The Right to Proceeds Under Revised Article 9

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Dec/Jan 2000

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When a debtor disposes of the secured party's original collateral, current law protects the secured party in
two ways. In general, the security interest continues in the original collateral and can be enforced against
the new owner. See current §9-306(2).<a href="#1" name="1a">1</a> In addition, the security interest automatically extends to the
proceeds received as a result of the disposition. See current §9-306. Although revised Article 9 generally
continues both themes, it expands the definition of proceeds and thereby extends the reach of the secured
party's automatic security interest in such after-acquired property. This column reviews the basic
attachment rules for proceeds under revised Article 9. The perfection and priority rules for proceeds, as well
as the bankruptcy-specific implications of these rules, will be analyzed in future columns.

<h3>The Basic Rule</h3>

Section 9-315 of the revised act addresses the secured party's rights upon disposition of the collateral.
With several minor refinements, that section carries forward the rule under current law that, absent the
secured party's consent, the security interest continues in the original collateral notwithstanding its
disposition. Compare current §9-306(2) with §9-315(a)(1).<a href="#2" name="2a">2</a> The revised act adds the terms "lease" and
"license" to clarify that those types of transactions are dispositions covered by the rule. The revised act also
clarifies that the type of secured party consent required to cut off the lien is not mere consent to a
disposition, but rather consent to a "disposition free of the security interest."<a href="#3" name="3a">3</a> Interestingly, the revision does
not attempt to resolve the frequently litigated question of whether a consent that is conditioned upon the
secured party's receipt of the proceeds cuts off the lien. See §9-315, cmt. 2.

In addition to a continued security interest in the original collateral, the revised act also carries forward
the current rule that the security interest automatically extends to any "identifiable proceeds" of the original
collateral. See §9-203(f) and §9-315(a)(2). The attachment of the security interest to the proceeds is
automatic. §9-315(a)(2). There is no need to include language in the security agreement granting a security
interest in proceeds, nor is it necessary that the proceeds satisfy the description of collateral that is contained
in the security agreement.<a href="#4" name="4a">4</a> See §9-203(f). Note that, although the revised act includes "agricultural liens"
within its scope, the §9-315 proceeds rules do not apply to agricultural liens. See §9-315, cmt. 9. Thus, the
relevant state's non-UCC agricultural lien laws will determine whether the lien extends to proceeds.<a href="#5" name="5a">5</a>

The requirement that the proceeds be "identifiable" also has been clarified. Most courts interpreting current
law allow the secured party to use equitable tracing devices such as the "lowest intermediate balance rule"
to establish the identity of commingled proceeds,<a href="#6" name="6a">6</a> and the revised act expressly authorizes that practice.
See §9-315, cmt. 3. For cash proceeds and other non-goods proceeds, the proceeds are "identifiable" and
thus subject to the security interest "to the extent that the secured party identifies the proceeds by a method
of tracing, including application of equitable principles, that is permitted under" non-Article 9 law for
commingled property of that type. §9-315(b)(2). A different rule applies if the proceeds are goods that
become commingled with other goods such that their identity is lost in the product or mass. In such a case,
the "proceeds" security interest attaches to the entire product or mass. See §§9-315(b)(1) and 9-336(c).<a href="#7" name="7a">7</a>

Finally, the revised act makes clear that the security interest attaches to the proceeds of the collateral
even if those proceeds are not received by the debtor. See §9-102(64), cmt. 13(d). This resolves an
ambiguity in the language of current §9-306(2) that suggested the security interest was limited proceeds
received by the debtor. Thus, for example, if a transferee of the original collateral takes the collateral
subject to the security interest under §9-315(a)(1) and subsequently sells the collateral, the security
interest will attach to the proceeds of that sale under the revised act.

<h3>Expanded Definition of Proceeds</h3>

The most significant change in the proceeds rule is the expansion of the definition of proceeds. Current
law generally requires a "disposition" and limits proceeds to property that replaces the original collateral.
In contrast, the revised act expands the proceeds concept to include most property that is derived from the
original collateral. Compare current §9-306(1) with §9-102(64).

The revised act greatly expands the types of transactions that will be treated as "dispositions" that
generate proceeds. Under current law, it is unclear whether a lease or license involves a "disposition" and
whether rental and license fees qualify as proceeds. While the case law suggests that such "use" payments
are not proceeds,<a href="#8" name="8a">8</a> the Permanent Editorial Board takes the view that a lease does generate proceeds because
it involves the disposition of a partial interest in the collateral.<a href="#9" name="9a">9</a> The revised act resolves this question by
expressly including leases and licenses in the list of dispositions that generate proceeds. See §9-102(64)(A).
It is not clear how extensive these revisions are. Note that the Value-Added case involved funds generated
by the use of pay telephones. The Uniform Commercial Code (UCC) definition of "lease" seems broad
enough to cover such a short-term use. See §§9-102(b) and 2A-103(j). If so, then this provision may extend
the reach of the proceeds rule to funds generated by coin-operated devices.

Like current law, insurance payable by reason of loss or damage to the collateral is also proceeds. See
§9-102(64)(E). However, the revised act expands the insurance provision to include as proceeds insurance
payable by reason of nonconformity of the collateral, defects in the collateral or the infringement of rights
in the collateral. Although in most cases the secured party's right to proceeds is limited only by the amount
of its claim, the revised act limits the secured party's proceeds claim in insurance payments to the extent
of the value of the collateral. See §9-102(64)(E).

Collections on the collateral are included as proceeds under both the current law and the revised act. See
§9-102(64)(B) and current §9-306(1). However, the revised act expands the proceeds definition to also
include "whatever...is distributed on account of" the collateral.<a href="#10" name="10a">10</a> §9-102(64)(B). Thus, both dividends
payable on investment property collateral and collections or distributions on credit-support arrangements
("supporting obligations") are proceeds. See §9-102(64), cmt. 13(a) and (b). This change is designed to
reject the reasoning of <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. FDIC, 2 F.3d 1042, 1045 (10th Cir. 1993)</a>, which held that ordinary stock
dividends were not proceeds of the stock since there was no disposition of the stock. See §9-102(64), cmt.
13(a).

The shift away from a disposition requirement is most apparent in §9-102(64)(C), which expands the
definition of proceeds to include "rights arising out of collateral." Depending on how broadly the "arising
out of" language is construed, this provision could greatly expand the reach of the proceeds rule.
Unfortunately, the official comments do not discuss the meaning of this new provision.

Finally, the revised act extends the definition of proceeds to include various claims relating to the
collateral. See §9-102(64)(D). Thus, claims for nonconformity, defects in, damage to or the loss of the
collateral are proceeds.<a href="#11" name="11a">11</a> In addition, claims for interference with the use of the collateral or for
infringement of rights in the collateral are also proceeds. However, like the insurance provision, the
"claims" provision limits the secured party's proceeds security interest to the extent of the value of the
original collateral.

<h3>Enactment Update</h3>

With less than eight months remaining before the revised act's effective date, the outlook for uniform
national adoption is bleak. There has been no new enactment activity this fall. At present, only 27 states
plus the District of Columbia have adopted revised Article 9. The legislative sessions have ended in many
of the remaining states where revision bills were pending, and the revision bills will need to be reintroduced
when those legislatures reconvene.

<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> Note that the security interest, even if continued under §9-315, could be cut off by some other priority rule, such as the buyer
in the ordinary course provisions of §9-320(a). <a href="#2a">Return to article</a>

<a name="3">3</a> Although the language of the current statute is unclear, a Permanent Editorial Board comment to current §9-306(2) indicates
that current law also requires that the secured party consent to a "free-and-clear" sale. See PEB Commentary No. 3, §§9-306(2)
and 9-402(7) (March 10, 1990). <a href="#3a">Return to article</a>

<a name="4">4</a> By including appropriate after-acquired property language in the security agreement, the security interest could attach to both proceeds
and non-proceeds after-acquired property. The revised act continues the current law's broad validation of after-acquired property clauses. See

§9-204(a & b). However, unlike proceeds, the secured party's right to non-proceeds after-acquired property is dependent upon the
language of the security agreement. See §9-203. <a href="#4a">Return to article</a>

<a name="5">5</a> If the agricultural lien does extend to proceeds, the priority analysis can be rather complex. See §9-322, cmt. 12. If the
proceeds are themselves "farm products," then revised Article 9 will apply to the proceeds "agricultural lien" on those farm products. If,
however, the proceeds are not farm products, then non-UCC law may govern priority. See 9-333 (limited to possessory liens). <a href="#5a">Return to article</a>

<a name="6">6</a> Contra 2, Gilmore, "Security Interests in Personal Property," §27.4, at 736 (1965). <a href="#6a">Return to article</a>

<a name="7">7</a> If the security interest in the original collateral was perfected, the "proceeds" security interest in the product or mass will continue
to be perfected. See §§9-315(c), (d) and (e) and 9-336(d). However, special complex priority rules apply if there is a
competing perfected security interest in the product or mass. See §9-336(e) and (f). <a href="#7a">Return to article</a>

<a name="8">8</a> See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Value-Added Communications Inc., 139 F.3d 543 (5th Cir. 1998)</a> (coins for use of pay telephones
were not proceeds of the telephone because use is not a disposition). <a href="#8a">Return to article</a>

<a name="9">9</a> See PEB Commentary No. 9, §9-306(1) (June 25, 1992). <a href="#9a">Return to article</a>

<a name="10">10</a> This provision expands on the 1994 amendment to §9-306(1) that included in proceeds "payments or distributions made with respect
to investment property." However, the revised act does not limit the "distribution" proceeds provision to investment property collateral. <a href="#10a">Return to article</a>

<a name="11">11</a> Some cases under current law adopt the view that claims for damage to collateral are proceeds. See, e.g., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Combs, 968
F.2d 810, 828 (9th Cir.), cert. dismissed, 506 U.S. 948 (1992)</a>. <a href="#11a">Return to article</a>

Journal Authors

G. Ray Warner

Journal Date

Friday, December 1, 2000 - 12:00