KANSAS COMMENT, 1996

This section, which does not vary from the 1995 Official Text, governs priority battles among conflicting security interests in the same collateral, just as 84-9-201 governs the rights of secured creditors and 84-9-301 governs the rights of mere secured creditors as lien creditors and buyers of the collateral. Other sections in Part 3 of Article 9 govern the rights of secured creditors as against purchasers.

The basic rule is laid down in 84-9-312(5), namely, that for perfected secured parties, the first to be perfected is the first in right, whether by filing or by possession, as long as there is no gap in the perfection. For mere secured party versus mere secured party, the rule again is "first in time is first in right," as long as neither is perfected.

Subsection (1). This subsection merely cross references other rules in the UCC which govern priorities involving Article 9 security interests.

Subsection (2). This subsection creates a limited exception to the first in time rule and is a variation of the purchase money theme. It gives priority to a crop production lender over an earlier perfected security interest covering the crops, but only in very limited situations. To qualify for the priority, the production claimant must meet all of the following criteria: (1) he must give new value, in the form of a loan or credit sale; (2) the purpose of the new value must be to enable the farmer to produce the crops during the current production season; (3) the value must be given not more than three months before the crops are planted; and (4) obligations owing to the earlier secured party (such as a lender with an after-acquired property clause covering crops, a real estate lessor or a real estate mortgagee with a crop provision in the mortgage) must have been due more than six months before the crops were planted. The biggest problem for the crop production lender is that the purchase money priority will not come into play, as against a prior lessor or mortgagee of the farm who has a security interest in after-acquired crops, to the extent that the farmer has defaulted in the last six months. If the mortgage has an acceleration clause that is exercised within the six-month period, the production lender is out of luck. In other words, the purchase money security interest is entitled to priority only over obligations more than six months overdue at the time the crops are planted. For a good case which illustrates the very limited utility of this subsection for the short-term production lender, see United States v. Minster Farmers Coop. Exchange, 430 F. Supp. 566 (N.D. Ohio 1977).

Subsection (3). This subsection establishes a special priority rule for purchase money security interests in inventory. If the four hoops are jumped through, the purchase money security interest will prevail over a previously filed financing statement covering "all inventory," as to the inventory financed by the purchase money secured party. If the hoops are not jumped through, the prior filer will have priority under the "first to file" rule of subsection (5). The definition of purchase money security interest is set forth in 84-9-107, and includes both suppliers of inventory and third-party financiers whose loan enables a debtor to purchase the inventory from a supplier.

In order to gain priority under this subsection, the purchase money lender must jump through four hoops: (1) the purchase money security interest must be perfected (normally by an executed security agreement and filing) by the time the debtor receives possession of the inventory, and not one second later; (2) the supplier or third-party purchase money lender must give notification in writing to any competing security interest which has been previously filed; (3) the holder of the competing interest must receive the written notification within the five year period before the debtor receives possession of the inventory (i.e., the purchase money creditor must renew the notification every five years); and (4) the notification must state that the purchase money creditor "has or expects to acquire a purchase money security interest in inventory of the debtor, describing such inventory by item or type." As to this last hoop, for example, a purchase money supplier of computers could describe the goods generally as "computers." As to the first hoop, the only safe approach for the purchase money creditor is to have the security agreement executed and file the financing statement before the first delivery of inventory. If the purchase money secured party is the seller, the selling of the computers on credit and debtor's receipt of them will meet the value and the debtor's rights in the collateral requirements of 84-9-203(b) and (c). If the purchase money secured party is a financier and not the seller, the value is the financier's payment to the seller, and the debtor's rights in the collateral is the receipt of the collateral. See Kansas Comment 1996 to 84-9-107. One notification every five years is sufficient, even if the inventory is delivered in installments. For the leading decisions construing the requirements imposed by the four hoops, see Fedders Financial Corp. v. Chiarelli Bros., 289 A.2d 169 (Pa. Super. 1972) and King's Appliance & Electronics, Inc. v. Citizens & Southern Bank of Dublin, 30 U.C.C. Rep. 1738 (Ga. App. 1981). Finally, it should be mentioned that consignment sellers must jump through exactly the same hoops as traditional purchase money inventory financiers. See 84-9-114 and Kansas Comment 1996 thereto.

The purchase money priority covering inventory does not extend to all proceeds generated by the sale of that inventory. It does cover identifiable cash ("money, checks, deposit accounts and the like," 84-9-306(1)) proceeds received by the dealer on or before delivery of the inventory to a buyer (roughly equivalent to down payments), but it does not extend to trade-ins, accounts receivable or chattel paper generated by the sale of inventory. As to the latter proceeds, an earlier filing for inventory, accounts or chattel paper would have priority to the accounts under the first-to-file rule of subsection (5). Of course the inventory financier would retain its purchase money priority with respect to its inventory still on hand.

Subsection (4). This subsection establishes a superpriority for purchase money security interests in collateral other than inventory, e.g., farm products and equipment. If the purchase money lender wants priority over a prior-filed financing statement covering the collateral under an after-acquired property clause, several hoops must be jumped through, but these hoops are not as difficult as those governing inventory under the previous subsection, and there is an unlimited claim to proceeds. Most important, notification need not be given to competing financiers who have already filed. Instead, the purchase money creditor need only be sure that its security interest is perfected (normally by filing) within twenty days after the debtor receives possession of the collateral. For example, if Bank X has a prior-filed financing statement covering "all equipment of the debtor, now owned or hereafter acquired" and a supplier of new equipment later retains a purchase money interest to secure the price, the supplier will have priority if it properly files a financing statement (e.g., with the secretary of state in Topeka) within twenty days after delivering the equipment to the debtor. If the purchase money filing is not accomplished until the thirtieth day, Bank X will have priority under the first-to-file rule of subsection (5).

The purchase money priority established in this subsection extends not only to the original collateral, but to all proceeds received by the debtor from later disposition of the collateral. One difficult issue is when the "debtor receives possession" for purposes of the twenty-day grace period. In particular, when does the twenty days begin to run if the equipment is bought on approval, or under a lease with a purchase option which is not exercised until some time later? The weight of authority, and the better rule, is that the grace period does not begin to run until the buyer on approval or lessee makes a decision to purchase the equipment outright. See Rainier Nat'l Bank v. Inland Machinery Co., 631 P.2d 389 (Wash. App. 1981); In re Prior Bros., Inc., 632 P.2d 522 (Wash. App. 1981); Brodie Hotel Supply, Inc. v. United States, 431 F.2d 1316 (9th Cir. 1970); In re Ultra Precision Industries, Inc., 503 F.2d 414 (9th Cir. 1974); contra: James Talcott, Inc. v. Associates Capital Co., 491 F.2d 879 (6th Cir. 1974).

Subsection (5). This subsection sets forth the basic residual priority rule to be applied when subsections (2), (3) and (4) are not applicable: As between conflicting security interests, the winner is the first to file or perfect, whichever occurs first. Since this subsection is residuary, a secured creditor who fails to qualify for a superpriority under the prior three subsections will be governed by this subsection, as will all other secured party versus secured party priority contests. The first-to-file-or-perfect rule is based upon the "pure race" concept; knowledge is irrelevant. For example, if X makes a $5000 secured loan to the debtor but fails to file a financing statement, then Y makes a $7000 loan against the same collateral knowing full well that X has an unperfected security interest, then X files, Y would have priority under this subsection. The policy behind the "pure race" concept is the need for certainty in relying upon the public records. The only time actual knowledge could affect priorities is under 84-9-401(2), which provides that a filing made in good faith in an improper place is effective against any person who has actual knowledge of the contents of the financing statement. See Kansas Comment 1996 to that provision.

If both secured parties have perfected by filing, and no superpriority is in the picture, the first to file will prevail. For example, if X makes a $15,000 loan to the debtor and properly files, then Y makes a $20,000 loan to the debtor and properly files, and the collateral only brings $15,000 at foreclosure, Y is out of luck, and will be treated as a general creditor. Before Y made its loan, it could have checked the files and found X's prior financing statement; then Y could have refused to make the loan, obtained other collateral, have entered into a total or partial subordination agreement with X under 84-9-316, or taken over all the financing and forced X to file a termination statement under 84-9-404 or an assignment under 89-9-405. X would also prevail over Y to the extent of the debt to X at the time of default even if X had not made any loan when its financing statement was filed, and did not loan any money to the debtor until long after Y had made its loan.

If Y made the first loan, then X made a loan under an optional future advances clause, or pursuant to a new security agreement, X's priority would relate back to its earlier filing; it would make no difference that Y made a loan first, so that its security interest was first perfected. The leading Kansas case on this point is Allis-Chalmers Credit Corp. v. Cheney Investment, Inc., 227 K. 4, 605 P.2d 525 (1980). In that case, the debtor executed a security agreement in favor of A, A loaned funds to the debtor and properly filed a financing statement, B loaned funds to the debtor and filed against the same collateral, then A made subsequent advances under new security agreements not contemplated by the original security agreement. The Kansas supreme court held that A had priority with respect to all advances under the first-to-file-or-perfect rule of this subsection. B was left out in the cold. The court emphasized the "pure race" philosophy of the subsection, which is reinforced by subsection (7) and Example 5 in Official Comment 7 to 84-9-312 (even though the Cheney Investment case involved facts which predated the adoption of subsection (7) in Kansas as part of the 1972 Official Text). The Cheney Investment case is a classic example of the first-to-file-or-perfect rule, and it illustrates the wisdom of filing as soon as possible in order to establish priority over competing security interests. Later lenders should check the files and use the procedure laid out in 84-9-208 to protect themselves.

To vary the facts somewhat, suppose that Bank A files a financing statement but does not then make a loan to the debtor. Bank B then makes a loan and takes possession of the collateral instead of filing a financing statement. Then Bank A makes a loan, relying for priority on its previously filed financing statement. Since both creditors did not perfect by filing, but A filed before B perfected (by possession), A would have priority. B should have checked the files before making the loan. If Bank B had taken possession before Bank A filed, B would win. Finally, if neither creditor perfects at the time the credit is extended, the first to perfect will win. For example, assume that Dad's Finance Company loans money to Joe, taking household goods as collateral. The next day Mother's Finance Company makes a loan to Joe, taking the same household goods as collateral. Neither Dad's nor Mother's ever perfects its interest by filing. Two months later, Mother's repossesses the collateral upon Joe's default, and with Joe's consent (see 84-9-203(a)). In this case, Mother's would have priority because it was the first to perfect (by taking possession, as allowed by 84-9-305).

A Tenth Circuit decision applying Kansas law under this subsection is Transport Equipment Co. v. Guaranty State Bank, 518 F.2d 377 (10th Cir. 1975). In that case, a supplier sold inventory to the debtor on open account. Sensing the debtor's imminent collapse, the supplier then took a written security agreement and filed a financing statement at 1:57 a.m. on March 22. A bank which had made an earlier unsecured loan to the debtor filed a financing statement in January but never got the debtor to execute a security agreement. When the debtor defaulted, the bank repossessed the inventory at 3:24 a.m. on March 22. The bank argued that the first-to-file rule of this subsection gave it priority since its financing statement was filed before that of the supplier, even though the bank's security interest did not "attach" (by repossession of the collateral) and was thus not perfected until March 22.

The Tenth Circuit gave priority to the supplier as the first to perfect, concluding that the bank could not date its priority from its earlier filing. If the bank had obtained a written security agreement prior to repossession, the result would have been otherwise. Even though the court's reasoning may be open to question, the result seems sound. Since the bank had no written security agreement, its security interest had never "attached" and was thus not enforceable against the debtor. Therefore, the repossession as an event to trigger relation-back to the earlier financing statement should have had no effect. In short, the supplier was arguably the first to perfect because it was the only party to perfect. Moreover, although the court's approach in Transport Equipment somewhat waters down the "first to file or perfect rule" of this subsection, the Kansas supreme court appears to resurrect it in full force in the Cheney Investment case.

Pre-UCC Kansas law governing chattel mortgages and conditional sales contracts did not follow the "pure race" concept of this subsection. Former K.S.A. 58-301 and 58-314. However, former K.S.A. 58-804 established a rule for assignments of accounts receivable comparable to the rule of this subsection, since an assignee took priority over another assignee who filed later than he did, regardless of the relative dates of their assignments. Under former K.S.A. 58-804, an assignee also took subject to prior assignments of which he had written notice.

Revisor's Note:

Former section 84-9-312 was repealed by L. 2000, ch. 142, § 155 and the number reassigned to the current text.

Law Review and Bar Journal References:

Applicability to certain conflicting security interests discussed, Charles H. Oldfather, 14 K.L.R. 571, 582, 583, 584, 586, 587, 588, 589, 590 (1966).

"Official UCC Comment" and section mentioned in discussing priority of crop loans, Van Smith, 35 J.B.A.K. 299, 301, 302 (1966).

"The New UCC Article 9 Amendments," Barkley Clark, 44 J.B.A.K. 131, 169 (1975).

"Changes in Article Nine of the Kansas Commercial Code," Alan Tipton, 15 W.L.J. 212, 216, 217, 219 (1976).

Tenth Circuit survey on Contracts, U.C.C. and U.C.C.C., Martin R. Ufford, 15 W.L.J. 541, 545 (1976).

"Right of Secured Party to Recover Proceeds Commingled in Debtor's Bank Account," Kristen D. Balloun, 28 K.L.R. 325, 338 (1980).

"Secured Transactions: The Priority of Future Advances," Jennifer A. Strus, 21 W.L.J. 717, 718, 723 (1982).

"Survey of Kansas Law: Secured Transactions," J. Eugene Balloun, 32 K.L.R. 351, 361, 366 (1984).

"Agricultural Credit and The Uniform Commercial Code: A Need for Change?" Keith G. Meyer, 34 K.L.R. 469, 476, 477, 478 (1986).

"Is the Agricultural Security Interest Legally Healthy?" David A. Lander, 34 K.L.R. 505, 510 (1986).

"Bank's Right of Setoff—Iola State Bank v. Bolan," SueAnn S. Bradford, 33 K.L.R. 569, 580 (1985).

"Clear Title: A Buyer's Bonus, A Lender's Loss—Repeal of UCC § 9-307(1) Farm Products Exception by Food Security Act § 1324 [7 U.S.C. § 1631]," Mark V. Bodine, 26 W.L.J. 71, 84, 86 (1986).

"Revised Article 9 in Kansas," Hon. John K. Pearson, 51 K.L.R. 769, 779, 811, 863 (2003).

"A Brief Overview of Revised Article 9 in Kansas," John K. Pearson and J. Scott Pohl, 72 J.K.B.A. No. 8, 22 (2003).

Attorney General's Opinions:

Banking code; dissolution; insolvency; receiver in charge of assets; distribution. 85-112.

CASE ANNOTATIONS

1. Subsection (5) (a) discussed; financing statement failed to satisfy statutory requirements; security interest not perfected until bank took actual possession. Transport Equipment Co. v. Guaranty State Bank, 518 F.2d 377, 382.

2. Referred to; interest of holder of perfected security interest superior to interest of judgment creditor although failure to file financing statement within 10 days. Blair Milling & Elevator Co., Inc. v. Wehrkamp, 217 Kan. 122, 126, 535 P.2d 457.

3. Subsection (5)(a) discussed and applied; financing statement covers future advances under later security agreements whether or not contemplated by original security agreement. Allis-Chalmers Cred. Corp. v. Cheney Investment, Inc., 227 Kan. 4, 7, 8, 11, 12, 605 P.2d 525.

4. Subsection (5) discussed; protection of future advances had by including an after-acquired property and future advance clause in original security agreement (dissenting opinion). Allis-Chalmers Cred. Corp. v. Cheney Investment, Inc., 227 Kan. 4, 14, 605 P.2d 525.

5. Credit company's perfected purchase money security interest in vehicles has priority over bank's security interest; vehicles not sold to a buyer in ordinary course of business. First National Bank and Trust Co. v. Ford Motor Credit Co., 231 Kan. 431, 434, 646 P.2d 1057 (1982).

6. If properly employed, UCC protects unpaid sellers in variety of ways; mere knowledge that goods unpaid for does not invalidate otherwise legitimate security interest. Holiday Rambler Corp. v. First Nat. Bank and Trust, 723 F.2d 1449, 1453 (1983).

7. Severed crops are farm products, not "growing crops"; if in farm debtor's possession, financing statement needs no property description. In re Roberts, 38 B.R. 128, 129, 132 (1984).

8. Cited; lease-purchase agreement under economic development revenue bond act (K.S.A. 12-1740 et seq.) not complete sale; filing requirements inapplicable. In re Petition of City of Moran, 238 Kan. 513, 519, 522, 713 P.2d 451 (1986).

9. Statute is "pure race" type statute; secured creditor to first file has priority regardless of knowledge. J. I. Case Credit Corp. v. Foos, 11 Kan. App. 2d 185, 189, 717 P.2d 1064 (1986).

10. Cited; bank's prior interest in crops not diminished by lease between debtor and third party. First Nat'l Bank v. Milford, 239 Kan. 151, 155, 718 P.2d 1291 (1986).

11. Cited; action for failing to disclose existence of prior security interest, statute of limitations examined. Borg Warner Acceptance Corp. v. Kansas Secretary of State, 240 Kan. 598, 605, 731 P.2d 301 (1987).

12. Crop production lender's priority over prior perfected secured creditor under certain circumstances determined. In re Cress, 89 B.R. 163 (1988).

13. Purchase money security interest perfected holder who fails to satisfy (3) retains priority over later-filed security interests. In Re Mobile Travelers, Inc., 117 B.R. 651, 655 (1990).

14. No conflict exists between unenforceable security interest and perfected security interest. Garst Seed Co. v. Wilson, 17 Kan. App. 2d 130, 133, 833 P.2d 138 (1992).

15. Cited in holding good faith misfiling exception in K.S.A. 84-9-401(2) applies to improperly perfected purchase money security regardless when prior interests acquired knowledge. Community Nat'l Bank v. Moyer, 17 Kan. App. 2d 218, 220, 836 P.2d 1198 (1992).

16. Purchase money security interest fails because of lack of proper notification to existing security interests. Guaranty State Bank & Trust Co. v. Van Drist Supply Co., 30 Kan. App. 2d 1108, 55 P.3d 357 (2002).