VOL. 25, NO. 17, December 23 2005 (Paush 08, 2062 B.S. )

Introduction To New Secured Transaction Ordinance 2062 (Contd)

By GANDHI PANDIT

Types of movable Property: A security interest may be created in various types of personal property which includes goods such as consumer goods, equipment, fixtures; instruments such as checks, notes, bonds; document of titles such as bill of lading, warehouse receipt; accounts such as account receivable; general intangible such as patents, copy rights, franchise, royalties and the like.

Purchase Money Security Interest:

Purchase Money security Interest is an interest which is created when seller, while selling good on credit, obtain security interest in the goods sold. Seller often sells goods on credit. At the time of sale, the debtor gets goods on credit and seller obtains security interest in that goods sold.

Perfecting a Security Interest:

Even though a security interest is created, the secured party must still need to take additional steps to protect its interest over collateral from the claim of other creditors in the same collateral. The concept of perfection of a security interest establishes the right of secured creditors against other creditors who claim an interest in the same collateral. Perfection is the legal process by which secured parties protect themselves against the claim of third parties who may wish to have their debts satisfied out of same collateral.

Method of Perfecting a Security Interest:

There are basically three methods of perfecting a security interest which are as follows:

a. Perfection by possession of collateral: If the creditors have physical possession of the collateral, no financing statement has to be filed. Thus possession of collateral by creditor is the best way of perfecting security interest in that collateral. The rationale behind this rule is that if someone other than the debtor is in possession of the property, then a potential creditor is on notice that another person may have interest in the debtor's property.

b. Perfection by filing a Financing Statement: Most of the time, creditors find it difficult or impossible taking physical possession of the collateral because it would deprive the debtor of use of that collateral ( farm equipment, industrial machinery and consumer goods) and others are simply impossible e.g. account receivable. Filing a statement in the appropriate government office is the most common method of perfecting a creditor’s security interest in such collateral.

Financing statement is a document filed by a secured creditor with appropriate government office that constructively notifies the world of his or her security interest in that personal property.

c. Perfection by a Purchase Money Security in Consumer Goods: A creditor who extends credit to a consumer to purchase a consumer good under a written security agreement creating security interest in the goods purchased obtain purchase money security interest in that goods. This automatically perfects the creditor’s security interest at the time of the sale. The creditors do not have to file a financing statement or take possession of the goods to perfect his or her security interest.

Priority of Claims

Often, two or more creditors may claim an interest in the same collateral or property. The priority of the claims is determined according to (1) whether the claim is unsecured or secured and (2) the time at which secured claims were attached or were perfected.

The established set of rules for determining priority among conflicting claims of creditors is as follows:

Secured versus Unsecured Claims. A creditor who has the secured interest in the debtor's collateral has priority over unsecured interests.

Competing Unperfected Secured Claims . If two or more secured parties claim an interest in the same collateral, but neither has a perfected claim, the first to attach has priority.

Perfected versus Unperfected Claims. If two or more secured parties claim an interest in the same collateral, but only one has perfected his or her security interest, the perfected security interest has priority.

Competing Perfected Secured Claims. If two or more secured parties have perfected security interests in the same collateral, the first to perfect (e.g., by filing a financing statement or taking possession of the collateral) has priority.

Exceptions to the Perfection-Priority Rule

Perfection does not always protect a secured party from third-party claims. As discussed in the paragraphs that follow, the law recognizes several exceptions to the perfection-priority rule.

Purchase Money Sectary Interest - Inventory as collateral

Under certain circumstance, a perfected purchase money security interest prevails over perfected non-purchase money security interests in after-acquired property. The order of perfection is irrelevant. If the collateral is inventory, the perfected purchase money security interest prevails if the purchase money secured party gives written notice of the perfection to the perfected non-purchase money secured party before the debtors receive possession of the inventory.

Purchase money Security Interest – Nov-Inventory as Collateral

If the collateral is something other than inventory, the perfected purchase money security interest would prevail over a perfected non-purchase money security interest in after-acquired property if it was perfected before or within ten days after the debtor receives possession of the collateral.

Buyers in the Ordinary Course of Business

A buyer in the ordinary course of business who purchases goods from a merchant takes the goods free of any perfected or unperfected security interest in the merchant's inventory even if the buyer knows of the existence of the security interest. This rule is necessary because buyers would be reluctant to purchase goods from the merchant if the merchant's creditors could recover the goods from purchaser because the merchant defaults on loans owed to secured creditors and a security interest is created in the good purchase by innocent buyer.

Second hand Consumer Goods

Buyers of secondhand consumer goods take free of security interest if they do not have actual or constructive knowledge about the security interest, five value, and buy the goods for personal, family, or household purposes. The filing of a financing statement by a creditor provides constructive notice of the security interest.

Default

Secured Transaction law shall have provision for the rights, duties, and remedies of the secured party and the debtor in the event of default. The term default is usually not defined. Instead, the parties are free to define it in their security agreement. Failure to make scheduled payments, bankruptcy of the debtor, breach of the warranty of ownership as to the collateral, and other such events are commonly defined in the security agreement as default.

The secured transaction Ordinance 2062 has incorporated most of the concept explained above. The law is enacted but will remain ineffective unless secured transaction registry is established. Government is working toward formulating rules and regulation in order to establish secured transaction registry allowing secured party to file notice for perfection of his or her security interest in movable property placed by debtor as collateral.

(Gandhi is Attorney at Law)

(Concluded)