one buying farm products from somebody engaged in farming] takes free of a security interest created by the buyer’s seller, even if the security interest is perfected and the buyer knows [it].” 2 Here the buyer is usually purchasing inventory collateral, and it’s OK if he knows the inventory is covered by a security interest, but it’s not OK if he knows “that the sale violates a term in an agreement with the secured party.” 3 It would not be conducive to faith in commercial transactions if buyers of inventory generally had to worry whether their seller’s creditors were going to repossess the things the buyers had purchased in good faith. For example (based on example 1 to the same comment, UCC 9-320, Official Comment 3), Manufacturer makes appliances and owns manufacturing equipment covered by a perfected security agreement in favor of Lender. Manufacturer sells the equipment to Dealer, whose business is buying and selling used equipment; Dealer, in turn, sells the stuff to Buyer, a buyer in the ordinary course. Does Buyer take free of the security interest? No, because Dealer didn’t create it; Manufacturer did.
- Buyers of consumer goods purchased for personal, family, or household use take free of security interests, even if perfected, so long as they buy without knowledge of the security interest, for value, for their own consumer uses, and before the filing of a financing statement covering the goods. This—again—is the rub when a seller of consumer goods perfects by “mere attachment” (automatic perfection) and the buyer of the goods turns around and sells them. For example, Tom buys a new refrigerator from Sears, which perfects by mere attachment. Tom has cash flow problems and sells the fridge to Ned, his neighbor. Ned doesn’t know about Sears’s security interest and pays a reasonable amount for it. He puts it in his kitchen for home use. Sears cannot repossess the fridge from Ned. If it wanted to protect itself fully, Sears would have filed a financing statement; then Ned would be out the fridge when the repo men came. 4 The “value” issue is interestingly presented in the Nicolosi case ( Cases ).
- Buyers of farm products. The UCC itself does not protect buyers of farm products from security interests created by “the person engaged in farming operations who is in the business of selling farm products,” and the result was that sometimes the buyer had to pay twice: once to the farmer and again to the lender whom the farmer didn’t pay. As a result, Congress included in its 1985 Farm Security Act, 7 USC 1631, Section 1324, this language: “A buyer who in the ordinary course of business buys a farm product from a seller engaged in farming operations shall take free of a security interest created by the seller, even though the security interest is perfected; and the buyer knows of the existence of such interest.”
There are some other exceptions, beyond our scope here.
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