26. What are the common types of conflicts regarding the priority of security interests?
The following types of security interest are often in conflict:
• Lien Creditors vs. Security Interest – A lien creditor who establishes an interest in a debtor’s property prior to perfection by another secured party has priority over that secured party. Depending upon the type of lien, a lien creditor may have priority in collateral above a perfected secured party. This is true for “possessory liens” but not “non-possessory liens”.
⁃ Example: Fay holds a perfected security interest in an antique piece of furniture that John owns. Don performs restoration work on John’s furniture. If John does not pay for the work, Don may retain possession of the furniture pursuant to a possessory lien. This lien has priority over Fay’s perfected security interest.
• Buyers of Collateral vs. Security Interest – Generally, buyers who take possession of the collateral in many situation take the collateral subject to a perfected security interest. Two notable exceptions arise when 1) the collateral is a consumer good for personal use being sold to another consumer for personal use, and 2) when the collateral is inventory for the debtor. In either situation, a buyer of collateral subject to a security interest generally takes the collateral free of a security interest if the collateral is inventory for the seller or the security interest has not been perfected.
⁃ Note: A purchaser of goods subject to an unperfected security interest takes the goods free of the security interest only if the purchaser is unaware of the existence of the security interest.
⁃ Example: Hazel owns a small store. Gail holds a security interest in all of Hazel’s assets, which consists of some equipment and lots of inventory. Ira purchases goods from Hazel. She takes these goods free of Gail’s security interest because the goods are inventory for Hazel’s business. Juliet later purchases a piece of equipment from Hazel that is not part of her inventory. If she is unaware of the existence of the security interest at the time of her purchase, she takes the equipment free of Gail’s security interest.
⁃ Note: Gail likely has a security interest in the proceeds from the sale of Hazel’s inventory.
• Perfected vs Unperfected – A perfected security interest in collateral has priority over an unperfected security interest in the same collateral. This is true regardless of the timing of attachment of the security interest.
⁃ Example: Kyle takes a security interest in Leo’s property on October 1. He never perfects his security interest. On December 1, Marty takes a security interest in Leo’s property and perfects his interest by filing in a public office. Marty’s security interest has priority over Kyle’s security interest.
Each of these scenarios are discussed in greater detail below.
• Discussion: Why do you think the priority of the above types of secured creditor often comes into conflict? Do you generally agree with the order of priority? Why or why not? Do you notice any common principles reflected in the established order of priority?
• Practice Question: Beverly purchases a piece of equipment from Eve. Eve establishes an attached security interest in the collateral. Carlos later purchases the equipment from Eve. What additional information about this situation do you need to determine whether Carlos’ equipment is subject to Eve’s security interests?