Business Law and the Regulation of Business Chapter 38: Secured Transactions and Suretyship

1. Business Law and the Regulation of BusinessChapter 38: Secured Transactions and Suretyship By Richard A. Mann & Barry S. Roberts

2. Topics Covered in this Chapter I. Secured Transactions In Personal Property A. Essentials of Secured Transactions B. Classification of Collateral C. Attachment D. Perfection E. Priorities Among Competing Interests F. Default II. Suretyship A. Nature and Formation B. Rights of Surety C. Defenses of Surety and Principal Debtor

3. Secured Transactions in Personal Property • Definition of Secured Transaction – an agreement by which one party obtains a security interest in the personal property of another to secure the payment of a debt • Debtor – person who has an interest in the collateral other than a security interest; typically is the person obligated on the debt secured by the security interest • Secured Party – person in whose favor a security interest in the collateral is created or provided for under the security agreement

4. Secured Transactions in Personal Property • Collateral – property subject to a security interest • Security Agreement – agreement that creates or provides for a security interest • Security Interest – right in personal property that secures payment or performance of an obligation • Purchase Money Security Interest – security interest in goods purchased; interest is retained either by the seller of the goods or by a lender who advances the purchase price

5. Rights • Fundamental Rights of Debtor • – to redeem collateral by payment of the debt • – to possess general rights of ownership • Fundamental Rights of Secured Party • – to recover amount of debt • – to have collateral applied to payment of debt upon default

6. Classification of Collateral • Goods – things that are movable when a security interest attaches • Indispensable Paper • Intangibles

7. Types of Goods • Consumer Goods –bought or used primarily for personal, family, or household purposes • Farm Products –part of a farming operation including crops, livestock, or supplies used or produced in farming • Inventory –non-farm product goods (1) held for sale, lease, or to be furnished under a service contract, or (2) raw materials, work in process, or materials used in a business

8. Types of Goods • Equipment – goods not included in the definition of consumer goods, inventory, or farm products • Fixtures – goods that are so related to real property that they are considered part of the real estate • Accession – goods installed in or firmly affixed to personal property

9. Indispensable Paper • Chattel Paper – tangible or electronic record that evidences both a debt and a security interest in specific goods • Instruments – negotiable instruments or any other writing that evidences a right to payment of money that is transferable by delivery with any necessary indorsement • Documents – documents of title • Investment Property – investment security (stocks and bonds), security accounts, commodity contracts, and commodity accounts

10. Intangibles • Account – right to payment for (1) goods sold, leased, licensed, or otherwise disposed of or (2) services rendered. • General Intangibles – catch-all category; software, goodwill, literary rights, interests in patents, trademarks, and copyrights. • Proceeds– whatever is received upon sale, lease, license, exchange, or other disposition of collateral. • Deposit Accounts– a demand, savings, time, or similar account maintained with a bank.

11. Attachment • Definition – security interest that is enforceable against the debtor. • Value – consideration under contract law, a binding commitment to extend credit, or an antecedent debt. • Debtor's Rights in Collateral – a debtor is deemed to have rightsin personal property the debtor owns, possesses, is in the process of acquiring, or has the power to transfer rights to a secured party.

12. Security Agreement • An agreement between debtor and creditor creating a security interest: ­must be in a record authenticated by the debtor, unless, in the case of most types of collateral, the secured party has possession of the collateral, and ­must contain a reasonable description of.

13. Sample Security Agreement August 22, 1996 SECURITY AGREEMENT Daniel Debtor of 113 Hillsborough Street, City of Raleigh, County of Wake, State of North Carolina, hereinafter called the “Debtor,” does hereby grant to S.P. & Assoc., Inc., of Raleigh, North Carolina, hereinafter called “S.P.,” its successors and assigns, a security interest in the following described property, hereinafter called the “Collateral,” to-wit: One (1) Deluxe Personal Computer Serial number VDL16794321 Manufacturer: Apex Mechanical Equipment Co. Model 420Ato secure the payment of Debtor’s note or notes of even date herewith in the aggregate principal or aggregate face amount of Seven Thousand Five Hundred Dollars ($7,500.00), together with interest and any renewal or extension thereof, in whole or in part, and any and all other debts, obligations, and liabilities of any kind of Debtor to S.P., however created, arising, or evidenced, whether direct or indirect, joint or several, whether as maker, indorser, surety, guarantor or otherwise, whether now or hereafter existing, whether due or not due, and however acquired by S.P. (all hereinafter called the “Obligations”).

14. Sample Security Agreement (cont.) DEBTOR WARRANTS AND AGREES THAT: 1. Except for the security interest hereby granted, the Debtor will use the proceeds of advances made hereunder, which proceeds may be paid by the S.P. directly to the seller of the Collateral, to become the owner of marketable title to the Collateral free from any prior lien, security interest or encumbrance, and the Debtor will defend the Collateral against all claims and demands of all persons at any time claiming an interest therein. 2. The Collateral is and will be used primarily for personal, family, or household purposes, and the Debtor’s residence is that shown at the beginning of this Agreement. 3. The Collateral will be kept at the Debtor’s address shown at the beginning of this Agreement. 4. There are no financing statements covering any of the Collateral on file in any public office, and the Debtor has not executed in favor of other secured parties financing statements that could be placed on file prior to any of the S.P.’s financing statements

15. Sample Security Agreement (cont.) 5. DEBTOR AGREES THAT: A. He will pay to S.P. all amounts due on the note or notes mentioned above and the other Obligations secured hereby as and when same shall be due and payable, whether by maturity, acceleration, or otherwise, and will pay to S.P. reasonable attorney’s fees incurred by S.P. in collection of said Obligations or enforcement of this Security Agreement. B. He will maintain all mechanical equipment and machinery hereby covered in sound and efficient operating condition, including the procurement and installation of such new parts, attachments, and replacements as may be necessary or desirable to maintain said Collateral in proper operating condition. C. He will maintain such insurance upon all of the Collateral as S.P. may require, payable to Debtor and S.P. as their interest may appear, in an amount not less than the actual value of the Collateral.

16. Sample Security Agreement (cont.) D. He will pay all insurance premiums and taxes, licenses, or other charges assessed against the Collateral or required to be paid in connection with the use and ownership of the Collateral. If Debtor shall fail to pay such insurance premiums, taxes, licenses, or other charges when they are due, S.P., at its option, may pay the cost thereof, and the amounts so paid and advanced shall be added to the indebtedness secured hereby and shall bear interest at the maximum rate permitted by Law. E. He will not (a) permit any liens or security interest to attach to any of the Collateral; (b) permit any of the Collateral to be levied upon under any legal process; (c) sell or dispose of any of the Collateral without prior written consent of S.P.; (d) permit anything to be done that may impair the value of the Collateral or the security intended to be afforded by this Agreement. F. He will immediately notify S.P. in writing of any change of the Debtor’s place of residence, place or places of business, or the location of the Collateral. G. He will not remove the Collateral from the State of North Carolina without prior written consent by S.P.

17. Sample Security Agreement (cont.) 6. IT IS FURTHER AGREED THAT THE DEBTOR SHALL BE IN DEFAULT UNDER THIS AGREEMENT:A. If the Debtor uses any of the Collateral in violation of any statute or ordinance or the Debtor is found to have a record or reputation for violating the laws of the United States or any State relating to liquor or narcotics; or B. If the Debtor shall fail to perform any covenant or Agreement made by him herein; or C. If the Debtor shall fail to make due and punctual payment of any of the Obligations secured hereby when and as any part or all of such Obligation becomes due and payable; or D. If any warranty, representation, or statement made or furnished to S.P. by or on behalf of the Debtor in connection with this Agreement proves to have been false in any material respect when made or furnished; or E. If the Collateral suffers material damage or destruction; or F. If any bankruptcy or insolvency proceedings are commenced by or against the Debtor or any guarantor or surety for the Debtor; or

18. Sample Security Agreement (cont.) G. If the Debtor dies, becomes incompetent, is dissolved, or the Debtor’s existence otherwise terminates. Upon the happening of any of the above events of default or in the event that S.P., in good faith, deems itself insecure, S.P. may, at its option, declare all Obligations secured hereby due and payable immediately and have, in addition to other rights and remedies, the rights and remedies of a secured party upon default under the North Carolina Uniform Commercial Code. The waiver of any particular default of the Debtor hereunder shall not be a waiver of any other or subsequent default of the Debtor. Any requirement of the North Carolina Uniform Commercial Code of reasonable notification of time and place of public sale, or the time on or after which private sale may be held, may be met by sending written notice by registered or certified mail to the above address of the Debtor at least five (5) days prior to public sale or the date after which private sale may be made. The Debtor shall be and remain liable for any deficiency remaining after applying the proceeds of disposition of the Collateral first to the reasonable expenses of re-taking, holding, preparing for sale, selling, and the like, including the reasonable attorney’s fees, incurred by S.P. in connection therewith, and then to satisfaction of the Obligations secured hereby.

19. Sample Security Agreement (cont.) This Agreement and all rights, remedies, and duties hereunder, including matters of construction, shall be governed by the laws of North Carolina. This Agreement shall apply to, inure to the benefit of, and be binding upon the heirs, administrators, executors, and assigns of S.P. and the Debtor. This is the entire agreement of the parties, and no amendment, alteration, deletion, or addition hereto shall be effective and binding unless it is in writing and signed by the parties. Debtor acknowledges that this Agreement is and shall be effective upon execution by the Debtor and delivery hereof to S.P., and it shall not be necessary for S.P. to execute or otherwise signify its acceptance hereof. Signed and delivered on the day first above written. _________________________(SEAL) Daniel Debtor S.P. & Assoc., Inc. (Secured Party) By: __________________________

20. Perfection • Effect – enforceable against most third parties. • Automatic Perfection – perfection upon attachment; applies to a purchase money security interest in consumer goods and isolated assignments of accounts. • Temporary Perfection – a security interest in certificated securities, instruments, and negotiable documents is automatically perfected for twenty days.

21. Methods of Perfecting • Filing a Financing Statement – document filed to provide notice of a security interest; may be used for all collateral except deposit accounts, letter-of-credit rights, and money. • Possession – by the secured party (a pledge); may be used for goods, instruments, money, negotiable documents, tangible chattel paper, or certificated securities. • Control– may be use to perfect a security interest in electronic chattel paper, investment property, non-consumer deposit accounts, and letter-of-credit rights.

22. Methods of Perfecting Security Interests

23. I. Attachment II Perfection A. Agreement A. Files a financing statement, or 1. in writing (unless SP has possession), B. SP takes possession, or 2. providing a security interest, 3. in described collateral, C. Automatically, or 4. signed by debtor, D. Temporarily. B. Value given by secured party, and C. Debtor has rights in collateral. Requirements for Enforceability of Security Interests

24. Priorities among Secured Parties • Repossession– the secured party may take possession of the collateral on default without judicial process if it can be done without a breach of the peace. • Sale– the secured party may sell, lease, license or otherwise dispose of any collateral. • Acceptance– the secured party, unless the debtor objects, may retain the collateral in full or partial satisfaction of the obligation (with the exception of the compulsory disposition of some consumer goods).

25. Priorities

26. Suretyship -- Nature and Formation • Surety – a person who promises to answer for the payment of a debt or the performance of a duty owed to the creditor by the principal debtor, upon the principal debtor's failure to perform. • Principal Debtor – the party primarily liable on the obligation.

27. Suretyship Relationship C vs. PD:C’s rights under contractCollateral Principal Debtor Creditor S vs. PD:ExonerationReimbursementSubrogation C vs. S:C’s rights under contractCollateral Surety

28. Types of Sureties • Cosurety – each of two or more sureties who are liable for the same debt of the principal debtor. • Absolute Surety – surety liable to a creditor immediately upon the default of a principal debtor. • Conditional Guarantor of Collection – surety liable to a creditor only after the creditor has exhausted the legal remedies against the principal debtor.

29. Rights of Surety • Exoneration – the right to be relieved of his obligation to the creditor by having the principal debtor perform the obligation. • Reimbursement – the right to be repaid by the principal debtor. • Subrogation – the right of a surety who has paid the creditor to assume all the rights the creditor has against the principal debtor. • Contribution – the right to payment from each cosurety of his proportionate share of the amount paid to the creditor.

30. Fundamental Rights of Debtor and Secured Party money/credit (1) To redeem collateral by payment of debt (2) To possess general rights of ownership as limited by security agreement (1) To recover amount of debt (2) To have collateral applied to payment of the debt on default D SP security interest in collateral

31. Personal Defenses • … of Principal Debtor – incapacity, discharge in bankruptcy, and setoff. • … of Surety – incapacity, the statute of frauds, contract defenses to suretyship undertaking, setoff, modification of the contract between the creditor and the principal debtor, and the creditor's release of security or a cosurety. • … of Both Surety and Principal Debtor – include contract defenses to the contract between the creditor and the principal debtor.

32. Defenses of Surety & Principal Debtor PD’s incapacity PD’s discharge in bankruptcy PD’s setoff against C Forgery of PD’s signatureC’s fraud or duress on PDFraudulent and material alteration of contract Absence of mutual assent or consideration for PD’s contract C’s nonperformance of PD’s contract Illegality or impossibility of PD’s contract Payment or performance of PD’s obligationC’s release of PD unless C reserves his rights against S C’s refusal of tender Surety PrincipalDebtor S’s incapacity Statute of frauds Absence of mutual assent or consideration for S’s contract C’s fraud or duress on S Cosurety’s failure to sign contract S’s setoff against C Modification of contract between PD and C Extension of time unless C reserves rights against S Release of security Release of cosurety unless C reserves his rights against S