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Purchase Money Security Interest in Inventory

36. What is the priority of a purchase-money security interest in inventory?

Special rules apply to purchase money security interests in inventory. In order to qualify for PMSI priority in inventory, the secured transaction must meet the following requirements:

•    Perfection at Time of Possession – The PMSI must have been perfected at the time the debtor takes possession of the inventory. This means the security agreement and value extended must have taken place prior to the receipt of the inventory.

⁃    Note: This can be temporary automatic perfection that is later extended by filing within the 20-day window. The key aspect is that the security agreement must have already attached.

•    Notice to Secured Parties – The secured party must provide authenticated notification to any holders of conflicting security interests in the debtor’s collateral prior to perfection. The holder of the conflicting security interest must receive the notice within 5 years prior to the debtor obtaining possession of the collateral.

⁃    Note: Lenders who finance the purchase of inventory often send blanket notices to secured creditors that they will be extending credit and perfect a security interest.

•    Description of PMSI Collateral – The notification to other secured parties must state that the creditor intends to take a PMSI in the debtor’s inventory and it must describe the inventory.

The UCC extends PMSI priority to identifiable proceeds from the sale of the collateral. The priority in cash is limited, however, if the cash is deposited in a deposit account.

•    Discussion: Why do you think the law requires additional notification procedures to claim a PMSI in inventory? Why do you think the law requires perfection at the time the debtor takes possession? Does this right detriment existing secured creditors? Why or why not?

•    Practice Question: ABC Corp is a lender that regularly finances inventory purchase for small businesses. ABC loans money to 123, LLC to purchase inventory. LLC has numerous creditors with perfected security interests in all of 123’s assets. What process must ABC follow if it intends to lend money to 123 to purchase inventory and wishes to perfect a purchase money security interest?

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