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Perfection and Priority of a Security Interest

25. What role does perfection play in establishing the priority of a secured party?

A secured creditor must perfect her security interest to establish the priority of her security interest with relation to all other creditors. The first secure party to perfect a security interest in the collateral generally gives her priority above any other creditors who later attempt to establish a security interest in the collateral. In turn, failing to perfect a security interest allows a later creditor who perfects her security interest in the collateral to receive priority over the unperfected security interest. Most notably, an unperfected security interest is subordinate (lower priority) to certain lien creditors or a trustee in the event of bankruptcy. In short, perfecting a security interest is essential to ensure maintenance of the benefits of the security interest.

•    Note: There are limited situations that allow a secured creditor to receive priority over an earlier secured creditor. This generally arises in the event of the debtor’s bankruptcy. When a secured creditor is willing to extend new credit to the debtor in exchange for higher priority of her claim against the debtor.

•    Discussion: How do you feel about the first creditor to perfect a security interest receiving priority in collateral? Is this unfair to earlier secured creditors who failed to appropriately perfect her security interest? Why or why not?

•    Practice Question: Ester sells a piece of equipment to Sandra. At the time of the sale, Sandra has an outstanding loan to First Bank. The loan agreement with First Bank includes a security agreement covering all of Sandra’s property. It also contains an after-acquired property clause. Sandra also has several unsecured loans outstanding. Ester files a financing statement covering the equipment that she sells to Sandra. Who has priority in the equipment? Do things change if Sandra files for bankruptcy?

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