Opinion ID: 530287
Heading Depth: 2
Heading Rank: 1

Heading: Purchase Money Security Interests

Text: 7 The rules governing the rights of creditors are set out in Chapter 9 of the Texas Business and Commerce Code (Code), which essentially adopted the provisions of the Uniform Commercial Code--Secured Transactions. See Tex.Bus. & Com.Code Ann. Sec. 9.101 et seq. (Vernon 1989). 1 These provisions were enacted to provide a simple and unified structure within which the immense variety of present-day secured financing transactions can go forward with less cost and with greater certainty. Sec. 9.101, 1972 Official U.C.C. Comment. In keeping with these goals, rules were enacted prioritizing conflicting security interests in the same property. 8 The general rule provides that the first perfected security interest to be filed has priority and other perfected interests stand in line in the order in which they were filed. See Sec. 9.312(e). PMSIs are excepted from the first-to-file rule and take priority over other perfected security interests regardless of the filing sequence. Sec. 9.312(c), (d). The district court found that Raytheon did not fall within the PMSI exception, that MBank had priority as the first to file, under Sec. 9.312(e)(1), and that DuPont takes second priority since it filed next. 2 9 Raytheon claims the district court erred by not recognizing its priority in the accounts receivable as a PMSI under Sec. 9.312(d). 3 Section 9.312(d) provides that [a] purchase money security interest in collateral other than inventory has priority over a conflicting security interest in the same collateral or its proceeds if the purchase money security interest is perfected at the time the debtor receives possession of the collateral or within 20 days thereafter. 10 As a threshold matter, Raytheon must establish that it meets the statutory definition of a PMSI. Raytheon contends that it fits the statutory requirements of a PMSI under Sec. 9.107(2), which provides: 11 A security interest is a purchase money security interest to the extent that it is 12 .... 13 (2) taken by a person who by making advances or incurring an obligation gives value to enable the debtor to acquire rights in or the use of collateral if such value is in fact so used. 14 To meet these requirements Raytheon must show: (1) that it gave value; (2) that the value given enabled Howe to acquire rights in the accounts receivable; and (3) that the accounts receivable qualify as collateral within the meaning of the statute. 15 The value requirement is satisfied by any consideration sufficient to support a simple contract. See Thet Mah and Assoc. v. First Bank of North Dakota, 336 N.W.2d 134, 138 (N.D.1983); Sec. 1.201(44)(D) (Vernon 1968). Assuming arguendo that Raytheon gave value by extending credit to Howe in exchange for Howe's promise to assign the accounts receivable to Raytheon, see Thet Mah, 336 N.W.2d at 138, Raytheon has failed to satisfy the other two requirements. 16 To create a PMSI, the value must be given in a manner that enables the debtor to acquire interest in the collateral. This is accomplished when a debtor uses an extension of credit or loan money to purchase a specific item. See Ingram v. Ozark Prod. Credit Assoc., 468 F.2d 564, 565 (5th Cir.1972); In re Dillon, 18 B.R. 252, 254 (Bkrtcy.E.D.Cal.1982) (PMSI lien attaches to item actually purchased); Jackson & Kronman, Secured Financing and Priorities Among Creditors, 88 Yale L.J. 1143, 1165 (1979) (PMSI priority limited to loans that can be traced to identifiable, discrete items of property.). 17 The collateral at issue here is the accounts receivable. In an attempt to force its interest into the PMSI mold, Raytheon has characterized the transaction as follows: Raytheon, by agreeing to extend credit on its equipment, enabled Howe X-Ray to enter into subsequent contracts of sale with its customers, thereby acquiring rights in the contract accounts which, upon the specific advance and delivery of equipment, blossomed into a right to the collateral accounts receivable. Raytheon, however, cannot force this transaction to fit. To accept this characterization, we would have to close our eyes to the true nature of the transaction. 18 Raytheon, in essence, is claiming that it advanced x-ray machines to Howe on credit, which then enabled Howe to purchase accounts receivable from its customers. This, however, does not comport with our view of commercial reality. While, as Raytheon suggests, it may be theoretically possible to create a PMSI in accounts receivable by advancing funds for their purchase, see Northwestern Nat'l Bank Southwest v. Lectro Systems, 262 N.W.2d 678, 680 (Minn.1977); Gilmore, The Purchase Money Priority, 76 Harv.L.Rev. 1333, 1372 (1963), the same cannot be done by advancing x-ray machines. We view this as a two-step transaction in which Raytheon first advanced machines to Howe for retail sale and, once these machines were sold, Howe then assigned the accounts receivable to Raytheon. Through the credit advance, Howe acquired an interest in the machines, not the accounts receivable. Raytheon's credit advance, therefore, did not enable Howe to acquire an interest in the accounts receivable, as collateral within the meaning of the statute. 19 Additionally, in its characterization of the transaction, Raytheon is attempting to benefit from the PMSI's preferred status in a manner that was not contemplated by the U.C.C. drafters. PMSIs provide an avenue for heavily burdened debtors to obtain credit for specific goods when creditors who have previously loaned money to the debtor may be unwilling to advance additional funds. Jackson & Kronman, Secured Financing and Priorities Among Creditors, 88 Yale L.J. 1143, 1145 & n. 9 (1979). By giving a PMSI holder a priority interest in the specific goods purchased, there is some incentive for a lender to advance funds or credit for the specific transaction. The scope of a PMSI holder's preferred interest, however, is specifically limited by the Code. 20 Under Sec. 9.312(c), a PMSI in inventory is limited to that inventory or to identifiable cash proceeds received on or before the delivery of the inventory to a buyer.... The drafters noted that general financing of an inventory business is based primarily on accounts resulting from inventory, chattel paper and other proceeds. Sec. 9.312, Official U.C.C. Reasons for 1972 Change comment (4). Reasoning that [a]ccounts financing is more important in the economy than the financing of the kinds of inventory that produce accounts, and [that] the desirable rule is one which makes accounts financing certain as to its legal position, id., they specifically excluded accounts resulting from the sale of inventory from the protections of a PMSI. Thus, financing statements that are filed on a debtor's accounts take precedence over any subsequent claim to accounts as proceeds of a PMSI in inventory. Additionally, to protect lenders who make periodic advances against incoming inventory, the PMSI holder is required to notify other secured parties before it can take priority. Sec. 9.312(c)(2); see id., 1972 Official U.C.C. Comment comment 3. 21 The priority scheme, however, differs in the context of collateral other than inventory. Under Sec. 9.312(d), a PMSI in collateral other than inventory entitles the holder to a superior interest in both the collateral and its proceeds regardless of any intervening accounts. The differing entitlement to proceeds is due to differences in the expectations of the parties with respect to the collateral involved. 22 Collateral other than inventory generally refers to equipment used in the course of business. See id., Official U.C.C. Reasons for 1972 Change comment (4); Gilmore, The Purchase Money Priority, 76 Harv.L.Rev. 1333, 1385 (1963). Since, unlike inventory, it is not ordinarily expected that the collateral will be sold and that proceeds will result, [the drafters found it] appropriate to give the party having a purchase money security interest in the original collateral an equivalent priority in its proceeds. Sec. 9.312, Official U.C.C. Reasons for 1972 Change comment (3). 23 Howe's business primarily involved the sale of inventory, which included the Raytheon x-ray machines. See Sec. 9.109(4). 4 The accounts receivable are proceeds resulting from the sale of the machines. MBank and DuPont took security interests in the accounts receivable, in accordance with their expectation that sale of the inventory would generate the accounts. If we were to accept Raytheon's argument that it holds a PMSI in Howe's accounts receivable, we would be giving Raytheon a priority interest in the proceeds of inventory, in direct contravention to the express intent of the drafters. Additionally, Raytheon would have successfully avoided the notice requirements of Sec. 9.312(c)(2). 24 Raytheon argues, however, that the policies underlying PMSIs actually favor recognizing Raytheon's priority interest in Howe's accounts. It points out that Howe could find no other source of financing besides Raytheon and that MBank and DuPont benefited by the financing arrangements because the extension of [credit] by Raytheon helped Howe X-ray stay in business thereby servicing its debts. Raytheon also contends that if the Code is interpreted to limit the security interests of creditors, such as Raytheon, to a mere promise of repayment and the grant of a PMSI in inventory, a valuable source of credit to similarly encumbered debtors would dry up. This is because the risk of default is too great in the face of prior liens on the debtor's accounts. 25 The Code itself, however, answers this argument. The drafters were apparently well aware that the failure to extend a PMSI holder's priority status to the resulting accounts would provide less incentive for inventory financiers to provide credit. See Sec. 9.312, 1972 Official U.C.C. Comment comment 8. Yet, they did not extend the protections of a PMSI and merely noted that [m]any parties financing inventory are quite content to protect their first security interest in the inventory itself, realizing that when inventory is sold, someone else will be financing the accounts and the priority for inventory will not run forward to the accounts. Id. The drafter's recognition of the problem and the statutory favoring of accounts financing demonstrate that the drafters were not overly concerned that this source of financing would dry up. 26 Additionally, Raytheon had alternative means of securing its right to receive payment. Besides obtaining a PMSI in the inventory by complying with the Sec. 9.312(c)(2) notice requirements, it could have entered subordination agreements with MBank and DuPont on the specific accounts resulting from the sale of Raytheon's x-ray machines. It also could have sold the machines to Howe's customers who would have paid Raytheon directly, with Howe receiving a commission on the sale. If Raytheon had followed either of these courses, it would not have subverted the notice and filing requirements of the Code. As this transaction goes beyond that contemplated by the PMSI provisions, we decline to expand the scope of special protection afforded a purchase money security interest, lest in so doing we defeat the underlying purposes of the Code: to bring predictability to commercial transactions. Mark Prod. U.S., Inc. v. Interfirst Bank Houston, N.A., 737 S.W.2d 389, 393 (Tex.App.--Houston [14th Dist.] 1987). 27 Since Raytheon did not have a PMSI in Howe's accounts receivable, the first-to-file priority rules govern. See Ford Motor Credit Co. v. First State Bank of Smithville, 679 S.W.2d 486, 487 (Tex.1984). As the last to file, Raytheon's interest is subordinate to those of MBank and DuPont.