Real Estate Transactions Under Revised Article 9

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Jun 2000

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Current secured transactions law draws a distinction between real estate collateral and personal property
collateral. In general, Article 9 of the Uniform Commercial Code applies only to security interests in
personal property and fixtures, not liens on real property. See current §9-102(1)(a) and §9-104(b & j).<a href="#1" name="1a">1</a> In most respects, revised Article 9 generally continues this scheme, but with a few new twists.

The revised act makes several minor changes in the foreclosure rules governing fixtures and those involving
mixed collateral—i.e., where the obligation is secured by both real property and personalty. However, the
act's most significant real estate-related changes are in its treatment of transactions involving promissory
notes and other payment obligations that are secured by real estate mortgages.

The act's coverage has been extended to encompass not only security interests in real property secured
notes and payment obligations, but also outright transfers of such notes or obligations. The act provides new
perfection rules that make it easier to protect such transactions from avoidance by bankruptcy trustees.

<h3>Coverage of Real Estate-related Collateral</h3>

Although as a general rule Article 9 does not apply to transactions involving real property collateral,
the borderline between real property and personal property is not a precise one. Revised Article 9 generally
continues the current law's provisions regarding minerals, oil and gas, timber, growing crops and fixtures.

Like current law, revised Article 9 treats oil, gas and minerals before extraction as real property
collateral that is not subject to the act. However, if a debtor who has an interest in such assets prior to
extraction grants a security interest that will attach upon extraction, the revised Article 9 provisions do apply
to that transaction. The revised act creates a new defined category of collateral—"as-extracted collateral"—to
include both the as-extracted oil, gas and minerals and accounts arising from the sale of such oil, gas or
minerals at the wellhead or minehead. Unlike most other types of collateral, which are perfected by filing
a financing statement in the state of the debtor's location, financing statements covering as-extracted
collateral must be filed in the state where the wellhead or minehead is located. §9-301(4). Further, instead
of filing in the otherwise proper state office, such financing statements must be filed in the office where a
mortgage on the related real property would be filed. §9-501(a)(1)(A).

The revised act also continues the current law's treatment of standing timber. The timber is treated as
a "good" subject to Article 9 once it is to be cut and removed under a conveyance or contract for sale.
§9-102(44). A financing statement covering such standing timber must be filed in the office where a
mortgage on the related real property would be filed. §9-501(a)(1)(A). However, the instant the timber is
cut, it ceases to be "timber to be cut," and, in order to perfect a security interest in such cut timber, a
financing statement must be filed in the proper statewide office in the state of the debtor's location, which
may be a different state. See §9-301 & §9-501(a)(2).

Also continuing the current law's scheme, growing crops are treated as "goods" subject to revised
Article 9, even if they are produced on trees, vines or bushes. §9-102(44). The filing rules, however, have
been changed to eliminate the requirement of local filing in a county office. Under current law, a financing
statement covering crops would be filed in the state where the crops are growing, with many states
requiring that financing statements be filed both in the county where the debtor resides and the county
where the crops are growing. See current §9-401(1). Revised Article 9 dispenses with the requirement of
local filing at the county level and requires only a filing in the statewide filing office. In addition, for the
perfection of security interests, the filing must be made in the state where the debtor is located, not where
the crop is growing. §9-501(a)(2). However, if the filing is made to perfect a statutory agricultural lien
(which is now covered by Article 9), then the filing must be made in the state where the crops are located.
§9-302. Finally, current law requires a description of the land where the crop is growing in both the
financing statement and security agreement. See current §§9-203(1)(a) & 9-402(1). The revision eliminates
the land description requirement for crops in both the security agreement and financing statement. Compare

§§9-203(b)(3)(A) & 9-502(b).

The revised act clarifies the priority of a crop lender and an owner or mortgagee of the real property.
While current law turns on how the crops are treated under the state's real property law, revised Article 9
gives a perfected security interest in the crops' priority over the interests of an owner or mortgagee of real
property if the debtor is in possession of, or has an interest of record in, the real property. §9-334(i).

The revised act also generally continues the current law's treatment of fixtures. Like current law, revised
Article 9 makes no attempt to define "fixtures," deferring instead to the local real property law to determine
whether the goods have become sufficiently related to real property to be considered fixtures. §9-102(41).
Also like current law, a security interest in fixtures may be perfected by a regular filing as to the goods or
by a "fixture filing." See §9-501(a)(1)(B) & (a)(2). A "fixture filing" must be filed in the office where a
mortgage on the related real property would be filed, whereas the regular filing would be in the statewide
filing office of the state where the debtor is located. See §9-301(1) & (3)(A).

Generally a fixture filing is necessary in order to obtain priority over an owner or encumbrancer of the
real property. However, a regular filing will give priority over a subsequent conflicting interest or lien on
the real property that was obtained through a legal or equitable proceeding. §9-334(3). Thus, either type
of filing will protect a security interest in fixtures from avoidance by a bankruptcy trustee under §544(a)
of the Bankruptcy Code. See §9-334, cmt. 9. In addition, a regular filing will give the fixture security
interest priority over an owner or encumbrancer of the real property if the fixtures are readily removable
factory or office machines, replacements of consumer goods domestic appliances, or equipment that is not
primarily used in the operation of real property. §9-334(2). That provision addresses the problems created
by the difficulty of determining whether such items are fixtures and provides protection to creditors that
mistakenly treat them as regular goods. The revision generally continues the existing priority rules for
fixture filings, except that the 10-day grace period for filing a fixture filing to perfect a purchase money
security interest in fixtures has been extended to 20 days from the date the goods become fixtures.
§9-334(d).

The revision provides new special rules for "manufactured homes." Manufactured homes are included
within the definition of goods and covered by Article 9, even when erected on a permanent foundation.
§9-102(44 & 53). Most importantly, if a security interest in a "manufactured-home transaction"<a href="#2" name="2a">2</a> is
perfected under a relevant certificate of title statute, it generally has priority over a conflicting interest of
an owner or encumbrancer of the real property, even though no fixture filing was made. §9-334(e)(4).
Further, a financing statement covering a manufactured-home transaction can be made effective for 30
years, instead of the usual five years. §9-515(b).

Finally, the revision clarifies the foreclosure rights of a secured party in fixtures collateral. Under current
law, some courts have held that the secured party's only right is to remove the fixtures.<a href="#3" name="3a">3</a> The revised act
continues this removal right, but also clarifies that the secured party may foreclose under either Article 9
or the relevant real property law. §9-604(b & c).

<h3>Real Estate Secured Obligations</h3>

Like current law, Article 9 applies to a security interest in a secured obligation even though the
obligation is itself secured by a transaction to which Article 9 does not apply. §9-109(b). In addition,
revised Article 9's scope has been expanded to also include outright sales of payment intangibles and
promissory notes. §9-109(a)(3). The net effect of these provisions is to bring within Article 9 both security
interests in and outright sales of promissory notes and other payment obligations that are secured by real
property mortgages.<a href="#4" name="4a">4</a>

Although such sales are now included within Article 9, the buyer need not take any action to perfect
its interest against a trustee in bankruptcy. Sections 9-309 (3 & 4) provide that a sale of a payment
intangible or promissory note is perfected automatically upon attachment. Automatic perfection is not
available if the transaction is a security interest in a payment intangible or promissory note. However,
revised Article 9 now permits a security interest in instruments (promissory notes) to be perfected by filing
a financing statement, whereas current law requires the secured party to take possession of the instrument.
Compare §9-312(a) with current §9-304(1). Since security interests in both payment intangibles and
promissory notes can be perfected by filing, the safe practice will be to file in all cases so that the interest
will be protected from bankruptcy attack, even if a sale is recharacterized as a security interest.

With respect to instruments, however, perfection by filing will not protect the buyer or secured party
from a later buyer or secured creditor who gives value and takes possession of the instrument in good faith
and without knowledge that the purchase or lien violates the rights of the original buyer or secured party.
§9-330(d). Thus, it is still necessary to perfect by possession in order to receive full protection of an interest
in instruments.

The revised act also resolves the question under current law of whether perfection in the promissory
note or obligation also perfects the secured party's rights in the underlying mortgage that secures the
payment obligation. Codifying the rule that the mortgage follows the note, the revised act provides that
attachment of the security interest in the promissory note or other payment obligation automatically causes
the security interest to attach to the "supporting obligation," i.e., the mortgage. §9-203(g). In addition,
perfection of the security interest in the obligation automatically perfects the security interest in the
supporting obligation. §9-308(e). Thus, it is not necessary for the buyer or secured party to record a
mortgage assignment in the real property records in order to perfect its interest in the mortgage and defeat
a bankruptcy trustee, lien creditor or subsequent assignee of the mortgage. However, notwithstanding the
revision, failure to record the assignment in the real property records would expose the secured creditor to
the risk that the original mortgagee may record a fraudulent deed of release, which a bona fide purchaser
could rely on to take free of the mortgage.

<h3>Foreclosure of Real Estate-related Security Interests</h3>

In cases where the security agreement covers both real property and personal property, the revised act
gives the creditor the choice of proceeding against the personal property either under Article 9 or under real
property law. §9-604(a). Thus, if the secured creditor chooses, it can foreclose against both the real property
and personal property under real property law without being subject to the UCC foreclosure rules.
Alternatively, it can proceed against the personalty under the UCC rules without prejudicing its rights with
respect to the real property.

Perhaps more importantly, the revised act adopts the "rebuttable presumption" rule for dealing with sales
that do not comply with Article 9 in the non-consumer context. §9-626(a). In states where the "absolute
bar" rule is applied, the choice to use the UCC foreclosure process for personalty carried with it the risk that
the entire debt and the rights against the real property would be eliminated if the UCC sale was defective.
The revised act eliminates this deterrent to UCC sales in the non-consumer context.

Finally, upon default, a secured party holding a security interest in an obligation secured by a real
property mortgage has the right to enforce the mortgage. §9-607(a)(3). However, if the assignment of the
mortgage was not recorded in the real property records, the secured party will not be the mortgagee of
record and may not be able to foreclose if the original mortgagee is unwilling to sign a recordable
assignment. Section 9-607(b) solves this problem by giving the secured party the power to become the
assignee of record by recording the security agreement and an affidavit certifying default.

<h3>Enactment Update</h3>

Since last month's column, there has been a lot of legislative activity involving the revision of Article
9. Five new states have enacted the revision: Iowa, Kentucky, Maine, Minnesota and Virginia. In addition,
the act is awaiting the governor's signature in five other states: Alaska, Hawaii, Illinois, Kansas and
Vermont. No new states have introduced legislation to adopt revised Article 9. Thus, a total of 22 states
have passed or enacted revision bills, and 14 additional states have pending bills.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> All citations are to the revised 1999 version of Article 9 of the Uniform Commercial Code, unless otherwise indicated. Citations
to the currently applicable 1972 version of Article 9 are indicated by the term "current." <a href="#1a">Return to article</a>

<a name="2">2</a> A "manufactured-home transaction" means either a purchase money security interest in a non-inventory manufactured home or a secured transaction
where the primary collateral is a non-inventory manufactured home. §9-102(54). <a href="#2a">Return to article</a>

<a name="3">3</a> For a more detailed discussion of foreclosure rights, see <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, Rodney, "Revised Article 9 and Real Estate Foreclosures," 12 Prob. & Prop. 40, 45 (Sept./Oct. 1998)</a>. <a href="#3a">Return to article</a>

<a name="4">4</a> For a more detailed discussion of these transactions, see Whitman, Dale, "Transfers of Mortgage Notes under New Article 9," <a href="http://cctr.umkc.edu/dept/dirt/files/newart9i.htm" target="window2">http://cctr.umkc.edu/dept/dirt/files/newart9i.htm</a>. <a href="#4a">Return to article</a>

Journal Authors

G. Ray Warner

Journal Date

Thursday, June 1, 2000 - 12:00