Article 9 of the Uniform Commercial Code (“UCC”) has become highly technical, reflecting the complexity of modern secured transactions and the intricate relationships of debtors, secured parties and others who have or may have interests in a debtor’s assets. Some of its rules, however, seem relatively easy to understand and apply.
One of those is the rule that protects buyers who buy goods in the ordinary course of business, allowing such buyers to make purchases free and clear of security interests created by their sellers. UCC 9-320. This relatively simple concept is consistent with everyday buyers’ expectations. When one purchases at a store and pays for goods, one expects the secured party to follow the sales proceeds rather than unfairly repossess the purchased goods.
But the rule has some limitations and requirements. For example, there are special rules for sales by individual consumers of goods used for family, personal or household purposes, and for sales by farmers, which we will ignore for purposes of this article. In addition, the rule is applicable only to buyers of goods (so the rule does NOT apply to purchases of other types of property), who buys “in good faith, without knowledge that the sale violates the rights of another person in the goods, and in the ordinary course from a person, other than a pawnbroker, in the business of selling goods of that kind.” The buyer must take possession or be entitled to possession under Article 2, the goods may not be in possession of the secured party, and the sale must not be a “bulk sale,” a transfer for security or a transfer in total or partial satisfaction of a debt. UCC 1-201(b)(9) and 9-320(e).
It also should be emphasized that the rule only protects buyers from security interests created by their sellers. It does not protect against security interests created by the seller’s predecessors in interest. For example, consumers who purchase used cars will want to make sure that their seller has cleared liens created by any prior owner.
Leaving complexities aside, the rule essentially says an ordinary course buyer prevails over the seller’s secured parties. This is in contrast to a bulk sale, a sale of a business or another sale that is not in the ordinary course, where the buyer would take subject to perfected security interests.
Presumably, when a debtor disposes of collateral in a non-ordinary-course sale, a secured party will be able to protect itself by tracking down the goods and asserting its superior security interest against the buyer. Because of this, non-ordinary-course buyers conduct searches to identify perfected security interests and require those security interests to be released upon as a condition to purchase.
But what happens to the non-ordinary-course buyer who trusts its seller but later receives a demand from the seller’s lender because the seller violated a “no sale” covenant or did not appropriately pay down its loan with the sales proceeds? Does the buyer have to pay off the secured party, pay the purchase price again, or hand over the goods and seek reimbursement of the sales price from the seller (who is likely in distress)?
The answer would appear to be “yes” but there is a better answer in the UCC for buyers that still retain possession of their purchased goods.
Article 9 is not the only part of the UCC. In the case of sale of goods, Article 2 of the UCC also applies. Among many other things Article 2 addresses, it provides that all contracts for sales of goods have certain warranties unless those warranties are adequately disclaimed. The warranty of merchantability is probably the one that gets the most attention, but there is also a warranty of title. UCC 2-312. This is not at all surprising as buyers normally expect to get title, free and clear, as a result of a sale. The warranty of title can be disclaimed “only by specific language or by circumstances which give the buyer reason to know the person selling does not claim in himself or that he is purporting to sell only such right or title he or a third person may have.” UCC 2-312(2). The “circumstances” carve-out is intended to apply to things like sheriffs’ sales and would not apply to a regular sale, even one conducted outside the ordinary course of business.
Assuming the buyer is not willing to purchase with a title disclaimer, the warranty of title will apply. As a result, if the buyer discovers a lien post-sale, the seller’s warranty of title has been breached and the buyer may pursue remedies under Article 2. When good title is not delivered, the goods are non-conforming (UCC 2-106), and the buyer may reject them. UCC 2-601. However, the buyer is not required to return the non-conforming goods to the seller and, indeed, obtains a security interest in the non-conforming goods under Article 2 to secure the buyer’s recovery of any purchase price already paid. UCC 2-711(3). The security interest attaches to goods in the possession or control of the buyer, and Article 2 provides for a foreclosure process. UCC 9-711(3) and 2-706.
The buyer therefore has some significant rights and remedies as long as it retains the relevant goods, but what about the seller’s secured party, who presumably had a perfected first-to-file priority security interest, and who has suffered a non-ordinary-course sale of its collateral where its security interest remains intact? Sadly, for the seller’s secured party, the buyer’s security interest has priority over security interests created by the seller under Article 9. UCC 9-110. Note that this section of Article 9 is not found with the other priority provisions, so it tends to be overlooked. A non-ordinary course buyer is not in such a bad place as one might think they might be in the absence of UCC 9-110.
Let’s take a look at an example. After regular business hours on a Friday night, an auto dealer sells and delivers three autos from its inventory to another dealer who pays by check. A few days later, after the check has been cashed, the buyer gets a demand letter from the seller’s lender. The seller did not pay its lender as required and is presumably in distress, so the lender takes the position the autos were sold outside the ordinary course, its security interests remain in place and it wants to be paid or it will foreclose. There may be a debate over whether such a sale is ordinary course for an auto dealer (they trade vehicles all the time), but even if were not, as long as the buyer retains possession, the buyer’s Article 2 security interest has priority over the seller’s lender’s security interest until the buyer recovers its purchase price. Only when the price is recovered will the lender be able to repossess and foreclose over the buyer’s objection.
Secured parties should not rest easy, thinking that they are protected from non-ordinary course sales of collateral. They do maintain their security interests, but they will lose priority to a buyer in possession who identifies the applicable rules under Article 2 and UCC 9-110.