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Priority of a Secured Party vs a Buyer of Collateral

28. What is the “priority of buyers of collateral” that is subject to a security interest?

Generally, a buyer of collateral subject to a security interest takes the property subject to that security interest. That is, if a debtor sells collateral that is subject to a security interest, the security interest continues in the collateral following the sale to the buyer. This is true for validly perfected security interests or if the buyer knows about the security interest at the time of purchase. If the security interest remains with the collateral, this means that the secured party can repossess the subject collateral in the event of default on the original loan or obligation.

•    Note: Repossessing goods from the purchaser of collateral subject to a security interest may require bringing a conversion action against the debtor in possession of the collateral.

The following exceptions apply to this rule:

•    Authorization of Secured Party – A primary exception to this rule is when the secured party authorizes the sale. A secured party’s failure to object to the sale of the collateral may constitute authorization. Also, allowing prior sales of collateral without objecting may constitute an implied agreement authorizing the debtor to sell the collateral.

•    Buyers in the Ordinary Course of Business – A “buyer in the ordinary course of business” (BOCB) takes collateral free of any security interests created by the seller. This is true whether the security interest is perfected or no.

•    Consumers Purchasing Consumer Goods from Other Consumers – A purchaser of consumer goods from another consumer may take the goods free of an existing security interest. Two provisions protect consumers in this situation, UCC § 9-320(b) and the “Shelter Principle”.

Each of the above rules protecting purchasers of collateral subject to a security interest is explained below.

•    Discussion: How do you feel about the principle that a purchaser of collateral subject to a security interest takes the goods subject to the security interest? Do you think the above-referenced exceptions to this rule are necessary? Why or why not? Are they adequate?

•    Practice Question: Mark purchases a piece of equipment from Iris. Mark has become concerned that the equipment was subject to a security interest when Iris sold it to him. What information will you need to know to determine whether Mark’s equipment is still subject to the security interest?

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