Risk Management Manual of Examination Policies - FDIC

LOANS Section 3.2
security interest in or agricultural lien on the same
collateral if the statute creating the agricultural lien
provides for such priority. Otherwise, the agricultural lien
is subject to the same priority rules as security interests (for
example, date of filing).
A distinction is made with respect to proceeds of collateral
for security interests and agricultural liens. For security
interests, collateral includes the proceeds under Article 9.
For agricultural liens, the collateral does not include
proceeds unless State law creating the agricultural lien
gives the secured party a lien on proceeds of the collateral
subject to the lien.
Special Filing Requirements – There is a national
uniform Filing System form. Filers, however are not
required to use them. If permitted by the filing office,
parties may file and otherwise communicate by means of
records communicated and stored in a media other than
paper. A peculiarity common to all states is the filing of a
lien on aircraft; the security agreement must be submitted
to the Federal Aviation Administration in Oklahoma City,
Oklahoma.
Default and Foreclosure - As a secured party, a bank's
rights in collateral only come into play when the obligor is
in default. What constitutes default varies according to the
specific provisions of each promissory note, loan
agreement, security agreement, or other related documents.
After an obligor has defaulted, the creditor usually has the
right to foreclose, which means the creditor seizes the
security pledged to the loan, sells it and applies the
proceeds to the unpaid balance of the loan. For consumer
transactions, there are strict consumer notification
requirements prior to disposition of the collateral. For
consumer transactions, the lender must provide the debtor
with certain information regarding the surplus or deficiency
in the disposition of collateral. There may be more than
one creditor claiming a right to the sale proceeds in
foreclosure situations. When this occurs, priority is
generally established as follows: (1) Creditors with a
perfected security interest (in the order in which lien
perfection was attained); (2) Creditors with an unperfected
security interest; and (3) General creditors.
Under the UCC procedure for foreclosing security
interests, four concepts are involved. First is repossession
or taking physical possession of the collateral, which may
be accomplished with judicial process or without judicial
process (known as self-help repossession), so long as the
creditor commits no breach of the peace. The former is
usually initiated by a replevin action in which the sheriff
seizes the collateral under court order. A second important
concept of UCC foreclosure procedures is redemption or
the debtor's right to redeem the security after it has been
repossessed. Generally, the borrower must pay the entire
balance of the debt plus all expenses incurred by the bank
in repossessing and holding the collateral. The third
concept is retention that allows the bank to retain the
collateral in return for releasing the debtor from all further
liability on the loan. The borrower must agree to this
action, hence would likely be so motivated only when the
value of the security is likely to be less than or about equal
to the outstanding debt. Finally, if retention is not
agreeable to both borrower and lender, the fourth concept,
resale of the security, comes into play. Although sale of
the collateral may be public or private, notice to the debtor
and other secured parties must generally be given. The
sale must be commercially reasonable in all respects.
Debtors are entitled to any surplus resulting from sale price
of the collateral less any unpaid debt. If a deficiency
occurs (i.e., the proceeds from sale of the collateral were
inadequate to fully extinguish the debt obligation), the
bank has the right to sue the borrower for this shortfall.
This is a right it does not have under the retention concept.
Exceptions to the Rule of Priority - There are three
exceptions to the general rule that the creditor with the
earliest perfected security interest has priority. The first
concerns a specific secured transaction in which a creditor
makes a loan to a dealer and takes a security interest in the
dealer's inventory. Suppose such a creditor files a
financing statement with the appropriate public official to
perfect the security interest. While it might be possible for
the dealer's customers to determine if an outstanding
security interest already exists against the inventory, it
would be impractical to do so. Therefore, an exception is
made to the general rule and provides that a buyer in the
ordinary course of business, i.e., an innocent purchaser for
value who buys in the normal manner, cuts off a prior
perfected security interest in the collateral.
The second exception to the rule of priority concerns the
vulnerability of security interests perfected by doing
nothing. While these interests are perfected automatically,
with the date of perfection being the date of attachment,
they are extremely vulnerable at the hands of subsequent
bona fide purchasers. Suppose, for example, a dealer sells
a television set on a secured basis to an ultimate consumer.
Since the collateral is consumer goods, the security interest
is perfected the moment if attaches. But if the original
buyer sells the television set to another person who buys it
in good faith and in ignorance of the outstanding security
interest, the UCC provides that the subsequent purchase
cuts off the dealer's security interest. This second
exception is much the same as the first except for one
important difference: the dealer (creditor) in this case can
be protected against purchase of a customer's collateral by
filing a financing statement with the appropriate public
official.
DSC Risk Management Manual of Examination Policies 3.2-55 Loans (12-04)
Federal Deposit Insurance Corporation